Importance of a Well-drafted Arbitration Clause

Importance of a Well-drafted Arbitration Clause

Introduction

Arbitration is a method of dispute resolution between the parties to the contract by a third person known as “Arbitrator”. Arbitration is a cheap, quick, and easy method of settling disputes among the parties. The Arbitration is governed by the ‘Arbitration and Conciliation Act, 1996, in India. The parties to the contract always have an option to either incorporate a separate Arbitration Agreement or may incorporate a clause for dispute resolution/arbitration in the existing contract itself. The Arbitration clause in the contract binds the parties to refer to the proceedings of arbitration for the settlement of disputes if so arises. So, this article will throw some light on the meaning of this arbitration clause, its purpose, benefits, the importance of a well-drafted clause, and the consequences of a pathological arbitration clause.

Meaning and Purpose of Arbitration Clause

Meaning

An arbitration clause is a provision in the contract that provides the right to the parties to refer the future disputes related to the present contract, to the arbitration instead of filing a suit against other parties in the court. The parties hereby, decide to settle all or any of the disputes which may arise between them by the peaceful settlement through arbitration.

Purpose

The purpose for doing so is to prevent the parties from unnecessary lengthy and tedious proceedings, as arbitration is considered to be more flexible and informal when compared to litigation. Also, it allows the parties to discuss the remedies on their terms and conditions. It helps the parties to be prepared for future disputes and settle them by peaceful means of procedure like that of arbitration. The purpose to include the clause of arbitration is to have a clear mind to settle all or any dispute if so arises, by the means of arbitration rather than adopting formal court proceedings.
 

Merits and De-merits of Arbitration clause

Benefits

There are many merits of including an Arbitration clause in an agreement. As the business, these days have taken over the empire but at contemporary, to that, there are great chances of arousal of disputes in any business. So, to be on the safer side, it’s better to include a dispute resolution clause in your contract to avoid further stress.

Some benefits are:

1. It helps the parties to settle the disputes in a time-bound and flexible manner;
2. As the arbitration clause, provides right to the parties to nominate the arbitrator/s, so they can wisely choose the person or an expert in their field of work, which a judge in court may not be;
3. It also marks the line for the law, jurisdiction to be followed and avoids ambiguity;
4. It provides limited grounds on which the award can be set aside, as opposed to civil cases where a full-blown appeal is possible.
5. It provides freedom to the parties to choose the venue of their own choice for the arbitration proceedings.
6. As arbitration is cost-effective, so including this clause may help the parties to resolve the dispute at lower costs;
7. These arbitration proceedings are confidential in nature, so including such a clause may help preserve the reputation of parties in case a dispute arises.

Problems

Discussed benefits, so if there is an absence of arbitration agreement or an underlying clause, then the foremost problem that may arise is that the parties will have to go to the courts for resolving the disputes and by this, the parties will have to face lengthy court proceedings which are expensive and tedious. The cost of attorneys is also much more in litigation than in arbitration. The litigation procedure can be time taking and the parties to the dispute in the corporate sector may suffer great losses, both mentally and financially due to these lengthy procedures but, the same can be avoided if one has an option of the arbitration clause. So, the parties to avoid such problems must include an arbitration clause in their agreements.

Questions that must be covered in Arbitration Clause

Now, let’s trace what all questions should be covered to make an effective and workable draft of an arbitration clause.

1. No. Of Arbitrators:

The parties should always include the no. of arbitrators that shall be appointed in case of settlement of the dispute. The no. of arbitrators is always odd in number as per Section 10 of the Arbitration and Conciliation Act, 1996. The benefits of a sole arbitrator are that the pace of appointment and decision-making, more flexibility can be observed in determining dates for the hearing, and lesser the fees of arbitrator compared with arbitration tribunal. On the other hand, the parties are probably to have more say in appointing a tribunal of three or more arbitrators and this can be valuable wherein the parties come from differing legal and cultural backgrounds. In principle, at least, the fact that 3 distinctive arbitrators will make contributions in deciding the award, which reduces the probability of mistakes and misunderstandings, even though it does not assure a better quality of decision-making.

