In the economic analysis of legal systems, there are broadly stated two costs associated with the bringing of legal proceedings “error costs” and “direct costs”1. Error costs are expenses incurred not only by participants within the system but by non-participants as well. Error costs are expenses incurred on account of the legal system functioning sub-optimally. Sub-optimal functioning may be occasioned by a range of factors including : lack of manpower and or resources, poor allocation of available manpower and or resources, delays, ambiguous or complicated rules and laws, erroneous judgments, etc. Participants in the legal system incur direct costs i.e. the costs of initiating and prosecuting a legal proceeding. Direct costs include filing fees, lawyers’ fees, clerkage charges, photocopying expenses, witness travel expenses, expert witness fees, commissioners’ fees and most importantly time2.
Direct costs associated with litigation may in an optimal legal system be regarded as an investment by participants in the system3. These investments are made by participants with the objective of attaining a desired outcome4. These desired outcomes may be defined as the “stakes” of the litigation. One may legitimately ask, why should the legal system concern itself with the private investment of a litigant? After all these are an expense the party incurred to realise its desired stake. The writings of Jhering5 and Pound6 offer some insight in this regard. Participants in the legal system assert not only their own personal rights but also the “interests” behind those rights. Society has an interest in social order and hence the defence of every right no matter how big or small is a contribution to the defence of the whole body of law, something which is to the benefit of Society7. Furthermore, direct costs are not always voluntary and may be incurred by a party on account of external factors such as the complexities of the rules of the legal system and its procedures. Direct costs could also potentially be driven upwards by a legal system that is not functioning optimally and is prone to higher error costs8. An optimal legal system therefore constantly endeavours to maximize its efficiency by minimising direct and error costs1.
Legal systems introduce a host of policy measures aimed at the minimisation of direct costs9. Within the Indian legal system one can observe cost minimisation measures in provisions such as those establishing the jurisdiction of courts10, provisions entitling a litigant to the grant of a summary judgment11, provisions permitting the court to pass a judgment on the basis of admissions12, provisions relating to judicial notice of certain facts13, provisions relating to presumptions of certain facts14, the doctrine of estoppel15, the rule against the admissibility of hearsay evidence16, etc. Each of these provisions in their own way seek to reduce the direct costs associated with the prosecution of a litigation17. Cost shifting rules are yet another measure in this respect. They aim at transferring direct costs from the victorious party to the defeated party17. Not only does cost shifting provide a litigant with a “make whole” remedy, cost shifting functions as a means of discouraging unfair and unnecessary litigation17. There are two popular forms of cost shifting rules, they have come to be referred to as the American Rule and the English Rule. There is also a system unique unto the European continent. Beginning with a recount of the history of these systems the article evaluates their relative strengths and weaknesses. The author then proceeds to study the Indian legal system’s cost shifting rules in civil proceedings with an analysis of how the system works in the country’s commercial capital Mumbai. Thereafter, the author weighs in on the cost shifting system applicable to domestic arbitrations governed by the provisions of the Act. The article will attempt to present a normative basis for determining reasonable costs under the cost shifting regime introduced for arbitrations under the Act. The purpose being to offer predictability and certainty in the manner in which the regime is operated in India. A predictable system is an efficient system18 and an efficient system must mitigate costs19.
A SURVEY OF COST SHIFTING SYSTEMS AROUND THE WORLD
The American Rule
The United States of America is the only common law jurisdiction in which attorney fees do not “follow the event”20 i.e. absent an express statutory exception allowing for an attorney fee cost award21. Hence, baring the express provisions of a statute each party must bear the total expense of compensating their attorney22. Given that the American legal system borrowed many elements of the English legal system it is truly fascinating that it did not adopt the English Rule of indemnity for attorney fees22.
The normative justifications of the American Rule are (a) litigation is an uncertain venture and hence a party should not be penalised for merely defending or prosecuting a law suit, (b) the English Rule requiring the losing party to indemnify the successful party acts as a barrier to accessing justice, it discourages the institution and defence of claims, and (c) the time, expense and difficulties encountered in deciding what would constitute a “reasonable fee” under the English Rule necessitates the English courts to operate and maintain a separate quasi-judicial infrastructure. The costs incurred by the administration in maintaining this infrastructure is passed on to the litigant who must pay a considerable “court fee” to access justice, this court fee can itself be a barrier to accessing the legal system23.
In addition to the normative justifications for the rule stated above, perhaps the prevalence of the rule is partially a factor of American history. In the seventeenth century, when America was still a colony of Great Britain, attorneys in the American colonies were prohibited by statute under threat of disbarment from receiving fees from their clients24. In time statutes in virtually all the colonies sought to fix by enactment the fees chargeable by attorneys25. The purpose of these statutes was aimed more at limiting the amount of fee chargeable as opposed to being a measure of the fees that may be awarded as costs, but be that as it may, in time once the fee scale was fixed by statute, there seemed to be no difficulty in awarding it against the defeated party, statutes that could be defined as beneficial legislations began providing for awarding fees at the scale as an exception to the general rule25.
These fee fixing enactments however were not updated in a timely manner and soon fell out of touch with reality and a large gap emerged between the prescribed fees and the fee actually being paid by clients26. The gap between the prescribed fee and the market fee had to be bridged by the litigant. The litigant was not compensated by the system for these increased costs and hence the system can be said to have fallen into an inefficiency25.
