Reportable  IN THE SUPREME COURT OF INDIA

CIVIL APPELLATE JURISDICTION

CIVIL APPEAL NO. 9224 OF 2010 [Arising out of SLP [C] No.17114/2008]

With

CIVIL APPEAL NO. 9225 OF 2010 [Arising out of SLP [C] No.17115/2008]

S.N. Prasad  … Appellant

Vs.

Monnet Finance Ltd. & Ors. … Respondents

J U D G M E N T

R.V.RAVEENDRAN, J.

Leave  granted.  These  appeals  involve  the  question  whether  a  

guarantor for a loan, who is not a party to the loan agreement containing the  

arbitration  agreement  executed  between the  lender  and borrower,  can  be  

made a party to a reference to arbitration in regard to a dispute relating to  

repayment of such loan and subjected to the arbitration award.  

1

2. The  second  respondent  company  is  a  borrower  from  the  first  

respondent.  Third  respondent  is  the  Managing  Director  of  the  second  

respondent. The appellant, father of the third respondent, was a Director of  

the  second  respondent.  The  second  respondent  (also  referred  to  as  

‘borrower’)  after  repaying an earlier  loan taken from the first  respondent  

(also referred to as the ‘lender’), sought a fresh loan of Rs.75 lakhs. The first  

respondent sanctioned the loan. The appellant by letter dated 27.10.1995 in  

his capacity as a Director of the second respondent, stood guarantee for the  

loan of Rs.75 lakhs sanctioned by the first respondent.  

3. A loan agreement dated 28.10.1995 was entered between the lender,  

the  borrower,  and the third  respondent  as  the  guarantor,  in  regard to the  

lending of a sum of Rs.50 lakhs. The agreement provided that the amount  

advanced had to  be repaid  within  three  months  with interest  at  20% per  

annum and if there was default, the borrower was liable to pay a compound  

interest at the rate of 5% per month with quarterly rests. Clause 18 of the  

said loan agreement provided for settlement of disputes by arbitration.  In  

addition  to  the  loan  agreement,  the  borrower  executed  an  on  demand  

promissory note for the amount borrowed and the third respondent executed  

a  Deed  of  Guarantee  guaranteeing  repayment  of  the  loan  amount  with  

2

interest.  Similarly, a tripartite loan agreement was entered in respect of a  

loan  of  Rs.2500,000/-  on  6.11.1995,  among  the  first  respondent,  second  

respondent and third respondent followed by a promissory note by second  

respondent and deed of Guarantee by third respondent. The appellant was  

not a party to the loan agreements nor did he execute any separate deeds of  

guarantee  or  other  document  in  favour  of  the  first  respondent.  The  loan  

agreements did not refer to the letter of guarantee by the appellant.  

4. The lender issued a notice through counsel demanding payment and  

proposing to refer  the claims against  the borrower and its  guarantors  for  

arbitration.  This  was  followed  by  two  applications  by  the  lender  under  

section 11 of the Arbitration and Conciliation Act, 1996 (‘Act’ for short) for  

appointment of  an Arbitrator.  The borrower,  its  Managing Director-cum-

Guarantor,  and  the  appellant  were  impleaded  as  respondents  in  the  said  

application.  

5. The High Court of Delhi by two orders dated 23.5.2000 appointed a  

retired Judge of the High Court as the sole arbitrator. The arbitrations ended  

in two awards dated 1.5.2002. The first award directed respondents 2 and 3  

and appellant to pay Rs.93,23,288/- (that is Rs.50 lakhs with interest at 20%  

3

up to the date  of the appointment of  arbitrator)  with interest  at  18% per  

annum from 24.5.2000. Similarly the second award directed respondents 2  

and 3 and appellant to pay Rs.46,49,315/- (that is Rs.25 lakhs with interest at  

20% upto the date of appointment of arbitrator)  with interest  at  18% per  

annum from 24.5.2000. The two arbitration awards were challenged by the  

appellant  by  filing  applications  under  section  34  of  the  Act  (OMP  

No.319/2002  and  322/2002).  The  second  and  third  respondents  also  

challenged the awards in OMP No.320/2002 and 321/2002. A learned single  

Judge  of  the  Delhi  High  Court  by  a  common  order  dated  22.5.2006  

dismissed the said applications.  The said common order dated 22.5.2006,  

insofar as it dismisses OMP 319/2002 and 322/2002, is challenged by the  

appellant in this appeals by special leave.

