Validity of Arbitration Clauses in Agreements which are Insufficiently Stamped or Not Registered (When Compulsorily Registrable)

In a civil appeal brought before it, a Division Bench of the Supreme Court of India (consisting of Raveendran, J and Patnaik, J), examined the highly interesting question of the validity of an arbitration clause contained in agreements which may be insufficiently stamped and/or not registered when compulsorily registrable.

In addition to pronouncing decisions on the validity of such clauses, the Hon’ble Court also laid down a step-by-step procedure to be followed by Indian courts in determining whether or not such clauses are valid in cases which come before them.

This case is of particular interest to persons who include arbitration clauses in agreements and seek to then enforce them and draws attention to the importance of stamping and registering a document in accordance with the law and the legal effect of not doing so.

Scope of this Case Note

In the instant case, the Hon’ble Court explored several issues including the above-mentioned questions and others, such as whether an arbitration clause contained in one agreement signed between parties would be applicable to another agreement between the same parties but which did not contain its own arbitration clause.

This case note seeks only to state and discuss those facts and pronouncements of the Hon’ble Court on the questions of the binding nature of an arbitration clause contained in an agreement which is insufficiently stamped or which, being compulsorily registrable, has not been registered.

Details of the Case and the Parties

Judgment in Civil Appeal No. 5820 OF 2011 [Arising out of SLP [C] No.24484/2010]

M/s. SMS Tea Estates Pvt. Ltd. (Appellant) versus M/s. Chandmari Tea Co. Pvt. Ltd. (Respondent)

Date of the Judgment: 20th July 2011

Facts of the Case

The Appellant filed an application under Section 11 of the Arbitration and Conciliation Act, 1996 (the “Arbitration Act”) for the appointment of an arbitrator. The brief facts (reproduced almost verbatim from the judgment) are as follows:

On 7.10.2006 the Appellant requested the Respondent to grant a long term lease in respect of two tea estates of the Respondent. A lease deed dated 21.12.2006 was executed between the Respondent and Appellant under which Appellant was granted a lease of the two estates for a term of 30 years (the “Lease Deed”). Clause 35 of the Lease Deed provided for settlement of disputes between the parties by arbitration.

As the estates were hypothecated to United Bank of India, on 27.12.2006, the Respondent requested the said bank for issue of a no objection certificate for entering into a long term lease. The Bank sent a reply dated 17.7.2007, stating that it would issue a no objection certificate for the lease, if the entire balance amount due to the Bank was deposited by 14.8.2007.

Prior to the execution of the Lease Deed, on 29.11.2006, the Respondent had offered to sell the two tea estates to the appellant for a consideration of INR 4 Crore. The Appellant agreed to purchase them subject to detailed verification. The Appellant wrote a letter dated 27.6.2007 to the Respondent agreeing to purchase the estates. The appellant invested huge sums of money for improving the tea estates in the expectation that it would either be purchasing the said estates or have a lease for 30 years. The Respondent however abruptly and illegally evicted the Appellant from the estates and took over their management in January 2008.

The Appellant thereafter wrote a letter dated 28.3.2008 to the Respondent expressing its willingness to purchase the said two estates for a mutually agreed upon consideration and also discharge the liability towards the bank. The Appellant issued a notice dated 5.5.2008 calling upon the Respondent to refer the matter to arbitration under Section 35 of the Lease Deed. The Respondent failed to comply. According to the Appellant the dispute between the parties related to the claim of the Appellant that the Respondent should either sell the estates to the Appellant, or permit the Appellant to continue in occupation of the estates for 30 years as lessees or reimburse the amounts invested by it in the two estates and the payments made to the Bank.

