A division bench of Justices L. Nageswara Rao and B.R. Gavai was hearing a batch of appeals filed by the state of Kerala against a Kerala High Court judgment that had held that the Act is unconstitutional.
A division bench of the high court, in its judgment, on July 9, 2013, had declared the Act unconstitutional.
Why did the Kerala government enact the 1998 Act?
In 1961, the state of Kerala started constructing the Kallada Irrigation Project, a part of which was proposed to be executed with financial assistance from the World Bank from June 1982 to March 1989. As required by the World Bank, a Local Competitive Bidding Specification [LCBS] condition was inserted in the agreement. Clauses 51 and 52 of the LCBS provided for the settlement of matters in dispute through arbitration with a view to enabling speedy settlement of matters.
The high court struck down the Act on two grounds – that it was beyond the legislative competence of the Kerala state legislature, and that it had the effect of annulling the awards of arbitrators, and the judgments and decrees passed by courts, and was therefore encroaching upon the powers of the judiciary.
Later, it came to light that the arbitrators, in collusion with the contractors, had arbitrarily and irregularly awarded unreasonable amounts against the provisions of the agreement.
In public interest, the state government cancelled the arbitration clauses. Subsequently, it enacted the 1998 Act,which received the assent of the President of India.
Why did the Kerala High Court strike down the Act?
Soon after the Act was enacted, several petitions were filed before the Kerala High Court challenging the validity of the Act.
The high court struck down the Act on two grounds – that it was beyond the legislative competence of the Kerala state legislature and as such, held the same to be unconstitutional; and that it had the effect of annulling the awards of arbitrators, and the judgments and decrees passed by courts. It was therefore held that the Act encroaches upon the powers of the judiciary.
Therefore, the impugned legislation was an encroachment on the judicial power of the state, which was exercisable through courts in terms of the laws already made and in force.
“[The 1998 Act] infracts the quality doctrine and the avowed constitutional principles insulating the Judicial function which is cardinal to deliverance of justice as part of the seminal constitutional values, including separation of powers”, the high court had held.
Aggrieved by this decision, the present appeals were filed by the state government before the Supreme Court.
What were the main arguments challenging the high court judgment?
The state government argued that the 1998 Act is not repugnant to the 1996 Act. The latter, enacted by the Parliament, would be applicable where the parties had agreed to refer the dispute to arbitration. The 1998 Act pertains to cancellation of contracts, and would be covered by Entries 7 and 13 of the Concurrent List of the Seventh Schedule of the Constitution, it was argued. It was asserted that while tracing the source of the 1998 Act, the doctrine of pith and substance ought to be applied, and the enactment needs to be read as a whole along with its object, scope and effect.
The Supreme Court noted that in cases of repugnancy between state and central legislation, the latter would prevail under Article 254(1). But when state law received the assent of the President, it would prevail in terms of Article 254(2).
Further, it was contended that without any explicit prohibition in the Constitution, the state legislature cannot be restrained from legislating on entries enumerated in the State and Concurrent lists of the Seventh Schedule.
Countering these arguments, the respondents averred that the 1998 Act was arbitrary as it singled out the concerned Project for revoking the arbitration clauses.
The respondents further argued that the state legislature had travelled beyond its jurisdiction to enact a statute that draws its power from Entries 12, 13, 14, and 37 of the Union List of the Seventh Schedule. When the Parliament enacts a statute for giving effect to an international agreement (in this case, the 1996 Act was enacted to give effect to the United Nations Commission on International Trade Law [UNCITRAL] Model Law on International Commercial Arbitration) under Article 253 of the Constitution, a state would be divested from passing a legislation on the same subject matter, even when such subject matters fall in State or Concurrent List, it was contended.
Did the Supreme Court agree with the high court’s ruling entirely?
The court mainly considered the following two questions:
Whether the Kerala state legislature was competent to enact the 1998 Act?
Whether the Kerala state legislature encroached on judicial powers?
The Supreme Court was of the view that the state legislature was competent to enact the Act, and therefore, differed from the high court’s view in this regard.
These judgments pointed out that a state could legislate on the subject of arbitration, but the same ought to have been reserved for the assent of the President.
Further, the Supreme Court noted that in cases of repugnancy between state and central legislation, the latter would prevail under Article 254(1) of the Constitution. But when state law received the assent of the President, it would prevail in terms of Article 254(2).
The court also noted that since some entries are bound to be overlapping, the doctrine of pith and substance must be utilized to ascertain the true character of the legislation.
Moreover, after going through the Statement of Objects and Reasons of the 1996 Act and the resolution of the United Nations General Assembly regarding Model law on international commercial arbitration, the court opined that the 1996 Act was not enacted to implement the decision of an international conference in terms of Article 253. It was enacted based on a resolution in which a recommendation was made to adopt the UNCITRAL Model Law. Therefore, Article 253 does not endure to the benefit of the 1996 Act, the court opined.
Based on these observations, the court concluded that the 1998 Act is within the legislative competence of the state legislature.
What then were the points of agreement between the Supreme Court and the Kerala High Court?
The next question that the Supreme Court considered was whether the Act in effect annuls the awards passed by arbitrators and/or the judgments or decrees passed by courts, and whether it amounts to encroachment on the judicial powers of the courts.
The Court noted that in most of the Kerala arbitration cases involving the present matter, the award was passed prior to 1992, which was made the court’s rule before 1993. On the day the 1998 Act was enacted, appeals preferred under Section 39 of the 1940 Act were pending before courts in a few cases.
The Supreme Court was of the view that judgments and decrees passed by civil courts can be set aside only by higher courts and not by way of legislation.
The Kerala state government relied on G.C Kanungo, wherein the Supreme Court had held that decrees made by courts to make an award ‘rule of court’ is merely for enforceability and cannot be treated as judgments and decrees passed in the exercise of judicial power. However, ultimately the Kanungo case held the Arbitration (Orissa Second Amendment) Act, 1991 as unconstitutional as it annulled the awards passed by Special Arbitration Tribunals, which are passed in exercise of judicial power.
Further, the court was of the view that judgments and decrees passed by civil courts can be set aside only by higher courts and not by way of legislation. After applying the three-fold test of ‘separation of powers’ as elucidated by a five-judge Constitution bench of the Supreme Court in State of Tamil Nadu versus State of Kerala (2014), the Court held that the 1998 Act, which has the power to annul awards that have become ‘rules of court’, encroaches upon judicial powers, and hence violates the doctrine of separation of powers.
To sum up, the court arrived at the the following conclusions:
The finding in G.C. Kanungoto the effect that the powers exercised by courts in passing judgments and decrees for making arbitration awards ‘rule of court’ is not an exercise of judicial power and is per incuriam the provisions of the 1940 Act.
The Kerala High Court is right in law in holding that the 1998 Act encroaches upon the judicial power of the State, and is therefore liable to be struck down as being unconstitutional.
Click here to view the Supreme Court’s full judgment.