Introduction
In a significant ruling that reinforces the legislative intent of the Arbitration and Conciliation Act, 1996 (the ‘Arbitration Act’), the Supreme Court of India, in the case of The Managing Director Bihar State Food and Civil Supply Corporation Limited & Anr. v. Sanjay Kumar, has decisively settled the scope of judicial inquiry at the stage of appointing an arbitrator under Section 11 of the Act.
The judgment addresses a batch of appeals challenging the Patna High Court’s decision to appoint arbitrators in disputes between the Bihar State Food and Civil Supplies Corporation (the ‘Corporation’) and numerous rice millers. The core of the dispute revolved around the arbitrability of claims tainted by allegations of a massive, systematic fraud amounting to over a thousand crore rupees, which had also led to the initiation of widespread criminal proceedings.
The Corporation vehemently argued that such disputes, involving public funds and having serious public law ramifications, were non-arbitrable and should be outside the purview of private dispute resolution. However, the Supreme Court, while acknowledging the extensive jurisprudence on “serious fraud,” ultimately anchored its decision on the restrictive mandate of Section 11(6A) of the Arbitration Act.
It held that the role of the referral court is strictly confined to examining the mere existence of an arbitration agreement, leaving all other gateway issues, including non-arbitrability and limitation, to be determined by the arbitral tribunal itself. This judgment serves as a powerful precedent, championing the principle of kompetenz-kompetenz and promoting a pro-arbitration, non-interventionist judicial approach.
Brief Facts
The genesis of the dispute lies in agreements executed in 2013 between the appellant Corporation and the respondent rice millers. The Corporation, under a scheme by the Food Corporation of India (FCI), was responsible for procuring paddy from farmers in Bihar. The agreements stipulated that the rice millers would receive this paddy for custom milling and were obligated to deliver back milled rice, quantified at 67% of the paddy supplied.
The agreements contained two crucial clauses that became the focal point of the litigation. Clause 15 provided the Corporation with a remedy to recover any dues arising from default, loss, or damage by the millers as land revenue under the Bihar and Orissa Public Demands Recovery Act, 1914 (the ‘Recovery Act’). In parallel, Clause 16 established a dispute resolution mechanism:
“16. In case of disputes both parties agree to settle the issue(s) on mutual discussions. Failure to reach agreement the matter will be referred to Arbitrator. It has been also agreed that the Arbitrator will be District Collector of the concerned District whose decision shall be final, concerning the dispute referred to him.”
Within a year, the Corporation alleged that the millers had failed to supply the agreed quantity of rice and invoked Clause 15 by initiating proceedings under the Recovery Act. The millers challenged these recovery proceedings before the Patna High Court through writ petitions. Both a Single Judge and a Division Bench of the High Court disposed of these petitions, holding that since the agreements contained an arbitration clause (Clause 16), the parties should resort to that remedy for dispute resolution.
The matter escalated significantly when the Corporation claimed to have unearthed a massive fraud, alleging that the millers’ defaults had led to a loss of over a thousand crore rupees to the public exchequer. This led to the Corporation filing approximately 1200 First Information Reports (FIRs) against the rice millers across Bihar for offences under Sections 420 (Cheating) and 409 (Criminal breach of trust) of the Indian Penal Code. Subsequently, charge sheets were filed in 2016, and the Enforcement Directorate also initiated proceedings under the Prevention of Money Laundering Act (PMLA).
The scale of the alleged scam attracted the attention of the higher judiciary. The Supreme Court, in a related 2017 matter (State of Bihar v. Divesh Kumar Chaudhry), noted the gravity of the situation, involving the alleged misappropriation of around fifteen hundred crores, and issued directions for consolidating the trials at five specific locations for efficient adjudication. Furthermore, the Patna High Court, suspecting a larger conspiracy, constituted a Special Investigation Team (SIT) to ensure a focused and concerted investigation into all the cases.
Against this backdrop of ongoing criminal investigations and recovery proceedings, the respondent rice millers filed applications under Section 11 of the Arbitration Act in 2019, seeking the appointment of an arbitrator as per Clause 16 of their agreements.
