Judicial Inroads Into Arbitration: Section 34 Saga

The Arbitration Act 1940

The first major consolidated legislation to govern the conduct of arbitrations across India was the Arbitration Act, 1940 which was based on the (English) Arbitration Act, 1934. Section 30 of the 1940 Act provided for setting aside of awards.^[1] More often than not, awards were set aside and the proceedings conducted under the Act came under severe criticism. The anguish of the Hon'ble Supreme Court would be evident from the criticism of the 1940 Act made in judgments such as Guru Nanak Foundation v. Rattan Singh^[2]wherein the Hon'ble Supreme Court observed that "….the way in which the proceedings under the Act are conducted and without exception challenged in Courts, has made Lawyers laugh and legal philosophers weep…Informal Forum chosen by the parties for expeditious disposal of their disputes has by the decisions of the Court been clothed with 'legalese' of unforeseeable complexity."

The Arbitration and Conciliation Act 1996

In the year 1992, India opened itself to the world economy and in the said process, the Country was also analyzing the discrepancies and inconsistencies in the previous arbitration legislations and it was realized that unless the country has a proper dispute mechanism in place, India will never be a destination for the developed nations. The Indian legislature, recognizing the importance of modernizing the arbitration system, repealed previous statutes and enacted the 1996 Act, which came into effect on 25 January 1996.^[3] The 1996 Act was based on the UNCITRAL (United Nations Commission on International Trade Law) Model Law on arbitration. One of the primary objects of the 1996 Act was to minimize intervention of the courts during arbitral proceedings^[4] or an Award. Section 5 of the 1996 Act provides that no judicial authority shall intervene except for as provided in the 1996 Act^[5].

Section 34 (Prior 2015 Amendment)

This Section deals with the procedure for the application and the grounds for setting aside the arbitral Award^[6]. Section 34(2) (a) of 1996 Act^[7] mentions certain grounds on account of which the Court can set aside the arbitral award, provided the party assailing such awards is able to prove the conditions as mentioned therein, which are as follows :-

1. a party was under some incapacity
2. the arbitration agreement is not valid in accordance with the Law to which the parties to the Agreement have subjected it
3. no proper notice of the appointment of the arbitrator or the proceeding had been given to it
4. the dispute dealt by the arbitral award does not fall within the terms of the submission to arbitration, or the award contains a decision beyond the scope of the submission to arbitration.
5. the composition of the tribunal was not in accordance with the agreement of the parties.

Moreover, under section 34 (2) (b) of the 1996 Act^[8]the court may also set aside the Award if: -

I. the subject matter of the dispute cannot be settled by means of Arbitration;

II. the Arbitral award is in conflict with the public policy of India

The grounds given under Section 34(2)(a) are precise and specific and lay the law as it is without the inclusion of any open-ended expression, which otherwise would have given the courts an opportunity to widen their scope of interference with the arbitral awards. The only open-ended expression which has been of concern or which has left some ambiguity is the ground of public policy of India. No other ground possibly has been subject matter of debate and judicial intervention as much as the words "public policy" used in Section 34 (2)(b).

Public Policy (the Unruly Horse)

What constitutes to be against public policy so as to be a strong enough ground for setting aside of an Award has raised questions in the minds of jurists. The term "Public policy" finds no definition either under the 1996 Act^[9] or under any other Law in force and hence the term remained abstruse, and every term which is not clearly defined is always open to judicial scrutiny. Usage of the words public policy has led to a variety of interpretations. The concept of public policy^[10] being an ever shifting, vague concept; choosing a combination of words to define public policy became an arduous task. Justice Burrough in one of his judgments had observed that, 'public policy is a very unruly horse and when once you get astride it you never know where it will carry you. .^[11]" The Indian Courts have also in many cases termed "public policy" as an "unruly horse" thus giving the interpretation that it can never be defined or be a certain thing.^[12] Some judges have attempted to give structure to the concept of public policy with reference to setting aside of Awards. In this connection, it is necessary to analyse the Supreme Court's landmark decisions in Renusagar^[13] and Saw Pipes^[14].

