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Sahil Narang

Sahil Narang is Partner (Dispute Resolution) in Khaitan and Co. at New Delhi.

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Interpreting Pathological Arbitration Clauses

The arbitration clause serves as the foundation for the entire arbitration process, therefore, each word in the clause assumes paramount significance, however, it is only due to a lack of awareness about the importance of the wording of the arbitration clause that the parties end up incorporating a defective arbitration clause in their agreement. Inartistic drafting of a clause renders it suspect of being illegal on many counts

Introduction 

It is not uncommon to come across a defective or pathological arbitration agreement.The term ‘pathological clause’ was coined by Frédéric Eisemann in 1974[1]. Eisemann defines a pathological arbitration clause as one which does not conform to the four essential elements of an arbitration agreement.[2]

The arbitration clause serves as the foundation for the entire arbitration process, therefore, each word in the clause assumes paramount significance, however, it is only due to a lack of awareness about the importance of the wording of the arbitration clause that the parties end up incorporating a defective arbitration clause in their agreement. Inartistic drafting of a clause renders it suspect of being illegal on many counts. However, a defect in the arbitration agreement does not necessarily entail the invalidity of the clause.

The Indian courts have been very forbearing when presented with a defective arbitration clause. The courts have been mindful of the limited judicial interference permitted under the Act. They have often corrected a defective arbitration clause by severing the illegal portion. The Supreme Court has held that a party should not be allowed to take advantage of the inartistic drafting of the arbitration clause as long as the intention of the parties to refer the dispute to arbitration is clear.[3] However, the courts have refused to relegate the parties to arbitration when the entire clause was permeated with illegality. 

The article lists out various situations that make the arbitration clause defective and how the Indian courts have dealt with such defects. 

Unclear reference to Arbitration

One of the most essential requirements of an arbitration agreement is the intention of the parties to be bound by the agreement. When the intention of the parties is not clear in the agreement, the agreement is void and cannot be acted upon. 

In Jagdish Chander v. Ramesh Chander,[4]the clause postulated that the parties “shall be referred to arbitration if the parties so determine”, the Supreme Court held that the clause is not a valid arbitration agreement and only an agreement to enter into an arbitration agreement. A clause that requires a fresh consent of the parties to enter into arbitration is not a valid arbitration agreement.[5] Use of the word “may” in a clause entails only a possibility of arbitration, the same is not a concluded agreement.[6] Similarly, a clause that only provides for an expert determination of the issues is not an arbitration agreement.[7]

The High Court of Delhi,[8] Bombay,[9] Calcutta,[10] Rajasthan,[11] Punjab and Haryana,[12] and Andhra Pradesh,[13] have consistently held that a clause which only provides for a possibility of arbitration between the parties and requires fresh consent of the parties, is not a concluded arbitration agreement, therefore, there is no arbitration agreement between the parties.

Clause providing for even number of Arbitrators

The Supreme Court in M.M.T.C. Ltd v. Sterlite Industries,[14]held that the number of arbitrators specified under the agreement is not a ground to invalidate the arbitration agreement. When the agreement provides for an even number of arbitrators, the same shall be construed to be referring to a sole arbitrator.[15] Participation in the arbitral proceedings before a tribunal consisting of an even number of arbitrators deprives the parties from later objecting to the constitution of the tribunal.[16]

Therefore, the courts have adopted a pro-arbitration approach by giving effect to the intention of the parties to arbitrate, regardless of an issue as to the number of arbitrators specified under the clause.

Ambiguity as to the applicable law and the rules of arbitral institutions 

In Pricol Ltd. v. Johnson Controls,[17] the arbitration clause made reference to one “Singapore Chamber of Commerce” which is not an arbitral institution. The Court held that the clause is to be given a reasonable and meaningful construction, therefore, the reference was actually to Singapore International Arbitration Centre (SIAC). 

In System for International Agencies v. Rahul Coach Builders,[18] the clause provided that the parties shall be referred to arbitration under the by-laws of Indian Companies Act. The court held such a clause to be invalid as it made reference to a law that never existed. 

