Demystifying Pre-Deposit Clauses in Arbitration Agreements

[Anirudh Lekhi is an associate at a law firm in New Delhi, having graduated from National University of Juridical Sciences in 2017]

Parties elect to incorporate pre-deposit clauses (PDCs) in arbitration agreements to principally weed out frivolous claims. Typically, PDCs provide for parties to deposit a portion of the amount claimed, with a bank, before initiating arbitration. In this regard, a PDC was the subject matter of adjudication before the Supreme Court of India. In March, the Court in ICOMM Tele Ltd. v. Punjab State Water Supply & Sewage Board & Anr. struck down the PDC in question on the ground that it was arbitrary and unjust. Some commentators hailed the decision in ICOMM for adopting a “pro-arbitration” stance as they opined that the absence of such PDCs would now encourage more parties to arbitrate. (See here and here)

However, I submit that the Supreme Court’s belief that the absence of such clauses in arbitration agreements would encourage alternate dispute resolution, is misplaced. Importantly, I also establish that the Court misread previous case law on the subject matter and erroneously invaded into areas of state policy.

Facts in dispute

The Punjab State Water Supply & Sewage Board issued a notice inviting tender, which contained a detailed arbitration clause. The arbitration clause in turn contained a PDC that required a party to deposit 10% of the amount claimed with a scheduled bank before initiating arbitration. Significantly, the deposit was only to be refunded in proportion to the amount finally awarded, while the rest of the amount was to be forfeited.

In view of the foregoing, ICOMM Tele participated in the above tender process. When certain disputes arose between ICOMM Tele and the Board, ICOMM Tele proposed to waive the 10% pre-deposit fee before commencing arbitration. However, the arbitrator’s refusal to accede to such a request compelled ICOMM Tele to challenge the PDC before the High Court of Punjab and Haryana. It is important to note that since the Board is a public body, administered by the State of Punjab, the PDC was challenged by way of a public law remedy i.e. a writ petition. However, the High Court dismissed ICOMM Tele’s writ, leading it to assail the High Court’s decision before the Supreme Court.

The Supreme Court’s ruling

The Supreme Court set aside the PDC primarily on the ground that it violated Article 14 of the Constitution of India. In holding so, the Court based its decision on two planks. First, it held that the imposition of exemplary costs was an equally effective way to eliminate frivolous claims. But since the PDC postulated that such deposit was to be made before any determination of the claim being frivolous, the same was held to be arbitrary and unfair.

Second, the Supreme Court observed that the clause was “excessive”, “disproportionate” and “wholly unjust”, as it required the party to forfeit the proportion of the deposit corresponding to the proportion of the claim that it was unable to establish. Accordingly, the Court struck the PDC down on the ground that a deposit of 10% would discourage parties from invoking arbitration. In the Court’s opinion, the presence of such a clause would run contrary to the objective of the de-clogging the court system and render the arbitral process ineffective and expensive.

Comment

The Supreme Court has been seized of disputes concerning challenges to PDCs previously as well. In this light, ICOMM is particularly vulnerable since it has misapplied prior case law on the subject and erroneously held that the object of alternative dispute resolution would be achieved more effectively in the absence of such PDCs.  

Misapplication of previous case law

In view of the above, the case of S.K. Jain v. State of Haryana is of particular significance. S.K. Jain concerned a challenge to a PDC that required a party to deposit 7% of the total amount claimed before initiating arbitration. Much akin to ICOMM, this clause was also challenged on the ground of it being “arbitrary”, “unreasonable” and “capricious” by way of a writ petition. The Supreme Court negated this challenge by placing key reliance on Excise Commissioner v. Issac Peter wherein the following was observed:

We are therefore, of the opinion that in case of contracts freely entered into with the State, like the present one, there is no room for invoking the doctrine of fairness and reasonableness against one party to the contract (State)…merely because it happens to be the State. In such cases, the mutual rights and liabilities of the parties are governed by the terms of the contracts…It must be remembered that these contracts are entered into pursuant to public auction, floating of tenders or by negotiation. There is no compulsion on anyone to enter into these contracts. It is voluntary on both sides…” 

[Emphasis added]

In view of the above, it bears emphasis that the Supreme Court clearly underscored that state contracts are entered into after discussion and deliberation. In fact, no party is ever compelled to broker any contract with the state. Though the decision in S.K. Jain was cited before the Supreme Court in ICOMM, it attempted to distinguish the same. However, in doing so, it is argued that the Supreme Court fell in grave error. 

