The Legal Arc Volume 1 Issue 1 Articles
The author is a graduate from the 2020 batch of Symbiosis Law School, Pune with immense interest in dispute resolution. She is a future joinee at Cyril Amarchand Mangaldas.
Third-Party Conundrum in Arbitration: An Introduction
Under the general law of contracts, a doctrine called ‘privity of contract’ prevents a third party from enforcing any obligations or acquiring any rights under a contract. Gradually, common law carved out exceptions to this doctrine. For instance, a non-signatory who was an intended beneficiary of the contract or an agent of the signatory was allowed to enforce the contract.
Although an agreement to arbitrate forms part of a contract, these exceptions were not directly applicable to enable a third party to compel/ be compelled to arbitrate [this is called ‘the third-party issue’ in arbitration]. The rationale was that arbitration is a consent-based dispute settlement mechanism; it bars court’s jurisdiction and a party cannot be denied the right to approach national courts without express intention.
In the 21st century, when each jurisdiction wants to portray itself as pro-arbitration, the above-mentioned exceptions get imported to the sphere of arbitration. Enforcing arbitration agreements against a third party is now possible by piercing the corporate veil, equitable estoppel, Group of Companies Doctrine etc. The reciprocal aspect of this problem – whether a third party can enforce arbitration against a signatory to the agreement – has not garnered much attention.
In this article, the author contends that a non-signatory, just like a signatory, can compel arbitration by application of certain legal theories. Further, the author analyses the status of the third-party issue in India to suggest its resolution by incorporation of these legal theories in Indian jurisprudence.
Legal Theories as Enablers of Third-Party Arbitration
Legal responses to the third-party issue can be classified into:
- use of legal theories that allow arbitration by/against a third party based on express/implied consent of signatory/ non-signatory; consent is inferred after examining intention of the parties for instance, in equitable estoppel, Group of Companies doctrine etc.
- in the second approach, regardless of the parties’ intention, consent is ‘deemed’ by operation of law or judicial practice e.g. by piercing of corporate veil, succession etc.
Adhering to the scope of the article, what follows is an analysis of three such legal theories which can enable a third party to compel arbitration:
- Third party beneficiary theory
Traditionally, this theory evolved from contract law to allow third parties who benefit from the performance of a contract to sue for breach of the same. For application of this theory, it is necessary to prove the intent of the signatories to benefit the third party, either by express language in the contract or by the post-contractual behaviour of the parties. An arbitral clause is just another provision in a contract and if a third party is an intended beneficiary under a contract, there is no reason why such dispute resolution clause cannot work to its benefit. In reference to this, the Swiss Supreme Court allowed third parties to enforce arbitration proceedings when it is so intricately connected with a contract’s subject matter or involved in its execution that the intention of the signatories appears to afford the benefit of arbitration clause to such third party. In India, the use of this theory is limited to extension of rights/obligations under a contract; there is no judicial precedent utilizing this theory to confer benefits of an arbitration agreement on third parties.
- Equitable Estoppel
This theory propounds that if a non-party derives benefits from a contract, it cannot escape the obligations imposed under it. Acceptance of contractual benefits by a non-signatory amounts to an implied consent to the obligations under the contract including the agreement to arbitrate. Similarly, if a signatory to the contract (containing an arbitration clause) chooses to enforce contractual claims against a non-signatory, the non-signatory can enforce the arbitration clause on the grounds that the claims of the signatory are deeply embedded in the contract. If the signatory can enforce rights under the contract, they are estopped from skipping the obligation to arbitrate under the contract; holding otherwise would amount to judicial support for cherry-picking. This doctrine has been religiously applied in the United States to allow third-party arbitration under two scenarios:
- the signatory’s claims indispensably rely on the terms of a contract containing the arbitral clause; or
- the signatory alleges “substantially interdependent and concerted misconduct by both the non-signatory and one or more of the signatories.”
Unfortunately, Indian courts have not yet come across an argument based on this theory and hence, it has not been formally recognized in India.
