THE UNION OF INDIA v.  KISHORILAL GUPTA AND BROS [1959 AIR 1362]

The Concept

Novation is the complete substitution of the old contract with a new contract. If such substitution is complete, then the old contract need not be performed. Novation is not mere amendment of the contract. For novation to occur, the change made should go to the root of the contract and change its essential character.

The parties should agree to either substitute the original contract or alter it or rescind it for the original contract to be not performed. 

Facts

The Respondent entered into three separate contracts with the Appellant. Each of the said contracts contained an arbitration clause. The three contracts were subsequently cancelled by the Appellant. Three separate settlement contracts were entered into.

The third settlement contract stated that, “The contracts stand finally concluded in terms of the settlement and no party will have any further or other claim against the other”. The disputes pertaining to breach of the original contracts were referred for arbitration by the  Appellant.

The arbitrator gave the award in favour of the  Appellant. The Respondent challenged the same and raised the contention before the High Court that the arbitration clauses in the original contracts have ceased to have any effect, as the contracts terminated on the execution of the settlement contracts, hence the award be set aside as null and void. The High Court ruled in favour of the respondents. Hence, the present appeal. 

Issue

Whether the arbitration clause of the original contracts survives after their termination or not?

Arguments by the  Appellant

  1. The jurisdiction of the arbitrator depends upon the scope of the arbitration agreement or submission;
  2. Its scope would depend upon the language of the arbitration clause;
  3. If the arbitration agreement in question is examined, it indicates that the dispute whether the original contracts have come to an end or not is within its scope;
  4. On the facts of the case, there had been no novation or substitution of the original contracts; and
  5. If there had been a novation of the original contracts, the non-performance of the terms of the new contract revived the original contracts and therefore the parties to the original contracts could enforce their terms including the arbitration clause.

Arguments by the Respondent

  1. The facts of the case are clear that  there had been a recission of the old contracts and substitution of a new, legally enforceable and unconditional contract, which came into immediate effect; 
  2. The new contract can be legally supported either under s. 62 or s. 63 of the Indian Contract Act or under the general law of contracts;
  3. The non-performance of the terms of the new contract did not have the effect of reviving the rights and obligations under the old contracts as they did not remain alive for any purpose; and 
  4. Even if the arbitration clause did not remain alive after the new contract, the arbitrator was bound to decide the case in terms of the new contract, and he having not done so, the error is apparent on the face of the record and therefore the award is liable to be set aside.

Judgment

The Hon’ble Court dismissed the Appeal by relying on the following grounds: 

  1. A contract can be discharged by the same process by which it was formed. The rights of the parties under the original contracts have been abandoned by the acceptance of the new agreement. This is called accord and satisfaction arrangement and when such accord and satisfaction takes place, it leads to extinguishment of prior rights of the parties. 
  2. The third settlement contract was for valid consideration and the parties’ intention was to substitute it for the original contract. It should form the basis of enforcement of claims of the parties.
  3. The arbitration clause perished with the original contract. It was an integral part of the original contract and did not have any existence independent of it. 
  4. Parties did not intend for the arbitration clause to survive even after they had rescinded the original contract and had substituted it with a new one. 

Reflective Question

Would the decision be different if the arbitration clause specifically read that it would survive beyond the termination of the agreement?