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Drafting An Effective Arbitration Clause: Challenges And The Way Forward

Tariq Khan & Muneeb Rashid Malik
14 Jun 2020 6:35 AM GMT
Drafting An Effective Arbitration Clause: Challenges And The Way Forward
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"No party can be allowed to take advantage of inartistic drafting of arbitration clause in any agreement as long as clear intention of parties to go for arbitration in case of any future disputes is evident from the agreement and material on record including surrounding circumstances." – [VISA International Ltd. v. Continental Resources (USA) Ltd (Arbitration Petition No. 16 of 2007)]

In spite of these clear observations by the Supreme Court, it is not uncommon to see parties taking advantage of defective or inartistic arbitration clauses to resist arbitration and to delay the dispute resolution mechanism. Arbitration as a dispute resolution mechanism has proven to be one of the most effective means of dispute resolution in international contracts, however, it is equally true that many commercial contracts have been pyramided on the foundation of defective dispute resolution clauses. In fact, in many cases, the arbitration clause itself becomes an issue which requires adjudication by the court or by the tribunal. The reason why this happens is that parties do not focus on the details while drafting arbitration clauses. There are unforeseeable perils that an unconscionable drafting of an arbitration clause may involve. A defective arbitration clause may result in a party losing a lot of money and time depending on the magnitude of the mistake. Some common examples of defective arbitration clauses are as follows:

  • "All disputes arising out of the present contract shall be settled by way of arbitration."

Though, it appears to be a valid arbitration clause but its applicability would be very difficult as it lacks essential elements of an arbitration clause like number of arbitrators, appointment mechanism, seat, applicable law, etc.

  • "Any controversy under this contract shall be referred to arbitration under the rules of……, parties will mutually decide the arbitrators and in case of disagreement between the arbitrators chosen by the parties, it is agreed that the dispute shall be submitted to the courts of Delhi"

In the second example, the first issue is that it is not clear under what rules arbitration will be conducted. Secondly, what is the number of arbitrators and what disagreement between the arbitrators is the clause referring to, that would render the clause ineffective? Lastly, it is not clear whether parties want to refer their disputes to arbitration or courts of Delhi.

Therefore, a lot of time and money will have to be spent to ascertain the real intention of the parties. Incidentally, there is no straitjacket formula to draft an arbitration clause and there cannot be a perfect arbitration clause as every contract is executed for different needs. However, parties must know "how to draft an arbitration clause" and more importantly know "how not to draft an arbitration clause" as an arbitration clause is extraordinarily important and once dispute arises between parties, it can have an exceptional influence on how the dispute between parties gets resolved.

Scope of an arbitration clause

It is entirely a matter for the parties to define as to what range of disputes may or may not be adjudicated by the arbitral tribunal. Usage of phrases like "all disputes arising from this contract" or "all disputes arising out of this contract" limit a tribunal's jurisdiction only to those disputes arising out of the applicability of express terms of the contract. Therefore, phrases that expand the jurisdiction of the tribunal must be used like "any dispute arising out of, or, in relation to this contract" which would ensure a one-stop adjudication and help in avoiding multiplicity of proceedings. This will also help in joinder of non-signatory parties to arbitration. [See: Mahanagar Telephone Nigam Ltd. v. Canara Bank & Ors. Civil Appeal Nos. 6202-6205 of 2019; Jes & Ben Groupo Pvt. Ltc. v. Hell Energy Magyarorzag KFT. (Hell Hunhry Ltd.) & Anr. CS (COMM) 257/2019; Cheran Properties Ltd. v. Kasturi and Sons Ltd. & Ors. Civil Appeal No. 10025/2017; Ameet Lalchand Shah vs Rishabh Enterprises SLP (C) 16798/2017 and Chloro Controls v. Severn Trent Water Purification Civil Appeal No. 7134 of 2012]

Excepted matters can also be specified in the arbitration clause to limit the jurisdiction of the arbitral tribunal. Recently, in the case of Triune Energy Services Pvt Ltd v. Indian Oil Petronas Pvt Ltd O.M.P. (Comm) 5/2016 the Court relied upon the judgement of the Supreme Court in J.G. Engineers Private Ltd. v. Union of India & Another (2011) 5 SCC 758 to hold that an award adjudicating claims, which are excepted matters would violate Section 34 (2)(a)(iv) and 34(2)(b) of the Act. [Also see: M/S Mitra Guha Builders (INDIA) Company vs. Oil and Natural Gas Corporation Limited Civil Appeal No. 5511 of 2012]

Seat of arbitration

Seat is considered as the most important element in international arbitrations as it determines the critical legal and practical aspects of arbitration. It gives exclusive jurisdiction to a court for challenge to an arbitral award or for the appointment or removal of the arbitrator. Hence, one should be aware of the prevailing practice in the jurisdiction of chosen seat of arbitration and must select a seat where courts are experienced in international arbitration. Seat of arbitration is essentially a choice of law whereas hearing venue can change as per the convenience of the parties which will not impact the supervisory jurisdiction of the judicial seat.

References like "venue" or "place" must be avoided as an objection may be raised by either party that these are merely physical or geographical locations and not the legal or judicial seat of the arbitration. Thus, leaving it open for the court to ascertain the seat of arbitration will eventually delay the arbitration proceedings.

