- Apprentice Lawyer
- Legal Jobs
A discussion on the validity of hybrid and split arbitration agreements and the consequences/foreseeable issues of such agreements.
Prior to the year 2008, in case a borrower defaulted on the payment of a loan, banks and financial institutions, after declaring the account as being a Non-Performing Asset (NPA), had the right under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) to take over the assets of the borrower.
Besides this, the banks and financial institutions (subject to registration under the SARFAESI Act) could apply to the Debts Recovery Tribunal for a recovery certificate. This process naturally took significant time.
After the sub-prime crisis, however, speedy recovery of debts became the prime concern of banks and financial institutions world over. To this end, they incorporated split or hybrid arbitration agreements in their facility agreements. This gave an additional option to the banks and financial institutions to pursue arbitration.
The author, by way of the present article, endeavours to discuss the validity of hybrid and split arbitration agreements and the consequences/foreseeable issues of such agreements, assuming they are valid and enforceable.
What is a split or hybrid arbitration agreement?
“Split” or “hybrid” arbitration agreements allow one or both parties the right to elect either litigation (by way of civil suits) or arbitration once the dispute has arisen. The ostensible reason behind this kind of arbitration agreement is to allow parties flexibility, privacy, neutrality, speed of adjudication, confidentiality and perhaps better quality of judgments, according to some experts.
Split arbitration agreements are of two types: “sole option,” where one party has the right of election, and “mutual option,” where both parties have the right of election.
A typical split or hybrid arbitration agreement
For a better understanding, a typical split or hybrid arbitration agreement is set out hereunder, with the bracketed portion relating to parts of a mutual option split arbitration agreement:
“The Lender (Either Party) may, at its option, choose to settle any disputes which may arise out of or in connection with this Agreement shall be referred to binding arbitration in accordance with the Arbitration and Conciliation Act, 1996. The arbitration shall be held at XYZ and such arbitration shall be conducted in English. The Parties hereto agree that the decision of the sole arbitrator shall be final and binding. The Parties hereby agree that the cost of the arbitration proceeding shall be borne by the parties in accordance with the directions of the arbitrator. The Lender (either party) may in addition bring action under the Securitization Act or the Recovery of Debts due to Bank and Financial Institutions Act (“DRT Act”), or any other special legislation or any civil remedy, as may be available to it.”
Views which could be taken
Since the Indian courts have not specifically adjudicated on this issue, the above arbitration agreement is susceptible to two views, which are discussed hereunder:
It could be argued that these hybrid or split arbitration agreements are pathological clauses as, at the time of signing the arbitration agreement, it gave the option to either party or a sole party to, “in its discretion”, trigger the arbitration agreement or pursue litigation. Thus, since the words used in the arbitration agreement are “The Lender (either party) may”, it does not reflect the absolute intention of the parties to adjudicate disputes by way of arbitration alone, especially at the time of signing the arbitration agreement.
Thus, the principle of interpretation in good faith could be applied, i.e. the parties' intention at the time of signing the agreement, to state that the absolute intention of the parties was not to solely arbitrate. Reliance to that effect may be placed on the interpretation of the Supreme Court to arbitration agreements where the word “may” used in the arbitration agreements was interpreted to mean that the agreement was not enforceable as it presupposed a subsequent agreement in future. It may be worthy to mention that this interpretation of the Supreme Court did not relate to hybrid or split arbitration agreements.
That apart, it could be argued that besides lacking the basic ingredient of mutuality, on account of the arbitration agreement being uncertain, as it causes hopeless confusion by giving an option to the parties to either pursue litigation or arbitration, the arbitration agreement is not enforceable.
As a consequence of the above, it is open to argue that in case of doubt, the principle of contra proferentem applies and the arbitration agreement cannot be given meaning to or be made enforceable.
This is also the position taken by the courts in France, which have not enforced such an arbitration agreement. In view of such a position of law, the parties are and could be relegated to adjudication of disputes by civil courts alone.
The principle of interpretation in good faith states that the intention of the parties at the time of execution of the agreement ought to be seen. The test is whether the parties desired that their disputes, if at all, were to be addressed by an arbitral tribunal or by a civil court. Applying the principles, it may be argued that the borrower, in the case of a sole option hybrid arbitration agreement, essentially agreed to reference of disputes to arbitration and hence, on the lender exercising its option under the arbitration agreement, the parties ought to be relegated to arbitration. It could thus be said that the exercise of the option is only an administrative act and does not affect the validity of the arbitration agreement itself.
It may be argued that the use of the words “shall” be referred to arbitration is also significant, as it shows that the intention of the parties was to arbitrate. Thus, it could be argued that if only the intention of the parties is seen, there is absolutely no ambiguity that the parties are to adjudicate their disputes through arbitration. The intention of the parties obviously ought to assume primacy.
As far as the issue of confusion between litigation and/or arbitration is concerned, it could be argued that once the lender (in case of a sole option hybrid arbitration agreement) or the parties (in case of a mutual option hybrid arbitration agreement) exercise the option of adjudication of disputes by arbitration, there would exist no confusion whatsoever.
There is another way of looking at it. As per the principle of effective interpretation, where a clause can be interpreted in two different ways, the interpretation enabling the clause to be effective should be adopted in preference to that which prevents the clause from being effective. Various Tribunals have taken this to be the “universally recognised rule of interpretation”.
It could therefore be argued that the presumption always lies in favour of the validity of the arbitration agreement and the choice of the parties rather than against it.[See ICC Award No. 1434 (1975), ICC Award No. 3380 (1980), Italian enterprise v. Syrian Enterprise (1981) 108 J.D.I. 927]. If this principle is followed, assuming there is any doubt whatsoever, arbitration is the only course to be followed.
Problematic areas in case of a sole option hybrid arbitration agreement
Either interpretation brings to the fore multiple issues. Some of the major foreseeable problem are:
(a) Where the lender does not exercise its option to arbitrate immediately and the borrower approaches a civil court (in case of an unregistered FI) or a debts recovery tribunal (registered bank or financial institution), whether an application under Section 8 of the Arbitration and Conciliation Act, 1996 could be filed by the lender by exercising its rights subsequently for referral to arbitration?
(b) Whether a subsequent exercise of right to arbitrate by the lender is permissible in law?
(c) Where the borrower has approached the civil courts/debt recovery tribunal, whether it becomes incumbent on the civil court/ debt recovery tribunal to mandatorily refer the parties to arbitration and direct the Borrower to file an application under Section 17 of the Arbitration and Conciliation Act for interim relief?
(d) Where rights have been exercised by the borrower before the civil courts/debt recovery tribunal prior in time, is it open to the civil court/debt recovery tribunal to not enforce the arbitration agreement, assuming it is enforceable in the first instance?
(e) Can it be argued that by bringing a suit before the civil courts/debt recovery tribunal, prior to the lender enforcing the arbitration agreement, the borrower has accrued rights and cannot be referred to arbitration?
These issues remain unanswered presently by the courts. However, if that be the case, the borrower, in a sole option hybrid arbitration agreement, could essentially never avail its remedies and the lender would always be in a position to defeat any remedies that the borrower may have, if it so desires.
While it may be argued that considering the present exposure of the banks (looking at the scenario at hand), the rights of the borrowers are required to be fettered considerably, one should not forget that the legislative intent was not to restrict the rights of a borrower, but to allow it a fair and reasonable adjudication by the respective courts.
The author is a practicing advocate in the Delhi High Court.