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Arbitration clause in contracts

October 5, 2024

This article is written by Soram Agrawal. It defines the arbitration clause, its importance, and the rules and guidelines on how to use them, the difference between binding and non-binding agreements and the rules for international arbitration. It also discusses how these arbitration clauses work and why they are important in resolving disputes. This article also describes agreements for conflict resolution and the importance of arbitration clauses in modern contracts.

Table of Contents

Introduction

A part of a contract or a contractual element known as an arbitration clause requires disagreements to be settled by arbitration as opposed to litigation. If disputes emerge between parties, the arbitration clauses specify the methods, regulations, and arbitration procedure to be followed by the disputing parties. Different types of arbitration clauses can be arranged to meet the specific needs of the parties involved. These include mandatory, voluntary, and multi-tiered clauses.

To guarantee justice and efficiency in the settlement of disputes, it is important to carefully examine jurisdiction, selection of arbitrator, and procedural norms when drafting arbitration agreements. These provisions are very important because they provide parties with a faster, more affordable, and more confidential option to traditional litigation. Well-drafted arbitration clauses within important agreements like commercial arrangements, international trade transactions, employment contracts, and joint venture agreements give certainty and clarity to the parties.

What is an arbitration clause

A contract provision known as the arbitration clause indicates when the dispute must be arbitrated. It means the part of the contract that explains what can be done if any legal dispute arises. Most of the arbitration contracts preclude the suing of the parties against one another. So, instead of going to court, they settle disputes by arbitration.

Arbitration is a formal method of dispute resolution wherein parties choose a neutral third party called the arbitrator, who makes a final binding decision. The ruling of a third party is referred to as the ‘arbitrators,’ ‘arbiters,’ or the ‘arbitral tribunal,’ who gives a decision in the form of an ‘arbitration award.’ An arbitration decision or award is legally binding upon both parties and is enforceable in court unless all parties agree in advance and stipulate that the process and decision of arbitration are non-binding.

Usually, one or more independent third parties, an arbitrator, or an arbitration panel conduct the arbitration. The parties may choose the arbitrator(s), or the institution may suggest them; for example, in the United States, it is the Financial Industry Regulatory Authority, FINRA. The arbitrators review the case and reach a decision that subsequently becomes legally binding for both parties. It is a very flexible method of dispute resolution that can be applied to many types of disputes: commercial, labour, consumer, and international. Being an alternative method of dispute resolution to conventional litigation, it provides a lot of advantages, such as flexibility of procedure, more confidentiality, speedier resolution, and an opportunity to pick arbitrators with specific expertise relevant to the case.

Nevertheless, arbitration has its drawbacks. A major disadvantage occurs when the result of the arbitration goes against a party because there is limited scope for appeal. It can also be very costly at times, and issues related to the neutrality of arbitrators may come up. Awards are very tough to enforce, especially in international matters. Hence, while there are several advantages to arbitration, care should be exercised that the parties who enter this process weigh the pros and cons properly before entering the process.

Non-arbitrable matters

Non-arbitrable matters, or matters that are not capable of settlement by arbitration under Indian law, include the following disputes:

Rights in Rem;
criminal offences;
matrimonial disputes;
Guardianship matters;
Insolvency and winding-up matters;
Testamentary matters;
Eviction or tenancy matters governed by special statutes;
Cases arising out of trust deeds;
Antitrust and competition matters;
Bribery and corruption issues; and
Fraud disputes.

Components of an arbitration clause

An arbitration clause is one of the most important components of a contract that describes how disputes will be resolved outside the general court litigation process. It may be possible for the parties, through careful drafting, to have a really strong arbitration clause that enables efficient and effective dispute resolution with the least likelihood of litigation, thereby ensuring clarity in the arbitral process.

Binding agreement

The clause should express that the decision of the arbitrator will be binding on both parties so that the award rendered becomes enforceable in the court of law.

Consent to jurisdiction

The parties shall consent to the jurisdiction of the arbitration tribunal, which may emanate from mutual agreement or upon a court order that might refer the case to arbitration.

Number of arbitrators and method of appointment

The number is usually odd, and the method of appointment should be stated. The clarity ensures that doubt is taken away as to who is to resolve the dispute.

Seat and venue of arbitration

The “seat of arbitration” is the legal jurisdiction and the venue is where the arbitration process is physically anchored. The seat of arbitration must be specified, as it defines the procedural laws under which the arbitration process will operate. This involves the applicable rules that govern the conduct of arbitration and the ability to enforce the arbitral award or have that award challenged in local courts.

Language of proceedings

It is the clause that should specify the language in which the arbitration is to be conducted to avoid any misunderstanding and in which all parties can participate effectively.

Governing law

There must be a mention of the substantive law that is going to govern the arbitration agreement. This avoids all sorts of complications regarding legal interpretations arising in disputes to be taken up in the future.

Type of arbitration

The clause may provide that the arbitration shall be institutional, under the rules of an established arbitration institution, or ad hoc, specially arranged for the dispute at hand.

Finality of award

It should emphasise that the award of the arbitrator shall be final and binding, further manifesting the undertaking towards the settlement of disputes through arbitration.