First, the Court suggested that S.K. Jain was distinguishable from ICOMM inasmuch as no plea concerning a violation of Article 14 of the Constitution was raised in S.K. Jain . But this inference is plainly contrary to the grounds of challenge mentioned in paragraph 5 of S.K. Jain, which includes—“arbitrariness” as one such ground. In fact, as extracted above, S.K. Jain itself alludes to “fairness” and “reasonableness” (as cited in Issac Peter), which are nothing but facets of Article 14 only.

Second, the Supreme Court distinguished the PDC in S.K. Jain from the one in ICOMM on the basis that while the former required the entire deposit to be refunded upon the culmination of the arbitral proceedings, the latter provided for a refund only on a proportionate basis. In this regard, though the PDC in ICOMM is concededly different, that alone should not lead the Court to observe that the ratio in S.K. Jain is “wholly distinguishable”. Evidently, the different commercial realities or requirements of each tender may justify the uniqueness of each PDC. Surely, the Supreme Court ought to be alive to the fact that it will be exceedingly difficult to apply judicial precedents, which concern the same tender conditions. In any event, the grounds of challenge, the contentions of the parties and the question of law, were materially similar in both ICOMM and S.K. Jain. Therefore, it could not be said that the ratio of S.K. Jain was not applicable to ICOMM.

In light of the above, it emerges that even though S.K. Jain was rendered by a larger bench of three judges, ICOMM made a meek attempt to circumvent S.K. Jain’s ratio, which it was otherwise bound by.

Nature of pre-deposit clauses

At this juncture, it may be recalled that ICOMM held the PDC to be arbitrary since the proportionate forfeiture of the deposit was “excessive” and “unjust”. In holding so the Supremee Court observed that the imposition of exemplary costs could serve as an alternative for eliminating frivolous claims.

However, it is submitted that the Court’s reasoning is entirely fallacious. It is relevant to note that “exemplary costs” are merely post facto measures that are imposed as penalties for frivolous claims. On the contrary, PDCs constitute a mode to deter vexatious claims even before the arbitration commences. Given that valuable time and money may be spent during arbitral proceedings, it is more imperative to guard against the perils of frivolous claims before their commencement rather than after their culmination. It is evident that that not only did the Supreme Court misunderstand the true purport of PDCs, but it also egregiously strayed into an area only reserved for state policy (See Tata Cellular v. Union of India).  

Objectives of alternate dispute resolution

Finally, the Supreme Court remarked that the absence of such PDCs would subserve the objective of alternate dispute resolution by encouraging more parties to arbitrate. However, this understanding is inapplicable to all arbitrations.

It must be underscored that ICOMM’s ratio is only applicable to cases where at least one party is a public body or a State entity. In fact, the presence of a ‘public element’ in ICOMM is manifest from the state-owned Board being one of the parties. This is precisely the reason the PDC in question was challenged by way of a public law remedy.

In such light, a strictly private contract involving no ‘public element’ will not be governed by ICOMM’s ratio. Consequently, private parties will be free to incorporate PDCs such as the like in ICOMM and initiate arbitration. It is therefore palpable that where a dispute emanates from a purely private contract, there will be no meaningful encouragement for more parties to arbitrate. This being the case, even the objects of alternate dispute resolution that the Supreme Court sought to espouse will not be achieved in such cases.

Conclusion

Seen from any prism, ICOMM suffers from myriad inconsistencies that render the decision extremely vulnerable. In this regard, the Supreme Court failed to appreciate that the need to discourage frivolous claims through exacting PDCs is equally integral to the object of efficient alternate dispute resolution. While such clauses must certainly not be arbitrary, ICOMM misunderstood S.K. Jain’s ratio to reach a specious conclusion.

Moreover, the Court’s belief that more parties would be encouraged to arbitrate will not hold good for disputes involving private parties, as they would fall outside the purview of ICOMM’s ratio. Therefore, it is quite incredible that some commentators have celebrated ICOMM when there exists more cause to lament it.         

Anirudh Lekhi 

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