Supreme Court Invalidates Arbitral Tribunal Composition: Ellora Paper Mills vs. State of Madhya Pradesh (2022)

Case Background

In 1993, the State of Madhya Pradesh issued a tender for the supply of paper, which was awarded to Ellora Paper Mills. A dispute arose when the State rejected some consignments, claiming they did not meet specifications, and failed to make full payment. Ellora Paper Mills contended that they had supplied the paper as per the contract.

Initially, Ellora Paper Mills filed a civil suit in 1994 seeking a permanent injunction against the State from awarding the contract to a third party. This suit became infructuous when the State awarded the contract to another party. Subsequently, in 1998, Ellora Paper Mills filed another suit for recovery of ₹95,32,103/-. The State then applied for a stay of proceedings under Section 8 of the Arbitration and Conciliation Act, 1996, citing an arbitration clause in the agreement. The Civil Court rejected this application, but the High Court of Madhya Pradesh allowed the State’s revision petition in 2000, referring the matter to arbitration by a “Stationery Purchase Committee” composed of the State’s officers.

Ellora Paper Mills challenged the constitution of the Arbitral Tribunal, but the challenge was rejected by the Tribunal in 2001. A writ petition filed by Ellora Paper Mills in the High Court was dismissed in 2017, with liberty to raise objections before the appropriate forum. Finally, in 2019, Ellora Paper Mills filed an application under Sections 14, 11, and 15 of the Arbitration Act, seeking termination of the mandate of the existing Arbitral Tribunal and appointment of a new arbitrator, relying on Section 12(5) of the Arbitration Act, 1996, as amended in 2015.

Timeline

Course of Proceedings

The dispute began in the Civil Court at Bhopal, where Ellora Paper Mills initially sought an injunction and later filed a suit for recovery. The State’s application for a stay of proceedings under Section 8 of the Arbitration Act, 1996, was initially rejected by the Civil Court. However, the High Court of Madhya Pradesh overturned this decision in 2000, referring the dispute to arbitration by the Stationery Purchase Committee, which consisted of officers of the State.

Ellora Paper Mills challenged the constitution of this Arbitral Tribunal, which was rejected by the Tribunal itself. A subsequent writ petition filed by Ellora Paper Mills in the High Court was dismissed in 2017, with the court granting the company the liberty to raise objections before the appropriate forum. In 2019, Ellora Paper Mills filed an application before the High Court under Sections 14, 11, and 15 of the Arbitration Act, 1996, seeking termination of the mandate of the existing Arbitral Tribunal and appointment of a new arbitrator, based on the 2015 amendment to the Act. The High Court dismissed this application, leading to the appeal before the Supreme Court.

Legal Framework

The core legal issue in this case revolves around Section 12(5) of the Arbitration and Conciliation Act, 1996, as amended in 2015. This section, along with the Seventh Schedule, specifies the circumstances under which an arbitrator is ineligible to be appointed. It aims to ensure the neutrality and impartiality of arbitrators.

Section 12(5) of the Arbitration and Conciliation Act, 1996 states:
“Notwithstanding any prior agreement to the contrary, any person whose relationship with the parties or counsel or the subject-matter of the dispute, falls under any of the categories specified in the Seventh Schedule, shall be ineligible to be appointed as an arbitrator.”

The Seventh Schedule lists various relationships and situations that disqualify a person from acting as an arbitrator, including being an employee of one of the parties. The amendment was introduced to address concerns about the neutrality of arbitrators, particularly in cases involving government entities. The amendment is based on the recommendations of the Law Commission, which emphasized the need for “neutrality of arbitrators.”

Arguments

Ellora Paper Mills’ Arguments:

• The appellant argued that the Arbitral Tribunal, composed of officers of the State of Madhya Pradesh, was ineligible under Section 12(5) of the Arbitration Act, 1996, read with the Seventh Schedule, as these officers were employees of one of the parties to the dispute.

• They contended that the 2015 amendment to the Arbitration Act, which introduced Section 12(5) and the Seventh Schedule, aimed to ensure the neutrality of arbitrators, and this provision should apply to the present case.