Interim relief

Interim relief provisions should be provided to enable the parties to apply for interim measures from the court or the tribunal pending the final award. The dispute must precisely be defined in scope so that there is no ambiguity of disputes later on and all relevant issues are taken care of.

These components, when combined, will provide the parties with a sound arbitration clause that will enable them to have a fair and efficient dispute resolution process.

Sample arbitration clause

Any dispute or difference arising out of or relating to this Agreement shall be settled by arbitration in accordance with the provisions of the Arbitration and Conciliation Act, 1996. The seat of arbitration shall be at _____________(City), India. The arbitration shall be conducted in English/Hindi and the parties shall appoint one/three arbitrator(s) from the panel of arbitrators maintained by _______________(Name of Arbitration Institution, if any). The award shall be final and binding on both parties.

Binding and non-binding arbitration clause

A clause pertaining to arbitration may be binding or non-binding. Let us see what it means:

Binding of an arbitration clause: In binding arbitration, the disputing parties waive off their right to trial as they agree to stand by the decision made by the arbitrator. Binding arbitration is more suitable to expedite some outcomes where two parties need to resolve internal conflicts in regards to business disputes.

For example, a contractor had accepted to do building work for a retailer but had misunderstood the terms of their contract as to the form payment would take. It is in the interest of the contractor to get those stores open as quickly as possible, and it is within the construction company’s interest to get paid. As such, binding arbitration suits both parties because the continuation of the work is invaluable to both of them, which could not be done without the resolution of the misunderstanding.

In general, the decision of the arbitrator in binding arbitration may not be appealed against, except in very unique circumstances, for example, when fraud or an infringement of public policy can be proved. It has to be noted that anyway, even when appealed, national courts tend to respect the arbitrator’s expertise and judgement.

The Arbitration and Conciliation Act, 1996, is silent on disputes that are non-arbitrable. However, it has been accepted as a basic principle that all other disputes are arbitrable as long as they are capable of being resolved by arbitration, e.g., disputes that are essentially disputes concerning the rights of third parties or have an erga omnes effect. The erga omnes effect means a legal right or obligation that is not only executable between the parties to the case but also towards or against all persons and entities. Rather, such issues must be adjudicated by courts or appropriate judicial forums. Arbitration is a means of settling private disputes between identifiable parties, whereas issues with the erga omnes effect are those wherein the public interest is involved, which requires the supervisory function of the courts for consistency and public policy or which are relatable to sovereign functions and public functions or inalienable functions of the state and would generally be treated as non-arbitrable.

The Supreme Court has applied the doctrine of “group of companies” to allow the extension of the arbitration agreements to non-signatory companies constituting a part of the same corporate group. Recently, in Chloro Controls India Private Ltd. vs. Severn Trent Water Purification Inc. and Others (2013), the Indian Supreme Court applied this principle to hold that there could even be a fastening of non-signatories to an arbitration if there is a direct relationship with the signatory company, commonality of the subject matter, and interdependent agreements. In the case of Cheran Properties Limited vs. Kasturi And Sons Limited (2018), the Court reiterated that the doctrine simply enforces the common intention of the parties to the effect that both signatories and non-signatories were intended to be bound by the arbitration agreement.

In brief, this doctrine finds its application when there exists a direct relationship with the signatory company, commonality of the subject matter, and interdependent agreements. This doctrine is used to bind all the parties by their common intention so that no party escapes the agreement of arbitration, whether a signatory or non-signatory, to efficiently resolve disputes within the corporate entities.

S.No.	Basis	Binding Arbitration	Non- Binding Arbitration
1.	Definition	The award made by the arbitrator is usually final and binding.	Arbitrators’ awards do not carry the force of law and are thus advisory.
2.	LegalEnforceability	The parties are then mandatorily bound by the determination of the arbitrator enforceable in courts of law.	Parties can accept or refuse the decision and, when not content with it, can appeal in the courts of justice.
3.	Finality	Provides a definitive resolution to the dispute.	This means after arbitration, it might be allowed to negotiate or litigate further.
4.	Cost and Time efficiency	Generally, quicker and cheaper than litigation, although its binding nature may mean higher costs.	It is often cheaper initially but could eventually become more expensive, considering further legal steps to be undertaken.
5	Right of Appeal	Very limited	Decisions can be ignored, thus allowing parties to seek other possible legal remedies.

Classification of arbitration clauses

There may exist three classes of arbitration clauses: simple, general, and comprehensive ones. All of them were made for specific purposes or applications depending on the particular circumstances and needs of the parties involved.

Simple clauses

Simple clauses are the minimum provisions required to have a binding agreement to arbitrate. They usually contain the basic essentials that one would need in an arbitration clause, such as the process for resolving disputes, the administering institution, and the seat of arbitration. Basic clauses are generally used in normal contracts. Institutions like the Chartered Institute of Arbitrators or the London Court of International Arbitration provide these kinds of provisions.

