Kashmiri Lal vs Union of India (UOI)

S.M. Fazl Ali, J.—This is an appeal against an order of Bhat J. accepting the application of the Defendant for staying the suit and referring

the mailers in suit to arbitration.

The Plaintiff brought a suit for the recovery of Rs. 22,000/- as earnest money and damages against the Defendant in respect of a contract given

to him by the Union of India for storage accommodation somewhere near Udhampur. The Plaintiff's case was that tenders were invited for starting

the work of construction of storage accommodation and the Plaintiff submitted his tender which was ultimately accepted. The Plaintiff entered into

contract with the Defendant on the specific footing that the area where the work was to be carried on was an unrestricted area.

Subsequently, however, when the Plaintiff visited the spot, he found that it was a restricted area and, therefore, he was unable to perform ' the

contract on the terms accepted by him due to misrepresentation practiced on him. The Plaintiff wanted a substitution of a new contract on fresh

terms but as the Defendant did not agree to the same, the Plaintiff has filed the present suit for damages and return of earnest money. While the suit

was pending before the learned single Judge of tills court, an application was filed by the Defendant praying that the suit may be stayed u/s 34 of

the Arbitration Act in view of the fact that the agreement between the parties contained an arbitration clause under which all disputes arising out of

the contract had to be referred to the arbitrator.

This application was resisted by the Appellant on several grounds, the most important of them being the fact that the contract between the parties

was invalid as it was not in consonance with Article 229 of the Constitution of India. This appears to be the only objection pressed by the

Appellant before the learned Single Judge. The learned Judge after hearing the parties rejected the objection of the Plaintiff and held that the

contract was valid and did not suffer from any formal defect- The learned Judge, accordingly, stayed the suit and referred the matter to arbitration.

Hence this appeal under the Letters Patent before us.

Appearing for the Appellant Mr. Vidya Sagar did not challenge the finding of the learned Judge on the question that the agreement was valid in

accordance with the provisions of the Constitution, but submitted that the agreement itself was void inasmuch as, it was obtained by

misrepresentation or it was based on mutual mistake of fact. It is true that this objection was not specifically raised by the Appellant before the

learned Single Judge, but reading the various paragraphs of the plaint and the objections, it is clear to us that it was specifically raised in the

objections. As the point taken by the Appellant goes to the very root of the contract and is essentially a point of law, we allowed the Appellant to

raise this point before us and gave an opportunity to the Advocate General to meet this point.

The Advocate General, in answer to the argument, submitted that even the grounds which go lo the root of the contract so as to make it void or

voidable would be matters which would be governed by the arbitration agreement and, therefore, there was no reason why the order of stay of the

suit, passed by the learned Single Judge, should be disturbed. We have heard the arguments of the learned Counsel for the parties at length.

It has now been settled by the consensus of judicial decisions of various High Courts in India as also the Supreme Court that in an application

u/s 34 of the Arbitration Act, a question which goes to the very root or the .basis of the contract, can be decided by the courts rather than by an

arbitrator. It seems to us that the crux of the matter in such cases is to see whether the suit brought by the Plaintiff is itself independent of the

contract and proceeds upon assailing the contract on grounds of fraud mistake or misrepresentation etc. or whether the suit is based on the

contract .itself. In the former case, it is manifest, that the point has to be decided by the court and not by the arbitrator. In the latter case, however,

the point clearly falls within the ambit of the arbitration clause.

In the instant case, Paras Nos. 3, 4, 5, 9, 40 and 13 of the plaint clearly show that the present suit is not based on the contract but is completely

independent of the same. The averments further show that the Plaintiff has treated the contract as void inasmuch as it was obtained by

misrepresentation or was based on mutual mistake. It has clearly been alleged by the Plaintiff in the plaint that the contract was entered into on the

footing that the Para; where the work was to be carried on was an unrestricted area, whereas subsequently on spot inspection, it was found that

the area was a restricted one. Either the fact that the area was unrestricted was known to the Defendant or was not, known to him. If this fact was

known neither to the Defendant nor to the Plaintiff at the time when the agreement was entered into, the agreement would clearly void, due to

mutual mistake.

On the other hand, if the Plaintiff did not know-that the area was unrestricted one, but the Defendant knew about this fact, then, obviously the

contract will be vitiated by misrepresentation practiced by the Defendant on the Plaintiff. Of course, the question whether the Plaintiff has been able

to prove this plea, will have to be determined by the trial court and we have only at this stage to proceed on the allegation made by the Plaintiff in

his plaint. In these circumstances, therefore, there can be, no doubt, that the present suit is not based on. The contract but is completely

independent of it, and even in the relief portion of the plaint, the Plaintiff has claimed damages and the return of earnest money. This being the

situation, the question is as to whether or not, i.e. matter, should be determined by the court or by the arbitrator.

