Gaya Electric Supply Co., Ltd vs The State Of Bihar

Rewritten Version Notice: This is a rewritten version of the original judgment.

Court: Supreme Court of India

Case Number: Civil Appeal No. 175 of 1951

Decision Date: 3 February 1953

Coram: Mehr Chand Mahajan, Ghulam Hasan

In the matter titled Gaya Electric Supply Co., Ltd versus The State of Bihar, the Supreme Court of India delivered its judgment on 3 February 1953. The opinion was authored by Justice Mehr Chand Mahajan, who sat on the bench together with Justice Ghulam Hasan. The case is recorded as Gaya Electric Supply Co., Ltd v. The State of Bihar, citation 1953 AIR 182, also reported in 1953 SCR 572. The judgment appears in the citation index E & D 1985 SC1156, at pages 49 and 52. The issues before the Court concerned the application of section 34 of the Indian Arbitration Act of 1940 to a contract that contained an arbitration clause, the rescission of that contract by one of the parties, and the request for a stay of a suit.

The headnote summarised the legal principle that when an arbitration agreement is broad, comprehensive, and embraces any dispute arising out of the contract, a party seeking to avoid the contract on a ground that stems from the contract itself must refer the dispute to arbitration. Conversely, if the party attempts to avoid the contract for reasons external to the contract, the arbitration clause cannot be invoked, because a party may not rely on a term of the contract to repudiate it and simultaneously claim that the arbitration clause does not apply. The headnote further explained that when an arbitration clause is not drafted in such expansive language—specifically lacking phrases such as “in respect of any agreement” or “in respect of anything arising out of it”—the foregoing principle does not apply. In such circumstances, the arbitration clause must be interpreted according to its actual wording and the surrounding circumstances of its creation.

The factual background involved a dispute between the State of Bihar and Gaya Electric Supply Co., Ltd, an electric supply company whose licence had been revoked by the State. The parties entered into an agreement whereby the State agreed to make an advance payment of five lakh rupees to the company, and the company agreed to hand over its undertaking to the State. The agreement stipulated that the undertaking would be valued within three months. If the government’s valuation determined that the amount due to the company exceeded five lakh rupees, the excess would be paid to the company; if the valuation was less than five lakh rupees, the company would refund the excess it had received.

The agreement contained an arbitration clause that read: “In the case of any difference or dispute between the parties over the valuation as arrived at by the Government and that arrived at by the company, any such difference or dispute, including the claim for additional compensation of twenty percent, shall be referred to arbitration.” After the State allegedly failed to carry out its valuation and to make the required payment of any excess within the time fixed—time that the contract considered essential—the company rescinded the agreement. The company then instituted a suit seeking a declaration that the undertaking belonged to it, damages, and the appointment of a receiver. The State, invoking section 34 of the Arbitration Act, applied for a stay of the suit, contending that the arbitration clause covered the disputes raised in the proceedings.

In this dispute, the company argued that the State had failed to make the payment of the excess amount within the time fixed by the agreement and that time was expressly treated as essential to the contract. Consequently, the company said it had rescinded the agreement and was praying for a judicial declaration that the undertaking rightfully belonged to it. In addition, the company sought monetary damages and asked that a receiver be appointed to manage the undertaking. The State responded by invoking section 34 of the Arbitration Act and applied for a stay of the suit on the ground that the matter should be referred to arbitration. The Court examined the arbitration clause contained in the settlement agreement and held that its scope was very narrow. The clause gave the arbitrator authority only to determine the pure question of valuation of the undertaking. Matters relating to breach of the contract, including the rescission of the agreement, lay outside the ambit of the arbitration clause. Accordingly, the Court concluded that the suit could not be stayed under section 34 because the issues raised were not covered by the arbitration agreement. The Court referred to the authority in Heyman v Darwins Ltd (119421 A.C. 356) and distinguished the decisions in Harinagar Sugar Mills Ltd v Skoda (India) Ltd (A.I.R. 1948 Cal. 230) and Governor-General in Council v Associated Livestock Farm Ltd ([1937] 41 C.W.N. 563) in arriving at this conclusion.

