Arbitrability Of Corporate Disputes In India: A Critical Study
Written by Tejas Sateesha Hinder
Third Year student, B.A. LLB. National Law Institute University, Bhopal
Source: Etheringtons Solicitors
Disclaimer: Please note that the views expressed below represent the opinions of the article's author. The following does not necessarily represent the views of Law & Order.
The Government of India has recently accepted the fact that litigation has flooded specialised tribunals like the National Company Law Tribunal (hereinafter “NCLT”) and the National Company Law Appellate Tribunal (hereinafter “NCLAT”), devised to settle conflicts in the business sector. Recognizing the same, the legislature has taken measures. The decriminalisation of such company law conflicts and giving them a civil colour is one such initiative.
A committee created under the chairmanship of Mr. Injeti Srinivas submitted its report to the Ministry of Corporate Affairs on 14 August 2018, entitled Report of the Committee to Investigate Offences under the Companies Act, 2013. One of the Committee's key recommendations was to re-categorize 16 out of 81 offences in the compoundable offence category into an in-house adjudication framework in which defaults would be subject to a penalty levied by the adjudicating officer.
The 2019 changes were implemented in the Companies Act, 2013, following the submission of the committee's recommendations to the MCA, which whittled down the rigours of criminal incarceration and fines for administrative lapses and incorporated the rules for levying punishments into an in-house adjudication process, moving certain cases from NCLT and NCLAT to in-house adjudication, giving these offences a civil colour.
In order to explain the raison d'être of this article, in situations concerning business conflicts, one needs to understand the complications of the justice system.
In the case of business conflicts, the case-loads have long ago been burdened by the NCLT and NCLAT being the sole forum. The free-flow of justice has been obstructed by minor and insignificant incidents of non-compliance and administrative anomalies. This delayed complaint processing results in an increased logistical workload and a burden on the economy.
The deterrent that the sentences can bring melts out in thin air once the time involved in litigation is extended. The expert committee appointed by the Ministry of Corporate Affairs (MCA) has acknowledged and discussed this part of the clogged tribunals time and again. The predecessors of the Injeti Srinivas Report, namely the Shardul Shroff Committee (2001), Irani Committee (2005), and the 21st Standing Committee on Finance (2010) had recommended that civil penalties be prescribed for transgressions which are purely procedural in nature and a broader outlook to be taken up in such scenarios and such technical deviations should be dealt under an in-house mechanism designed for levying penalties in case of technical defaults.
The debates and introspections surrounding the suitability of arbitration as a forum for settling intra-corporate conflicts have taken centre stage alongside the drumbeats of headlines heralding the changes to the Companies Act. Traditionally, business cases have become the state courts' exclusive venue, but with the increasing origins of arbitration, the question arises if these roots will bear fruit in disputes over corporate law.
Is arbitration needed for the newly decriminalised offences?
The report of the Injeti Srinivas Committee contained few clauses pertaining to failure to meet with corporate governance principles that separated them into serious and non-serious crimes and then concluded that the latter were readily observable and thus did not warrant a proper criminal trial. As a result, they recommended that certain crimes be decriminalised and punished by penalties and not fines. In addition, it was recommended that in-house adjudication be forwarded to them.
These offences include offences under Section 53(3) (Prohibition on the issuance of discount shares), Section 165(6) (Acceptance of directorships above a defined limit), Section 191(5) (Payment to directors not to be rendered in the event of loss of office, except under certain cases and according to the limitations laid down. Any sum earned by the director shall be kept in trust), Section 197 (15) (Overall full management remuneration and management remuneration in the absence or inadequacy of profits) and Section 203 (5) (Overall maximum management remuneration and management remuneration in the absence or inadequacy of profits) (Appointment of key managerial personnel in certain classes of companies).
