Supreme Court clarifies the definition of an ‘Arbitration Agreement’ in contract disputes: Solaris Chem Tech Industries Ltd vs. Karnataka Urban Water Supply Board (2023)

Date of the Judgment: 10 October 2023
Citation: 2023 INSC 916
Judges: Dr Dhananjaya Y Chandrachud, CJI, J B Pardiwala, J and Manoj Misra, J.

Can a dispute resolution clause that refers disputes to a departmental officer be considered an arbitration agreement? The Supreme Court of India recently addressed this question in a case involving a water supply agreement. The core issue was whether a clause in an agreement that stipulated the resolution of disputes by the Chief Engineer of the Karnataka Urban Water Supply and Drainage Board constituted a valid arbitration agreement, thereby preventing the High Court from exercising its writ jurisdiction.

The Supreme Court bench, comprising Chief Justice of India Dr Dhananjaya Y Chandrachud, Justice J B Pardiwala, and Justice Manoj Misra, unanimously held that the clause in question did not constitute a valid arbitration agreement. The Court emphasized that an arbitration agreement requires an impartial adjudicator, which a departmental officer cannot be.

Case Background

Solaris Chem Tech Industries Ltd. (the appellant) established a factory in 1975 for manufacturing Caustic Soda in Karnataka. On 5 July 1971, the Government of Mysore entered into an agreement with the appellant to supply water at concessional rates for 20 years from the start of production.

On 3 April 1987, the Karnataka Urban Water Supply and Drainage Board (the Board) was formed under the Karnataka Urban Water Supply and Drainage Board Act, 1973. The Board continued to supply water to the appellant for industrial and non-domestic use.

The original agreements were replaced by subsequent agreements. The last agreement, relevant to the dispute, was signed on 11 November 2011, effective from 27 October 2011 to 26 October 2014. This agreement fixed the tariff for industrial use at Rs 18.40 per kL and for non-domestic use at Rs 9.20 per kL. Between 6 June 2014 and 16 September 2014, bills were raised based on these rates.

On 18 July 2014, the Assistant Executive Engineer issued a demand notice to the appellant, seeking to implement new water rates and demanding a differential amount from 20 July 2011 to 30 June 2014. The appellant was asked to pay Rs. 8,22,62,337.00 as arrears. The appellant responded on 5 August 2014, expressing readiness to negotiate.

On 22 September 2014, another notice was issued, stating the Board’s no-profit-no-loss basis and the need to pay dues to HESCOM. The notice cited audit objections against non-revision of water bills and requested payment of arrears. The appellant requested the withdrawal of the demand notice on 15 October 2014.

The appellant then filed a Writ Petition before the High Court challenging the notices dated 18 July 2014 and 22 September 2014.

Timeline:

Course of Proceedings

The Single Judge of the High Court dismissed the appellant’s Writ Petition, citing Clause 11 of the agreements. This clause stipulated that disputes should be resolved through mutual discussion, and if that failed, by referring the matter to the Chief Engineer, whose decision would be final. The Single Judge also noted that Clause 4 of the agreement allowed the Board to increase rates, but directed the appellant to use the contractual remedy under Clause 11.

The Division Bench upheld the Single Judge’s decision, stating that the demand notices fell within the scope of “disputes” under Clause 11. The Division Bench thus concluded that the dispute was covered by the agreement and did not warrant interference under Article 226 of the Constitution of India.

Legal Framework

The primary legal framework in this case is the Arbitration and Conciliation Act, 1996. Section 2(b) of the Act defines “arbitration agreement” as an agreement referred to in Section 7.

Section 7 of the Arbitration and Conciliation Act, 1996, states:

“7. Arbitration agreement. —(1) In this Part, “arbitration agreement” means 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.
(2) An arbitration agreement may be in the form of an arbitration clause in a contract or in the form of a separate agreement.
(3) An arbitration agreement shall be in writing.
(4) An arbitration agreement is in writing if it is contained in —
(a) a document signed by the parties;
(b) an exchange of letters, telex, telegrams or other means of telecommunication including communication through electronic means which provide a record of the agreement; or
(c) an exchange of statements of claim and defence in which the existence of the agreement is alleged by one party and not denied by the other.
(5) The reference in a contract to a document containing an arbitration clause constitutes an arbitration agreement if the contract is in writing and the reference is such as to make that arbitration clause part of the contract.”

