Reportable

IN THE SUPREME COURT OF INDIA

CIVIL APPELLATE JURISDICTION

CIVIL APPEAL NO. 9224 OF 2010

[Arising out of SLP [C] No.17114/2008]

With

CIVIL APPEAL NO. 9225 OF 2010

[Arising out of SLP [C] No.17115/2008]

S.N. Prasad … Appellant

Vs.

Monnet Finance Ltd. & Ors. … Respondents

J U D G M E N T

R.V.RAVEENDRAN, J.

Leave granted. These appeals involve the question whether a

guarantor for a loan, who is not a party to the loan agreement containing the

arbitration agreement executed between the lender and borrower, can be

made a party to a reference to arbitration in regard to a dispute relating to

repayment of such loan and subjected to the arbitration award.

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2.The second respondent company is a borrower from the first

respondent. Third respondent is the Managing Director of the second

respondent. The appellant, father of the third respondent, was a Director of

the second respondent. The second respondent (also referred to as

‘borrower’) after repaying an earlier loan taken from the first respondent

(also referred to as the ‘lender’), sought a fresh loan of Rs.75 lakhs. The first

respondent sanctioned the loan. The appellant by letter dated 27.10.1995 in

his capacity as a Director of the second respondent, stood guarantee for the

loan of Rs.75 lakhs sanctioned by the first respondent.

3.A loan agreement dated 28.10.1995 was entered between the lender,

the borrower, and the third respondent as the guarantor, in regard to the

lending of a sum of Rs.50 lakhs. The agreement provided that the amount

advanced had to be repaid within three months with interest at 20% per

annum and if there was default, the borrower was liable to pay a compound

interest at the rate of 5% per month with quarterly rests. Clause 18 of the

said loan agreement provided for settlement of disputes by arbitration. In

addition to the loan agreement, the borrower executed an on demand

promissory note for the amount borrowed and the third respondent executed

a Deed of Guarantee guaranteeing repayment of the loan amount with

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interest. Similarly, a tripartite loan agreement was entered in respect of a

loan of Rs.2500,000/- on 6.11.1995, among the first respondent, second

respondent and third respondent followed by a promissory note by second

respondent and deed of Guarantee by third respondent. The appellant was

not a party to the loan agreements nor did he execute any separate deeds of

guarantee or other document in favour of the first respondent. The loan

agreements did not refer to the letter of guarantee by the appellant.

4.The lender issued a notice through counsel demanding payment and

proposing to refer the claims against the borrower and its guarantors for

arbitration. This was followed by two applications by the lender under

section 11 of the Arbitration and Conciliation Act, 1996 (‘Act’ for short) for

appointment of an Arbitrator. The borrower, its Managing Director-cum-

Guarantor, and the appellant were impleaded as respondents in the said

application.

5.The High Court of Delhi by two orders dated 23.5.2000 appointed a

retired Judge of the High Court as the sole arbitrator. The arbitrations ended

in two awards dated 1.5.2002. The first award directed respondents 2 and 3

and appellant to pay Rs.93,23,288/- (that is Rs.50 lakhs with interest at 20%

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up to the date of the appointment of arbitrator) with interest at 18% per

annum from 24.5.2000. Similarly the second award directed respondents 2

and 3 and appellant to pay Rs.46,49,315/- (that is Rs.25 lakhs with interest at

20% upto the date of appointment of arbitrator) with interest at 18% per

annum from 24.5.2000. The two arbitration awards were challenged by the

appellant by filing applications under section 34 of the Act (OMP

No.319/2002 and 322/2002). The second and third respondents also

challenged the awards in OMP No.320/2002 and 321/2002. A learned single

Judge of the Delhi High Court by a common order dated 22.5.2006

dismissed the said applications. The said common order dated 22.5.2006,

insofar as it dismisses OMP 319/2002 and 322/2002, is challenged by the

appellant in this appeals by special leave.