The Respondents opposed the said application. The Respondents contended,inter alia, that the unregistered lease deed dated 21.12.2006 for thirty years was invalid, unenforceable and not binding upon the parties, having regard to Section 107 of Transfer of Property Act 1882 (“TP Act”) and Section 17 and Section 49 of the Registration Act, 1908 (“Registration Act”); that the Lease Deed was also not duly stamped and was therefore invalid, unenforceable and not binding, having regard to Section 35 of the Indian Stamp Act, 1899 (“Stamp Act”); that Clause 35 providing for arbitration, being part of the said lease deed, was also invalid and unenforceable. The respondent denied that they had agreed to sell the two tea estates to the applicant for a consideration of INR 4 Crore. It contended that as the lease deed itself was invalid, the appellant could not claim appointment of an arbitrator under the arbitration agreement forming part of the said deed.

Views of the Hon’ble High Court of Guwhati

The learned Chief Justice of Guwahati High Court dismissed the Appellant’s application by order dated 28.5.2010 holding that the Lease Deed was compulsorily registrable under Section 17 of the Registration Act and Section 107 of the TP Act, and as the Lease Deed was not registered, no term in the said lease deed could be relied upon for any purpose and therefore Clause 35 could not be relied upon for seeking reference to arbitration. The High Court also held that the arbitration agreement contained in Clause 35 could not be termed as a collateral transaction, and therefore, the proviso to Section 49 of the Registration Act would not assist the Appellant.

This decision was challenged in this appeal to the Supreme Court.

Issues for Consideration by the Hon’ble Supreme Court of India

The Hon’ble Court had, inter alia, the following issues to consider:

  1.        i.            Whether an arbitration agreement contained in an unregistered (but compulsorily registrable) instrument is valid and enforceable?
  2.      ii.            Whether an arbitration agreement in an unregistered instrument which is not duly stamped, is valid and enforceable?

Relevant Provisions of Law

For the convenience of the reader, we are stating below some of the relevant legal provisions mentioned above and relevant to the case at hand:

The Arbitration and Conciliation Act, 1996

Section 11 of this Act pertains to the appointment of the arbitrators in a dispute between parties or, in case of a failure by the parties to so appoint an arbitrator, the taking of necessary measures by the Chief Justice (or a person designated by him) in regard to the appointment of arbitrators.

Section 16 of this Act pertains, inter alia, the competence of arbitral tribunal to rule on its jurisdiction and states that “… the arbitral tribunal may rule on its own jurisdiction, including ruling on any objections with respect to the existence or validity of the arbitration agreement, and for that purpose,–

(a) an arbitration clause which forms part of a contract shall be treated as an agreement independent of the other terms of the contract; and (b) a decision by the arbitral tribunal that the contract is null and void shall not entail ipso jure the invalidity of the arbitration clause.”

The Transfer of Property Act, 1882

Section 107 of this Act states that “… a lease of immovable property … for any term exceeding one year … can be made only by a registered instrument.”

The Indian Stamp Act, 1899

Section 33 of this Act states that “… every person having by law or consent of parties, authority to receive evidence … before whom any instrument, chargeable, in his opinion, with [stamp] duty, is produced or comes in the performance of his functions, shall, if it appears to him that such instrument is not duly stamped, impound the same.”

Section 35 of this Act states that “… no instrument chargeable with [stamp] duty shall be admitted in evidence for any purpose by any person having by law or consent of parties authority to receive evidence, or shall be acted upon, registered or authenticated by any such person or by any public officer, unless such instrument is duly stamped.” This section also provides that such an instrument may be produced in evidence on payment of duty with which it is chargeable together with a penalty.

The Registration Act, 1908

Section 17 of this Act mandates that instruments relating to the lease of immovable property for any term exceeding one year shall be registered.

Section 49 of this Act provides that no document which is required to be registered under Section 17 or any provision of the Transfer of Property Act, 1882 shall:

  1.        i.            affect any immovable property comprised therein;
  2.      ii.            confer any power to adopt; or,
  3.   iii.            be received as evidence of any transaction affecting such property or conferring such power;

unless it has been registered.

