Fundamentals of a legally enforceable Arbitration Agreement: Key principles and pitfalls

The presence of an arbitration clause in commercial contracts has developed noticeably over the period of time in India. However, it is meaningful only when the clause is enforceable. The Arbitration and Conciliation Act, 1996 (the “Act”) provides for the statutory framework governing an Arbitration Agreement for domestic and international commercial arbitration in the country. The Supreme Court of India, in several landmark cases, has laid down the essential characteristics of a valid Arbitration Agreement and clarified what constitutes a legally binding Arbitration clause.

This article lays down the essential ingredients of an Arbitration Agreement with the help of judicial precedents, statutory provisions, and examples.

The Supreme Court of India, in cases such as KK Modi v. K.N. Modi, Bharat Bhushan Bansal v. UP Small Industries Corporation Ltd., and Bihar State Mineral Development Corporation v. Encon Builders (I) (P) Ltd., has identified the core attributes of a valid Arbitration Agreement. Additionally, in State of Orissa v. Damodar Das, the Supreme Court reaffirmed that a clause in a contract can be construed as an Arbitration Agreement only if an obligation to arbitrate disputes is expressly or impliedly stated.

From these judicial interpretations, the following essential elements of an Arbitration Agreement emerge:

1. Clear and Unambiguous Intention to Arbitrate:

An Arbitration Agreement must demonstrate an unequivocal intention of the parties to refer disputes to Arbitration.

2. Obligation to Submit Disputes to Arbitration:

The Agreement should not leave the decision to arbitrate future consent or negotiation. The Hon’ble Supreme Court, in Jagdish Chander v. Ramesh Chander, has held that an Arbitration Agreement cannot require a further agreement for reference to arbitration.

3. Reference to a Neutral and Impartial Tribunal:

A valid Arbitration Agreement must ensure that disputes are resolved by an independent Arbitral Tribunal. The Hon’ble Supreme Court, in Solaris Chem Tech Industries Ltd. v. Asst Executive Engineer Karnataka Urban Water Supply and Drainage Board & Anr, while reiterating the principles laid down in Ellora Paper Mills Ltd. v. State of M.P., and Jila Dugdh Utpadak Sahkari Sangh Limited v. Ajay Sales and Suppliers, interpreted Section 12(5) of the Act, and emphasized that Arbitrators must be free from conflict of interest and should not have any bias toward either party. Notably, if an Agreement allows one party unilaterally to appoint an Arbitrator without due process, courts may strike it down.

4. Finality and Binding Nature of the Arbitral Award:

A valid Arbitration Agreement must specify that the Arbitral Award is final and binding on the parties. The Agreement must not permit parties to unilaterally challenge the award in a manner inconsistent with the Act.

5. Compliance with Statutory Requirements:

Under Section 7 of the Arbitration and Conciliation Act, 1996, an Arbitration Agreement must:

i. Be in writing, including any exchange of statement of claim and defence exchanged between the parties in which the existence of the agreement is alleged by one party and not denied by the other.

ii. Be contained in a contract, exchange of letters, or any written communication confirming the intent to arbitrate.

iii. Clearly outline the process for arbitration and the governing law.

Illustrative Examples of a valid Arbitration Clause:

“Any dispute, controversy, or claim arising out of or relating to this contract, including its existence, validity, or termination, shall be referred to and finally resolved by Arbitration in accordance with the Arbitration and Conciliation Act, 1996. The Arbitration shall be conducted by a sole arbitrator mutually appointed by the parties. The Award of the Arbitrator shall be final and binding on both parties. The seat of Arbitration shall be [City], and the proceedings shall be conducted in ....”

The above satisfies the following legal justification:

• Clearly mandates arbitration as the exclusive dispute resolution mechanism.

• Ensures a binding arbitral award.

• Complies with statutory and judicially established principles.

The Supreme Court of India has clarified the legal validity of Arbitration Agreements in numerous judgments.

In Jagdish Chander v. Ramesh Chander the Supreme Court dealt with an issue whether Clause 16 of the Deed of Partnership is an ‘arbitration agreement’ within the meaning of Section 7 of the Arbitration and Conciliation Act, 1996.

Clause 16 of the Deed of Partnership read as follows:

"If any dispute touching the partnership arises between the partners, the same shall be mutually decided by the partners or shall be referred for arbitration if the parties so determine."

The Supreme Court held that the relevant clause of the Deed of Partnership is not an arbitration agreement, but a provision which enables arbitration only if parties mutually decide after due consideration as to whether a dispute should be referred to arbitration. Further it was held that the clause requires the consent of parties before the dispute can be referred to arbitration. In the absence of an arbitration agreement, an arbitrator could not have been appointed.

In State of Orissa v. Damodar Das, the Supreme Court stated that an arbitration clause must expressly or impliedly mandate arbitration. If there is merely a possibility of the parties agreeing to arbitration in future, as contrasted from an obligation to refer disputes to arbitration, there is no valid and binding arbitration agreement.

An arbitration clause remains valid and enforceable even if it contains a precondition of conciliation or mutual discussion. Such preconditions are discretionary in nature and do not affect the validity of the arbitration clause. Courts have consistently held that while parties are encouraged to follow the agreed dispute resolution mechanism, the failure to do so does not render the arbitration clause invalid or bar reference to arbitration. The objective of such clauses is to promote amicable settlement, and non-compliance cannot prevent reference to arbitration.

• Always use mandatory language in arbitration clauses.

• Ensure the arbitrator is neutral and independent.

• No clauses that allow civil litigation as an option.

• Arbitration Agreements must be self-contained and not contingent on future negotiations.

By adhering to these principles, parties can avoid unnecessary litigation on the interpretation of arbitration clause and effectively serve their intended purpose.

About the authors: Sonam Mhatre is the Managing Partner of of Dhaval Vussonji & Associates. Shruti Kulkarni is an Associate at the Firm.

Disclaimer: The opinions expressed in this article are those of the author(s). The opinions presented do not necessarily reflect the views of Bar & Bench.

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