Arbitration 101: What You Need To Know To Negotiate An Arbitration Clause

Arbitration 101: What You Need To Know To Negotiate An Arbitration Clause

In your journey to elevate your start-up into the next big Indian business, you would have or will definitely end up reviewing a multitude of agreements – vendor agreements, service agreements, customer agreements and so on. For those who have been through this grind, this exercise may have brought you face to face with a term called ‘arbitration’; and perhaps led you to questions like: what is arbitration, how is it different from litigation, what will be the implications of accepting an arbitration clause and will accepting arbitration be in your company’s best interest? In this article, we will tell you all you need to know about arbitration – so that you can negotiate your next arbitration clause like an expert.

What is Arbitration? How is that different from litigating in Court?  

Not all disputes over a commercial relationship need to go to court. Arbitration is an alternate method to resolve such disputes. The Arbitration and Conciliation Act, 1996 (referred to as the “Arbitration Act” or simply the “Act” that governs all matters related to arbitration) permits two or more parties (i.e., are in a commercial or civil relationship) to resolve their disputes through arbitration instead of litigating in court. To do this, the parties must execute a written agreement that sets out the essentials of the arbitration process agreed to by all (referred to as the “Arbitration Agreement”). The Act defines Arbitration Agreement as an “agreement by the parties to submit to arbitration all or certain disputes which have arisen or which may arise between them in respect of a defined legal relationship, whether contractual or not.” This Arbitration Agreement does not need to be a separate contract. Even the addition of an arbitration clause in any contract/agreement will be treated as the Arbitration Agreement.

What should be included in an Arbitration Agreement?

While drafting an Arbitration Agreement (or the arbitration clause), parties should record the number of ‘judges’ that will constitute the ‘Arbitral Tribunal’ for deciding their dispute. These ‘judges’ are called ‘Arbitrators’. Parties can either choose to mutually appoint either one Arbitrator; or any odd number of Arbitrators, to form their Arbitral Tribunal. However, it should be kept in mind that the number of Arbitrators agreed to by the parties must always be an odd number.

Second, parties could set out a process for appointing the Arbitrators.  For example, typically each party chooses to appoint an even number of Arbitrators of their own choice and agrees that the last odd numbered Arbitrator will be appointed by a mutual decision of all the other Arbitrators (appointed by the parties). In this regard, you may note that the Act does not prescribe any restriction/ qualifications/ criteria over who can be choose as an Arbitrator. Furthermore, a person of any nationality can be chosen as an Arbitrator. This type of arbitration is called ‘ad-hoc arbitration’.

Parties can also choose an institution specialising in arbitrations, for settling their dispute; which may have their own process for constituting Arbitral Tribunals and conducting arbitral proceedings. When the arbitration is administered by an institution, it is called institutional arbitration. Some of the popular institutions that conduct arbitration include the Singapore International Arbitration Centre (SIAC), London Court of International Arbitration (LCIA), Indian, New Delhi International Arbitration Centre (NDIAC), Mumbai International Arbitration Centre (MIAC) etc.

Third, parties may also decide and record the procedure that an Arbitral Tribunal is to follow for deciding disputes (such as the process to determine the admissibility, relevance, materiality and weight of any evidence etc. referred to as the “procedural law” by lawyers). Where parties opt for institutional arbitration, they typically agree to the arbitration being conducted under the procedural laws of such arbitral institution.

Fourth, the parties should agree upon the substantive law that will apply to the subject matter of the dispute. Substantive law is a set of rules that govern the rights and responsibilities/obligations as well as sets out penalties and punishments for breach of obligations (eg: the Indian Contract Act, 1872; the Companies Act, 2013 of India). The Act states that if the place of arbitration of a domestic arbitration (explained in the next para) is India, then the substantive law of India would apply to such domestic arbitration. In case of an international commercial arbitration (explained in the next para), where the place of arbitration is situated in India, the parties have the right to decide the substantive law. This means the parties can choose that the substantive law of another country will govern the subject matter of their dispute.

Fifth, the parties can also decide the venue for holding such arbitration and lastly, agree and record the language in which arbitral proceedings are to be conducted.

What is Domestic Arbitration and International Arbitration?

As the term suggests, domestic arbitration means an arbitration conducted to settle dispute between two Indian parties (which could either be individual(s) or entity(ies)). These disputes can be commercial or non-commercial/civil in nature.