6.The following contentions are urged by the appellant :

(i)The appellant was not a party to the tripartite loan agreements

executed among respondents 1, 2 and 3 (that is the lender, the

borrower and borrower’s Managing Director-cum-Guarantor)

containing the arbitration clause. He had merely given a short letter

dated 27.10.1995 standing guarantee for a loan of Rs.75 lakhs

sanctioned by the first respondent. As there was no arbitration

agreement between the first respondent and appellant, the claim

against the appellant could not be referred to arbitration, nor could any

award be made against him. The awards against the appellant were

therefore liable to be set aside under section 34(2)(a)(ii) of the Act.

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(ii)The appellant had merely given a letter dated 27.10.1995 indicating

his willingness to stand guarantee, but he did not execute the loan

agreement or any deed of guarantee, as it was decided that the third

respondent would be the guarantor instead of appellant. Consequently,

the third respondent executed the loan agreement as guarantor as also

a deed of Guarantee. Therefore, the appellant was not a guarantor and

is not liable.

(iii)Even assuming without conceding that there was an arbitration

agreement between the appellant and first respondent, and that he was

liable in respect of the loan amount, there could be no award for

interest against him as he had not agreed to guarantee the payment of

interest.

Re : Contention (i)

7. Section 2(b) defines “arbitration agreement’ as an agreement referred

to in section 7 of the Act. Section 2(h) defines “party” as party to an

arbitration agreement. Section 7 of the Act defines an ‘arbitration

agreement’. Sub-section (1) of Section 7 defines an arbitration agreement as

an agreement by the parties to submit to arbitration all or certain disputes

which have arisen or which may arise between them in respect of a defined

legal relationship, whether contractual or not. Sub-section (2) provides that

an arbitration agreement may be in the form of an arbitration clause in a

contract or in the form of a separate agreement. Sub-section (3) requires an

arbitration agreement to be in writing. Sub-section (4) explains as to when

an arbitration agreement could be said to be in writing, that is : (a) a

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document signed by the parties; (b) an exchange of letters, telex, telegrams

or other means of telecommunication which provide a record of the

arbitration agreement; or (c) an exchange of statements of claim and defence

in which the existence of the arbitration agreement is alleged by one party

and not denied by the other. Sub-section (5) provides that the reference in a

contract to a document containing an arbitration clause constitutes an

arbitration agreement if the contract is in writing and the reference is such as

to make that arbitration clause a part of the contract. Thus there can be

reference to arbitration only if there is an arbitration agreement between the

parties. The Act makes it clear that an Arbitrator can be appointed under the

Act at the instance of a party to an arbitration agreement only in respect of

disputes with another party to the arbitration agreement. If there is a dispute

between a party to an arbitration agreement, with other parties to the

arbitration agreement as also non-parties to the arbitration agreement,

reference to arbitration or appointment of arbitrator can be only with respect

to the parties to the arbitration agreement and not the non-parties.

8.There is no dispute that the loan agreements among the first

respondent (lender), the second respondent (borrower) and the third

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respondent (guarantor) contained a provision for arbitration. The said

provision for arbitration is extracted below :

“In the event of any dispute, question or difference arising out of or in

connection with this agreement and the respective rights and obligations

of the parties hereunder, the same shall be referred to the arbitration in

accordance with the provisions of the Arbitration Act, 1940.”

But the appellant was not a party to the same. In fact appellant’s letter of

guarantee for Rs.75 lakhs was given on 27.10.1995, prior to the dates of the

two loan agreements. It is also not in dispute that the letter dated 27.10.1995

given by appellant to the first respondent did not contain a provision for

arbitration; and that except the said letter dated 27.10.1995, the appellant did

not execute any document or issue any communication. An arbitration

agreement between the lender on the one hand and the borrower and one of

the guarantors on the other, cannot be deemed or construed to be an

arbitration agreement in respect of another guarantor who was not a party to

the arbitration agreement. Therefore, there was no arbitration agreement as

defined under section 7(4)(a) or (b) of the Act, in so far as appellant was

concerned, though there was an arbitration agreement as defined under

section 7(4)(a) of the Act in regard to the second and third respondents. As

the letter dated 27.10.1995 does not refer to any document containing an

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arbitration clause, there is also no arbitration agreement between first

respondent and appellant as contemplated under section 7(5) of the Act.