Hybrid Arbitration Clause

Such clauses provide for the administration of arbitration proceedings by an arbitration institution under the rules of another institution.[19]

In Value Advisory Services v. ZTE Corp.,[20] the High Court of Delhi considered an arbitration clause that provided foradministration of arbitration proceedings by SIAC under the ICC Rules. The court held that such a clause would be unworkable as both institutions administer the arbitration under their own rules. But such unworkability would not invalidate the entire agreement and the court can sever the offending portion of the clause. 

Clause restricting the right to challenge the arbitral award

In Shin Satellite v. Jain Studious,[21] the clause precluded the parties from filing an appeal against the award of the tribunal. The court held that portion of the clause to be invalid. However, the court clarified that partial invalidity would not affect the entire clause and the court could give effect to the remaining portion by severing the void part of the clause. Similarly, in Union Construction v. Chief Engineer,[22]the court held that an arbitration clause that ousted the jurisdiction of the ordinary courts to examine the validity of the award would be void to the extent of such proscription. 

Unilateral Option Clauses

These clauses essentially confer the right of arbitration only on one party to the agreement. The arbitration, in such cases, becomes an option exclusively exercisable only by a party given the right of arbitration.  

The High Court of Calcutta in Kedarnath Atmaram v. Kesoram Cotton Mill,[23]had to consider the validity of a unilateral option clause. The court upheld the validity of the clause on the ground that both parties agreed to be bound by the arbitration clause. 

In New India Assurance v. Central Bank of India,[24]the court held that a unilateral option in the clause does not invalidate the agreement but only restricts its enforceability. The privilege that one party enjoys is the result of the express consent of the other party recorded in the agreement. A similar approach was adopted by the High Court of Madras in Castrol India Ltd. v. Apex Tooling,[25]wherein it held that there is no requirement of mutuality in the arbitration agreement as the parties enter into such an agreement with their free consent.

In Union of India v. Bharat Engineering,[26]the High Court of Delhi held a unilateral option clause to be a ‘contract of option’ which is only enforceable after the option has been exercised. However, the court clarified that a clause that only allows the claims of only one party to be decided by the arbitrator would be invalid in law. 

In Bhartia Cutler Hammer v. AVN Tubes,[27]the High Court held that a clause that confers the right of reference only on one party suffers from the want of mutuality. In Emmsons International v. Metal Distributors,[28]the clause not just conferred unilateral reference power on one party but also restricted the other party from enforcing its right, the court held such a clause to be in teeth of Section 28 of the Indian Contract Act.[29] An agreement which confers unilateral power on a party to abandon the arbitral proceedings lacks a necessary element of mutuality, therefore, also falls within the rubric of a unilateral option arbitration agreement, therefore, void.[30]

Unilateral Appointment Clauses

Unilateral arbitration clauses confer the right of appointment of a sole arbitrator on one party.The Courts have consistently held such a would not make the entire arbitration clause fall with it. 

The Supreme Court, in its judgment in Perkins Eastman v. HCC (India) Ltd[31], construed an arbitration clause that provided for unilateral appointment by one party and held that unilateral appointment of sole arbitrator is impermissible in law. The Court held that a person who himself is ineligible to be appointed as the arbitrator cannot also appoint the sole arbitrator for the parties. However, the Court did not have the opportunity of considering the effect of such illegality in the procedure on the entire arbitration clause as no argument to that effect was made by either party. 

In Karismaa MEP Services v. KSG Milestone[32], the High Court of Madras was facing a situation wherein the named arbitrator was not just the director but was holding 33% shares in the respondent company. The respondent argued that since the person named in the arbitration agreement cannot be appointed as the arbitrator, the entire clause becomes unconscionable and stand obliterated. The Court held that the entire arbitration clause would not fall merely because the person specified by designation in the arbitration clause is incapable of arbitration. 

The High Court of Delhi in Jyoti Swarup Mittal v. SDMC[33] considered an arbitration clause that conferred the unilateral right of appointment of arbitrator on the respondent and stipulated that there shall be no arbitration in case the person so appointed is unable to act. The Court the entire arbitration clause would not fall merely because it is no longer permissible to follow the appointment procedure in the agreement. 

