Introduction
Facts
Issue
Arguments
Decision

Comment


Introduction

In its 22 April 2020 decision in National Agricultural Cooperative Marketing Federation of India (NAFED) v Alimenta SA, the Supreme Court refused enforcement of a foreign award on the basis that it was contrary to the fundamental public policy of India.

Although this is a recent decision, the dispute arose almost 40 years ago and thus pertains to an era which preceded the amendment of the Arbitration and Conciliation Act 1996. In its decision, the Supreme Court, among other things, analysed:

  • the concept of public policy; and
  • the difference between contingent contracts and frustration as a principle for voidability of contracts under Sections 32 and 56 of the Contract Act 1872, respectively.

The main issue in this case was the interpretation of the scope and consequences of a government directive which had rendered a party incapable of performing its contractual obligations.

Facts

On 12 January 1980 NAFED entered into a contract with Alimenta, under which the former would supply the latter with Indian hand-picked and selected groundnuts (the commodity). The contract was for the year 1979-1980.

The contract's terms and conditions were to be the standard terms of the Federation of Oils, Seeds and Fats Association, London (FOSFA) 20 contract (Clause 11). A notable provision under the contract was Clause 14, whereby in case of an export ban under any executive or legislative act of the government of the country of origin (ie, India), the agreement or any unfulfilled part thereof would be cancelled.

Under the contract, NAFED was required to ship 5,000MT of the commodity between 1979 and 1980. However, NAFED could ship only 1,900MT within the stipulated period. The remaining 3,100MT could not be shipped due to crop damage caused by adverse weather. It was therefore agreed via an addendum to the contract that the remaining quantity would be shipped during the 1980-1981 period.

NAFED was a canalising agency for the government with regard to the export of the commodity. As such, to carry forward any export from the previous year, NAFED had to obtain the government's express permission. While NAFED was permitted to undertake exports between 1977 and 1980, it was not permitted to carry forward exports from the 1979-1980 season to 1980-1981. In view of this, NAFED approached the government to obtain the necessary permission. However, the government did not grant it and prohibited NAFED from shipping any leftover quantities from previous years. As such, NAFED could not implement the previous year's contract with Alimenta. It therefore informed Alimenta that the export of the contracted quantity was impossible because of the government's executive action banning such exports. Alimenta treated this as a default by NAFED and commenced arbitration proceedings before FOSFA on 13 February 1981. Between 1981 and 1987, many rounds of litigation took place before the Delhi High Court and the Supreme Court whereby NAFED sought to restrain Alimenta from continuing the arbitration proceedings. During this time, NAFED also received clarification from the government that the directions refusing the fulfilment of the previous year's contract were lawful and binding on NAFED. Finally, in its 9 January 1987 decision, the Supreme Court relegated the parties to the arbitration pending before FOSFA.

On 15 November 1989 FOSFA passed its award, (the impugned award), directing NAFED to pay Alimenta certain sums plus interest. Aggrieved, NAFED filed an appeal before the Board of Appeal challenging the impugned award. On 14 September 1990 the Board of Appeal compounded NAFED's issues by increasing the award amount and the interest. Armed with the impugned award, Alimenta filed a petition under Sections 5 and 6 of the Foreign Awards (Recognition and Enforcement) Act 1961 (Foreign Awards Act) seeking enforcement of both the impugned award and that of the Board of Appeal. The dispute finally reached the Supreme Court pursuant to an appeal filed by NAFED. The Supreme Court had to adjudicate the matter on the merits and disposed of the case by way of its 22 April 2020 decision.

Issue

The issue in the present appeal was whether the foreign award was enforceable in India. In deciding this issue, the Supreme Court answered the following questions:

  • Was NAFED unable to comply with its contractual obligation to export groundnuts due to the government's refusal?
  • Could NAFED be held liable for damages due to a breach of contract, particularly in view of Clause 14 of the agreement?
  • Would enforcement of the impugned award contravene Indian public policy?

