Between the Lines | Supreme Court: Relief of specific performance of a contract is no longer discretionary after the 2018 amendment of the Specific Relief Act, 1963

The Supreme Court (“SC”) has in its judgment dated September 18, 2020 in the matter of B. Santoshamma & Another v. D. Sarala & Another [Civil Appeal No. 3574 of 2009], observed that relief of specific performance of a contract/agreementis no longer discretionary pursuant to the amendment to the Specific Relief Act, 1963 (“SRA”) bought about under the Specific Relief (Amendment) Act, 2018 (“Amendment Act”).

Facts
Brief facts of the case are that one B. Santoshamma (“Appellant”) purchased 300 square yards of land in Survey No. 262, Hayathnagar Village and Taluk in Ranga Reddy District, Andhra Pradesh (“Suit Property”), from one Mr. D. Tanesha, under a registered sale deed dated August 20, 1982. After about ten days from the date thereof, the Appellant entered into an oral agreement with one Mr. Pratap Reddy, for sale of 100 square yards out of the Suit Property, for a total consideration of INR 3,000/-, out of which an amount of INR 2,500/- was received as an advance. Simultaneously, possession of the said 100 square yards of the Suit Property was delivered to the said Mr. Pratap Reddy on the date of the said oral agreement. Subsequently, on January 20, 1984, the oral agreement between the Appellant and Mr. Pratap Reddy was reduced into writing, upon payment of the balance consideration of INR 500/- (“Agreement 1”) and the Appellant allegedly agreed to execute the sale deed on an auspicious day.

On March 21, 1984, the Appellant entered into another agreement with one Smt. D. Sarala (“Respondent”), for sale of the entire Suit Property to the Respondent for a total consideration of INR 75,000/- (“Agreement 2”), out of which a sum of INR 40,000/- was paid by the Respondent to the Appellant in the first instance and a sum of INR 5,000/- was paid subsequently, as advance. The Appellant allegedly informed the Respondent about the existence of Agreement 1, receipt of the entire sale consideration thereunder, and delivery of possession of the said 100 square yards of the Suit Property to Mr. Pratap Reddy. The Appellant allegedly requested the Respondent to incorporate a clause with respect to the existence of Agreement 1 in Agreement 2. However, the Respondent assured the Appellant that she would get Agreement 1 cancelled as her husband knew Mr. Pratap Reddy well and had already spoken to him in this regard, to whom Mr. Pratap Reddy had allegedly assured that there would be no difficulty created by him.

However, upon the Respondent allegedly failing to make payment of INR 30,000/- towards the balance consideration even after expiry of 20 days from the stipulated period under Agreement 2, the Appellant executed a registered deed of conveyance dated May 25, 1984, transferring the said 100 square yards of the Suit Property in favour of Mr. Pratap Reddy (“Sale Deed”). The Appellant and her husband and Mr. Pratap Reddy have alleged that the Respondent tried to interfere with Mr. Pratap Reddy’s possession of 100 square yards of the Suit Property. On June 20, 1984, the Appellant issued a notice to the Respondent stating that, in view of the existence of Agreement 1, the validity of Agreement 2 was subject to clearance/ no-objection by Mr. Pratap Reddy of the arrangement under Agreement 2. On June 22, 1984, the Appellant’s husband, Mr. Darshan Reddy, lodged a complaint with the Station House Officer, Hayathnagar, alleging that the original sale deed, pertaining to sale of the Suit Property in favour of the Appellant, had been stolen from his residence, alongwith other documents. Thereafter, the Respondent filed a suit (O.S. No. 222 of 1984) before the Court of the Principal Subordinate Judge, Rangareddy District (“Trial Court”) seeking specific performance of Agreement 2 (“Suit for Specific Performance”) claiming delivery of possession of the entire Suit Property from the Appellant.

By and under a judgment and decree dated March 30, 1994, the Trial Court allowed the Suit for Specific Performance in part, holding that the Respondent was not entitled to seek specific performance in respect of the 100 square yards of the Suit Property covered by the Sale Deed, but entitled to relief of specific performance in respect of the remaining 200 square yards of the Suit Property. Being aggrieved by the aforesaid judgment of the Trial Court, the Appellant filed an appeal before the High Court of Andhra Pradesh (“HC”). By and under a judgment and order dated September 7, 2006, the HC, inter alia, dismissed the aforesaid appeal filed by the Appellant and confirmed the judgment passed by the Trial Court. Aggrieved by the same, the Appellant filed the present appeal before the SC.

Issue
Whether the Respondent was entitled to seek specific performance of Agreement 2.

Arguments
Contentions raised by the Appellant:

The Appellant, inter alia, contended that Agreement 2 between the Appellant and the Respondent was liable to be cancelled as the Respondent had defaulted in making payment of the balance consideration of INR 30,000/- within the period stipulated thereunder. Consequently, the Appellant executed and registered the Sale Deed in favour of Mr. Pratap Reddy. It was further argued that execution of a sale deed in favour of the Respondent was conditional upon cancellation of the Agreement 1. It was further contended that the Respondent, who knew of the pre-existing Agreement 1, had assured the Appellant that she and her husband had already spoken to Mr. Pratap Reddy to get Agreement 1 cancelled, but failed to do so. Also, Agreement 2 was a composite agreement for sale of 300 square yards of the Suit Property for a lump sum consideration of INR 75,000/-. Since it was not possible to sell 300 square yards of the Suit Property to the Respondent as per the Agreement 2, the said agreement became infructuous and incapable of specific performance and there was no scope for sale of 200 square yards of the Suit Property at a reduced consideration.