It is foreseeable that as such, penal laws have transitioned into civil provisions parties would try to include them under the ambit of arbitration agreements. The authors are of the view there is no need or practicality of pushing arbitration herein because of the following reasons:
1. Absence of a Second Party
In spite of the implicit protections in the rules, except for the wrongdoer on account of the discoverability and quick identification of such defaults, the above-mentioned violations were placed under the in-house adjudication after the 2019 amendment, which corrected them by enforcing penalties.
According to the law provided for in Section 7 of the Arbitration and Conciliation Act, 1996, certain clauses are merely non-compliance on the part of the corporation, there is an absence of a second party, rendering them nearly impossible to arbitrate.
2. Efficiency and effectiveness of introducing arbitral mechanism
The revised regulations are slight technical defaults or procedural lapses which the adjudicating officer can readily cope with. In order to provide a timely settlement of such conflicts, these amendments were made. Pushing arbitration for such disputes would further prolong the time required, as time-consuming steps are the appointment of the arbitrator, the selection of the seat of arbitration, etc.
In comparison, arbitration needs a reasonable sum of money to be spent at all points, and looking at cost benefit analyses relative to the amount of penalties potentially owed for non-compliance, the author argues that arbitration is not a viable solution to court litigation and welcome the reforms to include a simple and cost-effective alternative.
Modus of introducing arbitration in Intra-corporate Disputes
A shareholder arrangement combined with a corporation's Article of Association (AoA) regulates a shareholder's relationship with a firm and continues to control conflicts between the same parties. The conflict arising from the arrangement of owners or the constitution of the corporation is clearly contractual and may be appealed to arbitration.
The minority shareholders are generally hanging on the pity of the majority anytime an intra-corporate disagreement occurs, and appear to seek refuge from the shareholder arrangement or the company's constitution that might have an arbitration provision. The Special Courts have currently declined to offer a speedy recovery from such conflicts, and thus arbitration no longer fits the shareholders' interest. In India, it is established that explicit consent from both parties should be given in order to make reference to arbitration.
In arbitration, the term 'mandatory' sounds like a threat to the requirement of free consent. The requirement of explicit consent, however, is not necessarily undermined by the mandatory shareholder agreement because the shareholders have to vote for it whenever this proposal is raised, and those who do not like the idea of arbitrating the forthcoming disputes may choose to vote against it. In addition, they will not let their shares go or acknowledge that they are bound by the arbitration agreement. In addition, the clause will be in the official document, which makes it practically necessary to be known about it by prospective shareholders. Considering this knowledge, they may make their decision and accept the agreement accordingly.
The question which now arises is whether the Indian Laws allow for such mandatory shareholder arbitrations. The Companies Act, 2013 and the Securities and Exchange Board of India Act 1992 (SEBI) are the potential hurdles before the implementation of Mandatory Shareholders Arbitrations (MSA). A clear reading of Section 36(1) of the Companies Act, 2013, provides for the presumption that the Articles of Association form a legal arrangement of which the corporation and its representatives are partners. The MSA may be enforced by replicating the dispute settlement clause of a company's articles of incorporation or by a private shareholder arrangement. Yet Section 9 of the 2013 Companies Act lays down that the terms of the memorandum or articles of association will be overridden by the Companies Act. Therefore, if a disagreement occurs and the clause of the terms of association goes against the sole authority of NCLT or NCLAT, it is not possible to impose an arbitration arrangement, except under some cases.
The arbitration clause of the Articles of Association varies from the arbitration clause of the Commercial Contracts, the customary procedure and the law requiring the parties to define the issues in terms of which the arbitration clause may be based upon. However, in the articles of association, these requirements are missing because they are only instructions for the company's administration matters.
In the case of Khusiram v. Honutal, the High Court of Kolkata ruled that the arbitration provision could be invoked only if a conflict occurred between the members of the company's close association. In the case of Shiv Omkar v. Bansidhar Jagannath, where the Bombay High Court claimed that the conflict is arbitrable if the transaction that initiated the dispute is beyond the confines of the article of association, this was further echoed.
