B.D. Agarwal, J.
1. These connected appeals arise against the orders passed by the II Civil Judge, Kanpur, dt. Jan. 24, 1984 and Feb. 4, 1984, in Original Suit No. 775 of 1983.
2. The respondent No. 1 is a registered Company engaged in the manufacture of mild steel ingots at Unnao. On Dec. 15, 1982, there was an agreement in writing entered into between the respondent and the appellants for the purchase of iron scrap required as raw-material to manufacture the ingots. The agreement is signed by the Controller of Stores, N. E. Railway, Gorakhpur, for and on behalf of the President of India. In terms of the agreement the respondent was to take delivery of the goods from the appellants on being intimated of the same and upon failure to take delivery the contract was liable to be cancelled and the security forfeited. On Dec. 11, 1982, the respondent 2 (Grindlays Bank) furnished guarantee for a sum of Rs. 2,45,680/- on behalf of the respondent 1. The validity period of the agreement is Dec. 15, 1982 to Dec. 14, 1983. The Controller of Stores, N. E. Railway, Gorakhpur, wrote to the respondent 2 on Dec. 8, 1983, intimating that the respondent 1 having failed to perform their part under the agreement, the same had been cancelled and asked for the guarantee amount to be encashed in favour of the appellants. The respondent 1 thereupon instituted the suit giving rise to these appeals in the Court of II Civil Judge, Kanpur, on Dec. 12, 1983, claiming permanent injunction to restrain the appellants from seeking encashment of the bank guarantee. An application was made for the appellants before the trial Court for stay of the proceedings in the suit under Section 34 of the Arbitration Act. The application was opposed by the respondent 1 and it was rejected on Jan. 24, 1984, with the observation that the agreement having been cancelled by the appellants, they could not seek reference to arbitration. The respondent 1 had also filed an application for grant of temporary injunction, which was opposed by the appellants, but under the order dt. Feb. 4, 1984, the trial Court has issued temporary injunction restraining the appellants from encashing the bank guarantee.
3. Aggrieved against the order dt. Jan. 24, 1984, the appellants have preferred First Appeal From Order No. 398 of 1984 under Section 39(1)(v) of the Arbitration Act, 1940, and against the other order dt Feb. 4, 1984, granting temporary injunction First Appeal From Order No. 397 of 1984 has been filed under Order 43 Rule l(r) Civil P. C. The appeals were heard together.
4. Learned counsel for the appellants submitted that the arbitration agreement is not wiped off due to unilateral cancellation of the agreement. It is argued that notwithstanding the demand made by the Controller of Stores, N. E. Railway upon therespondent 2 dt. Dec. 8, 198.1, to encash in their favour the bank guarantee, the dispute raised by the respondent 1 may still form the subject-matter of reference to arbitration. We find sufficient merit in this contention.
5. Under the agreement dt. Dee. 15, 1982, relied on for the appellants and referred to in the plaint, it is stipulated that in the event of failure of the respondent 1, to take delivery it shall be open to the Controller of Stores, N. E. Railway to cancel the sale and forfeit the security deposited or resell the material lying unremoved at the risk of the respondent. Clause 27 in so far as material reads : --
'In the event of any question, dispute or difference arising under these presents or in connection therewith (except as to any matters the decision of which is specially provided for by these presents) the same shall be referred to the sole arbitration of an Arbitrator appointed by the General Manager, N. E. Railway, Gorakhpur. It will be no objection that the Arbitrator is a Government servant, that he had to deal with the matters to which these presents relate or that in the course of his duties as a Government servant he has expressed views on all or any of the matters in dispute or difference. The award of the Arbitrator shall be final and binding on the parties to these presents.'