However, this section also makes an exception to the above rule and states that an unregistered document affecting immovable property and required to be registered may be used for the following purposes:

  1.        i.            it may be received as evidence of a contract in a suit for specific performance; or,
  2.      ii.            it may be received as evidence of any collateral transaction to required to be effected by registered instrument.

Views of the Hon’ble Supreme Court of India on the Issues under Consideration

With regard to the first issue under consideration, i.e., “Whether an arbitration agreement contained in an unregistered (but compulsorily registrable) instrument is valid and enforceable”, the Hon’ble Court observed as follows:

The Hon’ble Court first noted that as per the provisions of Section 17 of the Registration Act and Section 107 of the TP Act, a document pertaining to the lease of immovable property for a period greater than one year is compulsorily registrable. The Hon’ble Court then proceeded to note the effect of non-registration of a document which is compulsorily registrable, given in Section 49 of the Registration Act – that the same could not affect any immovable property comprised therein, confer the power to adopt or be received as evidence as evidence of any transaction affecting such property or conferring such power. However, the document would be permitted to be used for two limited purposes – as evidence of a contract in a suit for specific performance and as evidence of any collateral transaction to required to be effected by registered instrument. The Hon’ble Court stated that a “collateral transaction” is one that affects the immovable property, but “… a transaction which is incidentally connected with that transaction.” The question, therefore, was whether a provision for arbitration in an unregistered document (which is compulsorily registrable) is a “collateral transaction”, so as to make it eligible to fall within the proviso of Section 49 of the Registration Act and be permitted to be received in evidence.

The Hon’ble Court proceeded to observe that an arbitration agreement contained in a contract was a collateral transaction, unrelated to the performance of the main contract. It then went to on explain that an arbitration clause contained in a main contract would be like two contracts combined in one – the first contract being for the main transaction contemplated by the contract and the second contract being the arbitration agreement. Thus, in the instant case of the lease deed, it was as if two contracts had been rolled into one – one regarding the lease of the immovable property of 30 years, which was compulsorily registrable and one for arbitration of disputes under the agreement, which is not compulsorily registrable under the Registration Act. In order to further support this interpretation, i.e., of the arbitration agreement forming a separate agreement from the main contract, the Hon’ble Court relied on the provisions of Section 16 of the Arbitration Act (mentioned above) which states that for the purposes of an arbitrator deciding on its jurisdiction, “… an arbitration clause which forms part of a contract shall be treated as an agreement independent of the other terms of the contract.” The Hon’ble Court observed that therefore, “… even if a deed of transfer of immovable property is challenged as not valid or enforceable, the arbitration agreement would remain unaffected for the purpose of resolution of disputes arising with reference to the deed of transfer.

The Hon’ble Court, however, distinguished this from cases where the main contract would be voidable at the option of a party under the provisions of the Indian Contract Act, 1872. In such cases, the invalidity which applies to the main contract may also apply to the arbitration agreement, if the reason for which the main contract may be invalid or voidable applies to the arbitration agreement as well. For instance, where the contract was entered into under coercion, and the party so coerced seeks to avoid the contract for this reason, it would apply to the arbitration clause as well.’

Based on the above reasoning, the Hon’ble Court concluded that considering the an arbitration agreement is, indeed, a collateral transaction and having regard to the exception stated in Section 49 of the Registration Act, “… an arbitration agreement in an unregistered but compulsorily registrable document can be acted upon and enforced for the purpose of dispute resolution by arbitration.

