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

Introduction

Date of the Judgment: 04 January 2022

Citation: 2022 INSC 1

Judges: M.R. Shah, J. and B.V. Nagarathna, J.

Can an arbitration panel composed entirely of employees from one party be considered impartial? The Supreme Court of India recently tackled this critical question in a case between Ellora Paper Mills Limited and the State of Madhya Pradesh. The core issue revolved around the validity of an arbitral tribunal formed by the State, consisting solely of its own officers, in light of amendments to the Arbitration and Conciliation Act, 1996, which emphasize arbitrator neutrality. This judgment clarifies the importance of impartiality in arbitration proceedings.

Case Background

In 1993, the State of Madhya Pradesh issued a tender for the supply of paper. Ellora Paper Mills was awarded the contract on September 22, 1993. A dispute arose when the State allegedly failed to make payments and rejected some consignments, claiming the paper did not meet specifications. Ellora Paper Mills contended that they had supplied 420 MT of cream wove paper and 238 MT of duplicating paper, and the State had not paid 90% of the amount as per the contract.

Subsequently, Ellora Paper Mills filed a civil suit in 1994 seeking an injunction against the State from awarding the contract to a third party. This suit became infructuous when the State awarded the contract to a third party. Ellora Paper Mills then filed a second suit in 1998, seeking recovery of Rs. 95,32,103.

The State, in response, applied under Section 8 of the Arbitration and Conciliation Act, 1996, to stay the proceedings, citing an arbitration clause in their agreement. The Civil Court rejected this application on February 27, 1999, but the High Court allowed the State’s revision petition on May 3, 2000, referring the matter to arbitration by the Stationery Purchase Committee, comprising officers of the State.

Ellora Paper Mills challenged this order, but their special leave petition was dismissed as withdrawn on September 28, 2000. The arbitral tribunal, named the “Stationery Purchase Committee,” was then constituted with State officers. Ellora Paper Mills objected to this constitution on September 12, 2000, and challenged the tribunal’s jurisdiction, which was rejected on February 2, 2001. A writ petition by Ellora Paper Mills was dismissed on January 24, 2017, allowing them to raise objections in the appropriate forum.

Finally, Ellora Paper Mills filed an application in 2019 under Section 14, read with Sections 11 and 15 of the Arbitration Act, seeking to terminate the mandate of the existing arbitral tribunal and appoint a new, independent arbitrator, citing Section 12(5) of the Arbitration Act, 1996.

Timeline

Course of Proceedings

The dispute began in the Civil Court at Bhopal, where Ellora Paper Mills initially sought an injunction and later filed for recovery of dues. The State of Madhya Pradesh successfully moved the High Court to stay the civil proceedings and refer the matter to arbitration, based on an arbitration clause in their contract.

The High Court directed the arbitration to be conducted by the Stationery Purchase Committee, consisting of officers from the State government. Ellora Paper Mills challenged this constitution, but the High Court dismissed their writ petition, allowing them to raise objections in the appropriate forum.

Subsequently, Ellora Paper Mills filed an application before the High Court under Section 14, read with Sections 11 and 15 of the Arbitration Act, 1996, seeking to terminate the mandate of the existing arbitral tribunal and appoint a new arbitrator. The High Court dismissed this application, stating that the 2015 Amendment to the Arbitration Act, specifically Section 12(5), did not apply retrospectively to proceedings initiated before the amendment.

Legal Framework

The core of this case revolves around Section 12(5) of the Arbitration and Conciliation Act, 1996, which was introduced by the 2015 Amendment. This provision, along with the Seventh Schedule, addresses the neutrality of arbitrators.

Section 12(5) of the Arbitration 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, he shall be ineligible to be appointed as an arbitrator.”

This section aims to ensure that arbitrators are impartial and independent. The Seventh Schedule lists categories of relationships that disqualify a person from being an arbitrator.

The Supreme Court has interpreted this amendment to mean that any prior agreement that contradicts the principle of arbitrator neutrality is void. This provision is crucial for maintaining the integrity of the arbitration process.