The Patna High Court, in its impugned order dated July 3, 2020, allowed these applications. The High Court reasoned that the allegations of criminality were “simple accusations” and not “serious allegations of forgery or fabrication” that would bar arbitration. It also held that the Arbitration Act, being a central legislation, would override the Recovery Act and that the issue of limitation could be examined by the arbitrator. It was this order that the Corporation challenged before the Supreme Court.
Contentions of the Parties
Before the Supreme Court, the parties presented detailed arguments on the fundamental question of arbitrability.
Appellant’s (The Corporation’s) Contentions:
- Non-Arbitrability due to Serious Fraud: The primary contention was that the dispute was not a mere contractual default but a systematic and massive public fraud. It involved the misappropriation of public funds meant for the Public Distribution System (PDS), thereby transcending the realm of a private dispute and acquiring a public law character. The pending criminal proceedings under serious charges like Section 409 IPC were cited as evidence of the gravity, making the matter unfit for private adjudication by an arbitrator.
- Bar by the Recovery Act: The Corporation argued that by invoking Clause 15 of the agreement and initiating proceedings under the Recovery Act, it had elected a specific statutory remedy. The respondents could not, therefore, subsequently invoke the parallel remedy of arbitration under Clause 16.
- Limitation: The applications under Section 11 were claimed to be barred by limitation. The cause of action, according to the Corporation, arose in 2015 when demand notices under the Recovery Act were first issued, whereas the arbitration was invoked only in 2019, well beyond the prescribed period.
- Res Judicata and Waiver: It was also argued that the dismissal of a previous reference by the Bihar Public Works Contracts Disputes Arbitration Tribunal on jurisdictional grounds, which went unchallenged, operated as res judicata. Furthermore, the failure of the millers to file an application under Section 8 of the Arbitration Act during the certificate proceedings was contended to be a waiver of their right to arbitrate.
Respondents’ (Rice Millers’) Contentions
- Arbitrability of the Dispute: The respondents maintained that the dispute was fundamentally contractual, arising from the alleged non-supply of rice. They argued that the allegations of fraud were “fraud simpliciter” and did not meet the high threshold of “serious fraud” necessary to oust arbitration. It was asserted that civil and criminal proceedings concerning the same facts can proceed simultaneously.
- No Bar from Recovery Act: The Recovery Act was described as a mechanism for the recovery of determined debts, not for the adjudication of the underlying dispute itself. Arbitration, as per Clause 16, was the agreed forum for resolving such disputes. It was argued that there was no conflict between the two, and even if there were, the central Arbitration Act would prevail over the state Recovery Act.
- Limitation as a Mixed Question: The issue of limitation, being a mixed question of fact and law, was best left for the determination of the arbitral tribunal and should not be a ground for refusing a reference under Section 11.
- Binding Precedent: The respondents relied on a previous decision of the High Court in Sadhna Kumari, where an arbitrator was appointed in a similar matter. The Special Leave Petition against that order had been dismissed by the Supreme Court, which, they argued, should guide the present case.
Analysis by the Court
The Supreme Court began its analysis by acknowledging the depth of the arguments on non-arbitrability due to serious fraud. It undertook a comprehensive review of its own precedents, including landmark cases like A. Ayyasamy v. A. Paramasivam, Rashid Raza v. Sadaf Akhtar, and Avitel Post Studioz Limited v. HSBC PI Holdings, to restate the governing principles. The Court synthesized the law as follows:
- Disputes are generally resolved by ordinary courts, with arbitration being a contractual exception.
- Certain categories of disputes are inherently non-arbitrable, a principle recognized by Section 2(3) of the Arbitration Act.
- The mere existence of parallel criminal proceedings does not automatically render a civil dispute non-arbitrable.
