Validity of Arbitration Clause in Unstamped Instruments: The Saga Continues

[Abhishek Mishra is an alumnus of Symbiosis Law School, Pune and practices at the Delhi High Court]

By way of its judgment dated January 11, 2021 in N.N. Global Mercantile Pvt. Ltd. v. Indo Unique Flame Ltd., the Supreme Court reopened the seemingly settled issue of whether non-payment of stamp duty on a contract will invalidate the constituent arbitration clause as well. Due to contrary judgments pertaining to the same, the Supreme Court referred the issue to a Constitution Bench of five judges for closing the Pandora’s box. This post seeks to analyse and discuss the position of law on the consequence of non-payment of stamp duty on the constituent arbitration clause. It will analyse the shift of the Supreme Court from a pro-judicial intervention to pro-arbitration approach.

Position prior to N.N. Global  

The first decision of the Supreme Court pertaining to this issue was pronounced in SMS Tea Estates Private Limited v. Chandmari Tea Company Private Limited. In this case, a lease deed was executed with respect to two tea estates. Clause 35 of the deed provided for settlement of disputes between the parties by arbitration. However, the lease deed was unregistered and unstamped.

With respect to the validity of the arbitration clause contained in an unregistered (but compulsorily registrable) instrument, the Supreme Court relied upon section 49 of Registration Act, 1908. The proviso to this section elucidates exceptions in which such an instrument can be received as evidence of any transaction affecting such property. The proviso states that it may be received as evidence of any collateral transaction not required to be effected by registered instrument. Applying the doctrine of separability, the Supreme Court held that an arbitration clause in a contract is a collateral term relating to the resolution of disputes and has nothing to do with the performance of the contract. Therefore, there are two independent documents:

(a) the substantive contract which requires registration; and

(b) the arbitration agreement which is not compulsorily registrable.
The Supreme Court concluded by stating that an arbitration agreement does not require registration under the Registration Act and, thus, can be enforced for the purpose of arbitration.

With respect to the validity of the arbitration clause in an unstamped instrument, the Supreme Court relied on sections 33 and 35 of the Indian Stamp Act, 1899. Section 33 of the legislation relates to the examination and impounding of instruments and section 35 provides that instruments not duly stamped are inadmissible in evidence and cannot be acted upon. At this juncture, it is essential to note that the Supreme Court rejected the application of doctrine of separability to an unstamped instrument containing an arbitration clause only for the reason that section 35 did not contain a proviso like the one in section 49 of the Registration Act, 1908. Therefore, the Supreme Court held that as the arbitration agreement is also a part of the instrument, it cannot be acted upon unless the stamp duty and penalty is paid. Interestingly, the Supreme Court failed to consider the fact that according to section 3 read with schedule I of the Indian Stamp Act, 1899, an arbitration agreement is not liable to be stamped. Only an arbitration award is liable to be stamped.      

The next landmark judgment pertaining to this issue was pronounced by the Supreme Court in Garware Wall Ropes Limited v. Coastal Marine Constructions and Engineering Limited. The issue in this case related to the stage at which the unstamped instrument is to be impounded: by the judge hearing an application under section 11 of the Arbitration and Conciliation Act, 1996 or by an arbitrator appointed under that section. This arose due to the insertion of section 11(6-A) by way of the Arbitration and Conciliation (Amendment) Act, 2015. Section 11(6-A) of the Arbitration and Conciliation Act, 1996 was inserted to confine the Supreme Court or the High Court to the examination of the existence of an arbitration agreement. The counsel for Coastal Marine Constructions and Engineering Limited argued that this amendment eroded the basis of SMS Tea.

The Supreme Court upheld SMS Tea and rejected the submissions of counsel for Coastal Marine Constructions and Engineering Limited on the basis of the following:

(a) When an application under sections 11(4) or 11(6) of the Arbitration and Conciliation Act, 1996 is filed, the Supreme Court or High Court is required by the Indian Stamp Act, 1899 to first impound and ensure that stamp duty and penalty is paid for the agreement as a whole before it can be acted upon. The Indian Stamp Act applies to the entire agreement as a whole and it is not possible to bifurcate the arbitration clause so as to give it an independent existence.

