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WHETHER SECTION 12(5) OF THE ARITRATION ACT CAN BE APPLIED RETROSPECTIVELY: SUPREME COURT REAFFIRMS

Ellora Paper Mills Ltd. vs. State of Madhya Pradesh [1]

Background:

  • The present appeal was preferred by Ellora Paper Mills Ltd. (Ellora) against the judgement of the Madhya Pradesh High Court (HC). The HC dismissed the application of Ellora seeking termination of mandate of the original arbitral tribunal and seeking substitution of a new arbitrator under Section 14 of the Arbitration & Conciliation Act, 1996 (the Act) read with Sections 11 and 15 of the Act.
  • The Respondent i.e. State of Madhya Pradesh (State) had issued a tender in 1993-94 for the supply of certain varieties of paper, the contract of which had been awarded to Ellora. Upon disputes arising between the parties with regards to the quantity and specification of paper supplied, Ellora first filed a civil suit seeking permanent injunction against the State from awarding the supply order to a third party. However, the State awarded the contract to a third party, thereby rendering the suit infructuous.
  • Subsequently, Ellora filed another suit seeking damages. In the said suit, the State filed an application under Section 8 of the Act seeking reference of the parties to arbitration. The application came to be rejected. In revision proceedings, the High Court overturned the order and referred the parties to arbitration in terms of the contract, by an Arbitral Tribunal comprising of the officers of the State (Tribunal). Against the said revision order, Ellora filed a special leave petition, which subsequently came to be dismissed as withdrawn.

Arbitration proceedings

  • After the Tribunal was constituted, Ellora filed its objections to the constitution of the Tribunal as well as an application before the Tribunal challenging its jurisdiction. The Tribunal rejected both the applications. Aggrieved, Ellora filed a writ petition before the High Court which eventually came to be dismissed by an order dated 24.01.2017.
  • In the intervening period, the members of the Tribunal as it stood originally constituted, ceased to hold their respective offices in the State. Ellora filed an application before the High Court seeking termination of the mandate of the originally constituted Tribunal and for appointment of a new arbitrator (which application is the subject matter of the present appeal). Relying on Section 12(5) of the Act [2] and on the decision of the Supreme Court of India (Supreme Court) in TRF Limited vs. Energo Engineering Projects Ltd. [3] (TRF case) a twofold contention was made by Ellora that:
  • all five officers constituting the Tribunal were employees of the respondent State, thereby rendering them and anyone appointed by them, ineligible; and
  • as the original members of the Tribunal had ceased to hold their offices in the respondent State, a new arbitral tribunal had to be constituted comprising of an impartial and independent arbitrator.
  • The High Court, rejected the submissions of Ellora on the grounds that the Arbitration Amendment Act, 2015 (Amendment Act), which inserted Section 12(5) of the Act, was effective from 23.10.2015. Hence, it could not be said to have retrospective application in arbitral proceedings already commencing prior to such date, unless the parties otherwise agreed. Aggrieved by the order of the High Court, Ellora challenged the order before the Supreme Court.

Arguments advanced by Appellant (Ellora):

Ellora challenged the order of the High Court principally on the following grounds:

  • As the Tribunal comprised only of the officers of the State, it had lost its mandate as per Section 12(5) of the Act read with the Seventh Schedule, and continuation of the Tribunal would frustrate the object and purpose of the Amendment Act providing for neutrality of arbitrators.
  • Ellora relied on the decision of the Supreme Court in Jaipur Zila Dugdh Sangh Ltd. vs. Ajay Sales & Suppliers [4] (Jaipur Zila case) to buttress the argument that even where a party had participated in the arbitral proceedings by filing a statement of claim, it would be open for it to approach the court under Section 12(5) of the Act seeking fresh appointment of an arbitrator.
  • Unless an express agreement in writing existed between the parties to continue with the mandate of the previous arbitral tribunal, an application seeking fresh appointment would be maintainable.
  • The High Court committed grave error in holding that the arbitral proceedings had commenced as, by virtue of the writ petition filed before the High Court, there was a stay operating on the proceedings between 04.05.2001 till 24.01.2017. During this period, the earlier incumbents of the Tribunal had retired, and no steps were taken to constitute a new arbitral tribunal.
  • As the members of the Tribunal had lost their mandate (being ineligible), a fresh tribunal was required to be constituted.

Arguments advanced by Respondent (State of Madhya Pradesh):

  • In response, the State submitted that:
  • The Tribunal was constituted in the year 2000 as per an agreement entered between the parties. Section 12(5) of the Act read with the Seventh Schedule, as was being relied upon by Ellora, would not be applicable retrospectively as held in a catena of decisions of the Supreme Court (and as had been relied upon by the High Court). Thus, the impugned judgement was a well-reasoned one.
  • Ellora had effectively prevented the Tribunal from proceeding with the arbitration by agitating the issue before various fora.
  • The Jaipur Zila case could be distinguished from the present case inasmuch as in the former, the arbitrator had been appointed after the Amendment Act.

 Issue before the Court

  • Whether the Tribunal had lost its mandate under Section 12(5) of the Act read with the Seventh Schedule, and if yes, whether a fresh arbitrator was required to be appointed.

