Pre-Arbitration Procedure: Mandatory or Directory?

PRE-ARBITRATION PROCEDURE

Very often, arbitration agreements provide that, in the event of disputes arising between the parties, they will take certain steps before they can refer the disputes to arbitration. These steps can include, inter alia, a requirement to discuss the matter among themselves with a view to amicably resolving the disputes; or obtaining the decision of a person, or more than one person in succession, in respect of the disputes; or appointing a mediator or conciliator to help settle the matter. The arbitration agreement may provide that if these steps do not help resolve the disputes, then, the disputes may, thereafter, be referred to arbitration.

Such steps, which are to be taken before a party can refer the disputes to arbitration, shall be referred to as “pre-arbitration procedure” in this article. These steps are also described or referred to as conditions precedent, or multi-tier clauses, or preliminary steps.

STATUS OF PRE-ARBITRATION PROCEDURE IN LAW

The discussion below will show that it is not certain at all, in India as also in England, as to whether pre-arbitration procedure is mandatory or not, and if mandatory, to what extent. Different views have been expressed in different judgments from time to time.

The judgments have adopted different approaches to the following two types of pre-arbitration procedures : (i) requirement of discussions/negotiations with a view to arrive at an amicable settlement of the disputes; and (ii) a requirement of obtaining decision of one or more persons. Therefore, the discussion below also discusses these two types of pre-arbitration procedures separately. In respect of both types, the decisions of courts in India and England are separately discussed.

REQUIREMENT OF DISCUSSIONS/NEGOTIATIONS/CONCILIATION WITH A VIEW TO ARRIVE AT AN AMICABLE SETTLEMENT OF DISPUTES : INDIAN JUDGMENTS

In Visa International Ltd. v. Continental Resources (USA) Ltd.¹, the agreement required that the parties should make an attempt at amicable settlement. This requirement was not followed before invoking the arbitration clause. It was held that the request for arbitration was not premature because : (a) there was no scope for amicable settlement as both parties had taken rigid stand; and (b) correspondence shows that attempts were made for amicable settlement. The first part of the reasoning shows that the court was of the view that the requirement of attempting amicable settlement need not be fulfilled where it has no hope of succeeding, and in such circumstances it is not mandatory.

In Rajiv Vyas v. Johnwin², the agreement required reference to conciliation before the arbitration clause was invoked. Invocation was done without following this procedure. It was held that the correct procedure would be to make an order under Section 11 of the Arbitration and Conciliation Act, subject to the parties complying with any preconditions. This would avoid multiplicity of proceedings. Secondly, it was also held that conciliation would be an empty formality in view of the stand taken by the respondent. The court should reject such defence without compelling the parties to go through empty formality. This second part of the reasoning is the same as what was held in Visa International Ltd. v. Continental Resources (USA) Ltd.³, mentioned in the previous paragraph. The first part of the reasoning is interesting, namely, invocation can be allowed and the tribunal can be constituted, but subject to the parties complying with the requirement of first referring the matter to conciliation.

The judgment in Haldiram Mfg. Co. (P) Ltd. v. DLF Commercial Complexes Ltd.⁴, was in an application under Section 8 of the Arbitration and Conciliation Act, to refer the suit to arbitration. The agreement required discussion for amicable settlement prior to requesting arbitration. The requirement of discussion was prefaced with the word “shall”. The requirement was held to be mandatory. The Court held that the defendant had not called upon the plaintiff to follow the procedure under the clause for amicable settlement. Therefore, the defendant cannot seek to refer the matter to arbitration. Section 8 application was dismissed.

In Simpark Infrastructure (P) Ltd. v. Jaipur Municipal Corpn.⁵, a clause requiring conciliation meetings before arbitration was held to be mandatory. The judgment is erroneously based on earlier judgments which did not deal with pre-arbitration procedure, but procedure for appointment of arbitrators (SCC OnLine Raj paras 17-20).