International commercial arbitration is defined by the Act to mean an arbitration conducted for dispute settlement where (i) at least one of the parties is an individual (national or resident) of a country other than India; or (ii) body corporate incorporated in another country than India; or (iii) association of body of individuals whose central management and control is exercised in any country other than India; or (iv) the Government of a foreign country. In this type of arbitration, only a dispute of a commercial nature can be referred to arbitration.

What are the rights of parties who agree to India as the place for arbitration?

Parties having their place of arbitration in India: The table below illustrates the variations of domestic and international commercial arbitration are possible in this category.

 

 

Where the parties agree to India as the place of arbitration, then Part I of the Arbitration Act automatically applies to such arbitrations. This will give the party to such an arbitration the following rights and choices:

  • Limitation Period: A party will be able to refer a dispute to arbitration only within the limitation period set out in the Limitation Act, 1963. By default, this limitation period will be calculated from the date on which an aggrieved party sends a request to the other party, to refer the dispute to arbitration. The parties also have the option to agree to calculate the limitation period differently – which should be recorded in the Arbitration Agreement.
  • Interim Order from Court: Before or during arbitral proceedings (if certain conditions are met), party will be able to apply to an applicable court for amongst others, an interim measure of protection (hereinafter, “interim relief”). A party can apply to the applicable court even after the Arbitration Tribunal has given its decision but before the award’s execution by the court. The Arbitration Tribunal’s decision is called an ‘Arbitral Award’. The interim relief referred to above may include – preservation/custody/sale of goods that are subject matter of the dispute; or securing a dispute amount with the court; or grant of an interim injunction (colloquially also known as ‘stay order’) where the applicable court may refrain the other party from taking a certain actions so that status quo is maintained; or any other interim measure of protection that may appear to the applicable Court as just and convenient.
  • Interim Order from Arbitral Tribunal: During the arbitral proceedings or after the Arbitral Award is granted by the Arbitral Tribunal but before the Arbitral Award’s execution, a party will also have the option to apply to the Arbitral Tribunal for amongst others, an interim relief. The interim reliefs that may be requested for are similar to that from a court. These could include – preservation/custody/sale of goods that are the subject matter of dispute; or securing the dispute amount with the court; or detention/preservation/inspection of any property that is the subject matter of arbitration; or an interim injunction; or any other interim measure of protection that may appear to the Arbitral Tribunal as just and convenient.
  • Issuance of Award by the Arbitral Tribunal and Appeal against Arbitral Award by the Court within prescribed time limit: The Act states that the Arbitral Award is to be made within a period of 12 months from the date that the Arbitral Tribunal enters upon reference i.e., the date on which all Arbitrators receive written notice of their appointment. If the arbitrators are not able to make the Award within 12 months, then the parties can consent to extend the period of arbitration for further 6 months. After this 18 month period (12 months and additional 6 months) ends, the mandate of the arbitrators will terminate. However, the parties will have the choice to request a relevant court to extend this arbitration period further.Once the Arbitral Award is given by the Arbitral Tribunal, the parties can apply to the relevant court for its enforcement. If a party is unsatisfied with the Arbitral Award, it can make application under Section 34 of the Act (an application to set aside Arbitral Award before the relevant court) and the application is required to “be disposed off expeditiously and in any event within a period of one year from the date on which the notice” (of such a challenge) “is served upon the other party.
    Furthermore, a party aggrieved by the order of the Court given for an application under Section 34 can appeal to a superior court as per Section 37 of the Act.
  • Fast Track Procedure: Parties can, at any stage either before or at the time of appointment of the Arbitral Tribunal, also agree in writing, to have their dispute resolved by a fast track procedure. Pursuant to a request for fast track arbitral proceedings, the Arbitral Tribunal may, amongst other things, decide the dispute on the basis of written pleadings, submissions and documents filed by the parties without any oral pleadings.
  • Settlement of Dispute: Arbitral Tribunal may give an option to the parties to use mediation, conciliation and other procedures to arrive at a settlement. It is upon the parties to consent to this suggestion or not. If the parties do consent and are able to arrive at a settlement; such settlement will be recorded as an Arbitral Award.

 

How will an Arbitral Award resulting from arbitration in India be enforced?

Where the arbitration is held in India and the arbitral tribunal makes an Arbitral Award, then such an Arbitral Award is treated as “final and binding” (unless it is challenged in court). An Arbitral Award can be enforced by the parties on filing an application before the relevant court, just like a regular court decree.

 

How can an Arbitration Award be challenged or appealed against?