General clauses

General clauses are wider in scope and include other provisions like language, venue, designation, and governing law. It could also provide for preliminary steps before entering into arbitration, such as mediation or negotiation. Major transactions usually make use of general clauses. Many agreements in the energy sector incorporate such general clauses as joint operating/drilling contracts, supply contracts for natural gas, and construction contracts for power plants.

Comprehensive clauses

The complexity of an arbitration clause may be quite detailed, as its extent is usually determined. These range from issues of confidentiality and discovery of evidence to handling multi-party disputes; consolidation of several claims in one arbitration proceeding; adoption of split clauses, which reserve the possibility for certain issues to go to litigation while others must be resolved before arbitrators; use of expert determination in relation to technical matters; stipulations on determinations of arbitrability of dispute; provisions as to waiver of appeals or consent to appeal; provision to enable the arbitrator to fill up contractual lacunae or complete incomplete terms of contract, etc. Such clauses seek clarity, efficiency, and thoroughness in dispute resolution by way of arbitration, thus accommodating the diverse needs and complexities of present-day commercial contracts. A high level of customisation and control over how arbitration should be conducted are desired by parties in complex clauses, which are usually used in high-stakes/high-value transactions.

Types of arbitration clauses

This provides an overview of different types of arbitration clauses utilised for the resolution of contractual disputes. Such are standard, ad hoc, institutional, multi-tiered, and opt-out clauses in arbitration. Further, the paper explains each procedure itself, along with its benefits and probable drawbacks. More than that, it tells about legal precedents and emphasises careful drafting of the clauses to avoid conflicts. In addition, it describes how flexible and inexpensive the arbitration technique is compared to traditional litigation procedures. It further adds some real-world examples and judicial interpretations.

Standard arbitration clause

The standard arbitration clause is a contractual provision that compels the parties to resolve their dispute through arbitration rather than going to court for litigation. This is a private, cost-effective, and quicker alternate dispute resolution method. It then provides the full details of the dispute resolution procedure, including the arbitral institution, number of arbitrators, legal seat, arbitration rules, and contract governing law. In addition, it saves money and time compared to going to court for lawsuits. It is therefore private and flexible because the parties could decide how they want their case managed. Common applications include maintaining privacy in divorce proceedings, insurance disputes, business partner conflicts, requiring an employee’s signature, and avoiding civil court for personal injury cases. The decision of the arbitrator is finally authoritative; hence, disputes are brought to a close.

Ad hoc arbitration clause

Ad hoc arbitration is a tailored form of dispute resolution that the parties may institute independently of any institutional guidelines. It, above all, makes the process of choosing arbitrators and deciding on a procedure flexible so that the parties to the dispute can set an arbitration procedure to suit their own requirements and needs. In theory, the process should be perfectly adapted to one’s needs and the nuances of the dispute. International arbitration is seen to be among the fastest supplements in court litigation processes, particularly where parties are of different nationalities. Many advantages exist with an ad hoc process, including that it is less expensive because parties avoid administrative fees; it allows for increased speed because parties may proceed as quickly as possible without institutional involvement; it is more flexible to accommodate any party’s needs; and it offers more confidentiality protection. Disadvantages, however, include that because of a lack of institutional support, it may complicate things for parties, put a greater burden on the parties to manage it themselves, and increase the risk of unfairness since it all depends on the parties to elect the arbitrators and decide on the procedural rulemaking.

Institutional arbitration clause

In opting for institutional arbitration, the contracting parties undertake to adopt a given institution’s procedural rules and to have that institution administer and supervise the conduct of any arbitration commenced under the arbitration agreement. It may also involve institution administration, typically excluding the actual appointment of arbitrators or the determination of their costs; guiding, where its rules so provide, arranging collection of deposits and payments; making logistic arrangements for hearings; and possibly reviewing the draft of the award to make sure it is executable.

This is a preference that should be decided at the time that contracts, treaties, or separate arbitration agreements for institutional arbitration are negotiated. The clause should, however, be included only if both parties desire it.

Arbitration organised by an established arbitral institution like the American Arbitration Association, the London Court of International Arbitration, or the International Chamber of Commerce is simply referred to as institutional arbitration. That is why institutional arbitration is generally preferred over ad hoc, where the process is managed by the parties, because it relieves the burden on the parties of needing to draft their own set of procedural rules, providing an effective and well-established framework for the resolution of various disputes.

Multi-tiered dispute resolution clause

Multi-tiered dispute resolution clauses are even termed escalation, multi-step, or “ADR first” agreements. Both parties understand that if an issue arises, they will use a process-based approach, which may include negotiation, mediation, or conciliation, along with expert determination or arbitration, if appropriate. Multi-tier dispute resolution clauses provide for different procedures to be used in the resolution of disputes, progressively starting with one stage and then moving to the next if the first one fails. Failure to comply with the steps as agreed upon may affect the enforceability of the dispute resolution clause, hence complicating the process should a party fail in the same.

Despite the growing usage of multi-tier dispute resolution clauses around the world because of their flexibility in dealing with a wide range of issues, a few countries remain unclear on how to enforce the clauses. The legal status of pre-arbitration procedures in India is uncertain. Courts generally have taken two approaches. For the most part, courts have ruled that all pre-arbitration procedures must be carried out, including things like gathering evidence and issuing subpoenas.

