This article is written by Hitesh Vachhani (Founder Juristic Legal) and Shikhar Khandelwal. This article focuses on section 7 of the Arbitration and Conciliation Act, 1996 and certain exceptional circumstances wherein the Arbitration Agreement is made binding upon the Non-Signatories to the Arbitration Agreement as well.
DECLARATION
We, Hitesh Vachhani and Shikhar Khandelwal, hereby declare that this work is the result of our own intellect and the necessary references are provided in the article. This article is only for an academic purpose. The matter embodied has been properly referenced and acknowledged to avoid any kind of copyright issues.
ABSTRACT
The Arbitration and Conciliation Act, 1996 [ACA] does not give a choice of an alternative court but it provides something which is alternative to the court. The ACA provides that a party can proceed to the arbitration only when the court, upon being satisfied of the making of the valid arbitration agreement, makes any such order in pursuance thereof.
Arbitration, being an agreement between the parties can be imposed only against such persons’ who are party to the agreement and no other person. Therefore, in the light of the same, this research article aims to analyze Section 7 of the Arbitration and Conciliation Act, 1996, which talks about arbitration agreement between the parties [Signatories] to that agreement. Through this research article we aim to highlight certain exceptional circumstances wherein the Arbitration Agreement is made binding upon the Non-Signatories to that Agreement as well.
INTRODUCTION
Arbitration agreement is governed by the provisions of the law of contract. Section 7 of the Arbitration and Conciliation Act, 1996 defines “arbitration agreement” as an agreement by the parties to submit to arbitration all or certain disputes which have arisen or which may arise between them in respect of a defined legal relationship, whether contractual or not. Therefore, the jurisdiction of the Arbitrator is derived exclusively from the parties’ agreement to use arbitration as a means to resolve their dispute.
Thus, as a corollary, the jurisdiction only extends to those who are privy to the arbitration agreement. As a general rule, the inclusion of non-signatories in an arbitration agreement does not mean that the arbitration agreement is (artificially/virtually) expanded to third parties but interpreted to include non-signatories as parties based on their consent to arbitrate. Such consent could either be given by means of “deemed consent” based on objective causes or “implied consent” based on the subjective expectation of the non-signatory. Extension of the arbitration agreement to “non- signatories”, the expression most used, covers situations in which a party’s standing to sue or to be sued under an arbitration agreement is considered, whenever this party is not named or designated in the arbitration agreement or the contract containing it, or appears to have signed the arbitration agreement or the contract on behalf of a third party.
Generally the non-signatories to the agreement would not be bound by the agreement as there is no privity of contract. However, there are exceptions to this general rule of privity of contract. As an arbitration agreement is governed by the ordinary principles of contract law, non-signatories may be compelled to arbitrate in a number of circumstances. Over the course of time, a range of legal theories have been developed to facilitate this determination either for or against including such non-signatories. Parent companies, subsidiaries, contract assignees, governmental and quasi-governmental entities, beneficiaries and other non-signatories to an underlying arbitration agreement may find themselves bound by an arbitration agreement, and by the subsequent arbitral award. Compelling a non-signatory to arbitrate involves complex theories of contract and corporate laws that are themselves unsettled or at least highly fact dependent in their application. Various national courts and arbitral tribunals, from both, common law and civil law systems have evolved some of these theories:
- Group of Companies Doctrine
- Veil-piercing or Alter-ego
- Agency
- Incorporation by Reference
- Estoppel
- Assignment
- Third-Party Beneficiary
GROUP OF COMPANIES DOCRTINE
The “Group of Companies” doctrine illustrates the concept of implied consent, which was introduced in the Dow Chemical Case 1984 Rev Arb 98 and addressed the members of a group of companies as “one and the same economic reality”. Following this approach, the (controlling) parent company shall not be able to use its likely not equally capitalized subsidiaries to avoid arbitration proceedings. The concept of deemed consent is, for instance, applied in the “Chain of Transactions” concept. This concept has been supported by a line of cases in France and basically means that the arbitration clause is interpreted to include parties, which entered into subsequent agreements, provided that these subsequent agreements are closely linked to or dependent on the agreement containing the arbitration clause. The facts of the case must provide for the reasonable expectation to be included in arbitration proceedings. The group of companies’ doctrine states that a company entering into an arbitration agreement within a group of companies may bind its non-signatory affiliates based on their contractual relationship. This doctrine was recognized by the New York Convention, 1985 which in Article II (1) recognizes an agreement between parties “in respect of a defined legal relationship, whether contractual or not”.