How this problem was proposed to be solved is a testament to the American spirit of free enterprise and entrepreneurial ingenuity. By agreeing to work on a contingent fee basis the attorney assured the client that the high cost of litigation would not result in a denial of access to justice for the client27. The contingency fee arrangement usually stipulates that the attorney would bear all costs including time and effort associated with the initiation and prosecution of a legal action in return for a share of the “common pool” or proceeds of the litigation28. The solution faced its legal setbacks as contingency fees were seen as champertous and hence unenforceable27. With time however, precedents disallowing contingent fee arrangements gave way to a more receptive view29. The contingency fee is now a universal phenomenon and is practised in almost every State in the United States. Class action proceedings also proved a worthy measure to bridge the gap and the attorney agreed to receive fees from the common benefit earned through such litigation30.
Over the course of several years, the number of legislations both Federal31 and State32 that have recognised exceptions to the “American Rule” have increased exponentially. The objects of these enactments however are more directed towards promoting access to justice for a category of cases rather than as an endeavour to shift cost22. The American Rule on cost shifting therefore continues to require parties to bear their own expenses. These expenses are sought to be regulated and controlled to keep the direct costs associated with access to the legal system at a minimum. Where the market stipulates for a fee which a party cannot meet, these expenses may be met by contingent fee agreements or collective actions where the attorney fee is realised from the common pool earned in those proceedings. As an exception, certain beneficial legislations allow for an award of attorney fees minimising the cost to access the system for the successful party.
The English Rule
The history of costs in England is beneficially studied by separating the development of cost shifting orders in the common law courts from such orders passed by the courts of equity. If the plaintiff failed in his action at common law, the plaintiff was amerced pro falso clamore, if the plaintiff succeeded, the defendant was in misericordia for the unjust detention of the plaintiff’s right but was not liable to the plaintiff for any costs of the suit at least under that title33. In common law there could be no award of costs unless the statute provided. The English common law rule on costs is said to have come into existence around 1875 when a provision of the Statute of Gloucester (1275) pertaining to the issuance of a writ of eviction were interpreted by Lord Coke to provide for an order of costs against the defeated party17. Statutes also fixed the amount of costs that could be awarded as a measure to limit the filing of small and vexatious claims34. Certain statutes also provided for an award of costs in favour of the defendant35. In contrast, the jurisdiction of the Lord Chancellor to award costs in equity was entirely discretionary and was based on inherent powers and not on statute36.
In 1875, the Rules of Court were amended and whereas in previous statutes costs had followed the event, the relevant provisions now provided that with certain exceptions “the costs of and incident to all proceedings in the High Court shall be in the discretion of the court”17. Costs once awarded by a court are taxed by the Taxing Master. The solicitor of the successful party prepares a bill of costs in which every taxable item of expense incurred by a client is included. If the items are consented too by the solicitor for the defeated party an order of costs is passed by agreement. Failing an agreement, the Taxing Master must conduct a hearing, in which each disputed item of cost is discussed and either allowed or disallowed. A wide discretion is conferred on the Taxing Master and decisions on quantum are in the absence of particular circumstances final37. An appeal lies from the order of the Taxing Master to the Judge in Chambers on both questions of law and fact. No further appeal lies from the order of the Judge in Chamber without leave on questions of fact, however an appeal may be preferred without leave on all points of law38.
In passing its order the Taxing Master is allowed to tax certain defined items of costs. The common perception is that under the English Rule all charges paid by a litigant to its lawyer will be recovered. This is not so. The items which the Taxing Master considers are : (a) fees paid to court, (b) fees paid to the solicitor, (c) fees paid to the counsel, (d) expenses paid to witnesses. Fees paid to court are usually recovered in full unless it is determined that they have been unnecessarily incurred. For the purpose of taxation, an itemised bill of all fees paid to a solicitor for his services must be furnished. Charges for most items on this list are fixed by statute. The fees fixed for these items are the most outdated and critiqued aspect of the English system as the quantum of fees are rarely revised and in most cases were fixed when solicitors were persons skilled in the details of clerical work pertaining to law suits and performed mainly clerical functions17. On the matter of costs in respect to the payment of fees to Barristers the English Rule is very much akin to the American Rule and ordinarily the general rule here is that the costs are borne by the party themselves save to the extent permitted by statute17. The Taxing Master’s discretion here include determining whether it was even necessary for the party to engage counsel or more than one counsel39. When it comes to taxing items pertaining to the expenses in connection with the travel of a witness again the Taxing Master has immense discretion and can determine based on the social standing of the witness whether the witness was justified in travel by air, train, road and even the class of such travel17. The Taxing Master can also determine the reasonability of expenses in connection with expenses incurred for presenting expert opinions40.
Cost shifting systems in Europe
Most European countries trace the history of their legal systems to Roman Law. In the beginning of Roman legal history there were almost no costs associated with accessing the legal system as litigation was sponsored by the high priests or was brought by the Government. Legal advice too was rendered free41. Judicial proceedings carried a sacral aura and were not to be undertaken without good cause. Expenses were minimal and a litigant was only required to make a temple deposit known as a sacramentum into the temple at the time of institution of the action. When the decision was rendered, the prevailing party was refunded this deposit while the defeated parties deposit was forfeited42. By Justinian times, lawyers began to charge fees to represent parties in litigation and while there was still some attempt to outlaw these fees, the defeated party was required to make payment of all costs incurred by the winning party41.
