UNVEILING THE DISTINCTIVE DYNAMICS OF SECURITIES ARBITRATION: A COMPREHENSIVE EXPLORATION BY - YAJUR SOOD
"UNVEILING THE DISTINCTIVE DYNAMICS OF SECURITIES
ARBITRATION: A COMPREHENSIVE EXPLORATION"
AUTHORED
BY - YAJUR SOOD
Associate
at AKB Lex- Indian Arbitration Law Firm
B.com LLB
(Hons.) from UILS, Panjab University (2017-22)
Abstract
India is receiving
high levels of Foreign Portfolio Investment and Foreign Direct Investment each
year, a trend that is only expected to grow further. In an emerging economy
like India, securities arbitration will play the role of a vital mechanism for
investor protection, market integrity, addressing disputes, fostering investor
trust and attracting foreign investment. This paper explores the realm of how
securities arbitration within the framework of SEBI Byelaws has been
interpreted by various Indian courts. It examines the crucial and distinct
provisions of the SEBI’s byelaws pertaining to arbitration— a valid arbitration
agreement, and interim measures in securities arbitration amongst other things,
highlighting SEBI's regulatory framework as the backdrop and contributing to a
comprehensive understanding of the same. This study is novel in analyzing key
provisions and precedents relevant to securities arbitration, something that
the existing literature has not delved into deeply.
Introduction
Securities
arbitration is a resolution process of disputes arising between investors and
professionals in securities industry like brokers, investment advisors and
brokerage firms. Arbitration, not a novelty anymore in the Indian Scenario, is
an Alternative Dispute Resolution (ADR) method involving a neutral third party—
arbitrator or umpire, or a panel of the same to hear both the sides and come
upon a decision that shall be binding on the both parties. Arbitration in the
securities transaction disputes became common in USA in the 1980’s, and the
American Supreme Court upheld the enforceability of arbitration agreements to
redress investor claims in Shearson/American
Express Inc v. Mcmohan[1]. Securities
arbitration is an investor friendly and credible mechanism under the SEBI
regulated stock exchanges to redress stakeholder’s grievances
and resolve their disputes amicably.
The
mechanism and procedure for such arbitral proceedings is provided by the
byelaws of various stock exchanges- that are empowered under S. 9(1) r/w (2)(n)
of the Securities Contracts (Regulation) Act, 1956 to notify such byelaws.
Further the Securities Exchange Board of India (herein referred to as SEBI),
being the apex regulator of all stock exchanges, is empowered u/s 10 of the Act
to make or amend byelaws of recognized stock exchanges. The bulk of these
byelaws were made by the SEBI via its various circulars that were issued time
to time that later coalesced into the master circular[2] of 2010.
While there
has been considerable research in the past about the desirability and
suitability of arbitration in diverse areas, including securities transactions,
there is not much existing literature on the judicial interpretations of its
substance and procedure. Hence, this paper primarily and largely relies on past
judicial precedents to build upon the subject. This paper has been divided into
two parts dealing with two most distinguishable facets of securities
arbitration— Part I dealing with the jurisprudence of a valid arbitration
agreement, and Part II dealing with interim reliefs. There shall also be
references to terms related to capital markets, since it forms the subject
matter of securities transaction disputes. While the securities arbitration
mechanism differs from the procedure provided under Arbitration and
Conciliation Act, 1996, this paper is confined only to the substantive aspects
of it, omitting a deep dive into purely procedural ones like the appointment of
arbitrator, appellate tribunals, enforcement of awards etc. The term ‘byelaws’ has also
been frequently used. As mentioned earlier, these byelaws are made by the stock
exchanges u/s 9 of the Securities Contracts (Regulation) Act, 1956 and are
almost identical in all SEBI recognized stock exchanges. Hence, the names of
the specific stock exchanges have been omitted to avoid confusion.
Part I
What
is a valid Arbitration Agreement for Securities
Transaction
in India?
