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Ergo Update

02-May-2020

Introduction

The Supreme Court of India, in its judgment dated 22 April 2020 in National Agricultural Cooperative Marketing Federation of India v Alimenta S.A., has refused enforcement of a foreign award on the ground of it being contrary to the fundamental public policy of India.

While the judgment was passed very recently, the dispute therein pertains to an era prior to the amendment of the Arbitration and Conciliation Act, 1996. In its judgment on a dispute that arose almost 40 years ago, the Supreme Court has inter alia analysed the concept of ‘public policy’, and the difference between contingent contracts and frustration as a principle for voidability of contracts, under Section 32 and Section 56 of the Indian Contract Act, 1872 (Contract Act), respectively. The main issue in the matter was interpreting the scope and consequence of a government directive by reason of which a party is rendered incapable of performing its contractual obligations.

Brief Facts

National Agricultural Cooperative Marketing Federation of India (NAFED) had entered into a contract on 12 January 1980 with Alimenta S A. to supply Indian HPS groundnut (Commodity) to Alimenta. The contract was for the year 1979-1980.

The terms and conditions of the Contract were to be the standard terms of Federation of Oils, Seeds and Fats Association, London (FOSFA) 20, contract (clause 11). A notable provision under the contract was clause 14, whereby in case of prohibition of export by any executive or legislative act of the Government, the agreement or any unfulfilled part thereof would be cancelled.

In terms of the contract, NAFED was required to ship 5000 MT of the Commodity between 1979-1980. However, only 1900 MT could be shipped by NAFED within the stipulated period. The remaining quantity of 3100 MT could not be shipped due to damage to crops by weather conditions. It was therefore agreed vide an addendum to the contract that the remaining quantity would be shipped during the 1980-1981 period. 

It is pertinent to note that NAFED was a canalizing agency for the Government of India (Government) for export of the Commodity and as such, to carry forward any export from the previous year to the next year, NAFED was required to obtain the express permission of the Government. While NAFED had the permission to enter into exports between 1977-1980, it did not have the permission to carry forward the exports for the season 1979-1980 to the year 1980-1981. In view of this, NAFED approached the Government to obtain the necessary permission. However, the Government did not grant the permission and directed NAFED not to ship any leftover quantities from previous years. As such, NAFED could not implement the previous year’s contract with Alimenta and informed Alimenta that the export of the contracted quantity was not possible because of the Government’s executive action banning such exports. Alimenta treated this as a default by NAFED and commenced arbitration proceedings before FOSFA, on 13 February 1981. Thereafter, many rounds of litigation took place between 1981 to 1987 before the Delhi High Court and Supreme Court whereby NAFED sought to restrain Alimenta from continuing the arbitration proceedings. During this time, NAFED also received a clarification from the Government that the directions refusing fulfilment of previous year’s contract were lawful and binding on NAFED. Finally, the Supreme Court vide its judgment dated 9 January 1987 relegated the parties to the pending arbitration before FOSFA.

FOSFA passed its award on 15 November 1989 (Impugned Award) by which NAFED was directed to pay certain sums along with interest thereto to Alimenta. Aggrieved, NAFED filed an appeal before the Board of Appeal challenging the Impugned Award. The Board of Appeal passed its award on 14 September 1990 thereby compounding NAFED's issues by increasing the award amount and the interest. Armed with the Impugned Award, Alimenta filed a petition under Sections 5 and 6 of the Foreign Awards (Recognition and Enforcement) Act, 1961 (Foreign Awards Act) seeking enforcement of the Impugned Award as well as the award passed by the Board of Appeal. The dispute finally reached the Supreme Court pursuant to an appeal which was filed by NAFED and the Supreme Court was required to adjudicate the matter on merits. The Supreme Court has disposed of the matter by the judgment under discussion.

Issue

The issue in the present appeal was whether the foreign award is enforceable in India. The Supreme Court, while deciding the issue of enforceability of the foreign award, has answered the following questions: (i) whether NAFED was unable to comply with the contractual obligation to export groundnut due to the Government's refusal?; (ii) whether NAFED could have been held liable in breach of contract to pay damages particularly in view of clause 14 of the agreement?; and (iii) whether enforcement of the Impugned Award was against the public policy of India?

