Conflating Public Law & Private Law: Has the SC Blundered?

Punjab State Water Supply & Sewerage Board had a lengthy arbitration clause containing a unique provision:

“viii. It shall be an essential term of this contract that in order to avoid frivolous claims the party invoking arbitration shall specify the dispute based on facts and calculations stating the amount claimed under each claim and shall furnish a “deposit-at-call” for ten percent of the amount claimed, on a schedule bank in the name of the Arbitrator by his official designation who shall keep the amount in deposit till the announcement of the award. In the event of an award in favour of the claimant, the deposit shall be refunded to him in proportion to the amount awarded w.r.t the amount claimed and the balance, if any, shall be forfeited and paid to the other party.”

The first sentence of clause viii stated the objective of the clause: to avoid frivolous claims. It further provided that the party invoking arbitration (Claimant) would have to specify the dispute based on facts and calculations and has to state the amount claimed under each claim. So far so good. It then provided that the Claimant should furnish a "deposit-at-call" to the tune of 10% of the claim amount in the name of the arbitrator in a bank till the announcement of the award.

The clause stated that if the award was in favour of the Claimant, the deposit was to be refunded to him in proportion to the amount awarded with respect to what is claimed and the balance would be forfeited and paid to the Respondent. To explain this with an illustration, if the amount claimed is Rs. 10 lakhs, the deposit-in-call would be 10% thereof, that is, Rs. 1 lakh. If the Claimant is awarded only 6 lakhs out of Rs. 10 lakhs claimed, the Claimant would be entitled to be refunded Rs. 60,000/- of the deposit and the remaining Rs. 40,000/- in the deposit would be forfeited by the Respondent. If the Claimant was successful in the whole claim, she would be refunded the entire amount but if the claim was dismissed, Rs. 1 lakh deposited would be forfeited in full by the Respondent.

Clause xv of the agreement provided: "xv. No question relating to this contract shall be brought before any civil court without first invoking and completing the arbitration proceedings, if the issue is covered by the scope of arbitration under this contract. The pending arbitration proceedings shall not disentitle the Engineer-in-charge to terminate the contract and to make alternate arrangements for completion of the works."

From a purely objective stand point and seeing it without being prejudiced by the fact that clause viii was struck down as being violative of Article 14 of the Constitution of India, the drafter of this innovative clause has to be appreciated for the application of mind. The clause has three distinct advantages:

1. It provides negative incentives on the Claimant. It guards against exaggerated claims by the Claimant and provides a negative incentive for the Claimant not to do so.
2. If the Claimant is prevented from making exaggerated claims, the fee of the arbitrators is also kept at a reasonable level since it is ad valorem.
3. As we have argued in the past (see, here and here), the costs mechanism in India is not up to the mark and the arbitrators and the tribunals rarely award costs. This clause requires the tribunal to do what it should have otherwise done: award costs in favour of the Respondent and against the Claimant in respect of exaggerated claims. This is fairly standard in international arbitration practice.

The court held that the clause was violative of Article 14 of the Constitution of India, which is really erroneous and unfortunate. The unreasonable court interference in the commercial (as opposed to sovereign) acts of the state is uncalled for and the decision requires to be revisited by a larger Bench, The unjustified application of the public law principles in such disputes stifles innovation and protection of interests of the government sector. As such government sectors, especially, public sector undertakings, face a lot of heat with regard to competing with private sector and at the same time fulfilling the socio-economic obligations . The step-motherly treatment of these sectors from the courts, the unjustified contempt and prejudice shown by the courts when it comes to the public sector needs to be relooked at by courts.

Clearly, the court's invocation of Article 14 means that the private sector which is immune from claims regarding violation of fundamental (and not contractual or statutory) rights could insist on such a clause without qualms. With these preliminary remarks, let us how the court held the clause to be invalid:

Facts

Punjab State Water Supply & Sewerage Board, Bhatinda (PSWSSB) invited tenders for a project and Icomm Tele Ltd. (Icomm) was the successful bidder. A contract was entered into between the parties and it contained a arbitration clause, which included the above quoted provision. Disputes arose and Icomm wrote to PSWSSB for appointment of arbitrator and for waiver of the 10% deposit fee, which was not responded to.

Icomm challenged the clause through a writ petition contending that clause viii was unreasonable and arbitrary but the petition was dismissed. So Icomm approached the Supreme Court.

Contentions

Icomm challenged above clause on three grounds:

• The contract was hit by Section 23 of the Indian Contract Act, 1872 in that it was a contract of adhesion and was against the public policy of India.
• A 10% deposit is a clog on the arbitration process.
• The clause is arbitrary and highhanded.

PSWSSB on the other hand argued that the clause applied to both parties equally and that the argument as regards public policy is not applicable in case of commercial contracts.

Decision

On the first argument that the contract was against public policy and hit by virtue of the Supreme Court's decision in Central Inland Water Transport Corpn. v. Brojo Nath Ganguly, (1986) 3 SCC 156, the court held that this being a commercial contract, Icomm cannot make a valid argument that the clause was hit by Section 23 of the Indian Contract Act, 1872.

