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Need for an Arbitration Clause in Settlements executed in supersession of the Original Contract

Updated: Aug 2

- Gaurav Rai [1] and Rakshita Singh [2]

Introduction


Dispute resolution clauses in Commercial Contracts provide for the dispute to be resolved by arbitration or in a multi-tier dispute resolution format. However, instead of resolving the disputes through arbitration, the parties may choose to amicably settle the dispute by way of a negotiated settlement between themselves.


In some cases, the settlement arrived at may only resolve the ongoing dispute between the parties, while the parties continue to be governed by the contract's original terms, including the arbitration clause for any future dispute. However, certain settlements might change the obligations and nature of the contract to such an extent that the parties may agree to execute an agreement or Memorandum of Understanding (“MoU”) in supersession of the Contract already existing between the parties (“Original Contract”). In this article, the authors discuss the issues that can arise in the aforementioned situation. The article shall also consider the steps that can be taken by the parties to protect themselves from the pitfalls of novating or superseding the Original Contract.


The discussion in this article will be founded upon the judgment of the Hon’ble High Court of Delhi (“DHC”) in the case of B.L. Kashyap and Sons Limited v. MIST Avenue Private Limited ([2023] SCC OnLine Del 3518), which dealt with a similar fact situation as stated above.


Facts prior to the arising of disputes.


The Original Contract signed between the parties pertained to a civil structural project in the model of Bill of Quantities (“BOQ”) approximately worth Rs. 229 crores. The Original Contract contained a dispute resolution clause allowing the parties to settle any disputes by way of arbitration.


While certain disputes arose between the parties, they were mutually resolved through an MoU by which the Original Contract was changed to a cost-plus contract from the originally agreed BOQ contract. Consequently, certain agreed payments were made to settle the dispute. It is pertinent to note that the MoU did not contain an arbitration clause.


Dispute between the Parties and the Findings of the Arbitral Tribunal


A dispute arose between the parties and the same was referred to an arbitral tribunal (“Arbitral Tribunal”) for resolution. In the arbitration proceedings, B.L Kashyap and Sons (“Claimant”) sought to raise the claims under the Original Contract between the parties due to the breach of the terms of the MoU entered into between the parties. MIST Avenue Private Limited (“Respondent”), however, raised a preliminary objection regarding the existence of the arbitration clause. Respondent argued that the MoU had superseded the Original Contract and that the Original Contract along with the arbitration clause no longer exist. Accordingly, the disputes between the parties, if any, cannot be raised before an arbitral tribunal as per the provisions of the Original Contract.


The issue before the Arbitral Tribunal was whether the arbitration clause in the Original Contract could be revived even after the execution of the MoU. The Arbitral Tribunal, while interpreting the terms of the Original Contract, came to the conclusion that the Original Contract was indeed superseded by the MoU. The Arbitral Tribunal held that the MoU had in fact novated the Original Contract, and thereby the tribunal does not have jurisdiction to try the present case as per the arbitration clause contained in the Original Contract.


While giving the aforesaid finding, the Arbitral Tribunal relied on the judgments of Young Achievers v. IMS learning Resources Pvt. Ltd.[2013] 10 SCC 535. & Ansal Housing and Construction Ltd. v. Samyak Projects Pvt. Ltd.[2018] SCC OnLine Del 1286. It was stated by the Arbitral Tribunal that the language of the MoU made it clear that the Original Contract was forthwith superseded on the execution of the MoU. Further, the supersession was not contingent on successfully fulfilling the terms of the MoU, as sought to be relied on by the Claimant.


The Case before the DHC under Section 34 of The Arbitration and Conciliation Act, 1996


Aggrieved by the Award of the Arbitral Tribunal, the Claimant challenged the same under Section 34 of the Arbitration and Conciliation Act, 1996 (“Act, 1996”) before the DHC. B.L Kashyap and Sons (“Petitioner / Claimant”) submitted that the Award passed by the Arbitral Tribunal was arbitrary and perverse and therefore manifestly illegal. It contended that execution of the MoU on a cost-plus basis was a conditional settlement, and the Respondent had breached the same. Therefore, the Petitioner was entitled to settle all dues as per the Original Contract. The Petitioner / Claimant contended before the DHC that the MoU would stand satisfied only if conditions under the MoU were complied with in its entirety. Since the same was not done, the arbitration proceedings were therefore correctly invoked under the Original Contract and the presence of a subsequent MoU could not bar such proceedings.


The Petitioner / Claimant further submitted that the Original Contract allowed the Petitioner to file any legal measures for this purpose, and accordingly, the claims of the Petitioner before the Arbitral Tribunal were under the Original Contract and not under the MoU. Basis the aforesaid, the Arbitral Tribunal should not have rejected the Petitioner’s claims for want of jurisdiction. The Claimant relied on the judgments in Union of India v. Kishorilal Gupta & Bros AIR 1959 SC 1362 & Lata Construction v. Rameshchandra Ramniklal Shah (2000) 1 SCC 586 for its arguments.


The Respondent, on the other hand, argued that the view taken by the Arbitral Tribunal was a correct and plausible one. The Respondent submitted that upon a proper reading of the MoU, it can be inferred that parties arrived at a mutual settlement by way of the MoU. Therefore, the Original Contract stood ‘cancelled or closed’, and accordingly, the Original Contract only allowed the Claimant to raise claims contained in it and not revive the arbitration clause. Therefore, the Claimant cannot invoke the arbitration proceedings as per the clause contained in the Original Contract for a breach of the MoU. The Respondent relied on the judgments of Nathani Steel Ltd. v. Associated Constructions [1995] Supp (3) SCC 324. & Damodar Valley Corporation v. K.K. Kar [1974] 1 SCC 141. in support of its submissions.


