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From “Unenforceable” to “Curable Defect”: Unpacking the Nexus Between Unstamped Contracts and Arbitration Agreements

Third-year law student at National Academy of Legal Studies and Research (NALSAR), Hyderabad


 

I. Introduction


In December 2023, the Supreme Court (“SC”), in its verdict ‘In Re: Interplay Between Arbitration Agreements under the Arbitration and Conciliation Act 1996 and Indian Stamp Act 1899’ (“In Re: Interplay"), tried to answer a critical legal question requiring the harmonisation of conflicting legal frameworks. The SC navigated the tension between upholding the State's fiscal prerogatives under the Stamp Act, 1899 (“Stamp Act”) and ensuring the efficacy of alternative dispute resolution mechanisms as championed by the Arbitration and Conciliation Act, 1996 (“Arbitration Act”).


India's initial Arbitration Act of 1899 provided a basic framework but lacked the international sophistication achieved in the 1996 Act. This latter Act, closely aligned with the UNCITRAL Model Law and empowered by provisions like Section 5 (a non-obstante clause), significantly strengthened the non-interference principle in Indian arbitration. Within the dynamic landscape of arbitration, the doctrine of ‘arbitral autonomy’ holds central importance. The SC has, in multiple judgments, reiterated that the Arbitration Act is a self-contained code. The legal fiction of separability of the arbitration agreement from the underlying contract is the cornerstone of arbitration law, meant to uphold the parties' contractual freedom to settle their disputes.


However, the purpose of the Arbitration Act clashed with the Stamp Act, a fiscal measure that was brought up to secure revenue for the state by levying tax on certain classes of instruments. The SC, in Hindustan Steel Ltd. v. Dilip Construction, highlighted the ‘curable’ nature of the unstamped instrument. It observed that the Stamp Act was not enacted to arm a litigant with a weapon of technicality as it would defeat the purpose of the Act. Despite the principle of non-interference, judicial action has not only been commonplace but also appears to favour the State's fiscal objectives disproportionately.


This article aims to explain the position of law on this matter, juxtaposing the line of reasoning of the Court in the recent judgment from earlier judgments.

 

II. Chronological Analysis of Judicial Pronouncements


In 2011, the SC’s two-judge bench in SMS Tea Estates v. Chandmari Tea (“SMS Tea Estates”) relied predominantly on the provisions of the Stamp Act while deciding on the impact of an unstamped instrument over an arbitration agreement. The Court noted that Section 35 makes unduly stamped instruments inadmissible as evidence in Courts. Thus, if the instrument is unstamped, Section 33 of the Act provides a mechanism for authorised personnel to seize unstamped documents and deal with them as per Section 38 of the Act. Thereafter, the judgment read:

“(iii) (…) if the deficit stamp duty and the penalty is paid, (…) and the defect with reference to deficit stamp is cured, the court may treat the document as duly stamped."

Later, another two-judge bench in Garware Wall Ropes v. Coastal Marine Constructions (“Garware Wall Ropes”) upheld SMS Tea Estates, reiterating that the arbitration clause is part of a larger contract and an agreement becomes a contract only when it is enforceable by law. Therefore, an unstamped contract will consequently end up making the underlying arbitration agreement void. This is because, as per the Stamp Act, an agreement cannot be enforceable in law unless duly stamped. Therefore, even a plain reading of Section 11(6A), read with Section 7(2) of the Arbitration Act and Section 2(h) of the Contracts Act, 1872 (“Contract Act”), would, as per the Court, “make it clear that an arbitration clause in an agreement would not exist when it is not enforceable by law."


Then, in the 2020 landmark case of Vidya Drolia v. Durga Trading Corporation (“Vidya Drolia”), the SC delved into the interpretation of Section 11 of the Arbitration Act. The Court attempted to answer whether the term ‘existence’ in Section 11 refers to (i) the mere existence of an arbitration agreement, excluding questions regarding enforcement, or (ii) it encompasses both aspects. The Court ruled that the interpretation of the term must be made ‘contextually’. With reference to this case, an agreement evidenced in writing was observed to be meaningless “unless the parties can be compelled to adhere and abide by the terms." Further, the judgment reaffirmed the Garware Wall Ropes‘s reasoning.


The SC veered away from the contentious yet firmly established position the following year in N.N. Global Mercantile v. Indo Unique Flame Ltd. (“N.N. Global 1”), whereby, instead of delving into the interplay of statutory provisions governing the arbitration agreements, the Court relied on the jurisprudential values underlying the arbitration agreements. Expounding on the ‘doctrine of separability’ as given in the judgment of Heyman v Darwins, the SC held that arbitration agreements are separate and autonomous agreements. Thus, invalidity, ineffectiveness, or termination of the substantive commercial contract would not result in the termination of the arbitration agreement.


