The Group of Companies Doctrine – The Blog of Daksh Pandit

It is a settled principle of Contract law that a third party or a non-signatory to an agreement cannot be held liable for any consequences emanating from a binding contract between/among the signatories to the contract. The aforesaid principle flows from doctrine of privity which means that a contract cannot confer rights or impose liabilities on any person except the parties to the Contract. However, in certain circumstances and peculiar fact situation a non-signatory to an agreement may be extensively involved in the commercial transaction between the two parties to the contract so much so that an inextricable connection can be found between the signatories to the contract and the non-signatory party which would lead to travesty of justice if the non-signatory party is not made party to the contract for dispensing complete justice.

To address the aforesaid anomaly, the ‘group of companies’ doctrine has been adopted by the courts. This article is confined to the judgment rendered by the Constitution Bench of the Supreme Court in the matter Cox and Kings vs SAP India Ltd. & Anr.¹ wherein the Constitution bench of the Supreme Court was called upon to determine the validity of the Group of Companies doctrine in the jurisprudence of the Indian Arbitration. The Group of Companies doctrine provides that an arbitration agreement which is entered into by a company within a group of companies may bind non-signatory affiliates, if the circumstances are such as to demonstrate the mutual intentions of the parties to bind both signatories and non-signatories. This doctrine is best applicable in cases which involves composite nature of transaction involving various companies, which although may not be part of the main agreement, however, play an active role in giving effect to the Agreement between the signatories. However, in order to assimilate the group of company doctrine in the field of Indian Arbitration, it is imperative to first address an equally vexing issue i.e. whether the Arbitration and Conciliation Act, 1996 [“the Act”] allows joinder of a non-signatory as a party to an arbitration agreement.

The issue hinges upon the interpretation of expression “claiming through or under” appearing in Section 8 and Section 45 of the Act. In Chloro Controls Pvt. Ltd. vs Severn Trent Water Purification² a three-judge bench of the Supreme Court recognized the applicability of the group of companies doctrine in arbitration proceedings thereby paving the way for non-signatories to the arbitration agreement to be part of the same. The Court held that the non-signatory could be subjected to arbitration “without their prior consent” in exceptional cases on the basis of four determinative factors viz.-

A direct relationship to the party which is a signatory to the arbitration agreement.
A direct commonality of the subject-matter and the agreement between the parties being a composite transaction.
The transaction being of a composite nature where performance of the mother agreement may not be feasible without the aid, execution, and performance of supplementary or ancillary agreements for achieving the common object and collectively have a bearing on the dispute.
A composite reference of such parties will serve the ends of justice.

However, the aforesaid ratio was doubted by a three-judge bench of the Supreme Court which referred the issue to the constitution bench to throw light upon the validity and applicability of the doctrine in the field of arbitration. The constitution bench of Supreme Court observed as follows-

The Theory of Implied Contract by Conduct

The Court noted that the non-signatory parties can be made parties to the agreement by analyzing their acts and conduct. Under the Indian Contract Law, the actions or conduct of the non-signatories can be an indicator of their consent to be bound by the contract. Court further observed that this also applies to the arbitration agreement since it is a creature of contract, however, it is imperative that the arbitration agreement itself must first satisfy all the requirements as laid down in Section 7.

“Legal Relationship” u/s 7 including relationships where there is no contract between the parties could form subject matter of arbitration agreement

The court referred to Vidya Drolia vs Durga Trading Corporation³ wherein the Supreme Court interpreted “legal relationship” i.e. which gives rise to legal obligations and duties and confers a right which may be contractual or non-contractual. Therefore, the Supreme Court observed that the legislative intent underlying Section 7 suggests that any legal relationship, including relationships where there is no contract between the persons or entities, but whose actions or conduct has given rise to a relationship, could form a subject matter of an arbitration agreement under Section 7. The court further observed that for legal relations to be contractual in nature, they ought to meet the requirements of Indian Contract Law which envisages an express contract and also an implied contract. In view thereof, the court held that it is not necessary for the persons or entities to be signatories to a contract to enter into a legal relationship- the only important aspect to be determined is whether they intended or consented to enter into the legal relationship by the dint of their action or conduct. Referring to Section 7(3) the court further observed that a written arbitration agreement need not be signed by the parties if there is a record of agreement⁴.

