The Supreme Court recently held, in Lombardi Engineering Limited v Uttarakhand Jal Vidyut Nigam Limited, that any arbitration clause inconsistent with the constitution is invalid. The court also held that it can determine if any arbitration clause is manifestly arbitrary and violative of article 14 of the constitution when considering a narrow application for the appointment of an arbitrator.
The petitioner, a Swiss company, contracted with the respondent, a company wholly owned by the state government of Uttarakhand, to provide services for a project in that state. The contract included an arbitration agreement in which the party initiating arbitration had to deposit 7% of the arbitration claim as security. Disputes were to be determined by a sole arbitrator appointed by the principal secretary (irrigation) of the Uttarakhand government.
Disputes arose and the petitioner issued a notice of arbitration, requesting the respondent to appoint an independent arbitrator. The respondent, however, terminated the contract, alleging the petitioner had not carried out its obligations. The petitioner applied to the Supreme Court under section 11(6) of the Arbitration and Conciliation Act, 1996, for the appointment of an arbitrator.
Among the issues before the court was the question of whether it had the jurisdiction to hear the challenge to the arbitration agreement. Under section 11(6A) of the act, a court considering an application under section 11(6) is confined to the examination of the existence of an arbitration agreement.
The second issue was whether the obligation to pay a deposit when invoking arbitration contravened article 14 of the constitution, which provides for equality before the law. Finally, the court had to decide whether requiring in the agreement that an officer of a party involved in the dispute appoint the arbitrator interfered with party autonomy violated article 14, and conflicted with its decision in Perkins Eastman Architects DPC and Anr v HSCC (India) Limited.
The petitioner contended that the claim of the respondent unilaterally to have the arbitrator appointed conflicted with the Perkins Eastman decision, which held that a party with an interest in the outcome of, or a decision in, the dispute could not appoint a sole arbitrator. The deposit condition was unfair, arbitrary and violated article 14.
The respondent argued that the security deposit was refundable and ensured only valid, good-faith claims were made. This prevented the project being interrupted because of frivolous claims. In any event, the court had no jurisdiction under section 11(6) to test the validity of a condition in the arbitration agreement against a provision of the constitution.
The Supreme Court rejected the argument that it could not determine the constitutionality of an arbitral clause when hearing an application under the Arbitration and Conciliation Act. Laws are valid only by conforming with the constitution, the paramount source of the law. The respondent’s contention, that the petitioner was itself breaching the principle of party autonomy by challenging the terms of the agreement after consenting to the deposit clause, was without merit. Such a principle could not be stretched to the extent that it violated fundamental rights under the constitution. The requirement for a deposit, applying to frivolous and legitimate claims alike, discouraged a party from properly invoking arbitration.
As for the clause giving an officer of the state government the right to appoint the arbitrator in a dispute in which that body had an interest, the decision in the Perkins Eastman case covered the matter. The clause was bad in law.
The dispute digest is compiled by Numen Law Offices, a multidisciplinary law firm based in New Delhi & Mumbai. The authors can be contacted at support@numenlaw.com. Readers should not act on the basis of this information without seeking professional legal advice.
