In this blog post, Balaji AG, a qualified ACA, ICWA, ACS and CIMA (UK) Industry Consultant and a CFO of a Listed Company for over five years, and who is currently pursuing his Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, details the importance of Arbitration in Government Contracts.

Background

One of the key focus areas of governments is in infrastructure development and maintenance.  Railways and Defense are entirely run by Government.  Apart from this, governments also take active involvement in Education and Healthcare.  Further, governments are involved in administration and collection of taxes at various levels.  All of this requires plenty of work to be done either in an on and off basis or on regular basis.  Most of the them involves contracts of significant value and time.  There is a formal tendering process in most cases.  The bids are received based on detailed specs and requirements.  However, project development activities like detailed feasibility study, land acquisition, regulatory clearances like environment/forest are not given adequate importance.  This leads to inadequate definition of requirements or inadequate data at the time of bidding.  This results in bidding on basis of approximations.  When the work is executed the reality is far off from the initial data.  This leads to disputes.

The delay in payments by government organisations has been a long-standing issue.  This is seen   across all departments of both central and state governments.  Government resources are always stretched and this invariably results in delays in payment.  There are penal provisions in the contracts for delays in payment which are not fully or partly adhered to and this again leads to disputes.

The third area is in definition of requirements when government moves from a traditional manual system to technology driven systems.  There is lack of clarity or changes in requirements mid-way during project execution.  This typically happens when a government adopts new technologies.  Team defining the requirements may not have full clarity due to the red tape or inadequacies of the operations constituent of the team.  In such situations, it is not possible to easily determine the quantum of compensation required for the changed requirement.

Another area of challenge in government contracts is the actual contract document.  Standardization of contract documents without adapting it for individual activity results in unnecessary misunderstanding.  This leads to many issues relating to actual scope agreed upon and consequently disputes

Post liberalization, many contracts are awarded to enterprises with significant or total control of foreign parties.  These entities are accustomed to execution of contracts and resolution of disputes in a smooth manner in other developed countries.  They seek to protect their interests at the contracting stage through appropriate provision of dispute resolution mechanism.  They also do not hesitate to invoke those provisions in case of disputes to quickly resolve the issues.

Impact of Disputes

As of 31^st March 2013, there were 135 cases before arbitral tribunal with over Rs. 9000 crores being disputed with regard to National Highways Authority of India.  Furthermore, there were 79 cases pending in various courts with over Rs. 2000 crores of arbitral awards being contested.  This is only the tip of the iceberg.  Similarly, each department of Central Government like Central PWD, Railways, Military Engineering Services, State Government departments, Government Corporations have sizeable amounts in arbitration.  This results in significant amount being held up as dues from government agencies.  According to Mr. Deepak Parekh, Chairman of HDFC, all construction companies face arbitration in every project with Government agencies / corporations and it is further aggravated by the arbitral award being contested in courts.    Contracting companies have huge outstanding disputes and are over leveraged.  Banks are not keen on funding them as it takes many years for disputes to be resolved.  He welcomed the recent move of Cabinet that asked the Government agencies / Public bodies to pay 75% of the amount even in case of dispute.

In view of the significant challenges in completing the projects and realising the payments, the late industry’s participation in various e-governance projects has been declining.  There are several projects which fail to acquire bids.  Consequent impact is both on industry and the government.

Dispute Resolution Mechanisms

Contracts with Government agencies and corporations holds special attraction to private sector even though they are one sided and involves several challenges.  However, over a period the private players have come to realize that it is not just getting contracts from the government which is important.  It is equally important that they are able to execute the contracts completely and realize the amount due on time.  If in the process, they face disputes, it should be possible to resolve the same without delays.  As discussed above, there are quite a few areas in which disputes arise in contracts with government entities.  Impact of such disputes is also very significant as highlighted above.  Existence of an efficient and credible dispute resolution mechanism is very important for successful execution of government contracts.  High value contracts with inadequate dispute resolution mechanism and the costs of delay in dispute resolution are perceived as very high risks and are not acceptable.

Court process in India is very cumbersome.  Counsels for the parties keep stretching the litigation process resulting in costly and time consuming litigation.  The Legal System is not efficient.  All of these push the parties to seek alternative mechanisms of dispute resolution.  Alternative dispute resolution methods include amicable settlement, mediation, conciliation, arbitration, expert determination, etc.,

The first preferred method of resolution of disputes is normally to arrive at an amicable settlement through negotiation.  If that is achieved, the agreed terms are converted into an agreement which is binding on both parties.