9.What therefore remains to be considered is whether there is an

arbitration agreement as contemplated under section 7(4)(c) of the Act,

which provides that an arbitration agreement in writing can be said to exist,

if it is contained in an exchange of statements of claim and defence in which

the existence of the arbitration agreement is alleged by one party and not

denied by the other. The statement of claim filed by the first respondent

before the arbitrator does not contain an allegation or assertion of an

arbitration agreement between the first respondent and appellant. Nor has the

appellant accepted the existence of any arbitration agreement by not denying

such arbitration agreement in the defence filed before the arbitrator. On the

other hand, the appellant specifically contended before the arbitrator that

there was no arbitration agreement between them (first respondent and

appellant) and therefore the arbitrator did not have jurisdiction.

10.But the words, ‘statements of claim and defence’ occurring in section

7(4)(c) of the Act, are not restricted to the statement of claim and defence

filed before the arbitrator. If there is an assertion of existence of an

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arbitration agreement in any suit, petition or application filed before any

court, and if there is no denial thereof in the defence/counter/written

statement thereto filed by the other party to such suit, petition or application,

then it can be said that there is an “exchange of statements of claim and

defence” for the purposes of section 7(4)(c) of the Act. It follows that if in

the application filed under section 11 of the Act, the applicant asserts the

existence of an arbitration agreement with each of the respondents and if the

respondents do not deny the said assertion, in their statement of defence, the

court can proceed on the basis that there is an arbitration agreement in

writing between the parties.

11.The question therefore is whether in this case, the application under

section 11 of the Act had alleged the existence of an arbitration agreement

between first respondent and appellant and such allegation was accepted by

non-denial thereof, by the appellant. The application filed by the first

respondent under section 11 of the Act referred to the loan agreement

containing the arbitration clause, which was executed by respondents 2

and 3 as borrower and guarantor in favour of the first respondent. The

application specifically relied upon the provisions of clause 18 of the loan

agreement as the arbitration agreement under which appointment of an

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arbitrator was sought. Significantly, the application under section 11 of the

Act did not allege or refer to the existence of any arbitration agreement

between the first respondent and the appellant. The only averment found in

the entire application with reference to the document executed by the

appellant is extracted below:

“Respondent No.3 vide his letter dated 27.10.95 guaranteed the repayment

of the total amount of loan i.e. Rs.75,00,000 (Rupees Seventy Five Lakhs)

sanctioned by the Petitioner to Respondent No.1. Copy of the letter dated

27.10.95 from Respondent No.3 guaranteeing repayment of loans is

annexed herewith and marked as “ANNEXURE-C”.

(Note: The term ‘petitioner’ refers to the lender, respondent No.1 refers to

the borrower and respondent No.3 refers to the appellant).

Except the aforesaid averment, there is absolutely no reference to any

agreement between the first respondent and the appellant or the existence of

any arbitration agreement between them. Therefore the application filed by

the first respondent under section 11 of the Act referring to the loan

agreement with respondents 2 and 3 containing the arbitration agreement

cannot be considered or construed to be an allegation of existence of an

arbitration agreement between first respondent and appellant. If there was no

reference to the existence of any arbitration agreement with appellant, the

question of the appellant accepting such arbitration agreement by ‘non-

denial’ does not arise.

