Just Stamp it!

Arbitration is an alternative dispute resolution method based on the consent of the parties, which is often preferred to domestic judicial systems for the resolution of disputes arising from commercial/contractual relationships. A dispute may be settled by arbitration where the parties have voluntarily entered into an arbitration agreement. Thus, as long as the subject matter of the dispute is arbitrable, the parties may decide to resolve the dispute through arbitration.

An arbitration agreement might be entered into as a separate agreement, or as a proviso under the original contract between two parties. Arbitration agreements concluded within a contract are defined as “arbitration clauses”. In practice, almost all arbitration agreements are concluded in the form of arbitration clauses.

Although the arbitration clause is a part of the underlying contract, they are essentially independent of each other. This is called the “separability”, “severability” or “autonomy” of the arbitration clause. This article will focus the principle of “severability” of the arbitration clause.

Principle of Severability

In various cases disputes arise with respect to the validity of the contract including the arbitration agreement itself e.g., a party may claim that the contract including the arbitration agreement was not executed and as such, is invalid. However, in order to carry out arbitration proceedings, the arbitration clause should remain uninfluenced by the claim of invalidity of the contract. In this context, the doctrine of severability has been introduced and accepted in the practice of arbitration. The severability of the arbitration clause from the underlying agreement/contract has been accepted as a principle which allows for arbitration to proceed notwithstanding the fact that the validity of the agreement/contract which incorporates such an arbitration clause, is itself under challenge.

According to the severability principle, the invalidity of the underlying agreement will not have an impact on the arbitration clause; likewise, the invalidity of the arbitration clause will not render the underlying agreement invalid.

Consequently, regardless of whether the original contract is pronounced invalid for any reason, the arbitration clause will remain valid; on the other hand, if the arbitration clause is invalid, the original agreement will remain valid and the dispute emerging from the underlying agreement will be resolved before domestic courts.

Indeed, the arbitration clause and the underlying agreement are two different agreements despite the fact that both exist within the same text/document. While the underlying agreement creates a relationship of obligation between the parties, the arbitration agreement solely addresses the mechanism of settlement/resolution of disputes between the parties.

Due to aforementioned reasons, the principle of severability establishes that the arbitration agreement and the underlying agreement are independent and the arbitration agreement shall not be affected when the main contract is rendered invalid.

Nevertheless, this principle doesn’t mandatorily require that the “fate” of these two agreements is always distinct. Certain reasons negating the original agreement may influence the legitimacy of the arbitration agreement as well. For example, where either or both parties to the dispute are found to lack the capability to have entered into the agreements, both agreements will be considered invalid.

The Arbitration Act was legislated and passed by the parliaments of countries like India and England in 1996 in accordance with, The UNCITRAL Model Law on International Commercial Arbitration of 1985 signed by the member nations who have signed and ratified the convention. Section 7 of Arbitration Act, 1996 (UK) and Section 16(1)(b) of, The Arbitration and Conciliation Act, 1996 (India) clearly adopt the doctrine of severability. A decision by the arbitral tribunal that the agreement is invalid and void shall not involve ipso jure the invalidity of the arbitration clause. The entry of this doctrine to India was because of the enactment of the new Act and the contemporary laws on arbitration confirm the concept. The United States Supreme Court in the judgment in Buckeye Check Cashing, Inc. vs. Cardegna 546 U.S. 440 (2006) acknowledged that the Severability rule permits a court “to enforce an arbitration agreement in a contract that the arbitrator later finds to be void”.

Similarly, the English High Court in Beijing Jianlong Heavy Industry Group vs. Golden Ocean Group Limited & Ors [2013] EWHC 1063 (Comm) recently addressed the issue of the Severability of arbitration agreements and the circumstances in which public policy factors invalidating the underlying contract may also impeach an arbitration clause. In its pro-arbitration conclusion, the court reinforced the strength of “powerful commercial factors” which weigh in favour of upholding an agreement to arbitrate.

