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SUPREME COURT’S TAKE ON THE VALIDITY OF ‘DEPOSIT-AT-CALL’ CLAUSES TO INVOKE ARBITRATION AND POSSIBLE

Author of this article – LakshmiNarayana C, B.B.A, LLB (Hons.), V Year, School of Law, SASTRA Deemed University, Thanjavur, Tamil Nadu.

Introduction

Pre-deposit clauses (“PDC”) to initiate arbitrations have been recently brought to question by the Supreme Court of India in ICOMM Tele Ltd. v Punjab State Water Supply and Sewerage Board & Anr. (2019) 4 SCC 401 (“ICOMM”) delivered on 11 Mar 2019. The author presents a brief of the points of law discussed, decision made & concludes with a critical analysis of the ambiguities that arise from the said judgment.

Facts

The first Respondent, the Punjab State Water Supply Board called for tenders for the extension of the water supply & sewerage system for various towns. The Appellant, ICOMM Tele Ltd., one of the participants of the tender process, accomplished to win the same and entered into a contract with the Executive Engineer (Second Respondent – a representative of the Respondent Department), as on 16 Jan 2009.

The said contract incorporated an arbitration clause for dispute resolution, a preferred mode for most government contracts which specifically negate the party’s right to approach a civil court to agitate a claim unless arbitral proceedings have been sought first. But initiation of the process had a requirement detailed to make “any party invoking arbitration shall, inter alia, furnish a ‘deposit-at-call’ for 10% of the amount claimed”. As any pre-deposit clause goes, it was framed purportedly to prevent frivolous claims from being initiated and to ensure security of payment of damages to the party whose claim holds merit; either a transfer or refund was imminent. But peculiar to this contract, the refund of the pre-deposit held another condition that the amount if to be refunded, shall be “in proportion to the amount awarded”.

The entire transaction of developing the various towns as per initial tender led to numerous contracts between the second respondent and the appellant, each noting the standardized presence of the same arbitration clause. The appellant soon found itself amidst disputes related to the contracts and sought to initiate the dispute resolution process and informed the second respondent regarding the same, with an additional request of waiving the pre-deposit fee required. The reason behind the request of the waiver was that the dispute itself was related to non-payment of amounts due, to the appellant, to the tune of 1933.60 lacs from the Respondents. They believed that the deposit waiver would safeguard the appellant from having to deposit more money in order to retrieve disputed dues.The Second Respondent gave no response to their situation but rather insisted the ‘deposit at call’ be implemented to the letter. Repeated requests kept eliciting the same response from the Respondent.

Thus, left stranded, the appellant attempted to resort to questioning the pre-deposit clause itself.This led to a writ petition being filed before the High Court of Punjab and Haryana protesting the said dispute resolution clause to be “arbitrary, unconstitutional and against the principles of public policy.” On 14 Sep 2016, The Court chose to dismiss their claim on the grounds that nothing about the clause was unreasonable or arbitrary and thus gave no grounds to interfere with the contractual obligation agreed upon by both parties.

Once again on 08 Mar 2017, the appellant chose to approach the same forum again by arguing that the case used for determining the previous judgment had different facts and thus was distinguished. While recommending an appeal against the impugned judgment, The Court dismissed the petition on the grounds that such argument was immaterial, and that the judgment wasn’t rendered on such case alone but rather done ‘generally’. Hence, the final approach was to appeal to the Supreme Court.

Issues

  1. Does the impugned Clause lead to a contract of adhesion?

  2. Whether the impugned clause is arbitrary & discriminatory and violative of Art 14?

Arguments advanced

Petitioner:

  1. It was contended that, a contract of adhesionis caused as there is unequal bargaining power between the parties and thus the court must intervene and strike down the unfair and unreasonable contract entered based on the holding of the Supreme Court in the case of Central Inland Water Transport Corporation v. Brojo Nath Ganguly [(1986) 3 SCC 156] which specifically dealt with similar circumstances of parties with unequal bargaining powers.

  2. Also, the 10% pre deposit was argued to be a ‘clog’ to entering the dispute resolution process.

  3. A pre-deposit to curb ‘frivolous claims’ was seen to be applicable to all cases thus causing a blanket obstacle for all claims. The appellant suggests the alternative of allowing all claims and charging frivolous claims with heavy costs.

  4. Further, refund of the deposit upon an award favouring claimant, is relative to the arbitrator’s award and not the deposit itself. This was claimed to lead to an arbitrary high-handed action by the Respondents.

Respondents:

  1. The Respondents asserted that there was no Article 14 violation as the clause was not just imposed on the appellant but was also applicable to the respondents if they were to initiate arbitration.

  2. The authority relied on by the appellant was argued to be inapplicable to the current scenario as it could not be applied to commercial contracts which was clearly the instance in this case.