Contentions raised by the Respondent:

The Respondent on the other hand contended that she should have been granted specific performance of Agreement 2 in its entirety and the Trial Court should have set aside the purported Sale Deed and directed the Appellant to sell the entire Suit Property to the Respondent. It was further argued that the execution and registration of the Sale Deed in favour of Mr. Pratap Reddy was in any case, subsequent to Agreement 2. Refuting the contention advanced by the Appellant about the lack of readiness and willingness on the part of the Respondent to perform her obligations under Agreement 2, the Respondent argued that the fact that the Respondent had paid INR 40,000/- on the date of execution of Agreement 2 itself, and subsequently a further sum of INR 5,000/- to the Appellant, established her intention to honour the arrangement under Agreement 2. The Respondent further contended that these payments towards part consideration were duly acknowledged by the Appellant. The Respondent also contended that she had offered to pay cash to the Appellant and her husband towards the balance amount of INR 30,000/- on April 30, 1984, and requested them to register the sale deed in her favour, but the Appellant and her husband refused to receive the said amount and instead requested the Respondent to make the said payment by way of a demand draft. However, even though the Respondent got a demand draft of INR 30,000/- made in favour of the Appellant on May 4, 1984, the Appellant declined to accept the same.

Observations of the Supreme Court

The SC observed that the contention of the Appellant, that the Agreement 2 was subject to the condition that the Respondent would get Agreement 1 cancelled, could not be accepted since Agreement 2 did not contain any such condition. The SC noted that it is a well settled principle that the onus of proof lies on the party making the allegation and that the Appellant had failed to establish that Agreement 2 was subject to the pre-condition of the Respondent and/or her husband negotiating with Mr. Pratap Reddy to get Agreement 1 cancelled. The SC further observed that, the concurrent finding of the HC and the Trial Court, that the Respondent had been ready and willing to perform, and had in fact performed her obligations under the Agreement 2, was also unexceptionable since the Respondent had paid INR 40,000/- out of the total consideration of INR 75,000/- on the date of execution of the Agreement 2 itself and had arranged to pay the remaining consideration within 47 days of execution of the said agreement. The SC further noted that it was well settled that time was not of essence to agreements for sale of immovable property, unless the agreement specifically, and expressly incorporated the consequence of cancellation of the agreement, upon failure to comply with a term within the stipulated date.

With respect to specific performance, it was further observed that prior to the SRA being amended under the Amendment Act, the relief of specific performance of an agreement was at all material times, an equitable, discretionary relief, and governed by the provisions of the SRA. Even though the power of the court to direct specific performance of an agreement may have been discretionary, such power could not be arbitrary. The discretion had necessarily to be exercised in accordance with sound and reasonable judicial principles. However, pursuant to the amendment of Section 10 of the SRA on October 1, 2018, the words “specific performance of any contract may, in the discretion of the court, be enforced” have been substituted with the words “specific performance of a contract shall be enforced subject to …”. Courts are now obliged to enforce the specific performance of a contract, subject to the provisions of sub-section (2) of Section 11, Section 14 and Section 16 of the SRA. Accordingly, grant of relief of specific performance of contracts is no longer subject to the discretion of courts.

The SC observed that an agreement to sell immovable property, generally creates aright in personam and the Respondent had accordingly acquired a legitimate right to enforce specific performance of Agreement 2. The SC also noted that although courts ordinarily enforce contracts in their entirety by passing a decree for specific performance, Section 12 of the SRA carved out exceptions, where courts may direct specific performance of a contract in part. Accordingly, courts may, under Section 12 of the SRA, direct the party in default to perform specifically, so much of its part of the contract, as it can perform, provided the other party pays or has paid the consideration for the whole of the contract, reduced by the consideration for the part which must be left unperformed. In the present case, the Respondent had arranged to tender the full consideration within the time stipulated in the Agreement 2, from the date of its execution. Also, admittedly, a major portion of the full consideration, that is, INR 45,000/- had already been paid by the Respondent to the Appellant and the Respondent had been ready to and had offered to pay the entire balance consideration to the Appellant.

Decision of the Supreme Court

In dismissing the appeal, the SC noted that Section 12 of the SRA was to be construed and interpreted liberally, in a purposive and meaningful manner, to empower the court to direct specific performance by the defaulting party, of so much of the contract, as can be performed, in a case like this. To hold otherwise would permit a party to a contract for sale of land, to deliberately frustrate the entire contract by transferring a part of the suit property and creating third party interests over the same. The SC observed that a contractee who frustrates a contract deliberately by his own wrongful acts cannot be permitted to escape scot free.

The SC further noted that after having entered into Agreement 2 for the sale of 300 square yards of the Suit Property and accepting a major part of the consideration, it did not lie in the mouth of the Appellant to contend that the contract should not have specifically been enforced in part in respect of the balance 200 square yards, which the Appellant still owned. It was also patently obvious that the Appellant did not disclose the existence of any prior agreement with respect to the Suit Property to the Respondent, as Agreement 2 did not bear reference to any such prior agreement.

In passing its judgement, the SC also held that the Trial Court had fairly reduced the total consideration payable under Agreement 2 by 1/3rd of the agreed amount, in lieu of damages, as 1/3 rd of the area agreed to be sold to the Respondent could not be sold to her.

Vaish Associates Advocates View:

In view of the amended Section 10 of the SRA, the courts no longer have the discretion to grant relief of specific performance and are now obliged to enforce the specific performance of a contract, subject to the provisions of sub-section (2) of Section 11, Section 14 and Section 16 of the SRA. The SC has therefore, in the extant judgement, relied on Section 12 of the SRA, in allowing specific relief in respect of a part of a contract where parties to a contract are unable to perform their obligations under the contract in entirety.

The SC in the present judgment has clarified that courts may, in the circumstances mentioned under Section 12 of the SRA, direct the specific performance of so much of such contract, as can be performed, particularly where the value of the part of the contract left unperformed is small in proportion to the total value of the contract. The above judgment should hopefully act as a deterrent to future immovable property owners who, with malicious intent, avoid fulfilling their obligations under an agreement for sale, by creating third party interests over a portion of the land.

