IMPLICATIONS OF NOVATION OF CONTRACTS ON ARBITRATION CLAUSES: A CASE COMMENT ON SANJIV PRAKASH V. SEEMA KUKREJA & ORS.

Implications of Novation of Contracts on Arbitration Clauses: A Case Comment on Sanjiv Prakash v. Seema Kukreja & Ors.

 Prof. (Dr.) Sairam Bhat, Professor of Law & Coordinator of CEERA, NLSIU

Lianne D’Souza, Research Fellow, CEERA, NLSIU

Introduction

The doctrine of ‘separability’ or ‘severability’ in the law governing arbitration postulates that an arbitration clause is deemed to be separate from or independent of the underlying contract. An arbitration clause in an agreement is an island in itself; a self-contained contract whose existence and validity are not affected when the validity of the substantive contract is contested. In other words, even if the obligations under the underlying contract are put to rest by way of frustration, rescission or breach of the contract, the arbitration agreement contained therein will continue to survive for the resolution of disputes connected therewith.[1] This principle has also been incorporated within the scheme of the Arbitration and Conciliation Act, 1996 (‘Act’)[2] on the lines of the UNCITRAL Model law on Arbitration.[3] Interestingly, though the courts have vehemently reiterated the supersession of the arbitration clause over and above the repudiation of the substantive contract, the position of the arbitration clause in the event of novation of the main contract was left undetermined. Recently, in the case of Sanjiv Prakash v. Seema Kukreja & Ors,[4] the High Court of Delhi has sought to clarify this position under the Arbitration and Conciliation Act, 1996 with reference to relevant provisions of the Indian Contract Act, 1872

Background of the Case

In the present case, the Petitioner and Respondents being family members, concluded a Memorandum of Understanding (‘MOU’) in relation to their company, ANI Media Pvt. Ltd., which inter alia constituted a succession plan and management scheme. Pursuant to this, in 1996, the said family members entered into a Shareholders Agreement (‘SHA’) and a Share Purchase Agreement with Thomson Reuters Corp., whereby the latter acquired 49% shares in the Company. The SHA further specified that this Agreement would supersede any or all prior agreements, understandings, arrangements.[5] In the course of time, a dispute arose vis-à-vis the transfer of shares among the said members, owing to which, the Petitioner invoked the arbitration clause under the MOU, seeking for the appointment of a sole arbitrator.

The issues that arose before the High Court was whether the impugned MOU stood vitiated as against the SHA and if so, whether the arbitration clause contained therein could be enforced.

It was the contention of the Petitioner that the MOU constituted a separate agreement vis-à-vis the SHA, thereby operating in different fields and the same was binding on the family members inter se. Further, for the enforceability of share transfers under the MOU, reliance was placed on proviso to Section 58(2) of the Companies Act, 2013 which recognizes private arrangements outside the Articles of Association for transfer of shares. In respect of the enforceability of the arbitral agreement, Section 5 read with Section 11 (6A) and Section 16 of the Act and the principle of ‘kompetenz-kompetenz’ was invoked to justify the jurisdiction of the Arbitral Tribunal in determining the validity of the MOU.

On the contrary, the Respondents contended that MOU stood replaced by the SHA and thus the relying on the former was illegal. The SHA is a comprehensive agreement between all shareholders, setting out the terms governing the relationship of all shareholders in the Company, with the inclusion of a dispute resolution clause. Therefore, any previous agreement was superseded by the SHA as under Section 62 of the Indian Contracts Act, 1872 (‘ICA’) and the arbitration clause contained therein perished with the novation of the MOU.

Judgement

In delivering its judgement, the High Court delved into the scope and ambit of the SHA to determine the validity of the MOU and the existence of the arbitration agreement.[6] The Court noted that the SHA has been executed by the shareholders of the Prakash family in their individual capacity and not as a ‘block’, thereby defining the rights and obligations of each shareholder individually. Further, the dispute resolution clause in the SHA contemplated disputes between all ‘shareholders’ and not exclusively to those between the family members and Reuters, thereby redefining the former arbitral clause in the MOU. Finally, the very fact that the SHA expressly provided that it would supersede any previous or ancillary agreements led the Court to reject the enforceability of the MOU.

The Court also relied on Section 62 of the ICA and a catena of precedents[7] to determine the enforceability of the former arbitration clause in the event of novation of the contract. It observed that when an arbitration agreement stood modified by a supplementary agreement such that it changes the entire edifice of the principal arbitration agreement, there can be no claim by the partied under the former. It expressly observed that “It is well settled that an arbitration agreement being a creation of an agreement, may be destroyed by agreement. That is to say, if the contract is superseded by another, the arbitration clause, being a component/part of the earlier contract, falls with it or if the original contract in entirety is put to an end, the arbitration clause, which is a part of it, also perishes along with it.”

