An Arbitration Award In Violation Of The Provisions Of The Indian Contracts Act Is Patently Illegal: Delhi High Court

The bench of Neena Bansal Krishna partially set aside an arbitration award that was passed in contravention of Sections 59-61 of the Indian Contracts Act, 1872. The Court explained the law of apportionment of funds vis-à-vis a running and non-mutual account.

The Court further distinguished between modifying an award and partially setting it aside. It held that it is not permissible to modify an arbitration award under Section 34 of the Act, however, it is possible for a Court to partially set aside an award by severing the illegal portion while retaining the remaining award.

Facts

The parties entered into Distributor on Consignee Agency Basis Agreement dated 28.12.2007 effective from 01.04.2008 for two years. It was renewed for another two years and ultimately expired on 31.03.2012. After the expiry of 7 months, the parties entered into another Consignee Agency Basis Agreement on 12.11.2012 for a period of three years. It was again renewed for another three years.

All this while, the respondent was selling the products supplied by the respondent. The petitioner maintained a ‘running and non-mutual’ ledger account for all the supplies made and payment received from 01.04.2018 to 31.03.2018.

The petitioner sent certain Balance Confirmation Letters to the respondent in the year 2016-17 against which the respondent sent its replies and admitted its liability for a sum of Rs. 2,64,99671/-. However, the respondent failed to make the payment for the admitted amount, consequently, a dispute arose between the parties. Accordingly, the petitioner issued a legal notice 27.06.2017 demanding certain payments, in its reply to the legal notice, the respondent again admitted an amount of Rs. 1,64,73,786/- as outstanding. However, no payment was released by it.

Aggrieved by the non-release of payment, the petitioner issued the notice of arbitration and appointed the sole arbitrator. The respondent, in reply, objected to the appointment of the arbitrator. Accordingly, the petitioner approached the Court under Section 11(6) for the appointment of arbitrator.

The arbitrator entered reference, the respondent again objected to the jurisdiction of the tribunal, it ultimately sopped appearing before the tribunal and was proceeded ex-parte.

The impugned award

The petitioner made a claim for Rs. 2,64,99,671/- in view of the unequivocal admission by the respondent admitting its liability. However, the tribunal partly allowed the claim of the petitioner only to the extent of awarding Rs. 28,92,620/-

The tribunal held that it could not adjudicate the claims that are dependant upon transactions that took place before the agreement dated 12.11.2012. It held that sales during the period from 12.11.2012 to 31.03.2018 under the Agreement amounted to Rs. 1,29,53,722/-, against which a sum of Rs. 1,00,61,102/- was paid by the respondent leaving an outstanding balance of Rs. 28,92,620/-. The other outstanding payments pertained to earlier Distribution Agreement and were not the subject matter of this arbitration.

Grounds of Challenge

The petitioner party challenged the award on the following grounds:

• The award is contrary to the public policy of India, justice and morality and patently illegal.
• The arbitrator has ignored the vital evidence on record. It failed to appreciate that the respondent had admitted its liability. It further failed to appreciate that the cause of action was continuing.
• The arbitrator erred in not deciding an application filed by the petitioner under Order XII Rule 6 of CPC. It failed to appreciate that even in its statement of defence, the respondent had admitted its liability, therefore, the petitioner deserved a judgment on admission.
• The award is passed in violation of Section 59-61 of Indian Contracts Act, 1872 as the arbitrator failed to appreciate that the petitioner maintained a ‘running and non-mutual’ ledger account for all the transactions and the amounts due to the petitioner from the respondent even if prior to 12.11.2012 were liable to be settled first and denial of the same is against the principle of appropriation of dues as provided under Sections 59, 60 and 61 of the Indian Contract Act, 1872.

Analysis by the Court

Firstly, the Court examined the objection that the respondent had taken in its statement of defence in the arbitration proceedings to the jurisdiction of the tribunal on account of non-service of notice of arbitration.

The Court held that the notice was duly served on the respondent. It held that although, the email was addressed to the arbitrator, however, it was served on the respondent through CC. Further, the respondent had replied to the said email, thus, it was duly admitted by it. Moreover, it had taken no objection regarding notice of arbitration under Section 11 of the A&C and acquiesced to the appointment of the arbitrator. Therefore, it could not object to the jurisdiction of arbitrator.

Next, the Court decided on the objection regarding the apportionment of dues as provided under Section 59-61 of the Indian Contracts Act.

