Introduction
In Lombardi Engineering Ltd v. State of Uttarakhand, the Supreme Court (“the Court”) ruled that a clause in an arbitration agreement that violates the Constitution cannot be enforced. The Court also ruled that it can examine whether arbitration clauses are manifestly arbitrary and violate Article 14 of the Constitution when considering an application for the appointment of an arbitrator.
This decision comes in a case where a Swiss company, Lombardi Engineering Ltd., applied Section 11(6) of the Arbitration and Conciliation Act 1996 seeking the appointment of an arbitrator in a dispute with the State of Uttarakhand. Lombardi objected to two clauses in the arbitration agreement: the requirement to pre-deposit 7% of the total claim for invoking the arbitration clause and the discretion vested with the Principal Secretary to appoint a sole arbitrator. The Court ruled that both of these clauses were invalid because they violated Lombardi’s constitutional rights.
Background Facts
In 2019, Lombardi Engineering Limited, a Swiss-based design consultancy firm, entered into a contract with Uttarakhand Project Development and Construction Corporation Limited (UPDCC), a wholly owned corporation of the Government of Uttarakhand, India. The contract was for the preparation of a detailed project report for the Arakot Tiuni Hydro Electric Project on the Pabar River in the Uttarkashi district of Uttarakhand. The project was valued at Rs. 1,39,45,000 and was to be completed within 24 months.
During the project, various disputes arose between Lombardi and UPDCC. These disputes primarily concerned the scope of work, payment terms, and delays in the project schedule. In May 2020, UPDCC issued a notice of termination to Lombardi, alleging that Lombardi had failed to perform its obligations under the contract.
In response to the termination, Lombardi invoked the arbitration clause in the contract and filed a petition for arbitration under the Arbitration and Conciliation Act, of 1996 before the SC. The arbitration agreement contained two clauses that Lombardi objected to:
1. Pre-deposit clause: The arbitration agreement required Lombardi to deposit 7% of the total claim before the arbitration could proceed.
2. Appointment of sole arbitrator: The arbitration agreement gave the Principal Secretary/Secretary (Irrigation) of the Government of Uttarakhand the power to appoint a sole arbitrator.
Arguments Advanced
The Petitioners argued the following before the Court:
1. That their case falls under the definition of “international commercial arbitration” under Section 2(f) of the Act 1996 since they are incorporated outside of India and hence, under Section 11(12)(a) of the Act 1996, the Court has the authority to take the necessary steps to establish an arbitral tribunal under Section 11(6) of the Act 1996 because the case involves international commercial arbitration.
2. That Clause 55.1(b)(I) of the Contract, which grants the Principal Secretary/Secretary (Irrigation), Government of Uttarakhand, the sole authority to appoint an arbitrator, is inconsistent with the Court’s decision in Perkins Eastman Architects DPC and Another v. HSCC (India) Limited. It was argued that the respondent’s unilateral right to appoint an arbitrator under the Contract is no longer enforceable.
3. That the requirement to pre-deposit 7% of the claimed amount to initiate arbitration by Clause 55.1(b)(I) of the Contract is contrary to the Court’s decision in ICOMM Tele Limited v. Punjab State Water Supply and Sewerage Board and Another. It was argued that such a clause could be considered arbitrary as it violates Article 14 of the Constitution in being unfair and unjust.
The Respondents argued the following before the Court:
1. That the petition should be dismissed outright because the petitioner failed to fulfill two prerequisites: (1) the pre-deposit of 7% of the claimed amount and (2) the petitioner’s failure to approach the Principal Secretary/Secretary (Irrigation), Government of Uttarakhand, for the appointment of an arbitrator as required by Clause 55 of the Contract.
2. That the Respondent cannot be considered to have failed to follow the prescribed procedure. Attention was drawn to a decision of the Court in the case of K. Jain v. State of Haryana and Another, in which a similar clause requiring a security deposit of a specific percentage of the claim amount was upheld. It was argued that the petitioner’s reliance on the Court’s decision in ICOMM Tele Limited (supra) was misplaced because the relevant arbitration clause in that case was worded differently from the pre-deposit clause in S.K. Jain (supra).