For more information please write to Mr. Bomi Daruwala at [email protected]

Between the Lines | Delhi HC: If the original contract in entirety is put to an end, the arbitration clause, which is a part of it, also perishes along with it

The Hon’ble High Court of Delhi (“DHC”) has in its judgement dated October 22, 2020 (“Judgement”) in the matter of Sanjiv Prakash v. Seema Kukreja and Others [ARB. Pet. 4/2020], held that if the contract is superseded by another, the arbitration clause, being a component/part of the earlier contract, falls with it. In other words, if the original contract in entirety is put to an end, the arbitration clause, which is a part of it, also perishes along with it.

Facts
The Petitioner is the son of Respondent No. 2 (the mother) and Respondent No. 3 (the father), and Respondent No. 1 is his sister, collectively the Petitioner and Respondents are addressed as “Prakash Family Members/Prakash Family”. Asian Films Laboratories Private Limited was incorporated on December 09, 1971, by the Respondent No. 3 and the entire amount of the paidup capital was paid by him. He then distributed the shares to the family members. Subsequently, the name of the company was changed to ANI Media Private Limited on March 06, 1997 (“Company”). The Petitioner serves as the Managing Director and the Respondent No. 3 serves as the Chairman of the Company. The Company, in the year 1996, engaged in business relationship with Reuters Television Mauritius Limited, now named as Thomson Reuters Corporation Pte. Ltd. (“Reuters”). It was stated by the Petitioner that prior to the execution of the agreement with Reuters in 1996, an undated Memorandum of Understanding (“MoU”) was entered into between the Prakash Family Members which constituted a special arrangement on succession plan and management scheme between the Prakash Family Members qua the Company.

On April 12, 1996, the Prakash Family Members entered into a Shareholders Agreement (“SHA”) and a Share Purchase Agreement (“SPA”) with Reuters, by which Reuters acquired 49% shares of the Company from the Prakash Family Members, who subsequently held 51% shareholding in the Company. It was stated by the Petitioner that the MoU was binding on the Prakash Family Members inter-se, while SHA was binding as between the Petitioner and the Respondents collectively addressed as “Prakash Family Shareholders” and Reuters. It was stated by the Petitioner that subsequently, the terms of the MoU were included in the Articles of Association of the Company on May 14, 1996 (“Articles of 1996”) to recognize the special rights that were existing in the MoU. The Articles of 1996 continued to be operative till August 30, 2012, however, later the Company, due to regulatory concerns, adopted Articles of Association which did not reflect the special rights of any of the parties. The Company again adopted the Articles of 1996 on March 26, 2014, before adopting the Articles of Association as existed in the current form in September 2014.

In terms of the dispute between the parties it was stated by the Petitioner that the Respondent No. 3 was desirous of transferring his shares in the Company to the joint shareholding of himself and the Petitioner. In furtherance, on September 16, 2019, the Petitioner by his letter of lodgment to the Company, attached duly stamped and certified share transfer forms and original share certificate pertaining to the 4,28,100 shares. However, the Respondents No. 1 and 2 objected to the said transfer and also indicated a desire to have the shares of the Respondent No. 2 transferred to the joint names of Respondents No. 1 and 2, but the matter was deferred by the Board. On October 5, 2019, Respondent No. 3 moved a circular resolution for transfer of shares in consonance with the MoU. Subsequently a request was made by Respondent No. 2 on October 6, 2019 for transfer of 3,67,500 shares held by her to the joint shareholding of the Respondents No. 1 and 2. Correspondences were exchanged between Respondent No. 3, and Respondent No. 2 that the transfer request had not been properly made since the original stamped share transfer form and the original share certificates had not been lodged by Respondent No. 2. To this, Respondent No. 2 responded that she will produce the original share certificates at the time of transfer. In addition to the above, Respondent No. 3 and the Petitioner also sent e-mails reiterating that the proposal to transfer shares of Respondent No. 2 to the joint shareholding of the Respondents No. 1 and 2 was in breach of the terms of the MoU. To this, Respondent No. 2 responded that the MoU had been superseded. Thereafter, by e-mail dated October 12, 2019, the Respondents No. 1 and 2 assented to the transfer of the shares of the Respondent No.2 to the joint shareholding of the Respondents No. 1 and 2. Respondent No. 3 responded as the Chairman, stating that the circular resolution for the transfer of the shares of the Respondent No. 2 has not been initiated, and that the Company was still awaiting the original share certificates to be lodged in order to initiate the aforesaid transfer. Thereafter, Respondent No. 2 by e-mail dated November 11, 2019 marked to all directors, disputed the validity of the MoU and reiterated her demand of transferring the shares held by her to the joint shareholding of the Respondents No. 1 and 2.

Owing to the dispute arising out of and in relation to the MoU, the Petitioner invoked the arbitration clause as per MoU and issued a notice for invocation of arbitration dated November 23, 2019 (“Notice of Arbitration”) to the Respondents. The Respondent No. 3 by e-mail dated November 24, 2019, consented to the arbitrator nominated in Notice of Arbitration. However, Respondents No. 1 and 2 by their reply dated December 20, 2019 contended that the MoU has allegedly been superseded/invalidated by the SHA executed between Prakash Family Shareholders and Reuters and did not agree to the appointment of the arbitrator. Hence, this petition was filed under Section 11(5) of the Arbitration and Conciliation Act, 1996 (“1996 Act”), for appointment of a sole arbitrator under Section 11 of 1996 Act, for the purpose of adjudicating the disputes that have arisen between the parties under the MoU. It is worthy to note that the Respondent No. 3 filed a reply separately stating that the MoU is a valid and binding document as well supporting the stand taken by the Petitioner.

Issue
Whether on the contract/agreement being superseded or extinguished by a subsequent contract/agreement, the arbitration clause, being a component of the superseded contract/agreement stands superseded along with the terms of such superseded contract/agreement.

