Tuesday, May 17, 2011

The Combination of Arbitration Agreements

Around a month ago, the Supreme Court addressed yet another interesting question dealing with third parties and arbitration proceedings, an issue discussed earlier here. The facts of Deutsche Post Bank Home Finance Ltd v Taduri Sridhar are more tedious than complex, and need elaboration.

The case involved four agreements between different combinations of parties, all but three of which contained arbitration clauses. The first was a standard agreement entered into between the landowner, the developer and the prospective purchaser (respondent) of a flat being constructed on the land [Agreement I]. This agreement contained an arbitration clause. The prospective purchaser also entered into a loan agreement with the appellant bank, which contained another arbitration clause [Agreement II]. There was a third alleged agreement between the appellant and respondent, with the developer standing as guarantor, which provided that the loan amounts be provided directly by the appellant to the developer [Agreement III]. Finally, in pursuance of ‘Agreement I’, an undivided share in the land and a semi-finished apartment was transferred to the respondent, after which he entered into a construction agreement with the developer [Agreement IV] to complete the construction of the apartment. This agreement also contained an arbitration clause. On account of delays in the construction under ‘Agreement IV’, the respondent filed a section 11 petition against the developer. It was in these proceedings that the appellant (which was not party to ‘Agreement IV’, but only to ‘Agreement II’) was also impleaded. The cause of action against the appellant was that it had “had released the total loan amount to the developer without ensuring that there was sufficient progress of construction and without verifying the ‘ground realities’ and thereby failed to perform its minimum obligations and responsibilities as a lender”.

Thus, the simple issue before the Supreme Court was whether the appellant could be impleaded in a section 11 petition filed by the respondent against the developer, based on the fact that the respondent had entered into independent arbitration agreements with both the appellant and the developer, and that the causes of action against both of them were greatly overlapping. The Court, speaking through Justice Raveendran, answered this question in the negative; placing reliance on the following observation from S.N. Prasad vs. Monnet Finance Ltd, (2011) 1 SCC 320,

If there is a dispute between a party to an arbitration agreement, with other parties to the arbitration agreement as also non-parties to the arbitration agreement, reference to arbitration or appointment of arbitration can be only with respect to the parties to the arbitration agreement and not the non-parties.

On the language of the provisions of the Arbitration Act, and prior precedent of the Supreme Court, one cannot take issue with the decision. However, what it does mean is that proceedings which should have been heard and disposed of together will have to either be heard independently, or be disposed off without recourse to arbitration. The possibility of irreconcilable decisions in two independent proceedings against the developer and the appellant could force the respondent to undertake court proceedings, defeating the purpose of encouraging arbitration. Having said that though, viewing the arbitration agreement from a strictly contractual perspective, and based on the law as it stands,the decision was plainly correct.


Sumit Rai said...

Thanks for the update. Non-signatory inclusion in arbitration is indeed a difficult issue that has not found a widely accepted solution internationally. Many models exist - e.g. group of companies doctrine in France, the beneficiary of contract principle that is still in nascent stages, and piercing of corporate veil in circumstances involving bad faith. The two conflicting issues - statutory right of a non-signatory of access to courts and the need to avoid conflicting decisions on same issue are both difficult to reconcile.

However, it is debatable whether in this case conflicting decisions could be issued. On one hand is a breach of loan agreement or diligence issue with the bank. On the other, delay issues under development agreement with the builder. While it indeed is possible, chances of overlapping issues are difficult.

Another aspect of this issue is whether a final decision on this issue be not left to the arbitrator? Would it be better solution if court merely says that it shall appoint the arbitrator with respect to the signatories and the Claimant may file an application before the tribunal to implead the non-signatory?

Shantanu Naravane said...

Mr Rai, many thanks for your comments. I agree with you that conflicting decisions are not a necessary result on the facts here. However, the situation I had in mind was findings of fact regarding the breach of contract by the developer, since these findings would also be material to whether the bank should have exercised greater diligence in releasing funds to the developer.

As to your second comment, I must confess that I am not acquainted with the way arbitral proceedings work in practice, and whether arbitrators can or do exercise powers to implead non-parties. The supplementary powers of the Court under section 27 suggests that the tribunal's powers in this regard are limited. Hence, although referring the question of impleading non-parties may be best left to the tribunal, I am not entirely sure if this is permissible.

Sumit Rai said...

@ Shantanu - Maybe my use of words 'application' and 'implead' are misleading. What I have seen from French, Swiss, and UK decisions is that joinder of third parties or non-signatories is seen as an issue of jurisdiction. Then, relying on the principle of competence-competence, the question whether tribunal has jurisdiction over such party is left for it to decide. Court looks at it only during annulment proceeding.

Indian courts are willing to decide this issue at Sec. 11 stage itself (probably they will also do so under Section 8). The real question is when should the court take this call - at the 'gateway' stage or at the very end after award is rendered, thereby respecting competence-competence.

I am not sure which is better because it seems pointless to respect competence-competence, let the entire proceeding go through and then annul the award on this issue at the very end. Counterside is that Section 8 and 11 proceedings should be as 'summary' as possible so that arbitration commencement and continuance is not delayed (more a problem with 11 as at that time arbitration is stuck).