A three-Judge Bench of the Supreme Court comprising of Justice J.B. Pardiwala, Justice Manoj Misra and Chief Justice of India Dr. D.Y Chandrachud in the matter of Lombardi Engineering Ltd v. Uttarakhand Jal Vidyut Nigam Limited SC 2023 INSC 976 -6 Nov 2023 on 6th November 2023 upheld the supremacy of the Constitution of India as against an arbitrary arbitration agreement. In this case the Petitioner challenged the arbitration agreement arising out of a contract dated 25.10.2019 (Contract) and also requested for appointment of an impartial arbitrator for adjudicating the disputes and claims.
(i) The Petitioner is a design consultancy firm based in Switzerland and the Respondent is a wholly owned corporation of the Government of Uttarakhand which is engaged in the business of operating hydro power plants in the State of Uttarakhand. The Petitioner entered into a contract with Uttarakhand Project Development and Construction Corporation Limited (UPDCC) for a project which was later acquired by the Respondent. The contract was for providing consultancy services and preparation of modified comprehensive and bankable Detailed Project Report to the Respondent in Uttarakhand.
(ii) One of the major issues in the contract was Clause 55 (Arbitration Agreement) which provided for dispute resolution by arbitration. As per this clause it was agreed that the ‘Party initiating the arbitration claim shall have to deposit 7% of the arbitration claim in the shape of Fixed Deposit Receipt as security deposit.’
(iii) Moreover, according to the Agreement, the Sole Arbitrator was to be appointed by the Principal Secretary/Secretary (Irrigation), Government of Uttarakhand for claims amounting upto Rs. 10 Crores.
(iv) Due to several issues between the parties, the Petitioner issued a Legal Notice dated 06.05.2022 to the Respondent to initiate arbitration proceedings and to appoint an Arbitrator as per the Agreement. On the other hand, the Respondent issued a Letter dated 09.05.2022, terminated the Contract on the grounds of non-fulfillment of the contract.
(v) Hence, the Petitioner filed an Application for appointment of an Arbitrator under Section 11(6) of the Arbitration and Conciliation Act 1996. The counsel for the Petitioner submitted that the clause 55 of the Agreement was violative of Article 14 of the Constitution in the sense of being unfair and unjust.
A) Whether the condition of Pre-depositing 7% of the Arbitration claim amount as security deposit is violative of Article 14 of the Constitution.
B) Whether as per the decision of Perkins Eastman Architects DPC and Another v. HSCC (India) Limited reported in (2020) 20 SCC 760, the unilateral right of appointment of the arbitrator given to the Respondent under the Contract is unenforceable.
C) Whether the principles laid down in ICOMM Tele Limited v. Punjab State Water Supply and Sewerage Board and Another(2019) SLP (Civil) No.3307 of 2018 particularly in light of Clause 55 of the General Conditions of Contract are valid or not.
D) Whether the decision of Apex Court in the case of K. Jain v. State of Haryana and Another reported in (2009) 4 SCC 357, will be valid or not, wherein a similar clause 9 requiring a security deposit of certain percentage of the claim amount was held to be valid.
E) Whether an impartial sole Arbitrator could be appointed for resolution of disputes or the Secretary of Irrigation from Government of Uttarakhand must be empowered for the same.
The Supreme Court decided the matter and held as follows:
1) The Court placed reliance on principles of law from ICOMM Tele Limited v. Punjab State Water Supply and Sewerage Board and Another (supra)and stated as follows:
i) “That the pre-deposit condition in an arbitration clause is violative of Article 14 of the Constitution of India being arbitrary.”
ii) “Unless it is first found or prima facie established that the litigation that has been embarked upon is frivolous, the exemplary costs or punitive damages cannot follow.”
iii) “Deterring a party to arbitration from invoking the Alternative Dispute Resolution Process by pre-deposit of certain percentage would discourage arbitration. This would run contrary to the object of de-clogging the court system and would render the arbitral process ineffective and expensive.”
2) The Apex Court was of the view that if every Arbitration Agreement contains a clause for pre-deposit of a percentage of claim made, then that would result in creating a hindrance to parties choosing Arbitration and the main purpose of de-clogging the judicial system would be left spiritless.
3) That the Constitution is the supreme law of land and it is the paramount source of law in India. All other laws that are made must be in conformity with the Constitution. Infact the Constitution itself contains the provisions that provide that if any provision is in violation of the Constitution, it is liable to be struck down.
4) That in the context of Kelson’s theory of Grundnorm, the following would be the hierarchy of laws to be followed-
a) Constitution of India, 1950;
b) Arbitration and Conciliation Act, 1996 & any other Central/State Law;
c) Arbitration Agreement entered into by the parties in light of Section 7 of the Arbitration and Conciliation Act, 1996.
5) The Court was of the opinion that the Arbitration Agreement must be in conformity with the abovementioned laws as per ‘Grundnorm’ theory which puts the Constitution in the topmost bracket.
6) That the appointment of Irrigation Department’s Secretary as sole arbitrator was a violation of principles laid down in the judgment of Perkins Eastman Architects DPC and another v. HSCC (India) Ltd, (supra) which provided that individuals having interest in arbitration decisions should not possess the authority to nominate arbitrators. The Court further referred to the 2015 Amendment to Section 12 of the Arbitration and Conciliation Act.
The Apex Court concluded the argument by disregarding the two controversial conditions of Clause 55 of the Arbitration Agreement, firstly deposit of 7% pre-deposit of total amount claimed and secondly empowering the Principal Secretary (Irrigation) Government of Uttarakhand to appoint a sole arbitrator. Later on, Mr. V.K. Bist, the Former Chief Justice of the High Court of Sikkim, was appointed as the sole arbitrator by Supreme Court. This historic ruling establishes a precedent, upholding the integrity of the Indian arbitration process and reinforcing the Constitution’s supremacy over any other law. It emphasizes that the essential principles of the Constitution cannot be compromised by agreement, and that arbitrary prerequisites must not impede access to justice.
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(a) such as the existence either direct or indirect, of any past or present relationship with or interest in any of the parties or in relation to the subject-matter in dispute, whether financial, business, professional or other kind, which is likely to give rise to justifiable doubts as to his independence or impartiality; and
(b) which are likely to affect his ability to devote sufficient time to the arbitration and in particular his ability to complete the entire arbitration within a period of twelve months.
Explanation 1.—The grounds stated in the Fifth Schedule shall guide in determining whether circumstances exist which give rise to justifiable doubts as to the independence or impartiality of an arbitrator.
Explanation 2.—The disclosure shall be made by such person in the form specified in the Sixth Schedule.]
(3) An arbitrator may be challenged only if—
(a) circumstances exist that give rise to justifiable doubts as to his independence or impartiality, or
(b) he does not possess the qualifications agreed to by the parties.
(4) A party may challenge an arbitrator appointed by him, or in whose appointment he has participated, only for reasons of which he becomes aware after the appointment has been made.
2[(5) Notwithstanding any prior agreement to the contrary, any person whose relationship, with the parties or counsel or the subject-matter of the dispute, falls under any of the categories specified in the Seventh Schedule shall be ineligible to be appointed as an arbitrator:
Provided that parties may, subsequent to disputes having arisen between them, waive the applicability of this sub-section by an express agreement in writing.]