Arbitrability of Disputes – Vidya Drolia vs Durga Trading Corporation

Settling the conundrum regarding arbitrability of Disputes: Analysis of Vidya Drolia v. Durga Trading Corporation

Dated: December 14, 2020

Civil Appeal No. 2402 of 2019

Bench: Justice N.V. Ramana, Justice Sanjiv Khanna and Justice Krishna Murari JJ

Introduction

There has been a long due controversy revolving around the issue of determining subject matter dispute being capable of arbitration or not. The recent judgement of the apex court in Vidya Drolia v. Durga Trading Corporation (‘2020 Case’) provides finality to the question of arbitrability of disputes, particularly tenancy disputes, in domestic arbitration framework of India. Moreover, the judgement addresses significant issues pertaining to arbitrability of disputes related to fraud with an affirmative approach. The judgement has made the presumption in the favour of the arbitrability of tenancy and fraud disputes in the landscape of arbitration in India.

The deterrent outlook, prior to said position of law, traces its foundation on previously held belief which pertains to sheer refusal of any kind of reference to arbitration on mere allegation of fraud as a justifiable ground owing to public policy reasoning. However, the tables have turned towards a pro- arbitration approach after 2020 Case which recognises arbitration as a more effective and just alternative as opposed to traditional dispute resolution systems. The arbitral process of dispute resolution has proven to be more efficient and fairer with regard to disposal of disputes relating to such nature than traditional settlement mechanisms.

The said article analyses the legal scenario with respect to arbitrability of fraud and tenancy disputes prior to the said judgement along with the shift in the line of perception of the courts while dealing with such issues. The shift from cautionary one to more progressive approach is critically analysed in the light of several judgements which have paved the way for prospective affirmations. Moreover, it discusses the consequent effects on the exception pertaining to fraud in the arbitrability of the disputes in the domestic framework.

Background

The progressive and liberal interpretation of the apex court in Vidya Drolia v. Durga Trading Corporation addressing host of crucial issues pertaining to domestic arbitration framework has provided certainty to the unsettling position of law in relation to arbitrability of disputes and, to some regard, extent of judicial intervention. However, there have been series of judgements that have contributed to the said conundrum at length in the backdrop. One such case was N. Radhakrishnan v. Maestro Engineers (“2010 Case”) wherein the apex court bluntly denied the arbitrability of disputes involving serious allegations of fraud.

The 2009 Case leaves the dilemma revolving around the term ‘serious’ as the judgement did not provide with any test for determination of scope and extent of ‘serosity’ with respect to allegation of fraud.  The factual matrix of the case revolving around malpractices in account books and manipulative finance are indicative of allegations of financial propriety as ‘serious’. Such interpretation reflects lack of confidence of judiciary in arbitration as a mechanism of dispute resolution in certain disputes. Moreover, it vitiates the mandate of positive reference to arbitration of disputes brought before a judicial authority under Section 8.

However, in Ayyasamy v. Paramasivam (“2016 Case”), the apex court list out bi-standards for determination of the scope of the term ‘serious’ in alleged fraud. The court observed that the allegations of fraud concerning private business of parties having no larger public ramifications could be considered for arbitration. Mere allegation of fraud would not result in annulment of the arbitration agreement between the parties unless such allegation makes out a criminal case touching upon the public domain. In the latter situation, the court will dispose of the application under Section 8 to proceed with the case of merits.

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Moreover, where fraud is infused in whole of the contract or in cases involving major allegations of forgery, tampering or fabrication of documents or where the fraud is seriously affecting the validity of arbitration agreement or clause, then the subject matter dispute involving such complicated allegations could not be referred to arbitration. Thereafter, on the similar lines, in Rashid Raza v. Sadaf Akhtar (“2019 Case”) the apex court expressly laid down two-prong test for determination of arbitrability of disputes involving allegations of fraud. Firstly, whether such allegations are infused in the entire contract covering the arbitration agreement and thereby invalidating the same. Secondly, whether such allegations touch upon the internal affairs of the parties inter se or have a bearing on larger public domain. Herein, the case was referred to arbitration owing to partnership dispute failing the two-pronged test.

Lastly, in Avitel Post Studioz Ltd. v. HSBC PI Holdings (Mauritius) Ltd. (2020 Judgement), the apex court examined the several tests evolved significantly post 2016 Case. For satisfying the criteria of first test, it must be clear that party against whom allegations have been imposed could not have prima facie entered into arbitration agreement, i.e., no such clause pertaining to arbitration can be said to have been in existence. And with regard to the second test, if the allegations relating to fraudulent, malafide or arbitrary conduct are made against the State or any of its instrumentalities, then the matter, being in public domain, is liable to be heard by the court exercising writ jurisdiction.