Coming to modern times, while there is no single concise rule that could be identified as the “European Rule”, there are broadly stated two statements about the cost shifting rules in Europe that can be made : (a) they regard defeat as sufficient ground for imposing the costs on the losing party, without requiring any evidence of fault or bad faith, (b) included in the costs to be reimbursed to the winner by the loser are not only court fees and related costs but also attorney fees and other expenses incurred by the winner43.
In modern Europe, the courts of law are granted the power to award costs on the defeated party44. The cost shifting rule applies whether the winning party is the plaintiff or the defendant and hence the codes45 prescribe what is known as a “two-way fee shifting”. Defeat is usually defined as defeat in all major aspects of the case and hence when a party prevails on some major aspects but is defeated on other major aspects the codes provide for a division of the costs proportionately46. The statutes provide for limited judicial discretion with the Austrian, German and Netherlands cost systems being the strictest in this respect47. An exception to this is found in France and Italy where the courts are given large discretion on passing cost awards43.
While different legal systems may have a preference for one cost shifting system over another there are broadly stated two main justifications for such systems:“equity” and “incentives”. Litigation has the effect of impacting those who are not parties to a case through the doctrine of “stare decisis” or the norm creating function of the legal system. In return for the litigant participating in this norm formation objective of the legal system, equity grants the litigant a “make whole relief” as a reward48.
Cost Shifting in Civil Proceedings in India
Due to its colonial legacy, India inherited its cost shifting regime from Great Britain. For the most, the cost shifting rules and governing principles are common in both jurisdictions. In India, cost awards follow the cause and are rendered subject to rules governing the taxation of these costs by the Taxing Master of the Court49. The English Rule as we noted above was akin to the American Rule with respect to attorney fees and it is no surprise therefore that the Indian system appears to have inherited the same attitude towards awarding advocate/counsel fees. In Manindra Chandra Nandi v. Aswini Kumar Acharjya50 the High Court of Judicature at Calcutta had deemed the case to be an exceptional and complicated case51 justifying a litigant engaging more than one counsel and hence had awarded costs at the scale 3 i.e. the designated category for the most complex of litigation justifying engaging multiple counsel. In appeal, the order on costs was set aside as the Appeal Court opined that the case posed no problems outside the ordinary justifying the engagement of additional counsel and awarded costs at the scale for an ordinary litigation.
This outlook towards awarding advocate fees continues till date, and despite the very progressive opinion of the Supreme Court in Salem Advocate Bar Assn. (2) v. Union of India52 wherein the Supreme Court directed the High Courts to frame a scheme for the determination of reasonable costs to be passed in original proceedings so that “actual reasonable costs” incurred be awarded by the court to the successful party subsequent judgments have reverted to familiar. When the Delhi High Court sought to award actual legal expenses of Rs 45,00,000 (Rupees forty-five lakhs only) to the successful litigant in Sanjeev Kumar Jain v. Raghubir Saran Charitable Trust53 its judgment was set aside on costs by the Supreme Court54 with the Supreme Court opining those actual realistic costs must be reasonable and cannot refer to fanciful and whimsical expenditures incurred by parties who have the luxury of engaging a battery of high-charging lawyers55. The Court referred to the Delhi High Court Taxing Rules and held that an award of costs could not exceed the scale prescribed thereunder.
An examination of the cost shifting rules applicable to suits filed on its original side of the Bombay High Court may be useful at this juncture so as to understand the systems operation in the country’s commercial capital. The High Court on its original side may award costs under Rule 298 of the Bombay High Court Original Side Rules, 1980 which permit the court to state the amount of costs incurred in a suit and by whom and out of what property and in what proportion costs are to be paid. Just as in England, in the city of Mumbai once an order of costs is passed the matter is referred to the Taxing Master to determine the taxed costs in the cause. Chapter XXXI of the Bombay High Court Original Side Rules 600 to 610 deal with the taxation of advocates fees when costs are awarded. The maximum fee payable to an advocate under these Rules (which were last amended in the year 2020) are narrated in Rule 606 of the Rules. Since the pecuniary jurisdiction at the time of writing this article is Rs 1,00,00,000 (Rupees one crore only) and above, the entry with which one is concerned is the entry prescribing fees for such value claims which have a stated ceiling limit of only Rs 25,000 (Rupees twenty-five thousand only). The quantum stated in these Rules is totally out of touch with reality. The Bar Council of Maharashtra and Goa the governing body setting down the regulations for advocates enrolled in the State of Maharashtra prescribe “minimum” fees of “not less” than Rs 2,00,000 (Rupees two lakhs only) for a claim of Rs 10,00,000 (Rupees ten lakhs only). Running through each taxable item mentioned in Rule 606 one will find that each entry prescribes a taxable limit far below the minimum fee prescribed by the Bar Council.