Decision of the DHC


Before rendering its decision, DHC outlined the several undisputed principles of law formulated on the basis of various authorities cited by the parties. They were as follows:


a. An arbitration clause in a contract which is void ab initio cannot be enforced since the contract that contains such a clause itself was never enforceable, or legally came into existence;


b. A contract which is validly executed can still be extinguished by a subsequent agreement between the parties;


c. If the original contract remains in existence, then to deal with issues such as repudiation, breach, etc. arising in relation to that contract, the arbitration clause would continue to operate for those purposes; and


d. In case of a new agreement and wholesale novation of the previous contract, the arbitration clause in such previous agreement will stand extinguished due to the new contract coming into existence.


Relying on the aforesaid principles derived from the authorities cited by the parties, the DHC concluded that the arbitration clause would not extend to the subsequent MoU and the non-exercise of jurisdiction by the arbitral tribunal was a plausible interpretation of the contract between the parties. The DHC refused to interfere in the matter.


The DHC also underlined the fact that courts’ interference with the tribunal’s award can only be in cases where there seems to be a patent illegality. If the award granted by the arbitrator is not even one of the plausible interpretations and outcomes of the contract, then the award can be challenged on grounds of being arbitrary or patently illegal. In support of the aforesaid finding, the DHC relied on Sangyong Engg. & Construction Co. Ltd. v. NHAI [2019] 15 SCC 13. The arbitral award only has to pass the plausibility test, and consequently, it is upon the arbitrator to proceed on that view and grant the award. In support of the aforesaid finding the DHC relied on UHL Power Co. Ltd. v. State of H.P. [2022] 4 SCC 116. Therefore, the DHC held that the impugned Award was not patently illegal and needed no interference. The petition was accordingly dismissed. The DHC clarified that no observations were being made on the merits of the dispute, as the arbitral tribunal has only stated that it does not have jurisdiction to adjudicate the disputes, and the judgment of the DHC was also limited to this aspect of the award.


Analysis and Suggestions - Incorporation of Arbitration Clauses in Subsequent Contracts


The Act 1996 provides for what might be called a solution to such situations. However, the same does not come without its fallacies and loopholes. Section 7(5) of the Act,1996 provides for an arbitration clause to be incorporated or extended to subsequent contracts by referring to a contract which initially contains such clause. However, there is a fundamental difference between reference to a contract and incorporation. The former includes a specific part of the contract which the parties must have intended to include in subsequent agreements whereas in the latter case, the subsequent contract is incorporated in its entirety. In such cases, the arbitration clause will also be incorporated and applicable to the new agreement.


Then again, the incorporation of the arbitration clause itself is based on the consent of the parties, and in the absence of consent, nothing can be held to be a part of the agreement by virtue of implication. However, in contracts where both parties are the same (single contracts), an arbitration clause can be extended to a new contract given that the parties consented to it on the basis of the reasonability test. Notwithstanding the aforesaid, in cases where even one party is different (double contracts), such incorporation cannot be made, except in cases where a contract is a standard contract and the practice of a party is standard and well known.


In the above mentioned solutions, the idea remains the same: if the arbitration clause, is to be extended to the subsequent agreement between the parties, it shall be based on consent of the parties or on the test that a reasonable man would have expected such a term to be part of the contract impliedly. i.e. without having to be written down specifically.[3] However, to avoid the complications of referring to previous arbitration clauses, it is advisable for the parties, who are making an agreement in supersession of the previous agreement, to include a new arbitration clause in the new contract and not rely on the principle of incorporation of contracts.


With the growing acceptance of alternate dispute resolution mechanisms such as arbitration, mediation, or negotiated settlement, it is only prudent that any settlement arrived at between the parties be tactfully outlined in a settlement agreement. With some foresight, parties can avoid any complications at a later stage.[4] In the experience of the authors, there have been many cases where the absence of a well-drafted arbitration clause has led to conflicts and complications during dispute settlement, as was in the case of B.L. Kashyap and Sons v. MIST Avenue Private Ltd.. Thus, it is evident that a clear and well-drafted arbitration clause would significantly help in avoiding the situations that occurred in the case as discussed above.



 

[1] Gaurav Rai is an Advocate based in Delhi and a Senior Associate at Legafin Law Associates LLP. He is also the Editor of The Arbitration Workshop Blog.

[2] Rakshita Singh is a Second-Year law student, currently pursuing her BA.LLB(Hons.) degree from Institute of Law, Nirma University.

[3] See generally Kartikey Sanjeev Bhalotia, ‘“Incorporation by Reference”: A Need to Reconsider Standards?’ (Arbitration Workshop, 7 July 2020) <https://www.thearbitrationworkshop.com/post/incorporation-by-reference-a-need-to-reconsider-standards> accessed 28 June 2023.

[4] See generally Anish Jaipuriar and others, ‘Agreements for Settlement and Release in India: Legal Position and Essential Elements’ AKS Partners - Monthly Newsletter October 2021 <https://www.akspartners.in/newsletters/2021/october/AKSPartnersOctober2021Newsletter.pdf>.

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