India: Vidya Drolia v. Durga Trading Corporation | An Explainer

Introduction

In February 2019, a division bench of the Supreme Court of India ("SC"), while considering the arbitrability of tenancy disputes under lease deeds in Vidya Drolia and Others v. Durga Trading Corporation and Others¹ disagreed with the ratio laid down by another division bench of the SC in Himangni Enterprises v. Kamaljeet Singh Ahluwalia². It was held in Himangni Enterprises³ that disputes arising out of lease deeds were governed by the Transfer of Property Act, 1882, hence, were non-arbitrable. Pursuant to the reference, a three-member bench of the SC recently passed a judgment⁴ ("Vidya Drolia"), inter alia, holding that lease deeds are arbitrable if they meet certain criteria. Apart from settling the conundrum around arbitrability of tenancy disputes under lease deeds, Vidya Drolia touched upon other legal positions in connection with the Arbitration and Conciliation Act, 1996 ("Act"). This article delves into the nuances of arbitration brought out in Vidya Drolia.

Vidya Drolia Explained

While considering whether lease deeds are arbitrable, the SC was tasked with the deeper analysis of two interconnected questions: (i) the meaning of non-arbitrability of a dispute and (ii) who decides the question of non-arbitrability.

What is 'non-arbitrability'?

Arbitrability was widely considered by the SC in Booz Allen⁵ and Ayyasamy⁶, which in broad strokes identified this to be a question for which the answers lie in the difference between actions in rem and actions in personam. It was observed that a right in rem protects the rights of the society at large and right in personam is for the protection of the individual. Therefore, actions in personam may be referred to arbitration. Booz Allen further went on to state that subordinate rights in personam arising out of rights in rem can be adjudicated by arbitrators.

While distinguishing between non-arbitrable claims and non-arbitrable subject matters, the SC held that 'the former may arise on account of scope of the arbitration agreement and also when the claim is not capable of being resolved through arbitration. Generally non-arbitrability of the subject matter would relate to non-arbitrability in law.'

To understand whether there is implicit non-arbitrability, one must look into the relevant statute to find whether parties are barred from 'contracting out and waiving the adjudication by the designated court or the specific public forum.'⁷. While examining the doctrine of election, Vidya Drolia holds that only when there is no inconsistency between the mandatory statute and arbitration agreement can it be said that a dispute is arbitrable. The decision of the full bench of the Delhi High Court holding that matters covered under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 are arbitrable was hence overruled.

On whether allegations of fraud can be made subject matter of dispute, the SC distinguished between contracts obtained by fraud and fraud committed after the execution of a contract. If the alleged fraud does not trigger section 17 of the Indian Contract Act, 1872, an arbitrator is competent to adjudicate on frauds committed in connection with civil disputes. Thus, Vidya Drolia overruled the legal position on arbitrability of fraud laid down in N. Radhakrishnan v. Maestro Engineers and Others⁸.

Lastly, Vidya Drolia puts forward a fourfold test to determine the arbitrability of subject matters of a dispute. The SC has made it clear that the test is not a straight jacket formula and exists for the purpose of gaining certainty to confirm whether the subject matter of the dispute would be non-arbitrable. A subject matter is non-arbitrable if:

1. it is an action in rem and no subordinate action in personam arises out of it.
2. it has the erga omnes effect, i.e., adjudication on the subject matter would affect individuals who are not parties to arbitration.
3. it involves inalienable functions of the state.
4. it is expressly or impliedly non-arbitrable by virtue of law.

By applying the above test, it was held that lease deeds are arbitrable if they are not covered under special statues.

Who decides 'non-arbitrability'?

To arrive at the answer, the SC examined the following circumstances: (i) when a request for reference to arbitration is sought before a civil court (section 8), (ii) when an application for appointment of an arbitrator is made (section 11), (iii) when arbitration has commenced but statement of defense is yet to be filed (section 16), and (iv) when an arbitral award is sought to be set aside (section 34).

Since the 2016 amendment of the Act, a court, under section 8, is statutorily required to examine the validity of the arbitration agreement. Under section 16, an arbitrator is empowered to decide on arbitrability. Should the question of arbitrability be decided in favour of the claimant, the defense may appeal under section 34 and challenge arbitrability.

