Supreme Court judgment on 25 April 2023 (NN Global Mercantile Pvt Ltd v Indo Unique Flame Ltd) finally settled the ongoing legal conundrum of the enforceability of an arbitration agreement in an unstamped contract.
In a 3:2 majority, a constitution bench of the Supreme Court held that unstamped or insufficiently stamped agreements are not enforceable in law. Therefore, an arbitration agreement within the meaning of section 7 of the Arbitration and Conciliation Act, 1996, which attracts stamp duty if not stamped or insufficiently stamped, cannot be acted upon unless it is validated under the Stamp Act.
The background to this finding is:
- Respondent Indo Unique Flame was awarded a work order from Karnataka Power Corporation (KPLC). Indo Unique furnished a bank guarantee in favour of KPLC. Subsequently, Indo Unique entered into a subcontract work order with NN Global Mercantile (the appellant) to transport coal. The arbitration agreement was embodied under clause 10.
- A series of proceedings commenced before the Nagpur Commercial Court, later challenged by Indo Unique before the Bombay High Court. The high court rejected the commercial court’s findings and allowed the application under section 8 of the act by holding that there was a valid arbitration agreement, rejecting the contention that the alleged fraudulent invocation of a bank guarantee under the contract could not be resolved through arbitration.
- The court held that the issue of non-stamping of the work order could be raised at the stage of section 11 of the act, or before the arbitral tribunal at any other appropriate time.
NN Global Mercantile filed an appeal before the Supreme Court of India contending that since the subcontract was not stamped under the Maharashtra Stamp Act, 1958, the arbitration agreement would be unenforceable. A three-judge bench of the Supreme Court held that in case of an application filed under section 9 of the act, praying for urgent ad interim relief with respect to the substantive contract not duly stamped, the court would grant ad interim relief to safeguard the subject matter of the arbitration.
Further, the substantive contract would be seized, and the party concerned would be directed to take the necessary steps for payment of stamp duty as per the provisions of the relevant Stamp Act in a time-bound period.
The Supreme Court doubted the suitability of a cited previous decision, Garware Wall Ropes Ltd v Coastal Marine Constructions & Engineering Ltd (2019), which took the view that unless a subcontract was stamped, its arbitration clause would not exist as a matter of law. The division bench referred the matter to the constitution bench of the Supreme Court.
A majority opinion held that an instrument, which was eligible to stamp duty, may contain an arbitration clause and, which was not stamped, cannot be said to be a contract enforceable in law. An unstamped instrument, when it is required to be stamped, being not a contract and not enforceable in law, cannot exist in law. The court upheld the Vidya Drolia judgment, Vidya Drolia and others v Durga Trading Corporation (2021), and the reasoning of the Garware judgment.
The majority opinion further upheld the law affirmed in the Garware judgment as to the effect of an unstamped contract containing an arbitration agreement and the steps to be taken by the court, and opined that NN Global (the three-judge bench decision) was erroneously decided since it held contrary to the Garware judgment.
The court held that the doctrine of an arbitration agreement being a separate agreement (Doctrine of Kompetenz-Kompetenz) was well established. The efficacy of the arbitration clause in a contract is preserved, so that extinguishing the contractual obligations by termination or non-performance does not deprive the parties of their rights and the power of the arbitrator to adjudicate on disputes that otherwise fall within the ambit of the arbitration clause.
The underlying principle behind treating the arbitration agreement as a separate agreement is to create a mechanism that survives the contract so that disputes falling within the arbitration agreement are resolved. So, the rescission of the main contract would not result in the death of the arbitration clause.
However, proceeding on the basis that an arbitration agreement containing a clause in the main contract is a separate agreement and can exist independently, the fallacy behind such a line of argument is that there is a bar to the use of an instrument that is not stamped or insufficiently stamped for any purpose.
Unlike section 49 of the Registration Act, which allows an unregistered document to be used to prove a collateral transaction, an unstamped instrument that an arbitration clause is part of cannot be allowed to be used, as it would be allowing the instrument to be used to establish a collateral transaction.
Further, the majority opined that at the stage of section 11 of the above-mentioned act, the court is bound to examine the instrument, and if found to be unstamped or insufficiently stamped, the instrument is not to be acted upon. If a certified copy is produced at this stage, it must clearly indicate the stamp duty paid; otherwise, the court should not act on the certified copy.
In conclusion, the present judgment settled the dispute around the legality and the enforceability of an arbitration agreement in an unstamped or insufficiently stamped contract. However, the court also observed in the concluding paragraph of the judgment that the legal dispute revolving around the scope and ambit of section 9 of the act had been left unanswered, and it still stood referred to a constitution bench for adjudication.
The dispute digest is compiled by Numen Law Offices, a multidisciplinary law firm based in New Delhi & Mumbai. The authors can be contacted at firstname.lastname@example.org. Readers should not act on the basis of this information without seeking professional legal advice.