In M.K. Shah Engineers & Contractors vs. State of M.P. (1999), a private company, M.K. Shah Engineers & Contractors, pitted against a government entity, the State of Madhya Pradesh. It was related to a contractual agreement entered into by both parties for the construction of a road project. An arbitration clause therein provided that any dispute arising out of, in relation to, or in connection with the contract shall be resolved through arbitration. The dispute was that the state of Madhya Pradesh did not want to pay the contractor for work done at a particular amount stipulated in the contract. The contractor, M. K. Shah Engineers & Contractors, filed a petition before the arbitrator, praying for an award of the amount due from the State. The Supreme Court held that the prerequisite procedures mentioned in the arbitration clause are essential in nature. Parties cannot bypass or skip the prerequisites to invoke arbitration directly.

However, there are certain high courts that have delivered judgments that are partly different in nature when deciding the question of the mandatory or directory clause. The validity of the aforementioned issue was examined by the Bombay High Court on 8 February 2017 in the case of S. Kumar Construction Co. & Anr vs. Municipal Corporation of Greater Bombay & Ors. The said case was a challenge to a Supreme Court decision for the execution of an arbitration clause in a construction contract between a private company and a municipal authority. It underlined the need for due care while inserting the arbitration clause in any contract to avoid possible disputes regarding its interpretation and application.

The key question that arose in the case of S. Kumar Construction Co. & Anr vs. Municipal Corporation of Greater Bombay & Ors. is, under the judgement of the Bombay High Court dated 8 February 2017, the validity and interpretation of an arbitration clause in a construction contract. Yet, the court has made it clear that every such arbitration clause has to be drafted with a due degree of precision and clarity; otherwise, due to the vague wording of some provisions, controversies with respect to their interpretation and application may arise even at a stage beyond the commencement of the actual arbitration proceedings. On these grounds, the parties have been warned to be cautious when formulating the arbitration provisions so as to avoid possible disputes and legal uncertainties. The ruling also highlighted the question of whether prerequisites stipulated in arbitration clauses are mandatory or not, which greatly affects their enforceability and procedural adherence.

Opt-out arbitration clause

Arbitration agreements provide for an “opt-out” provision within 30 days after signing, which would allow the signing party to retain the right to file a class-action lawsuit with respect to a particular matter. Very often, such an opt-out clause would mandate on a user’s part the sending of a written letter or email at a particular address, citing that it is opting out of the arbitration clause. The provisions relating to arbitration and opt-out can often be really buried. Thus, if one is presented with a contract or terms of service and has any concerns, an attorney should be consulted right away.

How to draft fool-proof arbitration clauses

Such arbitration clauses should be drafted with skill to avoid associated pitfalls. This includes omissions of the place or rules of arbitration and over-specificity, which renders clauses quite impracticable. The setting of unrealistic expectations, as regards the course of the arbitration, can result in longer, more labyrinthine proceedings. Overreaching tends to compromise fairness and neutrality, giving an edge to clauses for the party that has drafted them. Such errors may be avoided, and only sound arbitration agreements may be established, protecting the efficiency and fairness of dispute resolution if the parties do not deviate from the established model clauses. The following points should be kept in mind to avoid common mistakes while framing the arbitration clauses:

Omission

One of the common drafting omissions is missing an essential or useful element in the arbitration clause. This can lead to a clause that conveys an agreement to arbitrate but not how or where. It is much better to include at least the bare minimum basics in the arbitration clause to establish arbitration without resorting to the courts. Key provisions that must be taken into consideration in an arbitration clause include the place of arbitration, the rules that are to be applied, the number of arbitrators, and the manner in which they are selected. These elements ensure that an arbitration process may proceed in the most painless and efficient way possible.

the agreement to arbitrate,
the rules that will govern the arbitration,
the institution, if any, which will administer the arbitration,
the place of arbitration,
in an international agreement, the language of the arbitration,
the applicable law, if not provided elsewhere in the agreement,
the procedural law that will apply to the arbitration,
the number of arbitrators and how they shall be selected, and
an agreement that judgment may be entered upon the award.

Over-specificity

The opposite of omission is over-specificity. Instead of too little information, they provide too much. Sometimes, creating an arbitration clause becomes an exercise that includes as many terms as possible. This has the potential to create a clause that is just about impossible to enforce in practice. Put simply, it is a fundamental error to overdraft an arbitration clause. If the arbitration clause is overly detailed, those layers of detail can thwart or prevent arbitration of a dispute when one arises. The model clauses suggested by the major arbitral institutions are used by many experienced people because they are battle-tested by the courts and they work.

Unrealistic expectations: It is no exception that the wording of the arbitration clause raises unrealistically broad, extensive, time-consuming, and costly procedures; some even reach complete failure of the arbitral procedure. These include unrealistic expectations, such as the tight time frames given to the arbitrators while submitting an award, and over-specific provisions in terms of adhering to rules that are wholly unnecessary. Another burden on the parties is unrealistic deadlines to be met for submitting one’s claims or raising defences. It is the unreasonable demands of arbitrators to follow some procedures strictly or to issue an award within a certain timeframe that again multiply the menace. Thus, such unrealistic clauses make arbitration inefficient and costly for all parties.

