Arbitration Agreements: Key Considerations for Effective Arbitration Clauses

INTRODUCTION

Arbitration is a way to settle disagreements outside of court. It’s become more common in recent years because it allows involved parties (called “parties”) to have more control (called “party autonomy”) and keeps things private (called “confidentiality”). This is decided in a binding agreement called an arbitration agreement. While arbitration offers benefits, it can also be complex.

Unlike going to court, arbitration doesn’t start when a disagreement happens. It starts when the parties agree to arbitration beforehand in an arbitration agreement. This agreement is crucial because it gives the arbitrator (the person who decides the disagreement) the authority to make a decision, and it allows that decision to be enforced later.

A well-written arbitration clause can make the arbitration process smoother. However, a poorly written one can lead to long, expensive disputes and unenforceable decisions. There’s a middle ground for crafting an arbitration agreement. It shouldn’t be too short or too long. A very short agreement might not be clear or even valid. A very long one could be difficult to follow and limit the arbitrator’s ability to handle the case effectively. The arbitration agreement acts as a guide for the entire arbitration process. It sets the rules and expectations for how the disagreement will be resolved.

In short, the facts of the case are what matters most, not technical legal rules. Because of this, a well-crafted arbitration agreement is essential for any situation where parties want to use arbitration to settle their disputes. It requires careful planning and consideration of potential issues.

THE ARBITRATION AGREEMENT

An arbitration agreement is the fundamental reason why arbitration even exists. It’s the key that unlocks the entire process. Through this agreement, parties choose to bypass the court system and have their disputes settled by a neutral third party, the arbitral tribunal. The agreement not only creates the tribunal but also defines its powers and limitations.

The Arbitration and Conciliation Act of 1940 offered a rather loose definition of an arbitration agreement. It simply stated that it was a written agreement to settle current or future disagreements through arbitration, with or without a named arbitrator.

Recognizing the need for more clarity, the Act of 1996 introduced a more specific definition in Section 7[1]. Here’s a breakdown of the key points:

• An arbitration agreement is a written pact between parties to submit all or some of their existing or potential disputes to arbitration.
• This agreement can be included as a clause within a larger contract or exist as a separate document altogether.
• It must be in writing, documented in one of the following ways:
  • A signed document by both parties
  • An exchange of written communication (letters, emails, etc.) that clearly records the agreement
  • Legal filings where one party claims the existence of an arbitration agreement and the other party doesn’t dispute it
  • Even referencing a document containing an arbitration clause within a written contract can be enough to establish an arbitration agreement.

In simpler terms, an arbitration agreement is formed when two parties agree in writing (through a contract or separate document) to resolve any future disputes arising from their agreement through arbitration, not the court system. A neutral third party, the arbitrator, will act as a judge and make a binding decision.

The 1996 Act emphasizes the importance of the arbitration agreement. Section 8 [2] clearly states that once a court acknowledges a valid arbitration agreement, it should refrain from getting involved in the dispute’s details and direct the parties to the arbitration.

An arbitration agreement is a commitment. As the Supreme Court ruled in the case of Ravi Prakash Goel v. Chandra Prakash Goel[3], parties cannot disregard the agreement and go directly to court if a dispute arises. When a valid arbitration agreement exists, Section 8 of the Act mandates courts to refer the parties to arbitration.

THE MANY FORMS OF ARBITRATION AGREEMENT

The Arbitration and Conciliation Act of 1996 (the Act) requires arbitration agreements to be in writing (Section 7). However, the Act offers parties flexibility in how they create that written agreement[4]–

1. Standalone Arbitration Agreement

This is a separate document distinct from the main contract between the parties. It specifically addresses arbitration as the dispute resolution method.

2. Arbitration Clause

This is a clause embedded within a larger contract, typically outlining dispute resolution procedures in case of disagreements arising from the contract. An arbitration clause functions as a complete arbitration agreement.

3. Incorporation by Reference

Imagine a scenario where you have a standard arbitration clause in a separate document. You can incorporate this clause into a new contract by simply referencing it. Section 7(5) of the Act allows this but with a caveat:

• The new contract must be in writing.
• The reference to the separate document containing the arbitration clause must be clear and demonstrate the intention to make it part of the new contract.

The Supreme Court, in M/s Elite Engineering and Construction (HYD.) Private Ltd. v. M/s Techtrans Construction India Private Ltd.[5], clarified that a vague reference to incorporating a separate arbitration clause won’t suffice. The reference needs to be specific and show the parties’ intent.

4. Agreement Through Communication

Section 7(b) of the Act allows for arbitration agreements formed through written communication channels. This includes emails, letters, telexes, or telegrams. The key is that this communication must clearly and undeniably establish both parties’ agreement to resolve disputes through arbitration.