Arguments

Contentions raised by the Petitioner:

The Petitioner contended that the MoU has not been superseded on the following grounds:

• SHA and SPA executed was to govern the relationship between Reuters and the Prakash Family Shareholders. The inter-se relationship of Prakash Family Members was governed by the MoU. Also, the MoU has not been amended, nor have the parties entered into any other MoU, modifying the terms of the same, and that the Prakash Family Members never acted contrary to the MoU.
• The Respondent No. 3, being the Chairman of the Company and a signatory of the MoU, had time and again endorsed the MoU and its validity. Also, Respondents No. 1 and 2 had conceded to the fact that they do not dispute their signature to the MoU.
• The MoU was a separate and distinct agreement vis-à-vis the SHA and the SPA dated April 12, 1996. Further, the contention that the MoU was superseded by the SHA is ex-facie belied as the terms of the MoU were incorporated in the Articles of 1996, after executing SHA, which would not have been incorporated/amended if the MoU had been superseded.
• The Prakash Family Members have consciously entered into the MoU. Further, each benefited from the MoU and the partnership with Reuters, therefore were bound, and continued to be bound, inter-se by the terms of the MoU. Hence, they are estopped from claiming that the MoU is not valid.
• The request made by the Respondent No. 2 for transfer of shares held by her to the joint shareholding of Respondents No. 1 and 2 was not in consonance with the terms of the MoU, as the Petitioner would be entitled to the shares of the Respondents No. 1 and 2 as their successor.
• The SHA describes itself as an agreement executed between Prakash Family Members (as one group) and Reuters (as another group). Further, the SHA and MoU occupy and operate in different fields and govern completely different sets of rights of the respective parties thereto, and are executed between different sets of parties.

It was further submitted that, on a comprehensive reading of Sections 5, 11(6A) and 16 of the 1996 Act, and the principle of ‘kompetenz-kompetenz’ (Arbitrator’s ability to determine its own jurisdiction including ruling on any objections with respect to the validity or existence of the arbitration agreement), the question of the binding nature of the MoU is an issue that needs to be decided by the arbitral tribunal appointed as per the arbitration agreement contained in the MoU. The scope of enquiry under Section 11(6A) of the 1996 Act is only limited to the prima-facie question of satisfaction of the court as to the existence of the arbitration agreement and it is the arbitral tribunal which would decide any preliminary issues including the validity, the efficacy and the effect of the MoU. Further, the plea of Respondents No. 1 and 2 that the arbitration clause (Clause 16) under the SHA should have been invoked instead of arbitration clause under the MoU, was rebutted by stating that the tribunal constituted under the MoU would be well within its jurisdiction to decide whether the MoU is valid or has been superseded by the SHA, whereas a tribunal constituted under the SHA, even if it accepts the case of the Petitioner that the MoU is valid, will be without jurisdiction to enforce the same. Further, the Clause 16 under the SHA is intended for disputes between Reuters and the Prakash Family Shareholders and hence provides that the mediation would be between Reuters and Respondent No. 3.

Lastly, it was submitted that the SHA states that Reuters can transfer any of the shares held by it to a company which is a member of the Reuters Group and similarly Prakash Family can transfer any shares held by it to each other, this cannot be construed to mean that the Prakash Family Members cannot have a separate agreement to govern their rights inter-se. It was submitted that the SHA and MoU should be construed harmoniously.

Contentions raised by the Respondents No. 1 and 2:

There is no subsisting MoU. Therefore, the appointment of arbitrator under Section 11(5) of the 1996 Act was barred by law, as the Petitioner has relied on an invalid document to invoke arbitration. It was also stated by Respondents No. 1 and 2, without prejudice that no cause of action as per the MoU has accrued in favor of the Petitioner. Not once, the MoU terms were incorporated in the SHA and the Articles of Association. Therefore, the language of the Articles as it then stood, reflected the intention of the parties to be bound by terms set out in the Articles itself, both in respect of dealings inter-se Prakash Family and in respect of their dealings with Reuters. With respect to the alleged MoU, even Respondent No. 3 herein had sought opinion on the sanctity of the same way back in 2014, to be informed that the MoU was not a legal document owing to non-bearing of any signatures on the first three pages. The said MoU has no binding effect or legal sanctity as the same had never been shared or placed during any general body or board meeting except on September 17, 2019 hence, the Company did not acknowledge it and it cannot override the provisions of the Articles of Association and the SHA.

The SHA is the only valid and subsisting agreement amongst the Petitioner and the Respondents even with regard to their inter-se rights of shareholding in the Company. Further, Clause 28 of the SHA contains an entire agreement clause whereby parties to the SHA agreed that the SHA supersedes any and all prior agreements, explicit/implicit which may have been entered into prior to SHA between the parties, other than the ancillary agreements and the SPA. They also submitted that the SHA contains dispute resolution clause wherein, any dispute including the present dispute can only be arbitrated after following the procedure set forth in Clause 16 of the SHA. It was submitted that arbitration clause of the SHA, that is, Clause 16.2 stated that the seat of arbitration was London, and the proceedings envisaged being an international commercial arbitration, the Hon’ble Supreme Court was the court designate as per Section 11(9) of the 1996 Act, hence this Court did not have jurisdiction under Section 11(5) of the 1996 Act.

It was contended that the legal principle regarding the novation of contract states that an arbitration clause in an agreement cannot survive if the agreement containing the arbitration clause has been superseded/novated by a later agreement. Even if it is presumed that MoU was validly executed between the then shareholders of the Company, the then shareholders put an end to it as if it had never existed and substituted a new SHA for it. By relying on the definition clause in the SHA, it was submitted that Prakash Family Members means each of the Prakash Family Shareholders and shareholder means each of Prakash Family shareholder and Reuters. It was immaterial whether the dispute had been raised qua Reuters or among the other shareholders. The SHA had been executed by all the shareholders of the Prakash Family in their individual capacity and not by one person representing the family or block. The fact contended was that the dispute is between the individual shareholders of the Company with respect to the shares of the Company and not a family dispute as alleged by the Petitioner.