The sine qua
non of a valid arbitration agreement to be enforceable is that it must take
place with the consent of the parties that are a party to the proceedings. For
this purpose, S. 7 of the Arbitration Act provides that an arbitration
agreement must be in writing and has to be signed by both the parties, failing
which the agreement to refer the dispute to arbitration shall not be considered
valid. However, the agreement in a securities transaction is in the form of a
contract note. Unlike an arbitration agreement u/s 7 of the Arbitration Act, an
agreement under the byelaws and regulations pertaining to arbitration, is a
part of the contract notes drafted. A contract note is a formal and legal
record of a transaction that may have taken place in a stock exchange by
availing the services of a stockbroker. A contract note describes key details
of a particular transaction together with date, time, price, quantity traded
etc. and most importantly the byelaws and regulations pertaining to
Arbitration.[3] Since the
signature of both the parties is not essential for a contract note to be valid
as per the byelaws of most stock exchanges[4], therefore,
it follows that an arbitration agreement in a securities transaction need not
also contain signatures of both the parties to be valid. This contract note is
drafted under a special statute i.e. the Securities Contracts (Regulation) Act, 1956 and
mentions a clear stipulation of it being subject to the rules, byelaws and
regulations notified by the relevant Stock Exchange. The mode of executing this
contract note, according to the governing law, is the signature of a registered
stockbroker. Hence ‘the arbitration agreement contained
in these special contracts are not arbitration agreements any the less, on the
ground that the writing is not signed by both the parties’.[5]
Does
an agreement require the specific incorporation of an arbitration clause?
For a valid
arbitration agreement u/s 7 of the Arbitration Act, 1996, it is essential that
the parties to an agreement must specifically agree to refer the dispute for
arbitration. However, such an agreement may not specifically mention the words ‘arbitration’ or
‘arbitrator’. An
arbitration agreement in implied terms is also an equally valid one if it
fulfills certain essential elements namely: “(a) The
agreement should be in writing. (b) The parties should have agreed to refer any
disputes (present or future) between them to the decision of a private
tribunal. (c) The private tribunal should be empowered to adjudicate upon the
disputes in an impartial manner, giving due opportunity to the parties to put
forth their case before it. (d) The parties should have agreed that the
decision of the Private Tribunal in respect of the disputes will be binding on
them.” [6]
However,
whether arbitration is to be mandatorily proceeded with in case of a dispute in
securities transaction is an interesting question and depends upon the question
whether every securities transaction agreement has an implied arbitration
clause or not. There have been two divergent views taken by the Hon’ble Bombay
High Court and the Hon’ble Calcutta High Court on this.
It was submitted before the Hon’ble High Court of Bombay in
the case of Mrs. Asha Anilkumar Kataria v. Ashok kumar S/O Kevalchand Bafna[7], that the arbitration clause is a statutory
term of the agreement between the parties transacting and therefore arbitration
is mandatory. The court rejected the
contention and held that the regulations that were made, required
an agreement between the parties giving specifications of their the scope of
authority and responsibility, but the regulations don’t mandate incorporating
all the conditions in the agreement as mentioned in the model agreements of the
stock exchange including an arbitration clause. Hence, the submission that the
arbitration clause is a statutory term and condition of a securities
transaction contract cannot be accepted and the application u/s 8 of Arbitration Act, 1996, that bars the
court from entertaining a suit subject to arbitration would fail. The court
also went ahead and held that the said regulations do not in any way take away
the jurisdiction of the civil courts, but simply provide an alternative remedy-
as it is a case of having a pre-existing right under common law and an
additional remedy provided by way of an arbitration clause, which if mentioned by
the parties in the agreement and with the express exclusion of the jurisdiction
of the civil court provided, shall alone be valid.[8]
On the other
hand, the Hon’ble Court in the case of S & D Securities Pvt. Ltd. &
Anr. v. Union Of India[9]
accepted the
contention that the arbitration clause is a statutory term of the agreement
between the parties transacting and therefore arbitration is mandatory for the
parties, from which they cannot derogate. It held that once it is established
that there is a dealing between the parties then, it shall be deemed that the
Bye-laws, Rules and Regulations of the respective stock exchanges govern such
contracts. Further, the idea of introducing the Securities Contracts
(Regulation) Act, 1956 and the Bye-laws, Rules and Regulations is to regulate
the dealings in securities. ‘In all the Byelaws, Rules and Regulations burden
has been placed on the trading member that they may not cheat bona fide
customers who are interested in dealing in securities. Regulation 4.3.1
provides that if a broker fails to execute the agreement with his customer, the
agreement shall be deemed to have been executed. Statute has made such a deeming
provision. Therefore, an inference of a ‘statutory deeming’ has to be drawn in
the scheme of the provisions of the Act, Byelaws, Rules and Regulations.