The rules also stipulate the fees taxable where more than one counsel is engaged. Rule 606(3) provides that:
606. (3) Where at the hearing of any suit, reference under the Land Acquisition Act, or appeal, disposed of on merits, more than one advocates have appeared, the court disposing of the matter may allow such fee, for a second advocate, as it deems fit not exceeding half the fee allowable under sub-rule (1) …
The taxable limit of fees for assisting counsel is therefore Rs 12,500 (Rupees twelve thousand five hundred only). This is probably what a junior or assisting counsel marks for an appearance perhaps even what some junior counsel mark for a “non-effective” hearing. The words of Professor Ehrenweig come to mind here, it would appear that the rules were framed in some bygone era and thereafter nobody looked at these cost shifting rules ever again56. Even on the original side there is a push back against the award of actual and realistic costs, in Boots Company Plc v. Ind Swift Ltd.57 a Single Judge of the Bombay High Court ordered costs of Rs 10,00,000 (Rupees ten lakhs only) towards advocates’ fees incurred by the defendant in view of multiple adjournments by the plaintiff. While the Appeal Court agreed with the need to award actual and realistic costs, it reduced the sum to Rs 50,000 (Rupees fifty thousand only).
Having pointed out the flaws within the civil litigation system in original civil proceedings in the commercial capital of India, the author remarks that a litigant is undoubtably better off here than when it files proceedings in a regular civil court outside the presidency towns. In cases filed outside the presidency towns, Order 20-A of the Code stipulates the matters in respect of which costs may be awarded, these include items such as expenses in connection with the giving of a notice before the institution of a suit, expenditures incurred for typing, writing and printing of pleadings, charges with respect to inspection of court records, expenditures incurred by a party for producing witnesses, charges with respect to the obtaining of copies of orders, judgments and decrees of a court. The provisions notably do not provide for the computation of lawyers’ fees in cost awards and the provision appears to be a “fee shifting” regime as opposed to a “cost shifting regime58.” With this background, let us now shift our attention to the cost regime in arbitrations governed by the Act.
COST SHIFTING IN ARBITRATIONS UNDER THE ACT
The Arbitration Act, 1940 did not have any provisions pertaining to the award of cost and hence Arbitral Tribunals would have awarded costs basis the general principles on costs followed by civil courts and discussed above59. Prior to the 2016 amendment of the Act, cost shifting was provided for in Section 31(8) of the Act. In the year 2016, a new provision Section 31-A was inserted into the Act which reads:
31-A. Regime for costs.—(1) In relation to any arbitration proceeding or a proceeding under any of the provisions of this Act pertaining to the arbitration, the Court or Arbitral Tribunal, notwithstanding anything contained in the Civil Procedure Code, 1908, shall have the discretion to determine—
(a) whether costs are payable by one party to another;
(b) the amount of such costs; and
(c) when such costs are to be paid.
Explanation.—For the purpose of this sub-section, “costs” reasonable costs relating to—
(i) the fees and expenses of the arbitrators, courts and witnesses;
(ii) legal fees and expenses;
(iii) any administration fees of the institution supervising the arbitration; and
(iv) any other expenses incurred in connection with the arbitral or court proceedings and the arbitral award.
(2) If the court or Arbitral Tribunal decides to make an order as to payment of costs—
(a) the general rule is that the unsuccessful party will be ordered to pay the costs of the successful party; or
(b) the court or tribunal may make a different order for reasons to be recorded in writing.
(3) In determining the costs, the court or Arbitral Tribunal shall have regard to all the circumstances, including—
(a) the conduct of the parties;
(b) whether a party has succeeded partly in the case;
(c) whether the party had made a frivolous counter-claim leading to delay in the disposal of the arbitral proceedings; and
(d) whether any reasonable offer to settle the dispute is made by a party and refused by the other party.
(4) The court or Arbitral Tribunal may make any order under this section including the order that a party shall pay—
(a) a proportion of another party’s costs;
(b) a stated amount in respect of another party’s costs;
(c) costs from or until a certain date only;
(d) costs incurred before proceedings have begun;
(e) costs relating to particular steps taken in the proceedings;
(f) costs relating only to a distinct part of the proceedings; and
(g) interest on costs from or until a certain date.
(5) An agreement which has the effect that a party is to pay the whole or part of the costs of the arbitration in any event shall be only valid if such agreement is made after the dispute in question arisen.
Section 31-A is a non obstante clause, legislature has specified that the provisions of Section 31-A shall not be affected by the provisions of the Civil Procedure Code, 1908. Non obstante clauses are a legislative device usually employed to give overriding effect to a provision over some contrary provisions that may be found either in the same or in some other enactment60. Attention is invited to the provisions of Section 19 of the Act which states that the Arbitral Tribunal was not in the conduct of the arbitral proceedings bound by the provisions of the Civil Procedure Code, 1908. The Delhi High Court had interpreted the language of Section 19 to mean that though the provisions of the Code are not binding on the Arbitral Tribunal, its fundamental provisions, which exist to ensure justice and fair play, must be followed by the Arbitral Tribunal61. The Bombay High Court felt that though the Arbitral Tribunal was not bound by the provisions of the Code, it was bound to take notice of substantial laws and recognised principles and practices of civil laws, natural justice, fair play and equity in the conduct of the proceedings62. In a more recent ruling, the Supreme Court opined that the provisions of the Code would apply to arbitral proceedings only insofar as they are not inconsistent with the provisions of the Act63. It can be concluded from the reiteration of the non-applicability of the provisions of the Code with respect to awarding costs in arbitral proceedings, that legislature views the provisions of the Code with respect to costs as being in conflict with the provisions of the proposed regime and hence in order to give effect to a fundamental alteration in the general system of costs and the policy of law pertaining thereto64.