This legal proposition was recognized in India by the Supreme Court in Chloro Controls (I) P. Ltd vs Severn Trent Water Purification Inc. & Ors. (2013) 1 SCC 641 where the Supreme Court was dealing with the scope and interpretation of Sec. 45 of the 1996 Act and, in that context discussed the scope of the relevant doctrines on the basis of which “non-signatories” could be said to be bound by the arbitration agreement, including in cases of inter-related contracts, etc. The doctrine of group of companies assists the courts in binding non-signatories to arbitration agreements by analyzing their relationship within its corporate structure. When the circumstances are established, the group of companies constitute the same economic reality despite their distinct juridical identities, warranting the impleadment of the non-signatory. Hence, where a commonality of intention to bind both signatories and non-signatories is extracted, the doctrine finds its application.
It is, in the context of the above, important to know the relative nature and scope of Sec. 45 and 8 of the Act. Section 45 is enacted materially on the lines of Article II of the New York Convention, 1958. For proper interpretation and application of Chapter I of Part II of the 1996 Act, it is necessary that those provisions are read in conjunction with schedule I of the Act since it is the very foundation of Section 45. The language of Section 45 read with Schedule I of the 1996 Act is worded in favor of making a reference to arbitration when a party or a person claiming through or under him approaches the court and the court is satisfied that the agreement is valid, enforceable and operative. Because of the legislative intent, the mandate and the purpose of section 45 being in favor of arbitration, the relevant provision would have to be construed liberally to achieve the object.
In all “group of companies” decisions, the finding of an express or implied consensus of the parties remains key in binding non-signatories to an arbitration clause, and this doctrine is not applied due to mere affiliation of the companies. In essence this doctrine states that when a non-signatory company of group of companies is an active participant in the contractual relationship, then the arbitration agreement can be extended to it. In Sarhank v. Oracle Corporation, a tribunal sitting in Cairo decided, as a matter of Egyptian law:
“Despite their having separate juristic personalities, subsidiary companies to one group of companies are deemed subject to the arbitration clause incorporated in the contract because contractual relations cannot take place without the consent of the parent company owning the trademark by, and upon which transactions proceed.”
However, the Courts in England and Australia have been very reluctant to apply the doctrine of group of companies. In Peterson Farms Inc. v. C&M Farming Ltd. (2004) EWHC 121 the Commercial court of England had held that the group of companies’ doctrine forms no part of English Law. In Australia and Switzerland too, this doctrine has been rejected for the purpose of extending the arbitration agreement to non-signatories.
An arbitration agreement, being a commercial contract, is governed by principles of contract law. And as a rule of evidence the conduct of the parties before contract, at the time of the contract and after the contract has been negotiated must be given due consideration in determining the intent of the parties. This conduct singularly reflects the intention of the parties at the time of conclusion of an agreement. If, a third party is in an advantageous position at the time of the agreement between the two principal contractors (actual parties), though is not a signatory to that agreement, then subsequently the party would be deemed to have waived their right to object in case of any adverse circumstances.
PRE- CHLORO CONTROLS (I) P. LTD VS SEVERN TRENT WATER PURIFICATION INC. & ORS.
Before the decision of the Hon’ble SC in Chloro Controls (supra) the settled position of law with respect to the arbitration agreement was that the agreement would be binding upon the parties to the arbitration agreement and not the third party. Thus, the extension of arbitration agreement was refused by the courts reasoning that only signatories were bound by the same.
But the two Judge Bench of the Hon’ble Supreme Court while interpreting Section 7 in Indowind Energy Limited v. Wescare (India) Limited (2010) 5 SCC 306 held that two conditions should be satisfied to constitute an arbitration agreement for the purpose of section 7. The two conditions are:
- it should be between the parties to the dispute; and
- it should relate to or be applicable to the dispute.
That was a case where an agreement of sale was entered into between W and S. The agreement described S and its nominee as a buyer and as the promoter of Indowind. Under the agreement, the seller agreed to transfer to the buyer certain assets for a consideration which was payable partly in cash and partly by the issue of equity shares. The Board of Directors of W accorded approval to the agreement, as did the Board of S. No approval was, however, granted by the Board of Directors of Indowind. According to W, certain disputes arose between it and S and Indowind on the other. W filed a petition Under Section 11(6) against S and Indowind for appointment of a sole arbitrator.
