DEMYSTIFYING THE PATHOLOGICAL ARBITRATION CLAUSE CONUNDRUM: A JUDICIAL INSIGHT

[Kunal Saini and Ananya Raghavendra are final-year students at School of Law, Christ University, Bangalore]


Introduction


Defective arbitration and dispute resolution clauses are referred to as pathological clauses, also commonly known as “Champagne Clauses” or “Midnight Clauses” which embodies the degree of seriousness attached while drafting the clause itself. The main predicament arising out of such clauses is that it defeats the very purpose of arbitration by additionally requiring the need to resolve ambiguities in such clauses alone before the courts, which adds onto the existing costs and time.


Such clauses may be drafted in different manners, with deficiencies regarding different aspects of the arbitration. Some of them include failure to make the arbitration mandatory, reference to a non-existent, hybrid or erroneous institution, designation of a body or arbitrator unwilling to act, and clauses either with inherent inconsistencies or those inconsistent with other clauses, to name a few. This article will be addressing such clauses, looking into the interpretation of pathological clauses as construed in jurisdictions like the United Kingdom, United States, Singapore and India.


Interpretation in International Jurisdictions


The English Courts have generally preferred an interpretation favoring arbitration in consonance with parties’ intention to refer a matter to arbitration, unless there exists a situation where such clauses are incorrigibly ambiguous. In the Shagang South-Asia (Hong Kong) Trading Co Ltd v Daewoo Logistics case, a more plausible interpretation was adopted wherein an arbitral award was set aside because the arbitrator was appointed in the wrong seat, proving that while ambiguous clauses are generally upheld, this would not occur if proceedings itself was wrongfully based on such ambiguous clauses. In another landmark case of Mangistaumunaigaz Oil Production Association v United World Trade Inc (UWT), UWT argued that the clause “if any, by ICC Rules in London” did not evince the common consensus of both parties to arbitrate as such arbitration was conditional only on the existence of a specific prior arbitration agreement, after which arbitration proceedings according to ICC arbitration in London would be binding. The Queens Bench rejected such contention and upheld the arbitration clause stating that it sufficiently reflected the intention of both parties to settle disputes by arbitration, further concluding that interpreting such clause in any other manner would “strain common sense.”.


In the United States case of Mastrobuono v. Shearson Lehman Hutton, an arbitral award of punitive damages was upheld, notwithstanding the fact that arbitrators were legally prohibited from awarding punitive damages. The Supreme Court in this case also reiterated that ambiguities concerning the scope of an arbitration clause itself should be resolved in favour of arbitration. Contrary to this, in another case, the clause which allowed reference to “the American Arbitration Association or any other US court” was held to be ambiguous in its reference and hence, the validity was not upheld.

Lastly Singapore courts have also preferred upholding arbitration agreements emphasizing that if parties have portrayed a clear intention to settle by means of arbitration then such intention must be given effect to, without prejudicing the rights of either party. Additionally, while the validity of the clause is dependent on the type and extent of its pathology, a favorable interpretation is preferred if the ambiguities or inconsistencies are such that it can be overcome by interpretation. In the landmark case of BNA v BNB the court reiterated the need to properly draft arbitration clauses, especially being cautious while designating the seat of arbitration in unambiguous, clear terms. The Courts also make use principles of interpretation of contracts for such clauses, as seen in another case, where a non-existent institution was preferred for reference of matters, the clause was upheld stating that any arbitral tribunal could be approached, provided arbitration would be administered under the ICC Rules. This clause noted that this clause sufficiently portrayed the parties’ intention to submit to arbitration and hence, interpreted it to allow the parties to opt for a hybrid method of arbitration.


Judicial Interpretation of Pathological Clauses: Indian Scenario


It is imperative to extensively deal with pathological clauses and the judicial scrutiny afforded to the interpretation of such clauses. The judicial saga on adopting a pro-arbitration clause approach was clearly set out in the landmark decision of Pricol Limited ("Pricol") v. Johnson Controls Enterprise Ltd. ("Johnson") & Ors. wherein while dealing with a mention of an arbitral institution which was non-existent, the Supreme Court afforded a meaningful and reasonable construction to the arbitration clause in order to give effect to the arbitral process. The Court also succinctly observed the ‘real intent’ of the parties to arbitrate and sought to modify the arbitration clause itself by referring to the correct arbitral institution. On similar lines, the Supreme Court in Visa International Ltd. v. Continental Resources (USA) Ltd. held that a clear and evident intention of the parties to proceed with arbitration shall not derail the process in lieu of any party taking disadvantage through an inartistic drafting.

