Recently in Sanjiv Prakash v. Seema Kukreja & Ors.1, the Delhi High Court has reiterated that novation of an agreement would necessarily result in destruction of the arbitration clause contained therein. In this regard, it was observed that an arbitration agreement being a creation of an agreement may be destroyed by agreement.
Facts of the case:
Respondent No. 3 had incorporated a company in 1971, under the name of Asian Films Laboratories Private Limited, which was subsequently renamed as ANI Media Private Limited in 1997 ("Company"). The shareholders of the said Company were Respondent No. 3's son ("Petitioner") and his daughter and wife ("Respondent No. 1" and "Respondent No. 2" respectively) (Petitioner and Respondents together hereinafter referred to as the "Family"). The Petitioner was the Managing Director of the Company. In 1996, Thomson Reuters Corporation Pte. Limited ("Reuters") approached the Petitioner for a long-term equity investment in the Company on the condition that the Petitioner would play an active role in the management of the Company.
Accordingly, pursuant to a Shareholders Agreement ("SHA") and a Share Purchase Agreement ("SPA") entered into between the parties, Reuters acquired 49% shares of the Company in 1996. Clause 16 of the SHA provided for resolution of disputes through inter alia arbitration seated in London and governed in accordance with the rules of London Court of International Arbitration ("LCIA"). Further, Clause 28 of SHA recorded that the SHA would supersede any or all prior agreements, understandings, arrangements, whether oral or in writing, explicit or implicit between the parties.
It is pertinent to note that prior to the execution of the SHA and the SPA with Reuters in 1996, an undated Memorandum of Understanding ("MoU") was entered into by the Family. The said MoU contained an arbitration clause (being clause 12), which provided for appointment of a sole arbitrator subject to the provisions of the Arbitration Act, 1940, or any other enactment or statutory modification thereof.
Over time, Respondent No.3 was desirous of transferring his shares in the Company to the joint shareholding of himself and the Petitioner. This was objected to by Respondent Nos. 1 and 2. On the other hand, Respondent Nos. 1 and 2 indicated a desire to have Respondent No. 2's shareholding transferred to the joint names of Respondent Nos. 1 and 2. The Petitioner was not in favour of such transfer, which according to him was violative of the Companies Act, 2013, as well as the MoU. The parties exchanged substantial correspondence in this regard.
Subsequently, the Petitioner invoked the arbitration clause under the MoU and issued a notice for invocation of arbitration dated November 23, 2019 ("Notice of Arbitration"), to the Respondents. Whilst Respondent No. 3 consented to the arbitrator nominated by the Petitioner, Respondent Nos. 1 and 2 contended that the MoU had allegedly been superseded and invalidated by the terms of the SHA.
Accordingly, the Petitioner filed an Arbitration Application under Section 11 of the Arbitration and Conciliation Act, 1996 ("Act"), seeking appointment of a sole arbitrator in accordance with the arbitration clause contained in the MoU, for the purpose of adjudicating the disputes between the parties.
Arguments on behalf of the Petitioner:
The Petitioner contended that (i) the MoU constituted a special arrangement between the Family members, constituting a succession plan and management scheme for the Family qua the Company; (ii) the MoU was a separate and distinct agreement from the SHA and the SPA and that the MoU was binding on the Family members inter-se whereas the SHA was binding as between the Family members (i.e. the family shareholders of the Company) and Reuters.
It was further contended that the MoU had not been superseded as (i) the transaction with Reuters was to govern the relationship between Reuters and the Family members and not the inter-se relationship of Family members, which was governed by the MoU; (ii) even after the SHA was executed, the Articles of Association of the Company adopted in May 1996 incorporated material terms of the MoU; (iii) the Respondent No. 3, being the founder-promoter of the Company and a signatory of the MoU, had time and again endorsed the MoU and its validity.
Additionally, it was also contended that as per Section 5, read with Section 11 (6A) and Section 16 of the Act and the principle of 'kompetenz- kompetenz', the question of binding nature of the MoU was an issue that needed to be decided by the arbitral tribunal appointed as per the arbitration agreement contained in the MoU. It was also contended that the scope of the enquiry in an application filed under Section 11 of the Act was limited only to prima facie satisfaction of the existence of an arbitration agreement and it was the arbitral tribunal, which would decide preliminary issues including the validity, efficacy and the effect of the agreement.
Arguments on behalf of the Respondents
The Respondents challenged the invocation of the arbitration clause contained in the MoU and contested the maintainability of the Arbitration Application. They inter-alia contended that (i) the SHA was executed between the Petitioner, the Respondents (1, 2 & 3) and Reuters to govern their inter- se relationship as equity shareholders and members of the Company; (ii) As per the definition clause in SHA, shareholder meant each of the Family members and Reuters; (iii) the SHA was a comprehensive agreement between all shareholders and it set out the terms governing the relationship of all shareholders in the Company, along with the dispute resolution clause (i.e. Clause 16 of the SHA); (iv) Subsequent to the execution of SPA and SHA, any previous arrangements between the then shareholders were superseded by the SHA in view of Clause 28 of the SHA. Accordingly, the MoU had been novated by the terms of the SHA.
It was further contended that in accordance with Section 62 of the Indian Contract Act, 1872, when a contract with an arbitration clause gets novated/superseded, the arbitration clause perishes and the same cannot be invoked. It was also submitted that the scope of Section 11 of the Act had been expanded by the Apex Court to look into the validity of the arbitration agreement. Accordingly, scope of inquiry under Section 11(6A) required the Court to decide the fundamental issue of novation/supersession.
Additionally, it was also contended that given the fact that the proceedings envisaged were an international commercial arbitration (as the seat according to the SHA was London), the Supreme Court would be the Court designate as per provisions of Section 11(9) of the Act and not the Delhi High Court.
Findings of the Court:
The Delhi High Court held that the application filed by the Petitioner was not maintainable. It inter-alia held that (i) as per the definition provided in the SHA, 'parties' to SHA included the Family shareholders both in their individual capacity as well as collectively and Reuters; (ii) the SHA has been executed by all the shareholders of the Family in their individual capacity and not by one person representing the family or as a 'block' as contended by the Petitioner; (iii) Clause 16 of the SHA contemplated dispute between 'shareholders', which had been defined to include individual shareholders of the Family ( i.e. in their individual capacity) and Reuters; (iv) Clause 28.2 of SHA provided that any kind of prior agreement 'between the parties' would stand superseded and given the fact that the Family members were individually recognised as parties under the SHA, the terms of the MoU were superseded by the terms of the SHA.
It was further observed that an arbitration agreement being a creation of an agreement could be destroyed by agreement. Accordingly, if a contract was superseded by another contract, the arbitration clause, being a component/part of the earlier contract, would fall with it. Similarly, if the original contract in entirety was put to an end, the arbitration clause, which is a part of it, would also perish along with it.
Accordingly, it was held that the arbitration clause of the MoU perished with the MoU, owing to novation by way of SHA and the invocation of arbitration under the MoU was unjustified. As a result, the Petitioner's plea of doctrine of 'kompetenz-kompetenz' and the reliance placed on Section 11 (6A) of the Act was found to be untenable under the present circumstances.
In the instant case, the Delhi High Court has clearly set out the legal implications of novation of a contract, on the arbitration clause contained in it. The Court has however observed with caution that it was trite law that in order to attract the theory of novation as per Section 62 of the Contract Act, there should be total substitution of the earlier contract and its terms and all the terms of the earlier contract (including the arbitration clause) should perish with it.
1. Arbitration Petition Number 4/2020, Judgment delivered on October 22, 2020
November 6, 2020
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.