Between the Lines | Supreme Court: Non-payment of stamp duty on the commercial contract does not invalidate the arbitration agreement February 23, 2021
Published in: Between The Lines
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The Hon’ble Supreme Court (“SC”) by way of its judgement dated January 11, 2021 in the matter of M/s N.N. Global Mercantile Private Limited v. M/s Indo Unique Flame Limited and Others [Civil Appeal Nos. 3802 – 3803/ 2020 arising out of SLP (Civil) Nos. 13132 – 13133 of 2020)] (“Judgement”) laid down that an arbitration agreement embedded in a commercial contract is independent of the substantive agreement, due to which, nonpayment of stamp duty on the commercial contract does not render the arbitration agreement unenforceable.
Indo Unique Flame Limited (“Respondent No. 1”) applied for grant of work of beneficiation/washing of coal to the Karnataka Power Corporation Limited (“KPCL”) in an open tender and was awarded the work order on September 18, 2015. Subsequently, Respondent No. 1 furnished bank guarantees for INR 29.29 crores in favour of KPCL through its banker, State Bank of India (“Respondent No. 2”). Respondent No. 1 subsequently entered into a sub-contract termed as a work order dated September 28, 2015 (“Work Order”) with M/s. N.N. Global Mercantile Private Limited (“Appellant”), for the transportation of coal from its washery to the stockyard, siding, coal handling and loading into the wagons. As per the Work Order, the Appellant furnished a bank guarantee for INR 3.36 crores on September 30, 2015 in favour of Respondent No. 2. Under the principal contract with KPCL, certain disputes and differences arose with Respondent No. 1, which led to the invocation of the bank guarantee by KPCL on December 6, 2017. Subsequently, Respondent No. 1 invoked bank guarantee furnished by Appellant. This led to the Appellant initiating a suit before the Commercial Court, Nagpur (“Commercial Court”) against the Respondent No. 1, Respondent No. 2 and its banker, Union Bank of India , collectively known as “Respondents”. The Appellant prayed for a declaration that Respondent No. 1 was not entitled to encash the bank guarantee as the Work Order had not been acted upon. It was expressly stated that Respondent No. 1 had not allotted any work under the Work Order, nor were any invoices raised, or payments made by it. Consequently, there was no loss suffered which would justify the invocation of the bank guarantee by the Respondent No. 1. The Commercial Court directed status quo with regards to enforcing bank guarantee. Respondent No. 1 filed an application under Section 8 (Power to refer parties to arbitration) of the Arbitration and Conciliation Act, 1996 (“Act”) seeking reference to arbitration, which was rejected by the Commercial Court. Subsequently, Respondent No. 1 filed a writ petition under Articles 226 and 227 of the Constitution of India before the Hon’ble Bombay High Court (“BHC”), which in favour of Respondent No. 1, held the arbitration application under Section 8 of the Act to be maintainable. With regards to the unenforceability of the unstamped Work Order, the BHC held that the Appellant could raise the issue before the arbitral tribunal at an appropriate stage. Aggrieved, the Appellant filed a Special Leave Petition before the SC.
Contentions before the Supreme Court
Contentions raised by the Appellant:
The Appellant submitted that application under Section 8 of the Act for reference of disputes to arbitration was not maintainable, since, in light of Section 34 (Instruments not duly stamped inadmissible in evidence) of the Maharashtra Stamp Act, 1958 (“Stamp Act”) the Work Order being an unstamped document could not be received in evidence for any purpose, or acted upon, unless it is duly stamped. Consequently, the arbitration clause in the unstamped agreement also could not be acted upon or enforced since the arbitration clause would have no existence in law, unless the applicable stamp duty is paid on the Work Order. The Appellant relied upon Garware Wall Ropes Limited v. Coastal Marine Constructions and Engineering Limited [(2019) 9 SCC 209] (“Garware”), which held that an arbitration clause in an agreement would not exist when it is not enforceable by law. The BHC had violated Section 34 of the Stamp Act since it enforced a non-existent arbitration clause.
It was submitted that the bank guarantee was furnished to ensure due execution of the Work Order. The Appellants argued that the invocation of the bank guarantee was fraudulent, since the agreement had never been acted upon. There was no invoice raised or payment received under the Work Order. In the absence of any legal liability for payment under the Work Order, the invocation of the bank guarantee was fraudulent.
