Introduction
The Hon’ble Supreme Court, vide its recent judgment in Lombardi Engineering Ltd. v. State of Uttarakhand[1] adjudicated inter alia upon whether, when deciding an application under Section 11(6) of Arbitration and Conciliation Act, 1996[2] (“1996 Act”), for appointment of a sole arbitrator, the validity of a pre-deposit condition can be looked into on the anvil of Article 14 of the Constitution of India?
The Apex Court, through Hon’ble Mr. Justice Pardiwala, categorically held that for an arbitration clause to be legally binding, it must be in consonance with the “operation of law”, wherein the Constitution of India operates as the ‘Grundnorm’. Accordingly, (i) the court is equipped to ascertain the validity of a pre-deposit condition when considering an application under Section 11(6) of the 1996 Act; and (ii) a vague and ambiguous pre-deposit condition, may be invalidated, as arbitrary and violative of Article 14 of the Constitution.
Relevant Facts:
Lombardi Engineering Ltd. (“Lombardi/Petitioner”) a company based in Switzerland, entered into a contract dated October 25, 2019 (“Contract”), with Uttarakhand Project Development and Construction Corporation Limited (“UPDCC”) for providing certain consultancy services in relation to a hydro-electric project in the State of Uttarakhand (“Project”).
Uttarkhand Vidyut Nigam Limited (“UVNL/Respondent”) took over the said Project from the UPDCC, vide a tripartite agreement datedOctober06, 2020 (“Tripartite Agreement”), whereby the Contract was novated to the extent that the Respondent stepped into the shoes of UPDCC and took over all the obligations under the Contract.
Clause 53, read with Clause 55 of the said Contract, set out the Arbitration Agreement between the parties, and provided inter alia that (i) the party initiating arbitration shall deposit 7% of the arbitration claim in the form of a security deposit; and (ii) for a claim amount of up to INR 10 Crores, the case shall be referred to a sole arbitrator, to be appointed by the Principal Secretary (Irrigation), Government of Uttarakhand.
Certain disputes arose between the parties and Lombardi issued a notice of arbitration, calling upon UVNL to appoint an arbitrator in terms of Clause 53 of the Contract. UVNL, however, terminated the Contract on May 09, 2022, alleging non-fulfilment of various contractual obligations on the part of Lombardi. Hence, Lombardi sought an application under Section 11(6) of the 1996 Act, for appointment of arbitrator, before the Hon’ble Supreme Court.
Contention of the Parties:
The counsel for Lombardi primarily contended that (i) the unilateral right to appoint an arbitrator, accorded to UVNL, was unenforceable and in contravention of the decision of the Hon’ble Supreme Court in Perkins Eastman Architects DPC and Anr. v. HSCC (India) Limited [3], whereby it was settled that a party “who has an interest in the outcome or decision of the dispute must not have the power to appoint a sole arbitrator”[4]; and (ii) that a condition for pre-deposit was unfair, arbitrary and violative of Article 14 of the Constitution of India.
On the other hand, the counsel for UVNL inter alia contended that the security deposit contemplated under the Contract was refundable in nature, with the object of ensuring that only valid and bona fide claims are made by the parties and that the Project is not halted basis frivolous claims. It was also contended in this regard that the Hon’ble Supreme Court ought not to test the validity of a condition stipulated in the Arbitration Agreement on the touchstone of Article 14 of the Constitution, when considering a Section 11(6) application.
Findings of the Hon’ble Supreme Court:
Re: Requirement of pre-deposit
The Hon’ble Supreme Court rejected the argument that it cannot examine the constitutionality of an arbitral clause whilst exercising its jurisdiction under Section 11(6) of the 1996 Act. It categorically held in this regard that all laws in India assume validity by being in conformity with the Constitution of India, as it was the ‘grundnorm’ or the paramount source of law in the country. In relying upon the above Kelsenian theory, the court put forth the following compliance hierarchy:
“81. Thus, in the context of the Arbitration Agreement, the layers of the Grundnorm as per Kelsen’s theory would be in the following hierarchy:
- Constitution of India, 1950;
- Arbitration and Conciliation Act, 1996 & any other Central/State Law;
- Arbitration Agreement entered into by the parties in light of s. 7 of the Arbitration and Conciliation Act, 1996.”
