Insolvency of parties
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This article is written by Manaswee, pursuing Certificate Course in Arbitration: Strategy, Procedure and Drafting from LawSikho. The article has been edited by Aatima Bhatia (Associate, LawSikho) and Dipshi Swara (Senior Associate, LawSikho).

Introduction

The December 2020 judgement of the 3-judge bench of the Hon’ble Supreme Court in Vidya Drolia and Ors. v. Durga Trading Corporation has been a landmark in settling many controversies that had been looming over the Arbitration Law jurisprudence ever since the 1996 Act came into force. Primarily addressing the issue of arbitrability in landlord-tenant disputes which are governed by the provisions of the Transfer of Property Act, 1882 (“TPA”), the Court delved deeper into the issue of subject-matter arbitrability and scope and ambit of the jurisdiction of Court while dealing with an application made under Section 8 or 11 of the Arbitration and Conciliation Act, 1996. The court also settled down the question of arbitrability of fraud much in line with its recent judgment in Avitel. 

In this article, we shall look deeper into its two primary determinations: subject matter arbitrability and scope and power of such determination under Sections 8 and 11 of the Arbitration and Conciliation Act, 1996.

Factual background

The present case was an Appeal challenging the legal ratio expressed by a Division Bench of the same Court in Himangni Enterprises v. Kamaljeet Singh Ahluwalia (2017) that landlord-tenant disputes which are governed by the provisions of the TPA are non-arbitrable based on the ground that such would be opposed to public policy. In Himangini Enterprises, the Court primarily relied upon Natraj Studios (P) Ltd. v. Navrang Studios and Booz Allen & Hamilton Inc. v. SBI Home Finance Ltd. 

In brief, Natraj Studios ruled that on broader consideration of public policy, the licensee-landlord dispute was exclusively triable by Small Causes Court as per the statute governing it. While Booz Allen ruled that tenancy matters that are governed by special laws under which the tenant enjoys statutory protection, only the specified court under that statute has jurisdiction.

The landmark rulings of this judgement can be classified into two:

A. Subject matter arbitrability,

B. Scope and power of determination under Section 8 and Section 11

Subject matter arbitrability

Vidya Drolia recalibrates the law on subject-matter arbitrability and holistically articulates the fourfold test supplementing the rights test laid down in Booz Allen2 the ratio of which was however held to be per incuriam with regard to the arbitrability of the tenancy disputes governed by the TPA.

The interesting thing about the determination of arbitrability is that its test is an inquiry into the non-arbitrability of the cause of action and subject matter of the dispute. Thus, arbitrability comes with a negative test which if the matter in question satisfies, becomes non-arbitrable. These have been nicely summed up by Pradeep Nayak and Vikas Mahendra as follows:

  1. “Cause of action of dispute or its subject matter relates to actions in rem, which do not pertain to subordinate rights in personam that arise from rights in rem.
  2. It affects third party rights; have erga omnes effect
  3. It requires centralized adjudication, and mutual adjudication would not be appropriate and enforceable
  4. It relates to the inalienable sovereign and public interest functions of the State and hence mutual adjudication would be unenforceable
  5. When the subject matter of the dispute is expressly or by necessary implication non-arbitrable as per mandatory statute(s).”

In order to better acknowledge the contribution of this judgement, we will understand this judgement alongside the backdrop of judgements relating to the arbitrability of fraud and tenancy disputes before this case.

Arbitrability of tenancy disputes

The jurisprudence on arbitrability of tenancy disputes can be understood by the position of the Supreme Court over the years in the three landmark cases, namely: Natraj Studios, Booz Allen and Himangni Enterprises that made the law governing arbitrability of tenancy disputes prior to Vidya Drolia.

In 1981, case of Natraj Studios, the Supreme Court held that for a tenancy covered under the special statutes regarding rent control, the disputes between landlords and tenants protected by the statute can be tried exclusively by the special court provided by the statute and are thus not arbitrable. 

In 2011, the Supreme Court in Booz Allen reiterated the same view on tenancy matters regulated by special laws where the tenant enjoys statutory immunity from eviction; the jurisdiction over such disputes is bestowed on only the specified courts. 

In 2017, the Himangni Enterprises case reaffirmed the non-arbitrability of lease and eviction disputes and held that even in cases governed by the TPA, and not by a special statute it would be the subject matter jurisdiction of the civil court and not of an arbitrator to adjudge upon landlord-tenant disputes. 

The rationale so far in these cases continued to be the public policy perspective that statutes dealing with tenancy are special statutes and are inherently public welfare legislations serving the two-folds purpose of protecting tenants from unfair evictions and also from unfair rent/exploitation, striking a balance against an inherently weaker bargaining power in the hands of the tenant. Therefore, the disputes covered under these legislations were consistently ruled as non-arbitrable by Indian Courts. The shift in this viewpoint comes in Vidya Drolia.