Another method is mediation.  A mediator asks the parties to put forth their views and claims in a joint session.  The mediator then meets them separately to reach a settlement.  If settlement is arrived at, it is converted into an agreement.

The third method of dispute resolution is conciliation.  This is recognised under the Indian Law.  Conciliation is a non-binding procedure.  Conciliation can commence even in the absence of provision in the contract.  Settlement agreement signed by both parties and authenticated by a conciliator is binding like a decision of court of law

Another very important and most popular method of alternative dispute resolution mechanism is arbitration.

Importance of Arbitration

Arbitration has of late become one of the most viable means of dispute resolution in disputes between government entities and private parties.  Invariably the government contracts provide for arbitration evidently due to its relative advantages in terms of speedy disposal and technical knowledge of the adjudicators.  According to Section 28 of the Indian Contract Act, contracts are void if it places absolute restraint on legal proceedings.  However, if a contract has provision for arbitration mechanism it continues to be valid.  Arbitration in contracts involving Indian parties is mostly under the Arbitration and Conciliation Act, 1996, which is based on the UNCITRAL model law.  It provides the framework for legally binding arbitration awards with limited grounds for challenge in a time bound manner.

Arbitration clauses included in the contract is very important and needs to be worded appropriately.  This will determine the speed and the quality of arbitration apart from the cost associated with it.  It will also determine the extent of court intervention.  Ultimately, the very purpose of an alternate dispute resolution mechanism is to ensure speedy resolution of disputes.  If the clauses leave room for intervention of courts or referral of awards to courts of law the very purpose would be defeated.  As stated earlier, in many instances the government contract arbitral clauses have been worded in such a manner leaving adequate room for intervention of courts and referral of awards.  Consequently, many disputes are remaining unresolved and significant amounts are locked in court battles.  To avoid this situation, the contract arbitration clauses needs to be drafted with great care.

Following details in arbitral clauses needs to be defined properly to ensure that arbitration mechanism benefits are fully secured

1. Qualification of arbitrators. It would be appropriate to define the minimum qualifications of the arbitrators based on the nature of contract.  This would ensure that the technical aspects and industry practices are factored in the interpretation of contract terms.

2. Number and process of appointment of arbitrators including timelines and process to be followed if timeline is not adhered. This has been one of the real challenges in government contracts.  Arbitrator is typically an officer of the same government organisation.  He is the sole arbitrator.  This results in a possible bias which is against principles of natural justice.  At the time of contract negotiation, the private parties sign on the dotted line without understanding the implication of this clause.  It is important that the arbitrator is a neutral party.

3. Procedure for challenge of arbitrators

4. Specification of role of arbitral institution if any. NASSCOM President during the interaction between the Industry and DeitY (Department of Electronics and Information & Technology, Government of India) in 2015 requested for neutral panel to be constituted.  This would take the form of Institutional arbitration and would avoid the issue of bias in government contracts.  Further the arbitral clause should be clear about the procedure for arbitration to avoid intervention of courts.  Typically, the institutional arbitrator has their own rules which govern the procedure which would be followed.

5. Power to issue interim orders. This would facilitate faster partial relief to the affected party and also ensure prevent actions which are likely to frustrate the arbitral award

6. Cost of arbitral proceedings and sharing ratio

7. Time limits for passing interim orders and award. Time is the essence in dispute resolution.  Not only does it have an impact on cost of arbitration, but also at times impacts the survival of the private parties.  Stipulation of time limit for passing of interim orders and award improves the benefit of arbitral process.  Further, it brings in discipline to the arbitral process and the parties involved

Summary

Considering the high stakes involved in most of the government contracts and the past experience in the approach of the government organisations in raising disputes on almost all the contracts the importance of arbitration for dispute resolution is very apparent.  The loosely worded arbitration clauses in government contracts lend itself to significant court intervention which defeats the very purpose of resorting to alternative dispute resolution mechanism.  Intervention of court cannot be totally eliminated as those are statutorily enshrined under the Arbitration and Conciliation Act.  However, clarity on the details mentioned above will help in making tighter arbitration clauses which are less susceptible to court intervention and other procedural delays.  Further, the full benefit of resorting to arbitration mechanism can be ensured.