Does Arbitration Clause Survive Novation of Contract

Introduction

Arbitration has developed itself as the more competent dispute resolution mechanism between the parties where the two parties prefer to refer the dispute to Arbitration and the decision of the Arbitral Tribunal will be binding on the parties. The parties generally by way of an Arbitration clause or otherwise agree to refer the dispute to Arbitration, the Arbitration Clause may or may not be contained in the Agreement.

It is settled law in India and several other jurisdictions that the Arbitration Clause in any contract is deemed to be separate or independent from the Contract consisting of that contract, The said principle is called the Doctrine of separability. When the legality of the substantive contract is questioned, the existence and validity of the arbitration clause remain unaffected.

An arbitration clause is independent of the contract. In other words, even if the underlying contract’s responsibilities are fulfilled by frustration, revocation, or breach, the arbitration clause within will still apply to settle any disputes arising from those obligations. However, where the parties, by their mutual consent, decide to completely novate the contract, the question arises whether the old arbitration clause will survive anew.

According to common law, novation occurs when one agreement is completely replaced by a new agreement as a result of an assignment. If the original contract is dissolved, both contracting parties must agree, which indicates that the assignee of the arbitration agreement must approve in order for the arbitration agreement to be enforced.

A current agreement is replaced by a novation agreement. A previous contract is cancelled and a new one is put in its place that modifies the roles and responsibilities of the contractual parties, as agreed upon by the parties to the contract. Section 62 of the Indian Contract Act of 1972, recognizes the novation of a contract.

High Court of Delhi in Sanjiv Prakash v. Seema Kukreja & Ors, tends to clarify the position under the Arbitration and Conciliation Act, 1996 with reference to relevant provisions of the Indian Contract Act, 1872 but the Apex Court has overruled the judgement on the account of limited power of the court under section 11 of Arbitration Act which provides power to prima facie review as to whether an arbitration agreement exists between the parties.

The purpose of this article is to investigate whether an arbitration provision survives novation or supersession of the agreement containing the condition.

What is the Novation of Contract?

Novation is said to be an act whereby parties to a contract reciprocally agree to substitute terms of the contract with a new set of terms or where contracting parties are restored with a new party. The cardinal rule of novation is that it is an act done in mutual harmony by the contracting parties; which includes the new parties where the new party has replaced the preceding one. Novation implies the complete substitution of the old contract for a new one.

The essentials of valid Novation are first, that parties must have Consensus ad idem. Secondly, there must be a previous contract between the parties. Thirdly Substitution, recession or alteration of a contract gives rise to a valid new contract. Frothy complete termination of the old contract and the previous agreement is void when a contract is novated, and the parties are then obligated by the new agreement. The Act provides that “the original deal need not be performed if the parties to the contract agree to substitute a new contract for it, to withdraw it or to change it.”

Supreme court has held in Lata Construction & Ors v. Dr. Rameshchandra Ramniklal Shah, that Only under certain circumstances does the original contract not need to be carried out; novation calls for a full replacement of the old contract with the new one. The conditions of the previous contract should be nullified or fully altered by the new substituted contract.

In Ramdayal v. Maji Devdiji, the court noted that novation occurs when additional clauses or parties are added to the contract. A party must consent to have his obligation or debt extinguished or discharged in order to enter into a novation contract. There cannot be a novation till this has been performed. As a result, the test is to determine whether or not the parties are meant to engage in a new contract.

According to the Calcutta High Court’s ruling in the case of Juggilal Kamlapat v. NV Internationale, for novation to be effective, the amendment to the contract must alter its fundamental nature.

The Novation of a contract may occur in two ways firstly by substituting the terms of the contract with a new one and secondly by altering the parties of the contract.

Effect of Novation of Contract in Arbitration Clause

One of the theoretical and practical pillars of arbitration across the jurisdiction is the doctrine of separability. It indicates that an arbitration clause in a contract is seen as existing independently of the main contract of which it is a part and does so even in the event of the main contract’s termination, breach, or invalidity.

