Is Your Arbitration Clause Built to Arbitrate? — Supreme Court Answers

An analysis of the Supreme Court’s recent decisions on arbitration agreements, examining the requirements under Sections 7 and 11 of the Arbitration and Conciliation Act, 1996, and the importance of clear and mandatory language in arbitration clauses.

Arbitration agreement: Foundation of every arbitration

If only for the word “can”, the word “shall” would have been written in the arbitration clause, the decision would have been materially different. This is what the claimant in Nagreeka Indcon Products (P) Ltd. v. Cargocare Logistics (India) (P) Ltd.¹ must be thinking after the Supreme Court refused to refer the parties to arbitration in a petition under Section 11, Arbitration and Conciliation Act, 1996 (Arbitration Act).

The arbitration agreement is the source of the arbitrator’s mandate and the foundation of the entire arbitral process. Without a valid arbitration agreement, there is, simply, no arbitration. A valid arbitration agreement provides certainty of forum, avoids the expense of court litigation, and eliminates jurisdictional contests at the threshold.

Intersection of Sections 7 and 11, Arbitration Act

One of the first landmark judgments on the validity of an arbitration agreement under a Section 11 petition was K.K. Modi v. K.N. Modi², wherein the Supreme Court laid down the ingredients for a valid arbitration agreement, that the Tribunal’s decision must be binding; its jurisdiction must derive from the consent of the parties; it must determine substantive rights; it must act impartially; the agreement must be enforceable; and the dispute must be formulated at the time of reference. The Court held that mere nomenclature is not decisive. Thereafter, in Jagdish Chander v. Ramesh Chander³, the Supreme Court examined Clause 16 of a partnership deed, which provided that any dispute “shall be mutually decided by the partners or shall be referred for arbitration if the parties so determine”. The Court held that this clause was not an arbitration agreement. Critically, the Supreme Court laid down that the words used in an agreement must disclose a determination and obligation to go to arbitration and not merely contemplate the possibility of going for arbitration. The Supreme Court enunciated four binding principles for a valid arbitration agreement, that the intention to arbitrate must reflect a clear willingness to be bound; the words “arbitration” or “arbitrator” need not appear; a clause providing that disputes “shall be referred” is valid; but, most consequentially, “mere use of the word “arbitration” or “arbitrator” in a clause will not make it an arbitration agreement, if it requires or contemplates a further or fresh consent of the parties for reference to arbitration”.

The principles enunciated in the case of Jagdish Chander were applied in two subsequent judgments. In Visa International Ltd. v. Continental Resources (USA) Ltd.⁴, the dispute resolution clause provided that disputes “shall be settled in accordance with the provisions of the Arbitration and Conciliation Act” without specifically naming arbitration or conciliation as the mechanism. Applying a purposive interpretation, the Supreme Court held that a binding clause did exist, and that the absence of one or two words was not decisive. The Court held that the whole clause had to be read together to determine the intention of the parties. In Babanrao Rajaram Pund v. Samarth Builders & Developers⁵, the Supreme Court followed Visa International and confirmed that the construction of an arbitration clause must be pragmatic, not pedantic; a deficiency of words could not annul a clause that otherwise clearly reflected the intent to arbitrate, and the absence of words “final and binding” did not by itself render the clause invalid.

The current legal position

Presently, the examination under Section 11, Arbitration Act, for the appointment of an arbitrator, is restricted to the existence of an arbitration agreement, leaving other issues, including jurisdictional, to the discretion of the Arbitral Tribunal.⁶ However, three recent judgments of the Supreme Court show how a prima facie examination under Section 11 can defeat a claim to arbitration when the language of the purported arbitration clause is insufficient.

In BGM & M-RPL-JMCT (JV) v. Eastern Coalfields Ltd.⁷, the dispute resolution clause read, “In case of parties other than Govt. Agencies, the redressal of the dispute may be sought through Arbitration and Conciliation Act, 1996 as amended by Amendment Act of 2015”. The Court held that “may be sought” was merely an enabling clause and further consent of the parties was required for arbitration. Applying Jagdish Chander, the Court held that the clause was not an arbitration agreement.

