Supreme Court Clarifies Arbitration Clause Requirements in Share Sale Agreement: Shyam Sunder Agarwal vs. P. Narotham Rao (2018)

Date of the Judgment: July 23, 2018
Citation: (2018) INSC 638
Judges: R.F. Nariman, J., Indu Malhotra, J.
Can a clause in a contract that uses the terms “mediators/arbitrators” automatically be considered an arbitration clause? The Supreme Court of India recently addressed this question in a case involving a share sale agreement, clarifying the essential elements required for a valid arbitration agreement. The Court examined whether the specific clause in the Memorandum of Understanding (MoU) was indeed an arbitration clause or merely an arrangement for dispute prevention. The judgment was delivered by a bench comprising Justice R.F. Nariman and Justice Indu Malhotra.

Case Background

This case involves a dispute arising from a Memorandum of Understanding (MoU) dated December 8, 2005, concerning the sale and purchase of shares of M/s Mancherial Cement Company Private Limited. All parties involved were directors of the company. The central issue was whether Clause 12 of the MoU constituted a valid arbitration clause. The appellant, Shyam Sunder Agarwal, contended that the clause was indeed an arbitration agreement, while the respondents, led by P. Narotham Rao, argued otherwise.

Timeline:

Course of Proceedings

The appellant initially filed a Section 11 petition seeking the appointment of an arbitrator, claiming that Clause 12 of the MoU was an arbitration clause. This petition was rejected. Subsequently, the appellant filed a Company Petition No. 49 of 2011, seeking reliefs that flowed directly from the MoU. This petition was later withdrawn. The respondents had also filed a Company Petition before the Company Law Board, where they succeeded in obtaining the necessary reliefs. The appellant then filed an appeal against this order in the High Court. The appellant also filed a Special Leave Petition against the order rejecting his Section 11 petition with a delay of 358 days.

Legal Framework

The primary legal framework in this case revolves around the interpretation of Clause 12 of the Memorandum of Understanding (MoU). The relevant clauses of the MoU are as follows:

• Clause 6: “The parties of 1st part hereby handed over 9 cheques favouring Sri P. Narotham Rao… to Sri K. Sudhakar Rao… and Sri Gone Prakash Rao… Mediators/Arbitrators.”

• Clause 8: “The parties hereinabove declare and confirm that for successful completion of this transaction in order to avoid any further unforeseen litigations, both the parties hereby mutually appointed Sri K. Sudhakar Rao… and Sri Gone Prakash Rao… as mediators and arbitrators to whom the above cheques as well as all other following documents are handed over and the same will be under their custody till satisfactory completion of the entire transaction as per the terms and conditions contained herein.”

• Clause 10: “The parties of 1st part further agree and undertake to substitute the personal guarantees given by the parties of 2nd part with the personal guarantors of their associates with M/s Andhra Bank within two months from the date of this document.”

• Clause 11: “Till the total transaction is satisfactorily completed and till entire sale consideration is paid and till the personal guarantees of parties of 2nd part are substituted by the personal guarantees of the Associates of parties of First Part with M/s Andhra Bank, the above named Arbitrators/Mediators shall not hand over the share certificate with duly signed share transfer deeds in respect of the shares of the parties of 2nd part to the parties of 1st part.”

• Clause 12: “It is further agreed that any decision to be taken by said Mediators/Arbitrators during the period of entire transaction in the event of any breaches committed by either of the parties shall be final and binding on all the parties hereinabove.”

Arguments

Appellant’s Arguments:

• The appellant argued that Clause 12 of the MoU is an arbitration agreement because it uses the word “decision” and the term “Mediators/Arbitrators,” which indicates that the parties intended to resolve disputes through arbitration. The clause also states that the decision would be final and binding, which is a key characteristic of an arbitration agreement.

• The appellant contended that the three essential elements of an arbitration clause were met: (1) disputes between the parties; (2) adjudication of disputes after hearing the parties; and (3) a final and binding decision.

• The appellant relied on the judgment in K.K. Modi vs. K.N. Modi, (1998) 3 SCC 573, asserting that their case fell squarely within the parameters laid down in that judgment. They distinguished their case from other judgments where clauses spoke of a preliminary decision subject to a final decision by a court.

Respondent’s Arguments:

• The respondents argued that the term “Mediators/Arbitrators” was used loosely. They contended that Mr. K. Sudhakar Rao and Mr. Gone Prakash Rao were actually escrow agents responsible for holding documents and ensuring the successful implementation of the MoU.

• The respondents argued that Clauses 6, 8, 10, and 11 of the MoU must be read together with Clause 12. They argued that the “decision” mentioned in Clause 12 was limited to the period of the transaction and was related to breaches under Clause 10, specifically the substitution of personal guarantees.

• The respondents pointed out that three other purchasers of shares, who were in a similar position as the appellant, had filed a civil suit instead of seeking arbitration, which indicated that they did not consider Clause 12 to be an arbitration clause. The respondents also argued that the appellant’s conduct was mala fide, as they first issued a notice under the MOU in 2007 claiming the clause to be an arbitration clause and then filed a Section 11 petition after two and a half years.