Therefore, looking to all the deeming clauses, even if the arbitration
agreement has not been entered into, then too it will be deemed that the parties
are subject to the Bye-laws, Rules and Regulations of the Exchange and if any
dispute arises between them, then they can certainly request the authorities to
refer the dispute to arbitration.’[10]
It is
submitted that the view taken by the Hon’ble Calcutta
High Court, seems to be the correct interpretation of the legislative intent on
two grounds. Firstly, the
Arbitration and Conciliation Act, 1996 has all the features resembling a general statute. It
deals with the whole gamut of subjects ranging from domestic arbitration to conciliation.
In domestic arbitration also, it brings under
its scope a wide of matters showing its general nature.[11] On the
other hand the byelaws made by the stock exchanges under S. 9 of Securities
Contracts (Regulation) Act, 1956, is a specific statute dealing with securities
transactions. The maxim Generalis
Specialibus Non Derogant means that in case of a conflict
between a general statute and a special statute, the former must yield to the
latter. Hence it is only logical that the byelaws of Stock exchanges providing
for mandatory arbitration shall prevail over the Arbitration and Conciliation
Act 1956.[12]
Secondly, the Mischief Rule of
interpretation of statutes is that in applying a rule, the court shall inquire
which particular mischief the authority enacting the statute intended to
rectify, even though it might not be explicitly covered by a literal reading of
the statute's wording. It must be noted that it was post the creation of SEBI
in 1992, that there was a strong impetus towards investor protection and
ensuring fair play in the securities market. Hence the Arbitration mechanism
was introduced for the purpose of protecting the investor and continues to be
investor friendly in its working. Therefore, it is not erroneous to assume that
the enacting authority intended the arbitration clause to be mandatory.
Is
Arbitration Reserved for Securities Transaction Disputes only?
Another
interesting case of implied contracts of arbitration came before the Bombay
High Court in the case of Newage Fincorp (India) Ltd. vs Asia Corp
Securities Limited[13],
wherein the main question before the court was whether the dispute relating
to a membership card (which empowers the holder to carry on the business of
shares and securities in the stock exchange), could be the subject matter of
arbitration under the byelaws which provided for claims or disputes arising out
of or in relation to dealings, transactions and contracts of securities made
subject to the rules, byelaws and regulations of the Stock Exchange. The
parties entered a memorandum of understanding (MOU) for the purpose of nominating
members for the membership card. One of the clauses stated that “both the
parties shall take all the necessary steps to get the approval of this MOU as
per the Companies Act or
any other rules and regulations for the time being in force.” It was contended
that there was no arbitration agreement between the parties and the transaction
relating to nomination of a member, which was the subject matter of the present
MOU, cannot be termed as dealings in securities attracting the provisions of
the Byelaws of the Stock Exchange. The Court rejected the contention and held
that in the said clause, arbitration agreement may not be specifically
mentioned in the MOU but it is to be deemed as a part of the MOU since the MOU
specifically mentions that “both the parties shall take all the necessary steps
to get the approval of this MOU as per the Companies Act or any other rules and
regulations for the time being in force.” which shall mean and be inclusive of
the rules and byelaws notified by the
Stock Exchange. It was held that the membership and nomination to exchange are
governed by the rules framed by the Stock Exchange. Therefore, the MOU referred
to, if understood in its proper perspective, will include reference to the
rules, which by necessary implication make the byelaws applicable wherein any
dispute between the parties arising out of contract can be referred to an
arbitrator.