6. The following contentions are urged by the appellant :

(i) The  appellant  was  not  a  party  to  the  tripartite  loan  agreements  executed  among  respondents  1,  2  and  3  (that  is  the  lender,  the  borrower  and  borrower’s  Managing  Director-cum-Guarantor)  containing the arbitration clause. He had merely given a short letter  dated  27.10.1995  standing  guarantee  for  a  loan  of  Rs.75  lakhs  sanctioned  by  the  first  respondent.  As  there  was  no  arbitration  agreement  between  the  first  respondent  and  appellant,  the  claim  against the appellant could not be referred to arbitration, nor could any  award be made against him. The awards against the appellant were  therefore liable to be set aside under section 34(2)(a)(ii) of the Act.  

4

(ii) The appellant had merely given a letter dated 27.10.1995 indicating  his willingness  to stand guarantee,  but he did not  execute the loan  agreement or any deed of guarantee, as it was decided that the third  respondent would be the guarantor instead of appellant. Consequently,  the third respondent executed the loan agreement as guarantor as also  a deed of Guarantee. Therefore, the appellant was not a guarantor and  is not liable.  

(iii) Even  assuming  without  conceding  that  there  was  an  arbitration  agreement between the appellant and first respondent, and that he was  liable in respect  of the loan amount,  there could  be no award for  interest against him as he had not agreed to guarantee the payment of  interest.

Re : Contention (i)

7. Section 2(b) defines “arbitration agreement’ as an agreement referred  

to  in  section  7  of  the  Act.  Section  2(h)  defines  “party”  as  party  to  an  

arbitration  agreement.  Section  7  of  the  Act  defines  an  ‘arbitration  

agreement’. Sub-section (1) of Section 7 defines an arbitration agreement as  

an agreement by the parties to submit to arbitration all or certain disputes  

which have arisen or which may arise between them in respect of a defined  

legal relationship, whether contractual or not. Sub-section (2) provides that  

an arbitration agreement may be in the form of an arbitration clause in a  

contract or in the form of a separate agreement. Sub-section (3) requires an  

arbitration agreement to be in writing. Sub-section (4) explains as to when  

an  arbitration  agreement  could  be  said  to  be  in  writing,  that  is  :  (a)  a  

5

document signed by the parties; (b) an exchange of letters, telex, telegrams  

or  other  means  of  telecommunication  which  provide  a  record  of  the  

arbitration agreement; or (c) an exchange of statements of claim and defence  

in which the existence of the arbitration agreement is alleged by one party  

and not denied by the other. Sub-section (5) provides that the reference in a  

contract  to  a  document  containing  an  arbitration  clause  constitutes  an  

arbitration agreement if the contract is in writing and the reference is such as  

to  make that  arbitration  clause  a  part  of  the  contract.  Thus  there  can be  

reference to arbitration only if there is an arbitration agreement between the  

parties. The Act makes it clear that an Arbitrator can be appointed under the  

Act at the instance of a party to an arbitration agreement only in respect of  

disputes with another party to the arbitration agreement. If there is a dispute  

between  a  party  to  an  arbitration  agreement,  with  other  parties  to  the  

arbitration  agreement  as  also  non-parties  to  the  arbitration  agreement,  

reference to arbitration or appointment of arbitrator can be only with respect  

to the parties to the arbitration agreement and not the non-parties.

8. There  is  no  dispute  that  the  loan  agreements  among  the  first  

respondent  (lender),  the  second  respondent  (borrower)  and  the  third  

6

respondent  (guarantor)  contained  a  provision  for  arbitration.  The  said  

provision for arbitration is extracted below :  

“In the event of any dispute, question or difference  arising out of or in   connection with this agreement and the respective rights and obligations  of the parties hereunder, the same shall be referred to the arbitration in  accordance with the provisions of the Arbitration Act, 1940.”  

But the appellant was not a party to the same. In fact appellant’s letter of  

guarantee for Rs.75 lakhs was given on 27.10.1995, prior to the dates of the  

two loan agreements.  It is also not in dispute that the letter dated 27.10.1995  

given by appellant  to the first respondent did not contain a provision for  

arbitration; and that except the said letter dated 27.10.1995, the appellant did  

not  execute  any  document  or  issue  any  communication.  An  arbitration  

agreement between the lender on the one hand and the borrower and one of  

the  guarantors  on  the  other,  cannot  be  deemed  or  construed  to  be  an  

arbitration agreement in respect of another guarantor who was not a party to  

the arbitration agreement. Therefore, there was no arbitration agreement as  

defined under section 7(4)(a) or (b) of the Act, in so far as appellant was  

concerned,  though  there  was  an  arbitration  agreement  as  defined  under  

section 7(4)(a) of the Act in regard to the second and third respondents.  As  

the letter  dated 27.10.1995 does not refer to any document containing an  

7

arbitration  clause,  there  is  also  no  arbitration  agreement  between  first  

respondent and appellant as contemplated under section 7(5) of the Act.   