Indowind resisted the petition on the ground that it was not a party to the agreement which was entered into between W and S. The Chief Justice of the Madras High Court allowed the application for appointment of an arbitrator, holding that though Indowind was not a signatory to the agreement, it was bound. In appeal, this Court held that W had not entered into an agreement with Indowind, referring to the agreement which contained an arbitration agreement, with an intention to make the arbitration agreement a part of their agreement. In the view of this Court:
…The question is when Indowind is not a signatory to the agreement dated 24-2-2006, whether it can be considered to be a “party” to the arbitration agreement. In the absence of any document signed by the parties as contemplated under Clause (a) of Sub-section (4) of Section 7, and in the absence of existence of an arbitration agreement as contemplated in Clauses (b) or (c) of Sub-section (4) of Section 7 and in the absence of a contract which incorporates the arbitration agreement by reference as contemplated under Sub-section (5) of Section 7, the inescapable conclusion is that Indowind is not a party to the arbitration agreement. In the absence of an arbitration agreement between Wescare and Indowind, no claim against Indowind or no dispute with Indowind can be the subject-matter of reference to an arbitrator. This is evident from a plain, simple and normal reading of Section 7 of the Act.
The fact that the agreement was entered into by S as the promoter of Indowind and described the latter as its nominee and that the agreement was signed on behalf of S by a person who was also a director of Indowind was held not to make any difference. This Court held that S and Indowind were two independent companies each of which was a separate and distinct legal entity and the mere fact that the companies had common shareholders or a common Board of Directors will not make them a single entity. Nor could there be an inference that one company would be bound by the acts of the other. In the view of this Court:
…A contract can be entered into even orally. A contract can be spelt out from correspondence or conduct. But an arbitration agreement is different from a contract. An arbitration agreement can come into existence only in the manner contemplated Under Section 7. If Section 7 says that an arbitration agreement should be in writing, it will not be sufficient for the Petitioner in an application Under Section 11 to show that there existed an oral contract between the parties, or that Indowind had transacted with Wescare, or Wescare had performed certain acts with reference to Indowind, as proof of arbitration agreement.
The decision in Indowind was followed by a two Judge Bench in S.N. Prasad, Hitek Industries (Bihar) Limited v. Monnet Finance Limited. (2011) 1 SCC 320. The issue in that case was whether a guarantor to a loan who is not a party to a loan agreement between the lender and borrower could be made a party to a reference to an arbitration in regard to a dispute governing the repayment of the loan and be subjected to the arbitral award. The loan agreement contained an arbitration clause. In the view of this Court:
An arbitration agreement between the lender on the one hand and the borrower and one of the guarantors on the other, cannot be deemed or construed to be an arbitration agreement in respect of another guarantor who was not a party to the arbitration agreement. Therefore, there was no arbitration agreement as defined Under Sections 7(4)(a) or (b) of the Act, insofar as the Appellant was concerned, though there was an arbitration agreement as defined Under Section 7(4)(a) of the Act in regard to the second and third Respondents…
Consequently, the impleadment of the Appellant as party to the arbitration proceedings and the award were held to be unsustainable. The principle which was formulated by the Court was this:
…The Act makes it clear that an arbitrator can be appointed under the Act at the instance of a party to an arbitration agreement only in respect of disputes with another party to the arbitration agreement. If there is a dispute between a party to an arbitration agreement, with other parties to the arbitration agreement as also non-parties to the arbitration agreement, reference to arbitration or appointment of arbitrator can be only with respect to the parties to the arbitration agreement and not the non-parties.
DECISION IN CHLORO CONTROLS
Both the decisions i.e., Indowind and the Prasad, were prior to the three Judge Bench decision in Chloro Controls(supra). In Chloro Controls this Court observed that ordinarily, an arbitration takes place between persons who have been parties to both the arbitration agreement and the substantive contract underlying it. English Law has evolved the “group of companies doctrine” under which an arbitration agreement entered into by a company within a group of corporate entities can in certain circumstances bind non-signatory affiliates. The test as formulated by this Court, noticing the position in English law, is as follows:
Though the scope of an arbitration agreement is limited to the parties who entered into it and those claiming under or through them, the courts under the English law have, in certain cases, also applied the “group of companies doctrine”. This doctrine has developed in the international context, whereby an arbitration agreement entered into by a company, being one within a group of companies, can bind its non-signatory affiliates or sister or parent concerns, if the circumstances demonstrate that the mutual intention of all the parties was to bind both the signatories and the non-signatory affiliates. This theory has been applied in a number of arbitrations so as to justify a tribunal taking jurisdiction over a party who is not a signatory to the contract containing the arbitration agreement. [Russell on Arbitration (23rd Edn.)]
