September 8 2011 Supreme Court rules on dragging non-parties to arbitration Khaitan & Co | Arbitration & ADR - India Arbitration & ADR IntroductionDeutsche Post caseSN Prasad caseCommentIntroductionCourts are often faced with situations in which party A claims that a valid agreement exists and the matter should be referred to arbitration, while party B contends that it has not entered into such an agreement and hence ought not to be subjected to arbitration. These situations are common. Although the law on the subject is relatively clear that a party that is not a signatory to an arbitration agreement cannot be subjected to arbitration proceedings, however, in today's complex world, situations may arise where there may be genuine concern that unless non-parties are joined in arbitration proceedings, the dispute may not be fully resolved.Two recent Supreme Court judgments deal with a situation where, due to the peculiar facts of the case, non-parties to the arbitration agreement were joined in the arbitration proceedings. The court therefore considered whether the arbitration agreement should be allowed to have effect in relation to all parties before the court, or only with respect to the parties to the arbitration agreement.Deutsche Post caseFactsIn Deutsche Post bank Home Finance Ltd v Taduri Sridhar,(1) a developer entered into a development agreement with a land owner for the construction of independent houses and multi-story apartments. The owner, the developer and a third party (who wanted to acquire an apartment) entered into an agreement for sale. Under the agreement, the owner agreed to sell an undivided share of the entire property and the developer agreed to construct a residential apartment for the third party.At the request of the third party, an independent financier approved the housing loan for purchase of the apartment. The loan agreement entered into between the third party and the financier provided for settlement of the dispute by arbitration by the financier's managing director or his nominee as the sole arbitrator. A separate tripartite agreement was alleged to have been entered into between the third party, the developer and the financier, under which it was agreed that the loan amount should be disbursed by the financier directly to the developer and such amount paid to the developer would be deemed a disbursement of loan by the financier to the third party.Under the agreement, the financier paid the entire sale price to the developer. The developer and the third party subsequently entered into a construction agreement whereby the third party entrusted the construction of the flat to the developer. Following a delay in construction and delivery of the apartment, the third party issued notice to the developer invoking arbitration (in terms of the construction agreement), and sought reference of the disputes between the developer and the third party to arbitration.As there was no response from the developer, the third party filed a petition under Section 11 of the Arbitration and Conciliation Act 1996 before the Andhra Pradesh High Court for appointment of an arbitrator. In this petition, the petitioner (ie, the third party) also sought to bring the financier into the dispute by impleading it as a respondent along with the developer.The High Court allowed the application and appointed a retired judge of the High Court as the sole arbitrator. When referring to the construction agreement between the third party and the developer, the judge did not refer to the financier's contention that, since it was not a party to the dispute or the construction agreement, the petition under Section 11 of the act was therefore not maintainable against it. As a result of this order, the financier, though not connected to the dispute between the third party and the developer, was joined as a party to the arbitration proceedings.The financier challenged the High Court order before the Supreme Court of India primarily on two grounds: Since only the third party and the developer were parties to the construction agreement containing the arbitration clause, the financier could not be dragged into the dispute between them by being made a party to the petition under Section 11 of the act; and The court ought to have examined whether the respondents before it were parties to the arbitration agreement before making an order appointing the arbitrator.The Supreme Court therefore had to consider whether the financier could be made a party to the arbitration proceedings, even though it was not a party to the arbitration agreement contained within the construction agreement. Since the third party had made a demand for damages against the developer and the developer had refused to comply, resulting in invocation of arbitration agreement by the party, the Supreme Court concluded that the High Court was justified in appointing an arbitrator insofar as the dispute between the third party and the developer was concerned. It then had to decide whether the financier, a non-party to the construction agreement, could also be roped in as a party to such arbitration.DecisionWhile examining the subject, the Supreme Court referred to existing case law(2) on the subject. Among other things, the court relied on Jagdish Chander v Ramesh Chander,(3) wherein it was held that:"the existence of an Arbitration Agreement as defined under Section 7 of the act is a condition precedent for exercise of power to appoint an Arbitrator/ Arbitral Tribunal, under Section 11 of the act by the Chief Justice or his designate. It is not permissible to appoint an Arbitrator to adjudicate the disputes between the parties in the absence of an Arbitration Agreement or mutual consent."After examining the facts and its previous judgments, the Supreme Court ruled that the two conditions required for appointment of an arbitrator under Section 11 of the act are: the existence of an arbitration agreement between the parties to the petition under Section 11 of the act; and the existence of disputes to be referred to arbitration. Furthermore, if a party to an arbitration agreement files a petition under Section 11 of the act impleading as respondents both the other party to the arbitration agreement and a non-party to such agreement, and the court appoints an arbitrator without deleting or excluding such non-party, the effect would be that both respondents (ie, both the party and the non-party to the arbitration agreement) will become parties to the