In Ravindra Kumar Verma v. BPTP Ltd.⁶, the agreement required discussion for amicable settlement prior to arbitration. The clause was held not to be mandatory so as to vitiate the invocation of the arbitration agreement. However, similar to the decision in Rajiv Vyas v. Johnwin⁷ (discussed above), the Court held that order appointing tribunal should be passed, but before starting arbitration proceeding, the steps contemplated in the precondition should be directed to be taken. Haldiram Mfg. Co. (P) Ltd. v. DLF Commercial Complexes Ltd.⁸ (discussed above) was held to be per incuriam. The Court gave the following two reasons for not holding that the clause was mandatory. First, if the clause is held to be mandatory, it will shorten the period of limitation. For example, if the clause requires discussion for amicable settlement should be done for a period of thirty days, then, in order to invoke the arbitration clause within a period of, say, three years, the party is required to initiate the step of discussion 30 days prior to the expiry of three years. If the party misses that, and decides to proceed, say, 29 days or less, before the expiry of three years, then, he will be barred by the law of limitation for invoking the arbitration clause. Secondly, the Court relied on Section 77 of the Arbitration and Conciliation Act, which lays down that the pendency of conciliation proceeding does not prohibit a party to initiate an arbitration or judicial proceeding for preserving its rights. Interestingly, the reasoning adopted in Haldiram case⁸ is not discussed or referred to in other judgments (though some judgments have followed this judgment). Particularly, the judgments which hold the requirement of conciliation to be mandatory, do not deal with the reasoning contained in this judgment.

In Demerara Distilleries (P) Ltd. v. Demerara Distillers Ltd.⁹, the agreement contained a requirement of mutual discussion before arbitration. Application was made without complying with this requirement. The Court rejected the contention that the application was premature, on the ground that any discussion at that stage would be an empty formality. Therefore, the requirement was not held to be mandatory.

In Satpal Sharma v. Union of India¹⁰, Union of India v. Baga Bros.¹¹, Sarvesh Security Services (P) Ltd. v. DSIIDC¹² and Siemens Ltd. v. Jindal India Thermal Power Ltd.¹³, the Courts followed Ravindra Kumar Verma¹⁴ and held the requirement of conciliation prior to arbitration, to be directory. In Siemens¹³, the Court further observed that no procedure for settlement was agreed; and only provision is that the parties shall endeavour to settle. This judgment thereby hinted that a requirement of settlement should contain further detailed procedure, in the absence of which it cannot be held mandatory.

In summary, the Supreme Court, in Visa International³ and Demerara¹⁵, has held that the requirement of mutual discussion to attempt amicable settlement need not be complied with if it would be an empty formality and there was no scope for amicable settlement. The Delhi High Court, in Haldiram⁸, held the requirement of discussion for settlement to be mandatory; but in Ravindra Kumar Verma¹⁴ (and four judgments following it), it has taken a view that the requirement is directory, and Haldiram⁸ was held to be per incuriam; however, it was also held that after making an order for appointment of arbitrator, the parties should be directed to comply with the requirement before proceeding with arbitration. The Bombay High Court has also taken a similar view in Rajiv Vyas⁷. The Rajasthan High Court, in Simpark¹⁶, however, has held that such a requirement is mandatory; however, the judgment is based on earlier judgments which did not deal with pre-arbitration procedure, but procedure for appointment of arbitrator.

REQUIREMENT OF DISCUSSIONS/NEGOTIATIONS/CONCILIATION WITH A VIEW TO ARRIVE AT AN AMICABLE SETTLEMENT OF DISPUTES : ENGLISH JUDGMENTS

In Itex Shipping Pte. Ltd. v. China Ocean Shipping Co.¹⁷, a contract clause requiring amicable settlement prior to arbitration, was held to be directory. The reason for so holding was that the clause was held to be not valid as it was a mere agreement to negotiate; it only expressed pious hope.

In Halifax Financial Services Ltd. v. Intuitive Systems Ltd.¹⁸, the Court was dealing with a requirement of negotiations prior to reference to arbitration. On interpretation of the contract clause, it was held that the clause did not make the requirement of negotiations as a condition precedent, and, therefore, legal proceedings can be initiated. Further, it was held that the clause is not an arbitration agreement. It was also observed that forced negotiations would be futile at the moment. Therefore, no stay of legal proceedings was granted although there were no prior negotiations.