In T.K. Consortium v. Rites Ltd[34]the High Court of Delhi, while reiterating that an arbitration clause providing for unilateral appointment would be inoperative by virtue of Section 12(5) of the Act, held that any adjunct condition to that clause stipulating that no arbitration would be permitted if the said procedure is not followed would be invalid. However, the invalidity of such a procedure or condition would not make the entire clause invalid. 

In Ram Kripal Singh v. NTPC[35]the High Court of Delhi held that an arbitration agreement has many facets dealing with different strands of the arbitration procedure. These may include an aspect governing the seat/venue of arbitration, procedure of arbitration, language of arbitration etc. However, these are distinct from the core agreement i.e the consent of the parties to refer the dispute to arbitration. Therefore, irregularity or invalidity of these aspects would not make the core agreement unworkable. 

Restrictive Arbitration Clauses

These clauses limit the scope of the arbitration agreement. In many cases, the arbitration clauses are so restrictive that it makes arbitration a mere formality or an impossibility.

In U.P. State Food & Essential Commodities v. Astha Coal Trading,[36] the Allahabad High Court held that when a clause provided that the arbitrator shall be appointed for the purpose of interpretation of any term of the contract, the arbitrator cannot decide any money claim of the parties, his jurisdiction remains confined to the terms of reference only i.e., interpretation of the contract. 

Agreement excluding the applicability of the Arbitration Act, 1996.

In Hyderabad Precision v. Govt. of India,[37]the arbitration clause excluded the applicability of the Arbitration Act, 1996 and provided for an alternate mechanism for the annulment of the award. The Court held such a clause to be invalid and against Section 23 of the Indian Contract Act. However, the parties intended to settle their disputes through arbitration, therefore, the court severed the illegal portion and relegated the parties to arbitration. Similarly, a clause that made reference to the Act of 1940 would not be entirely void, and the defect in the clause could be corrected by the courts while appointing an arbitrator.[38]

Conclusion

An arbitration agreement must not be rendered null and void by adopting a pedantic and over technical approach. When faced with an ambiguous clause, the court should examine it by taking into account the communication exchanged between the parties to determine the intention of the parties. Doctrine of Blue Pencil, that entails the severability of the offending portion of the arbitration clause, shall be applied to such defective clauses to make the same workable. 

The courts have generally refused to entertain the objections taken against the wording of arbitration clauses. The intention of the parties to refer their disputes to arbitration has been given primacy over minor faults in the clause.   The pro-arbitration approach taken by the Indian Courts while interpreting a defective arbitration clause minimizes the scope for judicial intervention at the pre-arbitral stage and brings India’s arbitration regime at par with the global standards. It is a significant step towards promoting the culture of arbitration and making India a hub of arbitration. 

There is a growing need to sensitize the parties about the importance of drafting an unambiguous arbitration clause. The judiciary can also step in and provide a standard arbitration clause that shall also allow the parties enough flexibility to amend the clause to meet their requirements.

[1]Frédéric Eisemann, La Clause d’arbitrage pathologique, in COMMERCIAL ARBITRATION: ESSAYS IN MEMORIAM EUGENIO MINOLI 129–61 (1974).

[2] Eisemann, supra note, 1 at 130 (referenced by Benjamin G. Davis, Pathological Clauses: Frederic Eisemann’s Still Vital Criteria, 7 ARB. INT’L 365, 365–88 (Dec. 1991) (“(1) The first, which is common to all agreements, is to produce mandatory consequences for the parties, (2) The second, is to exclude the intervention of state courts in the settlement of the disputes, at least before the issuance of the award, (3) The third, is to give powers to the arbitrators to resolve the disputes likely to arise between the parties, (4) The fourth, is to permit the putting in place of a procedure leading under the best conditions of efficiency and rapidity to the rendering of an award that is susceptible of judicial enforcement.”)).