A recent example is Galaxy Infra and Engineering Pvt. Ltd v. Pravin Electricals Pvt. Ltd, where the Delhi High Court recognized a draft agreement exchanged via email as a valid arbitration agreement.[6]

5. Agreement by Non-Denial

This hinges on Section 7(c) of the Act and the case S.N. Prasad v. Monnet Finance Ltd. Here, if one party asserts the existence of an arbitration agreement in a legal claim, and the other party doesn’t contest it (essentially remains silent), this silence can be interpreted as an agreement to arbitrate.[7]

While the Act offers various ways to form an arbitration agreement, incorporating an arbitration clause directly into the contract itself is generally considered the most recommended practice. This ensures clarity and avoids any potential disputes about the existence or validity of the agreement.

DRAFTING OF AN ARBITRATION AGREEMENT

The Supreme Court[8] has outlined key elements for a binding arbitration agreement:

• Written agreement: The agreement to arbitrate must be in writing.
• Broad scope: Disputes, current or future, arising from the contract can be referred to a private arbitration panel.
• Fairness: The arbitrators must be impartial and provide both parties a chance to present their cases.
• Binding decision: Both parties agree to be bound by the arbitrator’s decision.
• Clear intention: The agreement to use arbitration must be unambiguous and leave no room for doubt.
• Mutual understanding: Both parties must agree to the same thing in the same way (consensus ad idem).
• Obligation to arbitrate: The wording should show a commitment to arbitration, not just an option. Phrases like “may refer” or “can choose” are too weak.
• No opt-out clauses: The agreement shouldn’t contain clauses that specifically exclude the essential elements mentioned above, like allowing a decision without a hearing.
• Formal language not required: While clear and precise wording is best, using terms like “arbitration” or “arbitrator” isn’t strictly necessary. As long as the core principles are met, the agreement can still be valid.

While the previous points cover essential elements, here are some additional considerations for crafting strong arbitration agreements:

1. NUMBER OF ARBITRATORS – Decide how many arbitrators you’ll need. Complex issues might require a panel of experts, while simpler disputes can be handled by one. Each party may want to choose an arbitrator, which can be helpful for complex disputes. Indian law allows any number of arbitrators, but an odd number avoids deadlocks where arbitrators disagree. Having more arbitrators increases costs and makes scheduling meetings harder. For efficiency, most agreements choose either a sole arbitrator or a three-person panel.
2. APPOINTMENT- The best approach is for both parties to decide on a selection process in the arbitration agreement itself (Section 11 of the 1996 Act)[9]. If there’s no agreement, the law sets a default process:

• Sole arbitrator: A court will appoint the arbitrator.
• Three arbitrators: Each party picks one arbitrator, and those two choose a third (presiding) arbitrator.

In the past, agreements often gave one party sole power to appoint an arbitrator. This is no longer valid in India. The Supreme Court has ruled that both parties must have a say in the appointment process.[10]

3. LANGUAGE OF PROCEEDINGS – If the parties involved in arbitration speak different languages, misunderstandings and delays can occur. Translation costs can also add up quickly. To avoid these problems, include a clause in your arbitration agreement specifying the language to be used during the proceedings. This will save time and money in the long run.
4. AD HOC OR INSTITUTIONAL ARBITRATION-

Ad hoc: In this type of arbitration, you and the other party have complete control over the process. You decide on the rules and procedures, and you appoint the arbitrator(s) yourselves. This can be more flexible and potentially cheaper.

Institutional: Here, a specialized arbitration institution like the Delhi International Arbitration Centre (DIAC) handles the administration. They’ll provide pre-defined rules, appoint arbitrators, and offer general support throughout the process. This can be faster and more efficient, especially for complex cases.

Traditionally, ad hoc arbitration has been more common in India. However, recent changes in the law aim to make institutional arbitration a more attractive option.

5. SEAT AND VENUE-

The Arbitration Act doesn’t define “seat” and “venue,” which caused confusion until recent court cases. The Supreme Court ruled in the Balco case[11] that the “seat” is the most important location. It determines which court has oversight and what laws apply (curial law). For example, if the seat is in London, Indian law wouldn’t apply. The 2015 Act added a wrinkle. Even in international arbitrations with a seat outside India, some Indian laws might still apply. The good news is courts have clarified the difference between “venue” and “seat.” The “venue” is simply the physical location where hearings happen. So, even if hearings are held abroad, the Indian law can still apply if the seat is in India.

In a recent case of BGS-SGS SOMA-JV Vs. NHPC Ltd., the court said if the agreement only specifies a venue but not a seat, the venue will be considered the seat. To avoid confusion, always specify the seat of arbitration in your agreement. This determines which court has authority and what laws govern the process.

6. GOVERNING LAW –

There are two types of law to think about in arbitration agreements.

• The first is the law applied to the main contract itself (governing law of the substantive contract). This decides how the arbitrator settles the dispute.
• The second is the law applied to the arbitration agreement itself (the governing law of the arbitration agreement). This governs things like the validity of the agreement and the procedures used in arbitration.