In Cable and Wireless Plc. v. IBM United Kingdom Ltd.¹⁹, contract clause required that ADR procedure as recommended by CEDR should be followed before arbitration. This was held to be certain and enforceable, and therefore, mandatory. It was further held that even if no such identifiable procedure (that is, recommended by CEDR) was mentioned, the clause may still be enforceable. The Court stated that not enforcing such a clause would be contrary to public policy.

In Holloway v. Chancery Mead Ltd.²⁰, it was laid down that ADR clause should meet three criteria in order to be enforceable, namely, first, the process must be sufficiently certain; secondly, the administrative processes for selecting a person to resolve the dispute, and payment to him, should be defined; and, thirdly, the process or model of the process should be set out. The judgment makes reference to authorities which say that a bare agreement to negotiate has no legal content.

In Sulamerica Cia Nacional de Seguros SA v. Enesa Engenharia SA²¹, the Court followed the judgments in Cable and Wireless¹⁹ and Holloway²². Applying those principles, it was held that the clause in question was not enforceable or condition precedent. In para 20, there is a mention of submission that either party can go to court without fulfilling conditions precedent, or, follow condition precedent and then go to arbitration. This judgment was affirmed in appeal.²³

In Tang Chung Wah v. Grant Thornton International Ltd.²⁴, it was held that an agreement to agree and an agreement to negotiate in good faith, without more, are not enforceable. Court will strain to give effect to such clauses, but for that purpose, the obligations that the clause imposes must be clear and certain to be given legal effect to. In para 60 of the judgment, the following test is set out:

In the context of a positive obligation to attempt to resolve a dispute or difference amicably before referring a matter to arbitration or bringing proceedings the test is whether the provision prescribes, without the need for further agreement, (a) a sufficiently certain and unequivocal commitment to commence a process, (b) from which may be discerned what steps each party is required to take to put the process in place, and which is (c) sufficiently clearly defined to enable the Court to determine objectively : (i) what under that process is the minimum required of the parties to the dispute in terms of their participation in it, and (ii) when or how the process will be exhausted or properly terminable without breach.

In Emirates Trading Agency LLC v. Prime Mineral Exports (P) Ltd.²⁵, the Court distinguished earlier judgments of the appellate court, and differed with earlier judgments of Single Judges, and held that a time-limited clause requiring friendly discussion was mandatory and enforceable. The following reasons were given in support of this view. First of all, the use of the word “shall” in the clause indicated that it was mandatory. Secondly, the requirement makes commercial sense inasmuch as it is better for parties to avoid expensive and time-consuming arbitration through friendly discussion. Thirdly, commercial men expect court to enforce obligations which they have freely undertaken. Fourth, the object of such a clause is to avoid time-consuming and expensive arbitration. Therefore, such a clause is in public interest.²⁶ The Court agreed with the Australian authority that such clauses are enforceable and are not vague or incomplete; it further held that a mere difficulty in proving breach in some cases should not be confused with the suggestion that the clause lacks certainty; it held that there is a difference between an agreement to agree, and an agreement to hold negotiations in good faith, and the latter is only an agreement by a party to conduct itself in a particular manner, and it should be enforceable.

To summarise, the English Courts have mainly been concerned with the question as to whether an agreement to negotiate is a valid or enforceable agreement, and different views have been expressed in different judgments, partly also governed by the language of the clause in question; and based on the above, different views have been expressed about whether such a clause is mandatory or not. However, the last judgment, in Emirates Trading Agency²⁷, upholds validity and enforceability of an agreement to negotiate and holds it to be mandatory. That judgment also emphasises two important factors. First, it emphasises that commercial men expect court to enforce obligations which they have freely undertaken. Secondly, it emphasises the public interest and public policy aspects.

REQUIREMENT OF OBTAINING DECISION OF ONE OR MORE PERSONS PRIOR TO ARBITRATION : INDIAN JUDGMENTS

In Sikand Construction Co. v. SBI²⁸, the contract clause provided for decision of the architect first, before reference to arbitration. The clause used the words “shall refer”. The Court held that the clause was directory and not mandatory, and that disputes can be referred to arbitration without referring them to architect first. The reasons given for arriving at this conclusion were as follows. First, the decision of the architect was not final and was subject to the right of arbitration and review. Secondly, there was no indication of a judicial hearing by the architect. Thirdly, clause 37 confers absolute power in the arbitrator without any restriction. Fourth, consequences of not following the procedure have not been provided for.