The rule stems from the case of Harbour Assurance Co (UK) Ltd vs. Kansa General International Assurance Co. Ltd. and Others ([1993] 3 All ER 897) and was subsequently enshrined in Section 7 of Arbitration Act (UK). The practical impact of the rule is that unenforceability of the original contract doesn’t automatically render an arbitration agreement contained within it unenforceable. Without the rule, an arbitral tribunal would always be prevented from addressing any dispute which brought up an issue about the legitimacy or presence of the agreement containing the arbitration agreement. Beijing Jianlong represents the principle that whether or not the contract will be struck down relies on the nature of the public policy rule that nullifies the underlying contract.

In the authors opinion, the effect of the severability of arbitration agreements upon the choice of applicable law should also be analyzed; i.e. whether the law applicable to the underlying agreement will be, automatically, different from the law applicable to the arbitration agreement by reason of its severability. In other words, is the choice of law that applies to the original contract also applicable to the arbitration agreement?

This issue is especially important for arbitration clauses. Choice of law and arbitration clauses are often stipulated in international agreements; either as part of the same phrase, or as two paragraphs of the same article, or as consecutive articles. Therefore, it should be analyzed on a case to case basis whether or not the applicable law stated in the choice of law clause would apply to the arbitration agreement or not.

Unstamped Arbitration Agreement

The doctrine of severability of arbitration agreements has been adopted and practiced in a full-fledged manner by the Indian courts. The Full Bench of the Bombay High Court reserved its judgment on 1st March 2019, on a reference made to it on the interpretation of Section 11(6-A) in Vijay Sharma v. Vivek Makhija and anr (Arbitration Application No. 300 of 2018). The issue in Vijay Sharma was whether in view of Section 11 (6-A) it would be necessary for the Court passing final orders under Section 11(6) to await the adjudication by stamp authorities in a case where a document containing an arbitration clause is not properly stamped. The other issue before the Full Bench in the connected matter of Gautam Landscapes Pvt. Ltd. v. Shailesh S. Shah (Arbitration Petition No. 466 of 2017) was whether a Court can grant interim or ad-interim relief in an application under Section 9 of the Arbitration Act when a document containing an arbitration clause is unstamped or insufficiently stamped. The judgment was delivered by the Full Bench on 4th April 2019. The Full Bench after considering Section 11 (6-A) and TRF Limited v. Energo Engineering Projects Limited [(2017) 8 SCC 377, 401 paragraph 42,43], Duro Felguera S.A. v. Gangavaram Port Ltd. [(2017) 9 SCC 729], Vidya Drolia and others v. Durga Trading Corporation (Civil Appeal No. 2402 of 2019) came to the conclusion that it would not be necessary for the Court hearing an application under Section 11(6) to await the adjudication by the stamp authorities in a case where a document containing an arbitration clause is not properly stamped. The Full Bench in paragraph 102 of its judgment was of the view that pursuant to Section 11(6-A) being imported into the Arbitration Act the issue of “sufficiency or otherwise” of stamp duty on the said agreement “can be left to the decision of the arbitral tribunal.” The Full Bench also held that a Court can grant interim or ad-interim relief under Section 9 of the Arbitration Act when a document containing an arbitration clause is unstamped or insufficiently stamped. No sooner did the Full Bench of the Bombay High Court deliver its judgment that the same was partially overruled by the Supreme Court vide a judgment dated 10th April 2019, delivered in Garware Wall Ropes Ltd. v. Coastal Marine Constructions & Engineering Ltd. (Civil Appeal No. 3631 of 2019 paragraph 25) (hereinafter referred to as “Garware”). The Supreme Court in the said case was hearing an appeal that arose out a decision of the Bombay High Court in Coastal Marine Constructions & Engineering Ltd. v. Garware Wall Ropes Ltd. (MANU/MH/0416/2018) in which the Single Bench of the High Court had held that the Court can refer disputes to arbitration if a document containing an arbitration clause is unstamped. Allowing the appeal and setting aside the decision of the Single Bench of the Bombay High Court, the Supreme Court in Garware held in paragraph 27, “….the High Court must impound the instrument which has not borne stamp duty and hand it over to the authority under the Maharashtra Stamp Act, who will then decide issue qua payment of stamp duty and penalty (if any) as promptly as possible, and preferably within a duration of 45 days from the date on which the authority receives the instrument. As soon as stamp duty and penalty, if any, are paid on the instrument, any of the parties can bring the instrument to the notice of the High Court, which will then be proceeding to expeditiously hear and dispose of the Section 11 application.”  The Supreme Court in Garware in paragraph 24 also held that the arbitration clause contained in the sub-contract in the said case “would not “exist” as a matter of law until the sub-contract is duly stamped…”. In the very same paragraph, the Court also stated, “The argument made that Section 11(6-A) deals with “existence”, as opposed to Section 8, Section 16, and Section 45, which deal with “validity” of an arbitration agreement is answered by this Court’s understanding of the expression “existence” in United India Insurance Co. (supra), as followed in our observation.”