Timeline of the Dispute

1981- Natraj Studios (P) Limited v. Navrang Studios

The apex court, while upholding non-arbitrability of tenancy disputes, dismissed the application under Section 8 of 1996 Act for appointment of arbitrator on the ground of lack of jurisdiction. The tenancy disputes are governed by rent control legislations and relevant statutorily established courts will be having jurisdiction with regard to the same.

2011- Booz Allen & Hamilton Inc. v. SBI Home Finance Ltd

The apex court once again stipulated that eviction and tenancy matters are under the sole jurisdiction of special courts under rent control legislations and private forum like arbitral tribunal cannot exercise any kind of authority with respect to the same. Apart from holding such disputes to be non-arbitrable, the court laid down a guiding principle on arbitrability of disputes, i.e., disputes involving right in rem are not arbitrable (testamentary matters), however, at contrast, such involving rights in personam are arbitrable (those concerning individual rights).

2017- Himangni Enterprises v. Kamaljeet Singh Ahluwalia

Relying on aforesaid two cases, the apex court held that cases under Transfer of Property Act, 1882 (“1882 Act”) would be under exclusive jurisdiction of civil courts having jurisdiction to decide landlord-tenant dispute owing to public policy concerns and would not be arbitrable.

This has raised issues in two folds, i.e., one relating to extent of judicial intervention while dealing with application under Section 11 of Arbitration and Conciliation Act, 1996 (“1996 Act”) and other with regard to the arbitrability of tenancy disputes having rights in personam.

Judgement

On the question of subject matter arbitrability of other related disputes, the court elucidated that certain disputes which are not capable of being resolved and settled through arbitration. These tests are not restrictive in nature and must be applied pragmatically and holistically.

  1. When the subject matter dispute involves rights in rem which do not create any right in personam, i.e., when there is no subordinate right in personam arising out of right in rem.
  2. When the subject matter dispute has erga omnes effect, i.e., relating to rights of the third parties.
  3. When the subject matter dispute is significant from the point of centralised adjudication for being appropriately enforceable as opposed to mutual settlement.
  4. When the subject matter relates to functions of state concerning public interest and such sovereign functions which are inalienable in nature, thereby, making mutual adjudication by parties unenforceable due to larger public ramifications.
  5. When the subject matter dispute is either expressly or by necessary implication specified as non- arbitrable by mandate of the statute.
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In the light of the same, court held that disputes pertaining to allegation of fraud are neither vitiating the arbitration agreement nor affecting any rights in rem. As such disputes are not having any larger public ramifications, they would not be necessarily resolved in public forum, and thus are arbitrable. Moreover, the court has upheld the two-pronged test laid down in series of judgement and made it inclusive in the not-so-extensive test caved out in this case.

Applying the aforesaid test to disputes relating to bank recovery proceedings, the apex court overruling the case of HDFC Bank Ltd. v. Satpal Singh Bakshi by the High Court of Delhi, held that matters within the jurisdiction of Debt Recovery Tribunal (“DRT”) are non- arbitrable. It has been observed that DRT being a statutorily established body oust the jurisdiction of arbitral tribunal or any other private forum by necessary implication. The DRT Act defines specific rights of banks and institutions along with the modes of recovery, and therefore, arbitral institution is impliedly barred to waive jurisdiction of the DRT.

With regard to tenancy disputes, the apex court overruling Himangni Enterprises v. Kamaljeet Singh Ahluwalia (“2017 Case”) stated that such disputes governed by the 1882 Act are arbitrable as the rights involved in landlord-tenant disputes are creation of rights in personam arising out of rights in rem. Moreover, there would be no public policy violation as the provision of 1882 Act neither expressly nor by necessary implication bar the reference to arbitration. However, the arbitrator would be bound by the provisions of 1882 Act along with the object of ensuring adequate protection to tenants and effectively regulating the landlord- tenant relationships.

Moreover, those which are covered under the ambit of rent control act could not be subjected to arbitration as, being governed by a specific statute and having a statutory institution for adjudication of disputes, the right and obligations pertaining to landlord-tenant disputes are not enforceable through arbitral tribunal but are subjected to exclusive jurisdiction of special forum under rent control legislation. Thereafter, the court stated that the issue of non-arbitrability of a particular dispute can be raised at either of the three stages, namely,

  • Referral Stage– Before the court on application of stay on judicial proceedings and reference under Section 8 or for reference under section 11 of 1996 Act.
  • Arbitration Stage– Before the arbitral tribunal during the course of arbitral proceedings.
  • Challenging State– Before the court while challenging the awards or the enforcement.

