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The Enforceability of Arbitration Clauses in Substituted or Novated Contracts

The parties to the contract can form a consensus where they mutually decide to either substitute or rescind the entire contract or to modify, alter, vary or rescind some of its terms. Now, since the parties are free to modify or even entirely substitute the new contract with the old one, there may arise differences in interpreting the liabilities of the new one from the old one. A test was laid in Chrisomar Corpn. v. MJR Steels (P) Ltd., (2018) 16 SCC 117 to determine whether the case falls under the former or the latter part.

The court held that if the terms and conditions of the new contract are such that they are entirely changing the old contract by going to its very root, it will fall under Section 62 of the ICA, 1872 and otherwise it will fall under Section 63 of the ICA, 1872. One such clause that usually remains intact is the Arbitration Clause, which is deemed as a separate clause.

Doctrine of Separability

Doctrine of Separability was first established in the French court in the case of Gosset v. Raid 764 A.2d 138, which was then formally accepted by the Supreme Court of the United States in the case of Prima Paint Corp. v. Flood & Conklin Mfg. Co. 388 U.S. 395 (1967). The Doctrine of Separability says that if the terms of the old contract comes to an end due to breach, frustration or repudiation of the contract and the contract ends in such a way that there is a scope of a legal dispute arising between the party, the arbitration clause gets separated from the original or the substantive terms of the contract.

This should be picturised as there are two different contracts � one of performing the contract and another one of dispute resolution. So when there is unfulfillment of the original terms of the contract, just the contract terms come to an end, and not the agreed terms of dispute resolution. So if under such condition, if the parties want to file a case against each other, they must do it by the way of agrred mean (if abrbitration, the arbitration clause will surive). This was also held in SMS Tea Estates Ltd. v. Chandmari Tea Co. Ltd., (2011) 14 SCC 66.

(2) However, like that in the similar case of Young Achievers v. IMS Learning Resources Private Limited 2013 (1) SCC 535, the court duly held that "An arbitration clause in an agreement cannot survive if the agreement containing arbitration clause has been superseded / novated by a later agreement". The factual matrix was similar to that of the case in hand. IMS Learning Resources Private Limited filed a civil lawsuit in the High Court of Delhi seeking another consequential remedy as well as a permanent injunction barring Young Achievers from violating its registered brand, copyright, passing off of damages, and rendition of accounts of profits.

For the purpose of rejecting the plaint, referring the matter to arbitration, as well as for other consequential reliefs, Young Achievers preferred an Interim Application under Section 8 of the Arbitration and Conciliation Act, 1996 ("the 1996 Act," read with Section 5).

IMS objected to the application in question, claiming that the lawsuit may still be maintained. The Court in this case, did not apply the Doctrine of Separability because it was crystal clear that the parties mutually decided to end the contract. Justice K.S. Radhakrishnan and Justice A.K. Sikri discussed the submission of the parties and held as under:

"We may indicate that so far as the present case is concerned, parties have entered into a fresh contract contained in the exit paper which does not even indicate any disputes arising under the original contract or about the settlement thereof, it is nothing but a pure and simple novation of the original contract by mutual consent."

It was held that the arbitration clause in an agreement could not survive if the agreement containing the arbitration clause has been superseded / novated by the later agreement.

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