Arbitration Agreements: Understanding the Basics

Author: Sibani Panda, Research Associate

‘At all events, arbitration is more rational, just, and humane than the resort to the sword’ – Richard Cobden

The provisions of the Arbitration & Conciliation Act govern arbitration in India. The United Nations Commission on International Trade law (‘UNCITRAL’) which was established in the 1966 has been responsible for the development of international arbitration. India enacted the Arbitration and Conciliation Act, 1996 by taking into account the arbitration rules of UNCITRAL Modern Law on International commercial Arbitration. India is also a signatory to the New York Convention (1960) and the Geneva Convention (1924).  Arbitration under Arbitration and Conciliation Act, 1996 is a matter of consent, not coercion and the parties are free to structure their arbitration agreements as they see fit. ‘This concept of arbitral contractualism allows the parties  to write their own rules of arbitration, therefore, they can customize the arbitral process according to the needs of their transaction, eliminate legal rules or trial techniques that might prove inconvenient or unsuitable , and maintain procedural elements they believe essential to the dictates of fairness, finality and functionality ((Charbonneau, Cases and Materials on law and practice of Arbitration , second edn,2000, p 15)).’

According to Section 7 of the Arbitration and Conciliation Act, 1996

  1. An ‘Arbitration agreement‘ means an agreement by the parties to submit to arbitration all or certain disputes which have arisen or which may arise between them in respect of a defined legal relationship, whether contractual or not.
  2. An Arbitration agreement may be in the form of an arbitration clause in a contract or in the form of a separate agreement.
  3. An Arbitration agreement shall be in writing.
  4. An Arbitration agreement is in writing if it is contained in-
  • a document signed by the parties;
  • an exchange of letters, telex, telegrams or other means of telecommunication which provide a record of the agreement; or
  • an exchange of statements of claim and defense in which the existence of the agreement is alleged by one party and not denied by the other.
  1. The reference in a contract to a document containing an arbitration clause constitutes an arbitration agreement if the contract is in writing and the reference is such as to make that arbitration clause part of the contract.

In Arbitration agreements, the parties have the freedom and legal right to engage in arbitration and to make specific provisions for the implementation and operation of their arbitration. By entering into a contract of arbitration, the parties voluntarily abandon their rights to judicial relief and, in effect, create a private system of adjudication that presumably is better adapted to their transactional needs.

Section 7(1) contemplates two types of arbitration agreements:

        I. The first type of agreement is referred to as an ‘Arbitration clause’ where an agreement mainly takes place in the form of an arbitration clause, which is embedded, in the principal contract between the parties. The agreements where a clause is inserted in the contract that creates some rights and duties which, in the event of dispute, will be the subject of the intended arbitration are called substantive contract ((Mustill & Boyd, Commercial Arbitration, second edition , 1989, p 6)). The arbitral clause is a contract where the parties agree to submit future disputes to arbitration.  The arbitral clause has an autonomous legal existence and it must identify the contractual relationship to which it applies.

      II. The second type of agreement is referred to as a ‘Submission to arbitration’ or a ‘Submission agreement’ where an agreement is made between the parties after the disputes have already arisen. In submission agreement, an agreement is formed between the parties to submit a dispute to arbitration, which has already arisen between the parties before the arbitration agreement, comes into existence. The submission agreement is usually a detailed document, dealing with the construction of the arbitral tribunal, the procedure to be followed, the issues to be decided and other matters ((Redfern and Hunter , Law And Practice Of International Commercial Arbitration , fourth edn, 2004, p 7,para 1- 10)). It is necessary to have the necessary terms of reference in an arbitral process because it helps to establish the arbitral tribunal’s jurisdiction to adjudicate.

In Bihar State Mineral Development Corporation v Encon Builders (I) Pvt Ltd, ((2003 (3) Arb LR 133,137 (SC).))the Supreme Court has observed that the following four essential elements of an arbitration agreement:

  1. There must be a present or future difference in connection with some contemplated affair.
  2. There must be the intention of the parties to settle such difference by a private tribunal.
  3. The parties must agree in writing to be bound by the decision of such tribunal.
  4. The parties must be ad idem.