In Nirman Sindia v. Indal Electromelts Ltd.²⁹, the contract clause required prior decisions of engineer and adjudicator, before reference to arbitration. It was held that the parties were bound to comply with the mode prescribed in the agreement before referring the disputes to arbitration.

In Sushil Kumar Bhardwaj v. Union of India³⁰, the contract clause required hierarchical adjudication of claims by various authorities before arbitration. This was held to be mandatory. The Court relies on Nirman Sindia v. Indal Electrologists Ltd.³¹ referred to in the previous paragraph. The Court also relies on some other judgments³²; however, those judgments held that Section 11 of the Arbitration and Conciliation Act requires mandatory adherence to the procedure for appointment of arbitrator; they had no application because there is a difference between procedure for appointment of arbitrator, and pre-arbitration procedure.

In Build Fab v. Airport Authority of India³³, the contract clause required decision by Dispute Resolution Board upon a request being made within ninety days of dispute arising, and only the matters which are not resolved before DRB could be referred to arbitration. This requirement was not complied with. It was held that since the matter was not referred to DRB, arbitration clause could not have been invoked. It was further held that the regular remedy of filing of suit was available to the claimant, as the arbitration clause applied only to certain category of disputes which go through the procedure before DRB.

In Sun Security Services v. Babasaheb Bhimrao Ambedkar University³⁴, the contract clause provided for “settlement” by the Registrar; failing that, decision of the Vice-Chancellor shall be final and binding; if not satisfied, arbitration shall be conducted. Held, that it is not mandatory to go to the Registrar or the Vice-Chancellor before going for arbitration. The reasons given by the Court for this decision were as follows. First, Registrar and Vice-Chancellor have, by filing affidavits/letters in the matter, taken a stand. Therefore, settlement of disputes by them not feasible. Secondly, the clause does not contemplate any adjudicatory mechanism or passing of any order. It is only a pre-arbitration settlement mechanism. Thirdly, such mechanism cannot be interpreted as an absolute bar once the parties are sure of the stand taken by the other. Fourth, settlement by the Vice-Chancellor was arbitrable.

In JIL-Aquafil (JV) v. Rajasthan Urban Infrastructure Development Project³⁵, the contract clause required the matter to be referred to the Project Manager for decision, and if a party was dissatisfied with the decision, then, it had to give a notice of arbitration within 28 days of the decision of the Project Manager. The disputes were submitted to the Project Manager for his decision. He gave his decision. This requirement, however, was held to be directory, following the judgment in Ravindra Kumar Verma¹⁴ (discussed above). It was further held that, in any event, the clause requiring notice of arbitration to be given within 28 days of the decision, was invalid in view of Section 28 of the Contract Act.

In Ved Prakash Mithal and Sons v. DDA³⁶, the contract clause required hierarchical adjudication of claims by various authorities before arbitration. The Court relied on the decision in Sushil Kumar Bhardwaj³⁰ and followed it, and held that the procedure is mandatory. The decision in Sikand³⁷ was distinguished on the ground that it was under the 1940 Act and interpreting specific arbitration agreement. The decisions in Ravindra Kumar Verma¹⁴ and Siemens¹³ were distinguished on the ground that they related to a pre-arbitration procedure of amicable settlement.

In NHAI v. Pati-Bel (JV)³⁸, the contract clause required prior reference to DRB. The Court held this pre-arbitration procedure to be mandatory for the following reasons. First, a reading of the clause shows that it is mandatory. If the clause is so structured that it does give rise to a binding obligation, it may not be possible to contend that the preliminary step provided in the clause concerned is not a condition precedent. Secondly, the decision in Ravindra Kumar Verma¹⁴ was distinguished because it dealt with a conciliation clause. Thirdly, the decision in Haldiram⁸ was relied on. Also, the English decision in Channel Tunnel Group Ltd. v. Balfour Beatty Construction Ltd.³⁹ was relied on.

