India: Impact Of An Unstamped Arbitration Agreement

1. Introduction

On April 25, 2023, a constitution bench consisting of five judges of the Supreme Court issued a split verdict in the case of N.N. Global Mercantile Private Limited v. Indo Unique Flame Limited¹. The decision was passed by a 3:2 majority. The ruling clarified that an arbitration agreement as well as an instrument containing an arbitration agreement, if unstamped or insufficiently stamped and exigible to stamp duty under the Stamp Act ("Stamp Act") cannot be considered as legally enforceable contract under the meaning of Contract Act ("Contract Act"). As explained below, the SC position on the subject was unclear with several conflicting position and, as a consequence, the matter was referred to a larger bench.

This newsletter focuses on the distinct views taken by the constitution bench and what it means for parties executing arbitration agreements.

2. Factual Background

Indo Unique Flame Ltd. ("IUFL") executed a contract with NN Global for transportation of coal. The contract contained an arbitration clause. A dispute arose between the parties where IUFL invoked the bank guarantee furnished by NN Global who, in turn, filed a civil suit against the invocation before the commercial court and obtained an ex-parte interim order against the invocation. In view of the arbitration clause, IUFL filed an application under section 8² of the Arbitration and Conciliation Act ("Act") before the commercial court seeking to refer the dispute to arbitration. NN Global opposed the application on the ground that bank guarantee was a separate contract and did not contain any arbitration clause. The commercial court rejected IUFL's application on the ground that the arbitration clause in the contract was not a general arbitration clause which would cover bank guarantee disputes.

Thereafter, IUFL filed a writ petition before the Bombay High Court, contesting the order of the commercial court, on the ground that the executed contract contained an arbitration clause which was binding on parties and the dispute could be arbitrated. NN Global opposed the writ petition and contended that the arbitration agreement cannot be enforced because the contract lacked stamping and unstamped contract are not enforceable in law. The Bombay High Court allowed the section 8 application which provides for referring the parties to arbitration by the judicial authority for the resolution of dispute and held that (a) a valid arbitration agreement existed, and (b) the contention of unenforceability due to unstamped contract could be raised at two stages, i.e., while filing an application under section 11³ of the Act or before the arbitral tribunal at the appropriate stage. Aggrieved by the decision of the Bombay High Court, NN Global filed a special leave petition before the SC, leading to a verdict by three-judge bench which was later referred to a constitution bench.

3. Jurisprudential Evolution

Prior to NN Global, a division bench of the SC in SMS Tea Estate (P) Ltd v. Chandmari Tea Co. (P) Ltd⁴ held that if a document is found to be unstamped or insufficiently stamped, then the arbitration clause in the contract would be examined by the concerned officials in accordance with section 35⁵ of the Stamp Act. This section mandates that, as required, an instrument should be stamped in order to make it admissible in evidence. The SC reinforced this position in Garware Wall Ropes Ltd. v. Coastal Marine Constructions & Engg. Ltd. Both SMS Tea Estate and Garware were later reaffirmed by a three-judge bench in Vidya Drolia⁶. In this case, the SC held that existence and validity are intertwined and an agreement containing arbitration clause will have to fulfil all the conditions for enforceability, and one of which is adequate stamping.

This position was questioned by a three-judge bench of the SC in N.N. Global Mercantile Private Limited v. Indo Unique Flame Limited⁷ ("NN Global-1") who observed that since an arbitration agreement is a distinct and separate contract, it cannot be invalidated merely by insufficiently stamped of the main contract. Given that the Vidya Drolia was also a three-judge bench judgment with a contrary view, in NN Global-1 the SC referred the issue to a larger bench of five judges for consideration. The primary issue before the constitution bench was (i) whether an arbitration agreement can be enforced if the necessary stamp duty is not paid, (ii) if an unstamped instrument would render the arbitration agreement invalid or void.

4. The Views of SC

Both the views – majority and dissent – of the SC are discussed below.

4.1 Majority: The majority decision of Justices Joseph Kurian, Aniruddha Bose and CT Ravi Kumar differed from the views expressed in NN Global-1 and overturned its ruling based on the following:

(a) Intertwining of Contract & Stamp Act: Before discussing the majority view, it is important to explain the statutory provisions regarding contracts. The Contract Act contains conditions regarding void and unenforceable contracts. Section 2(h) provides an agreement enforceable by law is a contract. This implies there must be an agreement and it must be enforceable. Only a valid contract is enforceable by law, and a contract must fulfil certain conditions to be valid. If any condition is not fulfilled that contract is deemed void. Section 10 addresses enforceability and provides that all agreements are contracts made by free consent of parties competent to contract, for a lawful consideration, with a lawful object and which are not expressly declared to be void. A contract which ceases to be enforceable by law becomes void when it ceases to be enforceable.