Further, issue of novation/supersession is not a preliminary issue and beyond the jurisdiction of the arbitrator under Section 16 of the 1996 Act as the arbitrator is not empowered to decide upon any issue if the appointment of the arbitrator itself was on the basis of a novated arbitration clause which had become void along with the original contract. Reliance was placed on Section 62 of the Indian Contract Act, 1872 (“ICA”) to contend that, when the main agreement is novated, rescinded or altered, it loses its validity and the arbitration agreement becomes void, as the principle is that, if the contract is superseded by another, the arbitration clause, being a component part of the earlier contract, falls with it. It was further submitted that an arbitrator under Section 16 of the 1996 Act, cannot adjudicate upon superseded arbitration agreement. Reliance was placed on the case of Garware Wall Ropes Limited v. Coastal Marine Construction and Marine Limited. [2019 (9) SCC 2019]. As per Section 11(6A) of the Arbitration and Conciliation Amendment Act, 2015, court’s scope of inquiry requires to determine the fundamental issue of novation/supersession which is important before declaring any arbitration agreement valid/existing.

Observations of the Delhi High Court

It was observed that the Petitioner may be right in contending that there exists a contemplation of groups, that is, Prakash Family Members and Reuters under the SHA as ‘blocks’. However, on reading of the opening paragraph, it was observed that the term ‘parties’ envisages Prakash Family Shareholders both individually as well as collectively. Therefore, on a conjoint reading of the Clause 28 with the opening paragraph of SHA, it was concluded that, any kind of agreement as per Clause 28, ‘between the parties’ stood superseded.

The contention of the Petitioner, that the terms of MoU were incorporated in the Articles of 1996 after the execution of the SHA, and hence MoU was not superseded, was observed to not be appealing on basis of the effect of Clause 28 of SHA, by which the MoU stood superseded. The DHC further analysed the implication assuming, if terms para materia to MoU had been incorporated in the Articles of 1996, it is only with view to make such terms part of the Articles of 1996 and it does not mean that MoU continued to be valid. It was observed by the DHC that nothing precluded Prakash Family to include a stipulation in the SHA, that the SHA shall not supersede the MoU, as had been specially stated in Clause 28 with regard to ancillary agreements and SPA. The DHC observed that under Section 62 of the ICA, it is trite law, that to attract the theory of novation there should be total substitution of the earlier contract and all the terms of the earlier contract should perish with it.

The judgement of the Supreme Court in Union of India v. Kishorilal Gupta [AIR 1959 SC 1362] was relied upon by the DHC to determine the issue of validity of the arbitration clause. Following is the relevant portion: “22. … So too, if the dispute is whether the contract is wholly superseded or not by a new contract between the parties, such a dispute must fall outside the arbitration clause, for, if it is superseded, the arbitration clause falls with it. ….”.

The case of Damodar Valley Corporation v. K.K Kar [AIR 1974 SC 158], was also relied upon, relevant portion reads as follows: “7. …..Where, therefore, the dispute between the parties is that the contract itself does not subsist … that dispute cannot be referred to the arbitration as the arbitration clause itself would perish if the averment is found to be valid. As the very jurisdiction of the arbitrator is dependent upon the existence of the arbitration clause under which he is appointed, the parties have no right to invoke a clause which perishes with the contract.” Therefore, referring to the precedents, the DHC observed that the law relating to the effect of novation of contract containing an arbitration agreement/clause is well-settled.

It was observed that, it could not be said that Clause 16 of the SHA was intended only for disputes between Reuters and Prakash Family asa block, as the said clause contemplates dispute between ‘shareholders’ who have been defined as individual shareholders of both Prakash Family and Reuters.

Decision of the Delhi High Court

The DHC held that, Prakash Family Shareholders having been individually recognized under the SHA as parties, the MoU, an agreement, as relied upon by the Petitioner, which governs the inter-se rights and obligations of the Prakash Family Members, stood superseded/novated. The DHC further held that if the contract is superseded by another, the arbitration clause, being a component/part of the earlier contract, falls with it. In other words, if the original contract in entirety is put to an end, the arbitration clause, which is a part of it, also perishes along with it. Hence, the arbitration clause of the MoU, having perished with the MoU, owing to novation, the invocation of arbitration under the MoU was held to be not justified.

In view of the conclusion stated above, the plea of doctrine of ‘kompetenz-kompetenz’ and the reliance placed on Section 11(6A) of the 1996 Act were held to be untenable. Hence, it was also held that the petition filed by the Petitioner invoking the MoU for appointment of arbitrator was not maintainable and thereby was dismissed.

Vaish Associates Advocates View:

The DHC in this judgement has highlighted the law on novation of contract, explained the effect of such novation of contract on the arbitration agreement/clause therein and thereby has laid the limits for invocation of arbitration clause. It has been clarified that the arbitration clause even though is independent of the main contract, perishes with it, if such a contract is novated/ superseded by the parties.

Party autonomy plays a major role to invoke and conduct arbitration, therefore, the arbitration agreement being a creation of an agreement may be destroyed by an agreement. If the parties have agreed to novate the contract they cannot be forced to enforce rights/obligations against their intent under the previous contract. Therefore, a party is restrained from invoking arbitration under an invalid contract.

For more information please write to Mr. Bomi Daruwala at [email protected]

Between the Lines | Supreme Court: A personal loan to a promoter or a director of a company cannot trigger the CIRP under the IBC

The Supreme Court (“SC”) by its judgement dated August 28, 2020 (“Judgment”) in the case of M/S Radha Exports (India) Private Limited v. K.P. Jayaram & Another [Civil Appeal No. 7474 of 2019] held that a personal loan to a promoter or director of a company cannot trigger the Corporate Insolvency Resolution Process (“CIRP”).