Courtroom idealisation: Such provisions are a mine of trouble for this reason: they provide for the arbitration to be conducted under the rules of litigation. This means that the arbitrators will predictably but hopelessly waste a lot of money on unnecessary “wheel-spinning” over the question of how court rules are applied. It may also ensconce disputes linked to the discovery stage and other aspects of litigation-related matters that arbitration is supposed to avoid.

Overreaching: It has been termed one of the major pitfalls in drafting arbitration clauses. It follows that overeager drafters are looking toward manipulating the wording of the clause for the betterment of their clients. Indeed, this is a very unethical situation that more often than not happens with contracts of adhesion where one party is in a superior position to impose unilaterally unjust conditions on the other. In so doing, one can manipulate the arbitration clause in favour of their clients at the cost of fairness and neutrality, which are foundational ingredients for the institution called arbitration. The consequence might be to hold proceedings that are biased and delegitimise faith in the institution of arbitration, resulting ultimately in dispute resolution unjustly and inequitably.

Advantages and disadvantages of arbitration clauses

Commercial contracts benefit greatly from arbitration clauses because they offer a fast and effective alternative to the traditional judicial system for settling disputes. There are several ways to view the significance of arbitration clauses:

Preservation of business relationships: Arbitration clauses help business people preserve business relationships by avoiding a more adversarial process than litigation for resolving disputes. In fact, this collaborative aspect of arbitration seeks to foster cooperation among the parties to find a mutually acceptable solution with a reduced prospect of harming ongoing business relations. With arbitration being private and confidential, sensitive business information is kept out of the public domain, preventing potential reputational harm.

Flexibility and customisation: Arbitration is a more flexible process and allows the parties the opportunity to have the procedure of dispute determination done according to their care and desire. This is a process in which the parties may contract that the objectors may be selected, the rules to employ in the process, and the place where the process will take place.

Flexibility undoubtedly stretches to procedural matters amongst parties, where they are in a position to design a procedure suiting the schedules and requirements of the parties. This makes it more effective and flexible, unlike the quite rigid structure followed by court-litigation procedures.

Efficiency and expediency: Arbitration is generally faster than litigation. Having the hearings at the convenience of the parties and the arbitrator and using a less formalistic procedure generally leads to a faster resolution of disputes. This hastens the process, allowing parties to spend the least possible time embroiled in disputes and maintain productivity while keeping up their business operations.

Cost effectiveness: Although there are some associated costs, like the fees for the arbitrators, arbitration may turn out to be cost-effective compared to litigation in the long run. The faster process reduces legal costs and other expenses related to long court cases. Moreover, arbitration minimises the likelihood of protracted and tedious appeals; hence, it controls costs and offers financial predictability for the parties involved.

Expertise and specialisation: It enables the parties to choose arbitrators with specialised knowledge that may assist in resolving their disputes. This is especially applicable to commercial or technical disputes, in which it is vital to insist on certain kinds of specialised knowledge to comprehend the issues at hand. Expert arbitrators would yield more knowledgeable and, hence, accurate decisions that would come across as more just and fair.

Confidentiality and privacy: One of the most important advantages of arbitration is the confidentiality accorded to the parties. Unlike court processes, which are usually open to the public, the process of arbitration is private. This ensures that sensitive business information and trade secrets are well protected from possible disclosure to the public. Initial confidentiality in arbitration helps maintain the privacy of the parties involved and shields them from potential reputation damage.

Enforceability of awards: Arbitration awards are generally more easily enforced around the world than court judgments. Under the provisions of the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards, enforceability extends to more than 160 countries. It improves the chances of enforcement, gives the parties involved better faith in collection, and therefore can instil trust in dispute resolution.

Reduced appeal risk: The grounds of appeal from an arbitral award are usually restricted as against court judgments. This finality deters the risk of extensive litigation and offers the parties an effective final resolution to their disputes. A reduced chance of appeal enhances the efficiency and cost-effectiveness of the process, avoiding delays and costs connected with different levels of appeal.

Provisions for drafting international contracts

One should be aware that certain strategic decisions are often being made at the drafting stage, long before a dispute arises, which can substantially impact future arbitration. Of these, the following are some of the most important for international contracts:

Arbitral institutions: They differ not only by cost but also on relevant strategic issues, including multi-party arbitration, confidentiality, the interviewing of arbitrators and witnesses, and privileged information. One should be aware of the key procedural differences between the institutional rules. In a future column, we will examine the differences between the major arbitration rules and the advantages and disadvantages of choosing ad hoc arbitration rather than institutional rules like ICC or AAA.

