Impact of Assignment and Novation on Arbitration Agreements

[Kunal Kumar is 4th Year B.A., LL.B. student at National Law University, Jodhpur]

Introduction

In light of the judgment delivered by the Supreme Court in BALCO, Part I of the Indian Arbitration and Conciliation Act, 1996 (the “Act”) has no applicability to foreign-seated arbitration (except in case of agreements concluded prior to the judgment), and the parties shall be referred to arbitration under section 45. The only bar to refer parties to foreign-seated arbitrations are those which are specified in section 45 of the Act,[1]  which makes it clear that if there is prima facie evidence of a valid arbitration agreement, the dispute should be referred to arbitration.

In World Sport Group, the Supreme Court held that a judicial authority, when seized of an action in a matter in respect of which the parties have made an agreement referred to in section 44 shall, at the request of one of the parties, refer the parties to arbitration, unless it finds that the said agreement is null and void, inoperative or incapable of being performed.

Determining the validity of the agreement: does the assignment or novation of the agreement make it invalid?

If the agreement entered between the parties does not suffer from any lacuna, there is no fraud or misrepresentation which could have led the agreement to be null and void, and consent given by the appellant therein is qualified consent, the arbitration agreement will be a valid agreement and the parties shall have to be referred to arbitration. The Delhi High Court held in Mcdonalds that if the arbitration agreement is affected by some invalidity since its inception, such as lack of consent due to misrepresentation, duress, fraud or undue influence, then it is said to fall within the meaning of the expression ‘null and void’ under section 45.

The word “inoperative” can be said to cover those cases where the arbitration agreement has ceased to have effect, such as revocation or when an arbitral award has already been passed. The words “incapable of being performed” applies to those cases where the arbitration cannot be effectively set into motion.[2]

Assignment & Novation: Assignment of an arbitration agreement by substituting a third party is a valid procedure. It was observed in Kotak Mahindra Prime Ltd. v. Sanjeev that the assignability depends on the subject matter of the arbitration agreement and the assignment is regulated under the law of assignment of contractual rights and obligations.

But, under section 62 of the Indian Contract Act, 1872 ,when the main agreement is novated, rescinded or altered, it loses its validity and hence the arbitration agreement becomes void. The principle is that if the contract is superseded by another, the arbitration clause, being a component part of the earlier contract, falls with it.

However, courts have relied on the doctrine of severability to refer the dispute to arbitration. As held in Delhi Metro case, an arbitration agreement when assigned to a substituted third party will not novate the agreement and the obligations will flow from the main agreement which would have to be observed.

Severability of the arbitration agreement from the main contract

It is a well accepted jurisprudence that the arbitration agreement can be severed from the main agreement subsequent to its termination.[3] As severability tends to insulate the arbitration clause, it ensures that the arbitration shall be given effect provided severability of the arbitration clause is possible.

It was observed by the Supreme Court in Today Homes and Infrastructure Pvt. Ltd., the arbitration agreement being a separate agreement does not stand vitiated if the main contract is terminated, frustrated or is voidable at the option of one party. The contrary opinion that the parties should not be referred to arbitration as all rights and liabilities flowing from the agreement get extinguished with termination of the main agreement, and nothing is left for the tribunal to decide, is not sustainable.

Article 6(4) of the ICC Rules of Arbitration permits the arbitral tribunal to continue to exercise jurisdiction and adjudicate the claims even if the main contract is alleged to be null and void or non-existent because the arbitration clause is an independent and distinct agreement.

The crucial test, as laid down in the case of Enercon (India) Limited, places reliance on the intention of the parties to arbitrate. If parties have agreed to resolve all their disputes by arbitration, they cannot at a later stage avoid such an arbitration agreement. In Chatterjee Petroleum Company & Ors., it was observed that once the parties have agreed for arbitration, the Court should give effect to the arbitration agreement and litigation should not be resorted to.

Conclusion

Thus, in a foreign-seated arbitration, under section 45 of Act the courts shall have to refer the dispute to arbitration unless the arbitration agreement has become null and void, inoperative or incapable of being performed. As discussed above, an assignment and novation of the main agreement shall not be treated as a bar to refer the dispute to arbitration. Even if the main agreement gets terminated because of novation, the arbitration agreement can be severed from the main agreement to give effect to the intention of the parties.

Party autonomy is a foundation stone in the success of building the whole process of arbitration. Intervention by the national courts, if excessive or too intrusive, will defeat the whole arbitration process, destroying its sanctity and benefits; and in the long term may lead to crumbling of the institution of arbitration.

– Kunal Kumar

[1] Shin-Etsu Chemical Co. v Aksh Optifibre, (2005) 7 SCC 234.

[2] Albert Jan Van Den Berg, The New York Convention, 1958: An Overview at p. 11.

[3] Mulheim Pipe coatings GmbH v. Welspun Fintrade Ltd. and Anr. (Bom HC, 2013).

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