In AIR 1949 Cal 179, a division bench consisting of two eminent judges Harries C.J. And Mukherjea J. clearly held that where the Suit was for

damages and was independent of the contract, which was assailed on grounds pf fraud etc., no order for stay of the suit, could be made. In this

connection; their Lordships observed as follows:

If a court is entitled to go into the question what was substantially the nature of this claim, then Clough J.'s decision may well be right. But in my

view a court is not entitled at .this stage to go into such a question. The court must consider the suit as it is pleaded and; framed. If it comes to a

conclusion that such a suit; as pleaded is a suit on the contract or ; arising Out of the contract then the suit should 'be- stayed. But on the other

hand, if the suit as pleaded is a suit independent of the contract then the court has no power to stay the suit though it is satisfied that the frame of

the suit is merely a means of avoiding the consequences of alleging the true nature of the claim.

The same view/has been taken in a recent division bench decision of the Madras High Court reported in Union of India Vs. Coromandel

Engineering Co., Madras, where their Lordships after considering the entire case law on the subject observed as follows:

Obviously the true principle is that if the suit proceeds on the contract or is referable to any of the rights and obligations under the contract per se

then the clause concerning the arbitration comes into; full effect, and either party may invoke it in bar of the suit. But if the basis for action is itself

independent of the contract and indeed proceeds upon assailing the contract as void for fraud, mutual mistake etc. then it would obviously defeat

the very objective of such a suit to claim that it has to be stayed pending the enforcement of the arbitration clause.

The leading case on the point appears, to be the English case of 1 Icy man v. Darwins Ltd. 1942 AC 356. In this Court Viscount Simon observed

as follows:

Similarly, if one party to the alleged contract is contending that it is void ab initio (because for example, the making of such a contract is illegal) the

arbitration clause cannot operate for, on this view, the clause itself also is void.

Lord Macmillan observed as:

If it appears that the dispute is whether there has ever been a binding contract between the parties, such a dispute cannot be covered by an

arbitration clause in the challenged contract. If there has never been a contract at all, there has never been as part of it, an agreement to arbitrate.

The greater includes the less. Further a claim to set aside a contract on such grounds as fraud, duress or essential error cannot be the subject

matter of reference under an arbitration clause in the contract sought to be set aside.

Lord Writing has held as under:

... One party, though not denying that there was the appearance of assent might claim that the consent was vitiated by fraud or duress or mistake

or illegality and in that sense it is often said that he repudiates the contract. There again It would be a question of construction whether the collateral

arbitration clause could be treated as severable and could be invoked for setting such a dispute.

Similarly Lord Porter observed as follows:

Whether the contract itself is repudiated in the sense that its original existence; or its binding force is challenged e.g. where it is said that the parties

never .were ad idem, or where it is said that the contract is voidable ab initio (e.g. in cases of fraud, misrepresentation or mistake) and that it has

been avoided the parties are not bound by any contract and escape the obligation to perform any of its terms, including the arbitration clause.

This case was referred lo with approval of their Lordships of the Supreme Court in Anderson Wright Ltd. Vs. Moran and Company, , and in this

case their Lordships of the Supreme Court clearly indicated that the question regarding the validity of the contract could be determined by the

court and endorsed the observations of S.R. Das J. as he then was. In Khushi Rain v. Hanutmal 53 C WN 505. S.R. Das J. observed as follows:

Whether the Court will, on an application for stay, lake upon itself the burden of deciding the issue as to the existence of the arbitration agreement

or will in exercise of its discretion refuse the stay and allow the suit to go on, will depend on the facts of each case. In a complicated case involving

serious questions of fraud and the like the Court may in its discretion refuse lo go into and decide the issue as to the formation, existence or the

validity of the arbitration agreement. If the Court considers that the issue has been raised in good faith and the dispute is genuine the Court may

regard that fact by itself as a sufficient reason for not staying the suit.

A division bench of the Patna High Court, in AIR 1052 Pal 352, observed as follows:

It is well settled that if there be in a suit allegations and counter-allegations of fraud or misrepresentation in bringing a contract into existence, such a

suit is independent of the contract, and the dispute, must be decided by the Court and not by the domestic tribunal, for thc repudiation is of the

contract itself and not of the obligations arising out of the contract. The points in dispute cannot, therefore, go to the arbitrators under the

submission cause and the suit, cannot, in our view, be stayed u/s 34 of the Indian Arbitration Act....

Thus it would appear from an analysis of these decisions that where a suit is one for damages and is independent of the contract, and the Plaintiff

merely assails the contract as being vitiated by fraud or misrepresentation etc, then the matter is taken outside the ambit of Section 34 of the

Arbitration Act and has to be decided by the Court and Court alone. Apart from this there may be yet another aspect of the mailer. Where a suit is

brought by the Plaintiff and the very basis of the contract is assailed on the ground of fraud, mis-representation etc, then it follows that if the

contract falls, then the arbitration clause goes with it. Under these circumstances, it is again for...the Court to decide these questions. I am fortified

in my view by a decision of the Allahabad High Court reported in Godhu Mal Vs. Sm. Ganga Hasso Mal Idnani, , where their Lordships observed

as follows:

The law is clear on the point that a defence to the effect that an agreement was never entered into or that it was void for some reason is a mailer

exclusively for the determination of the Court and not for the arbitrator, because if the existence or validity of the entire agreement itself is denied,

and if this denial is found to be correct, the arbitration clause goes along-with the other parts of the agreement.

