Arbitrability of Shareholders' Agreements: Myriad Tales of Conflicting Jurisprudence

Introduction

Over the last two decades, arbitration being a time efficient and cost-friendly adjudication process, has become the most sought-after mode of dispute resolution. The arbitration framework in India took a steep curve by the introduction of the Arbitration and Conciliation Act, 1996¹ (the Arbitration Act) and the subsequent Amendment Act of 2015.² However, the Act still lacks clarity on the foundational concept of “arbitrability”. Courts in India have often struggled to differentiate between arbitrable and non-arbitrable disputes. While the Arbitration Act does not specifically make any distinction between arbitrable and non-arbitrable disputes, courts often tend to exclusively reserve certain disputes to be tried by themselves. The very genesis of arbitration emanates from the contractual relationship between parties, where they out of their own free volition may either resort to litigation before courts or submit their disputes to arbitration.

Post the Amendment Act of 2015, Section 8³ of the Arbitration Act casts an obligation on courts to mandatorily refer all disputes to arbitration, if in case there exists an arbitration clause in the underlying contract between parties. Section 8 of the Arbitration Act only contemplates referral of such disputes, which are arbitrable and can be decided by a competent arbitrator. The constant tussle of determining arbitrability of disputes seems to have led plethora of conflicting judgments with divergent opinions. In this article, we will tread into the discussions to find out if disputes arising out of a shareholders' agreement (SHA) are arbitrable and fall within the purview of the Arbitration Act.

What disputes are “arbitrable”

One of the key concerns of arbitrability has been the subject-matter of the dispute i.e. whether a particular dispute is capable of being referred to arbitration. In the absence of the Arbitration Act not specifically distinguishing between arbitrable and non-arbitrable disputes, courts, therefore, play a pivotal role in determining whether the subject-matter of dispute is capable of being referred to arbitration.

The issue was first addressed by the Supreme Court in Booz Allen & Hamilton v. SBI Home Finance Ltd.⁴ (Booz Allen), where the Court laid down the “test of arbitrability” and held that disputes concerning:

(i) rights in personam i.e. against a person or an individual, are capable of being adjudicated by arbitration; and

(ii) rights in rem i.e. against the world at large, are to be adjudicated by courts and public tribunals only.

However, the Court failed to provide a straitjacket formula to differentiate between arbitrable and non-arbitrable disputes. The Court further held that this test was not fool proof and subordinate rights in personam which may arise from rights in rem may be subject to arbitration.⁵

While this case undertook a “rights” based approach and compartmentalised disputes on the basis of right in rem and right in personam, it cautioned against the strict application of the test, thereby, sowing seeds in favour of arbitration. Since then, the Supreme Court in its various judgments has undertaken a pro-arbitration approach by widening the scope of rights in rem so that disputes arising therefrom can be referred to arbitration. However, the same has invited more ambiguity rather than answering the test of determining the arbitrability of disputes.

For instance, the Supreme Court in A. Ayyasamy v. A Paramasivam⁶ (Ayyasamy) held that unless the fraud in question is of a serious nature, mere allegation of fraud simpliciter cannot be a ground to hold the dispute as non-arbitrable. However, the Court failed to lay down specific parameters as to what would constitute a serious allegation of fraud. The situation similarly applies to arbitrability of intellectual property disputes.

The Bombay High Court in Eros International Media Ltd. v. Telemax Links India (P) Ltd. ⁷, held that while overlying copyright constitutes a right in rem, a specific contractual dispute over its infringement is arbitrable as it is a right in personam. However, pursuant to the Bombay High Court's decision in Indian Performing Right Society Ltd. v. Entertainment Network (India) Ltd.⁸, and stray observations made in Ayyasamy⁹, intellectual property disputes are considered to be non-arbitrable.

Nature of shareholders' disputes

Companies may mandatorily provide reference of disputes to arbitration prescribed in the dispute resolution clause of their articles of association (AOA). AOA, being the “constitution” of the company compulsorily binds all its members, directors, shareholders, and other stakeholders including the company itself.

Shareholders' disputes may, inter alia, arise from agreements executed between shareholders themselves or which the shareholders may individually or collectively have with the company. SHAs primarily govern the rights and obligations of the shareholders and affairs of the company. In situation of any dispute or breach of terms of the SHA, parties are bound by the terms mentioned therein.

The following may, inter alia, be considered as shareholders' disputes:

(i) general disputes between shareholders and the company affecting affairs of the company and the public at large;

(ii) disputes arising from privately executed SHAs amongst group of shareholders; and

(iii) disputes affecting third parties/shareholders who may not be parties to the SHA.

Like most modern day commercial contracts, SHAs executed amongst group of shareholders prescribe arbitration as a dispute resolution mechanism. Unlike an AOA which is a public document, an SHA is a privately executed contract. There are cases which advocate that the SHA should mandatorily be incorporated in the AOA, in order it to be binding on the company.¹⁰ However, there have been divergent opinion¹¹ where the Court has held that if a certain provision of the SHA is not incorporated in the AOA and at the same time, does not conflict with the AOA or the provisions of the Companies Act, 2013¹² (the Companies Act), it can be enforced as long as it only affects the rights in personam.

Section 6¹³ of the Companies Act stipulates that it shall have an overriding effect. An AOA of a company or any agreement executed by it may be rendered void if it contravenes any provision of the Companies Act.¹⁴ An arbitration clause in SHA may serve a dual purpose. If there arises a dispute between one or more shareholders which does not affect the affairs/management of the company at large, such a dispute can be referred to arbitration instead of invoking statutory remedies prescribed under the Companies Act.