Arguments

Arguments of the Appellant (Ellora Paper Mills)

• The arbitral tribunal, the Stationery Purchase Committee, consisted entirely of officers of the State of Madhya Pradesh, which made them ineligible to act as arbitrators under Section 12(5) read with the Seventh Schedule of the Arbitration Act, 1996.
• The 2015 amendment to the Arbitration Act, which introduced Section 12(5), was intended to ensure the neutrality of arbitrators. The continuation of the existing arbitral tribunal would frustrate the purpose of this amendment.
• 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 arbitral tribunal loses its mandate if it consists of individuals with relationships falling under the Seventh Schedule.
• The appellant argued that the arbitral proceedings had not effectively commenced because of a stay order by the High Court from 2001 to 2017. The members of the original Stationery Purchase Committee had also retired, necessitating the constitution of a new, impartial tribunal.
• There was no express agreement in writing to continue with the arbitration proceedings by the earlier Arbitral Tribunal.

Arguments of the Respondent (State of Madhya Pradesh)

• The State argued that the arbitral tribunal was constituted in 2000, long before the 2015 amendment to the Arbitration Act came into effect. Therefore, Section 12(5) should not be applied retrospectively.
• The State contended that Ellora Paper Mills had delayed the arbitration proceedings by initiating multiple legal actions.
• The State contended that the decision of the Supreme Court in Jaipur Zila Dugdh Utpadak Sahkari Sangh Limited (supra) was not applicable, because in that case, the arbitrator was appointed after the 2015 amendment of the Arbitration Act.
• The State argued that the arbitration proceedings had commenced, and the appellant had participated.

The following table summarizes the main arguments and sub-arguments presented by both parties:

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 respondent, has lost its mandate considering Section 12(5) read with the Seventh Schedule of the Arbitration Act, 1996.
2. If the answer to the above 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

The following table demonstrates how the Court decided the issues:

Authorities

The Supreme Court considered the following authorities:

Judgment

The following table summarizes how each submission made by the parties was treated by the Court:

The following table summarizes how each authority was viewed by the Court:

What weighed in the mind of the Court?

The Supreme Court’s decision was heavily influenced by the principle of arbitrator neutrality, as mandated by the 2015 amendment to the Arbitration Act. The Court emphasized that the composition of the arbitral tribunal, consisting entirely of State government officers, inherently violated this principle. The Court also noted that the arbitration proceedings had not effectively commenced due to a stay order and the retirement of the original members.

The Court’s reasoning was based on the following points:

• The need to uphold the principle of arbitrator neutrality and impartiality.
• The explicit language of Section 12(5) of the Arbitration Act, 1996, read with the Seventh Schedule.
• The interpretation of Section 12(5) as highlighted in the cases of TRF Limited v. Energo Engineering Projects Limited, (2017) 8 SCC 377, Bharat Broadband Network Limited v. United Telecoms Limited, (2019) 5 SCC 755 and Jaipur Zila Dugdh Utpadak Sahkari Sangh Limited v. Ajay Sales & Suppliers, 2021 SCC OnLine SC 730.
• The fact that the original members of the arbitral tribunal had retired.
• The absence of an express agreement in writing to waive the ineligibility of the arbitrator.

The following table shows the ranking of sentiment analysis of reasons given by the Supreme Court:

The ratio of fact to law that influenced the court to decide is as follows:

The Court’s logical reasoning for the issue of whether the Stationery Purchase Committee – Arbitral Tribunal has lost its mandate under Section 12(5) of the Arbitration Act, 1996:

Judgment

The Supreme Court held that the arbitral tribunal, the Stationery Purchase Committee, had lost its mandate due to the provisions of Section 12(5) read with the Seventh Schedule of the Arbitration Act, 1996. The Court emphasized that the 2015 amendment was aimed at ensuring the neutrality of arbitrators, and any prior agreement to the contrary would not hold.

The Court stated, “In order to achieve this, 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.”

The Court also noted that the arbitration proceedings had not effectively commenced due to a stay order by the High Court from 2001 to 2017, and the members of the original committee had retired. Based on these findings, the Court allowed the appeal filed by Ellora Paper Mills and set aside the High Court’s judgment.

