INDIAN SUPREME COURT RULES THAT PRE-DEPOSIT REQUIREMENT IN AN ARBITRATION AGREEMENT IS UNCONSTITUTIONAL

In a decision of 11 March 2019, the Supreme Court of India (the "Court") struck down part of an arbitration clause which required a claimant to deposit 10 per cent of the amount claimed with the arbitrator before the arbitration went ahead. The contract was between a government entity and a private party and the Court relied on principles of Indian constitutional and administrative law to hold that the clause was arbitrary and therefore liable to be struck down. The Court also emphasised the need for arbitration to be speedy, effective and inexpensive so that it can "de-clog" the overburdened court system in India. This is an important decision for parties with arbitration agreements with Indian state or state-owned entities, and another encouraging indicator of the pro-arbitration mindset shown by the highest echelons of the Indian judiciary.

Background

In 2008, Punjab State Water Supply & Sewerage Board (the "Board") awarded a tender to M/S ICOMM Tele Ltd. ("ICOMM") relating to work on a sewage treatment plant. The contract between the parties incorporated the Board's tender notice. The notice contained an arbitration provision and clause 25(vii) provided that the party initiating arbitration would have to furnish a deposit for ten per cent of the amount claimed in a bank. If the award was granted in favour of the claimant, the deposit would be refunded to them in proportion to the amount awarded with respect to the amount claimed and the balance, if any, would be paid to the other party.

After a dispute arose between the parties and arbitration was initiated, ICOMM wrote to the Board requesting a waiver of the 10 per cent deposit fee. ICOMM received no response from the Board and subsequently filed a writ petition in the Punjab and Haryana High Court, challenging the validity of clause 25(vii). After the High Court dismissed the writ petition, ICOMM appealed to the Supreme Court.

ICOMM's "unfair bargaining power" argument

ICOMM argued that the arbitration clause was void as it was a 'contract of adhesion' owing to the unfair bargaining power between ICOMM and the Board. ICOMM relied on Central Inland Water Transport Corporation v Brojo Nath Ganguly (1986) 3 SCC 156, a case concerning the disciplinary rules in an employment contract between a state-owned entity and its employees. The court found that the employees had no choice but to accept the rules owing to the inequality in bargaining power, and that the rules were discriminatory and arbitrary. However, the court also noted that its reasoning would not apply to a commercial transaction. On this basis, the Court rejected ICOMM's arguments.

Arbitrariness and Article 14 of the Indian Constitution

ICOMM also argued that the clause was arbitrary and therefore violated Article 14 of the Indian Constitution. At the outset the Court noted that "even within the contractual sphere, the requirement of Article 14 [of the Constitution of India] to act fairly, justly and reasonably by persons who are "state" authorities or instrumentalities continues". The court agreed with ICOMM's submissions that the clause was arbitrary for these reasons:

• The purpose of the 10 per cent deposit, as mentioned in clause 25(vii), was to avoid frivolous claims. However, it is a well-settled principle of Indian law that a frivolous claim could be dismissed with exemplary costs. The Court held that the requirement to deposit 10 per cent of the claim had no nexus with discouraging frivolous claims as the deposit was to be made for all claims, frivolous or otherwise.
• The court also emphasized the fact that even if a claimant were successful, it still may not be able to claim a refund of the entire deposit. This made the clause not only excessive and disproportionate, but also arbitrary.

Reducing the burden on the Indian court system

The Court also emphasised the need to encourage arbitration as an alternative means of dispute resolution due to the time and costs associated with litigation. It said that often a deposit of 10 per cent of a large claim would be more than the court fees which parties would have filed. The Court held that such pre-deposit clauses discourage arbitration and lead to "clogging" of the court system.

Comment

In recent times, a number of Indian appellate court judgments have focused on arbitration clauses in government contracts - for instance, we discussed a line of case law on the appointment of former or current employees as arbitrators, a common feature in government contracts, here. Private parties may have limited ability to negotiate terms in such contracts particularly (as in the ICOMM case) where these terms are contained in the invitation to tender and subsequently incorporated into the contract. This case shows that private parties may potentially be able to challenge onerous provisions in arbitration clauses under Indian constitutional law, although the threshold will be a high one. It is important to note that such constitutional challenges may not be available where there are no state parties involved and where commercial parties have willingly circumscribed their ability to commence claims under a negotiated arbitration agreement.

Even more significantly, from an international perspective, this judgment offers further evidence of the support for, and promotion of, arbitration by the Indian judiciary, and the goal to make India an increasingly arbitration-friendly jurisdiction.

For more information, please contact Nicholas Peacock, Partner, Nihal Joseph, Associate (India), Rebecca Warder, Professional Support Lawyer, or your usual Herbert Smith Freehills contact.