The Supreme Court also considered the Seventh Schedule of the Arbitration and Conciliation Act, 1996, which lists persons who are ineligible to be appointed as arbitrators.

Arguments

Appellant’s Arguments:

• The appellant argued that the High Court should have addressed the Board’s authority to increase tariffs beyond the agreed rates.
• The appellant contended that the Board’s reliance on a Government Notification that predated the agreement was incorrect.
• It was submitted that the Board acted in violation of the agreements and the statute which is the source of its power.
• The appellant asserted that the dispute was in rem (related to the right) and not in personam (related to a person), and thus the High Court’s jurisdiction was validly invoked.
• The appellant argued that the High Court erred by relegating the parties to Clause 11 of the agreements.

Respondent’s Arguments:

• The respondent defended the High Court’s decision to refer the matter to the Chief Engineer under Clause 11 of the agreement.
• The respondent argued that the dispute resolution mechanism under Clause 11 was valid and binding.

Submissions Table:

Issues Framed by the Supreme Court

The Supreme Court framed the following issue for consideration:

1. Whether the High Court was justified in dismissing the Writ Petition and the Writ Appeal on the strength of Clause 11 of the agreements between the parties.
2. Whether there was a valid arbitration agreement between the parties, justifying the referral to the Chief Engineer under Clause 11.

Treatment of the Issue by the Court:

Authorities

The Supreme Court considered the following authorities:

Cases:

• Jagdish Chander vs Ramesh Chander, (2007) 5 SCC 719, 724: The Court summarized the relevant factors for determining whether an agreement is an arbitration agreement within the meaning of S. 7 of the 1996 Act. The Court held that even if the words “arbitration” and “Arbitral Tribunal” are not used, the clause can still be an arbitration agreement if it has the necessary attributes.
• Jaipur Jila Dugdh Utpadak Sahkari Sangh Limited vs Ajay Sales and Suppliers, 2021 SCC OnLine SC 730: The Court held that a person who is an employee of one of the parties is ineligible to be an arbitrator, in view of Section 12(5) of the Arbitration Act read with the Seventh Schedule.
• Voestalpine Schienen GMBH v. Delhi Metro Rail Corporation Limited, (2017) 4 SCC 665: The Court emphasized the importance of the neutrality of arbitrators.
• Ellora Paper Mills Ltd. v. State of M.P, (2022) 3 SCC 1: The Court upheld the decision in Jaipur Jila Dugdh Utpadak Sahkari Sangh Limited (supra), emphasizing the rule against bias and due process in arbitration proceedings.

Legal Provisions:

• Section 2(b) of the Arbitration and Conciliation Act, 1996: Defines “arbitration agreement.”
• Section 7 of the Arbitration and Conciliation Act, 1996: Specifies the requirements of an arbitration agreement.
• Section 12(5) of the Arbitration and Conciliation Act, 1996: States that certain persons are ineligible to be appointed as arbitrators.
• Seventh Schedule of the Arbitration and Conciliation Act, 1996: Lists persons who are ineligible to be appointed as arbitrators.

Table of Authorities:

Judgment

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

How each authority was viewed by the Court?

• The Supreme Court followed Jagdish Chander vs Ramesh Chander, (2007) 5 SCC 719* to determine the essential attributes of an arbitration agreement.
• The Supreme Court followed Jaipur Jila Dugdh Utpadak Sahkari Sangh Limited vs Ajay Sales and Suppliers, 2021 SCC OnLine SC 730* to emphasize the importance of the neutrality of arbitrators and the disqualification of employees.
• The Supreme Court referred to Voestalpine Schienen GMBH v. Delhi Metro Rail Corporation Limited, (2017) 4 SCC 665* to highlight the object and purpose of Section 12(5) of the Arbitration Act.
• The Supreme Court followed Ellora Paper Mills Ltd. v. State of M.P, (2022) 3 SCC 1* to reinforce the rule against bias and due process in arbitration.
• The Supreme Court cited Section 2(b) of the Arbitration and Conciliation Act, 1996* for the definition of “arbitration agreement.”
• The Supreme Court cited Section 7 of the Arbitration and Conciliation Act, 1996* for the requirements of an arbitration agreement.
• The Supreme Court cited Section 12(5) of the Arbitration and Conciliation Act, 1996* regarding the ineligibility of certain persons to be arbitrators.
• The Supreme Court cited the Seventh Schedule of the Arbitration and Conciliation Act, 1996* for the list of persons ineligible to be arbitrators.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the need to uphold the principles of impartiality and fairness in arbitration. The Court emphasized that an arbitration agreement must provide for an independent and unbiased adjudicator. The Court found that Clause 11 of the agreement, which designated the Chief Engineer as the dispute resolver, did not meet these requirements because the Chief Engineer was an employee of one of the parties.

