Authors – Rahul Jacob & Keshav Kulshrestha
(Authors are third year law students from Institute of Law Nirma University)
Abstract
Through this piece, the authors critique the judgment of the Apex Court in Lombardi Engineering vs Uttarakhand Jal Vidyut Nigam Limited (’Lombardi Engineering’), which held ‘Pre-deposit’ arbitral clauses to be constitutionally invalid under Article 14 Constitution of India. The court while arriving at such a conclusion held that pre- deposit clauses hinders a party’s ability to initiate arbitration as it makes the process expensive. However, in the authors’ view, such reasoning is based on a flawed construction of law. The argument of the authors is two-fold, firstly, the authors question the extension of the court’s jurisdiction under section 11(6) of the Arbitration and Conciliation Act, 1996. Secondly, the authors highlight the flawed logic of the court in disregarding the effectiveness of the pre-deposit clause for preventing frivolous claims. Further, the authors also comment on the consequences of an application for security for costs, if the court’s judgment is to be put in force. To conclude the article, the authors highlight the urgent need for an express provision to empower the tribunal to pass an interim relief under Section 17 of the Act in the nature of security for costs.
Introduction
Recently, the Supreme Court in the case of Lombardi Engineering v. Uttarakhand Jal Vidyut Nigam Limited (‘Lombardi Engineering’) held that any clause that requires the party to deposit a certain amount of money (pre-deposit) to initiate arbitration is constitutionally invalid under Article 14 of the Constitution of India. The court held that such a pre-deposit and pre-condition hinders a party from invoking the jurisdiction of the tribunal, making the avenue of alternate dispute resolution ineffective as it firstly, renders arbitration expensive and secondly, fetters the right of a party to enforce their statutory rights. The court relied on previous (inapplicable) precedents to arrive at such a conclusion and reasoning. This article shall highlight why the aforementioned judgment is erroneous and flawed by presenting a three-fold argument and proceeds to show why the court has strained ‘security for costs.’
Reliance on Faltering Grounds
Firstly, to check the validity of an arbitration agreement against the touchstone of the Constitution of India, the court relied on the troubled jurisprudence as laid down in the case of Vidya Drolia and Ors. v. Durga Trading Corporation (‘Vidya Drolia’). At the outset, it should be noted that, as per Section 11(6A) of the Act, 1996, whenever the court has to appoint an arbitrator, the court has to confine itself only to the existence of an arbitration agreement. However, in Vidya Drolia, the court had conflated and intermixed the concepts of ‘existence’ and ‘validity’. The court in Vidya Drolia held that an arbitration agreement is said to be in ‘existence’ only when it is ‘valid’ in nature, thereby reading the requirement of ‘validity’ as mentioned under Section 8 of the Act, 1996 into ‘existence’ as mentioned under Section 11 of the Act, 1996.
Several subsequent judgments which went on to rely on Vidya Drolia thereby rendered an incorrect interpretation of the law, wherein the courts had disregarded the prima facie test that had to be adopted, i.e., confining itself to the existence of an arbitration agreement. The correct position of law was laid down in Duro Felguera, SA v. Gangavaram Port Limited, wherein the court held that all that the court had to do was look at the mere existence of an arbitration agreement, ‘nothing more, nothing less.’
Moreover, the said principle becomes clear in light of the decision of the Apex Court in In Re: Interplay. In this case, the 7-Judge Bench while dealing with the issue of stamping of an arbitration agreement, had explicitly made it clear that the interpretation that was taken in Vidya Drolia was clearly wrong. The court in In Re: Interplay held that equating ‘validity’ with ‘existence’ was totally incorrect and against the legislative intent, thereby overturning Vidya Drolia and held that the court should restrict itself to the existence of an arbitration agreement. In light of this, the court’s intervention to such a broad extent in Lombardi Engineering goes against settled principles of minimum court intervention.
Secondly, the court also placed its reliance on ICOMM v. Tele Limited (‘ICOMM’) wherein the court had similarly held a pre-deposit clause in an arbitration agreement to be non-est in law. However, the said reliance is misplaced because it is to be noted that the jurisdiction of the Supreme Court in ICOMM was invoked under Article 136 of the Constitution of India which has to be differentiated from the jurisdiction of the court in Lombardi Engineering.
