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Traversing the Constitutional Jurisprudence of a Pre-Deposit Clause in Arbitration Agreement

Updated: Jan 17

Shelal Lodhi Rajput[1]

Introduction:

The Supreme Court in Lombardi v. Engineering Limited (“Lombardi”), delivered by a 3-judge bench, reiterated that the Indian Constitution is a Grundnorm and every law needs to be in consonance with it. The court struck down a pre-deposit clause in an arbitration agreement by emphasizing the inviolability of the Constitution in arbitration agreements as it hindered the effectiveness of an alternate dispute resolution mechanism. The ruling is concerned with the dispute between a Swiss Corporation named Lombardi Engineering Ltd and Uttarakhand Jal Vidyut Nigam Limited (“UJVNL”), a corporation owned by the Government of Uttarakhand where Lombardi had filed an application under Section 11(6) of Arbitration and Conciliation Act, 1996 (“A&C Act, 1996”) for appointment of an arbitrator.


The Court has reemphasized its commitment towards a pro-arbitration approach and stands affirm with its path-breaking precedent of ICOMM Tele Ltd. v. Punjab State Water Supply & Sewage Board & Anr., (“ICOMM”) on a likewise subject matter. In the said case, the Supreme Court struck down the pre-deposit clause in question on the ground that it was arbitrary and unjust. The judgment was hailed as well as criticized at length. However, the latest ruling in Lombardi restates the stance of ICOMM ruling as a pro-arbitration approach adopted by the court in arbitration jurisprudence.


The decision in Lombardi deals with the intersection of constitutional law jurisprudence with arbitration law in the Indian milieu specifically regarding the existing jurisprudential understanding of Pre-deposit clauses in arbitration agreements. This article restricts its inquiry to the moot issue and does not explore other issues addressed by the Apex Court.


Background and Facts in Dispute:

In the instant case, the petitioner company entered into a contract with Uttarakhand Project Development and Construction Corporation Limited (UPDCC) provide consultancy services for a hydroelectric project. Subsequently, the project was transferred to UJVNL through a tripartite agreement. Dispute emerged between the parties, prompting the Petitioner to serve a Notice of Arbitration to the Respondent. This Notice aimed to initiate the process of selecting an arbitrator as outlined in the contract's arbitration clause. In response, the Respondent decided to terminate the contract, alleging that the Petitioner had not fulfilled their work and contractual obligations. The arbitration clause found in the General Conditions of Contract became a subject of scrutiny, and the Petitioner requested the appointment of an arbitrator to address their claims.


Issue for Consideration:

The crux of the matter lies in the objection raised by Petitioner against the two specific clauses Clause 53 and 55 of the General Condition of Contract (“GCC”). The core of the dispute revolved around the stipulation under Clause 55 of the agreement that the petitioner must deposit 7% of the arbitration claim as a security for invoking the arbitration clause. Apex Court has formulated the four major issues in the instant case for consideration but the core of dispute that’s addressed herein is whether the pre-deposit clause as provided in the Contract can be considered as violative of Article 14 of the Constitution of India for being manifestly arbitrary.


The Judgment: Analytical Perspective

On Constitution: Pre-deposit Clause and Arbitrariness


The major consideration for the Court was whether the conditions stipulated in Clause 55 of GCC pertaining to the pre-deposit condition could be tested on the anvil of Article 14 or not. The arbitration clause in the GCC was under consideration herein along with other issues of appointment of an arbitrator to resolve their claims. Undoubtedly, it’s not the first time that courts have tested the arbitration clause on the touchstone of Article 14 while deciding Section 11(6) application, however, some interesting aspects herein are that the State is a party to the contract and there’s a pre-deposit clause in consideration. To erudite the aforesaid rationale, the Court traversed into jurisprudential understanding pertaining to Kelson’s Pure Theory of Law to elaborate on how the Constitution is Grundnorm and every and any law in India needs to adhere to the Grundnorm. The applicability of Art.14 herein is in order to ascertain that the clause should not be arbitrary in nature. It means that the stipulation under Clause 55 shall not be arbitrary and such arbitrary clause cannot be acted upon even by the consent of parties or in accordance with the principle of party autonomy as it contravenes the Grundnorm i.e., Indian Constitution. Along with that, such a clause should not be discriminatory in its approach to its application and it should be applicable to both parties.


Further, the applicability of Art.14 in the context of a pre-deposit clause in the arbitration agreement has been explained by the Court in A.L. Kalra v. Project and Equipment Corporation of India Ltd.. In the case of ICOMM, the agreement explicitly stipulated the forfeiture of the security deposit, even if the judgment favoured the party that submitted the deposit. In this context, the court deemed such a provision arbitrary and in violation of Art. 14 of the Constitution. In the instant case, Clauses 3 and 4 of GCC concerning the security deposit for performance and its refund, are entirely unrelated to the predetermined 7% pre-deposit specified in Clause 55 of the GCC. The indistinct and ambiguous requirement of a 7% pre-deposit for the entire claim renders it more susceptible to arbitrary actions, thereby infringing upon Article 14 of the Constitution.