- A crucial distinction exists between “fraud simpliciter,” which is arbitrable, and “serious fraud,” which is not. The Court reiterated the two tests for “serious fraud” laid down in Rashid Raza: (i) where the fraud is such that the arbitration clause itself cannot be said to exist, and (ii) where allegations of arbitrary or fraudulent conduct are made against the State or its instrumentalities, raising public law questions.
- The Court further clarified that disputes involving allegations with public law implications, such as those affecting the integrity of governance or the distribution of essential commodities, would qualify as “serious fraud” and be non-arbitrable.
However, after this detailed exposition, the Court identified a “fundamental barrier” that prevented it from applying these principles to the facts at hand: the legislative mandate of Section 11(6A) of the Arbitration Act. This provision, introduced by the 2015 amendment, states that the court, while considering a Section 11 application, “shall, notwithstanding any judgment, decree or order of any Court, confine itself to the examination of the existence of an arbitration agreement”.
The Court heavily relied on its recent seven-judge bench decision in In Re: Interplay Between Arbitration Agreements…, which conclusively interpreted the scope of Section 11(6A). The analysis highlighted that the legislature’s intent was to drastically limit judicial intervention at the referral stage. The role of the court is not to conduct a “mini-trial” but simply to perform a prima facie “examination” for the existence of an arbitration agreement as defined under Section 7 of the Act.
All other preliminary or jurisdictional issues, such as the substantive validity of the agreement, limitation, waiver, and even the arbitrability of the dispute (including allegations of serious fraud), are to be decided by the arbitral tribunal under the principle of kompetenz-kompetenz enshrined in Section 16. The Court emphatically stated, “The curtains have fallen.” The judicial scrutiny under Section 11 must be confined to the singular question of the existence of an arbitration agreement.
Judgement
Applying this strict legal standard, the Supreme Court’s conclusion was swift and decisive. It noted that the existence of the arbitration agreement, Clause 16 in the contracts, was undisputed. As per the mandate of Section 11(6A), the Court’s inquiry had to end there.
The Court explicitly declined to adjudicate on the Corporation’s substantive objections regarding serious fraud, the bar of the Recovery Act, limitation, or res judicata. It held that these were precisely the kind of jurisdictional issues that the legislature intended for the arbitral tribunal to decide. The Court clarified that while the Corporation had much to say on these matters, the appropriate forum to say it was the arbitral tribunal, not the referral court.
In its final order, the Supreme Court dismissed the appeals filed by the Corporation and upheld the High Court’s decision to appoint arbitrators. It directed that all the issues raised by the Corporation, particularly those concerning non-arbitrability and limitation, were to be kept open and decided by the arbitral tribunal as preliminary issues after giving all parties a full opportunity to be heard.
Concluding Remarks
The judgment in The Managing Director Bihar State Food and Civil Supply Corporation Limited & Anr. v. Sanjay Kumar is a landmark reaffirmation of India’s pro-arbitration stance. It sends an unequivocal message to courts across the country to adopt a hands-off approach at the pre-arbitral stage, thereby respecting party autonomy and the legislative framework designed to make arbitration a more efficient and effective dispute resolution mechanism.
The key takeaway is the elevation of the kompetenz-kompetenz principle to its rightful place. By refusing to be drawn into a detailed examination of complex issues like serious fraud, the Court has empowered arbitral tribunals to be the primary arbiters of their own jurisdiction. This prevents the referral stage under Section 11 from becoming a protracted battleground, which often defeated the very purpose of arbitration—speedy resolution.
While the facts of the case presented compelling arguments for judicial scrutiny, given the public nature of the alleged fraud, the Court’s disciplined adherence to the statutory text of Section 11(6A) is commendable. It demonstrates a clear paradigm shift from the pre-2015 era, where courts often delved deep into the merits of such gateway issues. This decision solidifies the position that once a prima facie arbitration agreement is found to exist, the court’s job is done, and the matter must be referred to the chosen forum of the parties. It is a judgment that not only provides legal certainty but also significantly strengthens the institutional integrity and credibility of the arbitral process in India.
— Team AMLEGALS
Please reach out to us at rohit.lalwani@amlegals.com in case of any query.