[Ria and Raaghavi are students at Rajiv Gandhi National University of Law and Jindal Global Law School, respectively.]
The Expert Committee on Arbitration Law (Committee), set up to recommend reforms to the Arbitration and Conciliation Act 1996 (Act), released its much anticipated report on 7 February 2024.[1] The Committee identified several issues within the current arbitration system, noting its failure to achieve cost-effectiveness and impartiality, particularly in light of evolving business needs. The authors agree with this remark since there are underlying problems with the current arbitration structure, impairing fair adjudication and the capacity to resolve disputes inexpensively. Chief among those problems is the issue of pre-deposit clauses in arbitration agreements.
Arbitral clauses in agreements often impose pre-conditions on parties, such as attempts at amicable resolution before referring disputes to arbitration or depositing a percentage of the amount claimed by the referring party. While the rationale behind both is the prevention of vexatious claims, their implications are not identical. This is because the latter involves a financial burden, inherently placing both parties at an unequal level regarding their ability to refer the matter to arbitration. This scenario can arise if one of the parties suffers from financial weakness due to, inter alia, being in the nascent stage of their business and experiencing financial difficulties. Mandating a pre-deposit nullifies the ability of such a party to resolve disputes, thereby defeating the purpose of adding a dispute resolution clause to the contract in the first instance.
Recent rulings such as M/s ICOMM Tele Limited v. Punjab State Water Supply and Sewerage Board and Others (ICOMM) and Lombardi Engineering Limited v. Uttarakhand Jal Vidyut Nigam Limited (Lombardi) by the Hon’ble Supreme Court of India (SC) have been instrumental, establishing that pre-deposit clauses in arbitration agreements are manifestly arbitrary, violating Article 14 of the Constitution of India (Constitution). However, such rulings have limited application, as the rule of manifest arbitrariness applies in the case of state functionaries only. Therefore, less emphasis has been placed on the validity of pre-deposit clauses in arbitrations between private entities, mainly where one party is less affluent than the other. Addressing such questions becomes imperative in the era of burgeoning start-ups and micro, small, and medium enterprises (MSMEs).
In this article, the authors demonstrate how pre-arbitral deposits can be exploitative for financially weaker entities in a given contractual relationship. They point out how this hampers the equal treatment of parties as enshrined in the Act as well as the UN Commission on International Trade Law (UNCITRAL) Model Law on International Commercial Arbitration (Model Law). With this, the authors make suggestions to curb the detrimental effects of pre-deposit clauses in arbitration agreements.
Pre-deposits as Discretionary and Not Mandatory
The issue of pre-deposits has turned what was envisioned to be a simplistic means of resolving disputes into a legal conundrum, with conflicting views exacerbating the situation. The classification of pre-arbitral conditions as discretionary by the SC in the case of Demerara Distilleries Private Limited v. Demerara Distilleries Limited was a celestial observation. In this case, the court examined an agreement which contained a requirement of mutual discussion, followed by mediation, before resorting to arbitration. The court held that such preconditions were empty formalities, noncompliance with which shall not result in a premature referral to arbitration. It is argued that the court did not consider this an issue worth going in depth, because the relationship between the parties did not attribute any prudence in the attempt at a mutual discussion. The authors believe that through this ruling, the court showed its subscription to the idea that pre-arbitral conditions could not render a matter inarbitrable.
It is notable that in certain situations, compliance with pre-arbitral deposits can affect the ability to arbitrate itself. The court determined in Ravindra Kumar Verma v. M/S BPTP that pre-arbitration steps specified in an arbitration clause are discretionary and not mandatory. It was held that interpreting the arbitration clause narrowly, requiring parties to fulfil specific requirements before initiating arbitration, may result in an unjust disadvantage for the party requesting arbitration. This is because the duration of these initial processes, such as conciliation proceedings, would not be excluded from the time limit specified in the Limitation Act 1963. Therefore, implementing obligatory pre-arbitral procedures could reduce the amount of time parties have to submit their claims within the legally prescribed period, compromising their capacity to seek resolution through arbitration. The court further supported the premise that strict adherence to pre-arbitral deposit requirements may violate claimants' statutory rights to arbitration. Hence, the court underscored the significance of preserving adaptability in construing arbitration clauses to defend the interests of the involved parties while adhering to legal time limitations.
Furthermore, it is argued that conditions involving pre-arbitral deposits are products of contracts of adhesion, also demonstrated by the ICOMM case. Under a contract of adhesion, the party with less bargaining power typically has few options but to accept a standard contract offered by the other side on a non-negotiable basis. In such circumstances, the need for the contract supersedes the security concerns of the weaker party, creating unequal contractual relationships. Such agreements go against the core precepts of contractual law jurisprudence, namely the meeting of the minds and fair bargaining. In the ICOMM case, an arbitral provision that imposed a pre-condition of a 10% deposit of the claimed amount was addressed. The court explored that stipulating a substantial payment before the commencement of arbitration disproportionately impacts parties lacking the financial resources to fulfil such requirements. This serves as an obstacle to attaining legal recourse and even has the potential to deter individuals from engaging in arbitration. Hence, the court correctly acknowledged the deterrent effect of pre-deposit requirements on the arbitration process.
