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Court rules that non-signatory third party is not bound by arbitration agreement - International Law Office

International Law Office

Litigation - India

Court rules that non-signatory third party is not bound by arbitration agreement

June 22 2010

Facts
Issues
Supreme Court decision
Comment


In Indowind Energy Ltd v Wescare (India) Ltd(1) the Supreme Court of India held that a third party that was not a signatory to an arbitration agreement would not be bound by such an agreement. While interpreting Section 7 of the Arbitration and Conciliation Act 1996, the court held that a third party that is not a signatory to an arbitration agreement cannot be bound by the agreement, even if some sort of nexus exists between the third party and the transaction in question.

Facts

The first respondent, Wescare (India) Ltd, operates wind farms and generates power from wind electricity generators. On February 24 2006 Subuthi Finance Ltd, the second respondent and the promoter company of the appellant Indowind Energy Ltd, entered into an agreement with Wescare for the transfer of assets worth Rs981.9 million from Wescare to Subuthi and its nominee (ie, Indowind).

Clause 10 of the agreement provided for an arbitration clause, which read as follows:

"This AGREEMENT shall be governed by and interpreted in accordance with the laws of India. The Parties submit to the exclusive jurisdiction of the court in the city of Chennai, Tamil Nadu. Any dispute, difference, claims or questions arising under this agreement or concerning any matter covered by this Agreement or touching upon this Agreement, the same shall be referred to arbitration before a sole arbitrator to be appointed by consent of Seller, Buyer/IW. The decision/award of the Sole Arbitrator shall be final and binding on all parties. The provisions of the Arbitration and Conciliation Act, 1996 with such amendments there to as may be applicable, shall apply to the proceedings. The venue of the arbitration shall be Chennai and the language of the Arbitration shall be English."

Further, Clause 11 of the agreement related to approval of the agreement and read as follows:

"Notwithstanding anything to the contrary herein contained in this AGREEMENT this agreement is expressly subject to the approval of the respective Boards of Directors/Shareholders by the Seller, the Buyer and Indowind Energy Limited and if such approval is not obtained either by the Seller, the Buyer or IW on or before 30th June 2006 this AGREEMENT shall be null and void and of no effect whatsoever and all transactions done under the agreement shall be reversed with all the costs and damages to the defaulting party."

The boards of directors of Wescare and Subuthi approved the agreement on February 28 2006 and March 1 2006 respectively. However, there was no such approval by the board of directors of Indowind.

Disputes arose between Wescare on the one hand and Subuthi and Indowind on the other. Consequently, Wescare approached the Madras High Court seeking interim relief under Section 9 of the Arbitration and Conciliation Act. The single judge of the high court dismissed the applications, but clarified that nothing contained in the dismissal order should be construed as a final finding on merits and that the arbitrator should be free to decide the issues raised before him.

Subsequently, Wescare filed an application under Section 11(6) of the act seeking appointment of an arbitrator under the terms of the arbitration agreement between the parties. Subuthi resisted the application, claiming that no transaction had taken place between Wescare and Subuthi and hence there was no reason for the dispute, and that consequently the appointment of an arbitrator was inconsequential. Indowind, on the other hand, claimed that as it was not a party to the main agreement and had not ratified the same, there was no arbitration agreement between Wescare and Indowind.

Through its decision dated August 1 2008, the high court allowed the application under Section 11(6) and appointed a sole arbitrator to arbitrate the disputes between the parties. Aggrieved by the decision, Indowind preferred a special leave to appeal and approached the Supreme Court.

Issues

There were two issues before the Supreme Court. The first was whether an arbitration clause between two parties can be considered as a binding arbitration agreement on a person that is not a signatory to the agreement. The second was whether a company could be said to be a party to a contract containing an arbitration agreement, even though it did not sign the arbitration agreement, on account of subsequent conduct.