Facts

M/s Radha Exports (India) Private Limited (“Appellant Company”) filed an appeal under Section 62 of the Insolvency and Bankruptcy Code, 2016 (“IBC”), against an order of the National Company Law Appellate Tribunal (“NCLAT”). The brief background of the case is that, the National Company Law Tribunal (“NCLT”) had passed an order dated December 19, 2018 rejecting the application filed by Mr. K.P. Jayaram (“Respondent No. 1”) and Mrs. Shoba Jayaram (“Respondent No. 2”), (collectively “the Respondents”) under Section 7 of the IBC, inter alia, on the grounds that they were not financial creditors of the Appellant Company, and in any case the alleged claim of the Respondents was barred by limitation. Being aggrieved by the order of the NCLT, the Respondents preferred an appeal at the NCLAT. The NCLAT by a judgment and order dated September 02, 2019 allowed the appeal against the order passed by NCLT. Thereafter, being aggrieved by the order passed by the NCLAT, the Appellant Company filed this appeal at the Hon’ble Supreme Court.

The Appellant Company contended that the Respondents were closely acquainted with one Mr. M. Krishnan, and Mrs. Radha Gouri, who were the promoters of the Appellant Company. The Respondents had advanced an aggregated loan of INR 2.20 crores (unsecured and free of interest), to M/S Radha Exports, a proprietorship concern of Mrs. Radha Gouri, during the period between 2002 and 2004. Thereafter, the Appellant Company was incorporated under the Companies Act, 1956 on or about July 19, 2004, to take over the business of the proprietorship concern, M/s Radha Exports, along with its assets and liabilities. The Appellant Company stated that as on July 19, 2004, the proprietorship concern, M/s Radha Exports, had a loan liability of INR 1,11,85,350/-, which was taken over by the Appellant Company.

The Respondents requested the Appellant Company to convert a sum of INR 90,00,000/- from out of the said outstanding loan, as share application money for issuance of shares in the Appellant Company, in the name of the Respondent No. 2, and the same was confirmed by the Respondents, by their letter dated January 11, 2011, addressed to the Deputy Commissioner of Income Tax, Company Circle V(3), Chennai. Accordingly, a sum of INR 90,00,000/- was adjusted by the Appellant Company, as share application money, for issuance of shares of the Appellant Company in the name of the Respondent No. 2. Subsequently, the loan was repaid in full by the year 2006.

In October 2007, the Respondent No. 2 resigned from the Board of the Appellant Company. At the time of resignation, the Respondent No .2 requested the Appellant Company to treat the share application money of INR 90,00,000/- as share application money of Mr. M Krishnan and to issue shares of the value of INR 90,00,000/- in the name of Mr. M. Krishnan. The amount of share application money of INR 90,00,000/- transferred to Mr. M. Krishnan, was to be treated as a personal loan from the Respondent No. 2 to the said Mr. M. Krishnan.

Thereafter, by a legal notice dated November 19, 2012, the Respondents called upon the Appellant Company to repay to the Respondents a sum of INR 1,49,60,000/- alleged to be the outstanding debt of the Appellant Company, repayable to the Respondents as on July 19, 2004. By a letter dated December 05, 2012, the Appellant Company refuted the claim of the Respondents, whereupon the Respondents filed a petition in the High Court of Madras under Sections 433 (e) & (f) and 434 of the Companies Act 1956, for winding up of the Appellant Company. The said petition was transferred to the Chennai Bench of NCLT for adjudication. Thereafter, by an order dated August 04, 2017, the NCLT dismissed the said winding up petition, on the ground that the Respondents had failed to comply with the provisions of Section 7(3)(b) of the IBC. However, the order allowed the Respondents the liberty to withdraw the petition. Meanwhile the Respondents withdrew the said petition and consequently, on December 07, 2017, issued a fresh “demand notice” to the Appellant Company which was refuted by a letter dated December 14, 2017 by the Appellant Company, inter alia, claiming that all amounts due and payable by the Appellant Company or its predecessor-in-interest to the Respondents, had duly been paid within 2007 and 2008. The Respondents, thereafter, filed a petition under Section 9 of the IBC, as an operational creditor of the Appellant Company. However, the Respondents withdrew this case and filed a fresh petition under Section 7 of the IBC claiming principal amount of INR 2.10 Crores along with interest at the rate of 24% per annum from 2007, amounting to INR 4,41,60,000/-

Issues

Maintainability of the CIRP under Section 7 of the IBC initiated against the Appellant Company.

Observations of the Supreme Court

The SC observed that the NCLAT was not inclined to accept the submission of the Appellant Company, that the entire amount had been paid, for two purported reasons. The first reason was that the Correlation Statement showed payments of certain amounts amounting to INR 53,05,000/- in favour of Customs, Chennai and payments amounting to INR 1,75,000/- in favour of one Mr. Kulasekaran. The Respondents, as financial creditors, had disputed that these payments were towards the dues of the financial creditors. The second reason was that, if the total amount had been paid, there was no reason for the Appellant Company to take the plea that the amount was not payable, the same being barred by limitation.

In response to the second reasoning, the SC observed that it is well settled in law that alternative defences are permissible to contest a claim. It was thus open to the Appellant Company, to refute the claim of the Respondents by taking the plea of limitation and also to contend that no amount was in fact due and payable by the Appellant Company to the Respondents. The Court relied on Innoventive Industries Limited v. ICICI Bank and Another [(2018) 1 SCC 407] and B.K. Educational Services Private Limited v. Parag Gupta and Associates [(2019) 11 SCC 633] to hold that even otherwise, it was for the applicant invoking CIRP, to prima facie show the existence in his favour, of a legally recoverable debt, and once a debt, or even part thereof, becomes due and payable, the limitation period for resolution process begins. In other words, the Respondents had to show that the debt is not barred by limitation, which they failed to do.

The SC went on to observe that basis the letter signed by the Respondents, the Respondent No. 2 resigned from the Board of the Appellant Company and at that time the Respondent No. 2 requested the Appellant Company to treat the share application money of INR 90,00,000/- as share application money of Mr. M. Krishnan and to issue shares for aforesaid value to Mr. M. Krishnan. The amount was to be treated as a personal loan from the Respondent No. 2 to Mr. M. Krishnan, in essence, a personal loan to a promoter or a director of a company. Hence the same cannot trigger the CIRP under the IBC.