In KK Modi v KN Modi, ((AIR 1998 SC 1297))Supreme Court observed some of the important attributes of Arbitration agreement which are as follows:

  1. The arbitration agreements contemplates that the decision of the tribunal will be binding on the parties to the agreement.
  2. The jurisdiction of the tribunals to decide the rights of the parties is derived either from the consent of the parties or from an order of the court or from a statute, the terms of which make it clear that the process is to be an arbitration.
  3. The arbitration agreements contemplates that the substantive rights of the parties will be determined by the agreed tribunal.
  4. The tribunal determines the rights of the parties in an impartial and judicial manner, owing an equal obligation of fairness towards both sides.
  5. The agreement of parties to refer their disputes to the decision of the arbitral tribunal is intended to be enforceable in law.
  6. The agreement contemplates that the tribunal will make a decision upon a dispute, which is already formulated at the time when a reference is made to the tribunal.

An Arbitration agreement is required to be in writing which means that a legally binding and valid agreement between the parties purporting to submit to arbitration any existing or future disputes arising out of or in connection with the main contract, ((Union of India v GS Atwal and Co (1996) 3 SCC 568))must be in writing. A mere oral understanding between the parties to refer the disputes to arbitration would not constitute a valid arbitration agreement ((Jayant N Sheth v Gyaneshwar Apartment co-operative Housing society Ltd (1999) 1 Bom CR 774)).

According to Section 7(4) ((The Arbitration and Conciliation Act, 1996)), there are three situations in which an arbitration agreement should be treated in writing:

                    I. In a document: An arbitration agreement may be in the form of an arbitration clause in a contract, or in the form of a separate agreement. It is mainly required that the documents relating to the agreement should indicate that it is an agreement to arbitrate and it should be signed by the parties.

                 II. In the correspondence: An arbitration agreement also results from the correspondence between the parties. An arbitration agreement is in writing if it is contained in an exchange of letters, telex, telegrams or other means of telecommunication, which provide a record of the agreement ((The Arbitration and conciliation act, 1996, s 7(4)(b).)).  In these cases, even if the parties but the assent of do not sign the agreement each party is required in written form ((Study on New York Convention  A/CN 9/168, para 21)).

               III. In the claim and defense statements: In cases where the claimant in his claim statement alleges the existence of an arbitration agreement and the defendant, in his defense does not deny it, then a valid arbitration agreement will be inferable.

An agreement enforceable by law is a contract ((The Indian Contract Act 1872, s 2 (e).)). An arbitration agreement stands on the same footing as any other agreement. Every person capable of entering into a contract may be a party to an arbitration agreement. He who cannot contract, cannot make a reference to arbitration. An agreement to submit a dispute to arbitration is based on the consent of the parties. It is binding upon the parties unless it is tainted with fraud, undue influence etc. in which case it can be avoided like any other agreement. The terms of the arbitration agreement must be definite and certain. The parties to the arbitration agreement must be clearly identified either in the main contract or in the arbitration agreement. It is essential that while drafting an arbitration agreement, the intention of the parties should be mentioned in a clear and unambiguous language. The first and foremost requirement of drafting an arbitration clause is that the intention of the parties, that all disputes between them shall be resolved by arbitration, should be stated in clear and unequivocal words.

In order to constitute an arbitration agreement between two parties, the other must accept the proposal made by one person. Unless the proposal is accepted, there can be no binding and enforceable agreement. An arbitration agreement is separate and independent of the contract in which it is embedded. Even if the contract in which the arbitration clause has been embedded is held to be invalid for the reason that its subject matter is not arbitral under the law for the time being in force in India, the arbitration clause survives and the award resulting from the arbitral proceedings under such clause will be perfectly valid.

Incorporation of Arbitration Agreements:

An arbitration clause can be incorporated either by reference to a standard form of clause or to a set of trade terms which themselves include provisions requiring disputes to be submitted to arbitration. In Alimenta SA V National Agriculture Cooperative Marketing Federation Of India Ltd (([1987] 1 SCC 615)), the Supreme Court observed that ‘ the arbitration clause of an earlier contract can, by reference , be incorporated into a later contract, provided, however it is not repugnant to or inconsistent with the terms of contract in which it is incorporated’. Section 7(5) provides that ‘the reference in a contract to document containing n arbitration clause constitutes an arbitration agreement if the contract is in writing and the reference is such as to make that arbitration clause as a part of the contract’.

In a particular case, the scope and extent of an arbitrator’s jurisdiction and powers would depend on the proper construction of the arbitration agreement, therefore it is essential that the arbitral tribunal ‘must consider the dispute in question and then elicit from the arbitration agreement whether or not the parties intend a dispute of the kind in question to be resolved by arbitration’ ((Redfern and Hunter , Law And Practice Of International Commercial Arbitration , fourth edn, 2004, p 137,para 3-11)). The existence of difference or dispute is an essential condition for the arbitrator’s jurisdiction. If there is no dispute, there can be no right to demand arbitration. The dispute may be a present or a future one. In case of an agreement to refer future disputes to arbitration, the jurisdiction of the arbitrator does not arise until a dispute has arisen. A dispute means an assertion of a right by one party and repudiation thereof by another. A point as to which there is no dispute cannot be referred to arbitration.