3. That the pre-deposit clause in the present case was not arbitrary because it was only a “security deposit” and was refundable upon completion of the arbitration proceedings. It was also pointed out that Clause 4 of the General Conditions of Contract (GCC) stipulated that the security deposit should be refunded to the contractor on demand, after 14 days of the expiry of the Defects Liability Period.
4. That the present petition was only for the appointment of an arbitrator and that the Petitioner’s challenge to the pre-deposit clause should be addressed in a separate proceeding. It was also argued that any order passed by the Supreme Court under Section 11(6) of the Act 1996 would not be a binding precedent because of the decision of the Court in The State of West Bengal and Others v. Associated Contractors.
Issues For Consideration
The key issue that arose for consideration before the Court was whether the pre-deposit requirement of 7% of the total claim in Clause 55 of the General Conditions of Contract was arbitrary and unconstitutional under Article 14 of the Constitution of India.
Decision of the Court
At the very outset, the Court clarified that there is no conflict between the decisions in S.K. Jain and ICOMM Tele Limited because the arbitration clauses in those cases were different. In S.K. Jain, the arbitration clause did not specify how the security deposit would be handled at the end of the arbitration proceedings. The Court found that this made the clause vague and ambiguous and therefore arbitrary, in violation of Article 14 of the Constitution of India. However, in ICOMM Tele Limited, the arbitration clause explicitly stated that the security deposit would be forfeited if the claimant lost the case. The Court found that this clause was not arbitrary because it applied equally to both parties.
In the present case, the arbitration clause requires a 7% pre-deposit of the total claim. The Court found that this clause is similar to the clause in S.K. Jain because it does not specify how the security deposit will be handled at the end of the arbitration proceedings. The Court therefore concluded that the clause is vague, ambiguous, and arbitrary, in violation of Article 14 of the Constitution of India. The court had also referred to the Supreme Court of Canada case Uber Technologies v. Heller as an example of a situation where a pre-condition requiring high fees for arbitration was deemed unconscionable and unenforceable. Reliance was also placed on another foreign case Patterson v. ITT Consumer Financial Corporation, in which the Court of Appeal of California considered whether requiring claimants to pay filing and hearing fees for resolving a matter could be deemed unconscionable. The Court of Appeals in that case found such a condition to be “incomprehensible” and discouraging to borrowers in pursuing their claims.
Next, the Court rejected the argument that it cannot scrutinize arbitration clauses under Article 14 of the Constitution when deciding an application under Section 11(6) of the Act 1996 for the appointment of an arbitrator as being flawed. It observed that this argument is based on the concept of “party autonomy,” which suggests that parties should have the freedom to agree to the terms of their arbitration agreements. However, for an arbitration clause to be legally binding it has to be in consonance with the “operation of law” which includes the Grundnorm i.e., the Constitution. The Court referred to its ruling in TRF Limited v. Energo Engineering Projects Limited, Perkins Eastman, Voestalpine Schienen GMBH v. Delhi Metro Rail Corporation Limited where it had previously examined arbitration clauses in light of Article 14 when deciding Section 11(6) applications.
It observed that the respondent’s claim that the petitioner’s consent to the pre-deposit clause at the time of agreement execution prevents them from challenging its validity and arbitrary nature under Article 14 in a Section 11(6) petition is without merit as the concept of “party autonomy” cannot override the well-established principle that there can be no consent against the law and that fundamental rights cannot be waived.
Conclusion
The present decision of the Supreme Court is a significant milestone in Indian arbitration law. It reaffirms the principles of fairness and impartiality in arbitration proceedings and upholds the right of parties to access justice without unreasonable constraints. It sends a clear message that arbitration agreements must be fair and reasonable and that parties cannot be forced to accept arbitration agreements that are designed to disadvantage them. The ruling is likely to have a positive impact on the arbitration landscape in India, making it more attractive and accessible for businesses.
The Author is a 3rd-year law student at Chanakya National Law University with a strong interest in corporate and transactional law. He can be reached at 2636@cnlu.ac.in
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