Monday, May 30, 2011

An Instance of Accounting Fraud


The New York Times analyzes an instance of possible accounting fraud at a Chinese company, Longtop Financial Technologies that has close similarities with India’s own Satyam scandal (i.e. improper confirmation of bank balances). While the Satyam scandal came into the public domain through a confession letter of the Chairman, in this case the auditor blew the whistle. Here is an extract:
Deloitte, which had given clean audit opinions to Longtop for six consecutive years, apparently was well on its way to providing a seventh, for the fiscal year that ended March 31. But for some reason — Deloitte did not say why —the auditor went back to Longtop’s banks last week to again seek confirmation of cash balances.
It appears Deloitte sought confirmations from bank headquarters, rather than the local branches that had previously verified that Longtop’s cash really was on deposit. And that set off panic at the software firm.
 
It is reported that SEC has begun an investigation, which will also throw the spotlight generally on non-US companies listed on US stock exchanges.

Further Views on Merger Regulations


Our guest contributor Rahul Singh had earlier discussed the key features of the Competition Commission of India (Procedure in regard to the transaction of business relating to combination) Regulations, 2011 that will come into effect on June 1, 2011.
In addition, the following columns carry an interesting discussion about the impact of these regulations on business:
Merging Business with Competition Law by Satvik Varma in Governance Now; and
A Competition Conundrum Brews by Rahul Singh in the Mint.

Formalism under Section 8 of Arbitration Act wins the day in Delhi High Court

(The following post is contributed by Sumit Rai, who is an associate with Economic Laws Practice, Mumbai since 2007 and has been on a long study leave pursuing his LLM, Masters in International Dispute Settlement at Geneva)
In Arti Jethani v. Daeshan Trading (India) Pvt. Ltd. (decision dated 16.05.2011), the Delhi High Court held that a Section 8 application under the Arbitration & Conciliation Act, 1996 (Arbitration Act) was not maintainable if brought after the filing of written statement, even if the written statement raised jurisdictional objections on grounds of existence of an arbitration agreement. While there is authority to support this conclusion, it suggests a formalistic bias in the court’s approach to interpretation. An extremely formalistic approach to interpretation of the Arbitration Act, defeating an arbitration agreement, is the very anti-thesis of the policy that led to the new law in 1996. This decision also fails to take into account the negative effect of an arbitration agreement.
Background
The Court was hearing a petition under section 8 of the Act in a suit filed by one Ms. Arti Jethani (Applicant) against M/s. Daeshan Trading (India) Pvt. Ltd (Defendant). The Defendant appearing on summons on 04.01.2011 was ordered to file a written statement within 30 days. It did so on 25.01.2011, wherein a defense against the jurisdiction of the court was raised on grounds of existence of an arbitration agreement. The Plaintiff in its reply stated that having filed the written statement and not an application under Section 8 of the Act, there was no requirement to refer parties to arbitration. The Defendant filed the application on 22.02.2011.
Court’s Decision
The Court held that Section 8 of the Act clearly lays down that an application must be made “not later than when submitting …first statement on the substance of the dispute”. Since this was not done, Court held that one of the pre-conditions under the provision was not met.
The Court rejected Defendant’s contention that disputing jurisdiction on grounds of existence of an arbitration agreement in the written statement should amount to sufficient compliance under Section 8. It noted that “[m]ere disclosure of arbitration agreement in the Written Statement and claiming that Civil Court has no jurisdiction to try the suit would be of no consequences unless the Written Statement itself contains a prayer for referring the dispute to arbitration”. The Court also held that the jurisdiction of the Civil Court is not ousted on account of an arbitration agreement between the parties.
Form over Spirit
This is not the first time that a court has refused to consider a jurisdictional objection taken in the written statement as sufficient. This decision relies on some of them.
The Delhi High Court, however, recognized that an application in strict sense is not required under Section 8. It also agreed that such application could be made in the written statement itself. However, it held that such application cannot be read from a mere objection to jurisdiction based on the existence of an arbitration agreement and must be supplemented by a prayer to refer the parties to arbitration.
It seems pedantic to negate an arbitration agreement merely on grounds that a prayer for reference was not made. Further, a prayer to dismiss the suit must be sufficient for a defendant seeking enforcement of an arbitration agreement under the text of Section 8. Why should it be required of a defendant that may have no counter-claim or interests in pursuing a dispute to compulsorily seek a reference to arbitration? A meaningful construction would suggest that reference to arbitration would be the result of an objection to jurisdiction citing existence of an arbitration agreement, when read together with the plaint seeking adjudication of a dispute.
Civil Courts Retain Jurisdiction?
The real hurdle in a purposive interpretation of Section 8 lies in the conceptual rejection of the negative effect of arbitration agreement. An arbitration agreement necessarily implies the exclusion of jurisdiction of civil courts from adjudicating disputes subject to such agreement. It is a consequence of the positive effect, i.e. the transfer of right of adjudication from courts to an arbitral tribunal. This must also follow from the exception for arbitration agreements contained in Section 28 of the Indian Contract Act.
The Supreme Court in Sukanya Holdings Pvt. Ltd. v. Jayesh Pandya rejected this concept. It laid down three conditions that Section 8 requires to be met before a matter can be referred to arbitration, and concluded from it that until such conditions are met, civil court jurisdiction is not excluded. This interpretation hoists Section 8 by its own petard. What was meant to be a safeguard provision to mandate reference to arbitration on an application has now become the enabling provision for civil courts to usurp arbitral jurisdiction unless strict compliance of Section 8 is met.
Arbitration agreement, by force of pacta sunt servanda read with Section 28 of the Contract Act, leads to the obvious conclusion of exclusion of civil court jurisdiction. Section 8 is essentially an acknowledgment of the fact that parties can waive an arbitration agreement. Conditions under Section 8 are meant to provide for reading such waiver by conduct. When a suit is filed despite an arbitration agreement, it is an offer by one party to terminate this agreement. If the other party joins the suit by contesting it on substance, it accepts such offer and the arbitration agreement comes to an end. Section 8 provides that failure to invoke the arbitration agreement within reasonable time shall also be deemed to be an acceptance.
Nothing in the text of Section 8 suggests that civil courts retain jurisdiction despite arbitration agreement, unless it is excluded by a decision of the court itself in such application. On the contrary, Section 8(3) provides that notwithstanding a pending application, an arbitration could be commenced, continued, and an award be made. If the legislative intent were to prohibit the negative effect of arbitration agreement, this provision would be inane.
Conclusion
The manner in which Section 8 has been interpreted over the years raises serious concerns regarding the effectiveness of the Indian arbitral regime. The Delhi High Court decision has once again necessitated focus on this issue. It is interesting to note that other significant common law jurisdictions (England and US), where arbitration regime has essentially been successful, have legislations more comprehensive than that suggested by the UNCITRAL Model Law. Probably, this is a fact that needs to be noticed by the legislature.
However, no legislation can ensure its successful application. It can only provide tools. “The success of the [legislation] will depend on these tools being skillfully used to fashion the product for which they were designed. This means, above all, that they should be knowledgeably used, with an understanding of their origin, and of why they were designed as they were” (Rt. Hon. The Lord Bingham of Cornhill, Lord Chief Justice of England).
- Sumit Rai

