Arbitration Clause in Agreement: Can Owner Proceed for Cheque Bounce Case?

Impact of Arbitration Clauses on the Maintainability of Criminal Complaints Under Section 138 NI Act

In the landscape of commercial contracts, parties often include arbitration clauses to avoid the delays of traditional litigation. These clauses mandate that any dispute arising from the agreement be resolved by a private arbitrator rather than a civil court. However, a complex legal question arises when a payment made via cheque is dishonoured: Arbitration Clause vs Cheque Bounce: Can Owner Proceed?

When a business owner or a payee is faced with a bounced cheque, they typically look toward the criminal remedy provided by the Negotiable Instruments Act. The tension arises when the opposing party argues that the existence of an arbitration clause bars the payee from approaching a criminal court, insisting that the matter must be referred to an arbitrator.

The Legal Distinction Between Civil and Criminal Remedies

The core of this issue lies in the distinction between a contractual dispute and a statutory criminal offence. An arbitration clause is a civil agreement designed to resolve disputes over the interpretation or breach of a contract. In contrast, the dishonour of a cheque is treated as a quasi-criminal offence under the law to maintain the integrity of banking transactions.

The judiciary has consistently held that a criminal complaint under Section 138 of the Negotiable Instruments Act, 1881 (NI Act) is not barred by an arbitration agreement. This is because the criminal liability for a bounced cheque is independent of the underlying contract. As noted in legal precedents, cognizance has been taken under Section 138 of the N.I. Act, because the cheque issued was bounced. So, it has no connection with the arbitration clause

Korp Gems (India) Pvt. Limited and Anr. VS Suraj Products Ltd.

Parallel Proceedings: Can Arbitration and Criminal Cases Coexist?

A common misconception is that a party must choose either arbitration or a court case. In reality, the law allows for parallel proceedings. A payee can simultaneously pursue an arbitration award for the recovery of the principal amount and damages while pursuing a criminal case for the act of cheque dishonour.

The courts have clarified that Criminal proceedings can be maintained alongside arbitration proceedings for the same cause of action 2024 0 Supreme(Kar) 515. Even in scenarios involving complex Joint Development Agreements (JDAs), where an arbitration clause is explicitly present, the criminal nature of a cheque bounce case remains intact. If a trial court wrongly acquits an accused solely because of an arbitration clause, higher courts have been known to set aside such acquittals and remand the matter for a full trial under Section 138.

Addressing Common Defences against Section 138 Complaints

Defendants often attempt to quash Section 138 proceedings by claiming the transaction was purely civil in nature. However, the legal standard remains that the prosecution for the dishonour of a cheque could not be quashed on plea that transaction in which cheque was issued was entirely of civil nature or that agreement contained arbitration clause

Korp Gems (India) Pvt. Limited VS Suraj Products Ltd.

Furthermore, certain specific scenarios are often raised to challenge the maintainability of these cases:

• Section 8 of the Arbitration Act: While Section 8 of the Arbitration and Conciliation Act, 1996, mandates that courts refer civil disputes to arbitration, this does not apply to Section 138 proceedings because they are quasi-criminal. In cases where a recovery suit and a cheque bounce complaint are filed together, the court may refer the recovery aspects to arbitration but allow the Section 138 complaint to proceed in the magistrate's court 2007 1 Supreme 687.
• Security Cheques: A frequent defence is that the cheque was issued only as security and not for a current debt. However, if the cheque is dishonoured and it is proven that it was issued for a legally enforceable debt, the liability under Section 138 still attaches 2025 0 Supreme(Mad) 5123.
• Unregistered Firms: Parties may attempt to use Section 69 of the Partnership Act to bar petitions, but such technicalities generally do not shield an individual from the specific criminal liability of a bounced cheque 2006 0 Supreme(Del) 1066.

The Role of IBC Moratorium and Other Limitations

While arbitration clauses rarely stop a Section 138 case, the Insolvency and Bankruptcy Code (IBC), 2016, introduces a different dynamic. Under Section 14 of the IBC, a moratorium is declared when a corporate debtor enters insolvency proceedings. This moratorium halts proceedings against the corporate debtor, including those under Section 138 of the NI Act.

However, this protection is not absolute. The moratorium applies to the company (the corporate debtor), but not necessarily to the individuals running it. Legal interpretations suggest that Section 138/141 proceeding against them cannot be initiated or continued without corporate debtor... such proceedings can be initiated or continued against persons mentioned in Section 141(1) and (2) of Negotiable Instruments Act 2021 2 Supreme 528. Furthermore, if the insolvency relates to an individual (under Sections 94, 96, or 101 of the IBC), the moratorium typically does not shield them from criminal liability under the NI Act 2025 0 Supreme(SC) 588.

Jurisdictional Challenges and Counterblast Litigation

In some instances, parties attempt to use the arbitration clause to challenge the jurisdiction of the court. For example, if an agreement specifies Calcutta as the seat of arbitration, a defendant might argue that a criminal complaint filed in Chennai should be quashed 2024 Supreme(Online)(MAD) 3448. While jurisdictional arguments are valid, they are distinct from the argument that the arbitration clause completely bars the criminal case.

Additionally, some parties issue arbitration notices as a counterblast to the filing of a cheque bounce complaint, hoping to divert the legal focus toward a civil dispute

M/s. Shriram City Union Finace Limited, H.No.7-1-615,205,II nd Floor, Rahmat Complex, Ameerpet, Hyderabad-500 016. Rep. by its Branch Manager. vs Mr. Ch.Venkata Krishna Reddy, S/o. Sri Ch. Parasuram Reddy, Aged 41 Years, Occ: Self Employee, R/o. H.No.9-6-47, Anjaiah Nagar, Bowenpally, Secunderabad-500 009.

M.s. Shriram City Union Finance Ltd., vs Ch. Venkata Krishna Reddy, Son of Sri Ch. Parasuram Reddy,

Practical Steps for the Payee

If you are a business owner dealing with a bounced cheque and an agreement that contains an arbitration clause, the following steps are generally recommended:

1. Statutory Notice: Ensure a formal demand notice is served under Section 138(b) within 30 days of receiving the dishonour memo from the bank.
2. Timely Filing: File the criminal complaint within one month from the date the notice period expires 2013 0 Supreme(SC) 783.
3. Maintain Parallel Tracks: Do not feel pressured to drop the criminal case just because you have started arbitration for the recovery of the debt.
4. Explore Mediation: Since Section 138 is a compoundable offence under Section 147 of the NI Act, parties can seek mediation or conciliation. There is no bar to utilizing the alternate dispute mechanisms including arbitration, mediation, conciliation 2017 0 Supreme(Del) 3508

   Dayawati VS Yogesh Kumar Gosain

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Summary of Legal Position

To conclude, the presence of an arbitration clause does not grant immunity to a party who issues a cheque that subsequently bounces. The criminal remedy under the NI Act is a statutory right that operates independently of any private agreement to arbitrate. While the IBC moratorium can provide temporary relief to corporate entities, it does not extinguish the liability of the directors or individuals involved. As always, because legal outcomes depend on the specific facts of a case, these general principles should be verified with a qualified legal professional.