With regard to the second issue under consideration, i.e., “Whether an arbitration agreement in an unregistered instrument which is not duly stamped, is valid and enforceable”, the Hon’ble Court observed as follows:

In order to decide on this issue, the Hon’ble Court certain relevant provisions of the Stamp Act (mentioned above), including Section 33 which mandates that any person who by law or consent of parties is authorized to receive evidence and before whom an instrument is produced which is not, in his opinion, duly stamped, then he in under an obligation to impound such instrument and deal with it in the manner prescribed under Section 38 of the Stamp Act. The Hon’ble Court also noted that Section 35 of the Stamp Act states that instruments not duly stamped cannot be produced in evidence and cannot be acted upon; however, this section also provides that the instrument may be produced in evidence after paying the duty chargeable on it and paying the penalty stated therein. It was particularly distinguished from Section 49 of the Registration Act in that this provision of the Stamp Act did not carve any exceptions (in the manner of Section 49 of the Registration Act) to allow unstamped or insufficiently stamped documents to be produced as evidence of a contract for obtaining specific performance or as evidence of a collateral transaction.

Accordingly, the Hon’ble Court stated that if any instrument comes before a court or an arbitrator alleging the existence of an arbitration agreement, it is under an obligation to check whether the same has been properly stamped and if not, then to impound the document and deal with it in the manner prescribed under Section 38 of the Stamp Act.

The Hon’ble Court therefore held that under such circumstances, the court cannot act upon the document or admit the same for evidence. However, if the adequate duty and penalty has been paid under Section 35 of the Stamp Act, then the document may be received in evidence.

Procedure to be Adopted where an Arbitration Clause is Contained in an Agreement which is not Registered (but Compulsorily Registrable) and/or which is not Duly Stamped

The Hon’ble Court also laid down a detailed procedure to be adopted where an arbitration clause is contained in an agreement which is not registered (but compulsorily registrable) and/or which is not duly stamped, which has been reproduced verbatim from the judgment of the Hon’ble Court below:

  1.        i.            “The court should, before admitting any document into evidence or acting upon such document, examine whether the instrument/document is duly stamped and whether it is an instrument which is compulsorily registrable.
  2.      ii.            “If the document is found to be not duly stamped, Section 35 of Stamp Act bars the said document being acted upon. Consequently, even the arbitration clause therein cannot be acted upon. The court should then proceed to impound the document under Section 33 of the Stamp Act and follow the procedure under Section 35 and 38 of the Stamp Act.
  3.   iii.            “If the document is found to be duly stamped, or if the deficit stamp duty and penalty is paid, either before the Court or before the Collector (as contemplated in section 35 or 40 of the Stamp Act), and the defect with reference to deficit stamp is cured, the court may treat the document as duly stamped.
  4.    iv.            “Once the document is found to be duly stamped, the court shall proceed to consider whether the document is compulsorily registrable. If the document is found to be not compulsorily registrable, the court can act upon the arbitration agreement, without any impediment.
  5.      v.            “If the document is not registered, but is compulsorily registrable, having regard to section 16(1)(a) of the [Arbitration] Act, the court can de-link the arbitration agreement from the main document, as an agreement independent of the other terms of the document, even if the document itself cannot in any way affect the property or cannot be received as evidence of any transaction affecting such property. The only exception is where the respondent in the application demonstrates that the arbitration agreement is also void and unenforceable, as pointed out … above. If the respondent raises any objection that the arbitration agreement was invalid, the court will consider the said objection before proceeding to appoint an arbitrator.
  6.    vi.            “Where the document is compulsorily registrable, but is not registered, but the arbitration agreement is valid and separable, what is required to be borne in mind is that the Arbitrator appointed in such a matter cannot rely upon the unregistered instrument except for two purposes, that is (a) as evidence of contract in a claim for specific performance and (b) as evidence of any collateral transaction which does not require registration.”

Impact on the Current Law

This landmark decision of the Supreme Court of India lays down important interpretations regarding the validity of arbitration clauses in documents which suffer from defects in terms of stamping or registration, when compulsorily registrable. It also lays down a procedure and guidelines to be followed in case such document come before the courts in cases where arbitration agreements are alleged to exist vis-à-vis receiving such documents in evidence.

Thus, this judgment provides a caveat to parties who want to ensure that arbitration clauses executed by them are valid and binding, and those intending to execute such agreements would do well to bear these rules in mind while drafting and executing contracts containing arbitration clauses.

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