6. From a reference to the plaint it would appear that the respondent 1 has, inter alia, disputed the formation and validity of the contract. It has been asserted that the agreement in question lacks mutuality and that the Controller of Stores, N. E. Railway did not have the authority to sign the agreement for or on behalf of the President of India. Into the merits of these averments this Court is not called upon to express any opinion. Suffice it to say that the mere fact that these averments appear in the plaint may not necessarily lead the trial Court to reject the application made for the appellants under Section 34 of the Arbitration Act. The course of action to be adopted in such a case is laid down by the Supreme Court in Anderson Wright Ltd. v. Moran & Co. Ltd. : 1SCR862 . At p. 56 a reference was made to the observations of S. R. Das J. in Khusiram v. Hanutmal, (1949) 53 Cal WN 505 to the effect 'that where on an application made under S, 34 of the Arbitration Act for stay of a suit, an issue is raised as to theformation, existence or validity of the contract containing the arbitration clause, the Court is not bound to refuse a stay but may in its discretion, on the application for stay, decide the issue as to the existence or validity of the arbitration agreement even though it may involve incidentally a decision as to the validity or existence of the parent contract.1' Where, as in this case, there is challenge to the execution and validity of the agreement, the trial Court should, it has been held, decide the same itself, as a pre-condition to invocation of the arbitration clause. If the finding on that score is against the party seeking to avail of the arbitration clause, that would mean an end of the matter. The error in the present exists mainfestly inasmuch as without entering into that aspect, the learned Civil Judge has declined fo stay proceedings under Section 34, Arbitration Act on assumption that since the agreement has been cancelled, the arbitration clause does not survive. This course of action is not valid. Provided the formation the validity of the agreement is proved, the Court must turn to Section 34 and. if the conditions (hereof are satisfied, there should be very strong grounds for refusing stay in commercial cases especially vide Ram Bahadur Thakur v. Thakur Das, : AIR1958All522 . It should be borne in mind that by mere denial of a contract a party cannot defeat the arbitration agreement nor can he take away the jurisdiction of the arbitrator to decide the dispute on the merits. (See Pannalal Sagoremull v. Fateh Chand Muralidhar, (1951) 88 Cal LJ 34).
7. The decisions relied upon for the respondent No. 1 do not suggest a different course in such matters. In Ghelabhai M. Roy v. K. M. Nemani, AIR 1949 Bom 343 there wasnoquestion ofstay under Section 34, Arbitration Act. In that case there was reference made to arbitration without the factum of the contract being established. The Bench reiterated the well settled proposition that if one of the parties to a reference disputes the factum of existence of the contract in respect of which disputes arise and which disputes the arbitrator has no jurisdiction to decide the question is whether in fact the contract was entered into or not.
In Chinoy Chalani & Co. v. Y. Anjiah, AIR 1958 Andh Pra 384 which also is cited for the respondent the finding was that there had been no contract and on this footing it was held that there could be no valid submissionto arbitration. In Chartered Bank v. Commr. for Port, Calcutta, : AIR1972Cal198 the conclusion reached was that the appellant had been contending that the arbitration clause never came into being and there was no binding contract between the parties. It was, therefore, held that it did not lie in the mouth of the appellant to contend that even though there was no operative and binding agreement, the arbitration clause be permitted to be invoked still. In contrast the appellants before us have maintained throughout that the contract was duly executed and is valid but since, according to them, there was breach on part of the respondent, it had to be rescinded by them.
8. In our opinion attention must be directed to the true nature and function of an arbitration clause in a contract. It is distinct from the other clauses. The other clauses set out the obligations which the parties undertake towards each other, but the arbitration clause docs not impose on one of the parties an obligation in favour of the other. It embodies the agreement of both parties that, if any dispute arises with regard to the obligation which one party has undertaken to the other, such dispute shall be settled by a tribunal of their awn construction. 'And there is this very material difference, that where as in an ordinary contract the obligations of the parties to each other cannot in general be specifically enforced and breach of them results only in damages, the arbitration clause can be specifically enforced by the machinery of the Arbitration Acts. The appropriate remedy for breach of the agreement to arbitrate is not damages, but its enforcement.' (per Lord Macmillan, Heyman v. Darwins Ltd., 1942 AC 356 at p. 373). The court below has not borne this distinction in mind.
9. In Andcrson Wright Ltd. : 1SCR862 (supra) their Lordships expressed agreement with the observation of Lord Porter in 1942 AC 356 at p. 393 to the effect that even though the question whether the plaintiff was a party to the agreement at all is undoubtedly one which cannot go before the arbitrators and with that question they cannot possibly deal, but
'this does not mean that in every instance in which it is claimed that the arbitrator has no jurisdiction the court will refuse to stay an action. If this were the case such a claim would always defeat an agreement to submitdisputes to arbitration, at any rate until the question of jurisdiction had been decided. The court to which an application for stay is made is put in possession of the facts and arguments and must in such a case make up its mind whether the arbitrator has jurisdiction or not as best it can on the evidence before it. Indeed, the application to stay gives an opportunity for putting these and other considerations before the Court that it may determine whether the action shall be stayed or not.'