• Seat and Venue of Arbitration:

There is a difference between the seat and venue of arbitration. The seat is the place (country) where the arbitration proceedings shall be held. Eg: India, London, Paris, etc. The seat of the arbitration will determine the procedural rules which govern the arbitration.

Whereas, the venue decides the geographical location or the particular place where the arbitration proceedings shall be held.

Example: The seat of Arbitration can be in India with its venue at Delhi Arbitration Centre.

• Appointment procedure of Arbitrator:

There should be a clear mode for the appointment of an arbitrator that is whether the arbitration procedure should be by:

Ad-hoc; Institutional; or Court-appointed.

Parties should lay down whether there will be a sole arbitrator or arbitration tribunal of three, five, or more arbitrators and if so, who will appoint the sole arbitrator or arbitration tribunal and how.

• Laws and jurisdiction covered:

The laws and the jurisdiction that will govern the dispute and the proceedings shall be mentioned clearly. The laws may be the same or different to the seat of arbitration as the parties may mutually decide but the jurisdiction is the same as the venue of arbitration.

• Time-bound for the award:

There should be a clear mention of the time limits on the constitution of the tribunal and the issue of the final award.

• Cost of Arbitration:

The parties should include a clear mention of the Arbitration cost that parties are willing to bear for the arbitration proceedings. Also, the payment of fees of attorneys should be included that is whether to be paid separately by the parties or included in the cost of the arbitration procedure itself. Also, include who shall bear the cost of arbitration and fees of attorneys, the parties mutually, or the defaulting party.

• Language of Arbitration:

Parties should state the language adopted for the arbitration proceedings clearly. It will help the institution/arbitration tribunal/arbitrator to proceed with the arbitration smoothly. The language should be specified, which will be used upfront to save a considerable amount in translators’ fees. When the language of arbitration is not specified, the arbitrators have to choose the language for arbitration proceedings and this may result in great deviation from parties’ expectations.

• Procedure to be followed for arbitration proceedings:

The Arbitration procedure should be specified to avoid any form of ambiguity i.e., depending on the nature of the contract there should be specifications of the procedures to be followed. Whether it should be limited to Arbitration and Conciliation Act or will involve the Civil Procedures, Evidence Act, Companies Act, Trademark Act, or any other.

• Qualifications for the appointment of Arbitrator:

It imposes pre-qualifications for the arbitrators. Parties shall include this clause and state who, they believe will appreciate the nuances of their dispute, as they have the right to choose the arbitrator who is familiar with their industry.

Sample of Well Drafted Arbitration Clause

In the event any dispute or difference arises in connection with the interpretation, implementation, or purported termination of this Agreement as specified above, the Parties shall mandatorily refer the dispute for resolution by arbitration in accordance with the terms of this Agreement as provided hereinbelow.

The disputes shall be referred to and finally resolved by arbitration pursuant to the Arbitration and Conciliation Act, 1996 thereof, amendment or re-enactment thereto from time to time and under the Rules of the Indian Council of Arbitration (“ICA”)’, which Rules are deemed to be incorporated by reference into this Clause. The tribunal shall consist of three arbitrators. Each of the disputing parties shall appoint one arbitrator and the two arbitrators so appointed shall collectively appoint the third arbitrator.

The Arbitrators shall not be limited by the Code of Civil Procedure, 1908 and the Indian Evidence Act and shall be free to chart out the procedure followed for arbitration.

The language of the arbitration shall be English (or any other).

The place of arbitration shall be (State), (Country).

The arbitration award shall be final and binding, and the Parties shall be bound by the same and shall act accordingly.

The fees payable to the arbitrators (excluding any costs imposed for the delay, but including the arbitrator fees and costs, but excluding any filing fee payable by the party commencing the arbitration) shall be paid by the parties mutually and equally.

The content of the proceedings shall be private and confidential.