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12.The first respondent contended that the application under section 11 of

the Act consisted of two parts, that is a preamble containing three columns -

column (1) relating to the “provision under which the application was filed”,

column (2) relating to “Name of applicant with complete address” and

column (3) relating to “Name of the other parties to the arbitration

agreement with complete address”; and the second part contained the

running averments. It is submitted that the name of first respondent is shown

as the applicant in column (2); and against column (3) relating to “Names of

the other parties to the arbitration agreement”, the names of Hitek Industries

(second respondent), Prem Prakash Verma (third respondent) and S.N.

Prasad (appellant) was shown and that amounted to an allegation that the

appellant was a party to the arbitration agreement.

13.To constitute an arbitration agreement under section 7(4)(c) of the

Act, what is required is a statement of claim containing a specific allegation

about the existence of an arbitration agreement by the applicant and ‘non-

denial’ thereof by the other party. An ‘allegation’ is an assertion or

declaration about a fact and also refers to the narration of a transaction. As

noticed above, in the entire application under section 11 of the Act, there

was no allegation as to the existence of any arbitration agreement between

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first respondent and the appellant. Column (3) containing “Names of other

parties to arbitration agreement with addresses” cannot be considered to be

an assertion or declaration about the existence of an arbitration agreement

between the first respondent and appellant. Section 7(4)(c) of the Act cannot

therefore be relied upon to prove the existence of an Arbitration agreement.

14.It is of some relevance to note that in the year 1998 when the

applications under section 11 of the Act was filed and in the year 2000 when

the applications were allowed, an application under section 11 of the Act

was not considered to be a judicial proceeding and the order appointing an

arbitrator was considered to be an administrative order. Therefore at the

relevant time, the application under section 11 of the Act and the counter if

any thereto were not in the nature of ‘statements of claim and defence’. Be

that as it may.

15.Before the Arbitrator, the appellant specifically contended that by

relying upon the section 2(1)(h) and section 7 of the Act that he was not a

party to the arbitration agreement and therefore there could be no arbitration

in regard to the claim against him. The said contention was rejected by the

arbitrator on the ground that the designate of the Chief Justice, in his order

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dated 23.5.2000 appointing the arbitrator, had observed that the existence of

arbitration agreement was not denied and there was no dispute regarding the

existence of the arbitration agreement. But what was not denied was the

arbitration agreement between first respondent and respondents 2 and 3. The

arbitrator held that in view of the positive finding of the designate of the

Chief Justice about the existence of an arbitrator agreement notwithstanding

the fact that the letter of guarantee does not refer to the loan agreement

which was executed subsequently, it could not be said that there was no

arbitration agreement between the parties. The arbitrator ought to have

considered and decided the objections of the appellant that he was not a

party to the arbitration agreement on merits, instead of referring to the order

of the designate of the Chief Justice appointing the arbitrator. As noted

above, when the said application under section 11 of the Act was filed in

1998 and decided in 2000 (long prior to the decision in SBP & Co. vs. Patel

Engineering Ltd. – (2005) 8 SCC 618,) the prevailing view was that the

orders under section 11 of the Act were administrative orders and that the

Designate of the Chief Justice appointing an arbitrator was not adjudicating

on any disputed question of fact, including the existence of any valid

arbitration agreement; and that the Arbitrator was required to decide about

the existence of arbitration agreement and the arbitrability.

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16.The first respondent contended that the appellant having agreed to be

a guarantor for the repayment of the loan, can not avoid arbitration by

contending that he was not a signatory to the loan agreement containing the

arbitration clause. It was submitted that the liability of the principal debtor

and guarantors was joint and several and therefore there could be only one

proceeding against all of them; and that if the contention of the appellant

was accepted, it would necessitate two proceedings in regard to the same

loan transaction and same cause of action, that is an arbitration proceedings

against the borrower and one of its guarantors (respondents 2 and 3) and a

separate suit against the other guarantor (appellant). It was further submitted

that multiple proceedings may lead to divergent findings and results, leading

to an anomalous situation. It was also submitted that the letter

dated 27.10.1995 guaranteeing the loan of Rs.75 lakhs was written by the

appellant, as a Director of the borrower company; and that as the appellant

had already given a guarantee letter dated 27.10.1995, he was not required to

execute the tripartite loan agreements containing the arbitration clause; that

the appellant was aware of the terms of the loan and was further aware that

loan agreements with arbitration clause had to be executed; and that

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therefore it should be deemed that the appellant had agreed to abide by the

terms contained in the loan agreements, including the arbitration clause. We

find no merit in these contentions.