The Securities and Exchange Board of India Act (hereinafter “SEBI Act”) is the second challenge before the MSA, it deals with the matters of securities that have a huge influence on the public and economic development.It is an existing rule where the decision is absolutely vested in the possession of the special body referring it for arbitration as there is a law overseeing particular rights and responsibilities, it would be contrary to public policy if securities that have a significant effect on public and economic growth.
In view of this, it is evident that there is a ban on securities conflict arbitration, but the SEBI itself has adopted some principles that facilitate arbitration in related disputes. SEBI's circulars are released and set out the principles and procedures for remedying investor complaints.
In addition, SEBI bylaws have arrangements to settle conflicts resulting from trade between members through arbitration. Related clauses can also be included in the National Stock Exchange by-laws.
The unending pressure on the Special Courts has led the lawmakers and courts to find a viable way to mitigate the duties placed on NCLT and NCLAT. In order to make the functioning of the Special Courts plain sailing, the lawmakers have consistently taken up numerous changes. The decriminalisation of minor bureaucratic lapses and technical defaults was one of those exceptional reforms.
The author concludes that in-house adjudication of such disputes is the optimal mechanism, after proper analysis of all the conflict settlement mechanism with respect to the recently revised clauses, the other two key solutions, including circuit courts and arbitration, will entail costs and are unjustified.
The lawmakers are also trying to make India appropriate for commercial activities, and a new committee has recently been appointed to further strengthen the Companies Act to turn more criminal legislation into civil provisions.
The author recommends sending more and more disputes to arbitration and expanding the reach of arbitrable disputes as the only way for the courts to decrease the number of cases going to the NCLT and NCLAT. In addition, a flexible approach to adjudicating the arbitrability of intra-corporate disputes should be introduced to enable the courts to use statutory shareholder arbitration to do so.
 Ministry of Corporate Affairs, Report of the Committee to Review Offences under the Companies Act, 2013 (Aug., 2018), available at: https://www.mca.gov.in/Ministry/pdf/ReportCommittee_28082018.pdf.
 The Companies (Amendment) Act, 2009.  Companies (Adjudication of Penalties) Rules, §3 (2019).  Executive Summary 2001, Ministry of Finance (Sep 5, 2020, 12:20 am) available at: https://www.finmin.nic.in/sites/default/files/chandra.pdf  Report on Company Law 2005 (Oct. 6, 2020, 10:25 am) http://www.primedirectors.com/pdf/JJ%20Irani%20Report-MCA.pdf  The Companies Bill (2009).  Companies Act, sec. 53(3) (2013).  Id., sec. 165(6).  Id., sec. 195(5).  Id., sec. 197(15).  Id., sec. 203(5).  Report of the Committee to Review Offences under the Companies Act, 2013, 24, available at: http://www.mca.gov.in/Ministry/pdf/ReportCommittee_28082018.pdf.  Companies Act, § 165(6), § 53(3), § 191(5), § 197(15), § 203(5) (2013).  Supra Note 7, 44.  The Arbitration and Conciliation (Amendment) Act, §29A (2015).  Afcons Infrastructure Ltd. v. Cherian Varkey Construction Co. (P) Ltd., (2010) 8 SCC 24.  International Bar Association, IBA Guide on Shareholders’ Agreement, (October 1, 2019), available at: http://www.shareholderagreementweb.com/form/415828012-Raja-Sujith  O.P.Gupta v. Shiv General Finance (P.) Ltd 1975 SCC OnLine Del 147.  Khusiram v. Honutmal, 53 CWN 505 (H).  Id.  Shiv Omkar v. Bansidhar Jagannath, A.I.R. 1956 Bom. 459 (India).  Kingfisher Airlines Limited v. Capt. Prithvi Malhotra Instructor, 2012 SCC OnLine Bom 1704.  Securities Exchange Board of India, Model Bye Laws of Stock Exchanges, available at: https://www.sebi.gov.in/sebi_data/commondocs/stkexbylaws_h.html