Recently, the Supreme Court in the case of Mankastu Impex Private Limited V. Airvisual Limited (2020) SCC OnLine SC 301 held that the seat of arbitration is a vital aspect of any arbitration proceedings and significance of seat of arbitration is that it determines the applicable law when deciding the arbitration proceedings and arbitration procedure as well as judicial review over the arbitration award. In BGS SGS Soma JV V. NHPC Ltd. (2019) SCC OnLine SC 1585, the Supreme Court of India held that the designation of a seat confers exclusive jurisdiction on the courts of said seat; and a place of arbitration, regardless of its designation as a seat, venue or place, is the juridical seat of arbitration unless there is an indication to the contrary.

Appointment of arbitrators

The number of Arbitrators has to be odd and not even so that the disputes could be resolved without a tie. If the amount in dispute is small, then, it would be appropriate to appoint a sole arbitrator because a tribunal of three arbitrators may cost three times more. In a three-member tribunal, both the claimant and respondent have the right to nominate one arbitrator each to ensure that the tribunal has the expertise and background to fairly decide the dispute in question. If the number of arbitrators is not mentioned, some of the institutions provide default rules as per which the institution decides the number of arbitrators with regard to the amount involved. Alternatively, parties may also specify in the arbitration clause that if dispute is more than 'X' amount, then 3 arbitrators would be appointed and if it is less than 'X' amount, then a sole arbitrator would be appointed. An arbitrator's qualification may also be included that he be an expert in delay analysis or quantum or a resident of a particular country.

Recently, in Perkins Eastman Architects DPC and Another HSCC (India) Ltd. (2019) SCC OnLine SC 1517 the Supreme Court held that "a person who has an interest in the outcome or decision of the disputes must not have the power to appoint a sole arbitrator." Thus, a party cannot unilaterally appoint a sole arbitrator in a dispute.

Ad hoc or Institutional Arbitration

In institutional arbitrations, the rules of the institution address various procedural issues in an arbitration e.g., constitution of the tribunal, conduct of proceedings, cost of arbitration, fees of arbitrators, scrutinizing the awards, challenge to arbitrators, consolidation of proceedings etc., whereas in ad hoc arbitrations, parties approach the concerned courts for resolving these issues as there is no institution supervising the arbitration.

Most institutions provide model arbitration clauses which should be adopted if a party has a particular institution in mind e.g. SIAC, ICC, LCIA etc. Interestingly, when an institution is chosen for arbitration proceedings, it becomes contractually binding on the parties to follow the rules of such institution. One must bear in mind that by choosing an arbitral institution, parties do not choose the home jurisdiction of that institute e.g. seat may be in London whereas arbitral institution may be SIAC, so that there is no linkage between the two.

Governing Law

There are three main applicable laws namely:

  1. The law governing the substantive contract;
  2. The law governing the arbitration agreement;
  3. The law governing the arbitration proceedings.

It is important to specify the law governing the arbitration agreement where the seat of arbitration and the law of the underlying contract are not the same.

Language of Arbitration

Language is a crucial element of an arbitration clause as it can reduce the potential pool of arbitrators. It is important to specify the language of the arbitration as bilingual proceedings can be very inconvenient and time consuming. Imagine a case where one party is from Japan, another is from Russia, Arbitrator is from England, in such a case, if pleadings are filed in Russian and Japanese languages and an Award is passed in English, then it would cause a lot of discomfort and confusion. Therefore, it is absolutely necessary to mention such a language in an arbitration clause which is universal in nature and which can be easily understood by the parties, arbitrators and the courts. A uniform language substantially reduces the potential perplexities which may arise in an arbitration proceeding.

Virtual hearings

In these unprecedented times, the only way of conducting hearings is by using virtual platforms. Thus, it is imperative that parties may provide in the arbitration clause that they are in agreement for conducting virtual hearings so as to avoid any potential challenges which may pop up on the ground of principle of natural justice not being followed.

Multi-Tier Arbitration Clause

Joseph Grynbaum once said, "an ounce of mediation is worth a pound of arbitration and a ton of litigation" and this adage is gaining significance with the introduction of MedArb and Arb-Med-Arb clauses in contracts. In a Med-Arb clause, a dispute between the parties is first referred to mediation, and if parties fail to settle their disputes through mediation, then arbitration is initiated. Therefore, parties may consider incorporating such multi-tier arbitration clause in an agreement, however, it is necessary to specify a time limit for such negotiation or mediation to ensure that these clauses are not misused and in the garb of mediation, the arbitral process is not delayed.

Suggestions for drafting an effective arbitration clause:-

  • Avoid vague references;
  • Keep it simple and not complex;
  • Do not use words like "may" rather use "shall";
  • Specify the seat of arbitration and know the approach of the courts of that seat;
  • Institutional Arbitration should be preferred and usage of model clause of that institution is highly recommended;
  • Do not restrict your clause by adding too many qualifications for appointment of arbitrator;
  • Choose a convenient venue and language.

Lastly, one must always remember the words of Hon'ble Ms. Justice Indu Malhotra in the case of Mahanagar Telephone Nigam Ltd. v. Canara Bank & Ors., judgment dated 08.08.2019 in Civil Appeal Nos. 6202-6205 of 2019 that a valid arbitration agreement is the foundation stone on which the entire edifice of the arbitral process is structured. The arbitration agreement need not be in any particular form. What is required to be ascertained is the intention of the parties to settle their disputes through arbitration... The meaning of a contract must be gathered by adopting a common-sense approach, and must not be allowed to be thwarted by a pedantic and legalistic interpretation. An 'arbitration agreement' is a commercial document inter partes and must be interpreted so as to give effect to the intention of the parties, rather than to invalidate it on technicalities.

Views are personal only

(Tariq Khan, Principal Associate at Advani & Co. and Muneeb Rashid Malik, fourth-year student at Lloyd Law College. The Authors can be reached at [email protected] and [email protected] )

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