An intricate aspect herein pertains to the private aspect of the contract, however, the Court highlighted the term operation of law’ with relevant judicial precedents to depict the wider connotation resulting in coverage of the A&C Act, 1996. The court has not restricted itself to academic inquiry but also referred to five precedents from different high courts to demonstrate the theory of Grundnorm and they are Squadron Leader H. S. Kulshrestha v Union of India, Abdur Sukur & Another v State of West Bengal & others, Om Prakash Gupta v Hindustan Petroleum Corporation Ltd. & Anr, Government of Andhra Pradesh & Ors vs Smt. P. Laxmi Devi and Sunil v State of M. P. & Another. Thus, the arbitration agreement or any clause stipulated therein cannot be violative of Article 14 of the Constitution of India by virtue of Article 13 of the Constitution of India. A vital consideration herein pertains to the “party-autonomy” concept in arbitration law. Notably, it’s a settled position of law that there cannot be a consent against the law or to waive the fundamental rights. Thus, the arbitration clause needs to be in consonance with the “operation of law” to become legally binding and party autonomy cannot supersede the Grundnorm at any time.


The court analysed the Pre-deposit clause on the anvil of Article 14 along with leading precedents on the subject matter. The court has comprehensively analysed the ICOMM and S.K. Jain judgments as they render contrasting decisions due to their different footings. A total of six decisions from different high courts were scrutinised by the Court. Those 06 decisions were related to determining the validity of the pre-deposit clause in the arbitration agreement and the appointment of an arbitrator in arbitration. High Courts have looked at the dictum of ICOMM and SK Jain and followed either one of them as per the facts of the case. Apex Court concluded that both the decisions were correct and not in conflict with each other. By doing so, the principles enunciated in ICOMM was further reiterated, relied and emphasised in the instant case to render the judgment.


The Court concluded that Clauses 3 and 4, relating to security deposits for performance and their subsequent refund, were not directly or even indirectly related to the 7% pre-deposit mandate outlined in Clause 55 of the GCC. The lack of clarity and ambiguity surrounding the 7% pre-deposit requirement rendered it more prone to arbitrary interpretation, thereby infringing upon the principles of Article 14 of the Constitution.


Doctrine of Freedom of Contract & Arbitrator’s Appointment


Notably, this is not the first instance where the Court has granted special concessions to enhance the level of public interest in arbitration proceedings involving the State. In the case of Datar Switchgears Ltd. vs. Tata Finance Ltd. (2000), the court ruled in favour of a clause that allowed one party to unilaterally select the arbitrator in the event of a dispute. However, the discernible aspect herein is that the State is a party to the conflict and thus, the precedent of Datar is distinguishable on facts and is not applicable herein. This decision was based on the principle of contractual freedom, which granted parties complete discretion in shaping their own terms. This principle has been reaffirmed in various other cases involving two private parties.


The scenario differs somewhat when the State is a party to the arbitration as in the instant case. In Voestalpine Schienen GmbH vs. DMRC Ltd., the Court scrutinized a clause that permitted DMRC to choose a pool of arbitrators from which the other party could then appoint one. The Court emphasized the necessity of having independent and impartial arbitrators in the arbitration process and deliberated on the significance of the arbitrators' neutrality, as outlined in Section 12(3) of the A&C Act, 1996. It also discussed the application of this provision concerning contracts with State entities and how the balance between procedural fairness and the binding nature of contracts has shifted in favour of the former.


Closing remarks


In crux, the court speaking through Hon’ble Justice J.B. Pardiwala held that the two conditions within Clause 55- firstly, a 7% deposit of the total claim amount and secondly, appointment of a sole arbitrator by Principal Secretary should be disregarded. It is because it hinders the independent and impartial nature of the arbitrator in arbitration due to vested interest as the State is a party to the dispute. Notably, the principal secretary is an employee of the State and thus, has a vested interest in appointing the arbitrator. Notably, the ruling of Perkins Eastman Architects DPC and another v. HSCC (India) Ltd held that no party who has any interest in the dispute can unilaterally appoint the sole arbitrator due to aspect of bias. Individuals with a vested interest in arbitration are not allowed to have the authority to nominate arbitrators.


The Court has rightfully opined that the imposition of exemplary costs can be invoked in cases where claims are determined to be frivolous. However, requiring an upfront payment of 7% of the claimed amount and would contradict the primary objective of arbitration, which is to ensure the prompt, effective, cost-efficient, and expeditious resolution of disputes. This ruling establishes a precedent, upholding the integrity of the Indian arbitration process and reinforcing the Constitution as Grundnorm over arbitration agreements. It emphasises that the fundamental tenets of the constitution cannot be compromised by any agreement whatsoever and that arbitrary prerequisites must not impede access to justice.


A food for thought


Notably, on reading Para 82 of the judgment it seems that the Court has laid down a broad proposition of law for all arbitration agreements without deciphering the aspect of nature of parties and transactions involved in the dispute. In an instant case, the State is a party to dispute along with the private party, however, it would be interesting to see how the same facts will get treated in cases ahead as well as where dispute arises between private parties. In other words, in contrast to the discernible factor on the basis of which the ruling of S.K. Jain and ICOMM is deciphered. It poses a question of whether private law should be institutionalised.


It will be intriguing to observe how this approach might enable the penetration of arbitrary clauses between two private entities in different sets of facts and formulation of pre-deposit clauses in arbitration agreements. It is possible that the Court could examine such an agreement using Section 23 of the Indian Contract Act, which renders contracts against public policy null and void. However, it's worth noting that this section is only invoked when the entire agreement is contrary to public policy. Whether it can be invoked when only one clause in the agreement is in question remains to be seen.


 

[1] Shelal Lodhi Rajput is a 5th Year Student reading law [B.B.A. LL.B (Hons.)] at Symbiosis Law School, Pune (vidhigya.shelal88@gmail.com).

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