To the same effect are the decisions reported in:

Jnanendra Krishna Bose Vs. Sinclair Murray Co.,

Further more, it seems to us that h where serious allegations of fraud, misrepresentation or mistake are made by a party to the .; suit, it will be a

better and a sounder exercise of discretion, if the matter are decided by the Court rather than that they are left to be decided by the arbitrator.

Some of the authorities cited above, lay down this principle also. As against this however, the learned Advocate , General has relied on AIR 1901

SC 1285 and the learned Advocate General relies on the following observations of their Lordships in That case at page 1294, which run as

follows:

We may dispose of here a supplementary argument that the dispute till now is about the legal existence of the agreement including, the arbitration

clause and that this is not a dispute arising out of, or in relation to a cotton transaction. Reference was made to certain observations in 1942 AC

In our opinion the words of the Bye Law ""arising out of or in relation lo contracts"" are sufficiently wide-to comprehend matters, which can

legitimately arise u/s 20 the argument is that,, when a party questions the. Very existence of a contract No. dispute can be said to arise out of it.

We think that this is not correct, and even if it were, the further words, ""in relation to"" arc sufficiently wide to comprehend* even such a case. In

our opinion, this argument must also fail.

We are unable to agree with the Advocate-General that the observations of their Lordships lay down a universal rule that whenever a party

questions the very existence of a contract, the matter has lo be referred to arbitration. In the first place, their Lordships were-dealing with a case

u/s 20 of the Arbitration Act, the language of which is not identical with that of Section 34 of the Arbitration Act. Secondly, in that case also an

objection relating to the validity of the contract itself appears to have been raised by one of the parties and it was in fact decided by the Courts

below as also by the Supreme Court itself ins-lead of being left to the arbitrators to decide the same. Thirdly, in that case a single Judge bad

refused to decide the question relating to invalidity of the contract, but on appeal before a division bench of the Bombay High Court the case was

remitted to the Single Judge who after considering these questions, held that the contract was valid. There was an appeal to the division bench

which affirmed its decision and then the matter was taken to the Supreme Court. Finally their Lordships have indicated in unmistakable terms in

para. 25 of the judgment that questions as to the existence or validity of the agreement are saved from the decision by arbitrators: In this

connection, their Lordships have observed as follows:

Learned Counsel for the buyers contends that nothing is saved of the Act. This is not correct. To begin with, questions as to the existence or

validity of the agreement are saved from decisions by arbitrators or umpires however, appointed. Since such a plea can only be, raised in bar of an

application by persons seeking a reference to arbitration at least that portion of the Act still applies and that power can only be exercised by the

Court. Other provisions of Chap. II like Sections 15 and 16 still remain applicable. We need not give a list of all the provisions which may be

saved, because that, will involve an examination side by side, of the Sections of the Act and the provisions of the Bye-laws. So long as something

is saved it cannot be said that the Court after receiving the agreement and ordering that it be filed, .becomes completely functus officio.

Lastly the Bye-Law which was the arbitration agreement in the case before the Supreme Court was sufficiently wide to comprehend, objections

which went to the root of the contract. Their Lordships interpreted the words ""arising out of and in relation to"" as being sufficiently wide to

comprehend even such objections as went to the root of the contract. In the instant case, the arbitration clause runs as follows:

All disputes between the parties to the Contract (other than those or which the decision of the CWE or any other person is by the -contract

expressed to be final and binding) -shall, after written notice by either party to the contract to the other of them be referred to the only arbitration

of an Engineer Officer to be appointed by the authority mentioned in the tender document.

The language of this clause which allows -reference to arbitration only with respect to all disputes between the parties is not wide enough to cover

the objection relating to the validity of the contract on the ground of mistake of fact, misrepresentation etc. It is manifest, therefore, that the

language of this clause is quite different from the language of the Bye-law which was being construed by their Lord-f-ships in AIR 1901 SC 1285.

In these circumstances, therefore, we are clearly of the opinion that the Plaintiff is entitled to be heard in respect of his plea, that according to his

allegations in the plaint, the contract is vitiated by misrepresentation, fraud or mistake and if the suit is independent of the contract, it should not be

stayed. As, however, the Plaintiff did not press this objection before the learned Single Judge, he must be saddled with costs.

For these reasons, therefore, we would allow this appeal, set aside the order of the ,.learned Single Judge and remit the case to him for raising a

preliminary issue on the plea taken by the Appellant and deciding the same Rafter giving opportunity to the parties to lead evidence thereon. The

Plaintiff shall, however, pay Rs. 200 (Two hundred) as costs lo the Defendant.

J.N. Wazir, C.J.

I agree.