Renusagar

The Renusagar^[15]judgement, was one of the earlier judgments of the Supreme Court, which delved into the concept of public policy. In Renusagar, the Supreme Court held that an award in violation of the Foreign Exchange Regulation Act, 1973, being a statute enacted to safeguard the national economic interest, shall be contrary to the public policy of India and the fundamental policy of Indian law. The Supreme Court limited the scope of public policy to three grounds: (i) fundamental policy of Indian law; (ii) the interest of India; or (iii) justice or morality.

Saw Pipes

This judgement laid down that the term "public policy" should be construed and understood in a wider perspective and also includes the term "patent illegality" within its scope. "Patent Illegality", as explained in this case, meant any error of law on the face of the award. The judgment also held that an award could also be set aside, if it was so unfair and unreasonable, that it shocked the conscience of the Court.

On one hand, the law laid down by the Supreme Court in Saw Pipes led many other courts to interpret the law to include any error of law to be hit by Section 34 including the subsequent decisions of the Supreme Court, thus opening up the floodgates.^[16] On the other hand, some of the subsequent benches acknowledged the criticism directed against the Saw Pipes decision, but also held that they were bound to observe it under the principle of stare decisis.^[17] In McDermott International Inc v. Burn Standard Co. Ltd. & Ors.^[18] the Court expressly noted that it was only for a larger bench to reconsider the correctness of the Saw Pipes decision and that till this was done, the decision was binding upon it.

The scope of public policy was widened by the Supreme Court in its decision of Saw Pipes. The judgment was considered to be a step backward as the same illuminated a part for more judicial interreference into arbitral awards and frustrating one of the objects of the 1996 Act (i.e. to discourage interference with arbitral awards). At this stage, the law in India with regard to public policy as a ground for setting aside an award was in fact proving to be indeed to an "unruly horse".

The Run-Up to the 2015 Amendment

246^th Law Commission Report

To deal with the jurisdictional expansion of the notion of public policy, in August 2014, the Law Commission of India provided a narrow interpretation of public policy. It suggested substantial amendments to Section 34 of the 1996 Act with an endeavour to ensure that Renusagar position applies to all foreign awards and all awards passed in international commercial arbitrations. With respect to domestic arbitrations, the Commission recommended that the "patent illegality" test to be retained, although to be construed more narrowly than under the Saw Pipes regime.^[19] The Law Commission Report suggested amendments to the 1996 Act with the objective that terms such as "fundamental policy of Indian law" or conflict with "most basic notions of morality or justice" would not be widely construed.^[20]

ONGC vs Western Geco

A month following its 246^th Report, in September 2014, a three-judge bench of the Supreme Court in ONGC vs Western Geco^[21] interpreted the 'fundamental policy of Indian law 'i.e. the first head of public policy as stated in Renusagar, to include perversity or irrationality. As per the Supreme Court, an award could therefore be set aside if it was perverse or irrational and be set aside if the Arbitrator(s) came to a finding that "no reasonable man would have arrived at". The perversity or irrationality of the decision was to be tested on the touchstone of the Wednesbury principle of reasonableness. The Western Geco judgment in a way gave legal sanction permitting Section 34 of the 1996 Act Courts to review an arbitral award on merits on the basis of it violating public policy and expanded the Court's power rather than minimizing it.