Arguments

On behalf of NAFED, it was argued that the Impugned Award was against the public policy of India and thus unenforceable under Section 7(1)(b)(ii) of the Foreign Awards Act. The Impugned Award did not deal with the restriction imposed by the Government on export of the Commodity. The enforcement of the award was barred by Section 7(1)(a)(ii) of the Foreign Awards Act. The award flouts the basic norms of justice and enforcement thereof would result in the unjust enrichment of Alimenta. It was also urged that the enforcement proceedings were barred by limitation as they were not initiated within 30 days in terms of Article 119, Schedule I of the Limitation Act, 1963. Another point was that NAFED was not given a due opportunity to present its case by the FOSFA, though the arbitrator nominee of Alimenta represented the case on behalf of Alimenta before the Board of Appeal.  Enhancement of interest in the absence of appeal by Alimenta was also illegal.

On behalf of Alimenta, it was urged that the scope of interference in the enforcement of the Impugned Award was limited and countered all the points raised on behalf of NAFED. It was submitted that the Tribunal had found that the award was not against public policy as the ban on exports was not imposed by the Government but was a self-imposed restriction by NAFED. It was argued that in view of these clear findings recorded by the Tribunal, it was not open to the Court in the proceedings under the Foreign Awards Act to go into their correctness. 

Judgment

On the question of whether NAFED was unable to carry out its contractual obligations due to the Government’s refusal to export and as such the contractual obligation became void and unenforceable and whether consequently NAFED was liable to pay damages, the Court laid emphasis on the interpretation and application of clause 14 of the contract, Section 32 of the Contract Act and Section 7 of the Foreign Awards Act for arriving at a decision.

Clause 14 of the contract provided for cancellation of the agreement if the shipment became impossible for reasons mentioned therein, including prohibition of export by an executive or legislative act of the government of country of origin (being India). The Court held that the refusal of the Government incapacitated NAFED from effecting the supply / export of the commodity to Alimenta, which possibility was clearly envisaged under clause 14 of the contract. The Court observed that NAFED intended to perform its contractual obligations but being the canalizing agent of the Government, it could not have carried out the export owing to Government restriction.

On the point that under common law, frustration does not rescind the contract ab initio and only brings the contract to an end forthwith, thereby leaving undisturbed any legal rights that have already accrued, reliance was placed, inter alia, on the decision in Davis Contract Limited v Fareham Urbam District Council (1956) 2 All ER 145 wherein the test applied for frustration of the contract was whether there was a radical change in the obligation. Applying this test to the facts of the case, it was held that the unfulfilled part of the contract was required to be cancelled. NAFED was justified in not supplying the remaining quantity as the same would be violative of the Export Control Order and the Government’s decision of refusing to grant permission to carry forward the quantity of the previous years to the next year.

It was further held that the contract became void in view of Section 32 of the Contract Act. The court drew a distinction on the applicability of Section 32 and Section 56 of the Contract Act. In this regard, among others, reference was made to the decision in Satyabrata Ghose v Mugneeram Bangur & Co. AIR 1954 SC 44. The court opined that Section 32 of the Contract Act applies if the agreement provides for contingencies upon happening of which contract cannot be carried out. On the other hand, Section 56 deals with an agreement to do an impossible act or to do acts that afterward become impossible or unlawful. In the present case, provisions of Section 32 would be applicable because of the clear stipulation of contingency under clause 14 of the contract. Section 32 provides for a contract being void if it envisages performance of an impossible act, which in the instant matter occurred on the contingency (as was anticipated in the contract) of the Government’s refusal to grant the necessary permission.

Applying the law to the facts of the case, the Court held that the foreign award presupposes that supply could have been made despite the Government's refusal. However, the fact remains that if supply had been made, it would have been unlawful and in violation of the Government’s directive. The addendums to the contract for supply of the remaining quantities were entered into only subsequently, and the parties fully understood that if the Government did not allow carrying forward of export, NAFED would not be able to perform its part of the bargain. In any event, the supply could not have been made without the permission of the Government. Thus, the parties agreed for cancellation of the contract and as such, the foreign award was against the basic law and public policy as applied in India.

Further, Section 7 of the Foreign Awards Act was analysed to determine enforceability of the award vis-à-vis prohibition by the Government to supply / export. Section 7 inter alia provides that an award may not be enforced if it is contrary to public policy. The Court discussed the applicability of public policy while referring to and relying upon the precedents available on the issue, including the test laid down in Renusagar Power Co. Ltd. v General Electric Co. 1994 Supp. (1) SCC 644 (Renusagar case). It was held that the matter involved the fundamental policy of India and the parties were aware of it, and agreed that in case of such an exigency (provided in clause 14), the agreement shall be cancelled in respect of the supply which could not be done. Thus, the Impugned Award could not hold NAFED liable to pay damages for such a contract that became void.