• The appellant relied on the Supreme Court’s decision in Jaipur Zila Dugdh Utpadak Sahkari Sangh Limited v. Ajay Sales & Suppliers, 2021 SCC OnLine SC 730, which held that an arbitrator falling under the categories specified in the Seventh Schedule loses their mandate and a fresh arbitrator must be appointed.

• They argued that the Arbitral Tribunal had not effectively commenced proceedings due to a stay order by the High Court between 2001 and 2017, and the fact that the original members of the committee had retired.

• The appellant submitted that there was no express agreement in writing to continue with the arbitration proceedings by the earlier Arbitral Tribunal.

State of Madhya Pradesh’s Arguments:

• The respondent argued that the 2015 amendment to the Arbitration Act should not apply retrospectively to arbitration proceedings that had commenced before the amendment came into force.

• They contended that the Arbitral Tribunal was constituted in 2000, prior to the 2015 amendment, and that the appellant had participated in the proceedings before the Tribunal.

• The respondent relied on several decisions of the Supreme Court to support their argument that the amendment should not have retrospective application.

• They argued that the appellant had delayed the arbitration proceedings by initiating multiple legal proceedings and should not be allowed to challenge the composition of the Arbitral Tribunal at this stage.

Issues Framed by the Supreme Court

The Supreme Court framed the following key issues for consideration:

1. Whether the Stationery Purchase Committee – Arbitral Tribunal, consisting of officers of the State of Madhya Pradesh, lost its mandate considering Section 12(5) read with the Seventh Schedule of the Arbitration Act, 1996.
2. If the answer to the first issue is in the affirmative, whether a fresh arbitrator has to be appointed as per the Arbitration Act, 1996.

Treatment of the Issue by the Court

Authorities

The Supreme Court considered the following authorities:

Legal Provisions:

• Section 8 of the Arbitration and Conciliation Act, 1996: This section deals with the power of a judicial authority to refer parties to arbitration when there is an arbitration agreement.
• Section 11 of the Arbitration and Conciliation Act, 1996: This section deals with the appointment of arbitrators.
• Section 12 of the Arbitration and Conciliation Act, 1996: This section deals with the grounds for challenge to an arbitrator. Sub-section (5) and the Seventh Schedule were introduced by the 2015 amendment.
• Section 13 of the Arbitration and Conciliation Act, 1996: This section deals with the procedure for challenging an arbitrator.
• Section 14 of the Arbitration and Conciliation Act, 1996: This section deals with the termination of the mandate of an arbitrator.
• Section 15 of the Arbitration and Conciliation Act, 1996: This section deals with the appointment of a substitute arbitrator.
• Seventh Schedule of the Arbitration and Conciliation Act, 1996: This schedule lists the categories of relationships that disqualify a person from being an arbitrator.

Judgment

How each authority was viewed by the Court:

• TRF Limited v. Energo Engineering Projects Limited [CITATION]: The Court relied on this case to emphasize the importance of neutrality and independence of arbitrators and held that any person falling under the Seventh Schedule is ineligible to be an arbitrator.
• Jaipur Zila Dugdh Utpadak Sahkari Sangh Limited v. Ajay Sales & Suppliers [CITATION]: This case was followed by the Court to hold that the members of the earlier Arbitral Tribunal have lost their mandate and are ineligible to continue as members of the Arbitral Tribunal.
• Bharat Broadband Network Limited v. United Telecoms Limited [CITATION]: The Court relied on this case to determine that there must be an ‘express agreement’ in writing to satisfy the requirements of Section 12(5) proviso.

The Supreme Court held that the High Court erred in dismissing the application filed by Ellora Paper Mills. The Court emphasized that the 2015 amendment to the Arbitration Act, specifically Section 12(5) read with the Seventh Schedule, was enacted to ensure the neutrality and impartiality of arbitrators. The Court noted that the Stationery Purchase Committee, being composed of officers of the State, fell squarely within the ambit of the disqualifications listed in the Seventh Schedule.

