Arbitration clause is independent of main contract: Bombay High Court ruling on doctrine of separability

On July 22 this year, the Bombay High Court bench at Aurangabad held that an arbitration agreement survives termination of the parent contract, invoking Section 16(1) of the Arbitration and Conciliation Act, 1996.

The Court followed a line of decisions cited by the Supreme Court in SBI General Insurance Co Ltd v. Krish Spinning recognising the UNCITRAL Model Laws on International Commercial Arbitration, 1985, which embody the presumption of separability elucidated in the Act. It highlighted that an arbitration clause forming part of the contract is to be treated as an agreement independent of other terms of the contract. The decision of an arbitral tribunal of declaring the parent contract as null and void does not ipso facto make the arbitration clause invalid. 

The Court also cited National Agricultural Coop. Marketing Federation India Ltd v. Gains Trading Ltd, which lays down that an arbitration agreement is a collateral term in the contract that relates to the resolution of disputes and not performance. Even if the performance of the contract comes to an end due to frustration or breach of the contract, the arbitration agreement survives for the purpose of resolution of disputes arising in connection with the contract.

Background

The dispute relates to termination of the contract between EBIX Cash and Aurangabad Smart City Development (ASCDCL). EBIX was awarded a contract by ASCDCL in 2020 and thereafter ASCDCL issued a new tender in 2024, which was not a substitute tender to the 2020 tender contract. EBIX pushed back and said that it will face grave loss if the new tender is processed. Consequently, ASCDCL issued a show cause notice terminating the 2020 tender contract without any lawful excuse.

Based on the aforesaid termination, EBIX filed a writ petition against ASCDCL to set right the arbitrary actions of the State and/or against termination due to breach of contract.

Order of the Division Bench of the Bombay High Court

The Court recognised the discrepancy in the facts produced by both parties. However, without dwelling into the merits of the case, the Court held that ASCDCL issued a preliminary termination notice prior to the termination of the contract. The said termination was within the contractual domain. Furthermore, clause 16.2 of the request for proposal under the contract envisaged a mechanism for dispute resolution through arbitration, thus confirming that the dispute at hand is arbitrable.

Interestingly, the Court interpreted Section 16 of the Act and held that even if the underlying contract comes to an end, the arbitration agreement contained in such a contract survives.

Besides, the fundamental premise governing the doctrine of separability is that the arbitration agreement is entered into between parties with the mutual intention to settle disputes that may arise with respect to the underlying substantive contract. Thus, by its inherent nature, it is independent of the substantive contract.

The Court's decision in this case is based on two key assumptions:

1. Ancillary nature of the arbitration clause: The Court viewed the arbitration clause as ancillary to the main contract. This perspective holds that the arbitration clause, being a procedural mechanism for dispute resolution, is inherently linked to the substantive rights and obligations arising from the contract. Consequently, when these rights and obligations are assigned, the arbitration clause follows automatically without the need for a separate agreement. While this approach may enhance the commercial effectiveness of arbitration agreements, it conflicts with the widely accepted principle of separability. This principle treats arbitration clauses as autonomous and independent from the main contract, ensuring their survival even if the main contract is void or terminated.

2. Survival of the arbitration clause: The Court also reasoned that the arbitration clause should survive the termination or frustration of the main contract. The rationale is that contracts may be terminated or frustrated for various reasons, which are traditionally performance-based. However, in this judgment, the arbitration clause is seen as a collateral term that is sustained for the specific purpose of resolving disputes. Such a view ensures that even if the main contract becomes unenforceable, the mechanism for resolving disputes through arbitration remains unequivocal.

The Court's emphasis on the survival and independence of the arbitration clause underscores the importance of the doctrine of separability and the autonomy of arbitration agreements. This principle ensures that parties can still seek resolution through arbitration, de hors the status of the main contract, thereby providing a clear and consistent avenue for dispute resolution.

Natasha Sood is an arbitrator and counsel at Juscontractus.