Additionally, it will not be out of place to highlight that the nature of the arbitration clause varied, drastically, from each other. In ICOMM, the arbitration clause stated that if the claimant wins the arbitration, they would be entitled to get a refund only proportionately to the amount that was claimed and the remaining amount would go to the other side, which resulted in forfeiture of the deposit. It was only in the light of such a clause which would hinder arbitration, did the court in ICOMM found the clause to be arbitrary and disproportionate in nature, thereby distinguishing it from S. K. Jain v. State of Haryana, which found such a clause to be valid in nature. Now, this has to be contrasted and compared with the clause in Lombardi Engineering wherein all that was stated was that 7% of the arbitral claim had to be given as a pre-deposit. Therefore, the said distinction should not have been ignored by the court.
Thirdly, the court also found such a clause to be vague on the ground that the clause did not make any mention as to how the amount would be adjusted and refunded back to the party making the said ‘security deposit’. A ‘security deposit’ is in itself a ‘protection, assurance given by a debtor to assure the payment of performance of his debt, by furnishing the creditor with a resource to be used in case of failure of the principal obligation’. It will not be out of place to mention that ‘security deposit’ is in itself refundable in nature and a similar observation was also made by both the Calcutta High Court and Delhi High Court. Thus, to hold the clause to be vague on the said ground does not hold water.
Such an interventionist approach of the court under Section 11(6A) of the Act, 1996 has led to the derailment of party autonomy. Party autonomy is the brooding and the guiding spirit of arbitration., ultimately forming the backbone of arbitration. When parties have essentially agreed to be bound by a certain prescribed procedure, courts and arbitrators have to give effect to the same. A correct interpretation of the said issue concerning pre-deposits has been observed in S. K. Jain v. State of Haryana and Brij Gopal Constructions Co. Pvt. Ltd. v. Haryana Shehri Vikas Pradhikarn among others which have held such clauses to be valid in nature as they carry the laudable objective of preventing frivolous claims, thereby giving effect to the mandatory terms of the contract of the parties.
Another point that needs to be contoured is the applicability of the ratio in Lombardi Engineering to cases where both parties to an arbitration agreement are private. Despite the court’s ruling, what needs to be highlighted is the inapplicability of the judgment in a scenario where the parties to an agreement are private as firstly, fundamental rights cannot be enforced against them and secondly, as the concept of unequal bargaining cannot be applied in contracts that are purely commercial in nature.
Has the court Strained Security for Costs?
The court in Lombardi Engineering turned down the contention that a pre-deposit clause is essentially used to prevent frivolous claims on the ground that the court or the tribunal has the power under Section 31A of the Act to award exemplary costs in cases where a frivolous claim has been initiated. To substantiate this, the court relied on Uber Technologies Inc., v. David Heller, which stated that:
“Courts have many ways of preventing the misuse of court processes for improper ends. Proceedings that appear vexatious can be handled by requiring security for costs.”
The court in Lombardi, has evidently, as can be seen from above, mixed the concept of the regime for costs with security for costs and has consequently brushed the benefit of pre-deposit clauses under the carpet. The latter is a security provided by a claimant who would have no funds to bear the costs of arbitration after the termination of the proceedings, thereby protecting the respondent against the future uncertainties of its counterpart’s financial situation.[1] Whereas, on the other hand, it is to be noted that powers under Section 31A of the Act, which provides for “costs” of the arbitration, come into the picture only after an award has been passed as it is essentially based on the principle of ‘costs follow the event’.
However, upon a closer inspection of the said provision, it will be noted that the wordings under Section 31A(2) of the Act begin with ‘if the court or tribunal decides’, which makes it completely open-ended, leaving discretion with the authority to award costs. What remains flawed in the said approach is that the courts and the tribunals themselves are resistant to passing an order for costs under the current regime. A reason that can be attributed to the same is that the power to grant costs is entirely based on discretion. In this background, a fundamental question that remains to be answered is how the above-mentioned approach, of providing costs under Section 31A of the Act (which is entirely based on the discretion of the authority, that usually restricts itself from granting such orders) performs better than providing an upfront pre-deposit that essentially secures a party beforehand by providing a sense of certainty and assurance (by preventing baseless and inflated claims, which not to mention is refundable in nature).
Another serious issue that arises with the said background is that, with the court holding a pre-deposit clause to be contrary to the objective of the Act, questions are also raised concerning the validity/maintainability of an application for security for costs. An application for security for costs, generally made by the respondent, is an application for money, assets, bonds or guarantees that a party provides for future costs of the proceedings if that party loses.