Citing this with approval the Supreme Court laid down that it is incumbent upon the Court when invited to stay a suit under Section 34 of the Arbitration Act to decide first of all whether there is a binding agreement for arbitration between the parties to the suit. If satisfied on this score, the Court has next to consider in its judicial discretion the propriety of granting stay pending adjudication by the arbitrator.
10. The trial court may, therefore, decide upon the existence or validity of the agreement dt. Dec. 15, 1982, but subject thereto the mam point for consideration for purpose of Section 34 is whether the claim brought comes within the submission to arbitration. (vide Gaya Electric Supply Co. Ltd. v. State of Bihar : 4SCR572 ). The material fact to be taken note of, in our opinion, is that there is dispute arising between the parties the dispute being as to whether the Controller of Stores, N. E. Railway, was within his competence in cancelling the agreement and, if so, the effect thereof. In other words the respondent No. 1 plaintiff maintains that there has been no default on their part in taking the supply of goods and hence no occasion has arisen for the Controller of Stores, N. E. Railway, to forfeit the security or to ask for encashment of the bank guarantee. The Controller of Stores, N. E. Railway, has, on the other hand, proceeded, as mentioned above, unilaterally on Dec. 8, 1983, to cancel the agreement and ask for encashment of the guarantee. This is precisely the dispute and it arises under or in connection with the agreement. The test as to whether this arises under the agreements is that the terms thereof will have to be referred to in order to resolve the controversy. The arbitration clause reproduced above is wide in its terms and covers a dispute such as the present one within its purview.
11. The position under the English Law inthis respect is stated by Russell on Arbitration (Nineteenth Edition) (1979) at p. 176 asunder : --
'Certain of the older cases suggest that where a party to a contract containing an arbitration clause repudiates it altogether, he is necessarily disqualified from applying under the clause to have an action stayed. This question was, however, fully considered by the House of Lords in the case of Heyman v. Darwins Ltd., 1942 AC 356, where it was held that 'Where there has been total breach of contract by one party so as to relieve the other of obligations under it, an arbitration clause, if its terms are wide enough, still remains even though the injured party has accepted repudiation. The contract was not put out of existence though all future performance of the obligations undertaken by each party in favour of the other might cease. The contract survived for the purpose of measuring the claims arising out of the breach and either party might rely on the arbitration clause, 'The test in such cases has been said to be whether the contract is determined by something outside itself, in which ease the arbitration clause is determined with it, or by something arising out of the contract, in which ease the arbitral ion clause remains effective and can be enforced.'
12. The determination of the contract in the present case is not due to something dehors thereto but in the purported exercise of the power created thereunder.
13. Under the Arbitration Act, 1940, in this country the position in this behalf is not different. The decision of the House of Lords in the case of Heyman v. Darwins Ltd., 1942 AC356 was cited with approval by the Supreme Court in Union of India v. Kishorilal Gupta : 1SCR493 Among the propositions culled out by Subba Rao, J., speaking for the majority. In this case it was laid down at page 1370 'that where the dispute is in connection with a contract, such as the question ofrepudiation, frustration, breach etc., it is theperformance of the contract that has come to an end, but the contract is still in existence forcertain purposes in respect of disputes arising under it or in connection with it. As the contract subsists for certain purposes, it was held, the arbitration clause operates in respect of these purposes.' In Naihati Jute Mills Ltd. v. Khyaliram Jagannath : 1SCR821 aquestion arose whether the arbitration clause was extinguished as well due to frustration of the contract within the meaning of Section 56 of the Contract Act. This was answered in the negative holding that in case of frustration it is the performance of the contract which comes to an end but the contract would still be in existence for purposes such as the resolution of disputes arising Under or in accordance with it.
The question as to whether the contract became impossible of performance and was discharged under the doctrine of frustration would still have to be decided under the arbitration clause which operates in respect of such purposes. The same would be the position whether a contract is claimed to have been rescinded unilatcrally by one of the parties to the agreement and the dispute raised by the other side is that the cancellation was unwarranted.