This evolves the principle that a non-signatory party could be subjected to arbitration provided these transactions were with group of companies and there was a clear intention of the parties to bind both, the signatory as well as the non-signatory parties. In other words, “intention of the parties” is a very significant feature which must be established before the scope of arbitration can be said to include the signatory as well as the non-signatory parties.
The Court held that it would examine the facts of the case on the touch-stone of the existence of a direct relationship with a party which is a signatory to the arbitration agreement, a ‘direct commonality’ of the subject matter and on whether the agreement between the parties is a part of a composite transaction.
A non-signatory or third party could be subjected to arbitration without their prior consent, but this would only be in exceptional cases. The court will examine these exceptions from the touchstone of direct relationship to the party signatory to the arbitration agreement, direct commonality of the
subject-matter and the agreement between the parties being a composite transaction. The transaction should be of a composite nature where performance of the mother agreement may not be feasible without aid, execution and performance of the supplementary or ancillary agreements, for achieving the common object and collectively having bearing on the dispute. Besides all this, the court would have to examine whether a composite reference of such parties would serve the ends of justice. Once this exercise is completed and the court answers the same in the affirmative, the reference of even non-signatory parties would fall within the exception afore-discussed.
Explaining the legal basis that may be applied to bind a non-signatory to an arbitration agreement, this Court held thus:
The first theory is that of implied consent, third-party beneficiaries, guarantors, assignment and other transfer mechanisms of contractual rights. This theory relies on the discernible intentions of the parties and, to a large extent, on good faith principle. They apply to private as well as public legal entities. The second theory includes the legal doctrines of agent-principal relations, apparent authority, piercing of veil (also called “the alter ego”), joint venture relations, succession and estoppel. They do not rely on the parties’ intention but rather on the force of the applicable law.
The position in Indowind was formulated by a Bench of two Judges before the evolution of law in the three Judge Bench decision in Chloro Controls. Indowind arose out of a proceeding under Section 11(6). The decision turns upon a construction of the arbitration agreement as an agreement which binds parties to it. The decision in Prasad evidently involved a guarantee, where the guarantor who was sought to be impleaded as a party to the arbitral proceeding was not a party to the loan agreement between the lender and borrower. The loan agreement between the lender and borrower contained an arbitration agreement. The guarantor was not a party to that agreement.
As the law has evolved, it has recognized that modern business transactions are often effectuated through multiple layers and agreements. There may be transactions within a group of companies. The circumstances in which they have entered into them may reflect an intention to bind both signatory
and non-signatory entities within the same group. In holding a non-signatory bound by an arbitration agreement, the Court approaches the matter by attributing to the transactions, a meaning consistent with the business sense which was intended to be attributed to them. Therefore, factors such as the relationship of a non-signatory to a party which is a signatory to the agreement, the similarity of subject matter and the composite nature of the transaction weigh in the balance.
The group of companies doctrine is essentially intended to facilitate the fulfilment of a mutually held intent between the parties, where the circumstances indicate that the intent was to bind both signatories and non-signatories. The effort is to find the true essence of the business arrangement and to unravel from a layered structure of commercial arrangements, an intent to bind someone who is not formally a signatory but has assumed the obligation to be bound by the actions of a signatory.
POSITION AS OF TODAY
The answer to the question is not simple, since the courts have not stuck to one formula while deciding such matters. The recent pronouncement of the Supreme Court in the case of Reckitt Benckiser (India) (P) Ltd v. Reynders Label Printing India Private Ltd., (2019) 7 SCC 62 seems promising as it clears the doubt which existed because of the judgment of Chloro Control. The Supreme Court in this case re-affirmed that Non-Signatories can be bound only if they assent to the arbitration agreement.
The Doctrine of alter ego and Group of companies were given a go by in this judgment. While the Judgment of Reckitt Benckiser clearly states that doctrine of Group of companies cannot be applied to someone’s disadvantage and parties cannot be made subject to an arbitration agreement without their consent but it is our considered opinion that the rationale and analogy adopted in the abovementioned judgment cannot be put into a straightjacket formula. However, it remains to be seen, how long the courts stick to this position, as the courts have time and again evolved new principles to accommodate Justice. For now, the position of the court is clear as far as arbitration agreement is considered, a non-signatory cannot be made subject to an arbitration agreement by applying the group of companies or any other doctrine without their consent.
JURISTIC LEGAL 
Well Researched Article
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Quite detailed and informative Article.
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