A five-judge Constitution Bench of the Supreme Court of India, in Cox and Kings Ltd. vs SAP Pvt. Ltd. [Cox and Kings], delivered an authoritative ruling on the Group of Companies’ doctrine (GCD). GCD has been cemented in the Indian arbitration jurisprudence as a consensual doctrine to bind a non-signatory to an arbitration agreement.
For a long time, the application of GCD was doubted due to its intrusion into well-settled principles of “party autonomy”, “privity of contract”, and “separate legal personality." The result was a muddled jurisprudence on the GCD, since its adoption by the Indian Supreme Court way back in 2012 in the oft-cited case of Chloro Controls (India) (P) Ltd. v. Severn Trent Water Purification Inc. [Chloro Controls]. This posed significant challenges for the Indian courts in applying the doctrine, especially in the context of corporate conglomerates, leading to varying and inconsistent decisions.
The Constitution Bench has now finally put a quietus by reconciling divergent ‘strands of law’ and providing much-needed clarity on the doctrine’s foundation, scope, and application going forward.
Parties to Arbitration Agreement
The Supreme Court has held that the basis for GCD and joinder of non-signatories to an arbitration agreement in India arises from a harmonious reading of Section 2(h) read with Section 7 of the Arbitration and Conciliation, 1996 (“Act”) and that the definition of “party” can be said to include signatory as well as non-signatory parties. Therefore, it is not necessary for parties to be strictly signatories to be bound by the arbitration agreement.
Moreover, for a non-signatory to be bound to an arbitration agreement, it must be shown that the requirements of both the Indian Contract Act, 1872, and Section 7 of the Act must be met.
In terms of Section 7 of the Act, the arbitration agreement must be (i) in writing, as opposed to an oral agreement, and (ii) arise out of a defined legal relationship, whether contractual or not.
In this regard, the Supreme Court holds that the prime consideration while enjoining a non-signatory to arbitration is to determine whether the non-signatory “intended or consented” to effect legal relationships with the signatory parties and be bound by the arbitration agreement “through dint of their action or conduct."
Therefore, the Court reaffirms the position that the element of consensuality is a sine qua non for roping in a non-signatory to an arbitration, and the question of who is a “party” to an arbitration agreement is essentially a question of consent.
Mutual Intention and Preserving Corporate Distinctness
The Court recognized that the GCD is only one of the consent-based doctrines similar to doctrines of agency, assignment, assumption, etc. to bind a non-signatory to arbitration. While invoking the GCD, the objective is to identify the “common intention of parties” to bind such a non-signatory while preserving the legal personalities of the group companies. Therefore, GCD is a “mutual intent” driven doctrine, which does not undermine well-settled corporate principles of ‘party autonomy’ and ‘separate legal entity’.
In this light, therefore, the Court also affirmed that the principles of alter ego or piercing the corporate veil, which disregards the separate legal personality, cannot be the basis for the application of GCD.
Invoking the GCD - A twin approach
The Supreme Court has clarified that in most situations, the language of the contract is only suggestive of the intention of the signatories to such contract and not the non-signatories.
For the purposes of invoking the GCD, the Supreme Court held that courts or tribunals need to adopt a two-fold approach, that is, to determine: first, the existence of a group of companies; and second, the conduct of the signatory and non-signatory which indicates their “common intention” to join the non-signatory as a “veritable” party” to the arbitration agreement. Therefore, the intention of both the signatory and non-signatory is crucial.
While holding that the presence of a “group of companies” is necessary for invoking GCD, the Supreme Court clarifies that it is not a “sufficient condition’ in itself.
Deciphering Mutual Intention
The Supreme Court holds that various factors (as laid down by the Supreme Court in the case of Discovery Enterprises) must be cumulatively considered for deciphering the “mutual intention” of parties to bind the non-signatory to the arbitration. These factors are:
i. relationship inter-se entities within the corporate group;
ii. performance of the parties in the underlying contractual obligations;
iii. the commonality of the subject matter; and
iv. composite nature of the transactions.
The burden to establish the above factors is on the party seeking the joinder of the non-signatory.
Predominant Participation of Non-Signatory – A veritable party
The Supreme Court held that the participation of a non-signatory in the performance of the underlying contract is the most important factor for ascertaining the “mutual intention” of parties to bind the non-signatory. In other words, what needs to be determined is if a non-signatory undertook the mantle of a “true party” or a “veritable party” to the arbitration agreement based on their involvement in the conclusion, performance, or termination of the underlying contract containing the arbitration agreement.