Challenging Arbitral Award under Section 34: The courts will not enforce an Arbitral Award if either party challenges it by moving an application before the relevant court. As mentioned before, an application under Section 32 is required to be made. Court to set aside an Arbitral Award under this application in, amongst others, the following situations only:

(a) where a party files an application before the court that:-

  • it was under some incapacity; or
  • the Arbitration Agreement is not valid; or
  • it was not given proper notice of appointment of Arbitrator or arbitral proceedings and was not able to properly present its case; or
  • the Arbitral Award deals with a dispute not falling within the terms of submission to arbitration; or
  • that the composition of the Arbitral Tribunal or arbitral procedure was not in accordance with the agreed upon Arbitration Agreement; or

(b) where a court finds that the subject matter of dispute cannot be settled under the existing law and/or the Arbitral Award is in conflict with the public policy of India.  (Read more in Section 16(6) read with Section 34 of the Act).

First Appeal under Section 37: Where a court, basis the legal proceedings initiated by the application, makes an order to either set aside or refuses to set aside an Arbitral Award under a Section 34 application, the aggrieved party can also appeal to a higher court against such an order as per Section 37 of the Act.

Second Appeal under Section 37: An order of the higher court can further be appealed to in the Supreme Court, only where the matter merits an appeal.

It has been noted that in practice, nearly all Awards get challenged in the court of law. This means that a party will univariably get dragged into a court litigation after completion of the time bound arbitration. Therefore, if you are a small or a medium sized Indian business doing business with another Indian party, it is advisable to opt for dispute resolution directly through a court. This is because, in our opinion, the dispute resolution may take the same amount of the same time but may turn out to be cheaper than arbitration.

 

Do parties holding arbitration outside India get any rights under the Arbitration Act?

Parties having their place of arbitration outside India: The table below illustrates the variations of international arbitration that are possible in this category. In this article, we will only briefly touch upon the rights of a party conducting such an arbitration.

The Arbitration Act, by default, provides a party (having its place of arbitration outside India) the right to apply to High Court for assistance on the below listed matters set out in Part I of the Act. Please note that if the Parties do not wish to be governed by Part I of the Arbitration Act, then they have to expressly record this understanding in their Arbitration Agreement. Having said that, the following are the rights that a party having its place of arbitration outside India, can avail:

 

  • Interim Order from Court: Similar to the rights granted to parties whose place of arbitration is India, parties having their place of arbitration outside of India can before or during arbitral proceedings (provided certain conditions are met) can apply to the High Court, for amongst others, an interim measure of protection (i.e., ‘interim relief’). A party can apply to the High Court even after the Arbitral Award is granted by the Arbitral Tribunal but before the Arbitral Award is executed by the appropriate court. The interim relief may include – preservation/custody/sale of goods that are the subject matter of a dispute; or securing a dispute amount with the court; or getting an interim injunction; or any other interim measure of protection that may appear to the applicable court as just and convenient.

 

  • Assistance in Collection of Evidence: A party (with the approval of the Arbitral Tribunal) can apply to the High Court for assistance in taking evidence.

 

  • Order to Refer Parties to Arbitration: A party can apply to the single judge of the High Court to refer a matter to arbitration. If the single judge of the High Court refuses to do so, the party(ies) can appeal to against such orders before a division bench of the High Court and thereafter to the Supreme Court.

If you or your company is such an Indian party in a commercial relationship with a foreign party, then you may come across a clause in the Arbitration Agreement (or the Arbitration clause). The clause will state that words to the effect that – “Parties agree to exclude the application of Part I of the Arbitration and Conciliation Act, 1996”. It is important to note that by agreeing to this exclusion, you – as the Indian party are agreeing to waive off your right to take assistance of an Indian Court for the matters enlisted in the paragraph above.

 

How will the Act treat an Arbitral Award resulting from arbitration outside of India?  

An Arbitral Award that results from an arbitration having place of arbitration as outside India, is referred to as a ‘Foreign Award’. Part II of the Act deals with enforcement of such a Foreign Award and appeal from orders thereof. More details about enforcement of Foreign Awards in another blog.

This article is part of a series of posts on basics of contracting by Cornellia Chambers. If your current circumstances do not allow you to hire a lawyer, we hope that these posts will help you navigate a negotiation/ revision when you need to. Although there are several nuances to every legal principle. These layers have developed (and keep evolving) through case laws. So when and where possible you should consult a lawyer who loves thinking for you. 

 Next up in this series will be posts that discuss the basic legal principles around indemnification clause and limitation of liability clause etc. For those of you looking at raising funds, we will also take some glamour away from the ROFRs, ROFOs, TAGs, DRAGs and general investment transaction structures.  Stay tuned for more.

 

 Ishita Bisht with inputs from Pritika Kumar

 

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