Effect of Novation and Assignment on Arbitration Agreements

Arbitration has emerged as a preferred method of dispute resolution in commercial contracts due to its flexibility, confidentiality, and party autonomy. In India, arbitration is governed primarily by the Arbitration and Conciliation Act, 1996. 

Almost every major commercial contract today contains an arbitration clause to ensure that disputes are resolved outside traditional courts. However, complications arise when contracts are assigned or novated. A key legal question then emerges: what happens to the arbitration agreement when the main contract is assigned or novated?

This article examines the effect of assignment and novation on arbitration agreements under Indian law. It explains the legal principles involved, analyses important judicial decisions, and highlights the evolving approach of Indian courts, while maintaining a practical and reader-friendly explanation.

Nature of an Arbitration Agreement

An arbitration agreement is a consensual agreement between parties to resolve disputes through arbitration instead of courts. Under Section 7 of the Arbitration and Conciliation Act, 1996, it may exist as a separate agreement or as a clause within the main contract.

Indian law recognises the doctrine of separability, which treats the arbitration agreement as independent from the underlying contract. This principle ensures that even if the main contract is terminated, invalidated, or disputed, the arbitration clause may still survive to decide disputes arising out of that contract.

The Supreme Court has repeatedly affirmed that the arbitration agreement is not automatically extinguished merely because the main contract is terminated or challenged.

Understanding Assignment and Novation

Before analysing their impact on arbitration agreements, it is essential to understand what assignment and novation mean in contract law.

Assignment of Contract

Assignment involves the transfer of rights, and sometimes obligations, under a contract from one party to another. Under Section 37 of the Indian Contract Act, 1872, contractual rights may be assigned unless the contract is personal in nature or expressly prohibits assignment.

Assignment may be of:

• Rights alone, such as the right to receive payment, or
• Rights along with obligations, subject to consent of the other contracting party.

Novation of Contract

Novation is governed by Section 62 of the Indian Contract Act, 1872. It occurs when:

• A new contract replaces an existing one, or
• Parties to a contract are substituted by mutual agreement.

Novation results in the extinguishment of the original contract and replaces it with a new contractual arrangement.

Effect of Novation on Arbitration Agreements

The traditional position under Indian law is that when a contract is novated, the original contract ceases to exist. Since the arbitration clause is a part of the original contract, a question arises whether it also stands extinguished.

The general principle is that novation of the main contract leads to extinction of the arbitration clause, unless parties expressly or impliedly preserve the arbitration agreement.

Courts have explained that when a contract is superseded by a new one, the arbitration clause, being a component of the earlier contract, normally falls with it. This flows directly from Section 62 of the Contract Act.

However, Indian courts have softened this strict position by applying the doctrine of severability and examining the intention of parties. If it appears that disputes relating to the old contract or its performance still require adjudication, the arbitration clause may survive despite novation.

In Today Homes and Infrastructure Pvt. Ltd. v. Ludhiana Improvement Trust, the Supreme Court observed that termination or frustration of the main contract does not automatically render the arbitration agreement inoperative. The arbitration clause remains effective to resolve disputes arising out of or in connection with the contract.

Thus, while novation may generally extinguish arbitration agreements, courts focus on whether disputes survive and whether parties intended arbitration to govern such disputes.

Assignment of Contracts and Arbitration Agreements

The impact of assignment on arbitration agreements has generated far greater judicial debate than novation.

The central question is whether assignment of the main contract also results in assignment of the arbitration agreement, or whether fresh consent is required for the arbitration agreement to bind the assignee.

Indian courts have adopted two approaches in this regard.

Approach One: Specific Consent Required

A minority view taken by certain courts is that an arbitration agreement, being a distinct and separate contract, cannot be assigned automatically with the main contract unless there is specific consent.

In Delhi Iron and Steel Co. Ltd. v. U.P. Electricity Board, the Delhi High Court held that assignment of the principal contract does not ipso facto assign the arbitration agreement. According to the Court, arbitral intent must be clearly manifested between the original party and the assignee.

A similar approach was taken in Vishranti CHSL v. Tattva Mittal Corporation Pvt. Ltd., where it was held that in the absence of express consent, the arbitration agreement would not bind the assignee.

This line of reasoning draws support from the doctrine of privity of contract and the Supreme Court’s observations in M.C. Chacko v. State of Travancore, which stated that a person who is not a party to a contract cannot enforce its terms. However, even this decision recognised assignment as an exception to strict privity.

Approach Two: Automatic Transfer of Arbitration Agreement

The predominant and modern Indian view favours the automatic transfer of arbitration agreements along with the main contract.

In DLF Power Ltd. v. Mangalore Refinery and Petrochemicals Ltd., the Bombay High Court held that once rights and obligations under a contract are assigned and accepted, the assignee steps into the shoes of the assignor. As a result, the assignee is entitled to all benefits, including the arbitration agreement.

The Court emphasised that requiring execution of a fresh arbitration agreement would defeat commercial practicality and party autonomy.

Similarly, in Bestech India Pvt. Ltd. v. MGF Developments Ltd., the Delhi High Court rejected objections regarding lack of privity and allowed the assignee to invoke arbitration, relying on post-assignment conduct of parties.

Courts have consistently held that where the assignee performs contractual obligations, seeks extensions, makes payments, or participates in performance, arbitration agreements stand assigned along with the contract.

Conclusion

The effect of novation and assignment on arbitration agreements under Indian law reflects a balance between contractual consent and commercial practicality.

• Novation generally extinguishes the arbitration agreement unless parties intend otherwise or disputes survive the novation.
• Assignment, on the other hand, does not usually require fresh consent for arbitration agreements, especially where the assignee has stepped into the shoes of the assignor and the parties’ conduct reflects acceptance.

Overall, arbitration agreements in India are no longer viewed as fragile clauses vulnerable to contractual changes. Instead, they are treated as robust dispute resolution mechanisms capable of surviving novation and assignment, provided the underlying intent to arbitrate remains clear.