The judgment was delivered in the Civil Appellate Jurisdiction as Civil Appeal No 175 of 1951, filed by special leave against the order and decree dated 30 March 1951 of the High Court of Judicature at Patna (Ramaswami and Rai JJ.) in Miscellaneous Appeal No 19 of 1951. The appeal arose from an order dated 18 December 1950 of the Court of the Additional Sub-Judge Second at Gaya in Title Suit No 47 of 1950. Counsel for the appellant included N C Chatterjee, assisted by Rameshwar Nath, while the respondent was represented by M C Setalvad, Attorney-General for India, and Mahabir Prasad, Advocate-General of Bihar, assisted by B J Umrigar. The judgment was pronounced on 3 February 1953 by Justice Mahajan. The appeal concerned an application made by the State of Bihar under section 34 of the Indian Arbitration Act seeking a stay of proceedings in a suit that the Gaya Electric Supply Co. Ltd. had filed on 28 September 1950. The factual background relevant to the application was that a licence for supplying electricity in the town of Gaya had been originally granted to a person named Khandelwal in 1928 under the Indian Electricity Act 1910. With governmental approval, the licence was transferred to the company in 1932. By a notification dated 23 June 1949, the Government revoked the licence effective from 9 July 1949. The company thereafter instituted a suit challenging the revocation as arbitrary, mala fide and ultra vires. While the suit was pending, negotiations between the company and the State led to a deed of agreement dated 28 October 1949. The agreement stipulated that the company would unconditionally withdraw suit No 58 of 1949 on 25 October 1949, and that the State of Bihar would, within three days of the withdrawal, make an advance payment of rupees.

In the settlement deed the parties agreed that the company would withdraw suit No 58 of 1949 unconditionally on 25 October 1949 and that, within three days of the withdrawal, the State of Bihar would make an advance payment of five lakh rupees to the company. At the same time the company would formally hand over possession of the undertaking to an authorized government officer. Both sides also undertook to prepare their respective valuations of the undertaking within three months of the hand-over. The agreement provided that any balance due to the company, as determined by the Government’s valuation, would be paid to the company, while any excess amount paid under the advance of five lakh rupees would be refunded to the Government. The parties further agreed that if a difference or dispute arose over the balance after valuation, the matter would be submitted to the sole arbitration of a single arbitrator who must be a high-ranking provincial government officer of rank equal to or higher than a Divisional Commissioner, and that the arbitrator’s award would be final and binding on both parties. This arbitration clause was set out in a letter dated 13 October 1949 and was accepted by the company in its letter dated 17 October 1949. In the State’s application under section 34 of the Arbitration Act, it was stated that any difference or dispute between the parties over the valuations – including the company’s claim for an additional twenty per cent compensation – would be referred to arbitration.

Pursuant to the agreement the State took over the undertaking on 28 October 1949 and paid the company the agreed sum of five lakh rupees. On 19 January 1950 the company sent a valuation statement of its assets amounting to Rs 22,06,072 to the Chief Electrical Engineer of Bihar. The Chief Engineer described the company’s valuation of twenty-two lakh rupees as “fantastic” and indicated that a rough estimate placed the value at approximately five lakh rupees, adding that a final valuation could be made only after the company furnished a detailed history of its plants and machinery. The company refused to provide further details, contending that time was of the essence of the contract and that the deadline would be extended from 28 January to 15 February 1950. On 6 April 1950 the Chief Engineer informed the company that the valuation, as per the Government’s assessment, amounted to Rs 6,56,221. No response was received from the company to this communication. The State thereafter informed the company that a difference and dispute had arisen concerning the valuation and that Mr M. S. Rao, I.C.S., was being appointed as the sole arbitrator to decide the dispute.

On 28 September 1950 the company instituted a suit seeking a stay of the arbitration proceedings, having complied with the notice requirements of section 80 of the Code of Civil Procedure. In the plaint the company alleged that the State Government had failed and neglected to complete its valuation or to make the required payment to the company by 15 March 1950, thereby breaching the agreement. The company claimed that, as a result of this breach, it had rescinded the agreement and that the advance payment of five lakh rupees made by the State should be forfeited. The suit also sought a declaration that the electrical undertaking remained the property of the company, along with claims for damages, the appointment of a receiver, and an injunction.