Hence, the
peculiar feature of Securities Arbitration under the Stock Exchange is that it
is not solely reserved for disputes purely within the realm of the
subject-matter for which it was created i.e. securities transactions. This is
unlike other forms of arbitration, say for example Investment Arbitration that
necessitates that the legal dispute must pertain to rights flowing out of an
Investment Treaty alone to be arbitrated by ICSID[14],
but encircles all or any of the disputes between parties, that are subject to
the byelaws of the stock-exchange.
Can Arbitration only be between trading members of
the stock exchange?
It is not always
necessary that an aggrieved party maybe a member constituent of a stock
exchange. The membership of a stock exchange can be lost by way of suspension,
termination, surrendering etc. The
right of the parties to invoke arbitration in case of losing their membership
was dealt in Harinarayan Bajaj v. Madhukar Sheth[15]. In the
present case, the respondent, a trading member of the stock exchange lost his
membership owing to the cancellation of his certificate of registration by the
exchange. The question before the court was whether the arbitration agreement
still subsists and whether the trading member/respondent had the right to
invoke arbitration because the rules of the stock exchange regulations state
that a suspended member, faces exclusion from all the rights and privileges of
membership till the term of suspension lasts. Further as per the rules,
arbitration can take place only when the dispute is between a ‘member’ and ‘non-member’.
The court held that even such a suspended member had the right to invoke
arbitration. It held that there would be no valid arbitration
agreement where only one party is entitled to invoke arbitration and also the
rules, bye-laws and regulations don’t prevent a
suspended member from filing for recovery of dues. However, in case the member
filed a suit against the client and the client's application u/s
8 of
the Arbitration Act, 1996 is allowed, the suspended member would be bereft of
any remedy to recover his dues since he cannot take his claims to arbitration.
On one hand his suit would have come to an end without adjudication on merits
by virtue of the order under section 8 and on the
other hand he would not be entitled to have his claim decided by arbitration.
It would be unfair where the non-member does not agree to the suspended member referring
his claim to arbitration thereby compelling him to pursue a civil suit but
refers his claim to arbitration. The suspended member would not be entitled to
raise a counterclaim either and may lead to a conflict of decision between a
public forum and a private forum.
Should
Parties always have a contractual relationship?
Another interesting decision on this subject came from the
Hon’ble High Court of Madras in the case of Rajanarayan Capital
Markets v. S.S. Chokkalingam[16]. In
the present case the petitioner was a trading member of the stock exchange and
had appointed a firm as their dealer and started with the trading activities.
There arose a dispute between the firm and the respondent, and consequently the
respondent invoked arbitration against the petitioner, on the ground that the
firm in question was their agent since it still made certain payments
to the petitioner and attended investor meetings arranged by the petitioner.
The petitioner contended that the firm was their
client, and their contractual relationship came to an end in the past. The
court held that the inference of the arbitrator that the firm was petitioner’s
agent/sub-broker was untenable and the award could not be passed against them
on this ground, since the byelaws clearly provide that the nature of the
relationship between the parties must be contractual and only if such a
contractual relationship exists, the provisions of the regulations can be
deemed to be a part of such contract.
How far is the
ratio decidendi in Rajnarayan
Capital Markets[17] valid after the decision of the apex court in Cox and Kings Ltd v. SAP India Pvt
Ltd[18], which upheld the application of the Group of Companies doctrine to Arbitration agreements,
is a polemical subject. The Doctrine of “group of companies” in simple words
means that a party that is a non-signatory can be bound by an arbitration
agreement if it is a member of the same group of companies as the signatory and
all the parties to the arbitration agreement mutually intend that the
non-signatory be bound by it. The parties’ intentions are usually determined by
their conduct, which can include determining whether the non-signatory was
found to be engaged in the negotiation, performance or termination of the contract.