In Backend Bangalore (P) Ltd. v. H.P. Road and Infrastructure Development Corpn. Ltd.⁴⁰, contract clause providing for reference of disputes to an adjudicator, was held to be directory. The reasons were as follows. First, the respondent too could have referred the disputes to adjudicator; but the respondent failed to do so. Secondly, reference to adjudicator would serve no purpose as the respondent has strenuously contested the matter, and 1.5 years have passed without reference to adjudicator. Thirdly, decisions in Visa International³, Haldiram⁸, Sikand³⁷, Ravindra Kumar Verma¹⁴, Servesh Security⁴¹, JIL-Aquafil⁴² and Rajiv Vyas⁷ were relied on.

To summarise, some High Court judgments have held such clauses to be mandatory whereas the others have held them to be directory.

REQUIREMENT OF OBTAINING DECISION OF ONE OR MORE PERSONS PRIOR TO ARBITRATION : INDIAN JUDGMENTS

In JT Mackley & Co. Ltd. v. Gosport Marina Ltd.⁴³, the contract clause required decision of engineer before referring the matter to arbitration. It was held that the reference to engineer was a condition precedent. It was further held that reference cannot be made and then kept in suspense till the decision of the engineer. This was for the reason that if this was held to be the correct position, it would make a mockery of the procedure laid down in the contract and time-limits specified for challenging the decision.

In AL-Waddan Hotels Ltd. v. Man Enterprise SAL⁴⁴, the requirement in FIDIC of decision of engineer before reference to arbitration, was held to be a condition precedent to arbitration, as this position was well-known and trite law.

ANALYSIS OF INDIAN JUDGMENTS

A study of the Indian judgments discussed above bring out the following points:

1. As is evident, the judgments are not consistent with each other.

2. Even the judgments which adopt a similar approach are supported by reasons which are varied and different.

3. No judgment contains an exhaustive study and analysis of prior judgments on the issue.

4. The judgments have not discussed the policy considerations which should have a bearing on the decision. This will be discussed in the next section in this article.

5. An important point has not been discussed in any judgment other than Ravinder Kumar Verma¹⁴, namely, the interplay between pre-arbitration procedure being mandatory and its effect on the period of limitation and applicability of Section 28 of the Contract Act. This will be discussed in the next section of this article.

6. The Indian judgments have also not discussed the main point in respect of pre-arbitration requirement of negotiations for amicable settlement, namely, whether and to what extent this requirement is valid and enforceable. This has been the main point of concern and discussion in the English judgments.

SUBMISSIONS

The following principles or policy considerations should govern the question of whether pre-arbitration procedure should be mandatory or directory.

First, commercial men expect court to enforce obligations which they have freely undertaken. Therefore, if the commercial men have intended, agreed and provided in the contract that before embarking on arbitration, attempts to resolve the disputes by other means ought to be adopted, then, the courts should respect that intention and agreement and enforce the same as far as possible. The choice made by the contracting parties, especially when they are commercial entities, on how they want to resolve potential differences between them should be respected.

Secondly, it is in public interest that the parties to a dispute ought to be saved from time-consuming and expensive proceedings. It is in public interest to promote consensual disposition of potential disputes. The object of pre-arbitration procedure is precisely that, namely, to avoid time-consuming and expensive arbitration proceedings by trying to resolve the disputes by other means. Therefore, it is in public interest to enforce such pre-arbitration procedure.

Thirdly, it is the public policy today to encourage alternative disputes resolution methods (ADR). Pre-arbitration procedure is nothing but ADR, and therefore, courts should be anxious to direct parties to resort to such agreed ADR steps before commencing any arbitration.

Fourth, there is also public policy to ensure efficient use of private and public resources, as also to ensure promotion of private interests of members of public in the efficient conduct of dispute resolution in a fair, speedy and cost-efficient manner. These public policy considerations also require that the courts enforce pre-arbitration procedure before the parties resort to arbitration.

The above policy considerations require that the pre-arbitration procedure should be treated as mandatory.