However, the bench in N.N. Global 1 referred the case to a larger constitutional bench as the strength of the bench in Vidya Drolia and N.N. Global 1 was the same. This review was done by the Court in the N.N. Global Mercantile v. Indo Unique Flame Ltd. (“N.N. Global 2”) judgment. In the majority opinion, Justice K.M. Joseph upheld Vidya Drolia while textually interpreting Section 2(h) of the Contracts Act, 1872. It was concluded that a contract becomes invalid if it is unstamped, rendering all of its constituents, including the underlying arbitration agreement, similarly invalid.


The Court observed that the Stamp Act, even though a fiscal measure, does not fall within the category of a procedural law. An unenforceable agreement on the grounds of substantive law should not be perceived as 'curable'. As long as it is unstamped, it does not hold any validity in the eyes of the law. This stance taken by the Court obviates an explanation of the assumption made by the Court regarding the inseparable relationship between an arbitration agreement and the contractual agreement under which it is placed.


Justice Joseph remarks while acknowledging the doctrine of kompetenz-kompetenz, as enshrined in Section 16(1) of the Arbitration Act, that N.N. Global 1 erred in concluding that the arbitration agreement underlying an unstamped instrument need not be stamped for it to be enforceable. Consequently, if allowed, it would encourage parties to contravene the mandate of the Stamp Act.

 

III. Decoding the Current Stance


A keen scrutiny of the provisions of the Stamp Act revealed an important distinction between inadmissibility and voidness. An unenforceable contract is fundamentally void. In the judgment, the SC held that Section 35 of the Stamp Act unambiguously renders a document inadmissible and not void. However, the stance taken by the SC in N.N. Global 2 was that an unstamped agreement is unenforceable. Thus, non-stamping does not lead to the invalidity of an instrument and is, therefore, rightly characterised as a 'curable defect' by N.N. Global 1.


The Court, in N.N. Global 2, acknowledged the separability of the arbitration agreement from the underlying contract. However, it was not applied in the context of Sections 33 and 35. Further, the doctrine of kompetenz-kompetenz empowers arbitral tribunals to have overarching powers of jurisdiction, including determining the existence or validity of arbitration agreements, which, as per the 1940 Act, were under the exclusive domain of Courts to decide.


Thus, the SC, bearing in mind the ratio of the Uttarakhand Purv Sainik Kalyan Nigam judgement regarding wide-ranging powers vested in the arbitral tribunal, held that such tribunals could effectively decide on the conflicts between the parties before the stamp duty is paid. It is important to note that after the Parliament inserted Section 11(6A) through the Arbitration and Conciliation (Amendment) Act, 2015, the legislature's intent was clear, i.e. to restrict the courts' pre-arbitral jurisdiction to the bare minimum.


In Re: Interplay also upheld the ratio of Duro Felguera, establishing that the scope of inquiry ceases to exist once an arbitration agreement is detected in a contractual setting. This rejects the interpretation in Vidya Drolia, which erroneously read the mandate of a valid arbitration agreement in Section 8 into the mandate of Section 11. This judgment clarifies the position on both Section 8 and Section 11, emphasising that the existence and validity of an arbitration agreement are not intertwined. It also explained that an arbitration agreement does not exist if it is illegal or does not satisfy mandatory legal requirements, but the powers of such determination must primarily be wielded by arbitration tribunals.


Lastly, the Court rightly calls for a harmonious construction of the statutes. The Court held that the arbitration tribunal continues to be bound by the provisions of the Stamp Act, and following through the mandate of the Stamp Act is not an optional exercise that could be avoided. The arbitration tribunal, armed with the ability to ensure agreement validity via stamping, shall gather evidence directly and resolve jurisdictional issues internally. This would not only breathe life into the kompetenz-kompetenz doctrine but also uphold the delicate balance between promoting efficient dispute resolution and safeguarding the State's fiscal interests. 

IV. Conclusion


This judgment injects much-needed clarity into the Indian arbitration landscape. By anchoring its reasoning in the core principles of arbitration, the Court fostered enhanced trust in arbitral tribunals. Resolving disputes through alternative methods is a fast-growing area in India, and judgments like this, which create a more arbitration-friendly environment, is a step in the right direction.


 

Note: This article has been reviewed by Mr. Ketan D. Parikh at the Tier - II stage.


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