• The respondents highlighted that the appellant had also filed a Company Petition seeking reliefs under the MOU, which they later withdrew to file a fresh company petition, demonstrating their willingness to pursue remedies under company law rather than arbitration. They also argued that the appellant had delayed filing the Special Leave Petition by 358 days.

Submissions Table

Issues Framed by the Supreme Court

The Supreme Court framed the following issue for consideration:

1. Whether Clause 12 of the Memorandum of Understanding (MoU) dated 08.12.2005 constitutes a valid arbitration agreement.

Treatment of the Issue by the Court

Authorities

Cases Relied Upon by the Court:

Judgment

How each submission made by the Parties was treated by the Court?

How each authority was viewed by the Court?

• The Court distinguished P. Dasaratharama Reddy Complex vs. Government of Karnataka and Another, (2014) 2 SCC 201, explaining that the clauses in the cited cases were different from the clause in the present case.
• The Court relied on K.K. Modi vs. K.N. Modi, (1998) 3 SCC 573 to explain the essential attributes of an arbitration agreement.
• The Court referred to State of U.P. vs. Tipper Chand, (1980) 2 SCC 341, to show that the Superintending Engineer’s role was supervision and not arbitration.
• The Court referred to Bihar State Mineral Development Corporation vs. Encon Builders (I) (P) Limited, (2003) 7 SCC 418, to emphasize that clauses for dispute prevention are not arbitration clauses.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the following factors:

• Interpretation of the MoU: The court emphasized that the MoU should be read as a whole. Clauses 6, 8, 10, 11, and 12 must be considered together to understand the intent behind Clause 12. The use of the term “Mediators/Arbitrators” was deemed loose, and the individuals were identified as escrow agents.
• Nature of “Decision”: The court clarified that the “decision” mentioned in Clause 12 was a pro tem decision, limited to the period of the transaction. It was not intended to resolve disputes between the parties after the transaction was completed.
• Conduct of the Parties: The court noted that the appellant’s conduct was not consistent with the claim that Clause 12 was an arbitration clause. The appellant’s delay in filing the Section 11 petition, the filing and withdrawal of the Company Petition, and the delay in filing the Special Leave Petition all weighed against the appellant.
• Purpose of the Clause: The court determined that the purpose of Clause 8 was to prevent disputes and ensure the smooth implementation of the agreement, rather than to adjudicate disputes.

Sentiment Analysis of Reasons Given by the Supreme Court

Fact:Law Ratio

Logical Reasoning

The court rejected the appellant’s argument that Clause 12 was an arbitration clause. The court stated: “A reading of the MOU as a whole leaves no manner of doubt that the said MOU only invests the two gentlemen named therein with powers as escrow agents to smoothly implement the transaction mentioned in the MOU and not even remotely to decide the disputes between the parties as Arbitrators.”

The court further observed: “the expression “decision” used in Clause 12 is only a pro tem decision – namely, that the two escrow agents are to make decisions only during the period of the transaction and not thereafter.”

The court also noted: “the conduct of the appellant leaves much to be desired.”

The court did not find any dissenting opinion in the judgment.

Key Takeaways

• Intention is Key: The mere use of the terms “mediators” or “arbitrators” does not automatically make a clause an arbitration agreement. The intention of the parties, as reflected in the entire document, is crucial.
• Escrow Agents vs. Arbitrators: Individuals named as “mediators/arbitrators” may actually be escrow agents tasked with ensuring the smooth execution of a transaction, rather than resolving disputes.
• Pro Tem Decisions: Decisions made during the transaction period may not be considered arbitration if they are not intended to resolve disputes finally.
• Conduct Matters: The conduct of the parties can be a significant factor in determining whether a clause is an arbitration agreement. Inconsistent behavior can weaken a party’s claim.
• Holistic Interpretation: Contracts should be read as a whole to understand the true intention of the parties. Clauses should not be interpreted in isolation.

Directions

The Supreme Court disposed of the appeal accordingly.

Specific Amendments Analysis

There was no specific amendment discussed in the judgment.

Development of Law

The ratio decidendi of this case is that a clause in a contract that uses the terms “mediators/arbitrators” is not automatically an arbitration clause. The court must examine the entire contract to determine the intention of the parties. The court emphasized that the individuals named as “mediators/arbitrators” were actually escrow agents. The term “decision” was limited to the period of the transaction and did not encompass a dispute resolution mechanism.

Conclusion

In conclusion, the Supreme Court held that Clause 12 of the Memorandum of Understanding (MoU) did not constitute a valid arbitration agreement. The court emphasized that the individuals named as “Mediators/Arbitrators” were actually escrow agents, and the “decision” mentioned in the clause was limited to the period of the transaction. The court also considered the conduct of the parties and the overall purpose of the clause in reaching its decision. This judgment clarifies the requirements for a valid arbitration agreement and highlights the importance of interpreting contracts holistically.