Court Can Examine If Arbitration Clause Is Arbitrary & Violates Article 14 While Considering S.11(6) Application : Supreme Court

In a significant judgment, the Supreme Court held that a clause in an arbitration agreement which is not in consonance with the Constitution cannot be enforced. The Court further held that it can examine if the arbitration clauses are manifestly arbitrary and violative of Article 14 of the Constitution while considering an application for appointment of arbitrator.

A bench comprising Chief Justice of India DY Chandrachud, Justices JB Pardiwala and Manoj Misra was deciding an application filed by Lombardi Engineering Ltd., a Swiss company, under Section 11(6) of the Arbitration and Conciliation Act 1996 seeking appointment of arbitrator in a dispute with the State of Uttarakhand.

The company filed the application before the Supreme Court taking objection to two clauses in the arbitration agreement - one, the condition that 7% of the total claim must be pre-deposited for invoking the arbitration clause; two, the discretion vested with the Principal Secretary/Secretary (Irrigation) to appoint a sole arbitrator.

Issues considered by the Court

The Court framed the following issues :

(i) Whether the dictum as laid down in ICOMM Tele Limited v. Punjab State Water Supply and Sewerage Board and Another(2019) can be made applicable to the case in hand more particularly when Clause 55 of the General Conditions of Contract provides for a pre-deposit of 7% of the total claim for the purpose of invoking the arbitration clause?

(ii) Whether there is any direct conflict between the decisions of this Court in S.K. Jain v. State of Haryana(2009) and ICOMM Tele Limited (supra)?

(iii) Whether this Court while deciding a petition filed under Section 11(6) of the Act 1996 for appointment of a sole arbitrator can hold that the condition of pre-deposit stipulated in the arbitration clause as provided in the Contract is violative of the Article 14 of the Constitution of India being manifestly arbitrary?

(iv) Whether the arbitration Clause No. 55 of the Contract empowering the Principal Secretary/Secretary (Irrigation), State of Uttarakhand to appoint an arbitrator of his choice is in conflict with the decision of this Court in the case of Perkins Eastman (supra)?

Principles laid down in ICOMM Tele Ltd

The Court noted that the principles of law laid down in ICOMM Tele Limited (supra) are as under:

(a) That the pre-deposit condition in an arbitration clause is violative of Article 14 of the Constitution of India being arbitrary.

(b) Unless it is first found or prima facie established that the litigation that has been embarked upon is frivolous, the exemplary costs or punitive damages cannot follow.

(c) Deterring a party to an arbitration from invoking the Alternative Dispute Resolution Process by pre-deposit of certain percentage would discourage arbitration. This would run contrary to the object of de-clogging the court system and would render the arbitral process ineffective and expensive.

The judgment authored by Justice Pardiwala held that there is no conflict between S.K. Jain (supra) and ICOMM Tele Limited (supra), as the relevant arbitration clauses that fell for the consideration of the Supreme Court in both the cases stood completely on a different footing. Also, the points of law on which S.K. Jain (supra) was distinguished and explained in ICOMM Tele Limited (supra).

Court can examine if the arbitration clauses are arbitrary while considering application to appoint sole arbitrator

Answering the issue in the affirmative, the Court stated that the Constitution is the the paramount source of law in our country.

The argument that the Court cannot examine the Constitutionality of the clause while exercising jurisdiction under Section 11(6) was rejected.

"It would be too much for the respondent to say that it is only the writ court in a petition under Article 226 of the Constitution that can consider whether a particular condition in the arbitration clause is arbitrary," the judgment stated.

"The Constitution is the basic and the ultimate source of law", Justice Pardiwala wrote relying on Kelsen's theory of Grundnorm.

The judgment explained that, in the context of the Arbitration Agreement, the layers of the Grundnorm as per Kelsen's theory would be in the following hierarchy:

(i) Constitution of India, 1950; (ii) Arbitration and Conciliation Act, 1996 & any other Central/State Law;

(iii) Arbitration Agreement entered into by the parties in light of s. 7 of the Arbitration and Conciliation Act, 1996.

Thus, the Arbitration Agreement, has to comply with the requirements of the following and cannot fall foul of: (i) Section 7 of the Arbitration and Conciliation Act; (ii) any other provisions of the Arbitration and Conciliation Act, 1996 & Central/State Law; (iii) Constitution of India, 1950, the Court stated.

"For an arbitration clause to be legally binding it has to be in consonance with the “operation of law” which includes the Grundnorm i.e. the Constitution. It is the rule of law which is supreme and forms parts of the basic structure. The argument canvassed on behalf of the respondent that the petitioner having consented to the pre-deposit clause at the time of execution of the agreement, cannot turn around and tell the court in a Section 11(6) petition that the same is arbitrary and falling foul of Article 14 of the Constitution is without any merit," the Court stated.

Rejecting the State's argument that the petitioner cannot challenge the pre-deposit clause after consenting to it initially, the Court said : "It is a settled position of law that there can be no consent against the law and there can be no waiver of fundamental rights." 

Clause empowering Irrigation Dept Secretary to appoint arbitrator

The Court said that this issue is covered by the judgment in Perkins Eastman Architects DPC and another v. HSCC (India) Ltd which held that persons interested in the outcome of the arbitration must not have the power to appoint arbitrators.

"If circumstances exist giving rise to justifiable doubts as to the independence and impartiality of the person nominated or if other circumstances warrant appointment of an independent arbitrator by ignoring the procedure prescribed, the Chief Justice or his designate may, for reasons to be recorded ignore the designated arbitrator and appoint someone else," the Court said.

Reference was made to Section 12 of the Arbitration and Conciliation Act as amended by the 2015 amendment.

The Court concluded that it should ignore the two conditions contained in Clause 55 of the GCC, one relating to 7% deposit of the total amount claimed and the second one relating to the stipulation empowering the Principal Secretary (Irrigation) Government of Uttarakhand to appoint a sole arbitrator and proceed to appoint an independent arbitrator.

Allowing the application, the Court appointed Mr. V.K. Bist, the Former Chief Justice of the High Court of Sikkim to act as the sole arbitrator. 

Case Title : Lombardi Engineering Ltd v. State of Uttarakhand

Citation : 2023 LiveLaw (SC) 958

Click here to read the judgment