Friday, May 27, 2011

Guest Post: Supreme Court's View on Substantive and Curial Law in Arbitration

(In the following post, Mr Vijay Kumar, Advocate, Madras High Court and Associate, Iyer & Thomas, discusses the law on implied exclusion)

This post analyses few of the significant decisions of the Supreme Court (SC) with reference to the essential difference between the law governing the contract (substantive law) and the law governing the arbitration proceedings between the parties to the dispute (curial law).

S. 28 of the Arbitration and Conciliation Act, 1996 (A&C) provides for the rules applicable to the substance of the dispute. However, s. 28 is applicable only when the place of arbitration is in India as it starts with the words ‘[w]here the place of arbitration is situate in India…’. Therefore s. 28 does not apply where the place of arbitration is outside India.

In international commercial arbitrations, it has become a practice that parties agree upon a substantive law and on curial law. It is in these circumstances, question arises as to whether Part I of A&C is excluded either expressly or impliedly by choosing procedural law other than A&C for conducing arbitration proceedings.

With the scope being limited to the premises stated above, decisions of the SC in the matter of Bhatia International , Citation Infowares, Dozco v Doosan; Videocon v Union of India and Gujarat HC’s decision in Hardy Oil are analysed below.

The SC in Bhatia International’s case held that

“Part I of the A&C would apply to all arbitrations and to all proceedings relating thereto. Where such arbitration is held in India, the provisions of Part I of A&C would compulsorily apply and the parties are free to deviate to the extent permitted by the derogable provisions of Part I. In cases of International Commercial arbitration held out of India provisions of Part I would apply unless the parties by agreement express or implied exclude all or any of its provisions. In that case the laws or rules chosen by the parties would prevail. Any provision in Part I which is contrary to or excluded by that law or rules will not apply.” (para 32)

The conclusion in unequivocal terms is that, that in international commercial arbitration where place of arbitration is outside India, the parties are free to agree upon the law governing the contract and the procedural law applicable to arbitral proceedings. Such law as agreed between the parties shall prevail over Part I of A&C. Therefore parties are free to choose the substantive law applicable to contract, curial law applicable to the arbitration proceedings and the judicial seat of arbitration. Where curial chosen is different from A&C, that law would prevail over A&C.