9. What  therefore  remains  to  be  considered  is  whether  there  is  an  

arbitration  agreement  as  contemplated  under  section  7(4)(c)  of  the  Act,  

which provides that an arbitration agreement in writing can be said to exist,  

if it is contained in an exchange of statements of claim and defence in which  

the existence of the arbitration agreement is alleged by one party and not  

denied by the other.  The statement  of claim filed by the first  respondent  

before  the  arbitrator  does  not  contain  an  allegation  or  assertion  of  an  

arbitration agreement between the first respondent and appellant. Nor has the  

appellant accepted the existence of any arbitration agreement by not denying  

such arbitration agreement in the defence filed before the arbitrator. On the  

other  hand,  the  appellant  specifically  contended before the arbitrator  that  

there  was  no  arbitration  agreement  between  them  (first  respondent  and  

appellant) and therefore the arbitrator did not have jurisdiction.  

10. But the words, ‘statements of claim and defence’ occurring  in section  

7(4)(c) of the Act, are not restricted to the statement of claim and defence  

filed  before  the  arbitrator.  If  there  is  an  assertion  of  existence  of  an  

8

arbitration  agreement in  any suit,  petition or  application  filed before any  

court,  and  if  there  is  no  denial  thereof  in  the  defence/counter/written  

statement thereto filed by the other party to such suit, petition or application,  

then it can be said that there is an “exchange of statements of claim and  

defence” for the purposes of section 7(4)(c) of the Act. It follows that if in  

the application filed under section 11 of the Act, the applicant asserts the  

existence of an arbitration agreement with each of the respondents and if the  

respondents do not deny the said assertion, in their statement of defence, the  

court  can  proceed  on  the  basis  that  there  is  an  arbitration  agreement  in  

writing between the parties.  

11. The question therefore is whether in this case, the application under  

section 11 of the Act had alleged the existence of an arbitration agreement  

between first respondent and appellant and such allegation was accepted by  

non-denial  thereof,  by  the  appellant.  The  application  filed  by  the  first  

respondent  under  section  11  of  the  Act  referred  to  the  loan  agreement  

containing  the  arbitration  clause,  which  was  executed  by  respondents  2  

and  3  as  borrower  and  guarantor  in  favour  of  the  first  respondent.  The  

application specifically relied upon the provisions of clause 18 of the loan  

agreement  as  the  arbitration  agreement  under  which  appointment  of  an  

9

arbitrator was sought. Significantly, the application under section 11 of the  

Act  did  not  allege  or  refer  to  the  existence  of  any arbitration  agreement  

between the first respondent and the appellant. The only averment found in  

the  entire  application  with  reference  to  the  document  executed  by  the  

appellant is extracted below:  

“Respondent No.3 vide his letter dated 27.10.95 guaranteed the repayment  of the total amount of loan i.e. Rs.75,00,000 (Rupees Seventy Five Lakhs)  sanctioned by the Petitioner to Respondent No.1. Copy of the letter dated  27.10.95  from  Respondent  No.3  guaranteeing  repayment  of  loans  is  annexed herewith and marked as “ANNEXURE-C”.  

(Note: The term ‘petitioner’ refers to the lender, respondent No.1 refers to  the borrower and respondent No.3 refers to the appellant).  

Except  the  aforesaid  averment,  there  is  absolutely  no  reference  to  any  

agreement between the first respondent and the appellant or the existence of  

any arbitration agreement between them. Therefore the application filed by  

the  first  respondent  under  section  11  of  the  Act  referring  to  the  loan  

agreement with  respondents 2 and 3 containing the arbitration agreement  

cannot  be considered or  construed to be an allegation  of existence of  an  

arbitration agreement between first respondent and appellant. If there was no  

reference to the existence of any arbitration agreement with appellant, the  

question  of  the  appellant  accepting  such  arbitration  agreement  by  ‘non-

denial’ does not arise.  