Conclusion

The very purpose of the Arbitration and Conciliation Act and the amendments thereto, along with the Arbitration and Conciliation Act (Amendment) Bill, 2018 is to encourage the parties to resolve matters by arbitration rather than pilling up the load on the courts. The supreme objective of this particular legislation is to encourage arbitration and the sole role of the courts is supposed to be, to just ensure that the arbitration agreement is valid and the job of the arbitrator is to then go into the merits of the case and also primarily see that the arbitration agreement is enforceable by law. The issue with Garware is that the court is considering stamping of an agreement to be paramount, but at the very same time, the court has not considered the fact that the arbitration agreement according to Section 7(4) (b) and (c) can be in the form of letters, telex, telegrams or in the electronic form and also in form of statements of claim and defence in which the existence of the agreement is professed by one party and not opposed by the other. Therefore, the chief argument here is that the arbitration agreement is not always a part of the main contract/agreement as the arbitration agreement can also be formulated at a later stage where when the issue between the two parties has already arisen and also when, as mentioned above, the agreement can also be in form of letters or electronic communication or in form of a statement which isn’t supposed to be stamped according to the Stamp Act.

Let us consider a situation where parties enter into an arbitration agreement, after disputes have arisen, to resolve the same by arbitration. In such a case, because the arbitration agreement is not contained in a document which ought to be stamped, the Court will have to send the parties to arbitration because the arbitration agreement by itself is not required to be stamped. Therefore, for the same dispute, in a case where the arbitration agreement is contained in the document/contract which ought to be stamped, the Court shall direct the parties to first deposit the stamp duty/penalty etc. as per Garware, and where the arbitration agreement exists as an independent arbitration agreement, the court shall send the parties for arbitration.

Now lets us consider a situation where parties were to enter into an arbitration agreement by writing an arbitration clause subsequent to the disputes having arisen, on the document which ought to be stamped and execute the same… What would happen in such a case? Would the courts impound it and direct the parties to pay the stamp duty/penalty or send the parties to arbitration? The decision in Garware leaves such issues open and it is the authors opinion that the said decision goes against the fundamental principle of severability of the arbitration agreement.

The Indian Law surely comes in the way of the arbitrator who cannot rely upon the terms of an agreement which ought to have been stamped and as such, makes this argument of severability academic, where the instrument would first have to be impounded by the court/statutory authority and stamped as per law for it to be considered as evidence. Perhaps this was weighing on the mind of the court when the Judgment in Garware was passed. But the decision, as discussed above, counters the principle of severability of the arbitration agreement when courts globally are adopting a pro-arbitration approach.

Authored By:

Pratyush Miglani, Founder & Managing Partner

Miglani Varma & Co.

Pratyush Miglani

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