The final award must be passed by the arbitrators within 60 days of the appointment of the third arbitrator.

Where any dispute is under arbitration, except for the matters under dispute, the remaining rights and obligations of the Parties will be valid and legally enforceable under this Agreement to the extent practicable. The arbitration proceeding shall be confidential.

This Agreement shall be governed by the law of India. (country). _________ .

Consequences of Pathological Clause

The expression “pathological clauses” refers to defective or badly drafted Arbitration Clauses. Although courts in many jurisdictions nowadays are in favor of the enforceability of arbitration clauses and undertake an interpretation that is in favor of giving impact to arbitration clauses, it is possible that courts may also undertake a diametrically contrary stand. In the latter situations, pathological clauses should probably have extremely damaging effects. The party that is on the receiving end of the notice invoking arbitration frequently takes benefit of these defects to defeat the salutary goals of arbitration of performance and finality. In such cases, there is significant wastage of effort and time in litigating in courts on whether or not the arbitration clause is valid or not in courts, frequently as much as the highest court in the applicable jurisdiction. Apart from massive wastage of effort and time, the invoking party has to dissipate substantial costs in litigating the matter in court. It is likewise possible that the party on the receiving end of the arbitration notice may also initiate proceedings in a country apart from the one selected by the parties withinside the agreement. This may cause more than one proceeding in distinct jurisdictions. A corollary of this is that more than one proceeding on the situation may cause inconsistent decisions on the enforceability of the arbitration clause.

Case Laws

International Agencies V. Rahul Coach Builders Pvt. Ltd. In this case, the court held that as the parties agreed to arbitration under the “by-laws of Indian Company Act 1956”, or as per the “International Trade Laws”, so, there exists no arbitration clause since the statement of this clause is extremely vague.

In Lucky-Goldstar International Ltd. Vs. Ng Moo Kee Engineering Ltd., the parties referred the arbitration to an association that does not exist. So, the Hong Kong High Court decides to refer the matter to another place under the seat of arbitration, chosen as per the arbitration clause.

AEZ Infratech Pvt. Ltd. Vs. SNG Developer Ltd.  In this case, the parties agreed to refer the dispute to the arbitration under the valid clause but also agreed contradictory that courts of certain places may have jurisdiction over the dispute. So, the same was under dispute and the High Court of Delhi ordered that as, there exists a contradictory clause, but as the parties are unable to clear this matter over the contradictory clause mutually, so would refer the dispute for arbitration. And finally, the parties were ordered to go for arbitration after so much chaos over the same.  

In Pricol Ltd. v. Johnson Controls Enterprises Ltd. & Ors.19, the Supreme Court of India referred the parties to arbitration under the arbitration rules of the Singapore International Arbitration Centre even when the parties provided for reference to arbitration under the arbitration rules of The Singapore Chamber of Commerce. Although there was no such arbitral institution, the Supreme Court construed the reference in the arbitration clause to mean the Singapore International Arbitration Centre.

Conclusion

To conclude, I would like to highlight certain points that ought to be taken care of while drafting an arbitration clause, these are:

1. Avoid vague language such as not including the specific and valid name of venue or seat, laws and jurisdictions to be followed.
2. Avoid conflicting clauses like that of including arbitration clause along with the litigation clause.
3. Avoid obligatory negotiation as at several times the dispute can be of nature that it cannot be resolved through means of negotiation. Then, in such a situation the disputes need to be addressed by the experts.
4. Try to replicate or take suggestions from the model clauses provided under the Laws for Arbitration to avoid any sort of mistakes.
5. Include the provision for arbitration costs like who shall pay the fees of arbitrators, attorneys, and other expenses of procedures.
6.  mention the laws to be followed and seat of arbitration, an important point in an arbitration clause in case of international disputes.
7. Seek expert advice (lawyers) and consider key elements given in the model clauses.

All, these points can be considered to draft an ideal arbitration clause and avoid the probabilities of disputes associated with pathological clauses under the Arbitration.