The majority noted that sections 2(g)⁸ and 2(j)⁹of the Contract Act and sections 33¹⁰ and 35 of the Stamp Act are intertwined with each other. This means that if a contracting party discovers that the necessary stamp duty has not been paid on the agreement, it can rectify the defect by paying the stamp duty and penalty, as may be determined by the concerned officials. If this is not done, the contract would be unenforceable and void under the Contract Act. Thus, SMS Tea Estate and Garware Wall Ropes Ltd represent the correct position in law.

(b) Section 11(6A) of the Act:¹¹ Section 11(6A) of the Act contains a restriction where the court is empowered to examine the existence of an arbitration agreement and not determine stamping. But the majority held that where an unstamped contract is produced in section 11 proceedings, the court is duty bound to examine the agreement and consider the stamping aspect as well. At the same time the SC stated that, if a party objects to an agreement being insufficiently or not duly stamped, and the court deems the objection to be baseless then it may refer the stamping issue to the arbitral tribunal.

4.2 Minority: The dissenting bench of Justices Ajay Rastogi and Hrishikesh Roy, reiterated the view taken in NN Global-1 and held that non-stamping or insufficient stamping of a substantive contract does not render the arbitration clause unenforceable since it is an independent clause. Specifically, they discussed the doctrine of separability. The minority maintained its view that an arbitration agreement is a distinct and separate agreement, independent from the substantive commercial contract. The doctrine of separability safeguards the arbitration clause from the main agreement to ensure there is no hindrance or delay on its enforceability. The minority asserted:

• the court cannot void an arbitration agreement on account of insufficient stamping since section 11 limits the scope of examination to the existence of an arbitration agreement and not its validity.
• section 35 of the Stamp Act allows the parties to correct the stamping deficiency. An instrument which is unstamped or insufficiently stamped may be admissible if the relevant stamp duty and a penalty is paid later.
• the issue of stamping should be decided by the arbitral tribunal.

The dissent emphasised the Act's objective which is to avoid procedural complexity and delay in litigation. Impounding an arbitration agreement at the pre-referral stage by the court could frustrate this very purpose.

5. Conclusion

The conclusive determination by the SC establishes that parties executing agreements on plain paper could run into challenges when disputes arise. An arbitration clause is a common provision in all contracts and for it be enforceable, the entire agreement must be stamped. This will minimize the risk of technical challenges and corresponding delays by raising the question of existence or adequacy of the stamp duty paid. It is also necessary that parties remain cognizant of the exact value of the stamp duty to be paid on the entire contract, in accordance with the Stamp Act. In case of deficiency, they must cure the defect, pay the remaining amount and corresponding penalty to minimize and avoid judicial delays. Hence, it is best to re-assess the practice of executing agreements on plain paper and, instead, pay the necessary stamp duty.

Footnotes

1 N.N. Global Mercantile (P) Ltd. v. Indo Unique Flame Ltd., 2023 SCC Online SC 495

2 This provision states the power of the court to refer parties to arbitration where such a contract exists

3 This clause provides for appointment of arbitrator by court where parties fail to agree

4 SMS Tea Estate Pvt Ltd v. Chandmari Tea Co. Pvt. Ltd (2011) 14 SCC 66

5 This provision does not allow an instrument chargeable with the duty to be admitted as evidence if it is not duly stamped

6 Vidya Drolia and Others v. Durga Trading Corporation, (2021) 2 SCC 1

7 N.N. Global Mercantile Private Limited v. Indo Unique Flame Limited (2021) 4 SCC 379

8 This section provides if an agreement is not enforceable by law, then it is void

9 This section stipulates where a contract, which ceases to be enforceable by operation of law, becomes void when it ceases to be enforceable

10 This section provides that public officials are obligated to examine every instrument chargeable with stamp duty which comes before them and to impound any instrument which appears not to be duly stamped

11 This provision envisages that court while appointing an arbitrator should confine their examination to the existence of an arbitration agreement

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