- Group of Companies Doctrine
The Indian Supreme Court in Chloro Controls (I) P. Ltd. v. Severn Trent Water Purification Inc. and Ors. [hereinafter “Chloro”] held that an arbitral clause can be extended to include all companies within a group of affiliated companies if a mutual intention to bind both signatory and non-signatory companies can be shown. Notably, this doctrine has been frequently used to bind non-signatories to arbitration. However, its application to enable non-signatories to enforce arbitration agreements has been nil. Arbitration experts like Gary B. Born have opined that this doctrine is linked to the principle of ‘implied consent’ and helps in determining whether a non-signatory was intended party to an arbitration agreement, notwithstanding the absence of a formal signature. If, in a particular case, application of this doctrine leads to the conclusion that non-signatory was intended party to the arbitration agreement, it must necessarily follow that all the rights and obligations attached to the agreement are conferred on the non-signatory. Thus, when signatories can enforce obligation to arbitrate against the non-signatory by virtue of the Group of Companies doctrine, it would not be a legal infirmity to argue that a non-signatory can compel arbitration against the signatory relying on this doctrine.
Is Indian Jurisprudence Ripe For The Incorporation of These Theories In Both Domestic And International Arbitration?
Under the Indian Arbitration and Conciliation Act 1996 [hereinafter “the Act”], Section 45 (concerning international commercial arbitration) mandates that wherever an arbitration agreement exists between the parties, the Courts shall refer them to arbitration on the request of a party or ‘any person claiming through or under him’. In the Chloro case, the Supreme Court held that a non-signatory third party may be ‘a person claiming through or under’ a signatory, provided there exists a well-defined legal relationship between the non-signatory and the signatory through or under whom they are claiming to be. According to the Court, this legal relationship may be based on theories of implied consent or force of law. By virtue of this statement of the Court, all the above-mentioned theories may be used to resolve the third-party issue in India, at least in international commercial arbitration. Although as an obiter dictum, the Court further stated that arbitration is possible between a signatory and a third party, even in cases where the claim to arbitration is by a third party. In practice, only the Group of Companies doctrine has been used by the Court, and its usage is limited to enforcement of arbitration against third parties, not by third parties.
However, this case only determined the scope of ‘party’ under Section 45 of the Act. Section 8 of the Act concerning domestic arbitration was distinguished by the Court from Section 45 as Section 8 did not expressly use the terms ‘a party claiming through or under’ a signatory until its amendment in 2015. After the amendment of Section 8, the Court in Ameet Lalchand v. Shah and Ors. v. Rishabh Enterprises and Ors.allowed some non-signatories to compel domestic arbitration against a signatory (Rishabh Enterprises) because the disputes of Rishabh Enterprises with non-signatories and that with another signatory could not be decoupled. No legal theory was relied upon to reach this outcome. This prompts the question whether amended Section 8 can be interpreted as widely as Section 45 to include the mentioned legal theories when the disputes are not interlinked in this manner.
There are instances of High Courts applying the Chloro pronouncement to expand the scope of Section 8. On May 21, 2020, the Delhi High Court, in Magic Eye Developers Pvt. Ltd. v. Green Edge Infra Pvt. Ltd. & Ors., relied on the Group of Companies doctrine as in the Chloro case to refer two signatories along with the director of the defendant signatory to arbitration under Section 8. The objection of the plaintiff that the director was a non-signatory was rejected by the Court. Earlier in 2019, the Karnataka HC held that a third party (in this case, a subcontractor who is not named in the contract) can rightfully compel domestic arbitration against a signatory. These two cases bring some clarity on the standing of third parties under domestic arbitration, however, in the absence of a clear pronouncement by the Supreme Court, uncertainty persists.
It is noteworthy that the above-mentioned theories originate from common law. Therefore, Indian courts could recognize these principles in the spirit of justice and equity, without waiting for the legislature to provide a basis for them by statutory amendment. This approach could have prevented the narrow interpretation of Section 8 vis-à-vis Section 45.
There is enough international judicial practice to suggest that third parties can not only be forced to arbitrate but can also compel arbitration against signatories to a contract. Third parties may rely on implied consent of the signatories to compel them to arbitrate, e.g. by application of theories like third party beneficiary, equitable estoppel and Group of Companies. In line with several pro-arbitration jurisdictions, India has now tacitly imported these theories in its legal system. While there are definite obiter dicta of the Indian judiciary in support of third-party enforcement of international commercial arbitration, its applicability to domestic arbitration under Section 8 is still uncertain.