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The Impact Of Supreme Court's Decision In M/S N.N Global Merchantile V M/S Indo Unique Flame Ltd

In a recent ruling by a constitution bench of the Supreme Court of India, referred to as the "Larger Bench," a 3:2 majority decision was reached in the case of N.N. Global Mercantile Private Limited v Indo Unique Flame Ltd and Others. The judgment established that an unstamped instrument, which is subject to stamp duty, and contains an arbitration clause, cannot be considered a legally enforceable contract under the provisions of Section 2(h) of the Indian Contract Act 1872 ("Contract Act"). Consequently, such instruments are not enforceable as per Section 2(g) of the Contract Act.

Furthermore, the ruling held that the stipulations outlined in Sections 33 and the restrictions specified in Section 35 of the Stamp Act 1899 ("Stamp Act"), which pertain to instruments liable for stamp duty as per Section 3 and the Schedule of the Stamp Act, would render the arbitration agreement contained within such an instrument legally null and void unless the instrument undergoes validation under the provisions of the Stamp Act.

a This judgment emanated from a reference made to the Larger Bench due to the presence of conflicting decisions from coordinate benches within the Supreme Court of India.

Brief Facts Of The Case
M/S Indo Unique Flame Ltd. was awarded a work order, the respondent entered into a sub-contract with M/S N.N. Global Mercantile Pvt. Ltd.. Clause 9 of the "Transport Work Order" specified for furnishing of a security deposit in the form of a Bank Guarantee whereas Clause 10 of the said contract mentioned the arbitration clause. Due to certain disputes in the sub-contract, M/S Indo Unique Flame Ltd. invoked the Bank Guarantee furnished by N.N. Global Mercantile, to which the applicant filed a civil suit before Commercial Court, Nagpur. Indigo Unique Flame Ltd. filed an application under section 8 of Arbitration and Conciliation Act, 1996 seeking to refer suit to arbitration, which was rejected by the Commercial Court.

Thereafter Indo Unique Flames Ltd. filed a writ petition against the order of the commercial court, the Bombay High Court allowed the application under Section 8 of the Arbitration Act,1996. It held that the non-stamping of Work Order can be raised at the stage of Section 11 of the Arbitration Act,1996 or before the Arbitral Tribunal at the appropriate stage.

An appeal was filed in the Hon'ble Supreme Court where a three-judge bench of the Supreme Court in deciding the validity of arbitration agreement in an unstamped or not-sufficiently stamped contract, held that, the arbitration agreement is separate and independent from the substantive contract in which it was embedded. The Hon'ble Apex Court placed reliance on doctrine of severability and held that when entering into a contract that contains arbitration clause, they enter into two separate agreements. First is the substantive agreement which contains rights and duties of the parties and second is the arbitration agreement.

Furthermore the Supreme Court held that exclusively Arbitral tribunal has the competence to rule on its own jurisdiction and entertain questions as regards to its validity or existence reliance was placed on Doctrine of Kompetenz-Kompetenz embedded is 16(1) of Arbitration and Conciliation Act, 1996. Furthermore the court held that legislative intent behind adding 11(6A) was for minimal judicial intervention.

The Apex Court refuted the principles laid down in SMS Tea Estates pvt Ltd. v. Chandmari Tea Co. Pvt. Ltd Garware Wall Ropes Ltd. v. Coastal Marine Constructions & Engg. Ltd and Vidya Drolia v. Durga Trading Corporation held that non-payment or insufficient payment of stamp duty does not invalidate the arbitration agreement and deems it to be non-existent in the eyes of law.

Since it was a three judge bench in Vidya Drolia V. Durga Trading Corporation, the matter was referred to a larger five-judge Constitutional bench.

Judgment by five-judge Constitutional bench of Supreme Court:

The apex court while expressing its majority view 3:2 in the present reference held that no instrument chargeable with duty under the Stamps Act shall be admitted in evidence or acted upon unless it is properly stamped according to Section 35 of the Stamps Act. This includes any arbitration agreements made in accordance with the 1996 Arbitration and Conciliation Act.

If the agreement is not stamped or insufficiently stamped, it is not valid and enforceable. The Hon'ble further explained that section 35 of the Stamp Act, 1899 bars collateral transactions thus if stamp duty is not paid on the substantive contract then the arbitration clause so embedded cannot be enforced or acted upon.

Section 35 of The Stamp Act, 1899 prohibits admission of instruments non stamped or insufficiently stamped as evidence. The supreme court explained that an unstamped contract, which is exigible to stamp duty, and which may contain an arbitration clause, cannot be said to be a contract that is enforceable in law. Therefore, such a contract, and the arbitration agreement therein, cannot be said to exist in law. In reference to this the apex court further elaborated that "existence" mentioned under section 11 of the Arbitration and Conciliation Act, 1996 does not mean mere physical existence, the arbitration agreement must exist in law i.e. it shouldn't be invalid, enforceable, illegal or void.

The Supreme court further held that the Stamp Act is not intended to be used as a weapon by a litigant to defeat the cause of the opponent,it is a curable defect, thus an instrument not duly stamped can become admissible when dues and penalties if any are paid as per section 42(2) of the Stamp Act, but until stamp and penalty are paid the contract is not enforceable and would not be a contract as provided under section 2(h) of the Indian Contract Act, 1872.

The Supreme Court overturned the judgment passed by the smaller bench and held that principles laid down SMS Tea Estates pvt Ltd. v. Chandmari Tea Co. Pvt. Ltd Garware Wall Ropes Ltd. v. Coastal Marine Constructions & Engg. Ltd and Vidya Drolia v. Durga Trading Corporation to be correct.

The Majority Judgment's effect is to reinstate the legal position established in SMS Tea. It is founded on a meticulous interpretation of the pertinent statutes and withstands scrutiny in that regard.

However, the decision's consequences are twofold: first, it involves judicial intervention at a pre-reference stage, and second, it leads to delays in the appointment of arbitrators. This aspect is particularly pertinent in the Indian context, given that the post-impounding adjudication process under the Stamp Act is known for its complexity and protracted nature. In this context, issuing directives to the authorities under the Stamp Act to act expeditiously could have been beneficial.

Notably, the Majority Judgment does not address applications under Section 9 of the Arbitration Act. Nevertheless, if we apply the principles set forth in the Majority Judgment and SMS Tea, even Section 9 applications should not be entertained, nor should orders be issued until the deficiency in stamp duty payment is rectified. After all, an agreement cannot be void for one purpose while remaining valid for another. The Stamp Act does not make such distinctions, at least not explicitly.

Conversely, the Minority Judgments acknowledge the concepts of severability and separability of an arbitration agreement, aligning with international standards. Arguably, the approach to minimize judicial interference, as discerned from the Minority Judgments, seems to be more in harmony with the true intent and spirit of the Arbitration Act.

The Larger Bench's decision has once again raised questions about the relationship between substantive contracts and the arbitration clauses they contain. In the future, parties will need to be diligent in ensuring the payment of stamp duty as mandated by the Stamp Act. Furthermore, the manner in which arbitration agreements are drafted may warrant reconsideration, possibly exploring the execution of separate arbitration agreements to safeguard the parties' rights.

While the Stamp Act primarily serves fiscal purposes and revenue interests, the fact that non-payment of required stamp duty is a remediable defect suggests that an interpretation aligning with expediting arbitration proceedings could have been a timely response, potentially bolstering India's standing as an international arbitration hub.

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