The new cost regime is based on the recommendations of the Law Commission of India’s 246th Report to Parliament. The Commission proposed a robust cost regime which would empower courts and arbitrators to award rational and realistic costs and thereby give effect to the recommendations of the Supreme Court in Salem Advocate Bar Assn. (2) v. Union of India52. In the Note annexed to the draft provision on costs, the Commission had stated that:
Note : The above principle ensures that the “costs follow the event” regime governs all arbitrations/arbitration related court litigation. Such a regime would disincentivise frivolous proceedings and inequitable conduct. The basis of the above provisions is Rule 44 of the Civil Procedure Rules of England.
The recommended draft clause has been accepted by legislature and the Arbitration and Conciliation (Amendment) Act, 2015 came to be enacted with the aforementioned Section 31-A being introduced into the legislation.
Since, the new clause is guided by the cost provision contained in Rule 44 of the Civil Procedure Code in England and the provisions of the Civil Procedure Code, 1908 are specifically excluded from applicability in view of the non obstante clause that precedes the provisions of Section 31-A of the Act, are its terms to be interpreted with the aid of judicial precedent under the Civil Procedure Code, 1908 or is English law to be looked at on costs under the English Rule? This presents with the proverbial, chicken and egg situation, for at least the following reasons : (a) English Courts and Indian Courts have in virtually every respect the same system and mechanism to determine costs; (b) the manner in which English Courts determine reasonable costs especially with respect to advocate/counsel fees and the manner in which Indian courts have determined this issue is identical and both jurisdictions revert to the American Rule; and (c) with the enactment of the Commercial Courts Act, 2015 the provisions of Section 34 of the Civil Procedure Code, 1908 in its application to commercial disputes are pari materia with the provisions of Section 31-A of the Act. Under the English Rule on counsel fees as seen above, the parties virtually bear the entire costs of their attorney fees as they are only compensated in this regard as per a fee scale prescribed by the rules of court or special statute, these provisions are completely out of touch with the actual costs, parties may have incurred on their lawyers’ fees17. How does the adoption of the English Rule give effect to the recommendations of the Supreme Court of India in Salem Advocate Bar Assn. (2) v. Union of India52 and award parties actual and realistic costs, something that the courts in England themselves seldom do, especially with regards to legal fees?
Another problem which presents itself is that though sub-section (1) of Section 31-A confers a discretionary power on the Tribunal to award costs the interpretation of this provision appears to be governed by the Explanation thereto. The Explanation clause remains to be interpreted in judicial proceedings but one may ask, is the Explanation to Section 31-A(1) negative or positive?65 i.e. does it limit or expound the discretion of the Arbitral Tribunal or court. The question legitimately arises because of the use of the word “reasonable” as the governing qualifier on the awarding of costs. The Explanation reads:
Explanation.—For the purpose of this sub-section, “costs” means reasonable costs relating to…
Once again, this appears to be a one step forward and two steps back approach to legal draughtsmanship and takes us back into the whirlpool of judicial pronouncements in England66 and in India67 on what constitutes reasonable costs especially in connection with attorney/counsel fees.
There exists however another way of perceiving the provisions. Where the Explanation to Section 31-A is read as being the heralding of an entirely new “substantive law on costs” in domestic arbitrations governed by the Act68, it is submitted that this is the only interpretation to the Explanation to Section 31-A(1) that could give effect to the recommendations of the Law Commission and bring into reality a regime for actual costs as recommended by the Supreme Court52. But this interpretation would require an elucidation of the term “reasonable” governing the Explanation. Some suggestions are made to ensure the predictability of the provisions by applying the normative justifications for cost shifting systems.
As society advances, old laws and precedent need to be invigorated to meet the needs of the future, this is known as the concept of dynamic predictability19. The English Rule where the loser pays the winner’s costs dissuades a litigant from bringing forward arguments that “push the envelope” so to say. A loser pays system incentivises the bringing of high probability cases and discourages unknown outcome or low probability or novel cases69. The American Rule, on the other hand encourages the bringing of novel and challenging claims as also the raising of novel and interesting defences, with there being no risk of increased costs of paying the opposite parties litigation expenses69. Perhaps, arbitrators need be mindful of this psychological effect caused by the English Rule on costs when exercising their discretion and in cases where they note that the claim or defence was novel and served to advance the procedural or substantive law applicable to the dispute, they should opt not to enforce the English Rule and rather direct that the parties to bear their own legal costs. The Arbitral Tribunal will of course be required to give reasons in support of its conclusion to apply the American Rule70.
Misused by parties cost shifting systems can create sub-optimal conditions within the system. Research indicates that the English Rule, encourages greater expenditure by claimants irrespective of the merits of their claim, an effect known as “the optimism effect”71. This may also be a litigation strategy adopted by more affluent litigants against litigants who are evidently less affording. Arbitrators must be mindful of and acquaint themselves with the background of the parties in proceedings before it and this must include an understanding about the parties’ financial limitations. Perhaps in such circumstances costs should be awarded by applying the doctrine of proportionality. Cost awards would therefore not be permitted to exceed a portion of the sum in dispute. Expenses over this proportion should not be considered. The Tribunal could communicate its intention to keep costs budgeted in this manner with the parties during the first procedural meeting in the proceedings72.