arbitration. Such a consequence is contrary to both the contract and the law on the subject.If a person who is not a party to the arbitration agreement is impleaded as a party in a petition under Section 11 of the act, the court should either delete such party from the array of parties or, while appointing an arbitrator, make clear that the arbitrator is appointed only to decide the dispute between the parties to the arbitration agreement. Clarifying the legal position, the court further observed that had there been any arbitration clause in a tripartite agreement between the third party, the developer and the financier, and if the party had made claims or had raised disputes against the developer or the financier with reference to such tripartite agreement, the position would have been different.Since that was not the case in this matter, the court allowed the financier's appeal and set aside the order passed by the High Court. Significantly, the order was set aside "in so far as the appellant was concerned". The court also clarified that the appointment of the arbitrator by the High Court under the impugned order will remain undisturbed with respect to this dispute between the third party and the developer.SN Prasad caseFactsIn SN Prasad v Monnet Finance Ltd,(4) the appellant before the court was the father of the managing director and was also a director of the borrower company. A loan agreement was entered into between the bank, the company and the managing director of the borrower company (who acted as the company's guarantor for the loan approved by the bank).The loan agreement provided for settlement of dispute by arbitration. A similar tripartite loan agreement was entered into among the same set of parties for a further sum of money.The appellant before the court was not a party to the loan agreement; nor did he execute any separate deeds of guarantee or other documents in favour of the bank. On default in repayment by the borrower company, the bank issued a notice through its counsel demanding payment and proposing to refer the claims against the borrower company and its guarantor for arbitration. The bank also filed two applications under Section 11 of the act for appointment of an arbitrator before the Delhi High Court.The borrower company, its guarantor and the appellant were impleaded as respondents in these applications. The High Court (by two orders dated May 23 2000) appointed a retired judge of the High Court as the sole arbitrator. The arbitration entered into awards. Both awards directed the respondents, as well as the appellant, to pay certain sums with interest to the bank. These awards were challenged by the appellant before the High Court. However, by a common order dated May 22 2006, the High Court dismissed the applications. This common order, insofar as it affected the appellant, was challenged by way of a special leave petition before the Supreme Court of India. The following contentions were raised by the appellant in support of its petition: The appellant was not a party to the tripartite loan agreements executed among the respondents - namely, the bank, the borrower company and the guarantor. These agreements contained the arbitration clause, while the appellant had provided only a short letter, standing guarantee for one of the loans approved by the bank. Furthermore, in the absence of an arbitration agreement between the bank and the appellant, the claim against the appellant could not be referred to arbitration; nor could any award be made against him. Hence, the award was liable to be set aside. The appellant had only provided a letter indicating his willingness to stand guarantee. However, he executed neither the loan agreements nor any deed of guarantee. Therefore, the appellant was not a guarantor and, hence, not liable. Therefore, even without conceding that there was a arbitration agreement between the appellant and the bank, and assuming that he was liable in respect of the loan amount, there could be no award for interest against him, as he had not agreed to guarantee the payment of interest. DecisionThe court examined the above contentions and observed that the terms 'arbitration agreement' and 'party' were all defined terms under the act. The court further observed that, in view of these definitions, there could be reference to arbitration only if there were an agreement between the parties. The court further observed that the act makes clear that an arbitrator can be appointed under the act at the instance of a party to the arbitration agreement only in respect of disputes with another party to the arbitration agreement. If there was a dispute between the party to an arbitration agreement with other parties to the agreement and non-parties to the agreement, reference to arbitration or appointment of arbitrator could be only with respect to the parties to the arbitration agreement, and not to the non-parties.The court further observed that to constitute an arbitration agreement under Section 7(4)(c) of the act, a statement of claim must be made containing a specific allegation regarding the existence of an arbitration agreement by an applicant and non-denial thereof by other party.CommentThese two judgments deal with the practical aspects of resolution of disputes through arbitration. While it may be that a dispute between two parties to an arbitration agreement presents a scenario in which it is deemed expedient by one of the parties to enjoin non-parties as parties to such arbitration proceedings, the position in law (as explained by the Supreme Court) amply clarifies the position and leaves no room for ambiguity.It is clear that a party that is not a signatory to an arbitration agreement cannot be dragged into and made party to the arbitration proceedings for deciding a dispute that may have arisen between the signatories to the arbitration agreement. Furthermore, if a non-party to the arbitration agreement is impleaded as a party in a petition under Section 11 of the act, the court should either delete such party from the array of parties or, while appointing an arbitrator, make it clear that the arbitrator is appointed only to decide the dispute between the parties to the arbitration agreement.For further information on this topic please contact Chakrapani Misra at Khaitan & Co by telephone (+91 11 4151 5454), fax (+91 11 4151 5318) or email ([email protected]).Endnotes(1) AIR 2011 SC 1899.(2) (2009) 1 SCC 372.(3) (2007) 5 SCC 719.(4) (2011) 1 SCC 320.