The Court agreed with the arbitral tribunal that it could only adjudicate the claims arising after the agreement dated 12.11.2012, however, the Court held that the tribunal erred in not appreciating that the ledger accounts of the petitioner reflected a debit balance of Rs. 2,64,99,671/- and the petitioner examined two witnesses to prove its content and it was duly proved as it remained uncontroverted by the respondent. The Court held that once the petitioner’s ledger account was duly proved, the arbitrator fell into error to not appreciate and apply the law pertaining to apportionment of funds in ledger account.

The Court explained the law of ‘running and non-mutual account’ vis-à-vis apportionment of funds. It held as under:

“46. The Ledger account maintained by the petitioner was a “running and non-mutual account” as has been explained in the case of Renganathan vs Saravana Store 2018 SCC OnLine Mad 5897. In case of a running and non mutual account between the buyer and seller, when goods are delivered by the seller to the buyer, the value of the goods is debited in the debit column and when amounts are paid by the buyer to the seller, they are entered in the credit column. The difference is continuously struck in the column for balance. In such a case, when the buyer defaults to make balance payment, the seller's action is not for the price of goods sold and delivered, but for the balance due at the foot of an account. The account is running as the amounts received are credited and the amounts still due is reflected as debit. Essentially, it is non mutual because the amounts being adjusted are those payable by one party. Mutual account implies that the credit – debit account is of both the parties.

47. The accounts being maintained being running and non-mutual, the manner of apportionment of money in running accounts has been explained in Section 59, 60 and 61 of the Contract Act,1872.”

51. Thus, to summarize where a debtor, owing several distinct debts to one person, makes a payment indicating that the payment is to be applied to the discharge of some particular debt, the payment must be applied accordingly in terms of S.59 of the Contract Act. However, where the debtor omits to so intimate, the creditor may apply it at his discretion to any lawful debt actually due and payable to him from the debtor, whether its recovery is or is not barred by the law in force for the time being as to the limitation of suits, according to S.60.Where neither party makes any appropriation, the payment shall be applied in discharge of the debts in order of time, whether they are or are not barred by limitation in terms of Section 61 of the Contract Act.

52. In the present case, there is neither any averment nor any evidence that the respondent while making payments to the appellant in terms of the Contract ever indicated the manner of apportionment. When neither party specifies the manner of apportionment, then the amount has to be first adjusted towards earlier debts irrespective of limitation as indicated by Section 61 Contract Act. Thus, the money which was continuously being received from the respondent was to be apportioned to the previous amounts that were due in the earlier Agreements as has been reflected in the ledger accounts. The amount as due in 2018 was the claimed amount of Rs.2,64,99,671/-.

53. The learned Arbitrator while was correct in observing that the arbitration had been invoked pursuant to the Contract of 12.11.2012 renewed in 2015, but he overlooked the statutory provisions under Contract Act for apportionment of money received from the Respondent from time to time,”

Hence, the Court held that since the petitioner maintained a running account, the payments made by the respondent were to be first applied to the debts in its order of time and not as per the date of the transaction since the respondent has failed to show that the payments that were made were for the discharge of any particular debt.

Next, the Court examined if the award is patently illegal for having been passed in violation of provisions of Indian Contract Act.

The Court held referred to Section 28 of the A&C Act that mandates the tribunal to adjudicate the dispute in accordance with the substantive law for the time being in force. It held that evidently, the arbitrator ignored the provisions of Indian Contract Act, 1872 which is a substantive law, therefore, the award suffers from patent illegality.

Lastly, the Court decided on the issue if it could partly set aside the award.

The Court referred to the judgment of the High Court of Bombay in R.S. Jiwani v. Ircon International, 2009 SCC OnLine Bom 2021 and Supreme Court judgment in J.G. Engineers Pvt. Ltd v. Union of India (2011) 5 SCC 758 to hold that it is not permissible to modify an arbitration award under Section 34 of the Act, however, it is possible for a Court to partially set aside an award by severing the illegal portion while retaining the remaining award.

It held that power to partially set aside an arbitration award is quintessential because it is possible that an arbitration award would be correctly decide certain claims and incorrectly decides the other and if an award is fully set aside, a parties would again have to go another round of litigation even on claims that were correctly decided.

Accordingly, it set aside the award to the extent it disallowed the claims of the petitioner on the ground that they relate to transactions that took place before the agreement came into being. However, the Court at the same time retained the award to the extent it allowed the claim of Rs. 28,92,620/- by observing that it was partial payment towards the liability admitted by the respondent.

Case Title: Amazing Research Laboratories v. Krishna Pharma

Citation: 2023 LiveLaw (Del) 231

Date: 13.03.2023

Counsel for the Petitioner: Mr. Siddharth Aggarwal

Counsel for the Respondent: Mr. A. Selvin Raja & Ms. Nikita Kumari

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