In a recent decision, the Supreme Court ruled on the validity of arbitration clauses, and when they can be struck down as being violative of constitutional norms.
Recently, the Indian Supreme Court ruled on whether an arbitration agreement can be struck down as being in violation of the Constitution of India, and particularly, the fundamental right to equality under Article 14 of the Constitution. In doing so, the Court in Lombardi Engineering Limited v. Uttarakhand Jal Vidyut Nigam Limited1, could have paved the way for a wider scrutiny of the fairness of arbitration clauses. The Court held that a clause mandating a pre-deposit of 7% of the claim amount was invalid, as being contrary to arbitrary and violative of the right to equality under Article 14.
The Appellant, Lombardi Engineering ("Lombardi"), a design consultancy firm based in Switzerland entered into a contract with Uttarakhand Project Development and Construction Corporation Limited for providing consultancy services in relation to a Hydro Electric Project ("Project"). The Project was later taken over by Uttarakhand Jal Vidyut Nigam Ltd. ("UJVNL"), the Respondent. Clause 53 read with Clause 55 of the General Conditions of Contract ("GCC"), set out the arbitration agreement between the parties. Clause 55.1(b)(I) provided for a condition to pre-deposit 7% of the claimed amount to be kept as a security deposit, as a pre-condition for invoking arbitration.
When disputes arose between the parties, Lombardi issued a notice of arbitration dated 06.05.2022, calling upon UJVNL to appoint an arbitrator in terms of the arbitration clause. However, the Respondent issued a termination letter dated 09.05.2022, thereby terminating the contract. Lombardi filed an application under S. 11(6) of the Arbitration & Conciliation Act 1996 ("the 1996 Act"), before the Supreme Court. One of the central questions was regarding the validity of the pre-condition for a deposit in clause 55 of the GCC.
Lombardi contended condition to pre-deposit 7% of the claim amount is contrary to the decision of the Supreme Court in ICOMM Tele v. Punjab State Water Supply and Sewerage Board.2. It was also contended that Clause 55.1(b)(I), providing for the condition of pre-deposit is also violative of Article 14 of the Constitution. UJVNL, on the contrary, relied on the decision in S.K. Jain v. State of Haryana.3 where a three-judge bench of the Supreme Court found a clause providing for a pre-deposit to be logical, because it was connected to the question of security for costs to dissuade frivolous claims. In addition to above, it was also contended that the Petitioner could not circumvent the principle of "party autonomy" having consented to the pre-deposit clause, and subsequently challenging it.
The main issues which fell for consideration before the Apex Court were: (i) whether clause containing pre-deposit of a percentage of the claimed amount before initiating an arbitration was contrary to the decision in ICOMM Tele Limited (supra); and (ii) whether the said decision was in conflict with the earlier decision in S.K. Jain (supra).
In S.K. Jain (supra), the Supreme court upheld the clause which directed the claimant to deposit 7% of the claimed amount before the arbitral tribunal with the condition the deposit would be used to cover any costs awarded against the claimant and the balance would be refunded to the claimant if he succeeded in the action.
In ICOMM Tele Limited (supra), the relevant arbitration clause provided that the party invoking arbitration shall furnish a "deposit-at-call" for 10% of the claimed amount. This would be be refunded to the Claimant but only in proportion to the amount awarded and the balance, if any, would be forfeited and paid to the other party. The Supreme Court while striking down the said clause observed the following:
- The pre-deposit condition in an arbitration clause is in violation of Article 14 of the Constitution being arbitrary;
- If the claim was frivolous, exemplary costs could be imposed on the claimant;
- The condition of pre-deposit would discourage a party to invoke an alternate dispute resolution method which was contrary to the object of de-clogging the court system.
The Supreme Court held S.K. Jain had been correctly distinguished in ICOMM, because the clauses in both the cases were materially different. The clause in S.K. Jain (supra) had a nexus with discouraging frivolous claims and also provided for a refund. However, in ICOMM Tele Limited (supra), the clause required a 10% pre-deposit which would not be fully refunded if the party succeeded only partially in its claims. It was held that such a clause did not have a nexus with costs and could have arbitrary outcomes, since the balance of the deposit would go to the unsuccessful party in the arbitration.
In Lombardi the Supreme Court noted that the arbitration clause did specify as to how the 7% pre-deposit as contained in Clause 55 of GCC would be ultimately adjusted at the end of the arbitral proceedings. It held that such a vague and ambiguous condition made the clause more vulnerable to arbitrariness, thereby violating Article 14 of the Constitution.
The Court also anchored its conclusions in Hans Kelsen's 'Pure Theory of Law'. It likened the Constitution of India to Kelsen's grundnorm, with arbitration agreements being subordinate to the 1996 Act and other state and central legislation, which in turn were subordinate, and deriving their validity from, the Constitution of India. According to the Supreme Court, the principle of 'party autonomy' could not be used to justify a violation of fundamental rights. The Supreme Court has previously held that there cannot be any waiver of fundamental rights.
Interestingly, the Supreme Court also relied on the doctrine of unconscionability of pre-conditions to arbitration in foreign cases. In Uber Technologies etc v. David Heller4, the Supreme Court of Canada held that a requirement of depositing an up-front administrative charge of USD 14,500 was unconscionable, as being an impediment to access to justice in that case. The Court also relied on two cases5 from the United States on the doctrine of unconscionability.
The Supreme Court's reliance on the doctrine of unconscionability should be of particular interest to those interested in arbitration law, because it could lead to a wider and deeper scrutiny into fairness and inequality of bargaining power in the context of arbitration. Traditionally, unfairness and unconscionability have not been grounds to avoid contracts under Indian contract law.
Generally, fundamental rights are enforceable against the state. All of the three Indian Supreme Court precedents discussed here – Lombardi, ICOMM and S.K. Jain concerned contracts against government entities, against whom fundamental rights guaranteed under the Constitution are directly enforceable. However, the application of the same rights to contracts between two private entities (like in Uber v Heller) is not straightforward. In Kaushal Kishore v State of Uttar Pradesh,6 the Supreme Court recognized that fundamental rights could potentially be enforced against non-state actors, but the boundaries of such application are still unclear.
It remains to be seen as to how much the application of constitutional values and norms will undermine the 'party autonomy' principle, which is the cornerstone of arbitration law in India. As always, much will depend on the nature of the pre-condition for arbitration, and in what manner it operates to impede the process of dispute resolution.
1. 2023 SCC OnLine SC 1422
2. (2019) 4 SCC 401
3. (2009) 4 SCC 357
4. 2020 SCC OnLine Can SC 13
5. Patterson v. ITT Consumer Financial Corporation, 18 Cal. Rptr. 2d 563 (Cal. Ct. App. 1993); Vegter v. Forecast Financial Corporation, 2007 WL 4178947.
6. (2023) 4 SCC 1
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