Arbitration Agreement to be in consonance with Fundamental Rights enshrined under the Constitution of India – Lombardi Engineering Ltd. v. Uttarakhand Jal Vidyut Nigam Limited– Supreme Court of India

CORAM: Hon ble Chief Justice Dr. Dhananjaya Y. Chandrachud, Hon ble Justice J.B. Pardiwala and Hon ble Justice Manoj Misra.

INTRODUCTION

The case of Lombardi Engineering Ltd. v. Uttarakhand Jal Vidyut Nigam Limited [i] outlined the basic fundamental principles forming a part of a binding arbitration agreement. The present case is arising out of a petitionunder Section 11(6) of the Arbitration and Conciliation Act, 1996 ( Arbitration Act ) before the Hon ble Supreme Court for the appointment of an arbitrator for the adjudication of a dispute arising out of a contract dated October 25, 2019 between Lombardi Engineering Ltd. (the Petitioner ) and Uttarakhand Jal Vidyut Nigam Limited (the Respondent ).

FACTS

The facts leading to the present caseare as follows:

                The Petitioner being a design consultancy firm entered into a contract dated October 25,2019, with the Uttarakhand Project Development and Construction Corporation Limited ( UPDCC )for providing certain consultancy services in relation to a hydro electric project.The Petitioner was to complete the work within a period of 24 (twenty-four) months of commencement, that is, September 25, 2021. Subsequently,a government order dated May 8,2020 was issued, directing the transfer of the hydro-electric project to the Respondent.

                The transfer of the project was done through a tripartite agreement dated October 6, 2020, which novated the original contract to the extent that the Respondent replaced UPDCC and took over the responsibilities, rights and duties therein. Clause 53 read with Clause 55 of thegeneral conditions of the contract ( GCC ) set out the dispute resolution clause which formed the arbitration agreement.Clause 55 (a) of the GCC specifically provided that the the party initiating arbitration claim shall have to deposit 7% of the arbitration claim in the shape of Fixed Deposit Receipt as security deposit.

                In terms of the appointment of arbitrator, Clause 55(b) of the GCC specifically provided that For claim amount upto 10.00 Crores, the case shall be referred to Sole Arbitrator to be appointed by the Principal Secretary/Secretary (Irrigation), GoU .

                As a result of disputes arising among the parties in relation to payment of dues of amount INR 1,04,32,664 (Rupees One Crore Four Lakhs Thirty-Two Thousand Six Hundred and Sixty-Four Only) by the Respondent,the Petitioner invoked the arbitration clause. A notice of arbitration dated May 6, 2022 was issued to the Respondent,calling upon the Respondent for appointment of anarbitrator in accordance with the arbitration clause.

                Further, the notice provided that since the amount involved in the dispute is less than INR 10,00,00,000 (Rupees Ten Crores Only), a sole arbitrator is to be appointed in terms of Clause 55(b) of the GCC.The notice further read that due to the settlement of position of law by the Hon ble Supreme Court in the case of Perkins Eastman DPC and Another v. HSCC (India) Limited [ii] that unilateral appointment of arbitrator is not legal , the name of the arbitrator shall be proposed by the Petitioner for the consideration and appointment by the Respondent.

                Instead ofrespondingto the notice, the Respondentissued a letter dated May 9, 2022 fortermination ofthe contracton the grounds of non-fulfillment of contractual obligation.

                Thus, in light of the above facts, the Petitioner preferred the present application for appointment of an arbitrator invoking Section 11(6) of the Act 1996.

ISSUES

The issues in the present case may be broadly understood as follows:

(i)             Whether Clause 55(a) of the GCC containing the pre-deposit amount prior to initiation of arbitration isvalid?

(ii)           Whether the present appointment clause stipulated in Clause 55(b) of the GCC is in violation of the principle laid down in the case of Perkins Eastman [iii] .

SUBMISSION OF THE PARTIES

Submissions of the Petitioner

                The Petitioner submitted that this Court has the jurisdiction to take measures for constituting an arbitral tribunal as per Section 11(6) of the Arbitration Act since the case is an international commercial arbitration under Section 2(g) of the Arbitration Act.

                Further, it was submitted that the right of appointment of arbitrator given to the respondent under Clause 55(b)(I) of the GCC is a unilateral right, which is unenforceable as on date and in violation of the principles laid down in the case of Perkins Eastman [iv] .

                The counsel further submitted that the pre-deposit amount of 7% (seven percent) prior to the initiation of arbitration under Clause 55(b)(I) of the GCC is also bad in law as it contradicts the decision of the Hon ble Supreme Court in ICOMM Tele Limited v. Punjab State Water Supply and Sewerage Board and Another [v] , which deals with the concept of pre-deposit prior to the initiation of arbitration proceedings and held that such conditions are in violation of Article 14 of the Constitution of India, 1950 ( Constitution ).

                It was further argued that such an arbitration clause is arbitrary, unfair andviolative of the right to equality prescribed under Article14 of the Constitution.

                In view of the above submissions, the counsel prayed that sole arbitrator be appointed for resolving the dispute at hand and the petition be considered on merits.

Submissions of the Respondent

                The counsel for the Respondent submitted that the GCC prescribes for a specific procedure which ought to be adhered to by the Petitioner.In the instant case, the Petitioner has failed to comply with the two conditions laid down under the GCC, being the pre-deposit of 7% (seven percent) of the amount claimed and failure of the Petitioner to approach Principal Secretary/Secretary (Irrigation), Government ofUttarakhand for appointment of an arbitrator. [vi]

                The counsel relied upon the case of SK Jain v. State of Haryana and Another [vii] wherein the three-judge bench of the Hon ble Supreme Court had upheld the pre-condition of deposit prior to initiation of arbitration proceedings. The Petitioner agreed to the pre-deposit clause and cannot question the legality of such a clause in a petition for the appointment of arbitrator violating the principle of party autonomy .