(b)   Sections 11(6-A) and 7(2) of the Arbitration and Conciliation Act, 1996 read with section 2(h) of the Indian Contract Act, 1872 provides that the arbitration clause in an agreement would not exist when it is not enforceable in law.

(c)   The arbitration clause in an agreement would not ‘exist’ as a matter of law until the agreement is duly stamped.

Moreover, the counsel for Coastal Marine Constructions and Engineering Limited argued that if an unstamped instrument containing an arbitration clause is impounded by the judge at the stage of application filed under section 11(6) of the Arbitration and Conciliation Act, 1996, then the 60-day period provided under section 11(13) would be breached. The Supreme Court relied upon the doctrine of harmonious construction to harmonise sections 33 and 34 of the Maharashtra Stamp Act, 1958 with section 11(13) of Arbitration and Conciliation Act, 1996 by providing an elaborate procedure that is to be followed for expeditious appointment of an arbitrator. Therefore, the Supreme Court upheld judicial intervention for impounding an unstamped instrument containing an arbitration clause.  

Shift in the approach of the Supreme Court: N.N. Global

The judgment of the Supreme Court in N.N. Global signifies a complete overhaul in the approach of the Court regarding the validity of an arbitration clause in an unstamped instrument. The Supreme Court held that an arbitration agreement is separate and distinct from the substantive commercial contract on the basis of two principles: the doctrine of separability and kompetenz – kompetenz. While the doctrine of separability has been discussed earlier, principle of kompetenz – kompetenz is relatively unexplored. This principle states that the arbitral tribunal is competent to determine and rule on its own jurisdiction, including issues of existence, validity and scope of arbitration agreement. The ruling of the arbitral tribunal is subject to judicial scrutiny by courts at a later stage. This legislative policy of minimal interference has been statutorily recognized by the Arbitration and Conciliation Act, 1996 by the following provisions:

(a)  section 5 prohibits judicial intervention except as specified in Part I of the Arbitration and Conciliation Act, 1996; and

(b) section 16 explicitly empowers the arbitral tribunal to rule on its jurisdiction and also recognizes the independent existence of an arbitration clause.
With respect to the specific issue of validity of arbitration clause contained in an unstamped instrument, the Supreme Court held that according to Maharashtra Stamp Act, 1958 (which was the legislation applicable in Garware as well), the arbitration agreement is not included as an instrument chargeable to Stamp duty. Therefore, due to the doctrine of separability, the arbitration clause will exist independently and would not be rendered invalid on account of non-payment of stamp duty as the same is not chargeable to it.

On this basis, the Supreme Court overruled the judgment in SMS Tea. Further, the Supreme Court stated that the judgment in Garware was affirmed by a coordinate bench in Vidya Drolia v. Durga Trading Corporation. Therefore, the Supreme Court referred the issue to a constitution bench of five judges of the Supreme Court.

Comments & Conclusion

This judgment of the Supreme Court in N.N. Global plays an essential role in righting the wrongs caused by SMS Tea and Garware. The non-application of the doctrine of separability in unstamped instruments but not in unregistered instruments brought up contradictory legal positions. Further, the increased scope of judicial scrutiny in section 11 applications caused enormous burden on the courts to deal with every issue possible regarding the ‘existence’ of an arbitration agreement. This judgment passes the same to the arbitral tribunals which are better equipped to deal with ‘existence’ issues. Moreover, N.N. Global also signifies a tectonic shift of the approach of the Court from increased judicial intervention to pro-arbitration, which has been developing since the Arbitration and Conciliation (Amendment) Act, 2015. With ambitions of becoming the next global arbitration hub, the same is necessary for increasing the confidence of stakeholders in India’s arbitration framework. Now, the burden is on the five judge constitution bench to decide the issue once and for all.            
Abhishek Mishra

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