Cases that raise vexatious and frivolous claims and defences and in particular cases that would fall under the category of covered cases where the alleged claims and defences have already been rejected by prior precedent must be met with an award of costs at actuals as a measure to dissuade litigants from raising such claims and defences73. This approach encourages the early settlement of such disputes. The same principle must be applied where parties litigate in bad faith and adopt delay and guerrilla tactics74 to undermine the arbitration proceedings75.
What would be reasonable costs, in a situation where the Arbitral Tribunal has to apportion costs between the parties. A few illustrations may help explain the situation, a claimant has been successful with respect to 80% of its claims made in an arbitration. The Tribunal may therefore opt to award the claimant 80% of its legal fees as costs. The respondent would bear its own costs. In the above example assume the respondent had been successful in respect of 20% of its counter-claims and hence was unsuccessful in 80% of its counter-claims. In such a situation the claimant would be entitled to receive 60% of its legal fees as costs and the respondent would have to bear its own costs. This principle of computing costs is known as the Welamson doctrine76 whereby the Arbitral Tribunal is to determine a costs reimbursement claim i.e. a percentage derived from dividing the monetary award by the monetary sum sought. The system encourages parties to file realistic and probable claims and therefore also encourages settlement75. Tribunals may opt to depart from applying these principles where it notes (a) the case advanced by the party liable to pay the costs reimbursement claim was novel and raised an unsettled question of law, and (b) the fees expended by the successful party were disproportionate to the sum in dispute77.
Arbitrators must require parties to submit a detailed cost statement showing the various items of work and the fees they have charged their client for the same. On receipt of such a statement the Tribunal may opt to apply what is known as the Lodestar figure of computing reasonable costs. The lodestar figure78 is arrived at by multiplying the number of hours of work spent on a matter with a reasonable hourly rate and adjusting this figure against factors such as : (a) the time and effort that could reasonably be required for performing the work needed for a particular case, (b) the novelty of the case at hand, (c) the skill required to perform the services properly, (d) preclusion from other avenues of employment on account of the dedication of time to the case at hand, (e) the desirability or undesirability of a case, and (f) fee awards in similar cases, etc79.
Ultimately, arbitration is about party autonomy and meeting the users’ expectations of the process is therefore paramount. Section 31-A recognises this important aspect and stipulates that a party agreement on costs will prevail over the provisions of the Act. The Act stipulates that such an agreement must be arrived at after the dispute being arbitrated has arisen. It seems unlikely that litigating parties are going to cooperate on an issue as biting as costs once a dispute has already arisen. This is perhaps another avenue for arbitrator involvement and an Arbitral Tribunal may be able to nudge the parties towards such an agreement through discussions on budgeting the proceedings at the first procedural meeting80. If the parties can be brought to an agreement on limits of procedural filings, evidentiary hearings, time-limits for arguments, costs in respect of venues, stenographers, travel, accommodation, etc. they may also be persuaded to agree on a fee rate limit for these items. An Arbitral Tribunal may then request the parties to submit their budgets to the tribunal for its record and the two budget statements together could well be treated as an agreement for the purposes of Section 31-A(5) of the Act.
Research indicates that these cost systems play a vital role in connection with a party’s decision to settle a claim or not. Settlement occurs when both sides agree that the offer on the table puts them in a better off position then going to trial81. That decision is however dependent on an information symmetry. But during the pre-trial stage, there is an asymmetry of information and the parties cannot be absolutely assured of the evidences available at the disposal of their opponent, in fact pre-discovery, they may themselves be unaware of certain evidence having a bearing on their own case. The defendants where the English Rule operates tend to misstate/overstate their case with the hopes of negotiating a more favourable settlement. This results in sub-optimal settlements or in a failure to settle and thus an increase in the number of litigations82. A tribunal may address this psychology by requiring the parties to share privately a without prejudice offer, the claimant must either accept or make a counter offer and the tribunal may even insist that the parties meet privately and deliberate the offers that have been exchanged prior to the completion of pleadings. After this process is completed, the Arbitral Tribunal should require both parties to share a “calderbank offer”83. The calderbank offer details may be shared by the parties with the Arbitral Tribunal when the Arbitral Tribunal pronounces its award on merits and is conferring with the parties on its decision on costs. If the tribunal finds that a reasonable offer was made and not accepted it may opt not to award costs to the successful party and vice versa. This would be a mechanism that brings predictability to the term reasonable offer appearing in Section 31-A(3)(d) of the Act.
While Section 31-A does not provide for a two-way offer mechanism as prescribed herein, arbitrators must insist on the aforementioned procedure as it ensures, that the offering party does not dig in their heels under a mistaken belief that by merely making the offer they have thereby avoided a cost shifting order against themselves in the future, likewise, allowing the party receiving the offer to make a counter offer ensures that they are not pressurised into accepting a low offer fearing that they may in the future have to bear their own expenses on account of an offer having been made and most importantly it gives the Arbitral Tribunal adequate information as to whether (a) the original offer was a reasonable one, (b) whether the offer was unreasonably refused and this information is necessary to make an appropriate order on reasonable costs under the regime. This mechanism enhances the likelihood of an optimal settlement84.
It is believed that applying these principles in the award of costs the new substantive law on costs in domestic arbitrations will be interpreted in a predictable manner bringing consistency and stability to the system. Hopefully, the system then becomes a regime that can live and not just be endured85.
† Mikhail Behl, FCI Arb, FPD, BA, LLM (Edinburgh).