Associate Builders^[22]

Western Geco judgment was followed by a subsequent judgment in Associate Builders vs. Delhi Development Authority.^[23] The Supreme held, inter alia, that merits of the award can be looked into only under the broad head of 'public policy'. The Supreme Court relied on the landmark judgments like, Renusagar^[24], Saw Pipes^[25], McDermott International^[26], Western Geco International Ltd^[27] and others and laid down what would constitute to be "fundamental policy of India'. The Hon'ble Supreme Court held that "Fundamental Policy of Indian law" would include factors such as a) disregarding orders of superior courts; b) judicial approach, which is an antithesis to an arbitrary approach; c) principles of natural justice etc. With reference to the ground of perversity, as a ground for challenge of an Award, the Supreme Court held that the principle of perversity to mean that a decision would necessarily be perverse where a) finding is based on no evidence; or b) an arbitral tribunal takes into account something irrelevant to the decision it arrives at; or c) it ignores vital evidence in arriving at its decision. The ruling marked a significant step in the prior Amendment regime with the pro arbitration decisions of the Supreme Court in the last few years. However, the judgment did leave some elbow room for setting aside in limited cases where factual errors reflected that the arbitrator 's approach to be arbitrary and thus patently illegal.

Supplementary to Report No. 246^[28]

In view of the above judgments (Western Geco and Associate Builders), the Law Commission apprehended that a negative consequence being (a) a further erosion of faith in arbitration proceedings amongst individuals and businesses in India and abroad; (b) a reduction in popularity of India as a destination for international and domestic commercial arbitration; (c) increased investor concern, amongst domestic and foreign investors, about the efficacy and speed of dispute resolution and potential for judicial interference; and (d) an incidental increase in judicial backlog.^[29] This was precisely the fear that prompted the Law Commission of India to submit a Supplementary Report dated 6 February 2015 on the recommendations and suggestions that it had already made in its 246th Report and to clarify what would constitute "fundamental policy of Indian law".

The Arbitration and Conciliation (Amendment), Act, 2015

The Arbitration and Conciliation (Amendment) Act, 2015 with effect from 23 October 2015 brought about significant modifications (based on the Law Commission Reports) in the 1996 Act, with the object of reducing intervention by the courts. The 2015 Amendment thus introduced certain amendments narrowing down the scope for setting awards.^[30] As per the 2015 Amendment, the scope of "public policy" in Section 34 has been narrowed and the award can be set aside only if the arbitral award (i) was induced or affected by fraud or corruption; or (ii) is in contravention with the fundamental policy of India; or (iii) conflicts with the most basic notions of morality or justice. A new Section 2A was introduced by the 2015 Amendment, which states that "if the Court finds that the award is vitiated by patent illegality appearing on the face of the award". In terms of this amended provision, an award cannot be set aside merely on the ground of erroneous application of the law or by re-appreciation of evidence. The amendment to the 1996 Act clearly demonstrated the will of the Indian legislator to interpret the public policy exception restrictively.

Post 2015 Amendment Era

Ssangyong Engineering & Construction Co. Ltd.

The decision of the Supreme Court of India in Ssangyong Engineering & Construction Co. Ltd. v. National Highways Authority of India (NHAI) ("Ssansyong")^[31], led to some notable developments. The judgment sums up the position post 2015 Amendment India, which is as follows: -

(a) The interpretation of the term 'public policy of India' had been narrowed down by the 2015 amendment and found that amendments to Section 34 of the 1996 Act, especially the doing away of the wide interpretation of the term 'public policy of India', were substantive in nature. Thus, the post-amendment position shall not apply to applications related to Section 34 instituted before the 2015 Amendment, unless otherwise agreed by the parties.

(b) "Public policy of India" would now mean the "fundamental policy of Indian law" as explained in Associate Builders, i.e. the fundamental policy of Indian law would be relegated to the "Renusagar" understanding of this expression. This would necessarily mean that the law led down in Western Geco has been done away with. However, insofar as principles of natural justice are concerned, as contained in Sections 18^[32] and 34(2)(a)(iii) of the 1996 Act, these continue to be grounds of challenge of an award, as contained in Associate Builders.

(c) Public policy of India is now constricted to mean firstly, that a domestic award is contrary to the fundamental policy of Indian law, as understood in Associate Builders or secondly, that such award is against basic notions of justice or morality as understood in Associate Builders.