Holdings and observations by the Court:

  • The Supreme Court held that the impugned judgement of the High Court was contrary to the law laid down by itself in the TRF case, in Bharat Broadband Network Ltd. vs. United Telecoms Ltd. [5] (Bharat Broadband case) and in the Jaipur Zila case, setting aside the impugned judgement. It further held that the earlier constituted Tribunal had lost its mandate by operation of law in view of Section 12(5) of the Act read with the Seventh Schedule. A fresh arbitrator, therefore, was required to be appointed.
  • Instead of remanding the matter back to the High Court for appointment of arbitrator, the Court itself appointed the arbitrator.
  • In holding so, the Court observed that without considering whether the employees of the State could have continued as arbitrators, no further steps had been taken after the constitution of the Tribunal in 2001. It therefore could not be said that the arbitration proceedings had commenced in the first place.
  • The Court also observed that where the arbitration clause fell foul of the amended Section 12(5) of the Act, the appointment of arbitrator would be beyond the scope of the arbitration agreement, thereby empowering the Court to appoint the same.
  • The Court further observed that where an arbitrator becomes ineligible to discharge his functions by operation of law, his mandate terminates automatically, and he needs to be substituted.
  • On the issue of retrospective applicability of Section 12(5) of the Act read with the Seventh Schedule therein, i.e. where the arbitrator was appointed prior to the amendment and insertion of the provision, the Court relied on its previous judgement in the Jaipur Zila case, where a similar issue had come up for consideration (and which in turn relies on a host of judgements including the TRF case and the Bharat Broadband case). It reiterated that neutrality (viz. independence and impartiality) of the arbitrator was a hallmark of any arbitral proceeding and could not be dispensed with in the name of party autonomy, reiterating that the provision would be applicable retrospectively.
  • To highlight the inviolable nature of arbitrator neutrality, the Court underscored excerpts from the recommendations of the Law Commission as highlighted in the Jaipur Zila case. Here it stated, that even where the state was involved, there could not be any distinction between a state party and a non-state party wherein the employee of a state party was permitted to sit as an arbitrator.[6]
  • The Supreme Court also relying on the Bharat Broadband case, held that merely because a party had filed a statement of claim and participated in the arbitration proceedings, did not mean that it had given a waiver under the proviso to Section 12(5) of the Act. What is required by the provision was an express agreement in writing post the dispute, signifying that such a waiver despite the ineligibility of the proposed arbitrator; is contra distinct to ‘deemed waiver’ or an agreement inferred by conduct.

Analysis:

  • By the present judgement, the Supreme Court having reiterated its previous decision in the Jaipur Zila case, has left no room for doubt on the retrospective applicability of the Amendment Act vis-à-vis Section 12(5) of the Act. Although, as per the facts of the present case, the arbitrator was appointed prior to the 2015 amendment but the arbitral proceedings were yet to commence, in a situation where the arbitral proceedings too have commenced prior to the 2015 amendment, the factual scenario would be covered by the Jaipur Zila case.
  • By the present judgement, the Court relying on the TRF case and the Bharat Broadband case, the former being subsequently interpreted in Perkins Eastman DPC vs. HSCC (India) Limited[7] (Perkins Eastman case), has once again highlighted the sacrosanct nature of arbitrator neutrality, reiterating that the principle of party autonomy cannot disregard the former. In doing so, it has harped on the principle that unilateral appointment of arbitrator is non est in law.
  • While the issue of retrospective applicability of the Amendment Act seems more or less to be settled, when it comes to the question of arbitrator neutrality, the Supreme Court itself seems to have adopted a differential stand. In the present case, the Court discussed the implications of the TRF case and affirmed that where an arbitrator is appointed by a person who is ineligible under Section 12(5) of the Act, such an arbitrator so appointed would also, consequently, be ineligible. Contrarily, in Central Organisation for Railways Electrification vs. M/s. ECI-SPIC-SMO-MCML (JV)[8] (Railway Electrification case) the Supreme Court upheld the appointment of two retired railway officers from a panel comprising four retired officers, all unilaterally elected by one party. The Court reasoned stating that the power of the state-run railways to unilaterally elect the panel of arbitrators was counterbalanced by the choice of 2 arbitrators given to the respondent. [9] While it merits mention here that the Supreme Court in Voestalpine Schienen GmbH vs. Delhi Metro Rail Corporation Ltd.[10]was of the view that ex-employees of the central government would not automatically be ineligible to be arbitrators but should not be directly related in any manner to the appointing party (as relied upon in the Railway Electrification case), such election of ex-employees unilaterally by state-run entities seem averse to the critical suggestions by the Law Commission on arbitrator neutrality. This is highlighted in the present case, and contrary to the principles laid down in various other precedents discussed above. Whereas in the Railway Electrification case the Court has refused to transgress from the appointment procedure as set out in the contract, in the present case, the Court relying on the TRF case and according primacy to the principle of neutrality of arbitrators, has itself appointed an arbitrator despite a stipulated procedure under the agreement.
  • As both the TRF case and the Railway Electrification case are three-judge bench decisions, the present issue of primacy of neutrality of arbitrators vis-à-vis adherence to a stipulated procedure of appointment under the agreement, may require further deliberation by a larger bench.

References:

[1]2022 SCC OnLine SC 8, decided on 4th January 2022
[2]S.12(5)- “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. Provided that parties may, subsequent to disputes having arisen between them, waive the applicability of this sub-section by an express agreement in writing.”
[3](2017) 8 SCC 377
[4] 2021 SCC OnLine SC 730
[5] (2019) 5 SCC 755
[6] The Law Commission was answering a suggestion posed by an ex-officio member that an exception be created for state entities to allow its employees to be appointed as arbitrators.
[7]2019 (9) SCC OnLine SC 1517
[8]2019 SCC OnLine SC 1635
[9]The Court has arrived at such conclusion after having considered the judgements in the TRF case and the Perkins Eastman case and seems to have failed to consider that the waiver under Section 12(5) of the Act can only be made after a dispute has arisen between the parties.
[10](2017) 4 SCC 665