Furthermore, while dealing with the seat-venue conundrum, the Apex Court in Enercon India Ltd v Enercon GmbH upheld the arbitration clause by adopting the “Doctrine of Severability” separating the defects in the arbitration clause from the underlying contract itself. In furtherance to uphold the doctrine, the court succinctly observed that any defect, omission or an error can be cured by the court by insertion which would ultimately be in consonance to the explicit intention of the parties.


A perusal of the aforementioned judgements both at the national and international jurisdictions, it demonstrates that the Supreme Court has sought to offer a favourable and reasonable construction towards such arbitration clauses. However, the Apex court in Jagdish Chander v Ramesh Chander did not concur with the multitude of pro-arbitration adjudications, ultimately observing that “consensus ad idem” between the parties was absent, and hence the mere mentioning of the phrase “disputes shall be referred for arbitration if the parties so determine” will not give rise to arbitration proceedings since the clause incorporates the usage of conflicting words “shall” and “may” at the same time. On similar lines, in one of the matters heard by the Andhra High Court while relying on the landmark Singapore High Court decision in Rizq International Holdings, gave effect to the arbitration clause even after adopting a restrictive interpretation to the clause in question.


It is also pertinent to note that considering the multitude of instances wherein parties commit mistakes while drafting dispute resolution clauses, the Apex Court in Wellington Associates v Kirit Mehta rightly observed that in instances where the term “may” is used, fresh consent needs to be sought by the parties for initiating the arbitration process. It is imperative to note that in scenarios pertaining to loosely drafted arbitration clauses including the usage of the terms “may”, fresh consent acts as a two-step approval process for the initiation of the arbitration process.


Road Ahead: Allied Issues and Recommendations


At the outset, it is imperative to note the very intention afforded by the legislators to the objective of the Arbitration and Conciliation Act, 1996 (“Act”) which is to provide speedy and effective dispute resolution mechanism with minimum court interference, as also postulated under Section 5 of the Act. However, considering the plethora of judgments on this grey area of pathological clauses, the purpose doesn't seem to be served since most of these arbitration proceedings are headed towards lengthy judicial proceedings.


Going ahead with caution and care in relation to drafting such dispute resolution clauses, it is pertinent to avoid using the terms “may” and “shall” at the same time. One such instance was recently adjudicated by the Bombay High Court in Quickheal Technologies Ltd v NCS Computech Pvt. Ltd. while dealing with optional symmetric clauses, where it was held that there was no valid arbitration agreement at the outset since it is not plausible to come onto a definite conclusion if such contradictory terms are used. This judgment goes against the pro-arbitration regime adopted by the Indian courts and risks opening the pandora box towards an altogether new jurisprudence on the aspects of symmetric and asymmetric optional arbitration clauses.


Considering the effect of pathological clauses, it is crucial for parties to exercise caution and due diligence at the time of drafting itself, ensuring that such arbitration clauses are drafted according to existing model clauses provided by arbitral institutions, as reiterated by the Philippines Court and further, to use simple and direct language in such clauses. Parties preferring arbitration should take a conservative approach in drafting arbitration clauses by specifying each aspect and element of the arbitration with clarity, and those who do not prefer arbitration must also specify such intention explicitly. Courts on the other hand, must adopt an expansive interpretation and uphold the arbitration clauses whenever possible, keeping in mind the intention and consensus of the parties. However, this interpretation must be limited to ensure that the terms itself are not rewritten by excessive construction or excessive interference, defeating the very purpose of arbitration. The parties must lay out risks associated towards loosely drafting an arbitration clause and carry out a risk assessment and apportionment while drafting the same.


On a concluding note, it is discernible that the interpretation of such arbitration clauses boils down to the consent and intention of the parties so recorded whilst drafting the clause itself. However, in order to avoid such discrepancies, reliance can be placed on the apex court’s decision in the aforementioned Wellington Associates case which demands that fresh consent needs to be taken for the initiation of the process. This in turn would ensure that the arbitration process does not get derailed and the cardinal principle of “Consensus Ad Idem” is maintained, hence facilitating a paradigm shift towards a pre-dominantly pro-arbitration regime in India.

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