As stated above, security for costs is a security that is provided to protect the respondent against the future uncertainties of its counterpart’s financial situation.[2] The respondent should not be faced with the inequitable decision of either not having to defend itself in the arbitration and risk an adverse award or defend itself in the arbitration and incur costs which it will likely be unable to recover from the other side.[3]
Further, the tribunal does not have an unfettered or unqualified power to order security for costs. An essential condition that has to be met before such an order can be passed is the substantial shift in the position of the party after the execution of the underlying contract and when there is a risk that a party may run out of business,[4] thus having no finances to repay the costs of arbitration. The consideration that has to be taken into account is the ability of the claimant to bear a cost award in case the respondent wins.[5] In Parkinson and Co. v. Triplan Ltd.[6], the criteria to order security for costs as provided in the CIArb’s Guidelines on Security for costs include a prima facie view of the success of the claim and the defence, whether the claimant has the resources to satisfy a cost award, the availability of assets that could help in effective enforcement, whether it’d be fair in all the circumstances of the case.
In India, there is no express provision that empowers the tribunal to order security for costs. At the most, a tribunal can take a wider reading and interpretation of Section 17(1)(e) of the Act to provide for such an order. Leaving such a provision of law outside the scope of the statute book can create a potential barrier to making India a global hub for arbitration and reduce the attractiveness and efficiency of arbitration as a go-to dispute resolution mechanism. With an increase in the cost of arbitration, globally, security for costs becomes an inevitable factor because no party would want to indulge and see itself stuck in baseless, frivolous disputes.
But with pre-deposits being held invalid on the ground that it hinders the party from submitting a dispute to arbitration, there lies a dilemma and uncertainty as to the validity or maintainability of an application of security for cost. If the same reasoning is to flow as and with regard to pre-deposits, an application for security for cost would not hold ground. The ratio that flows from Lombardi Engineering will only hinder arbitral tribunals from ordering security for costs as one may argue, it may impose undue financial burden on the claimant and enforce its statutory rights.
Conclusion
The aforementioned analysis contends that the ruling in Lombardi Engineering is not supported by cogent reasoning. The flawed reliance on past (inapplicable) precedents to justify increased judicial interference is only unreasonable. Such interference not only paves the way for the parties to contest the very constitutionality of the arbitration agreements under Section 11 under several other grounds but also undermines the arbitral autonomy enshrined under Section 16 of the Act. As rightly pointed out in the case of S. K. Jain and other cases that have arrived at a similar reasoning, a pre-deposit clause carries a laudable objective of preventing fictitious claims that result in high, unwanted costs to the parties. Such interference, consequentially, also brushes aside the fundamental and brooding principle of party autonomy. To hold that exemplary costs can be ordered for frivolous claims under Section 31A of the Act only keeps the job half done given the fact that ordering for costs is entirely based on the discretion of the tribunal or court, which generally are not inclined in considering such orders. By holding pre-deposit clauses to be unconstitutional in nature, the court has inadvertently strained the concept of security for costs too, as stated above.
As per an LCIA Report, the average cost of an arbitration proceeding is close to USD 97,000. In light of the increased costs of international arbitration, the inherent power of several renowned global arbitration institutions to order security for costs has become salient today. Despite this, what troubles the Indian landscape is the absence of an express provision that empowers the tribunal to pass an interim relief in the nature of security for costs. However, given the wide range of interpretations and standards that are applicable, it cannot be left for the tribunal to determine according to its discretion.[7] Therefore, in order to limit the tribunal’s discretion, the authors propose and underline the necessity of an express provision empowering the tribunal to pass interim relief, particularly in the nature of security for cost under Section 17(1)(e) of the Act.
[1] Ajar Rab, Interim Measures in International Commercial Arbitration: A Comparative Review of the Indian Experience (Kluwer Law International 2022), ch 8
[2] Ajar Rab (n 1)
[3] Axel Calissendorff and Patrik Schöldström (eds), ‘Stockholm Arbitration Yearbook 2022’ (Kluwer Law International 2023), ch 4
[4] Albert Jan Van Den Berg (ed), ‘Yearbook Commercial Arbitration Volume XXI-1994’ (Kluwer Law International 1996), pt 2
[5] Aquila Design (GRP Products) Ltd v Cornhill Insurance, 1988 BCLC 134
[6] Parkinson and Co v Triplan Ltd, (1973) 2 All ER 273
[7] Ajar Rab (n 1)
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