The arbitral tribunal must be the first and foremost authority to decide on arbitrability of disputes owing to competence- competence doctrine under Section 16 of 1996 Act. The courts may delve into the question of arbitrability later on at challenging stage. The jurisdiction and power of judicial review of courts under Section 8 and 11 are identically restrictive. The judicial interference under referral stage is warranted only when it is manifestly established that arbitration agreement is invalid or non-existent or dispute is not capable of being arbitrated. On the question of facts, the principle of minimal judicial interference must be put to place and the tribunal should decide exclusively.

Critical Analysis

The apex court expatiated the findings made in 2020 judgement to highlight the reasoning in the favour of non-arbitrability of disputes involving allegation of serious fraud, especially, public policy considerations which demands such disputes to be adjudicated and resolved in public forum like court of law.  The court observed that the fraud exception has been resulted from misinterpretation of one of the grounds under Section 34 (2) (b) which was founded on the reasoning that even if reference to arbitration is not barred expressly or by necessary implication, the same can be barred on the grounds of public policy. The same misconstrued approach can be attributed to two reasons:

  1. Section 34 (2) (b) provide grounds for setting aside the arbitral award when (i) subject matter is incapable of being resolved by arbitration or (ii) award is contravening the public policy of India. Therefore, it is reflected that conflict with public policy and subject matter of dispute are two distinct and independent grounds. The arbitrability would be questioned on account of public policy violation only if a specific statute exists that grant exclusive jurisdiction to specialized courts, and not otherwise. The courts must ensure that the object of the act regarding promotion and development of robust arbitration framework must not be compromised on misconstrued notion of public policy considerations.
  2. The presumption of court’s effectiveness and fairness over arbitral tribunal is other such reason. This assumption undermines arbitration being a fair, just, impartial and effective dispute resolution mechanism providing quality representation to parties. It is evident that being a party driven process, skill and expertise of arbitrators is essential for fair, just and impartial attribution of the arbitral process. Moreover, parties are equipped with certain adequate safeguards under the act to deter any kind of abuse in the process. Thus, a prior presumption pertaining to arbitration as incapable of reaching a favourable outcome based of fair and just process, results in imperfect assumption of non-arbitrability of such disputes.
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Although the court has reflected the pro-arbitration approach with regard to tenancy and fraud disputes welcoming faith in arbitral process, but the expositions or arbitrability still suffers with major poison darts. With respect to disputes under the ambit of DRT, the court has ignored the position that owing to overburdening of statutorily established institutions, the bank recovery disputes have switched their ways to more efficient, equally just and fair, less time consuming, less efforts driven and more convenient mechanism of dispute resolution, i.e., arbitration. Moreover, in relation to intracompany disputes such as disputes relating to oppression and mismanagement, the position laid down by the apex court seems to be inconsistent with its test relating to rights in rem.

Even though for major disputes, law in force emphasises National Company Law Tribunal (NCLT) to be the specialized forum, but again some minor and subordinate disputes can be arbitrated. However, the court ignoring the categorisation, labelled the entire category as non-arbitrable. Similarly, with regard to consumer disputes, the apex court in Emaar MGF Land Limited v. Aftaab Singh affirmed doctrine of election which allowed parties to waive consumer forum to choose arbitration mechanism. The same has been upheld by the court in this case but the same is not reflected in findings of consumer dispute being non-arbitrable.

Conclusion

The shift from cautionary approach to a progressive pro-arbitration approach has clarified the issue of arbitrability revolving around the fraud exception in satisfactory manner. However, the same has reflected certain discrepancies in prior assumption of non-arbitrability, based on subject matter dispute, on account to lack of confidence in the arbitral process. With this judgment, court has taken prospective approach establishing another hallmark in the arbitration friendly jurisprudence, thereby letting arbitration see the light of the day as an alternate dispute resolution mechanism. Moreover, the court has clarified and expanded the scope of Section 11 of 1996 Act by covering most of the disputes as arbitrable, along with defining extent of judicial intervention to be in consonance with rationale of the act. In some aspects non- arbitrability of a dispute will determine the nature and extent of judicial scrutiny which would protect the parties in cases of forced arbitration.

Author: Ritika Kanwar,
4th Year, B.Com. LLB. (hons.), Institute of Law, Nirma University, Ahmedabad

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