In Vidya Drolia and Ors. v. Durga Trading Corporation the Supreme Court ruled that tenancy disputes governed by the TPA are very much arbitrable. It observed that landlord-tenant disputes ”are not actions in rem but pertain to subordinate rights in personam that arise from rights in rem. Such actions normally would not affect third-party rights or have erga omnes affect or require centralized adjudication. An award passed deciding landlord-tenant disputes can be executed and enforced like a decree of the civil court. Landlord-tenant disputes do not relate to the inalienable and sovereign functions of the State. The provisions of the Transfer of Property Act do not expressly or by necessary implication bar arbitration.” Thereby overruling its decision in Himangni Enterprises the court clarified the law upon this point, it ruled that landlord-tenant disputes covered and governed by special statutes would not be arbitrable only “when a specific court or forum has been given exclusive jurisdiction to apply and decide special rights and obligations.”

Arbitrability of fraud

The history of the jurisprudence governing the arbitrability of fraud under the regime of the 1996 Act can be understood with the help of the following four judgements: N. Radhakrishnan, Ayyasamy, Rashid Raza and the most recent being Avitel, as it stood right before Vidya Drolia in 2020.

Starting from 2009, in N. Radhakrishnan v. Maestro Engineers, the Supreme Court held that a dispute involving “serious allegations of fraud” would be non-arbitrable, without defining the ambit and scope of the phrase- ‘serious allegations of fraud’. Understanding illustratively from the facts of the case, here the appellant had alleged malpractices in the account books and manipulation of the finances of the partnership firm by the respondent since the court ruled that it cannot be referred to arbitration We may thus conclude that the allegations of financial impropriety were considered as ‘serious’ and determination over such allegations non-arbitrable. 

In 2016, Ayyasamy v. Paramasivam the Supreme Court held that mere allegation of fraud “simpliciter” does not render a dispute no-arbitrable. So to say, matters having no public interest involved and that is purely between the parties shall not be regarded as non-arbitrable on grounds of fraud only. However, if the allegations are such as to make out a criminal case, or when they are so complicated as to require examination by a civil court in light of detailed evidence, the court may dispose of the Section 8 application and examine the case on merits. The Court further illustrated that in serious cases of fabrication or forgery, or where the fraud is such that permeates the entire contract, including the Arbitration Agreement, or when such fraud affects the validity of it, the matter is then non-arbitrable. The primary ruling, in this case, was the twin test that was further applied in the Rashid Raza case and has been discussed henceforth. 

The decision of the Supreme Court upheld the principle of kompetenz kompetenz (embodied in Section 16) under which the arbitral tribunal is empowered to determine its own jurisdiction. What must be noted is that the Ayyasamy judgement could not theoretically overrule the N. Radhakrishnan judgement due to their co-ordinate bench strength.

Thereafter in 2019 Rashid Raza v. Sadaf Akhtar, the ruling from Ayyasamy a two-pronged test was applied by the Court under which the Court has to first see whether the allegations of fraud permeated the entire contract, and especially the arbitration agreement, thereby rendering it void and second, to see that whether the allegations pertained to the internal affairs of the parties inter se or whether they had an implication on the public domain. 

In 2020 Avitel Post Studioz Ltd. v. HSBC PI Holdings (Mauritius) Ltd. when HSBC applied for interim measures while Avitel pleaded since there exist serious allegations of fraud and pending criminal cases therefore, no orders should be passed. The Court in applying the twin test found that there is no ‘public flavour’ in the allegations of the Respondent. The Court reinstated the arbitrability of fraud.

The Apex Court in deciding the case for Avitel also observed that the criteria of arbitrability laid down in Booz Alllen and Afkons should be read in consonance with the twin test laid down in Ayyasamy in deciding the issue of arbitrability of fraud. It further held that in a dispute involving allegations of ‘fraud’ whether under Section 17 of the Contract Act, 1872 and/or under the law of tort or criminal, alone would not lead to non-arbitrability of an otherwise arbitrable (by applying the twin test) dispute.

Thereafter in December 2020, Vidya Drolia, the Supreme Court reaffirmed the law laid down in Avitel. It overruled its decision in N. Radhakrishnan and held that fraud renders a dispute non-arbitrability only: 

  1. In a clear case where the arbitration clause or agreement itself cannot be said to exist; or 
  2. If allegations are made against the State or its instrumentalities of arbitrary, fraudulent, or mala fide conduct which requires a public enquiry.

The Court further observed that “it would be grossly irrational and completely wrong to mistrust and treat arbitration as flawed and inferior adjudication procedure” thus marking a clear shift in judicial perception and its increasing faith in the process of arbitration.