17.When the appellant gave the guarantee letter dated 27.10.1995, he

could not be imputed with the knowledge that the loan agreements which

were to be executed in future (on 28.10.1995 and 6.11.1995) would contain

an arbitration clause. Further, the appellant did not state in his letter dated

27.10.1995 that he would be bound by the terms of loan agreement/s that

may be executed by the borrower. Therefore the question of appellant

impliedly agreeing to the arbitration clause does not arise.

18.The apprehension of the first respondent that an anomalous situation

may arise if there are two proceedings (one arbitration proceedings against

the borrower and one guarantor and a suit against another guarantor), is not a

relevant consideration as any such anomalous situation, if it arises, would be

the own-making of the first respondent, as that is the consequence of its

failure to require the appellant to join in the execution of the loan

agreements. Having made only one of the guarantors to execute the loan

agreements and having failed to get the appellant to execute the loan

agreements, the first respondent cannot contend that the appellant who did

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not sign the loan agreements containing the arbitration clause should also be

deemed to be a party to the arbitration and be bound by the awards. The

issue is not one of convenience and expediency. The issue is whether there

was an arbitration agreement with the appellant.

19.As there was no arbitration agreement between the parties (the first

respondent and appellant), the impleading of appellant as a respondent in

the arbitration proceedings and the award against the appellant in such

arbitration cannot be sustained. As a consequence, both the arbitration

awards, as against the appellant are liable to be set aside. If the first

respondent wants to enforce the alleged guarantee of the appellant, it is open

to the first respondent to do so in accordance with law.

20.The above discussion and findings would also apply to the second

loan covered by the loan agreement dated 6.11.1995, as the facts are the

same.

Re : Contention (ii)

21.The appellant contended that on 27.10.1995 he was a Director of the

borrower company and he had agreed to guarantee the loan of Rs.75 lakhs;

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that subsequently, it was decided as he would be resigning from his

directorship on account of his advanced age, his son would be the guarantor;

and that therefore, he did not become a guarantor by executing a deed of

guarantee and he did not also execute the loan agreements. It was contended

that the fact that ultimately the loan agreements were executed only among

the lender (first respondent), the borrower company (2

nd

respondent) and the

3

rd

respondent (guarantor) and the further fact that third respondent alone

executed the Deed of Guarantee, demonstrated that only third respondent

was the guarantor and he was not a guarantor. According to him on

execution of the loan agreements among respondents 1, 2 and 3, the letter

dated 27.10.1995 given by him agreeing to be a guarantor ceased to be of

any effect. We cannot examine these aspects in an appeal arising from a

proceeding under section 11 of the Act. In a proceedings under section 11 of

the Act, what is relevant is existence of arbitration agreement and not the

defence on merits. Further, in view of our finding on the first contention, it is

not necessary to examine this contention. It is open to appellant to urge this

contention, if and when first respondent initiates action against him in

accordance with law.

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Re : Contention (iii)

22.It is true that where the letter of Guarantee issued by a guarantor,

guarantees repayment of only the principal sum and does not guarantee the

payment of any interest, he could not be made liable for the interest. But in

view of our finding on the first contention, this issue does not survive for

consideration.

Conclusion

23.In view of the above, these appeals are allowed and the impugned

order of the High Court and awards of the Arbitrator are set aside in part, in

so far as the appellant is concerned.

…………………………J.

(R V Raveendran)

New Delhi; ……………………….J.

October 22, 2010. (H L Gokhale)

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