Supreme Court decision

While relying on Section 7 of the act, the Supreme Court observed that two conditions must be met for an agreement to be a valid arbitration agreement within the meaning of Section 7: the agreement must be between the parties to the dispute and must relate to or be applicable to the dispute.(2)

Applying these conditions to the facts of the case, the court observed that Indowind had not entered into the main agreement (ie, the agreement dated February 24 2006) and had expressed no intention of entering into an arbitration agreement. Further, there was no exchange of statements of any claim or defence(3) and no exchange of letters, telegrams or other means of telecommunication that provided any record of an arbitration agreement between the parties.(4) Therefore, in the absence of an arbitration agreement between Wescare and Indowind, no claim against or dispute with Indowind could have been the subject matter of reference to an arbitrator.

With reference to the second issue, the court observed that Subuthi and Indowind were two independent companies incorporated under the Companies Act 1956. Each company was a separate and distinct legal entity, and the mere fact that the two companies had common shareholders or common boards of directors did not make the two companies a single entity. The court further held that the mere existence of common shareholders or directors could not lead to an inference that one company was bound by the acts of the other.

The court reasoned that if the director who signed on behalf of Subuthi was also a director of Indowind, and if the parties' intention was for Indowind to be bound by the agreement, nothing had prevented Wescare from insisting that Indowind be made a party to the agreement and requesting that the director who signed for Subuthi also sign on behalf of Indowind. Further, the facts that the parties carefully and consciously avoided making Indowind a party, and that the director of Subuthi, although a director of Indowind, was careful not to sign the agreement on behalf of Indowind, all revealed that the parties did not intend Indowind to be a party to the agreement.

Therefore, the mere facts that Subuthi described Indowind as its nominee or as a company promoted by it, or that the agreement was purportedly entered into by Subuthi on behalf of Indowind, did not make Indowind a party in the absence of Indowind's ratification, approval, adoption or confirmation of the agreement dated February 24 2006.

A further important point was that Clause 11 of the agreement dated February 24 2006 clearly stated that the agreement would be null and void and of no effect whatsoever unless it was expressly approved by the respective boards of directors or shareholders of Wescare, Subuthi and Indowind. Indowind's board of directors had not approved the agreement.

Therefore, the court held that if an arbitration clause is found in an agreement between two parties, it cannot be considered a binding arbitration agreement on a person who is not a signatory to the original agreement.

Comment

This decision is based on a strict application of Section 7 of the Arbitration and Conciliation Act and, in a way, creates a loophole wherein a third party that benefits from a commercial transaction can avoid arbitration proceedings when it commits a default. However, this decision will also ensure that arbitration clauses are now drafted in such a manner that a third party deriving benefits from a commercial transaction must be made party to the dispute resolution mechanism in order for such mechanism to be effective.

Further, the decision rules that an oral agreement to arbitrate is invalid and not binding on the parties. This stance distinguishes this decision from decisions of foreign authorities that have sought to convey that a party benefiting need not sign the arbitration agreement for it to be bound by the same. However, going forward, it will be important for parties to ensure that an intention to arbitrate is in writing or comprises an exchange of written correspondence and pleadings asserting the existence of an arbitration clause. In other words, conduct is strictly construed as revealing only an intention set out in Section 7(4)(d) and cannot be said to be a binding arbitration agreement in any other situation.

This will be particularly relevant for various infrastructure projects which use arbitration as a mode of dispute resolution where the agreement is entered into by a special purpose vehicle (SPV) incorporated to execute the project, while the negotiations are carried out by the parent company or entity other than the SPV. In such a situation, comfort may be drawn from the fact that the parent company or negotiating entity will be available to satisfy any claim in case the SPV is unable to satisfy the same. However, this may not hold true for any claim that may be instituted on the basis of an arbitration clause between the SPV and the other party to which the parent company is not a signatory.

For further information on this topic please contact Vijayendra P Singh or Dushyant Manocha at Amarchand & Mangaldas & Suresh A Shroff & Co by telephone (+91 11 2692 0500), fax (+ 91 11 2692 4900) or email (vijayendra.singh@amarchand.com or dushyant.manocha@amarchand.com).

Endnotes

(1) Supreme Court decision of April 27 2010 in CA No 3874/2010.

(2) Yogi Agrawal v Inspiration Clothes & U, 2009 (1) SCC 372.

(3) Section 7(4)(c) of the Arbitration and Conciliation Act.

(4) Ibid, Section 7(4)(b).


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