Scope and power of determination under Section 8 and Section 11

The second most notable ruling of this case is with regard to its determination of the scope and extent of inquiry that can be made under 

The issue of arbitrability may be raised at three distinct stages:

  1. Under Sections 8 or 11 before the Court (Referral Stage);
  2. Before the tribunal (Arbitration Stage); and
  3. While challenging the arbitral award before the Court (Challenge Stage).

The position of law had been clear with regard to the scope of enquiry into arbitrability at the Arbitration and Challenge stages. Section 16 (1) of the Act provides for the arbitral tribunal to decide as to its own jurisdiction, including questions as to the arbitrability of the issue. This is known as the Kompetenz Kompetenz Rule.

Similarly, for the Challenge stage Section 34 of the Act, a court may set aside an arbitral award if it finds that:

  1. “The arbitration agreement is not valid in law; or
  2. The award deals with a dispute which was not within the scope of the submission to arbitration; or 
  3. The subject matter of the dispute is, by law, not capable of being settled by arbitration.”

Upon the point of referral stage determination, the Court has laid down the following five points:

  1. “Sections 8 and 11 of the Act have the same ambit with respect to judicial interference.
  2. Usually, subject matter arbitrability cannot be decided at the stage of Sections 8 or 11 of the Act, unless it’s a clear case of deadwood.
  3. The Court, under Sections 8 and 11, has to refer a matter to arbitration or to appoint an arbitrator, as the case may be,   unless a party has established a prima facie (summary findings) case of non­existence of a valid arbitration agreement, by summarily portraying a strong case that he is entitled to such a finding.
  4. The Court should refer to a matter of the validity of the arbitration agreement cannot be determined on a prima facie basis, as laid down above, i.e., ‘when in doubt, do refer’.
  5. The scope of the Court to examine the prima facie validity of an arbitration agreement includes only:
  1. Whether the arbitration agreement was in writing? or
  2. Whether the arbitration agreement was contained in an exchange of letters, telecommunication etc?
  3. Whether the core contractual ingredients qua the arbitration agreement were fulfilled?
  4. On rare occasions, whether the subject matter of the dispute is arbitrable?”

The Court laid heavy reliance on the 246th Law Commission Report and held that the scope of review under both Sections 8 and 11 is the same, despite the difference of language in the provisions. The Court reiterated strict adherence to the words in the erstwhile Section 11(6-A) of the Act and has also stated that its omission in 2019 does not change the restrictive examination of the courts at the referral stage. Under Section 8 a judicial authority is required to refer the parties to arbitration unless it finds that no valid arbitration agreement exists prima facie while Section 11 gives restricted power to the court to determine only the existence of an arbitration agreement. However, such an agreement must be enforceable in law; an arbitration agreement that is invalid or illegal is not legally enforceable and can’t be called an agreement at all. This implies that even under Section 11 the court shall have the power to examine the validity of the arbitration agreement.

The test at the referral stage is thus a prima fascie test which the Court simplified and stated, “when in doubt, do refer”.

Criticism

Vidya Drolia has been a landmark with regard to its rulings on subject matter arbitrability in tenancy disputes and disputes involving allegations of fraud as well as with respect to its determination of scope and extent of inquiry under Sections 8 and 11 by the Court and has been welcomed for the most part. 

However, experts expressed concern over its ruling with respect to the DRTs that overlooks the concerns of banks and NBFCs and similarly over its ruling on non-arbitrability of all intra-company disputes without considering the subset of intra-company disputes that don’t need the specific powers available with the NCLT for their resolution.

Another point of concern has been pointed out in the matter of difference in appealability of the orders passed under Sections 8 and 11. It is speculated that such a lacuna could be used by recalcitrant parties to resort to dilatory tactics by filing mala fide Section 11 applications which would be antithetical to the intention of the legislature and the essence of the judgement in Vidya Drolia. The Supreme Court in 2021, Pravin Electricals (P) Ltd.  v. Galaxy Infra and Engg. (P) Ltd. has this inconsistency and expressed its concern in relation to what has been laid down in Vidya Drolia. The Court invited the attention of the legislature by making an observation stating that it might be needed to have a look at Sections 11(7) and 37 in order to bring the orders passed under Sections 8 and 11 at par on appealability

Conclusion

The Vidya Drolia judgment sets a landmark in the determination of arbitrability of disputes. By restricting the scope for the allegations of fraud to roar against the arbitrability of a dispute, the Court prevented a whole lot of trouble from getting in the way of efficient and smooth arbitration proceedings. Further, its test for arbitrability along with its observations on Sections 8 and 11 made it clear that the Indian Judiciary has started investing faith in the process of Arbitration. A few inconsistencies remain to be resolved and a few specifications would require elaboration and dedicated explanation for the Court in the future but the judgment has largely pushed India’s arbitration-friendly jurisprudence further ahead and has demonstrated that a similar approach may be expected from Indian courts in the future.


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