* The article has been published with kind permission of SCC Online cited as (2023) 1 SCC J-20
1. Richard A. Posner, “An economic approach to legal procedure and judicial administration”, 2 Journal of Legal Studies 399 (1973).
3. David M. Trubek, Austin Sarat, William L.F. Felstiner, Herbert M. Kritzer and Joel B. Grossman, “The costs of Ordinary Litigation”, 31 UCLA L Rev 72 (1983).
4. See Gould, “The Economics of Legal Conflict”, 2 Journal of Legal Studies 279 (1973); Steven Shavell, “Suit, Settlement and Trial : A theoretical analysis under alternative methods for the allocation of legal costs”, 11 Journal of Legal Studies 55 (1982).
5. Jhering, The Struggle for Law (1879).
6. Roscoe Pound, “A Theory of Social Interests”, 15 American Sociological Society Pub 16 (1920).
7. Harold G. Reuschlein, Roscoe Pound — “The Judge 90”, University of Pennsylvania Law Review 292 (1942).
8. An illustration of which are the increased investments in litigation on account of systemic delays and additional costs incurred in challenges to erroneous decisions. See David M. Trubek, Austin Sarat, William L.F. Felstiner, Herbert M. Kritzer and Joel B. Grossman, “The costs of Ordinary Litigation”, 31 UCLA L Rev 72 (1983).
9. Avery W. Katz and Chris W. Sanchirico, “Fee Shifting in Litigation : Survey and Assessment”, University of Pennsylvania Law School Institute for Law and Economics Research Paper No. 10-30. Accessible on SSRN here:<http://ssrn.com/abstract=1714089> (last accessed on 2-6-2022).
10. See : Sections 15 to Section 25 of the Civil Procedure Code, 1908. The jurisdiction of courts in India are determined on the basis of the subject-matter of the proceeding. In the Presidency Towns [Bombay (Mumbai), Calcutta (Kolkata) and Madras (Chennai)], the Letters Patent of the Chartered High Courts permit the bringing of original civil proceedings before the High Court if a “material part” of the cause of action arose within the territorial jurisdiction of the Court. See : Clause XII of the Letters Patent of the High Court of Judicature at Bombay. Thus, it appears as a theme running through civil procedure legislations that the court having the closest causal connection with proceeding are conferred jurisdiction. The aim of these provisions is to reduce the expenses connected with litigating in a forum non conveniens.
11. Order 37 of the Civil Procedure Code, 1908 under the provisions of which defendants are required to seek leave of the Court to defend monetary claims arising out of a defined category of instruments and transactions.
17. Arthur L. Goodhart, “Costs”, 38 Yale LJ 849 (1929).
18. Oliver Wendal Holmes, The Common Law, (1881).
19. Keith N. Hylton, “Fee Shifting and Predictability of Law”, 71 Chi-Kent Rev 427 (1995).
20. The expression “the costs shall follow the event” means:“that the party who on the whole succeeds in the action gets the general costs of the action, but that, where the action involves separate issues, whether arising under different causes of action or under one cause of action, the costs of any particular issue go to the party who succeeds upon it.” See : Reid Hewitt & Co. v. Joseph,  A.C. 717 (HL).
21. Arcambel v. Wiseman, 1 L.Ed. 613 : 3 US 306 (1796) : 3 Dall. 306.
22. Frances Kahn Zemans, “Fee Shifting and the implementation of public policy”, 47 Law & Contemporary Problems 187 (1984).
24. It is stated that there was a general distrust of the persons who acted as attorneys during this period. See Arthur. L. Goodhart, “Costs”, 38 Yale LJ 849 (1929).
25. A.H. Chroust, The rise of the legal profession in America (1965).
26. Ehrenweig, “Reimbursement of Counsel Fees and the Great Society”, 54 Calif L Rev 792 (1966). The author jokes about how a New York statute fixed the fees of attorneys in the year 1848 but then forgot to raise the rates as times changed.
27. Max Radin, “Contingent Fees in California”, 28 Cal L Rev 587 (1940).
28. Alfred D. Youngwood, “The Contingent Fee — A reasonable alternative”, 28 Modern Law Review 330 (1965).
29. Plitt, ex p, 19 F Cas 875 (CCED Pa 1853) (No. 11,228); Lytle v. State, 17 Ark 608 (1857); Bayard v. McLane, 3 Del. (3 Harr) 139 (1840); Newkirk v. Cone, 189 Ill 449 (1857); Evans v. Bell, 36 Ky (6 Dana) 479 (1838); Major’s Exec v. Gibson, 48 Va (1855).
30. John Leubsdorf, “Towards a History of the American Rule on Attorney Fee Recovery”, 47 Law & Contemporary Problems 9 (1984).
31. Civil Rights Attorney’s Fees Awards Act, 1976. Other Federal Statutes that prescribe fee shifting include the Organised Crime Control Act, the Freedom of Information Act, the Consumer Product Safety Act.
32. Fraudulent appraisal of jewellery in the State of New York invites an Attorney Fee Award under NY Gen Bus Law §239-c (McKinney Supp, 1982). Unfair dairy trade practices invite an Attorney Fee Award under Minn Stat Ann §32A-09 subd 1 (West 1981).
