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Guarantor not bound by arbitration agreement executed between lender and borrower
Practical Law UK Legal Update Case Report 2-504-0797 (Approx. 3 pages)
Guarantor not bound by arbitration agreement executed between lender and borrower
by Practical Law
| Published on 01 Dec 2010 • India |
Priyanka Gandhi (Associate) and Ankur Kashyap (Associate), Juris Corp
In a recent decision, the Supreme Court of India held that a guarantor who is not a party to the arbitration agreement cannot be made a party to the arbitration proceedings.
Background
Section 2(h) of the Indian Arbitration and Conciliation Act (Act) defines the term "party" as a party to an arbitration agreement.
Section 7 of the Act 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.
Under the Act it is mandatory that an arbitration agreement should be in writing. For these purposes, an arbitration agreement is deemed to be in writing if it is contained in:
- A document signed by the parties.
- An exchange of letters, telex, telegrams or other means of telecommunication which provides a record of the agreement.
- An exchange of statements of claim and defence in which the existence of the agreement is alleged by one party and not denied by the other.
Facts
In this case S.N. Prasad (the appellant) executed a guarantee letter for being guarantor of a loan in the sum of INR 7.5 million (the first loan) advanced by Monnet Finance Ltd. (the first respondent) to Hitek Industries (the second respondent) in which he was a director. After the first loan, two further loans, in the sum of INR 5 million (the second loan) and INR 2.5 million (the third loan) respectively were provided by the first respondent to the second respondent.
The appellant's son (the third respondent), who was the managing director (MD) of the second respondent, entered into two loan agreements, promissory notes and deed of guarantees with respect to the second loan and third loan. These loan agreements provided for the settlement of disputes by arbitration. The appellant was not a signatory to any of these agreements.
The first respondent issued a notice demanding payment of the first and second loan amounts from the appellant, and second and third respondents. By two separate Orders, the Delhi High Court appointed a sole arbitrator to decide the matter. The arbitrator issued two separate awards, deciding that the appellant, and second and third respondents were liable to pay the second and third loans with interest to the first respondent. A challenge to the arbitration award before the Delhi High Court was dismissed. The aggrieved parties appealed to the Supreme Court by way of a Special Leave Petition.
Decision
After reviewing the guarantee letter, the loan agreements and the accompanying promissory notes and guarantee deeds the Supreme Court reached the conclusion that:
- When the appellant gave the guarantee letter, he could not have known that the second and third loan agreements executed in the future would contain an arbitration clause.
- The appellant had not stated in the guarantee letter that he would be bound by the terms of the second and third loan agreements.
- As there was no arbitration agreement between the first respondent and the appellant, the appellant could not be made a party to the arbitration proceedings and the award against the appellant could not be sustained.
Comment
This judgment further reinforces the principle that a non-signatory to an arbitration agreement cannot be bound by an arbitration agreement. In an earlier decision in Indowind Energy Ltd. v Wescare (i) Ltd. and Anr. (not referred to or relied upon in this case), the Supreme Court of India had categorically held that a party who has not signed, ratified, approved or confirmed the arbitration agreement cannot be bound by it (see Legal update, Can a third party be bound by an arbitration agreement?). It is clear that the argument that a party is a party to an arbitration agreement by implication will not readily be accepted by the Indian courts. It is therefore advisable that specific signature/ratification/approval/confirmation is sought from the parties intended to be bound by the arbitration agreement.