October 20 2009
In The Branch Manager, MAGMA Leasing & Finance Ltd v Potluri Madhavilata the Supreme Court addressed the question of whether an arbitration agreement survives the termination of the main contract.(1) In its judgment the court discussed the legal positions of different jurisdictions and concluded that an arbitration clause will survive once the contract containing the clause has come to an end or been terminated.
MAGMA Leasing Limited Public United Company, a financial institution engaged in the business of providing funds for the purchase of plants and machinery and other assets by way of hire purchase, entered into a hire purchase agreement with Smt Potluri Madhavilata for the purchase of a motor vehicle. Pursuant to the terms and conditions of the hire purchase agreement, the hirer was required to pay the hire purchase price in 46 instalments. The hirer defaulted on the payment of a number of its instalments and as a result MAGMA seized the vehicle from the hirer. MAGMA also sent a notice to the hirer intimating that the agreement had been terminated.
The hirer proceeded to file suit against MAGMA seeking recovery of possession of the vehicle and an order to restrain MAGMA from transferring the vehicle. Upon receipt of the aforementioned notice, MAGMA made an application before the trial court under Section 8 of the Arbitration and Conciliation Act 1996, requesting that the dispute raised in the suit be referred to an arbitrator and the proceedings in the suit be stayed. The hirer contested the application on the grounds that since the hire purchase agreement had been terminated, the arbitration agreement did not survive and the matter could not be referred to arbitration.
The first trial court dismissed the application made by MAGMA under Section 8 of the act. MAGMA subsequently filed a civil revision petition before the High Court of Andhra Pradesh. The division bench of the high court dismissed the revision petition, holding that upon termination of the hire purchase agreement, the arbitration agreement did not survive. The high court's decision was challenged before the Supreme Court.
The Supreme Court discussed the English legal position following the House of Lords judgment in Heyman v Darwins.(2) In this case the House of Lords had laid down the scope of applicability of the arbitration clause in relation to the contract containing the clause. The House of Lords was of the opinion that an arbitration clause is a written submission which is agreed to by the parties to the contract. If the parties to the contract assert together that they have entered into a binding contract, but a difference arises between them over whether there has been a breach by one side or the other, or whether circumstances have arisen which have discharged one or both parties from further performance, such differences should be regarded as having arisen 'in respect of', 'with regard to' or 'under' the contract, and thus should be referred to arbitration.
The Supreme Court further analyzed the nature of an arbitration clause in a contract and was of the opinion that an arbitration clause is a collateral term in the contract relating to the resolution of disputes. The court held that even if the performance of the contract comes to an end on account of repudiation, frustration or breach of contract, the arbitration agreement would survive for the purpose of resolving disputes arising from or in connection with the contract.
The court also considered the US legal position and quoted in approval the judgment of the US Supreme Court in Buckeye Check Cashing Inc v Cardegna, which, among other things, acknowledged that the severability rule permits a court "to enforce an arbitration agreement in a contract which the arbitrator later finds to be void".(3) The court also referred to Section 16(1) of the act(4) and opined that as a collateral term, an arbitration clause need not in all situations perish when the contract comes to an end. On the facts of the case at hand, the Supreme Court allowed MAGMA's appeal.
This decision lays down certain important principles with regard to the scope and applicability of an arbitration clause after a contract is terminated or comes to an end.
First, an arbitration clause is a written submission agreed to by the parties to the contract and, similar to other written submissions to arbitration, must be construed according to its language and in light of the circumstances in which it is made.
If the dispute concerns whether the contract which contains the clause was ever entered into at all, that issue cannot go to arbitration under the clause because a party that denies that it ever entered into the contract thereby denies that it ever joined in the submission. If one party to the alleged contract contends that the contract is void from the beginning, the arbitration clause cannot operate because, on this view, the clause itself is also void.
However, if the parties are at one in asserting that they entered into a binding contract, but a difference has arisen between them over whether there has been a breach by one side or the other, or whether circumstances have arisen which have discharged one or both parties from further performance, such differences should be regarded as differences which have arisen 'in respect of', 'with regard to' or 'under' the contract, and an arbitration clause which uses these or similar expressions should be construed accordingly.
An arbitration clause is a collateral term in the contract which relates to the resolution of disputes and not performance. Even if the performance of the contract comes to an end on account of repudiation, frustration or breach of contract, the arbitration agreement survives for the purpose of resolving disputes arising from or in connection with the contract.
The doctrine of severability of an arbitration clause has been statutorily recognized in India. Section 16(1) of the act makes it clear that while considering any objection with respect to the existence or validity of the arbitration agreement, an arbitration clause which forms part of the contract must be treated as an agreement independent of the other terms of the contract. Further, a decision that the contract is null and void shall not result, by virtue of the law itself, in the invalidity of the arbitration clause.
For further information on this topic please contact Bishwajit Dubey or Tamal Mandal at Amarchand & Mangaldas & Suresh A Shroff & Co by telephone (+91 11 4159 0700), fax (+91 11 2692 4900) or email (email@example.com or firstname.lastname@example.org ).
"16. Competence of Arbitral Tribunal to rule on its jurisdiction:
(1) The Arbitral Tribunal may rule on its own jurisdiction, including ruling on any objections with respect to the existence or validity of the arbitration agreement, and for that purpose,--
(a) an arbitration clause which forms part of a contract shall be treated as an agreement independent of the other terms of the contract; and
(b) a decision by the Arbitral Tribunal that the contract is null and void shall not entail ipso jure the invalidity of the arbitration clause."
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