Is Arbitration Clause in Unstamped Contract Valid in India?

The validity of an arbitration clause in unstamped contracts has been subjected to numerous judicial discussions in different courts of law. However, all doubts related to the enforceability of arbitration clauses in such contracts were clarified by a Constitution Bench of the Supreme Court of India.

The Judgement of Constitutional Bench

In April 2023, the Constitution Bench of the Supreme Court, while hearing the matter of N.N. Global Mercantile Pvt. Ltd. vs. Indo Unique Flame Ltd. & Ors., ruled that an arbitration clause in an unstamped contract shall be invalid and not enforceable in law. As per the Apex Court, if a contract is unstamped or insufficiently stamped, it would invalidate the agreement and render it legally non-existent.

This case was previously heard by a three-judge bench, who doubted the correctness of the Supreme Court’s judgement in similar cases concerned with the same legal issue – SMS Tea Estates vs. Chandmari Tea Co. and Garware Wall Ropes Ltd. vs. Coastal Marine Constructions.

Garware Wall Ropes was quoted with approval in the matter of Vidya Drolia vs. Durga Trading Corporation by the three-judge bench and, thus, it was vital to refer to the Constitution Bench of the Supreme Court.

While referring to the Constitution Bench, the question asked was – ‘whether the statutory bar mentioned in Section 35 of the Stamp Act, 1899 applicable to instruments, which are chargeable to stamp duty, be non-existent, unenforceable or invalid if the instrument is unstamped or insufficiently stamped?’

However, this question was later reformulated by the Constitution Bench into – ‘whether the statutory bar mentioned in Section 35 of the Stamp Act, which is applicable to instruments chargeable to stamp duty, would deem the arbitration agreement mentioned in such an instrument non-existent if there was any payment pending for stamp duty on the said instrument.’

Relevant Statutory Provisions

Indian Stamp Act, 1899

All provisions related to stamping of various documents are stated under the Indian Stamp Act, 1899 (‘Act’).

As per Section 2(11) of the Act, ‘duly stamped’ refers to a document that has an adhesive or impressed stamp of not less than the proper amount and that such stamp has been affixed or used in accordance with the law in India.

Section 17 of the Act states that all instruments, which are chargeable with duty, must be stamped before or at the time of execution.

In addition, Section 18 allows for instruments that are executed outside India to be stamped within 3 months after it is first received in the country.

According to Section 35, if any instrument that is chargeable with duty is to be produced as evidence, it shall not be admitted to evidence unless it has been duly stamped.

Furthermore, Section 33 grants any individual who is legally authorized to receive the evidence, the right to impound any instrument that has not been duly stamped.

Arbitration and Conciliation Act, 1996

As per Section 5 of the Arbitration and Conciliation Act, a Court may only have a limited interference, unless it has been stated otherwise by the Act.

Section 16A states that when considering an application to appoint an arbitrator, the Court must confine to the ‘examination of the existence’ of the arbitration agreement.

Analyzing Constitution Bench’s Judgement

The Constitution Bench, with a 3:2 majority, held that by virtue of Section 33 and 35 of the Indian Stamp Act, instruments that are chargeable with stamp duty and which have not been duly stamped as such shall result in invalidating the arbitration clause in the agreement. It shall remain non-existent until it has been duly stamped.

• In the matter of SMS Tea Estates, a 2-judge bench of the Supreme Court stated that if a document has not been duly stamped, it cannot be acted upon, and the arbitration clause in such an instrument shall be invalid and cannot be acted upon.
• This decision was followed by the Supreme Court in the case of Garware Wall Ropes, where a 2-judge bench held that unless the sub-contract was duly stamped, the arbitration clauses mentioned in it shall be invalid.
• This decision was referred to and specifically approved by a 3-judge bench in the matter of Vidya Drolia.
• However, the 3-judge bench hearing the matter of N.N. Global Mercantile doubted all of the above-mentioned judgements.

Most of these judgements were passed while taking the aspects of the Contract Act and its relationship with the Arbitration Act and Stamp Act. In addition, it noted that while the Stamp Act may be a financial measure, it cannot be a procedural law.

The Constitution Bench further stated that agreements which are invalid as per any substantive law (in this case, the Stamp Act), shall not be considered as a contract. It noted that only when an agreement is enforceable will it be deemed to be a ‘contract’. It is only a ‘contract’ which would be the ‘Arbitration Agreement’ as contemplated under Section 11(6A) of the Arbitration Act.

In addition, the Constitution Bench held that the provisions of Section 11(6A) that demand Courts to limit themselves to the existence of the arbitration agreement would not mean ‘only existence in terms of fact’. Documents must be existent in law as well. Therefore, if any document that requires it to be stamped is not stamped, it shall not exist in law.

When questioned whether the Court, during a Section 11 application, had to review if an agreement had been duly stamped or the same could be assigned to the arbitrator, the Constitution Bench held that this was up to the Court to decide. However, the Constitution Bench also laid down the following guidelines:

• Where no stamp duty seems to be paid, the Court must impound the document and carry out its responsibilities under Section 33 and 35 of the Stamp Act.
• In instances where the stamp duty is paid but the Respondent claims that it has not been duly paid, i.e., it is insufficiently stamped, it is usually the Court’s responsibility to judge whether the stamp duty has been paid or not. However, if the Respondent’s claim of it being insufficiently stamped seems to be based on no concrete foundation to the Court, it may refer the parties to arbitration and allow the arbitrator to use his powers under Section 33 of the Stamp Act, if it is so needed.

The Constitution Bench held that the SMS Tea Estates and Garware Wall Ropes represent the right position of law as they related to the effect of an unstamped contract containing an arbitration agreement.

It also added that during a Section 11 application, if the Court comes across an insufficiently stamped instrument with an arbitration clause, it shall impound the document and consider the application as per law once the proper stamp duty has been paid.

Note: The Constitution Bench clarified that this ruling did not take Section 9 of the Arbitration Act into consideration.

Conclusion

The Constitution Bench’s judgement to deem arbitration clauses in unstamped contracts to be ‘invalid’ finally answered a long-standing vexed question. With more clarity about the legal provisions related to insufficiently stamped contracts, individuals shall be expected to pay more attention while submitting any instrument that requires it to be duly stamped.