It has been succinctly expressed in the decision of Hardy Oil and Gas Limited’s case decided by the Gujarat High Court. To appreciate the views expressed by the Gujarat HC, the relevant clauses of the contract are extracted below-:

“Governing Law and Arbitration

1. This Agreement (except for the provisions of Clause 9.5.4 relating to arbitration) shall be governed by and construed in accordance with the substantive laws of India.

2. Any dispute or difference of whatever nature arising under, out of, or in connection with this Agreement, including any question regarding its existence, validity or termination, which the parties are unable to resolve between themselves within sixty (60) days of notification by one or more Parties to the other(s) that a dispute exists for the purpose of this Clause 9 shall at the instance of any Party be referred to and finally resolved by Arbitration under the rules of the London Court of International Arbitration (SLCIA), which Rules (Rules) are deemed to be incorporated by reference into this clause.

3. The Tribunal shall consist of two arbitrators who shall be Queen's Counsel, practicing at the English Bar in the Commercial Division of the High Court, ……………………….

4. The place of arbitration shall be London and the language of arbitration shall be English. The law governing arbitration will be the English law……..

The Gujarat HC relied on Bhatia International and has stated certain principles drawing on National Thermal Power Corporation vs Singer with reference to choice and applicability of substantive and curial law with specific reference to conflict of laws. The principles are given below in brief –

Ø Parties have freedom to choose the law governing an international commercial arbitration agreement. They may choose the substantive law governing the arbitration agreement as well as the procedural law governing the conduct of arbitration. Such choice is exercised either expressly or by implication.

Ø Where there is no express choice of law governing contract as a whole, or the arbitration agreement in particular, there is, in the absence of any contrary indication, a presumption that the parties have intended that the proper law of the contract as well as the law governing the arbitration agreement are the same as the law of the country in which the arbitration is agreed to be held.

Ø On the other hand, where the proper law of the contract is expressly chosen by the parties (as in the present case), such law must, in the absence of an unmistakable intention to the contrary, govern the arbitration agreement which, though collateral or ancillary to the main contract, is nevertheless a part of such contract.

Ø In the absence of any indication to the contrary, the governing law of the contract being Indian law, it is that system of law which must necessarily govern matters concerning arbitration, although in certain respects the law of the place of arbitration may have its relevance in regard to procedural matters. The law governing such rights and liabilities is the proper law of the contract, and unless otherwise provided, such law governs the whole contract including the arbitration agreement, and particularly so when the latter is contained not in a separate agreement. This would be the situation where there is absence of a specific agreement to the contrary, as is the situation in the matter on hand.

In this case parties had expressly chosen laws of England as the law governing the arbitration proceedings and hence it was held that provisions of Part I of A&C were expressly excluded and it would be the English law that would govern arbitration proceedings. Therefore parties could not invoke the Indian Courts under Part I of A&C.

A different view has been taken in Citation Infowares where the SC distinguished the case from the principles enumerated in NTPC’s case, and holds that provisions of Part I of A&C act are applicable to the subject dispute. The relevant arbitration clause between the parties is given below-

“This agreement shall be governed by and interpreted in accordance with the laws of California, USA and matters of dispute, if any, relating to this agreement or its subject matter shall be referred for arbitration to a mutually agreed Arbitrator"

The SC held that the parties had agreed upon the substantive law and had not agreed either on the judicial seat of arbitration or the curial law. It also stated that there was nothing in the arbitration clause to exclude impliedly provisions of Part I of A&C and hence it was held that Part I of A&C is applicable and powers were exercised under Section 11 of the Act to appoint the arbitrator.

This view is contrary to principle enumerated in NTPC’s case wherein it was held that where there is no separate arbitration agreement but, arbitration agreement forms part of the principal agreement as a clause thereof and if there is no specific agreement between the parties to the contrary, law governing principal agreement would govern the arbitral proceedings. In Citation Infowares, though the parties had agreed upon the substantive law applicable to the contract, and the contract was silent on the curial law, it would have been the law of the contract that would be applicable to the arbitration proceedings. Since place of arbitration was not specified, SC held that the principle enunciated in the NTPC case would not be applicable. In my view, the omission by the parties to agree on place of arbitration makes Part I of A&C applicable is contrary to principles stated earlier. It introduces one more criterion to be considered in determining the intention of the parties which did not exist previously. When the parties had contemplated laws relating to California as the substantive law and there was nothing in the agreement to suggest that the parties negated the applicability of Californian laws as curial law. The natural inference would be that parties had positively agreed to subject themselves to laws of California as substantive and curial law.