Arguments

NAFED argued that the impugned award contravened the public policy of India and was thus unenforceable under Section 7(1)(b)(ii) of the Foreign Awards Act. The impugned award did not deal with the government restriction on the export of the commodity. Further, the award's enforcement was barred by Section 7(1)(a)(ii) of the Foreign Awards Act as it flouted the basic norms of justice and enforcement thereof would result in Alimenta's unjust enrichment. NAFED also argued that the enforcement proceedings were barred by limitation as they had not been initiated within 30 days in accordance with Article 119, Schedule I of the Limitation Act 1963. Further, NAFED claimed that FOSFA had not given it due opportunity to present its case, even though Alimenta's arbitrator nominee had represented the case on Alimenta's behalf before the Board of Appeal. Finally, it argued that the enhancement of interest in the absence of an appeal by Alimenta was illegal.

Alimenta argued that the scope of interference in the enforcement of the impugned award was limited and countered all of the points raised by NAFED. It claimed that the tribunal had found that the award did not contravene public policy as the export ban had not been imposed by the government but rather was a self-imposed restriction by NAFED. Alimenta also argued that in view of these clear findings by the tribunal, it was not within the court's jurisdiction in proceedings brought under the Foreign Awards Act to consider their correctness.

Decision

The court based its answers to the above questions on its interpretation and application of:

  • Clause 14 of the contract in question;
  • Section 32 of the Contract Act; and
  • Section 7 of the Foreign Awards Act.

Clause 14 of the contract provided for its cancellation if the shipment became impossible for reasons mentioned therein, including an export ban imposed by an executive or legislative act of the Indian government. The court held that the government's refusal had prevented NAFED from exporting the commodity to Alimenta, the possibility of which was clearly envisaged in Clause 14 of the contract. The court observed that NAFED had intended to perform its contractual obligations but, being a canalising agent of the government, was unable to do so due to the government restriction.

Among other things, the court relied on Davis Contract Limited v Fareham Urbam District Council ((1956) 2 All ER 145) to address the point that under common law, frustration does not rescind a contract ab initio but merely brings it to an end immediately, thereby leaving any legal rights that have already accrued intact. In this case, the test applied to contract frustration was whether there had been a radical change in the obligation. Applying this test to the facts of the present case, the Supreme Court held that the unfulfilled part of the contract had to be cancelled. NAFED had been justified in not supplying the remaining quantity of the export as to do so would have violated the export control order and the government's decision to refuse to grant it permission to carry forward exports from previous years.

It was further held that the contract had become void in view of Section 32 of the Contract Act. In this regard, the court distinguished between the applicability of Sections 32 and 56 of the Contract Act, referring to, among other things, Satyabrata Ghose v Mugneeram Bangur & Co (AIR 1954 SC 44). The court opined that Section 32 of the Contract Act applies if an agreement provides for contingencies on whose occurrence the agreement cannot be carried out. Conversely, Section 56 deals with an agreement to perform an act or acts which subsequently become impossible or unlawful. In the present case, Section 32 applied because of the clear stipulation of contingencies in Clause 14 of the contract. Section 32 provides for a contract becoming void if it envisages the performance of an impossible act which, in the present case, occurred when the government refused to grant the necessary permission (as anticipated in the contract).

Applying the law to the facts of the case, the court held that the foreign award presupposed that supply could have been made despite the government's refusal. However, the fact remained that if supply had been made, it would have been unlawful and in violation of the government's directive. The addendums to the contract for the supply of the remaining quantities had been entered into later, and the parties had fully understood that if the government prohibited NAFED from carrying exports forward, it would be unable to keep its side of the bargain. In any event, the supply could not have been made without the government's permission. Thus, the parties had agreed to cancel the contract and, as such, the foreign award contravened basic law and public policy as applied in India.

Further, the court analysed Section 7 of the Foreign Awards Act to determine the enforceability of the award given the government export ban. Among other things, Section 7 provides that an award cannot be enforced if it contravenes public policy. The court discussed the applicability of public policy while referring to and relying on the available precedents, including the test set out in Renusagar Power Co Ltd v General Electric Co (1994 Supp (1) SCC 644). It was held that the matter involved fundamental Indian policy and that the parties had been aware of this and had agreed that in case of such an exigency (provided in Clause 14), the agreement would be cancelled in respect of the supply which was impossible. Thus, the impugned award could not hold NAFED liable to pay damages as the contract had become void.