The mere presence of an affiliate relationship between a signatory and a
non-signatory cannot be used as a foundation for consent. The "group of
companies" concept, unlike other non-signatory theories that are based on
domestic law principles, is based on international arbitration jurisprudence.[19]
Considering the above, it can be safely inferred that the ratio in Rajanarayan
capital shall be read in consonance with Cox Cap, and shall be applicable only
in cases where the group of companies doctrine is inapplicable to the facts of
the case.
Part II
Interim Measures by Court: -
A party may
file an application u/s 9 of the Arbitration Act, 1996, to the court to obtain
any interim relief. The Court before the grant of interim measures of
protection must broadly satisfy itself that
(a)
the person seeking interim measures has made out a prima facie case (b) the
balance of convenience is in his favour and (c) the person in absence of
interim measures would suffer irreparable loss or injury. It has been time and
again repeated that in granting or refusing to grant interim measures, the
Court has wide discretion u/s 9 of
Arbitration Act, 1996, however the exercise of this discretion has to be in a
judicial manner depending upon the circumstances of each case. There can be no
hard and fast rule that can be laid down as regards the exercise of such
discretion. However, in the case of interim relief, the standard rule being
that the Court must be satisfied that the petitioner has a prima facie case,
does not mean that the Court shall examine the merits of the case minutely and
conclude that the petitioner’s case might succeed. This would be a case
prejudging the claims of the parties on their merits. The court has to only see
that prima facie the party claiming an interim relief has a case that needs
consideration and the balance of convenience also has to be looked into.[20]
In Newage
Fincorp (India) Ltd. Case [21], the
petitioner had applied for interim relief for preservation of property u/s 9 of
the Arbitration Act, 1996. The relief sought was that the respondent shall
ensure that the possession of the membership card is not alienated in any way
or third-party rights are not created therein,
until there was a final determination by the arbitrator. Rules of the Stock
Exchange, provided that a party being a member for a period of minimum three
years, alone can nominate a person meeting the eligibility criteria under the
Rules for admission to membership of the Exchange in their place, in case they
resign. The respondent terminated the contract, alleging breach by the
petitioner. They also contended that since the membership card does not fall
within the definition of property given under the Transfer of Property Act
1882, and it being purely a personal privilege, the same cannot be the subject
matter of arbitration and by consequence there can be no interim relief sought
for preservation of property u/s 9 of Arbitration Act, 1996. The court held
that the scheme of the rules provides for nomination by a member
and the possibility of a dispute between the parties arising out of nomination
cannot be completely ruled out. The rules providing a mechanism to resolve
disputes via the byelaws of the stock exchange also cannot be ruled out and
hence the arbitration mechanism provided in the byelaws cannot be denied. It further held that, the dispute between the
parties has given rise to serious issues meriting a trial. If via nomination,
the membership of the stock exchange is allowed to be transferred, in favour of
any third party, then it shall give rise to multiple proceedings, and the so
created third party rights shall not be the subject matter of arbitration
disputes between the present parties. Membership of the stock exchange is a
commercial privilege and loss of commercial privilege cannot be monetarily compensated
and hence, it shall be appropriate to consider the preservation of the subject
matter of the arbitral dispute as essential by allowing interim relief, as the
balance of convenience lied in the petitioner’s favour.
Specific performance in the case of determinable securities
contract: -
Section 14
of the Specific Relief Act, 1963 states that a contract is determinable if it
can be put to an end. This means that any contract that may be possibly voided
in any way is under the ambit of determinable contracts. In the case of Indian Oil Corporation Ltd v. Amritsar Gas Service[22], the Apex Court defined what a
determinable contract is. It stated that an agreement, which contains a clause
that shall give a right to any of the parties to terminate an agreement by
giving a prior notice, and without assigning any reason, is ‘determinable’ in nature, and hence cannot be
specifically enforced. The only relief that can be granted is compensation for
the loss of earnings and not specific performance.
