Pre-Deposit Clauses to invoke Arbitration Makes Arbitral Process ineffective and expensive

The Hon’ble Supreme Court of India, vide its order dated 11.03.2019 in M/s ICOMM TELE LTD. vs Punjab State Water Supply and Sewerage Board and Anr. Civil Appeal No. 2713 of 2019, struck down the arbitration clause requiring pre-deposit to invoke Arbitration proceeding to resolve dispute between the parties.

 THE CHALLENGE:

The facts related to this case are that in 2008, Punjab State Water Supply and Sewerage Board, ‘state’ as per Article 12 of the Constitution, issued notice inviting tender for extension of augmentation of water supply and many other services on turnkey basis. The Appellant applied in the same and his tender was selected and the parties executed a contract on 16.01.2009 wherein a detailed arbitration clause was provided in clause 25 of the contract in question. Clause 25 (viii) contained condition for pre-deposition of 10% of the claimed amount with a bank in the name of the Arbitrator and in the event of an award in favour of the claimant, the deposit shall be refunded to the claimant in proportion of the amount awarded w.r.t. the amount claimed and the balance, if any, shall be forfeited and given to the other party. It was also a condition in this clause that no civil court proceedings can be initiated without going through arbitration proceedings.

The Appellant challenged aforementioned clause being arbitrary and so violative of Article 14 of the constitution. It was further argued by the Appellant that 10% deposit would amount to clog on entering arbitration process. So, the aforementioned clause being contract of adhesion ought to be struck down. The Respondent argued that there is nothing discriminatory and the clause would apply to both the parties so there is no question of arbitrariness and so violation of Article 14 of the constitution is out of question. It was further argued by the Respondents that the theory of contract of adhesion does not apply in cases of commercial contracts and the pre-deposit is to prevent frivolous claims.

The Hon’ble Supreme Court, after hearing both the parties, struck down Clause 25 (viii) on the basis that though contract of adhesion theory does not apply in cases of commercial contracts, however, when one of the parties is state then courts have to remember that state ought not be allowed to use the veil of ‘commercial contract’ to practice arbitrariness and violate article 14 of the constitution. Pre-deposit clauses become a clog to the process of the arbitration proceedings resulting in increase in litigation cases thereby vitiating the whole purpose of the Arbitration and Conciliation Act, 1996. The Hon’ble Court further reiterated that an act of state in violation of Article 14 for being arbitrary does not necessarily requires discrimination. Arbitration per se is sufficient to violate article 14 and arbitrariness itself denies equal protection of law (Ajay Hasia’s case [1981] 2 SCR 79). It was also observed by the Hon’ble Court that the clause for forfeiting the deposited amount and paying the same to the party losing the arbitration proceedings would result in clog in arbitration proceedings.