The SC importantly also observed the limited scope of proceedings/disputes that the NCLT may entertain to resolve under Section 7 of the IBC. The SC stated that the disputes as to whether the signatures of the Respondents are forged or whether records have been fabricated, can be adjudicated upon evidence including forensic evidence in a regular suit.

The SC further observed that the payment received for shares, duly issued to a third party at the request of the payee, as evident from official records, cannot be a debt, not to speak of financial debt.

Decision of the Supreme Court
In view of the above, SC held that personal loan to a promoter or a director of a company cannot trigger CIRP under the IBC.

Vaish Associates Advocates View

This judgement of the SC will herald a much-needed clarity on the nature of transactions within a company that can be included as “debt” under IBC. It has been made clear by the SC that the payment received for shares, duly issued to a third party at the request of the payee cannot be a debt at all under the IBC.

Thus, this judgement clears the air on complex transactions between promoters and directors in their individual capacity, absolving the company from any liability that can be construed as debt under IBC. This judgement therefore prevents the misuse of the IBC, for purposes of initiating CIRP for the recovery of money.

For more information please write to Mr. Bomi Daruwala at [email protected]

Between the Lines | Calcutta HC: NCLT order mandating filing record of default from the Information Utility to prove financial debt by the financial creditors struck down

The High Court of Calcutta (“HC”) has in its combined judgment dated August 18, 2020 (“Judgment”) in the matter of Univalue Projects Private Limited v. Union of India [W. P. No. 5595 (W) of 2020] and Cygnus Investments and Finance Private Limited & Another v. Union of India and Others [W.P. No. 5861 (W) of 2020], held that financial creditors can rely on either of the modes of evidences at hand to showcase a financial debt, that is, either a record of default from the Information Utility (“IU”) or any other documents as specified in the Insolvency and Bankruptcy Code, 2016 (“IBC”) to prove the existence of a financial debt.

Facts

The writ petitions had been filed by the petitioners under Article 226 of the Constitution of India against an impugned order dated May 12, 2020 issued by the Registrar of the National Company Law Tribunal (“NCLT”) at its principal bench in New Delhi, that prima facie appeared to have been issued with the approval of the Hon’ble Acting President of the NCLT, New Delhi. The said order imposed a mandatory prescription on all financial creditors, as defined under the provisions of the IBC, to submit certain financial information as a record of default before the IU, as a condition precedent for filing any new application as well as retrospectively on all those financial creditors who have pre-existing applications filed under Section 7 of the IBC, and pending before various benches of the NCLT, prior to such final hearing of these applications.

The first writ petitioner who had a pre-existing application filed under Section 7 of the IBC pending before the NCLT at its Kolkata Bench, argued that the impugned order has altered their substantive rights. It was also urged that the order has been issued de hors the parent act that establishes the NCLT, that is, the Companies Act, 2013 (“CA”), other relevant provisions of the IBC and as well as in contravention of regulations issued by the Insolvency and Bankruptcy Board of India (“IBBI”).

The learned counsel for the second writ petitioner urged that the petitioner, Cygnus Investments and Finance Private Limited, wanted to file a new application under Section 7 of the IBC to initiate a corporate insolvency resolution process against the targeted corporate debtor, but was restricted to do so due to the impugned order that required a filing of such an application to be appended with the record of default from an IU. The Hon’ble judge heard both the petitioners jointly and decided to pass a common judgement.

Issues
(i) What is the scope of the NCLT and whether the impugned order is de hors the IBC and the rules and regulations framed thereunder?
(ii) If the answer of the above is in negative, whether the NCLT could enforce the same retrospectively?

Arguments

Contentions raised by the petitioners:

The counsel for the first writ petitioner, referred to Section 424 of the CA and stated that the functioning of the NCLT and the National Company Law Appellate Tribunal (“NCLAT”), though not bound by the Code of Civil Procedure, 1908, still has to be guided by the principles of natural justice and is subject to the provisions of both the CA and the IBC and the rules and regulations established thereunder. Therefore, it has no power to alter the provisions of the CA or the IBC or the regulations framed thereunder. It was further argued that, on a comprehensive reading of Section 214 and Section 215 read with Section 240 of the IBC and Regulation 20(1) of the IBBI (Information Utilities) Regulations, 2017, it is clear that Section 215(2)of the IBC becomes imperative in the case of class of financial creditors who have a ‘security interest’ with respect to the financial debt as against the unsecured class of creditors, as the petitioners, who do not have such a security interest.

The learned counsel relied on the judgment of the Supreme Court in Hitendra Vishnu Thakur v. The State of Maharashtra [(1994) 4 SCC 602] to point out that the procedural statute should not be applied retrospectively where it will result into creation of new disabilities or obligations.

The learned counsel of the petitioner contended that the continuous usage of word ‘or’ in the Section 7(3)(a) of the IBC implies and indicates that the intention of the legislature was to make this section disjunctive. Stress was laid on the fact that a record of default recorded with the IU is one of the designated methods to prove the existence of a financial debt that has accrued to a financial creditor. It was contended that the intention of the legislature must be found in the words used by the legislature itself in their plain grammatical meaning. The learned counsel also relied upon Regulation 8 of the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (“CIRP Regulations”) to highlight that Sub Regulation (2) of Regulation 8 enlists four other categories of documents in addition to the filing of records of default with IU, that may be submitted to prove the claims of creditors. Further, precedents of the NCLAT in Neelkanth Township and Construction Private Limited v. Urban Infrastructure Trustees Limited [Company Appeal (AT) (Insolvency) No. 44 of 2017 dated August 11, 2017] and Bharti Defence and Infrastructure Limited v. Edelweiss Asset Reconstruction Company Limited [Company Appeal (AT) (Insolvency) No. 71 of 2017 dated October 17, 2017] were referred, in which it was held that submitting the financial information before the IU cannot be a mandatory provision or sole criteria to prove the existence of a default in relation to financial debt.