33. Hullock, Law of Costs (1793).
34. 43 Eliz Cf 2 (1601)
35. 4 Jac I, c.3 (1607)
37. “The Taxing Master is the person whose duty it is to decide questions of quantum and it is not right for the Judge to interfere in such a matter”. See Ogilvie v. Massey,  P. 243 (CA); Smith v. Buller, [L.R.] 19 Eq. 473.
38. The Supreme Court of Judicature (Consolidation) Act, 1925.
39. Lord Justice Scrutton remarked that engaging Mr Jowitt KC was a “super luxury” and that the client who took that unnecessary step of briefing him must pay for the luxury.
40. Leonhardt v. Kalle, 39 Sol J 524 (1895).
41. L. Wenger, Institutes of the Roman Law of Civil Procedure (1940).
42. Engelmann, The Roman Procedure, in a History of Continental Civil Procedure [R. Millard (Ed.) 1927].
43. Werner Pfenningstorf, “The European Experience with Attorney Fee Shifting”, 47 Law and Contemporary Problems 37 (1984).
44. Austria § 41 App 85; Belgium Art 1017, App 89; Denmark § 312(1), App 90; France Art 696, App 102; Geneva Art 122(1), App 104; Germany § 91(1), App 106; Italy Art 91, App 110; Netherlands Art 56, App 112; Norway § 172, App 114; Spain (b), App 119; Sweden Ch 18 § 1, App 119; Zurich § 64, App 123.
45. Denmark § 313, App 91, provides specifically that an action that is dismissed entirely is deemed to be lost by the plaintiff for the purposes of cost reimbursement.
46. Austria § 43, App 86; Norway § 174, App 115; Italy Art 92, App 111; Netherlands Art 56(1), App 112.
47. Austria § 41(1), App 85; Germany § 91(1), App 106; Netherlands Art 56(1), App 112.
48. Thomas D. Rowe Jr., “The Legal Theory of Attorney Fee Shifting : A critical overview”, 1982 Duke LJ 651 (1982).
49. Section 35 of the Civil Procedure Code, 1908 makes the discretionary powers conferred by the section to award costs, subject to such conditions and limitations and provisions of any law being in force.
51. The case dealt with arguments regarding the “anticipatory breach of contract”.
55. The view of the court matches the view taken in England in (1928) 67 Law Journal 174.
56. Ehrenweig, “Reimbursement of Counsel Fees and the Great Society” 54 Calif L Rev 792 (1966).
59. Malhotra, Commentary on the Law of Arbitration, Vol. 1, 4th Edn. (Wolters Kluwer 2020).
66. See discussion above and reference notes 49 to 51.
67. See discussion above and reference notes 65 to 70.
69. Harold J. Krent, “the Fee-Shifting Remedy : Panacea or Placebo”, 71 Chi-Kent L Rev 415 (1995).
70. Section 31-A(2)(b).
71. Avery Katz, “Measuring the demand for litigation : is the English Rule really cheaper?” 3 Journal of Law, Economics and Organisation 143 (1987).
72. Professor Doug Jones AO, “Using Costs Orders to Control the Expense of International Commercial Arbitration”, International Journal of Arbitration, Mediation and Dispute Management, Vol 82, Issue 3, pp. 291-301 (2016).
73. George L. Priest & Benjamin Klein, “The Selection of Disputes for Litigation”, 13 Journal of Legal Studies 1 (1984).
74. Guerrilla tactics mean and include steps intended to delay, derail or sabotage arbitral proceedings. See Peter A Halprin, resisting guerrilla tactics in international arbitration, International Journal of Arbitration, Mediation and Dispute Management, Vol. 85, Issue 1, pp. 87-97 (2019).
75. John Yukio Gotanda, “Awarding Costs and Attorneys’ Fees in International Commercial Arbitrations”, 21 Mich J Int’l L 1 (1999).
76. Lars Welamson, “Principer om rattengangskostnader under debatt”, Festskrift Till Olivecrona, 684-709 (1964).
77. Edward F. Sherman, “from ‘Loser Pays’ to modified offer of judgment rules : reconciling incentives to settle with access to justice” 76 Tex L Rev 1863 (1988).
78. Stalnaker v. DLC Ltd., 376 F. 3d 819, 825 (8th Cir 2004); Atwell, In re, 148 BR 483, 488 (Bankr, WD Ky 1993).
79. Chip Bowles Jr., “What is Reasonable under Lodestar?” <https://web.archive.org/web/20180922071156/ https://www.americanbar.org/content/newsletter/publications/ law_trends_news_practice_area_e_newsletter_home/lodestar.html#2> (last visited on 10-6-2022).
80. Professor Doug Jones AO, “Using Costs Orders to Control the Expense of International Commercial Arbitration”, International journal of Arbitration, Mediation and Dispute Management, Vol 82, Issue 3 (2016).
81. Steven Shavell, “Suit, Settlement and Trial : A Theoretical analysis under alternative methods for the allocation of legal costs”, 11 Journal of Legal Studies 55 (1982).
82. Edward A. Snyder and James W. Hughes, “The English Rule for allocating legal costs : Evidence confronts theory”, 6 Journal of Law, Economics and Organisation (1990).
84. Thomas D. Rowe Jr. & Neil Vidmar, “Empirical Research on offers of settlement : A preliminary report”, 51 Law & Contemporary Problems 13 (1988).
85. Hubert Selby Jr., Requiem for a Dream (1978).