It was held that the State had breached the agreement, and because of that breach the company had terminated the contract and consequently forfeited the advance payment of five lakhs that the State had made. The company therefore prayed, among other things, for a declaration that the electrical undertaking was its property, for damages, for the appointment of a receiver and for an injunction. On 9 October 1950 the State Government filed an application under section 34 of the Indian Arbitration Act. In that application the State alleged that the company had acted with a dishonest and mala-fide motive, that it had instituted the suit in order to avoid the arbitration decision, and that the allegations in the plaint were false and incorrect. The State further asserted that the arbitration agreement was still in force, valid and binding on the parties and could not be regarded as having been rescinded as the company claimed. It contended that the cause of action pleaded in the plaint—non-compliance with the agreement—arose out of, and related to, the agreement and was therefore covered by the arbitration clause, and that the State was ready and willing to have the dispute resolved by arbitration. The company denied the State’s allegations of mala-fide conduct and maintained that the arbitration clause no longer existed. Even assuming the clause were still valid, the company argued that the suit was not connected with the alleged arbitration matter and therefore ought not to be stayed. The subordinate judge held that the suit did not pertain to any matter that the parties had agreed to refer to arbitration and that the court therefore lacked jurisdiction to stay the proceedings. Consequently, the application for a stay was dismissed. The State Government appealed this order to the High Court.

The High Court held that the dispute raised in the suit originated from, and was in respect of, the agreement and that the question presented in the suit fell squarely within the scope of the arbitration clause. By an order dated 22 May 1951, the court granted the company special leave to appeal under article 136(1) of the Constitution. Section 34 of the Indian Arbitration Act reads as follows: “Where any party to an arbitration agreement commences any legal proceedings against any other party to the agreement in respect of any matter agreed to be referred, any party to such legal proceedings may apply to the judicial authority before which the proceedings are pending to stay the proceedings, and if satisfied that there is no sufficient reason why the matter should not be referred in accordance with the arbitration agreement and that the applicant was, at the time when the proceedings were commenced, and still remains, ready and willing to do all things necessary to the proper conduct of the arbitration, such authority may make an order staying the proceedings.” From the language of this provision it is clear that the proceeding sought to be stayed must be in respect of a matter that the parties have agreed to refer to arbitration.

In this case the Court explained that a stay of legal proceedings can be granted only when the dispute involved falls within the matters that the parties expressly agreed to refer to arbitration. If a suit is filed concerning a question that lies outside the scope of the arbitration clause, the Court must refuse to stay the suit. The Court quoted the judgment of Viscount Simons L. C. in Heyman v. Darwins Ltd, stating that determining whether a dispute is covered by an arbitration clause requires answering two inquiries: first, what the dispute actually is; and second, what categories of disputes the arbitration clause was intended to cover. The Court observed that when an arbitration agreement is drafted in broad and comprehensive terms—using language such as “any dispute between the parties in respect of the agreement,” or “any dispute arising out of the agreement”—the clause will encompass a dispute even if one party attempts to avoid the contract, provided that the avoidance itself arises from the terms of the contract. Conversely, if a party seeks to avoid the contract for reasons external to it, the arbitration clause cannot be invoked because it is tied to the other terms of the contract. In other words, a party may not rely on a contractual term to repudiate the contract and then claim that the arbitration clause should not apply; reliance on the contract must be consistent for all purposes. The Court further noted that where the arbitration clause is not drafted in such sweeping language—as was the case in the House of Lords decision—not every dispute can be automatically referred to arbitration. Each arbitration provision must be interpreted according to its specific wording and the circumstances surrounding its formation. Turning to the first issue, namely the nature of the present dispute, the Court referred to paragraphs 14 to 17 of the plaint. Those paragraphs allege that the Government of Bihar breached the agreement by failing to carry out a valuation of the undertaking and by not paying the balance of the compensation money, despite time being of the essence. The Government allegedly did not complete the valuation within the original or extended time limits. As a result of this breach, the plaintiff says it rescinded the agreement, forfeited a sum of five lakh rupees, and is entitled to compensation for the wrongful deprivation of the use of its property. The plaint does not contain a claim for valuation of the undertaking or for any compensation related to the undertaking itself; instead, the suit is based on the rescission of the agreement, which contains the arbitration clause, and on the breach of that agreement. The Court observed that these matters may well be characterised as arising out of the agreement, and that if the arbitration clause had been worded in a broadly inclusive manner, the dispute could arguably fall within its ambit, but the clause in this agreement is expressed in a more limited fashion.

