The recent decision of the Supreme Court in Vidya Drolia corrects decades of uncertainty and rectifies the interpretation on a number of crucial aspects of arbitration. However, it throws a few googlies into the mix. The decision was rendered in response to a reference to consider the arbitrability of tenancy disputes, but covers significantly wider ground. Key highlights: it upholds arbitrability of tenancy disputes (unless governed by special statutes); all but undoes the “fraud” exception to arbitrability; and significantly narrows the scope of interference by courts in the pre-arbitral stage. On the other hand, the decision throws into disarray the dispute resolution options available to banks and NBFCs – who, statistically speaking, are the biggest users of arbitration. It also makes extremely broad observations which question the arbitrability of shareholder and consumer disputes. Given the broad scope and significance of the decision, we apologise in advance for the slightly long read!

Arbitrability

The most significant aspect of the decision in Vidya Drolia is the court’s exposition on the question of subject matter arbitrability. The court found that a dispute is not capable of adjudication and settlement by arbitration when the cause of action and subject matter of the dispute:

(1) relates to actions in rem, that do not pertain to subordinate rights in personam that arise from rights in rem.

(2) affects third party rights; have erga omnes effect

(3) requires centralized adjudication, and mutual adjudication would not be appropriate and enforceable

(4) relates to inalienable sovereign and public interest functions of the State and hence mutual adjudication would be unenforceable

(5) when the subject-matter of the dispute is expressly or by necessary implication non-arbitrable as per mandatory statute(s).

The court applied these principles and considered three specific cases to determine arbitrability:

1) Tenancy Disputes

The court found that landlord-tenant disputes governed by the Transfer of Property Act are arbitrable “as they are not actions in rem but pertain to subordinate rights in personam that arise from rights in rem. Such actions normally would not affect third-party rights or have erga omnes affect or require centralized adjudication. An award passed deciding landlord-tenant disputes can be executed and enforced like a decree of the civil court. Landlord-tenant disputes do not relate to inalienable and sovereign functions of the State. The provisions of the Transfer of Property Act do not expressly or by necessary implication bar arbitration.” They accordingly overruled the Supreme Court decision in Himangni Enterprises. The court clarified that landlord-tenant disputes covered and governed by rent control legislation would not be arbitrable when a specific court or forum has been given exclusive jurisdiction to apply and decide special rights and obligations.

2) Fraud

The court noted that historically parties opposed arbitration of disputes where allegations of fraud were made primarily on ground that arbitrators and the arbitral process were ill-equipped to consider such matters. The court held that while some of these concerns are valid, “it would be grossly irrational and completely wrong to mistrust and treat arbitration as flawed and inferior adjudication procedure.” The courts found that arbitrators are normally experts in the subject and perform their tasks by referring to facts, evidence, and relevant case law and complexity is not sufficient to ward off arbitration. The court accordingly overruled its previous decision in N. Radhakrishnan and held that fraud can be a ground to refuse reference to arbitration only: (i) in a clear case where the arbitration clause or agreement itself cannot be said to exist; or (ii) if allegations are made against the State or its instrumentalities of arbitrary, fraudulent, or mala fide conduct which requires a public enquiry.

3) Debt Recovery Tribunal

The court overruled the decision of the Delhi High Court in HDFC Bank Ltd. v. Satpal Singh Bakshi, which held that matters covered under the DRT Act are arbitrable. The court found that banks and financial institutions covered under the DRT Act have specific rights including the modes of recovery specified in the DRT Act. Therefore, it held that “the claims covered by the DRT Act are non-arbitrable as there is a prohibition against waiver of jurisdiction of the DRT by necessary implication.”

Analysis of the findings on Arbitrability

The exposition on arbitrability by the Supreme Court is exhaustive and provides much needed guidance on several aspects which were the subject of conflicting interpretations. The court’s finding in favour of arbitrability of tenancy disputes and fraud clearly signals the confidence that courts have come to repose in the arbitral process. However, on two aspects the court has, with respect, committed a serious error:

First, the Supreme Court’s finding on arbitrability of disputes capable of being referred to the DRT appears to be incorrect. It is a matter of fact that DRTs are over-burdened and banks and NBFCs have now been very regularly resorting to arbitration as being a quicker and more effective form of dispute resolution. It has never been in dispute that arbitral tribunals do not have the power to grant the same breadth of reliefs that a DRT can offer. However, banks and NBFCs, with full knowledge of these limitations have preferred arbitration, simply because of the convenience and time savings that it offers. The Supreme Court has failed to explain why if, a bank or an NBFC chooses to elect for such a remedy, an arbitral tribunal cannot exercise jurisdiction. This is particularly since such election has been considered valid in similar situations by the Supreme Court (see for example Emaar MGF).

There is nothing in the DRT Act which prohibits exercise of such powers for grant of reliefs flowing directly from a contract between banks and its customers. In fact, public policy, and the attempts to reduce the burden on courts and tribunals, should favour election of remedies in favour of the beneficiary. It is also unclear how transactions of identical nature (loans lesser than Rs. 20 Lakh, and loans above Rs. 20 Lakh – 20 Lakh being the monetary threshold to approach the DRT) can result in vastly different treatments on the question of arbitrability. The Supreme Court’s failure to consider these aspects will affect the tens of thousands of arbitrations that are filed every month by Banks and NBFCs, and therefore will need to be addressed immediately.

