Two Indian Parties Can Pick A Foreign Seat: But What About Substantive Law?

By Mr. Ajar Rab, Partner at Rab & Rab Associates LLP and Ms. Kirpen Dhaliwal, LL.M Candidate at NALSAR Hyderabad and research assistant to Mr. Ajar Rab

The recent judgment of a three-judge bench of the Supreme Court in PASL Wind Solutions Private Ltd.. v. GE Power Conversion India Private Ltd. (“PASL”) is a monumental victory for party autonomy in Indian arbitration. The Supreme Court has upheld the freedom of Indian parties to elect a seat of arbitration outside India, settling the much-debated law on this issue. Permitting two Indian parties to choose a foreign seat is a positive development as it effectively brings the Indian Arbitration and Conciliation Act, 1996 (“Arbitration Act”) in conformity with Article 1(3)(b) of the UNCITRAL Model Law, 1985 (“Model Law”). Article 1(3)(b) of the Model Law adopts a place-centric approach to define ‘international arbitration’. It recognizes the freedom of the parties to determine a place of arbitration outside of the State in which their place of business is situated.

Contrary to the Model Law, a slightly muddled approach was taken by a single bench of the Supreme Court in TDM Infrastructure Private Ltd. v. UE Development India Private Ltd. (“TDM”). The court held that two Indian parties cannot choose a foreign seat of arbitration. The court’s reasoning confused two critical issues, (a) the choice of substantive law and (b) the choice of lex arbitri, i.e. law of the seat. The analysis of the court was based primarily on Section 28 of the Arbitration Act to determine that Indian parties cannot be permitted to derogate from Indian substantive law as that would be violative of the public policy of the country. Though the court was correct in its view that Indian parties cannot be permitted to derogate from Indian substantive law, it did not venture into an analysis of how the choice of a foreign seat would result in such derogation.

The Place-Centric vs. Person-Centric Approach

Article 1(3)(b) of the Model Law adopts a place-centric approach and permits parties to pick a foreign seat. Similarly, Section 2(2) of the Arbitration Act provides that Part I shall apply only when the ‘place’ (seat) of arbitration is in India. Hence, all other provisions in Part I can only be read when the arbitration is seated in India. Once the parties pick a foreign seat, Part I cannot have any application and hence, the question of whether arbitration is domestic or international as provided in Section 2(1)(f) of the Arbitration Act could not have been addressed by the court in TDM.

Only when Part I applies, the court or the tribunal has to address the question of an arbitration being domestic or international. At this stage, the court shifts to a party-centric approach to determine the nature of the arbitration proceedings. Depending on the conclusion the court reaches, Section 28(1)(a) of the Arbitration Act would apply if the arbitration is domestic. Otherwise, Section 28(1)(b) would apply.

Once the court or tribunal determines that the arbitration is international, the court has to address the choice of substantive law. Therefore, the court could not have applied Section 28 of the Arbitration Act since the parties had chosen a foreign seat, and by virtue of Section 2(2) of the Arbitration Act, Part I would have been inapplicable.

Derogation of Indian Law

Though the court may have taken a different road, it reached the correct result. The principle laid down in TDM that choice of a foreign seat may effectively permit Indian parties to circumvent substantive Indian laws or conduct transactions in a manner not permitted under India laws was not inaccurate.

Article 28 of the Model Law provides that the dispute shall be determined in accordance with substantive law chosen by the parties. This provision has been incorporated without any qualifications in most national arbitration statutes such as section 46 of the English Arbitration Act, 1996, or section 32 of the Singapore Arbitration Act, 2001. When two Indian parties choose a foreign seat, for instance, London, the English Arbitration Act will govern the arbitral proceedings. At the seat, the arbitration will be international, and the parties will have the right to choose a foreign substantive law. For example, Section 46 of the English Arbitration Act recognizes the freedom of the parties to choose any substantive law. Therefore, two Indian parties, by opting for a foreign seat, would effectively sidestep Indian substantive law, which would undoubtedly be violative of public policy. Hence, by permitting two Indian parties to choose a foreign seat, there exists a danger of allowing Indian parties to do indirectly what cannot be done directly, i.e., contract out of Indian substantive law. .

PASL: Towards the Right Goal but Just Short

The Supreme Court in PASL has clarified that Part I and Part II of the Arbitration Act are mutually exclusive and that foreign seated arbitrations are enforceable in accordance with Part II. Relying on Atlas Export Industries v. Kotak & Company the court pointed out the exception to Section 28 of the Contract Act and held that there is nothing in Section 23 or 28 that prohibits two Indian parties from choosing a neutral foreign seat for arbitration. Unfortunately, it did not address the issue of foreign substantive law. Some authors take the view that by permitting the parties to choose a foreign seat, Indian parties may also choose a foreign substantive law. Such a view may not be supported by the language of Section 23 of the Indian Contract Act, 1872 (“ Contract Act”), which makes agreements void if they would defeat the provisions of the law in India.

In fact, most precedents such as Sasan, Reliance, etc which have affirmed the rights of parties to choose a foreign seat, were dealing with facts where parties had chosen Indian substantive law as the governing law but only opted for a foreign seat. Even in PASL the parties had not chosen a foreign substantive law, and hence, by implication, the court has only affirmed a hybrid approach where two Indian parties can opt for a foreign seat but not foreign law.

The Statutory Basis for the Hybrid Approach

Even though the courts have implied that they are willing to adopt a hybrid approach, and to that extent, overrule the view in TDM, without a well-reasoned statutory basis, the future judgements may muddle up the issue again. Therefore, as noted by the Supreme Court in PASL, there is a need to balance the freedom of contract with public policy. A harmonious interpretation of the principles laid down in TDM and PASL upholds the freedom of Indian parties to choose a foreign seat with a limitation that it cannot be used to defeat the purpose of mandatory Indian laws. Such an interpretation finds its statutory basis in section 23 read with section 24 of the Contract Act.

Any agreement between two Indian parties is governed by the mandatory provisions of the Contract Act. Section 23 specifies the contours of unlawful object and consideration of an agreement, i.e., ‘The object or consideration of an agreement is unlawful if it is forbidden by law, or if it defeats the provisions of any law, or it involves injury to another’s property or person, or if the court considers it as opposed to public policy’. Section 24 invalidates any agreement if any part(s) of the objects or considerations of such agreement is unlawful. Since the arbitration agreement would be entered into by two Indian parties, Section 23 would invalidate the choice of a foreign substantive and consequently the entire arbitration agreement. However, Section 24 of the Contract Act would rescue the arbitration agreement and only invalidate the choice of a foreign substantive law.

Conclusion

PASL has rekindled the age-old debate about India moving towards a pro-arbitration approach but has stopped short of conclusively laying to rest the contours of public policy and the derogation of Indian law, which was rightly attempted to be addressed in TDM. If courts were to analyze these questions first with a place-centric approach and then a person-centric approach in light of the bar under Section 23 and 24 of the Contract Act, the hybrid approach impliedly being affirmed would be formally recognized and clear the decks for Indian arbitration truly imbibing the holy grail of party autonomy in arbitration without offending its mandatory laws.