[3] Visa international v. Continental Resources, (2009) 2 SCC 55.

[4] (2007) 5 SCC 719.

[5] Wellington Associates v. Kirit Mehta, (2004) 4 SCC 272.

[6] Linde Heavy Truch Divison Ltd v. Container Corporation of India Ltd., 2012 SCC OnLine Del 5434.

[7] K.K. Modi v. K.N. Modi, (1998) 3 SCC 573; Bharat Bhusan Bansal v. U.P. Small Industries Corp., (1999) 2 SCC 166.

[8] Avant Garde Clean Room & Engg. Solutions Pvt. Ltd. v. Ind Swift Limited, 2015 SCC OnLine Del 3219; Panchsheel Constructions v. Davinder Pal, 2019 SCC OnLine Del 7176; Sara Internatinal v. Golden Agri, 2010 SCC OnLine Del 2238; Ashwani Kumar v. Scraft Products Pvt. Ltd., Arb.P. 488/2020.

[9] Quick Heal Technologies Ltd v. NCS Computech Pvt. Ltd., 2020 SCC OnLine Bom 693.

[10] Jyoti Brothers v. Shree Durga Mining Co., 1956 SCC OnLine Cal 188; State Trading Corp. v. Owners and Parties, 1998 SCC Online Cal 357; Consulting Engineering Services v. Govt. of W.B. 2014 SCC Online Cal 22716.

[11] B. Gopal Das v. Kota Straw Board, 197- SCC OnLine Raj 36.

[12] Sudarshan Company Law Board, 2004 SCC OnLine P&H 128.

[13] Gajulapalli Chenchu Reddy v. Koayyana Jaya Lakshmi, 2009 SCC OnLine AP 202.

[14] (1996) 6 SCC 716.

[15] Sri. Venkateshwara Construction Company v. Union of India, 2001 SCC OnLine AP 116; Rapti Contractors v. Reliance Energy Ltd., 2009 SCC OnLine Del 275; Wipro Finance Ltd. v. Sandplast India Ltd., 2006 SCC OnLine Del 367; North East Securities Ltd v. Sri Nageshwara Chemicals and Drugs Pvt. Ltd. (2000) 5 ALD 746; JMC Projects v. SDMC, ARB. P. 632/2017.

[16] Narayan Prasad Lohia v. Nikunj Kumar Lohia, (2002) 3 SCC 572. 

[17] (2015) 4 SCC 177; See also Glencore International AG v. Indian Potash Ltd., 2019 SCC OnLine Del 9591.

[18] (2015) 13 SCC 436.

[19]Carlos Molina Esteban, Hybrid (institutional) arbitration clauses: party autonomy gone wild, Arbitration International, Volume 36, Issue 4, December 2020, Pages 475–489.

[20] 2017 SCC OnLine Del 8933.

[21] (2006) 2 SCC 628.

[22] 1959 SCC OnLine All 310; see also Karam Chand Thapar v. Tehri Hydro Corporation, 2012 SCC Online Del 5705.

[23] 1949 SCC OnLine Cal 382.

[24] 1984 SCC OnLine Cal 166.

[25] 2015 SCC OnLine Mad 2095.

[26] 1977 SCC OnLine Del 45.

[27] 1991 SCC OnLine Del 322.

[28] 2005 SCC OnLine Del 17.

[29] Lucent Technologies v. ICICI Bank, 2009 SCC OnLine 3213.

[30] Tata Capital Housing Finance v. Shri Chand Construction, 2021 SCC OnLine Del 5091.

[31] (2019) SCC Online SC 1517

[32] 2015 SCC OnLine 6849

[33] 2021 SCC OnLine 3674.

[34] 2021 SCC OnLine 1188, see also ARSS Infrastructure v. Ircon International, 2021 SCC OnLIne Del 5100

[35] 2022 SCC OnLine Del 3743

[36] 2019 SCC OnLine All 4417.

[37] 2013 SCC OnLine AP 528.

[38] Rapti Contractors v. Reliance Energy, 2009 SCC OnLine Del 275.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house


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