Second, the Supreme Court’s observations on arbitrability of “intracompany disputes” is also unsatisfactory and cannot be legally sustained. For instance, the Supreme Court finds that “intracompany disputes” are rights in rem. However, this finding is inconsistent with the court’s own definition of “rights in rem”. Further, while the National Company Law Tribunal (NCLT) is a specialised forum created for adjudicating a certain category of intracompany disputes, there is a subset of intracompany disputes that do not require exercise of the specific powers available with the NCLT. It is unclear why the Supreme Court has, with one broad brush, found that the entire category of intracompany disputes is not arbitrable.

Similar also is the Supreme Court’s finding that “consumers can(not) waive their right to approach the statutory judicial forums by opting for arbitration.” This is particularly since the Supreme Court in the decision in Emaar MGF (which the court affirmed) specifically confirmed the doctrine of election, and permitted consumers to choose arbitration over a consumer forum, if they so desire.

Scope of Enquiry

The second part of the court’s decision concerned: who must decide issues of arbitrability, and to what extent. The issue of non-arbitrability of a dispute may be raised at three distinct stages:

a. Before a court or judicial authority under Sections 8 or 11 of the Arbitration Act (Referral Stage);

b. Before the arbitral tribunal (Arbitration Stage); and

c. Before a court when an arbitral award is being challenged (Challenge Stage).

So far as the Arbitration Stage is concerned, the position is fairly clear and well settled. Section 16 (1) of the Arbitration Act explicitly empowers the arbitral tribunal to rule on its own jurisdiction, including questions as to the existence or validity of the arbitration agreement. The Arbitration Act therefore recognises the principle of competence-competence, and empowers the arbitral tribunal to rule on all aspects of arbitrability.

Similarly, when an award is challenged before a court under Section 34 of the Arbitration Act, it may be set aside by the court if it finds that (a) the arbitration agreement is not valid in law; (b) the award deals with a dispute which was not within the scope of the submission to arbitration; or that the subject matter of the dispute is, by law, not capable of being settled by arbitration.

The court held that while the competence-competence principle requires priority to be given to the arbitral tribunal to decide issue of non-arbitrability at the Arbitration Stage, a second look by the courts is still open under Section 34 of the Arbitration Act at the Challenge Stage.

The court’s analysis of the scope available in the Referral stage is more instructive. At the outset the court reiterated that when adjudicating an application either under Section 8 or Section 11, a court does not perform a mere ministerial function, but a judicial one. The court accepted the view taken in Mayavati Trading, which held that the dictum in Patel Engineering, in so far as it relates to Section 11 has been legislatively diluted and overruled by virtue of the insertion of Sub-section 6A. The court held that the subsequent deletion of Sub-section 6A does not alter this position.

The court found that the scope of review under both Section 8 and Section 11 is identical, despite the difference in language. Section 8 of the Act requires a judicial authority to refer the parties to arbitration unless it finds that prima facie, no valid arbitration agreement exists. On a plain reading (of the now deleted sub-section 6A) Section 11 limits the court’s powers to determining only the existence of an arbitration agreement. The court, however, holds that an agreement has no meaning unless it is enforceable in law, and an arbitration agreement which is not valid or not legally enforceable is not an agreement at all. Therefore, even under Section 11 the court has the power to consider the validity of the arbitration agreement.

The court has accepted and adopted the position that issues regarding arbitrability as faced by a court at the Referral Stage fall into the 3 stages laid out in Boghara Polyfab but added a few elements:

First, as stated in Boghara Polyfab, questions regarding the jurisdiction of the court itself, identities of the parties before the court and identities of the parties to the arbitration agreement, must be decided by the referring court. The court clarified that in addition to these, questions of whether or not a cause of action relates to an action in personam or in rem, whether the subject matter affects third parties, whether it relates to inalienable sovereign and public interest functions of the state, and whether the subject matter is non-arbitrable by virtue of a statue, should also be considered.

Second, there are questions that the court may determine or defer for the consideration of the arbitral tribunal. These include questions such as whether there is a live and subsisting dispute

Third, are matter that must necessarily be deferred to the tribunal which includes questions on the arbitrability and merits of a claim.

The court clarified that even where a court does make a determination, it can only be a prima facie determination. This was clarified to mean a primary first review, aimed solely at weeding out ex-facie non-existent and invalid arbitration agreements and non-arbitrable disputes. The court clarified that a prima facie case is relatable to establishment of initial presumption, rather than an evidentiary standard. Only when the court is certain that no valid arbitration agreement exists, or that the disputes are not arbitrable, would an application under Section 8 be rejected. This determination is not to be made through a mini-trial, but must be preliminary and summary in nature, on the basis of documents produced. A referring court would ordinarily compel parties to abide by the arbitration clause unless there were good and compelling reasons not to. Where questions related to formation, existence or validity of the contract and questions related to non-arbitrability are complex and intertwined with issues of fact, the court has said that, these should necessarily be left for the arbitral tribunal to decide.

The Court notes that a court should refer a matter if the validity of the arbitration agreement cannot be determined on a prima facie basis. It also specifically clarifies that where there are jurisdictional issues concerning whether certain parties are bound by a particular arbitration agreement, under the group company doctrine or good faith, etc., or where a multi-party arbitration raises complicated factual questions, these must be left to the arbitral tribunal to handle.

The court recognises that in deciding these issues, the referring court has to strike a balance between enforcement of arbitration agreements, and protecting parties from being forced into arbitration where disputes are clearly non-arbitrable. The court has left to the discretion of the referring court the decision as to the intensity of the summary and prima facie review, always keeping in mind that the referring court is to assist the arbitration procedure and not usurp of the jurisdiction of the arbitral tribunal in that regard.

In summary, the rule for the Court is ‘when in doubt, do refer’.