The Court went on to explain that the threshold for the involvement of the non-signatory in the contract should be “direct”, “positive”, and “substantial." Therefore, what is contemplated is "active” participation by the non-signatory and mere incidental involvement of the non-signatory is not enough bind it.
Guard Rails against misuse of GCD
Interestingly, the Supreme Court also provided much-needed clarity to prevent the rampant misuse of the GCD by restricting its contours. In various instances, owing to the presence of a corporate group, financially stable members of a corporate group, particularly the listed companies, having no connection to the underlying contract, have been roped in, merely because the signatories defaulted on their obligations. It is in regard to such cases that the Court cautioned:
The mere presence of a “commercial relationship” between a signatory and a non-signatory is not sufficient to infer a legal relationship between the parties. The Court has specifically urged against impleading a “related entity” within a group even when “it does not have any rights or obligations under the underlying contract and did not take part in the performance of the contract.”
The presence of common shareholders or directors cannot lead to the conclusion that the subsidiary company will be bound by the acts of the holding company. Therefore, the rights and liabilities of a parent company cannot be transferred to the subsidiary company, and vice versa, unless there is a strong legal basis for doing so.
Further, the statements or representations made by promoters or directors in their personal capacity would not bind a company.
GCD cannot be applied solely based on the principle of “Single Economic Entity." Furthermore, imposing liability on a non-signatory within a group for the acts of other members merely because they belong to a “Single Economic Unit” will ride roughshod over the principles of separate corporate personality, which GCD aims to preserve.
The Supreme Court also conclusively ruled that GCD concerns only parties to an “arbitration agreement” and not the underlying contract. It refers to a situation where a non-signatory could be held to be a party to the arbitration agreement without becoming a formal party to the underlying contract.
Phrases “claiming through or under”
The Court laid down that GCD can be used to bind a non-signatory dehors the expression “claiming through or under” in Sections 8 and 45 of the Act. Accordingly, the Supreme Court held that the law in Chloro Controls (supra), to the extent that it traced the doctrine to the phrase “claiming through or under”, is erroneous.
Competence-competence principle of arbitration upheld
The Court also preserved the competence-competence principle by upholding that under Section 8 or Section 11 of the Act, a referral court is to only prima facie determine the validity of the arbitration agreement, while leaving the determination of whether the non-signatory is bound by the arbitration agreement to the Arbitral Tribunal.
While the Supreme Court has provided much-needed clarity on the scope and contours of GCD, what remains to be seen is whether merely by virtue of being bound to the arbitration agreement, a non-signatory can be held to be substantively liable under the underlying agreement.
As per Gary B. Born, it is entirely possible for non-signatories to become party to an agreement to arbitrate without thereby becoming a party to the underlying commercial contract. Gary B. Born says “It bears emphasis that the parties’ intentions – both actual and presumed – will often be different with regard to their arbitration agreement, and its dispute resolution mechanism, than with regard to their underlying commercial contracts. That is, there will readily be cases where the parties desire a unified, “one-stop” dispute resolution mechanism, particularly one extending to all the members of a corporate group involved in a particular transaction, without altering the allocations of substantive contractual rights contained in the underlying contracts.” [International Commercial Arbitration (3rd edition, Kluwer Law International 2021)p. 1526, 1566–67, 1602]
Further, the Supreme Court has given the task of applying GCD to bind non-signatories to the Arbitral Tribunal, before a non-signatory can apply for interim reliefs under Section 9 of the Act. It has been held that ”… Once a tribunal comes to the determination that a non-signatory is a party to the arbitration agreement, such non-signatory party can apply for interim measures under Section 9 of the Arbitration Act.”
This does not create a level playing field. While a signatory party can approach the court to seek interim relief against a non-signatory party, a non-signatory party would have to first seek a determination from an arbitral tribunal. A harmonious reading of the judgment would possibly convey that even in those rare cases, where a non-signatory seeks recourse to interim reliefs under Section 9 of the Act, the Court would be empowered to make a prima facie determination in this regard.
Overall, it is safe to say that the Constitution Bench has successfully adopted a balanced approach, reconciling the well-settled principles of separation of corporate entity with consensual principles of contract law that are the bedrock for arbitration. The Court by strictly defining the contours of the GCD has also significantly limited the scope of its abuse yet catered to the modern commercial realities. This Judgment is a step in the right direction.
About the author: Rohan Batra is a Partner and Sonali Malik is a Senior Associate at Anagram Partners.
Disclaimer: The contents of this article do not necessarily reflect the views/position of Anagram Partners but remain solely those of the author(s). This article is intended only as a general discussion of issues and is not intended for any solicitation of work. It should not be regarded as legal advice and no legal or business decision should be based on its content.