As such, the court held that UVNL’s contention that the principle of ‘party autonomy’ was being violated by Lombardi, having consented to the pre-deposit clause at the time of executing the Contract, was without any merit, and could not “be stretched to an extent where it violates the fundamental rights under the Constitution.”
The Court further held that a vague and ambiguous condition of pre-deposit (i) was arbitrary and violative of Article 14 of the Constitution; and (ii) had no nexus with preventing vexatious claims, as sought to be buttressed by UVNL. In this regard, the Hon’ble Supreme Court relied upon its judgment in ICOMM Tele Limited v. Punjab State Water Supply and Sewerage Board and Anr,[5]to emphasise that when a claim is ultimately found to be frivolous or vexatious, the arbitral tribunal is equipped to award costs in accordance with Section 31A of the 1996 Act. It further held that a pre-deposit of a certain percentage of a claim may have the effect of deterring a party from arbitration and, thereby run contrary to the object of de-clogging the court system.
The Court also relied on various judgments, including its decision in Vidya Drolia and Others v. Durga Trading Corporation[6], to delineate the scope of its interference or examination under Section 11(6A)[7], when considering a Section 11(6) application, and reiterated that:
“236…At first blush, the Court seems to have read the existence of the arbitration agreement by limiting the examination to an examination of its factual existence. However, that is not so, as the existence of arbitration agreement does not mean anything unless such agreement is contractually valid…A mere agreement is not legally binding, unless it satisfies the core contractual requirements, concerning consent, consideration, legal relationship, etc.”
Re: Appointment of arbitrator
As regards the validity of arbitration clause by way of which the Principal Secretary/ Secretary (Irrigation), Government of Uttarakhand, was empowered to appoint an arbitrator of its choice, it was held that the issue was squarely covered by the decision of the Hon’ble Supreme Court in Perkins Eastman,whereby it was held that the unilateral appointment of an arbitrator without the consent of the other party would be non-est in law.
Conclusion
The decision of the Supreme Court in Lombardi Engineering assumes significance as it curates a jurisprudence whereby the courts may eschew party autonomy and interfere and invalidate arbitral clauses that seek to (i) circumvent or contravene the Constitution of India; (ii) negate the very purpose of an arbitral regime as one that is required for de-clogging the court system; (iii) give an imprimatur for partiality or bias to seep into the appointment of an arbitrator by a party. The judgment categorically mandates non-arbitrariness and fairness in the construction of clauses by parties, in the absence of which an arbitral clause is open to judicial scrutiny, even in a Section 11(6) application.
It is also noteworthy that Lombardi Engineering is an instance where a state instrumentality is a party to an arbitration agreement, which has thereafter been scrutinised by the Supreme Court on the anvil of Article 14 of the Constitution of India. Arbitrary, unconscionable clauses, instituted inter alia by way of a power imbalance, find their place in arbitral agreements between two private parties as well. It would be interesting to see how the courts deal with arbitrariness in clauses between private entities and the threshold of judicial scrutiny therein.
[1] Arbitration Petition No. 43 of 2022.
[2] Section 11(6): Where, under an appointment procedure agreed upon by the parties,—
(a) a party fails to act as required under that procedure; or
(b) the parties, or the two appointed arbitrators, fail to reach an agreement expected of them under that procedure; or (c) a person, including an institution, fails to perform any function entrusted to him or it under that procedure,
a party may request [the Supreme Court or, as the case may be, the High Court or any person or institution designated by such Court]to take the necessary measure, unless the agreement on the appointment procedure provides other means for securing the appointment.
[3] (2020) 20 SCC 760
[4] Para 16, (2020) 20 SCC 760
[5] (2019) 4 SCC 401
[6] (2021) 2 SCC 1
[7] Section 11 (6A): The Supreme Court or, as the case may be, the High Court, while considering any application under sub-section (4) or sub-section (5) or sub-section (6), shall, notwithstanding any judgment, decree or order of any Court, confine to the examination of the existence of an arbitration agreement