But the court accepted the argument that the clause in issue was arbitrary. Following were the reasons that led the court to so decide:

• Frivolous claims could be dismissed with exemplary costs, as was held in Dnyandeo Sabaji Naik v. Pradnya Prakash Khadekar, (2017) 5 SCC 496
• In General Motors (I) (P) Ltd. v. Ashok Ramnik Lal Tolat, (2015) 1 SCC 429, the concept of punitive damages was discussed and the important principle that unless the litigation was held to be frivolous, exemplary costs would not follow.
• In this case, the deposit-at-call clause called for 10% of the claim amount, which could amount to a large sum of money does not have any direct nexus to the filing of frivolous claims, as it applies to all claims, even non-frivolous, at the threshold.
• The deposit-at-call clause is totally disproportionate to the object sought to be achieved, that is, prevent frivolous claims.
• The clause is arbitrary in that it is unfair and unjust and no reasonable man would agree to it. There are situations where a claim may be dismissed not for reasons of frivolity as is the case with majority and minority awards. Take a case of illegal termination of contract. If the court declares the termination to be illegal and awards only one-tenth of the claim, the respondents gets to hold 10% of the that amount, which means that the party which lost the arbitration will be entitled to forfeit nine-tenths of the amount deposited. This is arbitrary, disproportionate, and would lead to unjust results.
• Arbitration being an important part of the dispute resolution process, such a clause would be a clog on arbitration and cannot be encouraged. The primary objective of arbitration is speedy and efficient resolution of disputes but such a clause militates against these purposes. This clause would render the arbitration process expensive.

Further Comments

Apart from the critique in the first part of this post, a few other aspects are noteworthy.

Unequal Bargaining Power: The court rightly rejected the argument that the clause is invalid in view of the unequal bargaining power between the parties. The concept of unequal bargaining power is generally not applied in commercial contracts and the law is fairly settled in this regard: see, for instance, Central Inland Water Transport Corporation Ltd. and Anr. v. Brojo Nath Ganguly and Anr. MANU/SC/0439/1986, Para 89; SK Jain v Haryana MANU/SC/0323/2009; General Assurance Society Ltd. v. Chandmull Jain and Anr. MANU/SC/0180/1966; Patel Engineering v BT Patil 2016(3) Arb LR 162 (Bom).

Are Frivolous Claims Dismissed with Exemplary Costs? The ground relied on by the court that there was another way to deal with frivolous claims: "It is well settled that a frivolous claim can be dismissed with exemplary costs." This argument is not at all convincing for two reasons: (1) It is well known that rarely do Indian courts and tribunals award costs, even in proceedings of commercial nature such as arbitration proceedings (see, here, here, and here). Therefore, that courts and tribunals can grant exemplary costs is really a mirage. They don't do that, especially when the Government and the PSUs are at the receiving end.

In this blogger's experience in PSUs for ten years, courts rarely penalise petitioners for frivolous claims. Government subsidising frivolous litigation is a drain on taxpayer's money. Subsidisation of frivolous claims in commercial contracts is a massive drain on government's and taxpayer's wealth, especially in the context of PSUs. In the annals of Indian legal history, one can rarely find courts ordering costs on frivolous and unsuccessful challenges to awarding of contracts on a party instead of the petitioners. In sum, the argument relied on by the court is mere rhetoric and not a well-founded argument.

On the one hand, law is purported to be certain that assessment of damages is possible prior to a decision from a court and on the other hand, the court puts forth a hypothetical test wherein the claimant actually makes an exaggerated claim but the court gives the claimant the benefit. The hypothetical argument doesn’t comport with justice or any legitimate moral, social or economic principle.

Note that the clause does not state that if the claimant claims Rs. 10 lakhs and is awarded Rs. 10 lakhs, the respondent could forfeit the whole or part of it. It only states that if the claimant is awarded Rs. 1 lakh as against a claim of Rs. 10 lakhs (exaggerated), the respondent would be entitled to foreit Rs. 90,000 from Rs. one lakh deposited.

Stifling of Innovation: Stifles innovation in government sector, especially in the commercial contracts entered into by the Government and the Public Sector Undertakings. Having held that the contract is a commercial contract, invocation of Article 14 is shocking to the least, and is against the trends in jurisprudence of limited interference.

Application of Proportionality Test to Contractual Clauses: Private law proceeds on the principle that that the contracting parties are best judges of their contractual arrangement and the state cannot and should not interfere in contracts, unless absolutely justified. In this case, the bidder assessed the risk associated with all clauses in the tender and submitted its bid agreeing to all the clauses therein, including the arbitration clause when a contract is entered into. Therefore, interference by the Supreme Court by applying the proportionality test on a contract clause was wrong. The Supreme Court cannot be a judge of what is essentially an economic decision: using the deposit-at-call clause as a disincentive to frivolous claims. In fact, the clause fills the gap or defect in the application of law by courts and tribunals in ordering costs in case of exaggerated or frivolous claims. Can the proportionality test which is used in constitutional contexts be applied to test the validity of a contract clause is the larger question that requires a detailed consideration. The decision has created a new Frankenstein monster akin to public policy by applying the proportionality test to examine the validity of contractual clauses.

Is the Impugned Clause a Clog on Arbitration?: The finding that the clause is a clog on arbitration does not appeal to reason. It is only a clog on an exaggerated claim in arbitration and cannot be considered a clog on arbitration. Had the clause provided, for instance, that even if the Claimant is awarded the claim, the Claimant and not the PSWSSB will bear the costs of arbitration, will probably be a clog on arbitration. The court has not really justified how it will be so.

In all, the decision is least convincing and lacks an objective and incisive analysis of the underlying justifications that the issue really called for.

[Food for Thought: If the impugned clause is construed as an agreement to pay costs, wouldn’t it be hit by Section 31A(5)of the Arbitration and Conciliation Act, 1996?]

The decision can be accessed from here.