The Supreme Court dealt with a similar arbitration clause in Nagreeka Indcon, the only difference being the use of the word “can” instead of the word “may” used in BGM & M-RPL-JMCT (JV). Nagreeka invoked Clause 25 of the bill of lading, captioned “Arbitration”, which read: “Any difference of opinion or dispute thereunder can be settled by arbitration in India or a place mutually agreed with each party appointing an arbitrator”. The Supreme Court dismissed the appeal, holding consent to be the source of the Arbitral Tribunal’s jurisdiction. The Court examined the word “can” and held, by reference to dictionary meaning and judicial interpretation, that it connoted the possibility or capacity, not obligation, unlike “shall”, which signalled a mandate. Applying K.K. Modi and Jagdish Chander, the Court held that Clause 25 indicated merely the future possibility of referring disputes to arbitration. Since the respondent had withheld further agreement, no binding arbitration agreement existed. The clause heading “Arbitration” was not decisive; nor was the incomplete appointment procedure, specifying party-appointed arbitrators but silent on the presiding arbitrator, sufficient to save it.

The Court distinguished Babanrao Rajaram Pund and Visa International on the basis that both of those clauses used “shall”, making the intent to mandatorily refer the disputes to arbitration clear. The Supreme Court in the said cases had only held that the absence of the words “final and binding” did not defeat an otherwise unambiguous clause. In the case of Visa International, the absent word was “arbitration”, not the mandatory intent. The Court also referred to Enercon (India) Ltd. v. Enercon Gmbh⁸, where both parties were ad idem that arbitration was the chosen mechanism and only the appointment procedure was incomplete, which the Court read in pragmatically. The Court followed BGM & M-RPL-JMCT (JV), decided only months earlier, and expressly confirmed that the combined line from K.K. Modi, Jagdish Chander, and Enercon India requiring an obligation, not merely a possibility, remained the governing standard under the current legal position.

Eight days before the judgment in case of Nagreeka Indcon, the Supreme Court in Maharashtra State Electricity Distribution Co. Ltd. v. R Z Malpani⁹ addressed whether an arbitration clause in tender documents could bind parties where the only link was a letter of intent (LOI) that never matured into a concluded contract. The core issue was whether the LOI created a concluded contract under Section 7(1) and whether the arbitration clause in the tender documents was incorporated into it under Section 7(5).

The Supreme Court characterised this as a “rarest of rare” case where, even on a prima facie view without going into disputed facts, there appeared to be no existence of an arbitration agreement. On the concluded contract question, the Supreme Court relied on State of H.P. v. OASYS Cybernatics (P) Ltd.¹⁰ and reiterated that a letter of intent is ordinarily a precursor to a contract and not the contract itself. The LOI explicitly stated it was “issued to enable you to start with preliminaries to start the work as soon as the detailed work order is issued”, thereby confirming its conditional and inchoate character. However, no work order was issued, and no formal agreement was signed. The Court stated that a tender was an invitation to offer, a bid was an offer, and an LOI was a promise to make a promise. The LOI, thus, did not create a binding legal relationship, and the Supreme Court held that a valid arbitration agreement did not exist between the parties.

Conclusion: Proper drafting of arbitration clause is crucial

The trajectory from K.K. Modi¹¹, Jagdish Chander¹², Visa International¹³, BGM & M-RPL-JMCT (JV)¹⁴ , Enercon¹⁵, Nagreeka Indcon¹⁶, and Maharashtra State Electricity Distribution Co. Ltd.¹⁷ maps a coherent legal position. The Supreme Court has narrowed the Section 11 window to a prima facie examination of existence under Section 7, while simultaneously confirming that this examination is genuine, i.e. the arbitration clause must satisfy the well-established criteria of an arbitration agreement developed over three decades of jurisprudence.

An analysis of the judgments referred to above explicates the following aspects that a valid arbitration agreement must contain: It must be in writing, it should be contained in any of the documents mentioned in Section 7(4), it should disclose a clear obligation to go to arbitration and not merely a possibility or a further consent/agreement to arbitrate, it should contain the complete procedure for appointment of arbitrator(s), and it should contain the understanding of the parties that the decision of the arbitrator will be final and binding. Words such as “can”, “may be sought”, or “if the parties so determine” fail this test and constitute, at best, agreements to agree.

As Nagreeka Indcon demonstrates, ambiguity at the drafting stage results in costly litigation that may conclude against the party seeking to arbitrate. The best arbitration clause is one that never needs to be litigated.