When a tribunal faced a challenge over its jurisdiction, the doctrine became crucial for arbitration to work. A party seeking to avoid its arbitration obligation could claim that because the arbitration clause is a component of the main agreement, the arbitration clause itself is unlawful. The parties further asserted that the arbitral tribunal established in accordance with it lacks the authority to make an award.

The doctrine of separability is only applicable to the arbitration agreement’s validity as a result of the main agreement’s invalidity. This doctrine can only be used in this context. However, in the case of Novation, the situation becomes different as the Parties willingly substitute the contract with a new one. Any arbitration agreement is a creation of an agreement hence it could also be destroyed by agreement.

Similarly, The arbitration clause, being a part of the earlier contract, would be dissolved if it were to be superseded by another contract. Likewise, if the original contract as a whole was terminated, the arbitration clause that is a component of it would likewise be terminated)

Recently Delhi High-count dealt with the principle in the case of Sanjeev Prakash vs Seema Kukreja wherein the court held that because every arbitration agreement is the creation of an agreement it may be destroyed by the agreement that means if the contract gets superseded by another the arbitration clause which is part of earlier contract fall with it and if the original contract comes to an end entirely the arbitration clause which is part of it also perishes along with it.

Similarly, the Apex court gets into the question of whether an arbitration clause can be invoked in the case of a dispute under a superseded contract. The principle which is laid down in the instant case is that if the contract is superseded by another, the arbitration clause, being a component part of the earlier contract, falls with it. But where the dispute is whether such contract is void ab intio, the arbitration clause cannot operate on those disputes, for its operative force depends upon the existence of the contract and its validity.

Supreme Court in Larsen and Toubro Ltd. v. Mohan Lal Harbans Lal Bhayana, held that the arbitration agreement stands modified by the supplementary agreement when the terms of the supplementary agreement changed the entire edifice of the principal arbitration agreement, there could be no arbitration between the parties for the claims raised by the appellant and an application filed under Section 11 would thus be misconceived.

When a new contract replaces a prior one that contained an arbitration clause, the arbitration provision ceases to be in force. When parties decide to enter into a new contract and voluntarily agree on how conflicts will be resolved in the future and there is no mention of a previously completed contract’s dispute resolution provisions, it is obvious that a novation of the contract has occurred.

The stand of the court in all these cases seems slightly deferred from the principle of ‘Separability’ or ‘Severability’ of the arbitration agreement. The difference between a situation where a contract’s conditions are broken or left unfulfilled and one where the entire original contract is replaced by a new one is one of the parties’ “acquiescence.”

In the first case, the contract is void because one of the parties failed to fulfil their obligations under it or because it lacked a necessary component to make it legally binding. In certain circumstances, the contract is rescinded, but only insofar as it relates to future performance. Both the arbitration clause and the contract are still in effect for the purposes of determining damages.

As a result, in these circumstances, even though the arbitration clause is a part of the main contract and satisfies all the criteria for an essential contract under section 7 of the Act of 1996, it does not automatically stand abrogated because it is a separate contract with its own foundation and limbs. However, when a contract is novated, the situation is different because the new contract’s scheme supersedes that of the original.

The arbitration agreement or provision may also be dissolved with the parties’ mutual assent because it is based on their mutual consent and has legal effect. Therefore, in these situations, the parties do not have the right to rely on an arbitration clause that has been terminated by the parties’ own agreement.

Conclusion

The Court has said in several instances that the legal position is that once a new contract replaces a previous contract that contained an arbitration clause, the effect of that arbitration ceases together with the termination of the prior contract.

It is obvious when the parties decide to enter into a new contract and mutually decide on the mode and manner of dispute resolution should one ever arise in the future and there is no mention of the previously executed contract with regard to the resolution of disputes arising therefrom that a novation of the contract has taken place. The Courts have spelt out in a number of the aforementioned instances how a contract’s arbitration clause will be affected by novation.

By: Aniruddha Shrivastava