Single Economic Unit Theory

The Court recognized the principle of companies having a separate legal entity enshrined in Solomon vs Solomon, however, the court observed that in certain circumstances, the subsidiary of a parent company, although having its own distinct and separate entity, may be under the direct control of the parent company and effectively constituting one single entity. The court relied upon DHN Food Distributors Ltd. vs Tower Hamlets London Borough Council wherein Lord Denning held that a group of three companies should be treated as single economic entity on the basis of following two factors-

The Parent company owned all the shares of the subsidiary companies to the extent that it controlled every movement of the given subsidiary companies.
All the three companies in the group virtually acted as partners and could not be treated separately.

Therefore, the court observed that the determination of whether two or more companies constitute a single economic entity depends upon the concerted efforts of the companies to act in pursuance of a common endeavor or enterprise. However, the court held that “single economic unit” theory cannot be the sole basis to invoke the group of company doctrine and surrounding facts and circumstances must also be considered.

Courts must adopt “Common Sense Approach” while interpreting Contracts

The court observed that the courts, while interpreting the commercial contracts must not be rigid in their approach especially in view of the fact that in modern commercial contracts involving complex transactions among multiple parties, a situation may arise wherein a company which has signed the contract containing the arbitration clause is not always the one to negotiate or perform the underlying contractual obligations. In such a situation, if emphasis is given to formal consent and principles of contract and arbitration law are applied in stricto sensu, then such non-signatories who take a crucial part in discharging the contractual obligations would be excluded from the ambit of arbitration agreement which is going to result in multiplicity of proceedings. The Group of Company doctrine has been evolved to address the aforesaid anomaly. Therefore, the court must adopt a balanced approach and be attendant to factual circumstances surrounding the contractual agreements and only then ascertain the real intention of the parties.

Group of Companies Doctrine is a fact-based doctrine

The group of companies doctrine does not nullify the principle enshrined in Solomon vs Solomon i.e. each company having a separate legal entity. A subsidiary of a holding company cannot be held liable for the omissions and commission of the holding company. The Group of companies doctrine is invoked to ascertain the common intention of the parties belonging to the same ‘corporate group’ while maintaining the corporate separateness of the group companies. In some cases a subsidiary company may have taken part in the negotiation process and also performs the underlying contractual obligations but abstains from signing the contractual agreement which is only signed by the parent company. In such circumstances, the group of company doctrine can be invoked to bind the non-signatory company to the arbitration agreement. However, the courts must not mechanically apply this doctrine. Merely because a company belongs to the group of companies cannot be the sole criteria to bind that company to the arbitration agreement. The intention of the parties must be derived by the court by taking into consideration the totality of facts and circumstances surrounding the contractual agreement. Therefore, this doctrine enjoins the court to carry out a fact-based exercise before pressing this doctrine into service.

While applying this doctrine it is imperative to be mindful of the fact that this doctrine concerns only the parties to the arbitration agreement and not the underlying commercial contract. Consequently, a non-signatory could be a party to the arbitration agreement without becoming a formal party to the underlying contract. The Court further observed the ratio laid down in ONGC vs Discovery Enterprises Pvt. Ltd.⁵ and held that cumulative factors laid down therein must be considered in deciding whether a company within a group of companies is bound by the arbitration agreement. The Cumulative factors as laid down in Discovery Enterprises are-

The mutual intent of the parties.
The relationship of a non-signatory to a party which is a signatory to the agreement.
The Commonality of the subject matter.
The composite nature of the transactions; and
The performance of the Contract.

The aforesaid factors must be carefully ascertained by the court by undertaking a fact-finding exercise before invoking the doctrine. The court further stressed upon the “commonality of the subject matter” and held that it indicates that the conduct of the non-signatory must be related to the subject matter of the arbitration agreement. For instance, if the subject matter of the contract underlying the arbitration agreement pertains to distribution of healthcare goods, the conduct of the non-signatory party should also be connected or in pursuance of the contractual duties and obligations, that is, pertaining to the distribution of heathcare goods. The determination of this factor is important to demonstrate that the non-signatory party consented to arbitrate with respect to the particular subject matter.

Involvement of Non-signatory party in negotiation, performance, or termination of contract is an important factor

The court expounded upon the degree of involvement of the non-signatory party in execution of the contract signed between the signatories. The court stressed that the involvement of the non-signatory must be evaluated for the following reasons-

By being actively involved in the performance of a contract, a non-signatory may create an appearance that is it is a veritable party to the contract containing the arbitration agreement.
The conduct of the non-signatory may be in harmony with the conduct of other members of the group, leading the other party to legitimately believe that the non-signatory was a veritable party to the contract.
The other party has legitimate reasons to rely on the appearance created by the non-signatory so as to bind it to the arbitration agreement.

