Delhi High Court holds that an Arbitration clause does not survive on Novation of the Contract
Recently, on 02.06.2023, the Delhi High Court passed a judgement in the case of B.L Kashyap and Sons Ltd Vs. Mist Avenue Private Ltd dismissed a petition filed under Section 34 of the Arbitration and Conciliation Act, 1996 (‘the Act’) for setting aside an Arbitral Award. The issue involved was whether an arbitration clause survive on the novation of the contract.
FACTUAL MATRIX
A Construction Contract was entered into between the parties for a project in Noida, Uttar Pradesh. The Construction Contract contained an Arbitration & Dispute Resolution clause. Later, a Memorandum of Understanding (‘MoU’) was also executed between the parties. The MoU, however, did not contain any arbitration clause. The crux of the dispute between the parties is whether the Arbitration Agreement contained in the Construction Contract survived the execution of the MoU.
PROCEEDING BEFORE THE ARBITRATOR
The Arbitrator framed a preliminary issue as to ‘whether the arbitration tribunal has no jurisdiction in the matter in view of the execution of the MoU dated 08.10.2015?’. The Arbitrator concluded that, if the terms of the MoU was not fully complied it or even breached, it would not mean the arbitration clause in the Construction Contract stood revived.
SUBMISSIONS OF THE PARTIES
The Petitioner submitted that the cancellation of the Construction Contract was conditional and even otherwise, the Construction Contract stands novated by the MoU and the arbitration clause survived.
The Respondent, on the other hand, submitted that the terms of the MoU are unambiguous, the parties arrived at a settlement by which the Construction Contract was cancelled.
ANALYSIS
Examination of various judgments deals with the question of ‘whether an arbitration clause survives a supervening agreement between the parties’.
The Supreme Court in the case of Young Achievers Vs. IMS Learning Resources Pvt. Ltd. [(2013) 10 SCC 535] has held that “… parties have entered into a fresh contract contained in the exit paper which does not even indicate any disputes arising under the original contract or about the settlement thereof, it is nothing but a pure and simple novation of the original contract by mutual consent.”
The Supreme Court, in the case of Union of India v. Kishorilal Gupta & Bros [AIR 1959 SC 1362] had laid down guidelines in relation to the validity of the Arbitration Agreement on the Novation of Contract. The guidelines laid down by the Supreme Court are as follows –
“10. The following principles relevant to the present case emerge from the aforesaid discussion : (1) An arbitration clause is a collateral term of a contract as distinguished from its substantive terms; but nonetheless it is an integral part of it; (2) however comprehensive the terms of an arbitration clause may be, the existence of the contract is a necessary condition for its operation; it perishes with the contract; (3) the contract may be non est in the sense that it never came legally into existence or it was void ab initio; (4) though the contract was validly executed, the parties may put an end to it as if it had never existed and substitute a new contract for it solely governing their rights and liabilities thereunder; (5) in the former case, if the original contract has no legal existence, the arbitration clause also cannot operate, for along with the original contract, it is also void; in the latter case, as the original contract is extinguished by the substituted one, the arbitration clause of the original contract perishes with it; and (6) between the two falls many categories of disputes in connection with a contract, such as the question of repudiation, frustration, breach etc. In those cases it is the performance of the contract that has come to an end, but the contract is still in existence for certain purposes in respect of disputes arising under it or in connection with it. As the contract subsists for certain purposes, the arbitration clause operates in respect of these purposes.”
Keeping in mind the facts of the case and the law laid down, the principle that emerges is that when the new contract constitutes a wholesale novation of the original contract, the Arbitration clause would also stand extinguished by virtue of the new agreement.
JUDGEMENT
The Delhi High Court on examination of the Arbitral Award and the limited scope of interference under Section 34 of the Act as laid down in the case of Ssangyong Engg. & Construction Co. Ltd. v. NHAI [(2019) 15 SCC 131] and Delhi Airport Metro Express (P) Ltd. v. DMRC [(2022) 1 SCC 131] in cases of contractual interpretation, have held that Courts do not sit in appeal against the Arbitral Award. The permissible ground for interference on the ground of patent illegality is when the arbitrator takes a view which is not even a possible one or interprets a clause in the contract in such a manner which no fair-minded or reasonable person would.
The Delhi High Court concluded that the interpretation arrived upon by the Arbitrator, is plausible and therefore, the interpretation that MoU novated the Construction Contract is unimpeachable under Section 34 of the Act. The Arbitration Agreement in the Construction Contract perishes or ceases to exist upon the execution of the MoU.
Understanding Arbitration Clauses in Contracts
An arbitration clause in a contract is a legal provision that outlines the process for resolving disputes through arbitration instead of traditional litigation. Novation of a contract refers to the substitution of one party or terms with the consent of all parties involved, effectively creating a new contract. Novation ab initio means a contract was void from the beginning. In law, novation represents the replacement of an obligation or party in a contract. Features of arbitration include a neutral arbitrator, a binding decision, and a private and often more expedited process compared to court litigation.