10

12. The first respondent contended that the application under section 11 of  

the Act consisted of two parts, that is a preamble containing three columns -  

column (1) relating to the “provision under which the application was filed”,  

column  (2)  relating  to  “Name  of  applicant  with  complete  address”  and  

column  (3)  relating  to  “Name  of  the  other  parties  to  the  arbitration  

agreement  with  complete  address”;  and  the  second  part  contained  the  

running averments. It is submitted that the name of first respondent is shown  

as the applicant in column (2); and against column (3) relating to “Names of  

the other parties to the arbitration agreement”, the names of Hitek Industries  

(second  respondent),  Prem  Prakash  Verma  (third  respondent)  and  S.N.  

Prasad (appellant) was shown and that amounted to an allegation that the  

appellant was a party to the arbitration agreement.   

13. To constitute  an arbitration  agreement  under  section  7(4)(c)  of  the  

Act, what is required is a statement of claim containing a specific allegation  

about the existence of an arbitration agreement by the applicant and ‘non-

denial’  thereof  by  the  other  party.  An  ‘allegation’  is  an  assertion  or  

declaration about a fact and also refers to the narration of a transaction. As  

noticed above, in the entire application under section 11 of the Act, there  

was no allegation as to the existence of any arbitration agreement between  

11

first respondent and the appellant. Column (3) containing “Names of other  

parties to arbitration agreement with addresses” cannot be considered to be  

an assertion or declaration about the existence of an arbitration agreement  

between the first respondent and appellant. Section 7(4)(c) of the Act cannot  

therefore be relied upon to prove the existence of an Arbitration agreement.  

14. It  is  of  some  relevance  to  note  that  in  the  year  1998  when  the  

applications under section 11 of the Act was filed and in the year 2000 when  

the applications were allowed, an application under section 11 of the Act  

was not considered to be a judicial proceeding and the order appointing an  

arbitrator  was  considered  to  be  an  administrative  order.  Therefore  at  the  

relevant time, the application under section 11 of the Act and the counter if  

any thereto were not in the nature of ‘statements of claim and defence’. Be  

that as it may.  

15. Before  the  Arbitrator,  the  appellant  specifically  contended  that  by  

relying upon the section 2(1)(h) and section 7 of the Act that he was not a  

party to the arbitration agreement and therefore there could be no arbitration  

in regard to the claim against him. The said contention was rejected by the  

arbitrator on the ground that the designate of the Chief Justice, in his order  

12

dated 23.5.2000 appointing the arbitrator, had observed that the existence of  

arbitration agreement was not denied and there was no dispute regarding the  

existence of the arbitration agreement.  But what was not  denied was the  

arbitration agreement between first respondent and respondents 2 and 3. The  

arbitrator held that in view of the positive finding of the designate of the  

Chief Justice about the existence of an arbitrator agreement notwithstanding  

the  fact  that  the  letter  of  guarantee  does not  refer  to  the  loan agreement  

which was executed subsequently,  it  could not be said that  there was no  

arbitration  agreement  between  the  parties.  The  arbitrator  ought  to  have  

considered and decided the objections  of the appellant  that he was not  a  

party to the arbitration agreement on merits, instead of referring to the order  

of  the  designate  of  the  Chief  Justice  appointing  the  arbitrator.  As  noted  

above, when the said application under section 11 of the Act was filed in  

1998 and decided in 2000 (long prior to the decision in SBP & Co. vs. Patel   

Engineering Ltd. – (2005) 8 SCC 618,) the prevailing view was that the  

orders under section 11 of the Act were administrative orders and that the  

Designate of the Chief Justice  appointing an arbitrator was not adjudicating  

on  any  disputed  question  of  fact,  including  the  existence  of  any  valid  

arbitration agreement; and that the Arbitrator was required to decide about  

the existence of arbitration agreement and the arbitrability.  

13

16. The first respondent contended that the appellant having agreed to be  

a  guarantor  for  the  repayment  of  the  loan,  can  not  avoid  arbitration  by  

contending that he was not a signatory to the loan agreement containing the  

arbitration clause. It was submitted that the liability of the principal debtor  

and guarantors was joint and several and therefore there could be only one  

proceeding against all of them; and that if the contention of the appellant  

was accepted, it would necessitate two proceedings in regard to the same  

loan transaction and same cause of action, that is an arbitration proceedings  

against the borrower and one of its guarantors (respondents 2 and 3) and a  

separate suit against the other guarantor (appellant). It was further submitted  

that multiple proceedings may lead to divergent findings and results, leading  

to  an  anomalous  situation.  It  was  also  submitted  that  the  letter  

dated 27.10.1995 guaranteeing the loan of Rs.75 lakhs was written by the  

appellant, as a Director of the borrower company; and that as the appellant  

had already given a guarantee letter dated 27.10.1995, he was not required to  

execute the tripartite loan agreements containing the arbitration clause; that  

the appellant was aware of the terms of the loan and was further aware that  

loan  agreements  with  arbitration  clause  had  to  be  executed;  and  that  

14

therefore it should be deemed that the appellant had agreed to abide by the  

terms contained in the loan agreements, including the arbitration clause. We  

find no merit in these contentions.  