Place of arbitration: Very importantly, the place of arbitration entails actionable and strategic issues. It should notably be stated to have an advantage of enforceability as a matter of treaty rights. It should also be in a country where the courts will support and not obstruct the arbitral process. It means that the procedural disputes are governed by any courts of the place of arbitration, and such courts are the appropriate forum to decide the question of the judicial revision of the award. The procedural law is normally the arbitral law of the place of arbitration. In case of non-selection of any substantive law by the parties, the law of the place of arbitration may well be applied by the arbitrators. Finally, the cost factor should also be a consideration that parties must consider when choosing the place of arbitration.

Language: The choice of language should be such that it allows flexibility to the drafters at the time of selection of arbitrators without unnecessarily enhancing the costs for translations. In the absence of a common language, drafters usually choose English as the language for arbitration. Although the choice of language, such as English, provides a wider choice of arbitrators, if the parties are not from English-speaking countries or if the transaction and evidence are not in English, then the cost of arbitration could be increased.

Confidentiality: Even though most of the institutional rules of arbitration do not bind the parties to confidentiality as regards the arbitral proceedings, the parties may, in any case, wish to deal specifically with the question of confidentiality: the procedure itself; the documents used or exchanged in the arbitration; and the arbitral award.

Discovery: Whereas discovery in US litigation is normally very broad and very strictly regulated, under international practice, it is much narrower and less rigid. As the rules of most arbitral institutions do not mention the availability and scope of discovery, this issue should be stipulated in the arbitration clause.

Excluding punitive and consequential damages: As some courts, such as the US Supreme Court, allow arbitral tribunals to grant punitive damages in cases where the parties’ agreement does not prohibit this, it may be worthwhile for parties to include a provision explicitly prohibiting this. How the arbitration clause and associated provisions are drafted can make all the difference in the ultimate resolution of disputes. The parties should hence, be very careful in addressing, amongst others, the nature of disputes to be referred for arbitration, the procedure by which such arbitrations are to be conducted, and the appealability of arbitration awards.

While there may not be any universal or ‘model’ arbitration clause, all arbitration clauses should nevertheless be drafted bearing the foregoing principles in mind. In all but a few instances, parties to such a contract should seek the advice of experienced international arbitration counsel.

Relevant case law

Gujarat Composite Limited vs. A Infrastructure Limited & Ors., 24 July, 2018

Facts

The Gujarat Composite Limited vs. A Infrastructure Limited & Ors. (2018) is a case connected with the petitioner’s disputes with the opposing party on the terms of a corporate loan and sale of property. The major facts of this case are as follows:

A Infrastructure Limited availed the corporate loan of Rupees 500 lakh from the Bank of Baroda, duly secured by a first charge against the fixed assets of Gujarat Composite Limited.
It was agreed that Gujarat Composite Limited would create a first charge on its fixed assets in the name of Bank of Baroda and that it would release the first charge with prior approval from A Infrastructure Limited only.
During the term of the licence agreements, A Infrastructure Limited and Gujarat Composite Limited had agreed that the latter would not give title deeds to the land to any other party.
The dispute cropped up when A Infrastructure Limited invoked clause 3 of the original licence agreement and called upon Gujarat Composite Limited to extend the term of the licence agreement. Gujarat Composite Limited denied the proposal and claimed that the licence had expired by the end of time without any extension.
Gujarat Composite Limited filed a composite arbitration petition before the Gujarat High Court, challenging A Infrastructure Limited and its sister concern. A Infrastructure Limited raised the lack of arbitrability argument on the ground that the dispute, in the event, was incurably linked with otherwise related transactions at that time. The agreement therefore dictated any jurisdiction by the arbitrator.
A Infrastructure Limited filed a commercial civil suit before the Commercial Court at Ahmedabad against Gujarat Composite Limited, Bank of Baroda, Real Home Corporation, M/s. Raj Corporation, and RJD Buildcon Ltd. This suit sought for recovery of Rs. 32.66 crores, a declaration that the conveyance deeds executed by Gujarat Composite Limited in favour of other defendants are null and void, and an order to restrain Gujarat Composite Limited and other defendants from disturbing or obstructing occupation and possession of the suit property.

Issues

Arbitrability of dispute

The issue involved in the case was whether the dispute between Gujarat Composite Limited (GCL) and A Infrastructure Limited (AIL) could be resolved through arbitration. GCL had invoked the arbitration clause in their licence agreement with AIL to settle their dispute. However, AIL contested that it was a dispute running intermittently with several other transactions allied with the licence agreement on grounds of arbitrability.

Power of the court to serve issues and parties

The question then was if the court could bifurcate the parties and the subject matter and refer only a part of the dispute to arbitration. On this, the Supreme Court has also clarified that there is no provision in the Arbitration and Conciliation Act, 1996, under which the court can bifurcate disputes and parties and refer them to partial arbitration. The further clarification from the Court was that when the requirements under Section 8 are fulfilled, the discretion of the court is imperative, and the whole dispute has to be referred to arbitration.

Judgement

The decision regarding the arbitration clauses under Gujarat Composite Limited v. A Infrastructure Limited & Ors. is clearly explained with respect to the arbitrability of disputes, the conduct of arbitration, and the award. These decisions also help in elaborating on the role of arbitration in dispute resolution and the requirement for painstaking reasoning and fairness in the arbitral process.