Contentions raised by the Respondents:
The Respondents submitted that even though the Work Order was unstamped, it would be enforceable after it is duly stamped, for which an opportunity must be given to the Respondents to pay the deficient stamp duty and penalty determined by the collector. Non-payment of stamp duty would not render the agreement unenforceable and was a curable defect.
Observations of the Supreme Court
Validity of an arbitration agreement in an unstamped agreement:
The SC observed that when parties enter into commercial contracts, they essentially enter into two distinct agreements- the substantive contract and the arbitration agreement. The autonomy of the arbitration agreement is based on the twin concepts of separability and kompetenz-kompetenz (Arbitrator’s ability to determine its own jurisdiction including ruling on anyobjections with respect to the validity or existence of the arbitration agreement) enshrined in Section 16 (Competence of arbitral tribunal to rule on its jurisdiction) of the Act. The doctrine of kompetenz–kompetenz aims to minimize judicial intervention at the pre-reference stage. The arbitration agreement is separate and independent from the underlying contract in which it is embedded. An arbitration agreement exists and can be acted upon irrespective of whether the main substantive contract is valid or not. The legislative policy of minimal interference is enshrined in Section 5 (Extent of judicial intervention) of the Act, which by a non-obstante clause prohibits judicial intervention except as specified in Part I of the Act. A conjoint reading of Sections 5 and 16 of the Act would indicate that all civil commercial matters, including the issue as to whether the substantive contract was voidable, can be resolved through arbitration.
Analyzing the statutory scheme of the Stamp Act, the SC observed that Section 33 (Examination and impounding of instruments) of the Stamp Act obligates persons empowered to receive evidence, including arbitrators, to examine the instrument presented and ascertain whether the instrument is duly stamped. If an instrument is not duly stamped the instrument will be impounded. Section 34 of the Stamp Act operates as a statutory bar to an unstamped instrument being admitted in evidence, or being acted upon, for any purpose, by any authority with the power to receive evidence, unless such instrument is duly stamped. The proviso to Section 34 of the Stamp Act states that upon payment of the requisite stamp duty, the instrument may be admitted in evidence.
The SC noted the observations made by a division bench of the SC in SMS Tea Estates Private Limited v. M/s. Chandmari Tea Co. Private Limited [(2011) 14 SCC 66] (“SMS Tea Estates”) where the issue was whether an arbitration agreement in an unregistered and unstamped lease deed was valid and enforceable, being embedded in such an invalid and unenforceable lease deed. To answer this question the court in SMS Tea Estates looked at the validity and enforceability of the arbitration agreement in an unregistered but compulsorily registrable instrument and an unregistered instrument, not duly stamped. Doing so, the court noted that Section 49 (Effect of nonregistration of documents) of the Registration Act, 1908 (“Registration Act”) stated that if a compulsorily registrable document is not registered, it will not be received as evidence for any transaction related to the immovable property therein except as evidence of any collateral transaction like arbitration which by itself is not required to be effected by the registered instrument. The court held that an arbitration clause is an agreement independent of the other terms of the contract or the instrument. When an instrument or a document affecting immovable property contains an arbitration agreement, it is a collateral term relating to resolution of disputes, unrelated to the transfer or transaction affecting the immovable property. It is as if two documents—one affecting the immovable property requiring registration and the other relating to dispute resolution which is not compulsorily registerable – are rolled into a single instrument. Therefore, even if a deed of transfer of immovable property is challenged as invalid, the arbitration agreement would remain unaffected. However, it was further held that in case of voidable contracts, invalidity which attaches itself to the main agreement, may also attach itself to the arbitration agreement, if the reasons which make the main agreement voidable, exist in relation to the making of the arbitration agreement also. Taking into consideration Section 35 (Instruments not duly stamped inadmissible in evidence) of the Indian Stamp Act, 1899 (“ISA”) the court held that unless the stamp duty and penalty due in respect of the instrument is paid, the court cannot act upon the instrument and thereby cannot act upon the arbitration agreement embedded in the instrument. This was because Section 35 of the ISA, unlike Section 49 of the Registration Act, does not contain a proviso enabling the instrument to be used as evidence for a collateral transaction.