The court did not consider it necessary to discuss the other contentions in detail. However, its findings can be summarised as follows.

FOSFA's appointment of an arbitrator on NAFED's behalf
FOFSA should have complied with the Delhi High Court's interim orders. However, the proceedings had been dismissed in 1987 and were not contested at that time. As such, NAFED could not raise this objection at such a belated stage.

Legal representation before arbitral tribunal and Board of Appeal
Rule 3 of the FOSFA Rules bars parties from having legal representation before an arbitral tribunal. Hence, NAFED's submission as to non-representation before the arbitral tribunal was rejected.

Alimenta's nominee arbitrator appearing before Board of Appeal
Ordinarily, such participation constitutes bad law and contravenes the concept of justice and the rules of procedure provided in The State of Punjab v Shamlal Murari ((1976) 1 SCC 719). As per Indian law and ethical standards, the arbitrator could not have appeared before the Board of Appeal to defend the award. However, there was no concrete material on record to substantiate the objection in relation to the prevailing practice in the United Kingdom at the relevant time. Accordingly, the Supreme Court was not inclined to decide this issue.

Board of Appeal's enhancement of interest payable
The Supreme Court held that the Board of Appeal could not increase the interest in the absence of an appeal by Alimenta.

Comment

In deciding the enforceability of this foreign award, the Supreme Court arguably considered the merits of the matter and was largely influenced by the government's refusal to allow NAFED to carry forward the export of the commodity. For instance, the arbitral tribunal had held that the export ban was a self-imposed restriction by NAFED and that the government had imposed no such ban. However, the Supreme Court clearly held that the ban was due to the government's refusal. Further, the court considered the merits of the government's decision and held that it had rightly objected to the supply and declined the permission in question.

The decision appears to rely on the test set out in Renusagar, which is good law insofar as enforcement of an award with regard to public policy is concerned. However, the settled position is that the public policy defence which is permissible under Section 7(1)(b)(ii) of the Foreign Awards Act should be construed narrowly. In this case, a wider threshold appears to have been used and the scope of public policy as a ground for refusing enforcement of the foreign award was expanded. The court examined the facts of the dispute to arrive at its finding regarding the government approval, which has opened Pandora's box in terms of determining whether a particular aspect of an award contravenes Indian public policy.

Whether executive acts of the government can be construed as a change in law, or whether a breach of such direction is justification for invoking the ground of a violation of public policy, is a key issue, especially in light of public sector undertakings. Whether such a decision would give rise to a cause of action for bilateral treaty arbitrations must also be analysed at a greater length and considered by the courts.

As a matter of strategy, parties increasingly seek to bring public policy arguments with a view of creating a basis for challenging the enforcement of an award in India. While the public policy ground should be examined in cases where it is warranted, the courts should consider confining their examination to the strict scope of this ground. An undefined and wide interpretation would paint the enforcement mechanism of arbitral awards in a bad light. It remains to be seen whether this judgment will have a ripple effect on other disputes in which one party relies on a government directive as a defence for non-performance.

Separately, in this decision, the Supreme Court clearly explained the distinction between Sections 32 and 56 of the Contract Act. Parties often press for frustration of contract based on Section 56 of the act, which may not apply or be relevant to the facts of the case (which may actually be covered by Section 32 of the Contract Act). Before going to court, parties should be mindful that if their agreement provides for a contingency on whose occurrence the agreement will become void, Section 32 will apply and no party will be held liable for damages on account of the agreement becoming void. In the present COVID-19 climate where force majeure claims have become the norm, the Supreme Court's decision, along with the decision in Energy Watchdog v Central Electricity Regulatory Commission ((2017) 14 SCC 80), provide much-needed direction on the test for force majeure.

For further information on this topic please contact Ajay Bhargava, Manavendra Mishra, Saasha Malpani or Shivank Diddi at Khaitan & Co by telephone (+91 11 4151 5454) or email ([email protected], [email protected], [email protected] or [email protected]). The Khaitan & Co website can be accessed at www.khaitanco.com.