In Dozco vs Doosan, SC held that by specifying the substantive law, and the seat of arbitration as Republic of Korea it becomes fairly clear that the parties had agreed to exclude Part I of A&C and hence petition under Part I is not maintainable.

The arbitration clause that was agreed by the parties is given below for ready reference -

Article 23.1

“This agreement shall be governed by and construed in accordance with the laws of The Republic of Korea.

All disputes arising in connection with this Agreement shall be finally settled by arbitration in Seoul, Korea (or such other place as the parties may agree in writing), pursuant to the rules of agreement then in force of the International Chamber of Commerce (emphasis supplied)”

The SC held that language of Article 23.1 clearly suggests that all the three laws i.e the substantive law, curial law and the law relating to conduct of arbitration are the laws of The Republic of Korea. Hence parties impliedly excluded the application of Part I of A&C.

SC in Dozco’s case though has not stated in as many words but has followed the principles laid down in NTPC case. As in Bhatia International, the parties in Dozco had agreed upon ICC Rules of Arbitration. Since the substantive law applicable to the contract was the law relating to the Republic of Korea and the place of arbitration was Seoul which added up to enable SC reach conclusion that Part I of A&C was excluded by the parties and hence petition under Section 11 before SC was not maintainable. However as stated earlier, parties had agreed on ICC Rules and not on procedural law of Republic of Korea.

Lastly, traversing the decision in Videocon Industries Ltd vs Union of India, SC upheld the decision of Gujarat HC and the principles enunciated in Bhatia International and NTPC’s case. The clause of arbitration read as follows-

33.1 Indian Law to Govern

Subject to the provisions of Article 34.12, this Contract shall be governed and interpreted in accordance with the laws of India.

33.2 Laws of India Not to be Contravened

Subject to Article 17.1 nothing in this Contract shall entitle the Contractor to exercise the rights, privileges and powers conferred upon it by this Contract in a manner which will contravene the laws of India.

34.12. Venue and Law of Arbitration Agreement

The venue of sole expert, conciliation or arbitration proceedings pursuant to this Article, unless the Parties otherwise agree, shall be Kuala Lumpur, Malaysia, and shall be conducted in the English language. Insofar as practicable, the Parties shall continue to implement the terms of this Contract notwithstanding the initiation of arbitral proceedings and any pending claim or dispute. Notwithstanding the provisions of Article 33.1, the arbitration agreement contained in this Article 34 shall be governed by the laws of England.

The above clauses make it amply clear that substantive law is Indian Law and the curial law applicable is English law. Therefore the forum to be approached is English Courts and all the arbitration proceedings including interim measures, setting aside of award shall be in accordance with the provisions of English law.

To conclude, the decision of Bhatia International and NTPC is followed in all the cases. There is a distinction made in the case of Citation Infowares where even though the parties had agreed on the substantive law, and had omitted to agree on the place of arbitration and curial law, the SC differed from NTPC’s principle and held that omission by the parties to agree upon judicial seat of arbitration and language of arbitration resulted in applicability of Part I of A&C. When the parties had agreed upon the substantive law, the SC ought not to have looked at other considerations to determine applicability of Part I of A&C and the law governing the contract would be curial law as there is no contrary intention demonstrated by the parties to negate the applicability of substantive law as curial law. The decision is also not practically in accordance with the intention of the parties as SC appointed an Indian National to adjudicate the dispute in accordance with the laws of State of California.

It is necessary to state here that SC in Dozco’s case relies on the principle stated by Mustill and Boyd “In the absence of express agreement, there is a strong prima facie presumption that the parties intend the curial law to be the law of the 'seat' of the arbitration, i.e. the place at which the arbitration is to be conducted, on the ground that that is the country most closely connected with the proceedings. So in order to determine the curial law in the absence of an express choice by the parties it is first necessary to determine the seat of the arbitration, by construing the agreement to arbitrate.”

In my view, this presumption would arise only when the parties had agreed on the judicial seat of arbitration. When the parties had agreed on the substantive law and omitted to agree on the curial law and on the seat of arbitration, it did not give cause for holding that Part I becomes applicable to the parties. Part I of A&C cannot be applied to give benefit of doubt to the parties. When substantive law has been agreed with open eyes, unless contrary is shown it is presumed that parties would not agree to contrary with respect to curial law (NTPC case).