Observations by the Court

  1. The Supreme Court agreed to the in-applicability of Central Inland Water Transport Corporation (supra) in the current case as ‘both parties were businessmen’ and as the contract was a commercial transaction. Reliance was based on the case of K. Jain v. State of Haryana (2009) 4 SCC 357(“S.K.Jain”).

  2. On the allegation of violation of Art.14, the Court opined that the Constitution mandates ‘state’ instrumentalities’ actions to be just, fair & reasonable. Even though the clause was not discriminatory and applied to both parties, but the question of arbitrariness exists with respect to the dispute resolution clause.

  3. As a measure to curb frivolous claims, the clause had a blanket application to all claims, frivolous or not. The Court agreed with the Appellant that it was a noticed practice to avert frivolous claims by imposing exemplary costs or punitive damages as per General Motors (I) (P) Ltd. v. Ashok Ramnik Lal Tolat (2015) 1 SCC 429. And the sanction on the same is done only after a claim is proved to be frivolous & holding no merit, which prevents the harm caused by a blanket ban.

  4. The arbitrary notion, the court observed, was with respect to the refund of the deposit. The terms of the clause that linked the refund to be relative to the award given by the arbitrator instead of the deposit along with forfeiture of excess amounts to the other party, serves on purpose to having a just resolution in certain cases. The court proceeded to give an example of that of a wrongful termination claim, where if a successful claimant prays for a large sum and is only awarded a part thereof, it enables the losing party to benefit from the award as it gets to forfeit parts of the deposit that remains after proportional amount from the award is taken by the claimant. Thus, the clause was clearly arbitrary and unconscionable.

  5. Justice R.F. Nariman, on a concluding note, asserted the need to enforce arbitration to stay an alternative dispute resolution process, and any ‘clogs’, such as a pre-deposit that causes the arbitral process to become ineffective & expensive by dragging it to an already burdened civil court, should be severely discouraged. On that note the Hon’ble Supreme Court set aside the judgments appealed against and permitted the appeal.

Comments

The author believes that even though this pro-arbitration stance shall aid the Indian legal system to promote more towards alternative dispute resolution, the judgment itself seems to have fallacies that have been left unnoticed. This, the author sees through misemployed authorities as listed below:

  1. K. Jain v. State of Haryana (2009) 4 SCC 357.

  2. General Motors (India) (P) Ltd. v. Ashok Ramnik Lal Tolat (2015) 1 SCC 429.

  3. Centrotrade Minerals v Hindustan Copper Ltd. (2017) 2 SCC 228.

S.K. Jainv. State of Haryana

The case was regarding a pre-deposit clause challenge similar to ICOMM(at 7% deposit instead of 10%) through a writ petition that argued it to be unreasonable.And the case followed in the said judgment was Excise Comm v. Issac Peter(1994) 4 SCC 104 which held as follows:

“26. We are therefore, of the opinion that in case of contracts freely entered into with the State, like the present one, there is no room for invoking the doctrine of fairness and reasonableness against one party to the contract (State), for the purpose of altering or adding to the terms and conditions of the contract, merely because it happens to be the State.…It must be remembered that these contracts are entered into pursuant to public auction, floating of tenders or by negotiation. There is no compulsion on anyone to enter into these contracts. It is voluntary on both sides. There can be no question of the State power being involved in such contracts.”

The Supreme Court thus stressed on how the question of imbalance bargaining power doesn’t arise when the contracts are floated as tenders which are only entered after negotiation and deliberation. In fact, no party is ever compelled to broker any contract with the state.

Failure to Distinguish

The decision in ICOMM specifically tries to distinguish between S.K.Jainand its own by placing differences relating to the claims made& the different predeposit clause in each contract

  1. Question of arbitrariness

For the first, the ICOMM Bench mentions in Para 14, that “there was no plea that the aforesaid condition contained in an arbitration clause was violative of Article 14 of the Constitution of India as such clause is arbitrary…only pleas were for application of Inland Water & a cap on the quantum payable as security deposit, both of which failed”. The author finds that this is quite conflicting to a plain reading of Para 5 of the S.K. Jain judgment which states “The 7% deposit demand is wholly arbitrary” as per its petition in the High Court which was under appeal in S.K. Jain.’

  1. Demarcation in pre-deposit and refund sub clause

Secondly, the claim for different pre-deposit clauses attempts to delve us to a question is if such difference is enough for the Bench to not be bound by the 3 judge Bench from S.K.Jain. It could not possibly be expected that all predeposit clauses in tenders and other contracts shall be similar. The difference noted was,how the refund of the deposit is agreed on and not the purpose of the Pre-deposit Clause itself. The author believes that on those grounds, both S.K. Jain&ICOMM were similar in all facets to warrant the application of the S.K. Jain ratio of non-interference by the courts in the deposit-at-call process.