(d) Insofar as domestic awards made in India are concerned, an additional ground is now available under sub-section (2A), added by the Amendment Act, 2015 to Section 34. Here, there must be patent illegality appearing on the face of the award, which refers to such illegality as goes to the root of the matter, but which does not amount to mere erroneous application of the law. In short, what is not subsumed within "the fundamental policy of Indian law", namely, the contravention of a statute not linked to public policy or public interest, cannot be brought in by the backdoor when it comes to setting aside an award on the ground of patent illegality.

(e) The Supreme Court explained the concept of "patent illegality" post the 2015 Amendment and has expanded its ambit through an interpretation of Section 28(3) of the 1996 Act. If the arbitrator wanders outside the contract and deals with matters not allotted to him, he commits an error of jurisdiction. This ground of challenge will now fall within the new ground added under Section 34(2A).

(f) Re-appreciation of evidence, which is what an appellate court is permitted to do, cannot be permitted under the ground of patent illegality appearing on the face of the award.

(g) A decision which is perverse, while no longer being a ground for challenge under "public policy of India", would certainly amount to a patent illegality appearing on the face of the award. Thus, a finding based on no evidence at all or an award which ignores vital evidence in arriving at its decision would be perverse and liable to be set aside on the ground of patent illegality.

The Ssangyong judgment throws much needed light on the position of law as regards setting aside post 2015 Amendment and no doubt provides much needed clarity. The Supreme Court in a recent judgment of South East Asia Marine Engineering and Constructions Ltd (SEAMEC Ltd) v Oil India Limited^[33], set aside the Award in question on the ground that the interpretation provided by an arbitral tribunal to a contractual provision was not reasonably possible upon a reading of the contract as a whole. This judgment deals with the pre-2015 amendment situation and while being aware of the limited scope of Section 34 has somewhat dealt with the merits of the case. The three-judge bench of the Supreme Court in a judgment delivered very recently, Patel Engineering vs North Eastern Electric Power Corporation Limited^[34] extensively dealt with the history of "Patent Illegality as a ground for setting aside a domestic award. Dealing with the position post 2015 and the latest judgments holding the field including Ssangyong and Associate Builders, the Supreme Court has noted that the ground of patent illegality is a ground available under the statute for setting aside a domestic award, if the decision of the arbitrator is found to be perverse, or so irrational that no reasonable person would have arrived at the same or the construction of the contract is such that no fair or reasonable person would take or that the view of the arbitrator is not even a possible view. The Hon'ble Supreme Court in the recent Patel Engineering has basically reaffirmed the view that an arbitral award can be set aside under Section 34 of the 1996 Act if it is patently illegal or perverse.

There is no doubt over the fact that all concerned are propagating a regime where there will be less interference by the courts as far as setting aside is concerned and this in turn will encourage a norm of "Lets arbitrate and not litigate". At the same time, it should not be forgotten that the main objective of arbitration is to ensure delivery of legitimate award in the interest of justice and hence law permits the Courts to intervene in the arbitral proceedings in certain cases. The courts hearing Section 34 applications cannot also be reduced to a mere endorsing authority shying away from interference. A balanced approach is required by the Courts to execute the true object of the 1996 Act. The recent judgments, as discussed, point towards this direction. We await more rulings in the post 2015 amendment scenario to get more clarity on these issues. The Courts have to decide where "Laxman Rekha" has to be drawn within the four parameters of the 1996 Act so that there is less judicial interference but at the same time justice is also delivered upholding the spirit of Section 34 of the 1996 Act.

Nand Gopal Khaitan and Shounak Mitra are Partenrs at Khaitan & Co and Rishav Dutt is a Principal Associate there.

(The views of the authors expressed above are purely independent, and do not necessarily reflect the views of their organisations,Author may  be reached at ng.khaitanco.com, shounak.mitra@khaitanco.com and rishav.dutt@khaitanco.com)