English judgments have raised a question about validity and enforceability of a clause containing an agreement to negotiate for amicable settlement. However, as seen above the last judgment in Emirates Trading Agency²⁷, and the Australian and Singapore judgments referred to therein, uphold the validity and enforceability of such clauses. Further, these clauses are normally time-bound, that is to say, they provide for a period of time during which negotiations have to take place and allow parties to go to arbitration on the expiry of that period if no settlement is reached by then. In such time-bound clause, the questions of whether a breach of the agreement to negotiate has occurred or not, or which party is at fault, do not arise. Irrespective of breach or fault, upon the expiry of the prescribed period, the parties are free to resort to arbitration. It is submitted that not only the clauses requiring negotiations, but all pre-arbitration procedural steps should be time-bound, so that, on the expiry of the time prescribed, the parties are free to go to the next step. It is submitted that if the clause providing for pre-arbitration procedure do not make the procedure time-bound, then under Section 46 of the Contract Act, which would require that the procedure should be performed within a reasonable time, a time-limit ought to be fixed. In the absence of time-limit, the pre-arbitration procedure can prolong endlessly, and the problems of ascertaining whether there is a breach or by whom will crop up.

However, in Ravindra Kumar Verma¹⁴, the Court raised a very important issue. Any pre-arbitration procedure takes time. This time cannot be excluded while ascertaining of the arbitration proceedings were commenced within the period of limitation. Therefore, in order to initiate the arbitration proceeding within the period of limitation, the party initiating action has to commence pre-arbitration proceeding well before the expiry of the period of limitation, so that the arbitration proceeding can be commenced within the period of limitation. For example, if the contract provides for a period of 30 days for negotiations and arbitration proceeding can be commenced only after the expiry of the period of 30 days, then, if a party decides ten days before the expiry of the period of limitation to initiate arbitration proceeding, it cannot do so if the requirement of 30 day negotiation is held to be mandatory. That curtails the period of limitation that is available to the parties. Therefore, if the pre-arbitration procedure of 30 days of negotiations is held to be mandatory, then, the clause will be invalid under the provisions of Section 28 of the Contract Act as it provides a shorter period of limitation. This is a strong reason to hold that pre-arbitration procedure is directory, and cannot be mandatory.

One of the judgments discussed above, namely, Build Fab v. Airport Authority of India³³, suggested that it is always open to a party to file a suit in a court (without following the pre-arbitration procedure), when the contract contains a clause providing for pre-arbitration procedure. This, however, is not a solution to the issue raised in Ravindra Kumar Verma¹⁴. First of all, an arbitration clause which does not make it mandatory for a party to refer disputes to arbitration, and allows the party an option to file a suit instead, is not a valid arbitration clause at all⁴⁵. Secondly, such an interpretation of an arbitration agreement, where the party, at its option can choose to file a suit without following pre-arbitration procedure, or initiate arbitration proceeding after following pre-arbitration procedure, defeats the purpose and philosophy of promoting arbitration. A party who does not wish to resort to arbitration can easily escape the binding effect of arbitration clause, if this interpretation is correct. Thirdly, if such a suit is allowed to be filed without following pre-arbitration procedure, a question will arise if an application under Section 8 can lie at the behest of the opposite party. If it can lie, it will mean that the matter, in any event, will be referred to arbitration without following pre-arbitration procedure. And if it cannot lie, then, the provisions of Section 8 are rendered nugatory. Fourth, if the objective of pre-arbitration procedure is to avoid time-consuming and expensive legal proceeding, it will be anomalous that the pre-arbitration procedure is mandatory for arbitration, but not for suit.

As suggested below, the concern raised in Ravindra Kumar Verma¹⁴ ought not to result in treating pre-arbitration procedures as directory. A provision needs to be made in respect of matters where a party is likely to lose its rights (because of the bar of limitation) if the pre-arbitration procedure is followed.

In the circumstances, it is submitted that

(i) All pre-arbitration procedures should be mandatory;

(ii) If the contract clause does not make the pre-arbitration procedure time-bound, then under Section 46 of the Contract Act, a reasonable time-limit is required to be read into the clause;

(iii) This should be subject to an exception that, a party may initiate arbitral proceedings by issuing notice invoking arbitration clause, before complying with the pre-arbitration procedure, or during the course of its compliance, where, such initiation of arbitral proceedings is necessary for preserving his/its rights; however, no further steps will be taken pursuant to such invocation, before complying fully with the pre-arbitration procedure.

Alternatively, it is submitted that, if the legislature so deems fit, it can legislate that in respect of clauses with mandatory pre-arbitration procedure, the question as to whether the claim in arbitration is within the period of limitation or not should be ascertained with reference to the date on which the pre-arbitration procedure is commenced.