The SC noted that before the Arbitration and Conciliation (Amendment) Act, 2015 (“2015 Amendment”), the prevailing law was that at the pre-reference stage in an application under Section 11(6) of the Act, the courts could determine certain issues which would preclude the necessity of reference to arbitration. The 2015 Amendment altered this stance, restricting the court to examine only the existence of an arbitration agreement. The issue whether an arbitration clause in an agreement which needs to be stamped but is not, would be enforceable after the introduction of Section 11(6A) of the Act, was considered in the Garware case, where, upholding the SMS Tea Estates judgement, it was held that agreement only becomes a contract if it is enforceable by law, which it cannot until requisite stamp duty is paid. Hence, the court pronounced that an arbitration clause in an agreement would not exist when it is not enforceable by law and on applying the facts, the arbitration clause in the sub-contract would not exist until the sub-contract was duly stamped.
Schedule 1 of the Stamp Act enumerates instruments on which stamp duty is chargeable and an arbitration agreement is not one of them. The SC opined that non-payment of stamp duty on the Work Order did not invalidate the main contract. Since Section 34 of the Stamp Act only rendered the unstamped instrument invalid till the payment of stamp duty, the deficiency would be cured once the requisite stamp duty was paid. On account of the doctrine of separability, an arbitration agreement distinct from the underlying commercial contract would survive independently, would not be rendered invalid, unenforceable or non-existent, even if the substantive contract was not admissible in evidence.
The SC, while analyzing SMS Tea Estates, opined that the law laid down in it regarding the non-arbitrability of unstamped commercial contracts and invalidity of arbitration agreements in case of voidable contracts was incorrect. Arbitration agreement being an independent one between the parties is not chargeable with stamp duty and owing to its stand-alone nature, non-payment of stamp duty on the commercial contract would not invalidate the arbitration clause in it. Criticizing the decision of the court in SMS Tea Estates, the SC decided that the nonpayment of stamp duty on the substantive contract would not invalidate even the main contract. It is a deficiency which is curable on the payment of the requisite stamp duty. With respect to the view taken in SMS Tea Estates regarding voidable contracts, it observed that the allegations made by a party that the substantive contract has been obtained by coercion, fraud, or misrepresentation has to be proved by leading evidence on the issue which could be adjudicated through arbitration.The SC noted that the erroneous view taken in the SMS Tea Estates judgement was subsequently adopted by the court in the Garware judgement. The SC categorically stated that once the independent existence of the arbitration agreement is established, it can be acted upon, irrespective of the alleged invalidity of the commercial contract.
The SC noticed that the Garware judgement was relied upon and affirmed in the recent Vidya Drolia and Others. v. Durga Trading Corporation [Civil Appeal No. 2402 of 2019, Special Leave Petition (Civil) Nos. 5605-5606 of 2019 and Special Leave Petition No. 11877 of 2020 (Arising out of Diary No. 40679 of 2019)] (“Vidya Drolia”) by a three judge bench and hence the SC by this Judgement, decided to refer the validity of the Garware judgement to a Constitution Bench of five judges.
Power of impounding:
The SC further dealt with the issue as to who would exercise the power of impounding the instrument under Section 33 read with Section 34 of the Stamp Act, in a case where the substantive contract contains an arbitration agreement, and enlisted three possible scenarios:
Whether the fraudulent invocation of the bank guarantee is arbitrable:
In A. Ayyasamy v. A. Paramasivam and Others [(2016) 10 SCC 386], the court recognized that disputes which are of public nature, cannot be adjudicated by arbitration. Reference to arbitration can be refused in cases where there are very serious allegations of fraud, making it a criminal offence or where allegations of fraud are extremely complicated, necessitating them to be decided only by the civil courts owing to the voluminous evidence. Parties can be referred to arbitration when dispute is between parties inter se and does not affect third parties. Thus, the court in this case laid down a twin test:
The question of arbitrability of fraud was dealt with in Avitel Post Studioz Limited and Others v. HSBX PI Holdings (Mauritius Limited) [(2020) SCC OnLine SC 656]. It was held that the same set of facts may have civil as well as criminal consequences. If it is clear that a civil dispute involves questions of fraud, misrepresentation, etc. which can be the subject matter of a proceeding under Section 17 (Fraud) of the Indian Contract, 1872 (“Contract Act”), the mere fact that criminal proceedings can or have been instituted in respect of the same subject matter, would not lead to the conclusion that a dispute which is otherwise arbitrable, ceases to be so.
All civil and commercial disputes can be resolved through arbitration, unless excluded either expressly or impliedly by the statute. Certain categories of disputes are however reserved by the legislature, as a matter of public policy, to be adjudicated by a court of law, since they lie in the realm of public law. Disputes relating to rights in rem are not arbitrable whereas those relating to rights in personam are amenable to arbitration. The SC acknowledged that certain categories of disputes, inter alia, penal offences, bribery, corruption, matrimonial disputes are nonarbitrable.