So some of the essentials of the arbitration agreements can be summarized as follows:

  • An arbitration agreement must be in writing.
  • An arbitration agreement must comply with the requirements of a valid contract.
  • An arbitration agreement must be in respect of a dispute that is arbitrable.
  • Parties may agree on the number of arbitrators and their nationalities.
  • Parties may agree on the venue of the arbitration proceedings.
  • Parties may agree on the choice of procedure and the arbitration administered by an arbitral institution under its rules.
  • Parties may agree on the language of proceedings and pleadings;

Therefore it is always required that the arbitration agreements should be construed in a fair and proper manner according to the general principles of construction of statutes, statutory instruments and other contractual documents.

Arbitration Agreements under Arbitration and Conciliation Act 1996

Author: Prerna Khatri, Research Associate

For an arbitrator goes by the equity of a case, a judge by the law, and arbitration was invented with the express purpose of securing full power for equity.”  Aristotle

In layman’s terms, arbitration can be understood as an alternative means of resolving a dispute between conflicting parties. It is the submission of a dispute to an unbiased and neutral third party, known as an arbitrator, in order to settle the differences between the parties. The parties mutually agree to abide by the arbitrator’s decision, referred to as an award, which is final and rarely re-examined by the courts. The purpose of arbitration, as a means to resolve disputes, is to ensure speedy, efficacious and a reliable remedy to the parties as well as preserve the contractual/business/legal relationship.

Arbitration is increasingly growing to avoid the stringent court formalities and technical laches associated with it. It is largely preferred to litigation in the context of international transactions where for the purposes of trade and commerce, a foreign element is involved. In such a scenario, arbitration plays an important role if a dispute arises at the time of completion of the contract. To avoid confusion and chaos with respect to the prevailing law, the arbitration clause incorporated in the terms of the agreement would be of much help in case of a dispute since it clearly lays down the formalities to be followed at the time of an arbitration.

It is important to note that, not all matters can be referred to arbitration. There are certain exceptions, areas where the law of arbitration cannot be applied such as criminal proceedings, matters relating to divorce, guardianship insolvency, testamentary matters, dissolution of a company and matters concerning charitable trusts, among many others depending upon the relevant subject matter. Usually, all matters concerning civil rights such as contractual relationships, enforcement of contract, breach etc., can be referred to arbitration.

ARBITRATION AGREEMENT

An arbitration clause usually finds place either as a provision inserted in the contract or as an exclusive contract to facilitate arbitration in case of a dispute ((Section 7, The Arbitration and Conciliation Act, 1996)). The purpose of the ‘Arbitration and Conciliation Act, 1996’ is to ensure that in case of a dispute, an amicable settlement is achieved by the parties. It promotes a fair and unbiased means of resolving a dispute following the principles of natural justice ((Maneka Gandhi vs Union of Indian [1978 AIR 597, 1978 SCR (2) 621].))and the basic rules embodied in Article 14, The Constitution of India, 1950. The prime object of enacting such legislation was laid down by the Supreme Court in Food Corporation of India vs. Joginderpal, ((AIR 1981 SC 2075at 2076-77.))wherein it was observed that,

The law of arbitration must be `simple, less technical and more responsible to the actual reality of the situations’, `responsive to the canons of justice and fair play.”

The most important requirement for an arbitration agreement is that it must necessarily be in writing. Oral arbitration agreements that were acceptable by the old Arbitration Act, 1940 no longer find any relevance in the provisions of Section 7, The Arbitration and Conciliation Act, 1996. The Bombay High Court in Jayanth N. Sheth v Gnaneshwar Apartment Co-operative Housing Limited ((2000(1) RAJ 117 (Bom). 96))held that,

“A mere oral understanding between the parties to refer the dispute to arbitration will not make it a written agreement.”

The Act is liberal and very broad in terms of interpreting the term ‘the agreement must be in writing’. It is based upon the mutual consent of the parties as to how they want their agreement to be and what formalities are to be followed during the proceedings ((Impex Corporation AndOrs. vsElenjikal Aquamarine Exports AIR 2008 Ker 119)). All the conditions laid down in Section 7, The Arbitration and Conciliation Act 1996 must be complied with to be regarded as a valid arbitration agreement. It is essential that the agreement must be communicated between the parties in any form which can be either by mails, telefax, telecommunications, exchange of statement of claim and defence and the like, as prescribed in the Act ((M/S. Amk&Amp; Co. vs Deputy Chief Materials Manager [Writ Petition (MD) No.8856 of 2010].)).