In this case the Court observed that the arbitration clause in the agreement was not drafted in a broad manner. The clause was specifically worded to provide that if any difference or dispute arose between the parties concerning the payment of the balance that might be found due after valuation, such dispute was to be submitted to the sole arbitration of a single arbitrator. The Court explained that the agreement itself required the Government to carry out a valuation of the undertaking in accordance with the provisions of the Indian Electricity Act within three months of taking over the undertaking. After the Government’s valuation, any balance of money that the Government found to be due to the company was to be paid by the Government, and any excess payment made on account of the “on account payment” of five lakh rupees mentioned in paragraph one of the plaint was to be refunded to the Government. The Court further clarified that, where there was a difference between the valuation arrived at by the Government and the valuation arrived at by the company, that difference – including the company’s claim for an additional twenty per cent compensation – was to be referred to arbitration. Consequently, the Court held that the scope of the arbitration clause was very narrow; it conferred jurisdiction on the arbitrator solely on the question of valuation of the undertaking and did not provide that all disputes arising out of the agreement or relating to it would be decided by arbitration. Issues relating to breach of contract or to the rescission of the contract lay outside the reach of the clause. The arbitrator, therefore, did not have the power, under the clause, to determine whether the plaintiff was justified in claiming that time was of the essence of the contract or whether the State Government had breached the contract by failing to make a valuation within the specified period. The Court noted that the clause could not answer the company’s question, “Show me that I have agreed to refer the subject-matter of the suit to an arbitrator.” Moreover, the Court found that, apart from this clause, there was nothing in the agreement that could deprive the court of its jurisdiction to decide the plaintiff’s suit as presented. The Court also referred to the view of Ramaswami J, joined by Rai J, who had examined the terms of the contract and the related correspondence and concluded that the parties had not stipulated that the compensation money must be paid within three months. Rather, the parties intended that the Government would pay the compensation only after the arbitrator’s award was rendered. The Court held that this point was precisely the issue to be adjudicated in the suit itself, and that Ramaswami J had erred in deciding this matter in an enquiry under the specific statutory provision cited.

The Court explained that the court exercising jurisdiction under section 34 could not examine the substantive validity of the plaintiff’s contention in the suit because its function under that provision was narrowly limited. The sole issue for such a court was to determine whether the claim presented by the plaintiff, irrespective of whether it was strong, weak or indifferent, fell within the matters that the parties had agreed to submit to arbitration. The Court observed that, although the defendant might be able to persuade a proper tribunal that the plaintiff’s claim was frivolous and vexatious, such a consideration became relevant only if the question before the court was whether the suit itself was frivolous and vexatious and therefore should carry no weight in ascertaining the nature of the plaintiff’s claim. The Court cited Banks, L.J., in Monro v. Bognor Urban Council (1) to support this proposition, emphasizing that the true content of the plaintiff’s claim could be discovered only by examining the plaint.

Turning to the approach adopted by the High Court, the Court noted that the learned judges there had presumed that the arbitration clause in the contract was drafted in a broad manner, thereby encompassing all “disputes arising out of or in respect of the agreements” as referable to arbitration. To justify this view, the High Court relied on the decision of the Calcutta High Court in Harinagar Sugar Mills Ltd. v. Skoda India Ltd., and also on Governor-General in Council v. Associated Livestock Farm Ltd. (3). The Court held that this reliance was misplaced because, in Harinagar Sugar Mills, the arbitration clause was expressed in comprehensive language expressly stating that any dispute arising out of the agreement must be referred to arbitration. The earlier case therefore did not offer appropriate guidance for the present clause.

The Court then set out the exact wording of the arbitration clause in the present contract, which read: “Any dispute or difference arising out of the contract shall be referred to the arbitration of the officer sanctioning the contract whose decision shall be final and binding.” The Court pointed out that the authorities cited by the High Court – namely the decisions in Harinagar Sugar Mills and Governor-General in Council – could not be applied to this clause, as the wording in the present agreement was narrower and did not create a blanket referral of all disputes to arbitration.

Having examined the nature of the plaintiff’s claim, the Court concluded that the claim did not fall within the scope of the arbitration submission. Consequently, the judgment of the learned Subordinate Judge, who had dismissed the petition under section 34 on the ground that the claim was not arbitrable, was affirmed. The Court held that the High Court had erred in reversing that decision. Accordingly, the appeal was allowed, costs were awarded, and the Court formally stated that the plaintiff’s claim was not covered by the arbitration clause and that the dismissal of the petition under section 34 by the Subordinate Judge was correct. The order concluded with the note that the appeal was allowed, and the agents for the parties were identified as Rajinder Narain for the appellants and P. K. Chatterji for the respondent.