In some cases, both agreements use the same law. But you can also choose separate laws for each, as long as it’s clearly stated in the arbitration agreement. It’s important to specify the law governing the arbitration agreement to avoid confusion, especially in international contracts. This ensures everyone knows which laws apply to the arbitration process itself.

7. ARBITRATION RULES-

The agreement should specify which arbitration rules will be followed. These determine the procedures used throughout the arbitration, like how evidence is presented or whether arbitrators are chosen.

Examples of common arbitration rules include ICC, DIAC, and LCIA rules.

The governing law you choose decides how the dispute itself is settled, while the arbitral rules govern the arbitration process. Specifying the rules upfront avoids confusion and delays later. Everyone knows the procedures to be followed. Many arbitration institutions offer recommended clauses to include in your agreement. These can be a helpful starting point to ensure your clause covers everything it needs to.

CONCLUSION

Arbitration offers a valuable alternative to court litigation, providing a faster, more private, and potentially more flexible way to resolve disputes. However, the success of arbitration hinges on a well-drafted arbitration agreement. This agreement establishes the foundation for the entire process, outlining the key aspects of dispute resolution.

A strong arbitration agreement should incorporate several key elements. First and foremost, it must be in writing, clearly outlining the intent to use arbitration for future disputes. The agreement should encompass all potential disputes arising from the contract and ensure fairness by guaranteeing impartial arbitrators and the opportunity for both parties to present their cases.

Beyond these fundamentals, additional considerations can further strengthen the agreement. Specifying the number of arbitrators, their appointment process, and the language of proceedings can streamline the process and avoid potential roadblocks. Choosing between ad hoc or institutional arbitration offers a balance between flexibility and efficiency.

Clarifying the seat of arbitration, the venue for hearings, and the governing laws applicable to both the contract and the arbitration agreement itself minimizes confusion and ensures everyone involved understands the legal framework. Finally, referencing established arbitration rules provides a clear roadmap for conducting the arbitration process.

By carefully considering these elements and incorporating them into a well-drafted arbitration agreement, parties can ensure a smoother, more efficient, and ultimately more successful arbitration process. Remember, a well-crafted agreement is an investment that can save time, money, and frustration in the event of a dispute.

Reference(s):

[1] Section 7 in the arbitration and conciliation act, 1996. Available at: https://indiankanoon.org/doc/1846895/ (Accessed: 30 June 2024).

[2] Section 8 in the Arbitration and Conciliation Act, 1996. Available at: https://indiankanoon.org/doc/1146817/ (Accessed: 30 June 2024).

[3] Ravi Prakash Goel v. Chandra Prakash Goel . Available at: https://www.casemine.com/judgement/in/5609ae49e4b01497114136ac.

[4] Sehgal, D.R. (2020) Arbitration agreement: A Primer and a checklist, iPleaders. Available at: https://blog.ipleaders.in/arbitration-agreement-primer-checklist/ (Accessed: 30 June 2024).

[5] ELITE ENGINEERING AND CONSTRUCTION (HYD.) PRIVATE LIMITED Vs. TECHTRANS CONSTRUCTION INDIA PRIVATE LIMITED (no date) JURIS-THE LAWS. Available at: https://www.the-laws.com/Encyclopedia/browse/Case?caseId=008102711000&title=elite-engineering-and-construction-hyd-private-limited-vs-techtrans-construction-india-private-limited.

[6] Galaxy Infra And Engineering Pvt. Ltd vs Pravin Electricals Pvt. Ltd on 12 May 2020 Equivalent citations: AIRONLINE 2020 DEL 786,INDIAN  KANOON. Available at: https://indiankanoon.org/doc/149097059/.

[7]  S.N.Prasad,m/s Hitek … vs M/S monnet finance ltd.& ors on … Available at: https://indiankanoon.org/docfragment/1260958/?formInput=arbitration+agreement+and+parties (Accessed: 30 June 2024).

[8] Arbitration agreement – summary with case law – arbitration agreement (S7)  introduction – define Studocu. Available at: https://www.studocu.com/in/document/m-s-ramaiah-college-of-law/bballb/abitration-agreement-summary-with-case-law/79586625 (Accessed: 30 June 2024).

[9] Section 11 in the Arbitration and Conciliation Act, 1996. Available at: https://indiankanoon.org/doc/1841764/ (Accessed: 30 June 2024).

[10] Perkins Eastman Architects Dpc & Anr vs Hscc India Limited on 20 December 2022 (no date) INDIAN KANOON. Available at: https://indiankanoon.org/doc/94825348/.

[11] Bharat Aluminium Co. v. Kaiser Aluminium Technical Services Inc., (2012) 9 SCC 552 : (2012) 4 SCC (Civ) 810, 06-09-2012