Arbitration clause survives even if MoU bears no fruit

In a recent decision, the Supreme Court has reiterated the independence of an arbitration clause from the underlying contract and the principle of separability, by ruling that regardless of whether a memorandum of understanding (MoU) results in a contract, as envisaged by parties, the arbitration agreement will survive.

Ashapura Mine-Chem and Gujarat Mineral Development Corporation (GMDC) had entered into a MoU in 2007 for the purpose of establishing an alumina plant in Gujarat through a joint venture with a Chinese company. The MoU envisaged referring disputes to arbitration if amicable settlement through mutual consultation failed.

GMDC terminated the MoU, claiming that Ashapura failed to fulfil its conditions and also on account of significant proposed amendments to the MoU, precipitated by policy changes. The parties attempted, and failed, to amicably resolve their disputes. Consequently, they reached no consensus on the appointment of a sole arbitrator.

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Ashapura’s petition for the appointment of an arbitrator under section 11 of the Arbitration and Conciliation Act, 1996, was dismissed by Gujarat High Court. The court deemed the MoU to be stillborn since the joint venture failed to materialize, and ruled that the arbitration clause could not survive since the MoU was not a concluded contract. Ashapura filed a special leave petition before the Supreme Court to challenge the high court’s ruling.

Before the Supreme Court, Ashapura rightly contended that the unenforceability or invalidity of the underlying contract does not render the arbitration agreement contained within it void. The court, taking a pro-arbitration stance, upheld Ashapura’s contentions and the well-settled principle of separability, which mandates that unless the arbitration agreement itself stands impeached, invalidation of the underlying contract has no bearing on the enforceability of the arbitration clause, which remains juridically autonomous.

The Supreme Court relied on its judgments in Enercon (India) Ltd & Ors v Enercon GmbH & Anr, Reva Electric Car Company Pvt Ltd v Green Mobil and Today Homes & Infrastructure Pvt Ltd v Ludhiana Improvement Trust & Anr to set aside the high court’s dismissal of the section 11 petition and appointed a sole arbitrator.

Ruling on pre-emptive rights

Pre-emptive rights of shareholders, whether through a right of first refusal or otherwise, have been the subject of contention in the recent past. Bombay High Court has now considered a catena of judgments on the issue and ruled that such pre-emptive rights do not constitute a violation of section 111A of the Companies Act, 1956.

In an arbitration between Bajaj Auto and Western Maharashtra Development Corporation (WMDC), the arbitrator had held that, in terms of the agreement between parties, the 27% shareholding of WMDC in Maharashtra Scooters (jointly promoted by both parties and publicly listed) was to be valued for sale to Bajaj Auto at a fixed price which was determined through arbitration.

WMDC filed an appeal against the award before a single judge of Bombay High Court, who ruled that clause 7 of the protocol agreement entered into between Bajaj Auto and WMDC, which granted the right of first refusal to Bajaj Auto, was contrary to section 111A. The single judge, in the petition under section 34 of the act, reasoned that the pre-emption clause inter se between shareholders would breach the principle of free transferability enshrined in section 111A, and set aside the award on this basis alone. Cross-appeals were filed against the order of the single judge by Bajaj Auto and WMDC.

Subsequently, a division bench of Bombay High Court, in Messer Holdings v SM Ruia & Ors, had expressly considered and rejected the above view of the single judge. It was held that the rights of a shareholder in a public listed company, including that of entering into consensual terms of agreement for sale, are not whittled down merely because the company is publicly listed.

At the final hearing of the appeals, the division bench noted the precedent in Messer Holdings and also considered the historical background, i.e. the deletion of section 22A of the Securities Contracts (Regulation) Act, 1956, by the Depositories Act, 1996, and the consequent incorporation of section 111A into the Companies Act, 1956. The court observed that section 111A was aimed at regulating the powers of the board of directors of a company. The section’s purpose was merely to ensure that directors cannot refuse to transfer shares except for reasons specified in the statute, and it ought not to be so narrowly construed as to fetter the rights of a shareholder in a public company.

The court also observed that pre-emption agreements were expressly made a part of section 58 of the Companies Act, 2013, and are now to be treated as contracts. The order of the single judge was held to be unsustainable, to the extent that it set aside the award on the ground that the pre-emption rights envisaged by the protocol agreement between the parties violated section 111A.

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Vivek Vashi is the mainstay of the litigation team at Bharucha & Partners, where Shreya Ramesh is an associate.