As for section 11, the judicial view has evolved in four phases since the enforcement of the Act. Until 2005, the SC was of view that appointment of an arbitrator under section 11(6) was merely an administrative order⁹. In 2005, a constitutional bench of the SC constituting seven judges¹⁰ overruled this ratio. Thus, the scope of the courts under 11(6) was interpreted¹¹ as follows: the court must look into its own jurisdiction, existence of arbitration agreement and arraying of appropriate parties. The court may examine if the claim is time barred and whether the contracted is concluded. However, the court shall not consider the arbitrability and merits of the claim. It was also held that should an objection as to the arbitrability be raised on the ground that agreement was obtained by fraud, etc., the court would then be required to consider its validity.

With the amendment of the Act in 2016, the scope of courts under section 11(6) was curtailed with the introduction of section 11(6A) which required that a court must confine its findings only to the extent of existence of an arbitration agreement. Section 11(6A) later came to be omitted by way an amendment in August 2019.

With the above history in mind, Vidya Drolia, examines the principles of separability and competence-competence in the context of section 16 and held that 'the courts at the referral stage do not perform ministerial functions.' Section 16 gives the arbitration clause a life of its own. Therefore, for the purposes of both sections 8 and 11, 'the courts at the referral stage are not to decide on merits, except when permitted by the legislation either expressly or by necessary implication, such questions of non-arbitrability.'

While distinguishing between validity and arbitrability, the SC held that, 'only when the court is certain that no valid arbitration agreement exists or the disputes/subject matter are not arbitrable, the application under section 8 would be rejected. At this stage, the court should not get lost in thickets and decide debatable questions of facts. Referral proceedings are preliminary and summary and not a mini trial.' The SC positively steered clear from commenting on whether an on-going arbitration under section 8(3) must be stayed or deferred during the pendency of application under section 8(1).

With respect to section 11, Vidya Drolia holds that the mandate for a court is to satisfy itself as to the existence of an arbitration agreement. However, with abundant caution, the SC further states that 'The court is not powerless and would not act beyond jurisdiction, if it rejects an application for reference, when the arbitration clause is admittedly or without doubt is with a minor, lunatic or the only claim seeks a probate of a will.'

In effect, it is the arbitrator who has the authority under section 16 to consider arbitrability of a dispute. Once held to be arbitrable, the baton then gets passed on to the court under section 34 only for a 'second-look' on the question of arbitrability. While entertaining applications under sections 8 and 11, courts must restrict their examination to the existence of an arbitration agreement and not embark on determining arbitrability of the dispute. The judicial precedents on section 11 set prior to the 2016 amendment are no longer applicable despite the 2019 amendment.

Lastly, while considering the principles applicable in interpretation of arbitration clauses, the SC held that in purely commercial disputes, the principle of liberal interpretation must be adopted.

Conclusion

Through Vidya Drolia, the SC has taken a pro-arbitration stance by laying a catena of precedents. Lease deeds are arbitrable if they are not covered by special statutes. Allegations of fraud can be made subject matters of arbitration when they are in connection with a civil dispute, and do not have the seriousness of circumstances better described under criminal laws. It is the arbitral tribunal that has the first authority to determine arbitrability. The 'second-look' over arbitrability is conferred to the courts under section 34 of the Act. On rare occasions to protect parties to a dispute, the courts may, under sections 8 and 11, examine arbitrability when the very validity of arbitration agreement is put to question.

Footnotes

1. AIR (2019) SC 3498

2. (2017) 10 SCC 706

3. Supra

4. 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) decided on 14.12.2020

5. Booz Allen and Hamilton Inc. v. SBI Home Finance Limited and Others (AIR 2011 SC 2507)

6. A. Ayyasamy v. A Paramasivam and Others (AIR 2016 SC 4675)

7. Ibid

8. 2010 1 SCC 72

9. Konkan Railway Corporation Limited v. Mehul Construction Co. (AIR 2000 SC 2821)

10. SBP and Co. v. Patel Engineering Limited. and Others (AIR 2006 SC 450)

11. National Insurance Company Limited v. Boghara Polyfab Private Limited (2009 1 SCC 267)

Originally published May 31, 2021

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