The learned counsel appearing for the petitioners in the second writ petition, cited the dictum of General Officer Commanding – in – Chief v. Subhash Chandra Yadav [AIR 1988 SC 876] and stated that, two conditions must be fulfilled for a subordinate rule to have the effect of the statutory provision: (a) such rules must conform to the provisions of the statute under which it is framed, and (b) it must also be within the scope and purview of the rule making power of the authority framing the rule. Reference was made to the scope of Section 424 of the CA to infer that neither the Hon’ble Acting President of the NCLT, New Delhi nor the Registrar of the NCLT have the power of rule-making. The learned counsel also relied on the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016 (“AA Rules”), specifically Rule 4(1) of the AA Rules, that deals with the application filed by financial creditor. According to the said rule, other documents, records and evidences can be filed alongside the Form-1 to prove an existing default.

An interesting submission was made by the learned counsel that NCLT was also not empowered by the inherent powers under Rule 11 of the National Company Law Tribunal Rules, 2016 to promulgate the impugned order. Reliance was placed on Tata Chemicals Limited v. Kshitish Bardhan Chunilal Nath [AIR 2019 Cal 353] to submit that the scope of inherent powers cannot be exercised such that it is in conflict with the statute or against legislative intent.

Contentions raised by the respondents:

The learned counsel for the respondent argued that both the NCLT and NCLAT can regulate their own procedures as per Section 424 of the CA and hence, were well within their rights to issue the impugned order. It was further stated that the Section 215(2) of the IBC does not make any distinction between a secured creditor and an unsecured creditor. It was further submitted that in both the situations, that is, submission of financial information, and, information relating to assets in relation to which security interest has been created, in such form as prescribed by the regulations, a financial creditor has to file such information with the IU mandatorily, irrespective of being a secured or an unsecured creditor. The learned counsel then relies on the Supreme Court judgement of Izhar Ahmad Khan v. Union of India [AIR 1962, SC 1052] to submit that there are two categories of law, substantive and procedural law, wherein evidence is a part of procedural law. Hence, it is the power of the tribunal to regulate its own procedure within the Section 424 of the CA. He further argued that no new disabilities have been created by the impugned order since the Section 7(3)(a) of the IBC states mandatorily that the financial creditor shall furnish the application and record of default with the IU.

Observations of the High Court of Calcutta

Multiple precedents were referred and it was observed that while both the NCLT and NCLAT have been conferred with powers to regulate their own procedure, such use of its power is circumscribed and subject to, inter alia, the principles of natural justice as well as the provisions of the CA or the IBC, inclusive of any rules/regulations framed under such legislations. In Government of Andhra Pradesh v. P. Laxmi Devi (Smt) [(2008) 4 SCC 720] the SC had captured the hierarchy of the legal norms in India based on the jurist Kelsen’s ‘Pure Theory of Law’. Therefore, it was inferred that the Acts passed by the Parliament preceded over the Rules enacted by the Government or the Regulatory Board and at the bottom of the pyramid lay adjudicating authority regulating their own procedures.

The phrase ‘as may be specified’ under Section 7(3)(a) of the IBC, read with the definition of the term “specified” under Section 3(32) of the IBC were referred, to conclude that the positive conditions separated by “or” are read in the alternative and that there are three categories of evidence that can be provided. It was observed, while referring to various provisions, including Section 7 of the IBC read with Rule 4 of the AA Rules, Form-1 therein, Regulation 8 of the CIRP Regulations and precedents, that apart from the financial information of the IU, eight classes of documents can be considered to be sources that evidence a “financial debt”.

Decision of the High Court of Calcutta

The Hon’ble HC of Calcutta held that IU was only one of the designated methods of furnishing proof to the NCLT, to prove the existence of a financial debt that has accrued to a financial creditor. The Hon’ble Bench observed that the impugned order is a “prickly thorn” which is against the principle of natural justice and that it adversely affected the substantive rights of the petitioners as financial creditors envisaged under the IBC. The bench held that the order did not qualify the tests laid down in the judgement of General Officer Commanding – in – Chief v. Subhash Chandra Yadav [AIR 1988 SC 876]. The Bench further held that the retrospective nature of the order does create new disabilities for the financial creditors and was bad in law. The NCLT acted without jurisdiction and exceeded beyond its limit of the four corners of Section 424 of the CA, and was in violation of Section 7(3)(a) of the IBC and rules and regulations framed thereunder. Hence, the impugned order is de hors the CA, the IBC, and rules and regulations framed thereunder.

The HC was of the view that the financial creditors can rely on either a record of the default from the IU or any other document as specified to showcase a financial debt. Therefore, it can be inferred that Section 215 of the IBC is not mandatory in nature. It is also clarified that any delegatee under the IBC and the CA, that is, the Central Government, the IBBI and the NCLT, cannot make any retrospective regulations. Hence, the impugned order dated May 12, 2020 issued by the principal bench of the NCLT, New Delhi was held to be ultra vires the IBC and the regulations thereunder, and was accordingly struck down.

Vaish Associates Advocates View:

This judgement clarified an important area of law, pursuant to the order dated May 12, 2020 issued by the principal bench of the NCLT, New Delhi. The HC highlighted the hierarchy of legal norms in India and reiterated the well-established principle that a delegated or subordinate legislation cannot be retrospective in nature, unless the rule-making authority has been vested with power under a statute to make rules with retrospective effect. The HC has vividly looked at the nature of the transactions that the IBC governs, the dynamics of which cannot be restricted by imposing rules/regulations in retrospect.

The financial creditors play a major role in the society and therefore, in lines with the object of the IBC, the judgement has protected the interests of all the stakeholders. The HC, by making filings of record of default with the IU only directory in nature, has further prescribed that the procedural aspects of law cannot ride over the substance and the object of the law. The procedures are only meant to promote the interest of the beneficiaries. Even though IUs are, in principle, a positive change, the HC has worked to ensure that no person shall be negatively affected due to the non-filing of past debts with the IU. In due course of time, IUs shall be the norm, however, for now, the HC has rightly ensured that it is not mandatory in nature.

For more information please write to Mr. Bomi Daruwala at [email protected]