The judgement addresses the issue of the arbitrability of the dispute. While the parties had submitted to arbitration under the agreement, the respondent, A Infrastructure Limited, claimed that Gujarat Composite Limited’s claim was inextricably linked with the claims coming from transactions outside the four corners of their licence agreement, making the dispute nonarbitrable. A Infrastructure filed a civil suit, praying for various reliefs relating to the recovery of dues and nullifying certain conveyance deeds involving several parties and agreements. The Supreme Court therefore, agreed and held that the cause of action in the dispute was beyond the scope of the arbitration clause in the licence agreement, ruling that matters concerning non-signatory parties and multiple transactions can never be arbitrated but have to be decided only by the courts.

It is in these circumstances that the respondent, A Infrastructure Limited called upon the appellant to extend the term of the licence agreement, relying on clause 3 of the original licence agreement. The appellant refused and the respondent continued to hold possession of the premises. The arbitral award that was passed in the case. The award was challenged by the respondent, A Infrastructure Limited, before the Bombay High Court, which the single judge dismissed. The respondent thereafter preferred an appeal to the Division Bench, which allowed the appeal by setting aside the award. Further, upholding the order of the Division Bench in appeal, the Supreme Court held that as the arbitral award was silent about the method of computation of damages, it was therefore deficient. The Supreme Court also made it clear that while applying the principles of reasonableness and fairness, every possible reasoning has to be made in the arbitral process.

Result of the violation of the arbitration clause

Under Indian law, there are serious legal consequences in the case of failure to comply with an arbitration clause, which primarily revolves around the validity of the arbitration agreement. The Courts would intervene in the non-compliance by a party to the terms of the arbitration clause if it finds that the arbitration clause is unconscionable or arbitrary.

From the decisions of the Supreme Court, it follows that an arbitration clause has to meet the constitutional norms, more particularly the right to equality under Article 14. For instance, in Lombardi Engineering Ltd. v. Uttarakhand Jal Vidyut Nigam Ltd., the Supreme Court held that a condition that insisted on a pre-deposit of 7% of the claim amount was liable to be struck down as being arbitrary and, thus, violative of equality before the law. Such a holding emphasises that arbitration clauses cannot be utilised to impose unreasonable conditions on access to arbitration which would serve to defeat the policy supporting the alternative dispute resolution mechanisms.

The clause would also be liable to be struck down and therefore unenforceable if, apart from that, it is manifestly arbitrary or even violative of the Constitution. The courts can also look into the fairness and reasonableness of the terms in the arbitration agreement, and upon failure of the same, they might refuse to enforce such a clause and permit the parties to litigate the case.

In other words, the avoidance of an arbitration agreement in India encourages courts to engage in a form of judicial review, whereby such arbitration clauses may be rendered unenforceable if they cannot pass constitutional muster. This reiterates that the art of drafting arbitration clauses must be such that the clauses passed can be termed fair, reasonable, and in consonance with principles of the rule of law to avoid disputed cases and have an effective resolution mechanism.

Additional key points with respect to the violation of arbitration clauses: judicial pronouncements

Arbitrability of disputes

Arbitrability of disputes refers to the capacity of a particular type of dispute to be resolved through arbitration rather than through traditional court litigation. This concept is fundamental in arbitration law, as it determines whether an arbitral tribunal has the jurisdiction to hear a case.

The Supreme Court has held that even if there is an arbitration clause, the court can examine whether the dispute is arbitrable or not. In Booz Allen & Hamilton Inc. vs. SBI Home Finance Ltd. (2011), the court laid down categories of disputes that are not arbitrable, such as criminal offences, matrimonial disputes, guardianship matters, insolvency and winding up, etc.

Unconscionable clauses

Unconscionable arbitration clauses refer to those that are unfair in their making or terms that it would be unfair to enforce. Courts may invalidate such clauses. Where the arbitration clause reveals both procedural and substantive unconscionability, a court may decline to enforce it on grounds of unconscionability. The doctrine ensures one of the parties does not have a unfair advantage over the other during the arbitration process.

They have the effect of arbitration clauses, which are unfair and unreasonable and can be struck down by courts. In Perkins Eastman Architects DPC vs. HSCC (India) Ltd. (2019), the Supreme Court held that an arbitration clause empowering one party to unilaterally appoint an arbitrator is unconscionable.

Public policy

Public policy, in the context of arbitration, is a generic term that usually refers to the basic principles and norms of the legal system of a country and thus reflects the community values of a society. This is the reason why public policy is one of the critical grounds available for challenging an arbitration award under Section 34 of the Arbitration and Conciliation Act in India. An arbitration award that is against public policy, that is, against basic principles of morality or justice or the fundamental policy of Indian Law, may be set aside.

The arbitration award can also be challenged under Section 34 of the Arbitration Act if it is opposed to the public policy of India. While considering this, the Supreme Court in Associate Builders vs. DDA (2014) held that an award would be opposed to public policy if the same shocks the conscience of the court.