17. When the appellant  gave  the  guarantee  letter  dated 27.10.1995,  he  

could not be imputed with the knowledge that the loan agreements which  

were to be executed in future (on 28.10.1995 and 6.11.1995) would contain  

an arbitration clause. Further, the appellant did not state in his letter dated  

27.10.1995 that he would be bound by the terms of loan agreement/s that  

may  be  executed  by  the  borrower.  Therefore  the  question  of  appellant  

impliedly agreeing to the arbitration clause does not arise.  

18. The apprehension of the first respondent that an anomalous situation  

may arise if there are two proceedings (one arbitration proceedings against  

the borrower and one guarantor and a suit against another guarantor), is not a  

relevant consideration as any such anomalous situation, if it arises, would be  

the own-making of the first  respondent,  as that  is  the consequence of its  

failure  to  require  the  appellant  to  join  in  the  execution  of  the  loan  

agreements. Having made only one of the guarantors to execute the loan  

agreements  and  having  failed  to  get  the  appellant  to  execute  the  loan  

agreements, the first respondent cannot contend that the appellant who did  

15

not sign the loan agreements containing the arbitration clause should also be  

deemed to be a party to the arbitration and be bound by the awards. The  

issue is not one of convenience and expediency. The issue is whether there  

was an arbitration agreement with the appellant.  

19. As there was no arbitration agreement between the parties (the first  

respondent and appellant), the impleading of  appellant as a respondent in  

the  arbitration  proceedings  and  the  award  against  the  appellant  in  such  

arbitration  cannot  be  sustained.  As  a  consequence,  both  the  arbitration  

awards,  as  against  the  appellant  are  liable  to  be  set  aside.  If  the  first  

respondent wants to enforce the alleged guarantee of the appellant, it is open  

to the first respondent to do so in accordance with law.

20. The above discussion and findings would also apply to the second  

loan covered by the loan agreement dated 6.11.1995, as the facts are the  

same.  

Re :  Contention (ii)

21. The appellant contended that on 27.10.1995 he was a Director of the  

borrower company and he had agreed to guarantee the loan of Rs.75 lakhs;  

16

that  subsequently,  it  was  decided  as  he  would  be  resigning  from  his  

directorship on account of his advanced age, his son would be the guarantor;  

and that therefore, he did not become a guarantor by executing a deed of  

guarantee and he did not also execute the loan agreements. It was contended  

that the fact that ultimately the loan agreements were executed only among  

the lender (first respondent), the borrower company (2nd respondent) and the  

3rd respondent (guarantor) and the further fact that third respondent alone  

executed the Deed of Guarantee,  demonstrated that  only third respondent  

was  the  guarantor  and  he  was  not  a  guarantor.  According  to  him  on  

execution of the loan agreements among respondents 1, 2 and 3, the letter  

dated 27.10.1995 given by him agreeing to be a guarantor ceased to be of  

any effect.  We cannot examine these aspects in an appeal  arising from a  

proceeding under section 11 of the Act. In a proceedings under section 11 of  

the Act, what is relevant is existence of arbitration agreement and not the  

defence on merits. Further, in view of our finding on the first contention, it is  

not necessary to examine this contention. It is open to appellant to urge this  

contention,  if  and  when  first  respondent  initiates  action  against  him  in  

accordance with law.  

17

Re : Contention (iii)

22. It  is  true that  where the letter  of Guarantee issued by a guarantor,  

guarantees repayment of only the principal sum and does not guarantee the  

payment of any interest, he could not be made liable for the interest. But in  

view of our finding on the first contention, this issue does not survive for  

consideration.  

Conclusion

23. In view of the above, these appeals are allowed and the impugned  

order of the High Court and awards of the Arbitrator are set aside in part, in  

so far as the appellant is concerned.  

…………………………J. (R V Raveendran)

New Delhi; ……………………….J. October  22, 2010. (H L Gokhale)             

18