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Judgment_Evaluation__Analysis_Unstamped_Arbitration_Agreements_are_not_Valid-in_Law

Judgment Evaluation & Analysis Unstamped Arbitration Agreements are not Valid in Law

Background:

A 5- Judge Bench of Supreme Court in its judgement dated 25th April 2023 by a 3:2 majority held that “an instrument which is exigible to stamp duty may contain an arbitration clause and which is not stamped cannot be said to be a contract enforceable in law within the meaning of Section 2(h) of the Contract Act and is not enforceable under Section 2(g) of the Contract Act.” and that “Arbitration Agreement contained in such instrument as being non-existent in law unless the instrument is validated under the Stamp Act”. The present case has been decided on referral emanating from the 3-Judge Bench decision[1] which had addressed to the issue of stamping of the validity of arbitration agreements and was referred to Constitutional Bench because of fractured opinion of Supreme Court taken in various judgements on this issue.
Facts:

Indo Unique Flame Ltd. (hereinafter referred to as Indo Unique) was awarded a work order which contained the arbitration clause from the Karnataka Power Corporation Ltd. (hereinafter referred to as KPCL). Thereafter, Indo Unique further entered into a sub-contract under the said work order with NN Global Mercantile Pvt. Ltd (hereinafter referred to as NN Global). NN Global had furnished a bank guarantee, the invocation of which led to a suit by NN Global against the said encashment. Thereafter Indo Unique applied under Section 8 of the Arbitration and Conciliation Act, 1996 (hereinafter referred to as ‘the Act’) seeking reference which was rejected by the Commercial Court in Nagpur, one of the contention raised therein was that since the Work Order is unstamped, the Arbitration Agreement embedded in it became unenforceable against which Indo Unique filed a Writ Petition before the Bombay High Court which rejected the findings of the Commercial Court and allowed the Writ Petition.

Thereafter, a 3 Judge Bench of Hon’ble Supreme Court in this matter held that an arbitration agreement is a distinct and separate agreement from the substantive contract in which it is embedded[1]. Further, the Supreme Court also opined that the doctrine of Kompetenz-Kompetenz as postulated in Section 16 (1) of the Act provided for the Arbitral Tribunal alone to be competent to rule on its jurisdiction vis-a-vis existence, validity and the scope of the arbitration agreement.

While discussing the introduction of Sub-Section 6A Section 11 of the Act, the 3 Judge Bench opined that SBP & Co. Vs. Patel Engineering Ltd.[2] was decided before the said amendment. After the amendment was instituted, the court while deciding an application under Section 11 was only required to look into the existence of an arbitration agreement to refer the dispute to arbitration.

Considering that Garware Wall Ropes Ltd. Vs. Coastal Marine Constructions & Engineering Ltd.[1]  was affirmed by a Co-ordinate Bench in Vidya Drolia And Ors. v. Durga Trading Corporation[2], the 3-Judge Bench thought it fit to refer the matter to a Constitution Bench to settle the issue. However, in light of the abovementioned observations the Court held that the non-payment of the stamp duty on the main contract in which the Arbitration Contract is embedded will not render the Arbitration Clause/Agreement invalid and unenforceable.

Discussion/Findings:

The Majority Decision differed from the 3-Judge Bench and discussed the provisions[1] of Stamp Act which are relevant to Arbitration Act. It was held that the Stamp Act is a fiscal measure which is intended to be implemented in its entirety to protect revenue and opined “The duty of a Court must be to adopt an interpretation which results in the enforcement of the law, rather than allowing the law to be flouted with impunity.” Hence the doctrine of severability which entails that the invalidity of the underlying contract in which the Arbitration Clause/Agreement is embedded would not affect the validity of the arbitration agreement since it is separate from the underlying contract and remarked that Law of Arbitration is an evolving law and it “focuses on substance over form.”  It was further observed that although an arbitration agreement is liable to stamp duty under the residuary entry, the technicality of stamping places hurdles in ensuring efficiency and efficacy in arbitration proceedings and an arbitration agreement does not even mandatorily require signature for it to be valid as per Section 7 of the Act.

The Supreme Court further opined that the findings in 3 Judge-Bench that the argument that an arbitration agreement being an independent contract would not be invalidated upon the non-stamping or insufficient stamping of the underlying contract would not serve any purpose. Moreover, stamp duty is to be levied on the arbitration agreement being an independent agreement. Therefore, the rationale that the 3 Judge-Bench adopted to hold that a standalone arbitration agreement not being eligible to duty does not stand. In this regard, reference was made to Article 5 of the Stamp Act. The Supreme Court expressed that parties may act upon an unstamped agreement and transact amongst themselves by virtue of such agreement, but the State will not extend its protection in such cases and the rights which would have been available if the agreement was stamped would not exist.

The Hon’ble Court further opined that what Section 11(6A) contemplates is a contract and it is not an agreement which cannot be treated as a contract. This is despite the use of the words ‘arbitration agreement’ in Section 11(6A). In other words, contract must conform to Section 7 of the Act. And hence an unstamped agreement which is unenforceable in law and would not be a contract under Section 2(h) of the Contract Act, 1872, therefore un-stamping of an agreement which is otherwise required to be stamped is not merely a “curable defect”. Such agreement cannot be taken notice of for any other purpose as contemplated under Section 35 of the Stamp Act. Supreme Court further held that Section 11(6A) of the Arbitration Act cannot be understood as merely predicating for an arbitration agreement “existing” literally but it relates to existence in law. This means that the mere existence of the arbitration agreement for all intents and purposes on the exterior purporting to project a contract duly executed, may in certain situations, be insufficient under Section 11. If for reasons such as it being unstamped  when it is clearly required to be stamped, then it cannot be said to be a case where the agreement exists for it would be no existence in law.

Based on the above reasons, the Supreme Court approved the judgements, namely, SMS Tea Estates (P) Ltd. v. Chandmari Tea Co. (P) Ltd.[1], Garware wall Ropes (supra), Dharmaratnakara Rai Bahadur Arcot Narainswamy Mudaliar Chattram and other Charities v. Bhaskar Raju and Brothers[2] and Vidya Drolia (supra) and conclusively held that only on the basis of a prima facie finding an arbitration agreement existing between the parties, it would not be permissible to refer the matter to the arbitration.

Conclusion:

This hyper technical judgment has settled the position that the necessary stamp duty must be paid for an arbitration agreement for enforcing the main contract, further it has been made clear that it is mandatory for Court to decide this question at pre referral stage. The decision in this judgement does not augur well with India’s pro-arbitration stance as it is likely to create further delays in appointment of arbitrators by adding an additional layer of scrutiny and will also increase judicial workload. This judgement might be counterproductive in projecting India as an arbitration-friendly jurisdiction and can have ramifications on India’s liberal and pro-arbitration approach.

It is thus advisable now to ensure that the correct stamp duty is paid on contracts containing arbitration clauses, to avoid any judicial delays at pre-referral stage.

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