General Motors (India) (P) Ltd. v. Ashok Ramnik Lal Tolat

The flaw in referring to this authority is simply the forum it applies to. The said case was a reference to a ratio which mentions exemplary costs being imposed by a court. ICOMM suggested the same to be handled by the arbitrator. There is indeed a legal and a practical difference between a court and an arbitral tribunal. The difference in application can be noticed practically as costs are rarely awarded by arbitral tribunals specifically with PSUs being parties to the arbitration.

Centrotrade Minerals & Metal Inc. v. Hindustan Copper Ltd.

The court in the ICOMM judgment referred to this case in Para 25, with respect to establishing the pillar of the Arbitration and Conciliation Act by extracting the following:

“39. In Union of India v. U.P. State Bridge Corpn. Ltd., (2015) 2 SCC 52, this Court accepted the view that the A&C Act has four foundational pillars and then observed in para 16 of the Report that:‘16. First and paramount principle of the first pillar is ‘fair, speedy and inexpensive trial by an Arbitral Tribunal’. Unnecessary delay or expense would frustrate the very purpose of arbitration. Interestingly, the second principle which is recognised in the Act is the party autonomy in the choice of procedure. This means that if a particular procedure is prescribed in the arbitration agreement which the parties have agreed to, that has to be generally resorted to.’”

The stress was placed on “fair, speedy and inexpensive” arbitral proceedings and the rest left unnoticed. The author specifies what is left out is the 2nd Principle of “Party Autonomy”, a guiding principle that opines that if two parties agree to a set of terms & procedures, the court cannot interfere in the parties right to decide, choose & operate on their own terms.

Ambiguities

Frivolous Claims – The Bench further mentions that the notion of preventing frivolous claims by imposing a deposit for every possible claim serves as a blanket ban. The court suggests a solution of imposing exemplary costs for frivolous claims.

  1. The author submits that imposition of exemplary costs becomes a measure for ex post facto application to an act, endeavored to being discouraged in the first place. Instead of attempting to deter a claim if frivolous at the stage of inception (while accommodating a possibility that the party may approach for a civil remedy to get a waiver), the Court prefers a penalizing theory by allowing every claim that might be frivolous to proceed with arbitration, and then acting upon it after the entire arbitral process concludes. It must be understood that even arbitral proceedings for vexatious claims shall involve a waste of time & monetary resources for both parties. The idea for decreasing such claims, is a borrowed idea from the punishment theories in criminal law where a deterrent approach is preferred over a retributive one.

  2. Further, a pre-deposit clause not only is to act as a negative incentive to make frivolous claims but is also restrictive of exaggerated claims. The author perceives to have seen the same reflected by the clause used in ICOMM. Any method to decrease the claim made also impacts the costs of the process, as administrative costs in arbitral proceedings are ad valorem. ICOMM though acknowledges arbitrary PDCs negating claims from going to ADR and increasing costs, fails to expand on how existence of PDCs would in fact reduce relative costs to the arbitral process.

Encouraging alternate dispute resolution – The Supreme Court had concluded its judgment on a note that without the presence of such predeposit clauses, more matters shall be dealt through ADR.

  1. The author though sees the motive to be quite developmental, fails to see how much of an impact this decision makes. Considering the said judgment was with respect to a state instrumentality and a private contractor, the ratio of the judgment too shall become restricted for such situations which involve a public element.

  2. Thus, to expect that pre-deposit clauses shall also change in the contracts that are only between private entities is quite futile. The ICOMM objective of encouraging ADR thus becomes narrowed down to impacting only disputes with state entities which further could still include pre-deposit clauses, as long as it could be distinguished from the one in ICOMM, as not being arbitrary.

Conclusion

Although the decision in ICOMM is a refreshing move towards avoiding a repetition in arbitrary and unreasonable measures employed by a State party, the decision itself remains susceptible because of some loopholes that need to be resolved. The judgement seems to reflect the Indian judiciary’s attempt to hastily encourage ADR Processes in the country without absolute clarity in the domestic mechanisms.Questioning the efficiency of pre-deposit clauses puts a dent in the measure being an integral part of the process of aiding the arbitral procedure. Parties now not only have the option to invoke Article 14 in commercial contracts but now additionally have some assurance that a court may alter terms of a contract post agreement. Party Autonomy & the basic tenets of contract law now see a variation in application which now may lead to parties contending inconvenient terms to warrant the court’s interference to employ opportune ‘fairness’. Thus, a judgment to further the objective of promoting alternative dispute resolution could potentially have led to more obstructions being added to the medley.

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