                He further contended that the pre-condition of deposit of 7% (seven percent) is refundable upon the completion of the proceedings amongst the parties, sinceit is in the nature of a security deposit . The main object of such a clause is to ensure that only valid and bona fide claims are made by the parties, and that the project is not hindered by frivolous and baseless claims.

                The casescited by the Petitioner namely SK Jain [viii] and ICOMM Tele Limited [ix] were a substantive challenge to the pre-deposit clause whereas the present petition is under Section 11(6) of the Arbitration Act mainly for the appointment of the arbitrator. Thus, the present Petition ought to be rejected as it is devoid of merits.

ANALYSIS AND JUDGMENT

Pursuant to the analysis of the contentions and submissions of both the parties, the Hon ble Court held that the issue in the present case is not related to the dispute beingnon-arbitrable. It is settled and agreed by both the parties that the dispute is arbitrable. The central issue in the instant case pertains to the validity of the appointment clause under Clause 55(b) of the GCC.

The court analysed the cases of SK Jain [x] , Municipal Corporation Jabalpur and Other v. Rajest Construction Co [xi] and ICOMM Tele Limited [xii] to ascertain the established principles on the issue of the first issue pertaining to the validity of the pre-condition of deposit . It was concluded by the Apex Court in this regard that the clauses relating to the pre-conditions to arbitration in SK Jain and ICOMM Tele Limited were materially different. In the case of SK Jain, the clause provided for a clear refund and the intention of such a clause was to prevent frivolous claims whereas in ICOMM Tele Limited, the clause prescribed a 10% (ten percent) deposit prior to initiation of the arbitration proceedings which was not accounted for, as it would not be fully refunded to the claimant.

Following the same principle, the Hon ble Supreme Court held in the instant case, that there is nothing in Clause 55 of the GCC which provides for the utilisation of the pre-deposit. The contract specifically provides for the accounting of security deposit for performance, but nothing in those clauses of the GCC talk about the pre-deposit of 7% (seven percent). The Apex Court in this regard, held that Such vague and ambiguous condition of 7% pre-deposit of the total claim makes the same more vulnerable to arbitrariness thereby violating Article 14 of the Constitution. .

The Hon ble Supreme Court rejected the submissionof the Respondent that sincethis is a petition for appointment, the validity of the pre-deposit clause cannot be considered.It cannot be said that only a writ petition under Article 226 of the Constitution can decide upon the validity of the pre-condition in the present case.

It further analysed the Hans Kelsen s Pure Theory of Law and compared the Constitution to Kelson s grundnorm. The Hon ble Supreme Court stated as follows, At the top of the pyramid is the Grundnorm, which is independent. The subordinate norms are controlled by norms superior to them in hierarchical order. The system of norms proceeds from downwards to upwards and finally closes at Grundnorm . . The other laws have to be in consonance to the grundnorm. Thus, in the instant case, the layers of the grundnorm as per Kelsen s theory would be in the following hierarchy:

(i)             the Constitution;

(ii)           the Arbitration Act and any other Central/State law;

(iii)         the Arbitration Agreement entered into by the parties.

Thus, the arbitration agreement being subservient to the Arbitration Act, cannot be in violation of the fundamental rights enshrined in Part III of the Constitution and has to comply with the requirements of the Arbitration Act.The concept of party autonomy can thus, not be stretched to an extent where it violates the fundamentalrights provided for under the Constitution. Thus, the Apex Court struck down the argument of the Respondentthat since the Petitioner has agreed to the pre-deposit clause during the signing of the agreement, the Petitioner cannot laterclaim through a petition under Section11(6) of the Arbitration Act that the same is arbitrary and violative of Article 14 of theConstitution, is without any merit.

The Apex Court further,analysed the decision of the Hon ble Supreme Court of Cannada in Uber Technologies etc v. David Heller [xiii] to rely upon the doctrine of unconscionability of pre-conditions . According to this doctrine, any agreement which leads to an inequality of bargaining power, giving one party more power over the other, can be set aside.In this case, a nine-judge bench of the Supreme Court of Cannada stated that deposition of an amount of USD 14,500 (Fourteen Thousand Five Hundred Dollars) is unconscionable.

In regard to the second issue pertaining to the appointment of arbitrator by Principal Secretary/Secretary (Irrigation), Government of Uttarakhand in Clause 55(b) of the GCC, the Hon ble Supreme Court upheld the decisionunderthe Perkins Eastman [xiv] in respect ofthe intention of the legislature to maintain the neutrality of the arbitrators and invalidated the clause under the GCC. Thus, the Apex Court held that the two conditions mentioned in Clause 55(a) and Clause 55(b) of the GCCought tobe ignored, and further appointed Former Chief Justice of the High Court of Sikkim to act as the sole arbitrator.

CONCLUSION

The present caseof the Supreme Court has reiterated the established legal principles in regard to unilateral appointment andhas further gone a step further to re-emphasise the importance of the agreements to be in consonance with the fundamental rights enshrined under the Constitution. The Respondent in the present case is state under Article 12 of the Constitution and is under the duty to preserve and protect the fundamental rights.

Further, the Hon ble Supreme Court relied upon the doctrine of unconscionability leading to a deeper examination of the bargaining power in the appointment procedure. The ApexCourt has, time and again in various cases including Perkins Eastman [xv] and TRF Limited v. Energo Engineering Projects Limited [xvi] ,upheld the neutrality, independence and impartiality of the arbitrators which has been the fundamental principle in the decision of the present case.