The arbitration clause in the contract may also stipulate the following criteria which can be decided by the parties such as:

  • The law governing the contract;
  • The number of arbitrators to be appointed;
  • The language and the place of the proceedings; and
  • Other essentials which the parties agree upon during the course of the contract.

The terms of the arbitration agreement must be clear and unambiguous. It is extremely important to discuss and draft the terms of the agreement carefully. In a situation where foreign parties are involved, the national laws and other special requirements, if any, must be thoroughly examined to avoid any liability at a later stage. There must be consensus between the parties at every level with respect to the agreement.

In Videocon Industries Limited v. Union of India and Anr, ((SLP(C) No.16371 of 2008))whilst the agreement was to be governed by the law of India and the venue of arbitration was agreed to be Kuala Lumpur, Malaysia, parties had agreed that the arbitration agreement would be governed by the laws of England. The Supreme Court held that this would operate as an implied exclusion of Part 1 of the Act of 1996. Further inYograj Infrastructure Limited v. Ssang Yong Engineering and Construction Company Limited, ((SLP(C) No.25624 of 2010))the Supreme Court, amongst other things, held that once the parties had agreed to arbitrate under the Singapore International Arbitration Centre Rules with the seat of arbitration in Singapore, Part 1 of the Act would stand excluded. Once the terms of the agreement have clearly been laid down, it makes the arbitration proceedings convenient and free from any technical difficulties such as deciding the jurisdiction or the applicable law.

CONCLUSION

“When will mankind be convinced and agree to settle their difficulties by arbitration?” – Benjamin Franklin

The law is clearly laid down with respect to the essential conditions to be followed in drafting an arbitration agreement and deciding the other formalities. The Act is liberal in granting several rights and benefits to the parties to decide the terms of the proceedings. All in all, arbitration is a very useful means of peacefully resolving disputes between parties. It aims at arriving at an amicable solution keeping in mind the fundamental principles of fair play and natural justice. It ensures that the parties involved are given ample opportunity to present their case and after considerable discussions and deliberations only the decision is announced. Quite obviously it has its own downsides, but the benefits of arbitration, as an alternative means of resolving a dispute, clearly outweighs its negatives. Hence, it is largely preferred and extremely beneficial.

The most important element of a successful arbitration is the arbitration agreement. Once the agreement is properly drafted in accordance with the terms of the Act, nothing else can go wrong.

Essential Elements of an Arbitration Agreement

Author: Vedang Mishra, Research Associate

Arbitration provides for an alternative forum to the time consuming and expensive court proceedings and ensures speedy disposal of cases without the court’s intervention. In India, the provisions of the Arbitration & Conciliation Act, 1996, govern arbitration. As per section 7 of the said Act ‘Arbitration Agreement’ is an agreement by the parties to submit to arbitration, all or certain disputes which have arisen or which may arise between them in respect of a defined legal relationship, whether contractual or not. It may be in the form of an arbitration clause in a contract or in the form of a separate agreement.

Essential Elements of an Arbitration Agreement

  1. Written Agreement: An arbitration agreement must be in writing ((Section 7(3) of Arbitration and Conciliation Act, 1996)). It need not be in any particular form. It may be a single document containing all the terms or can comprise of two documents. However, an oral agreement of arbitration is not legally recognized in India.
  2. Capacity of the Parties: An arbitration agreement must be in compliance with all the requirements of a valid contract. It will be binding on the parties unless it is influenced by fraud, coercion or undue influence. The parties must have requisite capacity for entering into the contract. Lack of such capacity invalidates the contract.
  3. Intention: Another very important element is the intention of the parties to refer disputes already arisen or likely to arise in respect of a contract. A binding contract require consensus ad idem. It generally includes appointment of arbitrators, seat and the venue of the arbitration proceedings, choice of language and other procedures for proceedings and pleadings. If the intention of the parties is clearly discernible from the terms of the agreement, the presence or absence of the words ‘arbitration’, ‘arbitrator’, or ‘arbitral tribunal’ does not matter ((Sushila Seth v. State of MP, AIR 1980 Del 244)).
  4. Independent Clause: An arbitration clause in a contract is treated as an independent contract and even if main contract is itself illegal and void, it does not make the arbitration clause invalid ((Section 16(a) of Arbitration and Conciliation Act, 1996)). The contract survives for determining and measuring the claims arising out of breach and the arbitration clause survives for the mode of their settlement. This provision was incorporated with a view to give power to the arbitral, tribunal not only to rule on its own jurisdiction but also to decide objection with respect to the existence or validity of the arbitration agreement.