Shareholders' disputes can be referred to arbitration only when private rights of some or group of the shareholders are affected without affecting the rights other shareholders/ stakeholders of the company at large. Hence, if there is any reliance on any of the terms of the contract, which has the potential to be resolved without affecting the statutory rights of the parties, such a dispute would be arbitrable.

As per the test of arbitrability as propounded in Booz Allen¹⁵, a breach arising out of a shareholders‘ agreement is arbitrable subject to:

(i) the dispute should be the subject-matter of the arbitration agreement; and

(ii) the nature of legal rights affected: whether the breach affects the right in rem or right in personam.

The conundrum surrounding oppression and mismanagement

The National Company Law Tribunal (NCLT) has been vested with powers to adjudicate all disputes arising under the Companies Act. In addition, Section 8 of the Arbitration Act further obliges courts to refer parties to arbitration where there exists an arbitration clause in the underlying contract. Therefore, apparently there seems to be a conflict of jurisdiction arising out of:

(i) a privately executed contract (SHA) where the dispute resolution clause provides arbitration as the mode of dispute settlement; and

(ii) a dispute arising out a statute (Companies Act) like cases for oppression and mismanagement where ordinarily NCLT has jurisdiction.

Prior to the test of arbitrability put forth in Booz Allen¹⁶, O&M disputes were strictly held to be outside the purview of arbitration. In Haryana Telecom Ltd. v. Sterlite Industries (India) Ltd.¹⁷, the Court while adjudicating upon the winding up of a company held that winding up is an act which makes the company insolvent and affects the company and its members at large. Therefore, arbitration as a dispute resolution mechanism cannot replace or override statutory powers of court irrespective of an existing agreement between the parties.

The uncertainty surrounding the determination of arbitrability of disputes relating to O&M is characterised not by the absence of a definite test of arbitrability in India but by the ambiguity of the scope of a singular test. The test laid down in Booz Allen¹⁸, that unlike disputes involving rights in rem, only disputes involving rights in personam are arbitrable is arguably the only proper test other than the public policy test. However, unlike the test of arbitrability based on public policy, the scope of interference as explained in Booz Allen¹⁹ is largely uncertain in as much as disputes relating to subordinate rights arising from rights in rem have always been considered to be arbitrable.

Given that the remedy against O&M is statutorily based and that the NCLT has wide powers to issue orders binding on third parties dealing with the company in question [for example, terminating, modifying, or setting aside any agreement(s), unwinding any sale/ transfers which constitute a fraudulent preference and directing a shareholder to buy out other shareholder(s)], an Arbitral Tribunal being a private fora is not competent to award such remedies.

If the issues arising out of a dispute cannot be strictly bifurcated between in rem or in personam i.e. if the dispute does not arise entirely out of an SHA, but affects statutory rights of other members of the company, then the remedy available under Sections 241²⁰ and 242²¹ has to be mandatorily exercised. Thus, the determination of arbitrability is based on the nature and source of the right/power that is sought to be invoked as held in Rakesh Malhotra v. Rajinder Kumar Malhotra²² (Rakesh Malhotra). Unlike the reliance on the “rights” based approach as enunciated in Booz Allen²³, the Supreme Court in Rakesh Malhotra²⁴ sought to determine the arbitrability of dispute on the basis of “reliefs” sought. However, the Court carved out an exception for unscrupulous litigants in order to prevent them from vexatiously and frivolously dressing up contractual disputes as O&M disputes only with the sole purpose of avoiding arbitration.

Conflicting judgments: NCLT versus Arbitration

Prior to the introduction/enactment of the Arbitration Act, the general view of Courts was to give preference to statutory rights and remedies prescribed under the Companies Act. In Surendra Kumar Dhawan v. R. Vir²⁵, the Delhi High Court held that the disputes pertaining to the statutory jurisdiction of the NCLT cannot be ousted by way of a contract containing an arbitration clause, by placing reliance on Section 9²⁶ of the Companies Act, 1956 (Section 6 of the Companies Act, 2013).

In O.P. Gupta v. Shiv General Finance (P) Ltd. ²⁷, the Delhi High Court reiterated the same position as in Surendra Kumar²⁸ and held that the Companies Act had the exclusive jurisdiction to safeguard and protect the interest of the shareholders and any attempt to refer disputes to arbitration would be nothing but an empty formality.

The Gujarat High Court in Sadbhav Infrastructure v. Company Law Board²⁹ has also been of the view that O&M disputes are amenable to arbitration even if the claim can be brought under Section 241 or 242 of the Companies Act. The underlying point to determine is if the breach has arisen out of the contract or from the statute.

However, as explained above, post the introduction/enactment of Arbitration Act, 1996, the Courts have adopted a pro-arbitration approach as the Arbitration Act itself obliged the Court to mandatorily refer the disputes to arbitration. Recently, in Indus Biotech (P) Ltd. v. Kotak India Venture Fund³⁰, the NCLT allowed an application under Section 8 of the Arbitration Act seeking reference of disputes to arbitration while dismissing the company petition filed by the financial creditor. The NCLT went on to hold that arbitration being a special law prevails over the general law (lex specialis derogat legi generali) and courts are mandatorily duty-bound to refer parties to arbitration, where an arbitration clause exists.³¹ Therefore, it appears that even the NCLT is not opposed to the idea of promoting arbitrations of contractual disputes capable of being resolved by way of arbitration.

Way forward

Over the years, different courts and tribunals have passed judgments and discussed at length the issue of arbitrability of shareholders' disputes. While it appears that there is enough jurisprudence on the topic, the law still remains unsettled.

In light of the various conflicting judgments of High Courts/Tribunals, there does not seem to be a conclusive solution between the “pro-arbitration approach” and a “statutory remedy”. A conclusive decision is awaited from the Supreme Court which would hopefully put an end to all such anomalies.