14. The question cropped up more recently in Damodar Valley Corpn. v. K. K. Kar : 2SCR240 . The contention canvassed before the Supreme Court in that case was that as there had been a full and final settlement under the contract the rights and obligations under the contract did not subsist and consequently arbitration clause also perished along with the settlement and, if so, the dispute whether there had or had not been a settlement could not be subject of an arbitration. The submission for the respondent No. 1 before us is along these lines and it is this which found favour with the Court below. It was repelled by the Supreme , Court as suffering from a basic fallacy. It was observed (at p. 161 of AIR) :--
'A contract is the creature of an agreement between the parties and where the parties under the terms of the contract agree to incorporate an arbitration clause, that clause stands apart from the rights and obligations under (hat contract, as it has been incorporated with the object of providing a machinery for the settlement of disputes arising in relation to or in connection with that contract. The question of unilateral repudiation of the rights and obligations under the contract or of a full and final settlement of the contract relates to the performance or discharge of the contract. Far from putting an end to the arbitration clause, they fall within the purview of it. A repudiation by one party alone does not terminate the contract. It takes two to end it, and hence it follows that as the contract subsistsfor the determination of the rights and obligations of the parties, the arbitration clause also survives. This is not a ease where the plea is that the contract is void, illegal or fraudulent etc., in which case, the entire contract along with the arbitration clause is non est, or voidable.'
15. It is thus settled that depending on the existence and validity of the agreement being established, the reference to arbitration under Clause 27 of the agreement cannot be denied on the plea that since the appellants have cancelled the contract, the arbitration clause has also perished. The attribution survives and it is within the jurisdiction of the arbitrator to determine the legality of the cancellation brought about by the appellants and the consequential demand on their part for the encashment of the security. (See also M. S. Ramaiah v. State of Bihar, : : AIR1977Pat151 .
16. We may add that there is no assertion for the respondent 1 to the effect that at the commencement of the legal proceeding or as at present the appellants have not been ready and willing to submit to arbitration. The suit has been brought without notice under Section 80 Civil P.C. The respondent No. 1 claimed exemption in that respect and the trial Court has granted the same. As mentioned above the respondent 1 made an application for grant of temporary injunction simultaneously with the suit. Upon being informed of the same the appellants sought time to file objection against this application. It was on Dec. 21, 1983, that the trial Court granted ten days time to them for the purpose. Objection against the grant of temporary injunction was filed on Jan. 2, 1984, by the appellant. With effect from Jan. 1, 1977, the U. P. Civil Laws (Reforms & Amendment) Act, 1976 (U. P. Act XLVII of 1976) has inserted Explanation-2 to Section 34 of the Arbitration Act, which provides :--
'Explanation 2 -- A mere application for time to file a written statement or a mere contest to an interlocutory application for injunction, appointment of Receiver or the like, shall not amount to taking any steps in the proceedings.'
17. Therefore, it may not be contended for the respondent that before filing the application for stay under Section 34 of the Arbitration Act the appellants had taken any steps in the proceedings or that they were notready and willing at all relevant time to submit to arbitration. The Court below has cleatly erred in rejecting the application made under Section 34 by a cryptic order observing that since the contract had been cancelled, the arbitration clause also vanished.
18. In regard to the other appeal arising out of the grant of temporary injunction, the learned counsel for respondent 1 urged and not without force in our opinion that since the matter may have still to be referred to arbitration, it would be presenting them with a fact accomplished if in the meantime the bank guarantee were permitted to be encashed in the appellants, favour. The interest of the appellant is adequately secure under the bank guarantee given by the respondent 2 for and on behalf of the respondent 1. It is a moot question whether the appellants were within their right in cancelling the contract and the balance of convenience clearly lies in favour of the guarantee being permitted to remain intact instead of being encashed for so long as the dispute is unresolved. We, therefore, do not find merit in so far as the appeal against the gram of temporary injunction to the respondent 1 is concerned.
19. For the discussion made in the above, First Appeal From Order No. 397 of 1984 is dismissed, first Appeal From Order No. 398 of 1984 is allowed. The order dt. Jan. 24, 1984, passed by the II Civil Judge, Kanpur, is set aside. The trial Court is directed to re-decide the application under Section 34 of the Arbitration. Act in the light of the observations contained herein. In the circumstances there will be no order as to costs.