However, the court clarified that mere incidental involvement of the non-signatory in the negotiation or performance of the contract is not sufficient to bind the non-signatory to the underlying contract or its arbitration agreement. The burden is on the party seeking joinder of the non-signatory to the arbitration agreement to prove a conscious and deliberate conduct of involvement of the non-signatory based on objective evidence.

Group of Companies doctrine exists independently and cannot be traced to the expression “claiming through or under” in Section 8 and 45

The Supreme Court observed that the expression “claiming through or under” in Section 8 and 45 of the Act is used in the context of successors in interest that act in a derivative capacity and substitute the signatory party to the arbitration agreement. Per contract, the group of companies doctrine is used to bind the non-signatory to the arbitration agreement so that it can agitate the benefits and be subject to the burdens that it derived or is conferred in the course of the performance of the contract. The doctrine can be used to bind a non-signatory party to the Agreement regardless of the phrase “claiming through or under” as appearing in Sections 8 and 45 of the Act. Observing in the above terms, the court held that the approach adopted by the three-judge bench in Chloro Controls (supra) is incorrect to the extent that it traced the group of companies doctrine to the phrase “claiming through or under” which is erroneous and against the settled principles of contract and commercial law.

Can a non-signatory to the Arbitration Agreement approach Court for interim measures under Section 9?

The Court observed that once the Arbitral Tribunal determines that the non-signatory party is a party to the arbitration agreement then such non-signatory can approach court for interim measures under Section 9 of the Act.

Can group of companies doctrine be applied at reference stage of Section 8 and 11?

The Court observed that the scope of Section 8 and 11 is limited and the court, at referral stage, only has to determine the prima facie existence of an arbitration agreement. If the court is unable to decide the issue then it should leave it to be decided by the arbitral tribunal. The court relied upon Section 16 embodying the principle of Kompetenz-Kompetenz. Therefore, the Court held that when a non-signatory person or entity is arrayed as a party at Section 8 or Section 11 stage, the referral court should prima facie determine the validity or existence of the arbitration agreement, as the case maybe, and leave it for the arbitral tribunal to decide whether the non-signatory is bound by the arbitration agreement. Since application of group of companies doctrine in a particular case requires factual exercise which is the domain of the arbitrator, the arbitrator can delve into those aspects of the matter to decide whether its jurisdiction extends to the non-signatory.

The court concluded as follows-

The definition of “parties” u/s 2(1)(h) r/w Section 7 of the Arbitration Act includes both the signatory as well as non-signatory parties.
Conduct of the non-signatory parties could be an indicator of their consent to be bound by the arbitration agreement;
The requirement of a written arbitration agreement under Section 7 does not exclude the possibility of binding non-signatory parties;
Under the Arbitration Act, the concept of a “party” is distinct and different from the concept of “persons claiming through or under” a party to the arbitration agreement;
The underlying basis for the application of the group of companies doctrine rests on maintaining the corporate separateness of the group companies while determining the common intention of the parties to bind the non-signatory party to the arbitration agreement;
The principle of alter ego or piercing the corporate veil cannot be the basis for the application of the group of companies doctrine;
The group of companies doctrine has an independent existence as a principle of law which stems from a harmonious reading of Section 2(1)(h) along with Section 7 of the Arbitration Act;
To apply the group of companies doctrine, the courts or tribunals, as the case may be, have to consider all the cumulative factors laid down in Discovery Enterprises (supra). Resultantly, the principle of single economic unit cannot be the sole basis for invoking the group of companies doctrine;
The persons “claiming through or under” can only assert a right in a derivative capacity;
The approach adopted by the court in Chloro Controls (supra) to the extent that it traced the group of companies doctrine to the phrase “claiming through or under” is erroneous and against the well-established principles of contract law and commercial law;
The group of companies doctrine should be retained in the Indian arbitration jurisprudence considering its utility in determining the intention of the parties in the context of complex transactions involving multiple parties and multiple agreements;
At the referral stage, the referral court should leave it for the arbitral tribunal to decide whether the non-signatory is bound by the arbitration agreement; and

Conclusion

The decision of the Supreme Court in Cox and Kings (supra) has brought much more clarity to the concept of the group of companies doctrine and its applicability in the field of arbitration. The finding that the group of companies doctrine cannot be traced to the expression “claiming through or under” in Section 8 and 45 of the Act and that it exists independent of the said expression has opened the applicability of the doctrine to various factual scenarios which will not only curb the multiplicity of proceedings but also help in dispensing complete justice to the parties.

By Daksh Pandit