Non-availability of arbitrator and non-independence

Non-availability of arbitrators and issues pertaining to non-independence are considered defects that may render the arbitration award under Section 34 of the Arbitration and Conciliation Act void or unenforceable in Indian courts because they go to the root of the legitimacy of the entire arbitration proceedings.

An arbitration clause has to be independent, unbiased, and impartial. In TRF Ltd. vs. Energo Engineering Projects Ltd. (2017), the Supreme Court explained that a person who is ineligible to act as an arbitrator under Section 12(5) cannot be appointed even with the consent of parties.

Severability

The doctrine of severability is a cornerstone in the law of arbitration, aimed at securing the integrity of the arbitration process by keeping the arbitration agreement independent of the main contract. It allows the arbitration to proceed even if the underlying contract is disputed.

If a portion of the arbitration clause is held to be unconstitutional or unenforceable, the courts are empowered to sever such portions and enforce the remainder of the clause. In Duro Felguera, S.A. vs. Gangavaram Port Ltd. (2017), the Supreme Court upheld the severability of the arbitration clauses.

Put differently, while party autonomy is the backbone of arbitration, Indian courts can always intervene to strike down arbitration clauses that are unconstitutional, unconscionable, against public policy, and in violation of the principles of natural justice and due process. The balancing act pursued by the courts is one between strengths brought in by arbitration and protection of parties from unfair and unreasonable terms.

Conclusion

In a nutshell, drafting a commercial agreement with an arbitration clause primarily entails significant deliberations between the two parties over various aspects. An arbitration clause is usually contained in international agreements over the manner in which disputes ought to be settled; assuming such a clause exists and applies universally may get you into serious trouble later.

The parties are required to first discuss and agree on essential issues, such as the applicable law governing the arbitration, rules and provisions regarding how the arbitration will be conducted, and the jurisdiction governing the arbitration, before coming up with an arbitration clause. It also includes the language of the arbitration proceedings and the code of conduct for the arbitration process, among other important components that must be well-defined and mutually agreed upon.

It is very crucial because all these elements are not just mere formalities; they are essential components to ensure that both parties are on the same page in terms of expectations and understandings with regard to how potential disputes will be handled. Where an arbitration clause is properly articulated, it provides a uniform and efficacious procedure for dispute settlement, providing legal redress that is generally faster and cheaper than conventional litigation. However, the full potential of arbitration can only be materialised if the clause is drafted with specific needs and circumstances relevant to the particular contract.

Second, the constraints and any possible risks of arbitration are pinpointed, which vary according to the type of contract and sectors concerned. In sum, as business practices change and new issues crop up, so does the methodology in designing arbitration agreements, in order for it to continue being efficient and germane to provide just and equitable dispute resolution.

Basically, it will be the quality of negotiation and drafting of an arbitration clause that will ensure its success. The parties need to openly and frankly discuss the matter with no word, phrase, or line left to ambiguous interpretation that may defeat the very purpose of arbitration in efficiently and effectively disposing of disputes.

Frequently Asked Questions (FAQs)

What is an arbitration agreement?

Basically, an arbitration agreement is a clause in the contract stating that agreements are going to be settled through the process of arbitration and not by going to court. The agreement identifies the terms, methods, and regulations that shall govern the conduct of arbitration. This refers to the terminology used throughout the proceedings, the venue or seat of arbitration, the selection of the arbitrator, and the laws applied. By entering into an arbitration agreement, parties undertake to resolve all disputes other than in the courts and instead opt for a more obscure, efficient, and often cost-effective alternative. Arbitration clauses are applied to most forms of contracts, including employment, consumer, and commercial agreements.

Does the arbitration clause decide the number of arbitrators?

Yes, the number of arbitrators is normally specified in the very text of the arbitration agreement. The parties may agree on a sole arbitrator for less complex disputes. Otherwise, and more commonly in larger and more complex cases, there would be three arbitrators. That is how the process regarding the selection and qualifications of the arbitrators is addressed in the arbitration clause itself.

How long does an arbitration clause have a binding effect on parties?

The force of an arbitration clause continues until the contract is dissolved and may be amended or rescinded concurrently by both parties.

Are arbitration clauses purely legal?

Yes, arbitration clauses, in many places, are normally legal and effective unless against public policy and do not meet the legal requirements standards.

Is it okay if I sign an arbitration agreement?

It does, however, normally give up your right to take it to court when having a dispute.

Does the arbitration clause include a challenge before taking it to court?

Yes, there are reasons you can file a case with a court for challenging the arbitration clause, such as unconscionability, ambiguity, or on the basis of a lack of mutual consent.

What courts have jurisdiction over arbitration clauses?

The courts in the jurisdiction agreed upon in the contract or where the arbitration is taking place typically have jurisdiction over arbitration clauses.

What can and cannot be subjected to the arbitration clause?

Most commercial disputes can be arbitrated, but matters such as criminal cases, family law, and some statutory rights may not be subject to arbitration.

Who can be an arbitrator?

Any party in mutual agreement can be an arbitrator. Thus, it can be an expert of law or the concerned industry. Typically, arbitrators will be independent and will possess a degree of expertise in the matter being dealt with.

References

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