In the case of Integral
Finvest (P) Ltd. v. SEBI[23], before Delhi High
Court, the petitioner had prayed for an interim injunction u/a 226 of the Constitution,
asking the court to restrain the SEBI from transferring or varying the
shareholdings of the respondent until a final award has been passed in the
arbitration proceedings. Directions were also sought against the respondents to
withdraw the publication of the public offer and prohibit dealings in or allow
change of control and management relating to the respondent’s shareholding,
which is the subject matter of the disputes between the parties under the
memorandum of understanding (MOU). The parties had entered a MOU, which
contemplated the transfer of shares from the respondent to the petitioner, via
a subsequent agreement through which the execution of the MOU had to be worked
out including the price at which the shares were to be transferred. The court reasoned
that the MOU between both the parties was of a determinable nature, and
specific performance of the same cannot be asked for. The court reasoned that
even if a particular clause enabling the parties to terminate a contract, in case
the events mentioned therein occurred, is absent, the fundamental nature of the
impugned agreement being a private commercial transaction, it can be concluded
that the same could be terminated even without assigning any reason by serving
a reasonable notice. In the eventuality of the termination being found bad in
law, the remedy is to file a suit for compensation for wrongful termination and
not a claim for the specific performance of the contract.
Conclusion
Arbitration has
played a considerable role in building investor confidence and ensuring a ease
of investment in the stock market over the years. One may even go to the extent
of concluding that the introduction of a simple and investor friendly dispute
resolution mechanism has democratized the securities industry. However,
conflicting judgements from various high courts and lack of awareness and
judicial predictability amongst investors can surely act as an impediment. It
is suggested that such important questions of judicial interpretation shall be
settled by the highest court, or the apex regulator i.e. SEBI at the earliest.
Also India’s lack
of credibility with respect to enforcement of foreign awards negatively impacts
the evolving arbitration ecosystem. To strengthen its effectiveness, continued
efforts are needed to enhance transparency, accessibility, and enforcement of
arbitration awards, both domestic and foreign. The way forward involves
regulatory refinements and investor education to foster a resilient and
investor-friendly market ecosystem.
It is also
important that we prepare adequately for disruptions like Artificial
Intelligence based Online Dispute
Resolution (ODR) that can potentially threaten professionals, and add
uncertainty to the relevance of contemporary dispute resolution mechanisms. In
this regard it is submitted that the government, judiciary, advocates, industry
stake holders and civil society members should come forward in unison and a new
National Dispute Resolution Policy with sufficient emphasis on securities arbitration
should be rolled out to prepare all the stake holders and familiarize them with
the new changes that are expected to come sooner or later. Alternatively, the
proposed Arbitration Council of India in the Arbitration and Conciliation
(Amendment) Bill, 2021 should be created at the earliest and given the mandate
to deal with this subject.
[1] 482 U.S. 220.
[2]MASTER CIRCULAR ON
ADMINISTRATION OF STOCK EXCHANGES, ARBITRATION IN RECOGNISED STOCK EXCHANGES
AND STOCK EXCHANGE’ (Securities Exchange
Board of India, 31 December 2010), https://www.sebi.gov.in/legal/master-circulars/dec-2010/master-circular-on-administration-of-stock-exchanges-arbitration-in-recognised-stock-exchanges-and-stock-exchanges-trading-platform-for-small-and-medium-enterprises-including-guidelines-for-market-ma-_14420.html
(last visited Nov 26 2023).
[3] What is a Contract Note, Motilal Oswal (accessed
25 September 2023), https://www.motilaloswal.com/blog-details/what-is-a-contract-note/20247
[4] As
mentioned under Regulation 3.6, National Stock
Exchange (Futures
& Options Segment)
Trading Regulations.
[6] Jagdish Chander v. Ramesh
Chander & Ors (2007) 5 SCC 719.
[8] id.
[10] id.
[12] The Stock Exchange, Mumbai
v. Vinay Bubna, AIR 1999 Bom 266.
[14] ICSID Convention. art. 25.
[15]
(2015) 3 BomCR 15.
[16] Tr.O.P.No.437 of 2007.
[17] id.
[18] ARBIT. PETITION No. 38/2020
(Dec.
8, 2023, 9:29 AM) https://www.mondaq.com
[21] ibid.
[23] (2007) 2 CompLJ 433 Del.