Judicial Pronouncements:

Every arbitration agreement must be liberally construed so as to give effect to the intention of the parties. It helps in widening the scope of the arbitrator’s jurisdiction. Indian Judiciary has made significant decisions while interpreting various arbitration clauses. The Supreme Court in Renusagar Power Company Ltd v. General Electric Company, ((AIR 1985 SC 1156))held that whether a given dispute inclusive of the arbitrator’s jurisdiction comes within the scope or purview of an arbitration clause or not primarily depends upon the terms of the clause itself; it is a question of what the parties intend to provide and what language they employ.

Regarding the intention of the parties, the Supreme Court in another case held that the intention of the parties to refer a matter to arbitration is to be gathered from the expression used in correspondence and the meaning it conveys. In case it shows that there had been a meeting of minds between the parties and they had actually reached an agreement upon all material terms, then and then alone can it be said that a binding contract was capable of being spelt out from the contract or the correspondence ((Rickmers Verwaltung GmbH v. Indian Oil corporation, (1999) 1 SCC 1)).

In Bihar State Mineral Development Corporation v. Encon Builders (I) (P) Ltd, (([2003] 7 SCC 418))following essential elements of an arbitration agreement are observed by the apex court of India

                     i.            There must be a present or a future difference in connection with some contemplated affair.

                   ii.            There must be the intention of the parties to settle such difference by a private tribunal.

                 iii.            The parties must agree in writing to be bound by the decision of such tribunal.

                 iv.            The parties must be ad idem.

In K.K. Modi v. K.N. Modi, ((AIR, 1998 SC 1297))Supreme Court held the following attributes must be present in an arbitration agreement:

         i.            The arbitration agreement must contemplate that the decision of the tribunal will be binding on the parties to the agreement.

       ii.            That the jurisdiction of the tribunal to decide the rights of the parties must derive either, form the consent of the parties or from an order of the court or from a statute.

     iii.            The agreement must contemplate that substantive rights of the parties will be determined by the arbitration tribunal.

     iv.            That the tribunal will determine the rights of the parties in an impartial and judicial manner with the tribunal owing an equal obligation of fairness towards both sides.

       v.            That the agreement must contemplate that the tribunal will make a decision upon a dispute which is already formulated at the time where a reference is made to the tribunal.

Scott v. Avery Clause:

A clause providing that any dispute must go to arbitration first before any litigation commences, is known as ‘Scott v. Avery’ clause. It is called ‘Scott v. Avery’ clause because its validity is upheld in that leading case ((Scott v. Avery, (1856) 5 HL Cas 811)). This clause makes arbitration a condition precedent to any court action. The Supreme Court has observed that such clauses have been held to be valid ((The Vulcan Insurance Co. Ltd. v. Maharaj Singh, AIR 1976 SC 287)).

‘Atlantic Shipping’ clause or Time-Bar clause:

Where a clause in an arbitration agreement provides that claims to which the argument applies shall be barred unless some step to commence the arbitration is taken within a stated time, such clause in arbitration is called a time bar clause. Time bar clause is also known as Atlantic Shipping Clause as it takes its name from the decision in Atlantic Shipping and Trading Co. v. Dreyfus (Louis) & Co. (([1922] 2 AC 250))It is to be noted that the time bar clause do not fall within the mischief of Section 28 of the Contract Act, the reason being that they do not shorten the period of limitation to enforce a right, but extinguish the right itself. Generally these clauses are strictly construes against the party relying on them but courts are empowered to appropriately extend the time fixed which had expired on terms, if any, in cases where in the circumstances of the case undue hardship would be caused.

Proposed Amendment in Arbitration & Conciliation Bill, 2003

The bill proposes amendment in section 7 (4) (b) of the act by inclusion of following words in definition of ‘arbitration agreement’:

‘An agreement by implication such as where one party sends a communication to the other which provides a record of the agreement, even though the party which receives the communication does not send a reply, his silence will be treated as amounting to acceptance of the arbitration clause, which is accepted by the other party without demur.’

However, the Central Government withdrew the bill in 2006 and now again comments and suggestions are being invited to for introduction of a new Bill on arbitration so that it can remove the difficulties and lacunas in the existing act and object of enacting Arbitration law may be achieved.