The Court also considered the statutory framework of the Arbitration and Conciliation Act, 1996, particularly Section 12(5) and the Seventh Schedule, which disqualify certain persons from being arbitrators to ensure neutrality. The Court’s reasoning was thus driven by both contractual interpretation and statutory compliance.

Sentiment Analysis of Reasons:

Fact:Law Ratio:

Logical Reasoning:

The Supreme Court considered alternative interpretations of Clause 11, but rejected them because they did not align with the essential requirements of an arbitration agreement under the Arbitration and Conciliation Act, 1996. The Court emphasized that a valid arbitration agreement must provide for an impartial adjudicator, which a departmental officer cannot be.

The Court’s decision was to allow the appeal, set aside the judgments of the Single Judge and the Division Bench, and restore the Writ Petition to the file of the Single Judge for a fresh decision.

The Court’s reasoning was based on the interpretation of the contractual clause, the statutory requirements of the Arbitration Act, and the principles of natural justice. The Court emphasized that the Chief Engineer, being an employee of the Board, could not be considered an impartial arbitrator.

The Supreme Court quoted the following from the judgment:

“The expression “arbitration agreement” is defined by Section 2(b) to mean an agreement referred to in Section 7.”

“The 1996 Act does not prescribe a certain form of an arbitration agreement. The use or the absence of the word ‘arbitration’ is not conclusive and the intention of the parties to resolve the disputes through arbitration should be clear from the terms of the clause.”

“Independe nce and impartiality of the arbitrators are the hallmarks of any arbitration proceedings.”

There was no minority opinion in this case. The bench was unanimous.

Key Takeaways

• A dispute resolution clause that refers disputes to a departmental officer of one of the parties does not constitute a valid arbitration agreement.
• An arbitration agreement must provide for an impartial adjudicator.
• The Arbitration and Conciliation Act, 1996, requires that arbitrators be independent and unbiased.
• Employees of one of the parties to a dispute are generally disqualified from acting as arbitrators.
• High Courts should not dismiss writ petitions based on dispute resolution clauses that do not meet the requirements of a valid arbitration agreement.

The judgment has significant implications for future cases involving dispute resolution clauses in contracts, particularly where such clauses designate departmental officers as arbitrators. The ruling reinforces the importance of impartiality and independence in arbitration proceedings.

Directions

The Supreme Court directed that the Writ Petition be restored to the file of the Single Judge of the High Court of Karnataka at Dharwad Bench for a fresh decision. The Court clarified that it had not expressed any view on the merits of the case.

Specific Amendments Analysis

There is no specific amendment discussed in the judgment.

Development of Law

The ratio decidendi of this case is that a dispute resolution clause that refers disputes to a departmental officer of one of the parties does not constitute a valid arbitration agreement. This decision clarifies the requirements for a valid arbitration agreement under the Arbitration and Conciliation Act, 1996, emphasizing the need for an impartial adjudicator. This ruling reinforces the principles of neutrality and independence in arbitration proceedings and sets a precedent that could impact future cases. The Court has not changed the previous position of law but has reiterated and clarified the existing law.

Conclusion

The Supreme Court allowed the appeal, setting aside the judgments of the High Court. The Court held that Clause 11 of the agreement did not constitute a valid arbitration agreement because the Chief Engineer, being an employee of the Board, could not be considered an impartial arbitrator. The matter was remanded to the High Court for a fresh decision on the merits of the case. This judgment clarifies the definition of an arbitration agreement and emphasizes the need for impartiality in dispute resolution.