Arbitration Agreements and Third Party Non-Signatory

Vedang Mishra, Research Associate

Normally, arbitration takes place between the persons who have, from the outset, been parties to both the arbitration agreement as well as the substantive contract underlining that agreement. But, it does occasionally happen that the claim is made against or by someone who is not originally named as a party. No procedure or statutory power has been provided for an arbitral tribunal to enjoin a third party to pending arbitration proceedings. But certainly, they are no absolute obstructions to arbitration agreement. Arbitration, thus, could be possible between a signatory to an arbitration agreement and a third party.

As an arbitration agreement is governed by the ordinary principles of contract law, non-signatories may be compelled to arbitrate in a number of circumstances. A range of legal theories has been developed to facilitate this determination either for or against including such non-signatories.

Applicability of section 8 of the act against Third Parties

The expression ‘an action is brought’ under section 8 (1) of the 1996 act raises the threshold questions ((The Arbitration and Conciliation Act, 1996 section 8: A judicial authority before which an action is brought in a matter which is the subject of an arbitration agreement shall, refer the parties to arbitration)). Can such an action is brought only by party to the arbitration agreement or it can be brought by a non-party as well, in which party can invoke arbitration agreement and apply to the judicial authority to refer the parties to the arbitration? If such an action is brought by non-party to the arbitration agreement, can another party to the action apply to the court for referring the party to the arbitration agreement? The statute is silent on this.

Russell’s commentary sheds some light on these questions: An arbitration agreement is a contractual undertaking by which the parties agree to settle certain disputes by way of arbitration rather than by proceedings in the court. When a dispute arises however, one of the parties may nevertheless commence proceedings…In is for one of the parties to the arbitration agreement to take objection to the matter proceedings in court by applying for stay ((Russell on Arbitration, 22nd Ed, 2003)).

It can reasonably be presumed that as the arbitration agreement is a contractual undertaking to settle the dispute by arbitration, it is only a party to the arbitration agreement that can bring action u/s 8 (1) in a matter which is subject of an arbitration agreement before a judicial authority. In other words, it is implicit in expression ‘an action is brought’ that the person who brings such action must be a party to the agreement.

In Sumitomo Corporation v. CDS Financial Services ((AIR 2008 SC 1594)), the Supreme Court held that the parties in the judicial proceedings who are to be referred to arbitration in the disputes should be parties to the arbitration agreement as per Section 2(1) (h) of the 1996 Act. Section 2(1) (h) of the act provides for the definition of “party” as “a party to an arbitration agreement.” Thus, only a party to the arbitration agreement can apply to the court for interim measures. However, the provision nowhere talks about against whom the relief can be claimed.

Interim Orders against Third Parties

Section 9 of the Act confers upon the parties the right to apply to the Court for interim measures dealing with aspects such as guardianship, preservation of goods etc. It is clear that only a party to the arbitration agreement can apply to the court for interim measures. But the provision does not say against whom the relief can be claimed. There is nothing in this section, which restricts a court to pass orders under that section against third parties. The power of the court to grant interim measures under this section does not flow from the arbitration agreement. It emanates from the Act. It cannot be controlled by agreement between the parties.

In Value Advisory Services v. ZTE Corporation and Ors ((2009(3)ArbLR315(Delhi).))., the question before Delhi High Court was whether u/s 9 of the act an interim award could be passed and enforced against an entity not party to the original contract or to the arbitral proceedings. The Court reached on the conclusion that no general principle of maintainability/applicability or non-maintainability/non-applicability can be laid down. It will have to be determined by the court in the facts of each case. It further reasoned that for instance u/s 9 (1) of the act, a guardian may be such a party, or the goods may be required to be kept in custody, or sold to third parties. Therefore, the scope cannot / ought not to be restricted to securing possible with orders against parties to arbitration only.

There were many occasions in which civil courts have, in the past, made interim orders in respect of third parties. State Bank of India v. The Economic Trading Co. SAA & Ors ((AIR 1975 Cal 145))can be taken as a classic example where the court granted an interim injunction restraining non-signatory banks, which were either the guarantor or the beneficiary of a guarantee, from taking action with respect thereto. Therefore, it would be erroneous to deny the exercise of such power of Court against third parties.

Legal Theories on Third Party Arbitration Agreement (National & International Approach)

There are several doctrines for binding a third party to an arbitration agreement in international arbitral practice. However, all the doctrines are not accepted in all jurisdictions. The standard for binding non-signatories is much higher in common law countries than the civil law ones. This may be because in common law countries more emphasis is given to privity of contract while civil law jurisdictions stress on the principles of good faith and equity. Such important doctrines with the effect of binding a third party to an arbitration agreement include:

  1. Group of Companies:

This doctrine provides that several companies that form part of a larger corporate group may be regarded as a single legal entity or ‘une réalité économique unique’ and may be bound by arbitration agreement entered into by another group entity ((Mohit Saraf and Luthra & Luthra, Party to an Arbitration Agreement- Case of Non Signatory, Institutional Arbitration in India (2007).)).  But, there must be a clear intention of the parties to bind both, the signatory as well as the non-signatory parties. The Courts under the English Law have, in certain cases, also applied the “Group of Companies Doctrine”.