The court did not deem necessary to discuss the other contentions in detail. However, summarily, it was held as under:

  • On the appointment of arbitrator by FOSFA on behalf of NAFED: It would have been proper for FOFSA to comply with the interim orders of the Delhi High Court, however, the proceedings were dismissed way back in 1987 and were not agitated then. NAFED cannot be allowed to raise this question at such a belated stage.

  • On the legal representation before the arbitral tribunal and the Board of Appeal: Rule 3 of FOSFA Rules bars the parties from having legal representation before the arbitral tribunal, and hence, NAFED’s submission as to non-representation before the arbitral tribunal was not accepted.

  • On Alimenta’s nominee arbitrator appearing before the Board of Appeal: Ordinarily, such participation was bad in law and against the concept of justice and rules of procedure as provided in The State of Punjab & Anr. v Shamlal Murari & Anr. (1976) 1 SCC 719. As per the Indian law and ethical standards, the arbitrator could not have appeared before the Board of Appeal to defend the award, however, there was no concrete material on record to substantiate the objection in relation to the prevailing practice in the United Kingdom at the relevant time. Accordingly, the Court was not inclined to decide this issue.

  • On enhancement by the Board of Appeal of interest payable: It was held that the Board of Appeal could not have increased the interest in the absence of appeal by Alimenta.

Comments

It may be argued that while deciding on the enforceability of the foreign award, the Court has gone into the merits of the matter and has been largely influenced by the Government’s refusal to carry forward the export of the commodity. For instance, the arbitral tribunal had held that the ban on exports was a self-imposed restriction by NAFED and there was no such ban on exports by the Government. However, the present judgment has clearly held that the prohibition was on account of the Government’s refusal. Further, the Court has also gone into the merits of the Government’s decision and held that the Government rightly objected to the supply and the permission was rightly declined by the Government.

The present judgment appears to have relied on the tests laid down in the Renusagar case which is good law insofar as enforcement of award vis-à-vis public policy is concerned. However, it is a settled position that the defence of public policy which is permissible under Section 7(1)(b)(ii) of the Foreign Awards Act should be construed narrowly. It appears that in the instant case, a wider threshold has been used and the scope of ‘public policy’ as a ground for refusing enforcement of the foreign award has been expanded. The Court has examined the factual aspects of the dispute to arrive at the finding of the government approval and this opens a Pandora’s box in the matter of determining if a particular aspect of an award is contrary to the public policy of India.

Whether executive acts of the government can be construed as a change in law, or a breach of such direction would suffice to be a justification to invoke the ground of violation of public policy becomes a key issue, especially when one sees it in light of public sector undertakings. Would such decision then give rise to a cause of action for bilateral treaty arbitrations also needs to be analysed at a greater length and considered by Courts.

Increasingly, as a matter of strategy, parties have sought to bring in public policy arguments with a view to creating a base for challenging the enforcement of an award in India. While the idea is to examine the ground of public policy whenever a case does warrant it, Courts should consider confining themselves within the strict scope of examining the said ground. An undefined and wide interpretation of the term would paint the enforcement mechanism of arbitral awards in bad light. It remains to be seen if this judgment creates a ripple across all such other disputes, where one party is placing reliance on a government directive as a defence for non-performance, and the effect thereof.

Separately, the Court has clearly explained the distinction between Sections 32 and 56 of the Contract Act. Often, parties press for frustration of contract based on Section 56 of the Contract Act, which may not be applicable or relevant to the facts of that case which may, in fact, be covered by Section 32 of the Contract Act. Parties should be mindful before coming to courts that if their agreement provides for a contingency on the happening of which the agreement would become void, the provisions under Section 32 would be attracted as a result of which it is likely that no party would be held liable for damages on account of the agreement becoming void. In the present COVID 19 scenario, where force majeure claims have become the norm, the present judgment along with the judgment passed in Energy Watchdog & Ors. v Central Electricity Regulatory Commission & Ors. (2017) 14 SCC 80 provides the much-needed assertion on the tests for force majeure.

  • Ajay Bhargava (Partner), Manavendra Mishra (Principal Associate), Saasha Malpani (Associate) and Shivank Diddi (Associate)

For any queries please contact: editors@khaitanco.com

Ajay Bhargava (partners) , Manavendra Mishra ()

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