The Court directed the appointment of a new, independent arbitrator to resolve the dispute between the parties, in accordance with the Arbitration and Conciliation Act, 1996.

Ratio Decidendi

The ratio decidendi of this judgment is that:

1. Impartiality of Arbitrators: The 2015 amendment to the Arbitration and Conciliation Act, 1996, particularly Section 12(5) read with the Seventh Schedule, mandates the neutrality and impartiality of arbitrators. An arbitral tribunal consisting entirely of employees or officers of one party is ineligible to act as arbitrators.
2. Retrospective Application of Section 12(5): The provisions of Section 12(5) apply to arbitration proceedings, even if they were initiated before the 2015 amendment. Any prior agreement that contradicts this principle of arbitrator neutrality is void.
3. Waiver of Ineligibility: The ineligibility of an arbitrator under Section 12(5) cannot be waived unless there is an express agreement in writing to that effect.

The judgement emphasizes that the 2015 amendment was introduced to ensure that arbitration proceedings are fair and impartial. The Supreme Court has clarified that any arbitral tribunal that does not meet the criteria of neutrality and independence is invalid.

Final Order

The Supreme Court’s final order was as follows:

1. The appeal filed by Ellora Paper Mills was allowed.
2. The judgment passed by the High Court was set aside.
3. The existing arbitral tribunal, the Stationery Purchase Committee, was held to have lost its mandate.
4. A new, independent arbitrator was to be appointed to resolve the dispute between Ellora Paper Mills and the State of Madhya Pradesh, in accordance with the Arbitration and Conciliation Act, 1996.

Impact of the Judgment

This judgment has significant implications for arbitration law in India. It reinforces the importance of arbitrator neutrality and independence, as mandated by the 2015 amendment to the Arbitration and Conciliation Act, 1996. The key impacts include:

• Reinforcement of Arbitrator Neutrality: The judgment clarifies that any arbitral tribunal composed of individuals who have a relationship with one of the parties that falls under the Seventh Schedule of the Arbitration Act is invalid. This ensures that arbitration proceedings are fair and impartial.
• Retrospective Application: The judgment clarifies that the provisions of Section 12(5) of the Arbitration Act, 1996 apply to arbitration proceedings, even if they were initiated before the 2015 amendment. This means that any arbitral tribunal that does not meet the criteria of neutrality is invalid, regardless of when it was constituted.
• Emphasis on Express Agreement for Waiver: The judgment emphasizes that the ineligibility of an arbitrator under Section 12(5) cannot be waived unless there is an express agreement in writing to that effect. This protects parties from being forced to accept biased arbitrators.
• Guidance for Future Cases: This judgment serves as a precedent for future arbitration cases, particularly those involving disputes with government entities or other organizations where the arbitrator may be an employee or officer of one of the parties.
• Promotion of Fair Arbitration Practices: By invalidating arbitral tribunals that lack neutrality, the judgment promotes fair and transparent arbitration practices in India.

Conclusion

The Supreme Court’s judgment in Ellora Paper Mills vs. State of Madhya Pradesh is a landmark decision that reinforces the principle of arbitrator neutrality in arbitration proceedings. The Court’s interpretation and application of Section 12(5) of the Arbitration and Conciliation Act, 1996, along with the Seventh Schedule, ensure that arbitration tribunals are impartial and independent.

This judgment serves as a crucial precedent for future arbitration cases, particularly those involving disputes where one party has a significant influence over the composition of the tribunal. It underscores the importance of fairness and transparency in arbitration, promoting confidence in the arbitration process.

The key takeaways are:

• Arbitrator neutrality is paramount in arbitration proceedings.
• Section 12(5) of the Arbitration Act, 1996, applies to all arbitration proceedings, irrespective of when they were initiated.
• Any agreement that goes against the principle of arbitrator neutrality is invalid.
• The ineligibility of an arbitrator under Section 12(5) can only be waived through an express agreement in writing.
• This judgment provides a clear guideline for the appointment of arbitrators in India.