It is argued that while the ICOMM case was instrumental in highlighting the undeniable linkage between pre-deposit clauses and contracts of adhesion, it does not entirely apply to contracts involving private parties. This is because the operative part of the judgement is based on inequality as given under Article 14 of the Constitution. Thereafter, in the Lombardi ruling, the court ruled that in cases where there is no indication as to how the pre-deposit amount has to be treated, i.e. whether the same shall be forfeited or refunded, among other factors, the same would be held to be ambiguous under Article 14 of the Constitution. However, it cannot be undermined that even private entities can suffer from the ambiguity of such clauses, yet cannot be protected via this ratio.
The primary concern is the possible hindrance that pre-arbitral deposits, especially of the exorbitant nature may provide to less affluent parties’ capacity to seek justice. Additionally, the fact that most of these deposits are usually a percentage of the amount claimed, prevents financially weaker parties from claiming the full damages. The current arbitration regime does not provide safeguards against this when both parties to a contract are private in nature. This is even though the Act envisions equal treatment of parties during an arbitration; irrespective of whether they are public or private in nature.
Equal Treatment of Parties
The concept of equal treatment of parties has been enshrined under Article 18 of the Model Law. The same can also be found under Section 18 of the Act. It lays down that each party must be allowed to present their case equally and confer authority upon arbitral tribunals to forego any connotations of arbitrariness. It is argued that when one of the parties has lesser financial resources than the other and is still mandated to produce an equal deposit to refer the dispute to arbitration, it technically results in equality but not equity. This is because the different circumstances of entities are not taken into consideration. Therefore, despite an equal amount or percentage of claims being involved, the ability of the parties to produce that amount is not equal. The same shall become clearer with an illustration.
Illustration: Let us assume that company A (A), incorporated in 1998, has assets worth INR 25 crores, whereas company B (B), incorporated in 2021, has assets worth INR 40 lakhs. Soon after incorporation, B faced malicious litigation by a competitor, as a result of which it was losing its clients and its assets were dwindling. A, on the other hand, was flourishing in the market. Knowing this, A approached B with a contract worth INR 20 lakhs, giving B a period of 1 day to respond. In haste, B, despite knowing that there was a pre-deposit clause inserted in the contract, signed the agreement. The pre-deposit clause directed that the party referring a claim to arbitration was to deposit 8% of the amount of the claim. Subsequently, A breached the contract, refusing to furnish payment for the products ordered by it. As B approached the tribunal for arbitration, it realised that it could not afford to deposit 8% of the claim as pre-deposit, as it formed a substantial part of its assets. As opposed to this, if it were A who had to refer the matter to arbitration, it would have to deposit the same 8%, however, it would have been in a much better position than B to deposit such an amount. It would therefore find it convenient to refer the matter to arbitration.
The above illustration points towards how in various situations, parties to a contract can have a substantial difference between their financial positions. In such cases, pre-deposit clauses within arbitration agreements are a product of adhesion. They arise from and perpetuate unequal contractual relationships, which render certain less affluent parties unable to invoke arbitration when they are aggrieved. Therefore, compliance with such clauses should be according to the discretion of the parties.
Conclusion and Way Forward
It cannot be overlooked that there exists an inherent imbalance of bargaining power between large and small companies while negotiating contracts. It is crucial to view pre-arbitral deposits as discretionary to ensure that each party has equal access to arbitration and that neither party can be exploited owing to their inability to pursue their claim. Arbitral tribunals should be empowered to assess each case’s unique circumstances, including the complexity of the conflict, and the parties’ economic circumstances, and sufficiently interpret contractual intent. This methodology encourages flexibility so that the deposits’ capacity to deter false claims is not overshadowed by its imposition. While it is notable that the tribunal can mandate the company, however financially weak, to comply with the deposit, such a determination must be based on a careful consideration of the aforementioned factors.
To facilitate this, the tribunal can adhere to guidelines for pre-deposits which specify circumstances in which certain entities should not be made to comply with the requirements of pre-arbitral deposits, depending on their financial position. Such guidelines may include a minimum threshold of turnover or assets that an entity must have to be made to comply with the pre-deposit, and stability of financial position, among other factors which must be applied to the facts of each case to determine whether the entity should be made to comply with the deposit or not.
[1] Expert Committee, Centre on reforms in the Arbitration and Conciliation Act, 1996, Report of the Expert Committee to Examine the Working of the Arbitration Law and Recommend Reforms in the Arbitration and Conciliation Act 1996 to make it alternative in the letter and spirit para 1.2.3 (i)
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