The Court further held that the earlier Arbitral Tribunal had lost its mandate by operation of law and that a fresh arbitrator must be appointed. The Court rejected the argument that the 2015 amendment should not be applied retrospectively, stating that the amendment was intended to apply to all arbitration proceedings where the arbitrator’s mandate was still in effect. The Court also rejected the argument that Ellora Paper Mills’ participation in the proceedings before the Arbitral Tribunal validated the Tribunal’s constitution, noting that there was no express agreement in writing to waive the ineligibility of the arbitrators.

The Supreme Court quoted the following from the judgment:

“To achieve the main purpose for amending the provision, namely, to provide for “neutrality of arbitrators”, sub-section (5) of Section 12 lays down that notwithstanding any prior agreement to the contrary, any person whose relationship with the parties or counsel or the subject matter of the dispute falls under any of the categories specified in the Seventh Schedule, he shall be ineligible to be appointed as an arbitrator.”

“In such an eventuality, i.e., when the arbitration clause is found to be foul with the amended provision, the appointment of the arbitrator would be beyond the pale of the arbitration agreement, empowering the Court to appoint such an arbitrator as may be permissible.”

“It is further observed that once he becomes ‘ineligible’, it is clear that he then become dejure unable to perform his functions inasmuch as in law, he is regarded as ‘ineligible’.”

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the need to uphold the principles of neutrality and impartiality in arbitration, as mandated by the 2015 amendment to the Arbitration Act. The Court emphasized that the amendment was introduced to ensure that arbitrators are free from any bias or conflict of interest. The Court was also concerned about the fact that the Arbitral Tribunal was composed of officers of the State of Madhya Pradesh, which was one of the parties to the dispute. This composition was deemed to be a clear violation of the neutrality requirements. The Court also considered that the earlier Arbitral Tribunal had not effectively commenced the arbitration proceedings and that there was no express agreement to waive the ineligibility of the arbitrators.

Logical Reasoning:

Key Takeaways

• The judgment reinforces the principle that arbitrators must be neutral and impartial, particularly in cases involving government entities.
• The 2015 amendment to the Arbitration Act, specifically Section 12(5) and the Seventh Schedule, has a significant impact on the composition of arbitral tribunals.
• Any person falling under the categories specified in the Seventh Schedule is ineligible to be an arbitrator, regardless of prior agreements.
• The judgment clarifies that the 2015 amendment applies to all arbitration proceedings where the arbitrator’s mandate is still in effect, even if the arbitration was initiated before the amendment.
• There must be an express agreement in writing to waive the ineligibility of an arbitrator under Section 12(5) of the Arbitration Act, 1996.

Directions

The Supreme Court quashed and set aside the High Court’s judgment and allowed the application filed by Ellora Paper Mills. The Court declared that the earlier Arbitral Tribunal was ineligible to continue as arbitrators and directed the appointment of a fresh arbitrator. The Court appointed Justice Abhay Manohar Sapre, a former Judge of the Supreme Court, as the new arbitrator. The parties were directed to appear before the arbitrator within four weeks.

Development of Law

The ratio decidendi of this case is that an arbitral tribunal composed of individuals who have a relationship with one of the parties to the dispute, as specified in the Seventh Schedule of the Arbitration and Conciliation Act, 1996, is ineligible to continue as arbitrators. This position is irrespective of any prior agreement between the parties and the stage of the arbitration proceedings. This judgment reinforces the principle of neutrality of arbitrators and clarifies the application of Section 12(5) of the Arbitration Act, 1996, as amended in 2015. It also clarifies that there must be an express agreement in writing to waive the ineligibility of an arbitrator. This is a change from the previous position of law, where the focus was more on the agreement between the parties, and less on the neutrality of the arbitrators.

Conclusion

In conclusion, the Supreme Court’s decision in Ellora Paper Mills Limited v. The State of Madhya Pradesh underscores the critical importance of arbitrator neutrality and independence in arbitration proceedings. The Court invalidated the Arbitral Tribunal constituted by the State of Madhya Pradesh, holding that it was ineligible under Section 12(5) of the Arbitration and Conciliation Act, 1996, read with the Seventh Schedule. The Court appointed a new arbitrator, emphasizing the need for impartiality in resolving disputes. This judgment serves as a significant reminder of the legal standards that must be followed in arbitration, particularly in cases involving government entities.