Enforcing Arbitration Clauses: Overcoming Oppression And Mismanagement Claims

Enforcing Arbitration Clauses: Overcoming Oppression And Mismanagement Claims

This ‘Dressing-Up’ Practice Has Proved To Be An Immovable Object In India’s Attempts To Establish Itself As An Unstoppable Force In International Arbitration

Introduction

Parties’ practices of ‘dressing-up’ their shareholder disputes have been subject to copious controversy and debate. Shareholder disputes are often cloaked under different causes of action such as Oppression and Mismanagement (“O&M”) to oust the effect of arbitral clauses in Shareholder Agreements (“SHA”).

Two considerations, amongst a host of others, have propagated this practice. First, the broad nature of powers exercisable by the National Company Law Tribunal (“NCLT”) while adjudicating claims of O&M under Section 242 of the Companies Act, 2013 (“Companies Act”); and second, the ability to make non-signatories to a SHA party to such disputes.

Crucially, this ‘dressing-up’ practice has proved to be an immovable object in India’s attempts to establish itself as an unstoppable force in international arbitration. This article analyzes judicial authorities’ considerations in distinguishing between legitimate O&M claims and ‘dressed-up’ disputes.

Arbitrability of O&M Claims

The Supreme Court of India’s decisions in Booz Allen & Hamilton Inc. v. SBI Home Finances¹ (“Booz Allen”) and Vidya Drolia & Ors. v. Durga Trading Corporation² (“Vidya Drolia”) clearly held that only claims concerning rights in personam are arbitrable. Over the years, Courts have held O&M claims to be non-arbitrable for two reasons – first, as they concern matters “prejudicial to public interest”, they are not rights in personam; and second, the NCLT is empowered, under Section 242 of the Companies Act, 2013, to grant a wide range of reliefs that arbitrators are not empowered to grant.³

In matters where prima facie it appears that the ‘dressed-up’ claims cannot be adjudicated as O&M disputes, Courts and Tribunals have referred the matter to arbitration.⁴ In assessing dressed-up applications, Courts consider several factors viz. the remedy test, the subject matter of the dispute, the necessary party test and the totality test.⁵

a. Remedy Test

The NCLT, under Section 242 of the Companies Act, has the power to pass any order putting an end to O&M on the grounds of “equity”.⁶ However, arbitral tribunals are not given such powers under the Arbitration and Conciliation Act, 1996⁷ (“Arbitration Act”). If the remedy claimed is one which an arbitral tribunal cannot order, reference to arbitration will be declined.⁸

If a cause of action allows parties to claim a breach of Section 241 of the Companies Act and the SHA, parties may be allowed to raise claims concerning the breach of contract and violation of the Companies Act before an arbitral tribunal and the NCLT respectively.

b. Subject-matter of the dispute

Conduct is ‘oppressive’ when majority shareholders, through continuous conduct, act in a burdensome, harsh and wrongful manner towards minority shareholders.⁹ ‘Mismanagement’ refers to conducting a company’s affairs in manner which is prejudicial, dishonest or inept.¹⁰ In Escorts Finance Ltd. v. G.R. Solvents, the CLB found that the dispute was subject to arbitration, as prima facie the conduct alleged was neither ‘oppressive’ nor constituted ‘mismanagement’, but rather appeared to be violative of an agreement.¹¹ Consequently, the CLB referred the parties to arbitration.

Therefore, if ‘dressed-up’, O&M applications do not prima facie appear to constitute O&M, the dispute may be referred to arbitration.

c. Necessary Party Test

If judicial authorities find the dispute to be arbitrable, they shall consider whether an effective order can be passed against a party by an arbitral tribunal.¹² Under such circumstances the judicial authority primarily considers whether the respondents are non-signatories to the arbitration agreement and/or necessary parties to the proceedings. In Sidharth Gupta v. Getit Infoservices (P) Ltd.,¹³ the judicial authority held that certain non-signatory directors were not necessary parties as they were acting nominee directors of a majority shareholder, who was party to the SHA. Resultantly, the parties were referred to arbitration as the claims lay primarily against the majority shareholder for breach of contract.

d. The Parties’ Intention

Judicial Authorities undertake an assessment of whether the “dressed-up” petitions have solely been filed to defeat the arbitration clause in an SHA. If it appears that parties through clever drafting have ‘dressed-up’ frivolous claims as O&M disputes, they shall be referred to arbitration to resolve their disputes.¹⁴ The High Court of Bombay in Rakesh Malhotra v. Rajinder Kumar Malhotra held that if frivolous claims are raised under the guise of O&M disputes, parties can evade their obligations to arbitrate, which will defeat the purpose of the Arbitration Act.

Enforcing an Arbitration Clause: Issues with the Doctrine of Incorporation

Once judicial authorities find that O&M Petitions are ‘dressed-up’, under Section 8 of the Arbitration Act, they would assess the parties’ arbitration clause in their SHAs.¹⁵ Over time, the enforcement of SHA arbitration clauses has received polarized treatment, creating a battle between two schools of thought. First, the conservative view - proposing that SHA arbitration clauses are unenforceable unless they are incorporated in the AoA; and Second, the liberal view - that SHA arbitration clauses can be enforced without their incorporation in an AoA.

The conservative view stems from V B Rangaraj v. V B Gopalakrishnan (“Rangaraj”)¹⁶ wherein the Supreme Court of India held that terms of agreement are unenforceable unless they are incorporated into the AoA. The view in Rangaraj has subsequently been followed by judicial authorities to refuse reference to arbitration if the arbitration clause has not been incorporated in the company’s AoA.¹⁷

The liberal view on the other hand allows parties to enforce their SHA arbitration clauses even if such clauses have not been incorporated in the AoA. Cases such as Modi Rubber Ltd. v. Guardian International Corp.¹⁸ have endorsed the view that in the absence of any incorporation within an AoA, arbitration clauses are enforceable if they are not in conflict with the terms of the AoA.

Conclusion

Unlike Singapore and UK, Indian Courts have categorically held O&M claims to be non-arbitrable. In establishing such a position, judicial authorities, while deciding whether claims must be referred to arbitration, are placed with a heavy burden to considering the true nature of a dispute.

While judicial authorities undertake an assessment of ‘dressed-up’ O&M disputes, it appears that their findings exceed a prima facie view of the facts. Under such circumstances, the Authors believe that judicial authorities must be wary of the limitations placed upon their powers under Section 8 of the Arbitration Act, while assessing ‘dressed-up’ applications. While this specific concern has not been brought before judicial authorities, it appears to be one of the challenges which would have to be addressed in the future.

Disclaimer – The views expressed in this article are the personal views of the authors and are purely informative in nature.