Analysis

An overview of the case discussed above highlights the effect of the novation or rescission of a contract on the arbitration clause provided therein. The approach of the Court, though it seems to take a slight detour from the stipulations of the doctrine of ‘autonomy of arbitration clauses’, appears to be logical. The differentiating factor between a situation where the terms of the contract are breached or stand frustrated and that where the entire principal contract is superseded by a new contract is that of ‘acquiescence’ of parties. In the first situation, the contract stands abrogated by virtue of non-performance by a party to the contract or the want of some essential ingredient that renders it legally valid. In such cases, the contract ends by way of rescission; but only as far as it concerns future performance. The contract remains alive for the awarding of damages and so does the arbitration clause. As such, in these situations, where the arbitration clause fulfils all the requirements of an essential contract i.e. in terms of section 7 of the Act of 1996, the same does not automatically stand abrogated as it constitutes a separate contract founded on its own limbs, albeit a component of the principal contract. However, in the case of novation of a contract, the position changes as the scheme of the principal contract stands superseded by the new contract.

The doctrine of ‘novation’ postulates the creation of a new contract by substituting the terms of the contract and the parties’ rights/obligations with a new contract. The doctrine is recognized under Section 62 of the Indian Contracts Act, 1872 which provides that “if the parties to the contract agree to substitute a new contract for it or to rescind it or alter it, the original contract need not to be performed.” A plain reading of this provision thus highlights that a contract of novation must necessarily fulfil the tripartite conditions provided therein;

(a) there must be a substitution, recession or alteration of a contract giving rise to a valid new contract,

(b) the old contract must be terminated, AND

(c) the contract of novation must be based on the consensus ad idem of the parties.

The Supreme Court has noted that ‘novation’ implies ‘complete substitution’ of a new contract in place of an old one.[8]  Mere alteration to the structure of the terms of the contract is insufficient. The substitution must have the effect of completely rescinding, altering or extinguishing the previous contract,[9] such that there exists no obligation of performance thereunder. In other words, the modification of the contract must go to the root of the original contract.[10] This being stated, the true test for determining whether a contract has been substituted is the intention of the parties to do so.[11] The Apex Court has on many counts noted that a novation of a contract can take place only upon the mutual consent of parties.[12] Novation is a bilateral process which requires the clear and unequivocal intention of the parties to terminate a contract and substitute it with a new one, hence the name ‘novation’. Thus, the termination of any rights or obligations under the contract occurs in pursuance of the parties’ intent to do so.

Having understood the effect novation of a contract, it becomes clear that in ordinary circumstances, an arbitration clause contained therein ceases to exist if the parties intend to do so. As a matter of law, an arbitration clause holds the special designation of a survival clause. It survives even when the contract is void. It survives even after termination or expiration of the contract. By its very nature of being a dispute resolution clause, to decide on the validity of the contract or rights, the clause can be invoked.  However, in cases of novation, as seen from the facts of the current case, the arbitration clause in the original contract cannot survive for two reasons: (1) in this case the operation of the second agreement is not in the same space and is not linked to the old contract, (2) the SHA clearly stipulates overriding from the previous agreements thereby signifying the parties’ intention to rescind any right or obligation under the previous contract.

In such situations, the parties vide their consent terminate the previous contract by substituting it with a completely new contract, which thereby puts an end to the arbitration clause.  Furthermore, as the arbitration agreement/ clause derives its force from the mutual consent of the parties, the same can also be consequently terminated upon the parties’ mutual consent. Therefore, in circumstances as  these, the parties are rightly devoid of the right to invoke an arbitration clause which ceases to exist by the agreement of the parties themselves.

[1] National Agricultural Co-op. Marketing Federation India Ltd. vs. Gains Trading Ltd. 5 SCC 692, (SC: 2007)

[2] Arbitration and Conciliation Act, 1996, § 7.

[3] Article 16, UNCITRAL Model law on Arbitration, 1986=5.

[4] ARB.P. 4/2020, Delhi High Court, Order available at https://images.assettype.com/barandbench/2020-10/889db54e-e93a-4ade-afef-0e747c996a36/Sanjiv_Prakash_vs_Seema_Kukreja___Ors.pdf

[5] Clause 28 of the SHA, ¶ 23 of the Order.

[6] Note, under Section 11(6A), now repealed by Arbitration and Conciliation (Amendment) Act, 2019, the Court is empowered to inquire into the existence of an arbitration agreement.

[7] See, Union of India v. Kishorilal Gupta and Bros. AIR 1959 SC 1362 ¶ 20;  Damodar Valley Corporation v. K.K Kar, AIR 1974 SC158 ¶ 7; Larsen and Toubro Ltd. v. Mohan Lal Harbans Lal Bhayana, 2015 (2) SCC 461.

[8] Lata Construction & Ors v. Dr. Rameshchandra Ramniklal Shah, AIR 2000 SC 280.

[9] Lucknow Development Authority v. M.M. Gupta, (1994) 1 SCC 243.

[10] Juggilal Kamlapat v. NV Internationale AIR 1955 Cal 65.

[11] Ramdayal v. Maji Devdiji, AIR 1956 Raj 12

[12]  Kanchan Udyog Ltd v. United Spirits Ltd. 2017 (124) ALR 255, Essar Steel v. Union of India, AIR 2016 SC 1980.