However, the civil aspect of fraud is arbitrable, except when the allegation is that the arbitration agreement itself is vitiated by fraud, or the fraud invalidates the underlying contract, and impeaches the arbitration clause itself. Further, if the substantive contract is expressly declared as void under the Contract Act, due to incompetency of parties, the dispute would be non-arbitrable. The civil aspect of fraud dealt with under Section 17 of the Contract Act, can however be arbitrated. Analyzing the question of whether voidable agreements would be arbitrable or not, the SC observed that in case of voidable agreements, disputes would be arbitrable, since the issue whether the consent was procured by coercion, fraud, or misrepresentation requires to be adjudicated upon by leading cogent evidence, which can very well be decided through arbitration. Earlier precedents had held fraud to be non-arbitrable as it would entail voluminous and extensive evidence and would be too complicated to be decided in arbitration. The SC dismissed this view as archaic but at the same time noted that criminal aspect of fraud, resulting in penal consequences and criminal sanctions could be adjudicated only by a court of law, since it may result in a conviction, which is in the realm of public law.
Maintainability of the writ petition:
With regards to the maintainability of the writ petition, the SC deemed it non-maintainable since Section 37(1) (a) (Appeal against granting/refusing to grant interim relief) of the Act provides a statutory remedy to file an appeal against an order refusing to refer the parties to arbitration. The order refusing reference to arbitration passed by the Commercial Court was appealable under Section 37 of the Act and hence the BHC judgement under Articles 226 and 227 of the Constitution was not maintainable.
Decision of the Supreme Court
The SC held that there was no legal impediment to the enforceability of the arbitration agreement, pending payment of stamp duty on the substantive contract. The adjudication of the rights and obligations under the Work Order or the substantive commercial contract would however not proceed before complying with the mandatory provisions of the Stamp Act. The SC set aside the BHC judgement and held that concerning the bank guarantee, the Appellant could seek interim relief under Section 9 (Interim Relief) of the Act. The SC directed the Secretary General of the SC to impound the Work Order and forward it to the concerned collector in Maharashtra for assessment of the stamp duty payable on the said instrument, to be completed within a period of 45 days from the receipt of the same. Once determined, the Appellant was directed to pay the stamp duty to the collector, subject to the revision appeal under Stamp Act. It was decided that the issue of fraud with respect to the invocation of the bank guarantee was arbitrable, since it arose out of disputes between parties inter se and was not in the realm of public law.
The SC further held that the conclusion reached in SMS Tea Estates and Garware cases that the non-payment of stamp duty on the commercial contract would invalidate even the arbitration agreement, and render it nonexistent in law, and unenforceable, is not the correct position in law. Through this Judgement, the SC overruled SMS Tea Estates, holding that non-payment of stamp duty on the commercial contract would not make the arbitration agreement invalid due to its independence and that allegations of fraud are arbitrable. Since the recent Vidya Drolia judgement affirmed the judgement in Garware, the SC through the Judgement has referred to the Constitution Bench, the issue relating to: Whether the statutory bar contained in Section 35 of the ISA applicable to instruments chargeable to stamp duty would also render the arbitration agreement contained in such an instrument, which is not chargeable to payment of stamp duty, as being invalid pending payment of stamp duty on the substantive contract?
Vaish Associates Advocates View:
The instant Judgement throws light on the three-fold issues of (i) the application of the doctrine of separability, (ii) whether an arbitration agreement would be rendered unenforceable if the underlying contract was not duly stamped; and (iii) whether allegations of fraudulent invocation of the bank guarantee furnished under the substantive contract would be an arbitrable dispute.
This Judgement has upheld the principles of separability and kompetenz-kompetenz, the two fundamental tenets of arbitration jurisprudence in India. In a pro-arbitration move, the SC has ostensibly clarified that the ground that allegations of fraud cannot be arbitrated is a wholly archaic standpoint, which deserves to be discarded. The SC has also revisited the law on the validity of arbitration agreement in an unstamped document, overruling the findings of SMS Tea Estates. Further clarity on this crucial aspect will be obtained once the Constitution Bench authoritatively confirms whether or not the non-stamping of the underlying instrument will render the arbitration agreement invalid.
For more information please write to Mr. Bomi Daruwala at [email protected]