This doctrine has evolved in the famous Dow Chemical case ((Dow Chemical v. Isover Saint Gaimen, ICC No. 4131/1982)). It was held that Dow Chemical Company (USA) should become a party to an agreement applying to its subsidiary Dow Chemical (France) as it has and exercises absolute control over its subsidiaries having either signed the relevant contracts or, like Dow Chemical (France). In Chloro Controls(I) Pvt. Ltd. v. Severn Trent Water Purification ((2013(1)ABR563))also S.C. held that a non-signatory party could be subjected to arbitration provided these transactions were with group of companies and there was a clear intention of the parties to bind both, the signatory as well as the non-signatory parties.

  1. 2.      Lifting Corporate veil or Alter Ego

Under the alter ego doctrine, a corporation may be bound by an agreement entered into by its subsidiary, regardless of the agreement’s structure or the subsidiary’s attempts to bind itself alone to its terms, where their conduct demonstrates a virtual abandonment of separateness.

After looking the decisions in Gartner v. Synder ((607, F2d 582, 586 (2d Cir.1990).))and Kirno Hill Corp v. Holt ((618 F2d 980,985 (2d Cir.1980).))fundamental requirement contingent in invoking alter ego can be summarized as:

  • The parent company exercises full control over an entity with respect to every transaction.
  • Such control was used to commit a fraud that injured a party seeking to lift corporate veil.

The corporate veil has been lifted on several occasions by the Indian judiciary also, however, those have been in context of taxation, contract or company law. Therefore an argument can made that if rights or liabilities under a contract can be extended to non-signatories, the same may be extended to arbitration clauses as well. Moreover, India is also a common law country.

  1. 3.      Agency:

A principal will generally be bound by an arbitration clause in a contract signed by its agent. As a result, arguments will be raised only when there is no explicit contract between the principal and its agent, and the principal does not wish to be part of the arbitration. ICC tribunal generally while deciding the liability of principal in an arbitration agreement concluded by its agent  distinguish between the law governing the arbitration agreement and the laws which governed the agent’s capacity to conclude an arbitration agreement on behalf of the principal and the form in which such capacity should have been conferred on the agent. Article 15 of the Convention on Agency in the International Sales of Goods also stipulates that, where the conduct of principal causes a third party to believe that the agency has the authority to act on behalf of the principal, even in the absent of such authority principal will be liable.

  1. 4.      Third Party Beneficiary:

Courts have consistently recognized that non signatory third-party beneficiaries under an agreement containing an arbitration provision may compel arbitration against signatories of the arbitration agreements. General rule is that the Court must look to the intentions of the parties to confer the direct benefit to third party, at the time the contract was executed. In Mississippi Fleet Card v. Bilstat, Inc ((175 F. Supp. 2d 894, 899 (S.D. Miss. 2001).))Federal United States Court compelled the non-signatories to arbitrate as they were third-party beneficiaries of a contract containing an arbitration clause.

  1. 5.      Composite Transaction

A transaction is composite where the performance of the “mother agreement” is not feasible “without aid, execution and performance of the supplementary or ancillary agreements” and all the agreements are aimed towards achieving a “common object” and have a collective bearing on the dispute. In Chloro Controls(I) Pvt. Ltd. v. Severn Trent Water Purification ((Supra 8))the S.C. held that A non-signatory or third party could be subjected to arbitration without their prior consent, but this would only be in exceptional cases. The Court will examine these exceptions from the touchstone of direct relationship to the party signatory to the arbitration agreement, direct commonality of the subject matter and the agreement between the parties being a composite transaction. The Court would have to examine whether a composite reference of such parties would serve the ends of justice. It further held that the principle of ‘composite performance’ would have to be gathered from the conjoint reading of the principal and supplementary agreements on the one hand and the explicit intention of the parties and the attendant circumstances on the other.

It has been noticed that notice that this doctrine does not have universal acceptance. Some jurisdictions, for example, Switzerland, have refused to recognize the doctrine, while others have been equivocal. However, the doctrine has found favourable consideration in the United States and French jurisdictions.

  1. 6.      Estoppel:

The doctrine of estoppels has been extended in use to cover situations where third party beneficiaries of a contract containing an arbitration clause evading liability on the mere basis of being a non-signatory. It prevents a party who knowingly accepts the benefits of a contract containing an arbitration agreement from avoiding the obligation to arbitrate. This theory has so far been recognized only in the United States and Canada. In American Bureau of Shipping v. Tencara ((170 F.3d 349 (2 nd. Cir. 1999).)), following this theory, the Court held that the owners were compelled to arbitrate as non-signatories. Since they had received the benefit of the contract of construction of yatch i.e. lower insurance rates, they were estopped from claiming that the arbitration provision did not apply to them.

Another application of the doctrine is where a party to an arbitration agreement has been held to be estopped from refusing to arbitrate with a non-signatory where issues between the parties are “intertwined” with the agreement containing an arbitration provision. In MS Dealer Serv. v. Franklin Court laid down two grounds to determine that when non- signatories will be allowed to compel arbitration.

First ground applies when there is a written agreement containing an arbitration clause, signatory party must rely on the term of the written agreement in asserting its claim against the non-signatory. Second, ground is warranted when the signatory to the contract containing an arbitration clause raises allegations of substantially interdependent and concerted misconduct by both the signatory and one or more of the signatories to the contract.

Therefore, the expansion of arbitration agreements to non signatory party is rather a recent development, undoubtedly related to the growth of arbitration in general. The parties must be aware of all these doctrines and principles, and act accordingly in order to avoid inadvertently becoming subject to an arbitration agreement.