Court’s Decision
The Delhi High Court allowed the appeal under Section 37(2)(a) of the Arbitration and Conciliation Act, 1996, and set aside the arbitrator’s order dated 20.04.2024 which had discharged guarantors from arbitral proceedings. The Court held that the Deeds of Guarantee executed by the respondents expressly incorporated the Loan Agreement, making its arbitration clause binding on them. The Court observed:
“When a Deed of Guarantee records that it shall form an integral part of the Loan Agreement, it goes beyond a mere reference. It amounts to incorporation of the Loan Agreement in entirety, including the arbitration clause.”
Facts
The appellant, a Non-Banking Financial Company (NBFC), sanctioned a loan of ₹68,18,000 in December 2012 to a borrower under a Loan Agreement which contained Clause 32—an arbitration clause. On the same day, the respondents executed separate Deeds of Guarantee to secure repayment.
The borrowers defaulted, leading the appellant to invoke arbitration in 2015. The first arbitrator recused in July 2023; a new arbitrator was appointed in September 2023. In January 2024, the guarantors sought discharge from arbitration, arguing they were not parties to the Loan Agreement.
On 20.04.2024, the arbitrator accepted their plea, holding no arbitration agreement existed between the appellant and the guarantors, relying on M.R. Engineers & Contractors Pvt. Ltd. v. Som Datt Builders Ltd. (2009). Aggrieved, the appellant challenged this before the High Court.
Issues
- Whether guarantors, who executed Deeds of Guarantee contemporaneously with the Loan Agreement, are bound by the arbitration clause contained in the Loan Agreement.
- Whether Clause 4 of the Guarantee, declaring it an “integral part” of the Loan Agreement, amounts to incorporation under Section 7(5) of the Arbitration Act.
- Whether the arbitrator’s reliance on M.R. Engineers was justified.
Petitioner’s Arguments
The appellant argued that the Guarantee and Loan Agreement formed part of a single composite transaction. Clauses 2, 3, and particularly Clause 4 of the Guarantee explicitly incorporated the Loan Agreement, binding guarantors to all its terms, including arbitration.
They contended that the arbitrator misapplied M.R. Engineers, which distinguishes between mere reference and incorporation. Here, incorporation was explicit. Reliance was placed on Shinhan Bank v. Carol Info Services Ltd. (2023), which held that where an agreement records it forms part of another, all terms including arbitration stand incorporated.
The appellant also relied on Punjab National Bank v. Bikram Cotton Mills (1970), affirming that contemporaneous agreements forming a single transaction must be read together. Alternatively, even if treated as a “two-contract” case, Inox Wind Ltd. v. Thermocables Ltd. (2018) permits incorporation of arbitration clauses in standard form contracts by general reference.
Respondent’s Arguments
The respondents argued they were never parties to the Loan Agreement, the only contract containing an arbitration clause. The Guarantees were separate and independent contracts without any arbitration clause. They never consented to arbitrate disputes and thus could not be compelled into arbitration.
Reliance was placed on M.R. Engineers (2009), which held that arbitration clauses from a principal contract cannot automatically apply to sub-contracts unless specifically incorporated. They also cited NBCC (India) Ltd. v. Zillion Infraprojects Pvt. Ltd. (2024) and S.N. Prasad v. Monnet Finance Ltd. (2011), both holding that guarantors not party to an arbitration clause cannot be forced into arbitration.
They further relied on Vidya Drolia v. Durga Trading (2021) and N.N. Global Mercantile v. Indo Unique Flame (2021), reiterating that the existence of a valid arbitration agreement is sine qua non.
Analysis of the Law
The Court examined Section 7(5) of the Arbitration Act, which recognizes incorporation of arbitration clauses where contracts make another document an “integral part.” It applied the distinction in M.R. Engineers between general reference and incorporation.
The Court found Clause 4 of the Guarantee went beyond reference, declaring the Guarantee to be an “integral part” of the Loan Agreement. This reflected intent to incorporate the Loan Agreement in entirety, thereby binding guarantors to the arbitration clause.
Shinhan Bank (2023) was directly applicable, where incorporation was upheld on similar wording. Further, Inox Wind (2018) extended the principle even to two-contract situations involving standard forms. The Loan Agreement and Guarantees were executed on the same date, securing the same transaction, satisfying the “single contract” rationale.
Precedent Analysis
- M.R. Engineers (2009) – distinguished; applied only where contracts contain mere references, not express incorporation.
- Shinhan Bank (2023) – applied; incorporation upheld when one agreement forms part of another.
- Punjab National Bank v. Bikram Cotton Mills (1970) – contemporaneous agreements forming one transaction must be read together; applied.
- Inox Wind (2018) – applied; general reference sufficient in standard form contracts.
- NBCC (2024) and S.N. Prasad (2011) – distinguished; no express incorporation existed there, unlike here.
Court’s Reasoning
The Court held that the arbitrator erred in treating the Guarantee as an independent contract. Clause 4 of the Guarantee expressly incorporated the Loan Agreement, satisfying Section 7(5). By calling itself an “integral part,” the Guarantee imported all Loan Agreement terms, including the arbitration clause.
The Court emphasized commercial intent: the Guarantee and Loan Agreement, executed together, were part of a single composite transaction securing repayment. Guarantors could not escape arbitral jurisdiction by claiming separateness. The arbitrator’s reasoning was legally unsustainable and contrary to binding precedent.
Conclusion
The High Court set aside the arbitrator’s order under Section 37(2)(a), holding guarantors bound by the arbitration clause of the Loan Agreement. The appeal was allowed, restoring arbitral jurisdiction over guarantors.
Implications
This judgment clarifies that guarantors cannot escape arbitration when Guarantees expressly incorporate Loan Agreements containing arbitration clauses. It reinforces the principle that contemporaneous documents forming one transaction must be read together. It also narrows the scope of M.R. Engineers by emphasizing intent and express incorporation, strengthening creditor rights against guarantors in arbitration disputes.
FAQs
1. Are guarantors bound by arbitration clauses in loan agreements?
Yes, if the Guarantee incorporates the Loan Agreement as an “integral part,” guarantors are bound by its arbitration clause.
2. What did the arbitrator initially decide?
The arbitrator discharged guarantors, holding no arbitration agreement existed with them. The High Court reversed this.
3. How does this ruling impact guarantors in financial transactions?
It ensures guarantors cannot avoid arbitration by claiming separateness where Guarantees incorporate Loan Agreements, protecting lenders.
