Supreme Court Holds Arbitration Cannot Be Invoked on the Basis of an Agreement Founded on a Set-Aside Decree

In State of Madhya Pradesh v. Satish Jain (D) by LRs. & Ors. (2024 Latest Caselaw 251 SC), the Supreme Court held that where the very foundation of an agreement ceases to exist, any arbitration or settlement based on such agreement cannot be sustained. The Court observed that an agreement executed on the strength of an ex parte decree loses its legal sanctity once that decree is set aside. 

The respondent had instituted a civil suit claiming rights over government land on the basis of adverse possession. The suit was initially decreed ex parte in his favour. During the subsistence of the ex parte decree, an agreement was entered into between the respondent and the Bhopal Municipal Corporation (BMC), under which the respondent agreed to vacate the land in exchange for allotment of alternative plots. Subsequently, the ex parte decree was set aside and the matter was remanded to the Trial Court for fresh adjudication. Despite this, BMC sought reference of the dispute to arbitration under Section 89 of the Code of Civil Procedure on the strength of the earlier agreement. The Trial Court rejected the arbitral award, but the High Court restored it, leading to the present appeal. 

The principal issue was whether arbitration proceedings initiated under Section 89 CPC could be sustained when the underlying agreement was based upon an ex parte decree that had subsequently been set aside. 

The Supreme Court held that the High Court had committed a serious error in restoring the arbitral award. The Court observed that:

•The respondent had no crystallised rights over the land after the ex parte decree was set aside. 

•The agreement between the respondent and BMC derived its existence entirely from the ex parte decree. 

•Once the decree was set aside, the agreement lost its legal foundation and could no longer be relied upon. 

•BMC, being only an allottee of the State, had no authority to deal with the government land in the manner contemplated by the agreement. 

•The application seeking reference under Section 89 CPC itself was not maintainable. 

•The Trial Court had rightly rejected the arbitral award, whereas the High Court failed to consider these material aspects. The Supreme Court also noted that the suit regarding title to the land was still pending and the rights of the parties had yet to be finally determined. 

The Supreme Court: •Allowed the appeal. 

•Set aside the judgment of the High Court. 

•Restored the Trial Court's order rejecting the arbitral award. 

•Directed the Trial Court to proceed with the civil suit and decide it on its own merits based on the evidence led by the parties. 

The judgment clarifies that arbitration or settlement proceedings cannot survive where the underlying agreement itself becomes unenforceable. It reiterates that Section 89 CPC cannot be invoked on the basis of an agreement that has lost its legal foundation. The decision also underscores that courts must examine the validity of the underlying transaction before enforcing any arbitral or mediated settlement and reinforces that disputes relating to title must be adjudicated through proper civil proceedings.