Unveiling Injustice: Pre-Deposit Clauses in Arbitration Agreements
Vedant Mishra
4th Year, B.A LL.B (Hons.), National Law University Odisha
Introduction
Arbitration clauses within contracts often impose prerequisites on involved parties, such as attempting to resolve disputes amicably prior to escalating them to arbitration or requiring a deposit representing a portion of the claim amount. While the intention behind both measures is to deter frivolous claims, their consequences differ. The latter, involving a financial obligation, inherently creates an imbalance, placing the parties on unequal footing in their ability to initiate arbitration proceedings. One party may find themselves in this circumstance if they are financially disadvantaged, maybe as a result of confronting difficulties in the early phases of their business development. The fundamental reason for introducing a dispute resolution clause in the contract in the first place is undermined when a party is required to give up their ability to settle issues by requiring a pre-deposit.
Recent decisions rendered by the Hon’ble Supreme Court of India (SC) in cases such as M/s ICOMM Tele Limited v. Punjab State Water Supply and Sewerage Board and Others (ICOMM) (2019) ibclaw.in 149 SC and Lombardi Engineering Limited v. Uttarakhand Jal Vidyut Nigam Limited (Lombardi vs UPDCC) (2023) ibclaw.in 143 SC have been vital in proving that pre-deposit clauses in arbitration agreements are arbitrarily worded and therefore violate Article 14 of the Indian Constitution [see ¶42 of Lombardi]. The criterion of evident arbitrariness is often used in matters involving state entities; hence the scope of these verdicts is limited. As a result, the enforceability of pre-deposit agreements in arbitration procedures involving private corporations has received less attention—particularly in cases where there is a notable financial discrepancy between the parties. In an era characterized by the expansion of start-ups and micro, small, and medium-sized companies (MSMEs), the need to address such concerns becomes more urgent.
Opting for flexibility: The discretionary nature of pre-deposits
Pre-deposit requirements have turned what was intended to be a simple method of problem-solving into a legal maze, with conflicting views making matters worse. Sometimes, having to pay certain fees before starting arbitration can make it harder to actually arbitrate.
In the case of Ravindra Kumar Verma v. M/S BPTP, the court decided that the steps you have to take before arbitration, as mentioned in the arbitration agreement, are more like suggestions than strict rules. They said that if we interpret the arbitration agreement too narrowly and force parties to do specific things before starting arbitration, it could put one party at a disadvantage. This is because the time it takes to complete these initial steps, like trying to solve the issue through discussion, could eat into the time limit set by the law. So, making these steps mandatory could mean that parties have less time to file their claims within the legal deadline, which would make it harder for them to resolve their issues through arbitration [¶8]. The assumption that claimants’ statutory rights to arbitration may be violated by stringent adherence to pre-arbitral deposit rules was further upheld by the court. In the case of Demerara Distilleries Private Limited v. Demerara Distilleries Limited (2017) ibclaw.in 632 SC, the court examined an agreement that contained a requirement for mutual discussion, followed by mediation, before resorting to arbitration. The court mentioned that these requirements were just pointless rules and that not following them wouldn’t automatically send the dispute to arbitration early. Some argue that the court didn’t think this was a big deal because the parties didn’t even try to talk things out before. The author thinks that with this decision, the court basically said that pre-arbitration conditions couldn’t stop a case from being settled by arbitration.
As a result, the court emphasized how important it is to maintain flexibility while interpreting arbitration agreements in order to protect the parties’ interests and comply with deadlines.
It is further argued that conditions pertaining to pre-arbitral deposits originate from contracts of adhesion, a notion that is supported by the ICOMM case. The party with weaker negotiating power in an adhesion contract usually has little option but to accept a standard contract given by the other party on non-negotiable conditions. In these situations, the weaker party’s security concerns are superseded by the contract’s need, leading to unequal contractual relationships. These agreements violate basic contract law precepts including reasonable bargaining and mutual consent.
An arbitration provision that required a 10% deposit of the claimed sum as a precondition was evaluated in the ICOMM case. The court decided that parties who lack the financial resources to satisfy such criteria are disproportionately affected by demands for a large sum to be made before arbitration may begin. This makes it more difficult to get legal remedies and may even discourage people from engaging in arbitration. [¶23] [¶24] [¶27] As a result, the court correctly noted how pre-deposit restrictions hinder the arbitration process.
An appeal against a writ petition filed in the Punjab and Haryana High Court led to the ruling in the ICOMM case. The respondent had given the petitioner, a firm, a contract for a variety of civil and electrical services. An arbitration clause requiring a 10% pre-deposit of the amount sought was placed in clause 25 of the tender notice with the intention of discouraging “frivolous” claims. This section additionally stated that any balance that remained would be lost and transferred to the opposing party, and that a proportionate portion of the deposit would be restored if the petitioner achieved a favourable verdict. This clause, according to the petitioner, is arbitrary and goes against public policy. However, the High Court dismissed the writ petition, stating that the contract was a private agreement, openly and willingly entered into by both parties, and therefore did not warrant judicial intervention on its merits.
In the Lombardi case, the single judge bench of Punjab and Haryana High Court examined the rulings made by S.K. Jain vs State of Haryana and ICOMM Tele Limited. Following a three-judge bench’s ruling in S.K. Jain, the High Court chose to adopt the precedent established by that case after reviewing the pertinent arbitration provisions in each case.
The Lombardi Engineering case started with an application for the appointment of arbitrators made in accordance with Section 11(6) of the Arbitration and Conciliation Act, 1996. The Supreme Court looked into the existence and legality of the parties’ arbitration agreement, carrying on its recent practice of using Section 11(6) to exercise broad authority. In accordance with Article 14 of the Constitution, it was determined that the pre-deposit clause was blatantly arbitrary. Because UPDCC is a public entity and the arbitrariness concept does not apply to private parties, the Court invoked it in this case.
Over here the author argues that, the Supreme Court misapplied its remarks in the ruling in ICOMM Tele Ltd. v. Punjab State Water Supply and Sewerage Board. Furthermore, the author contends that even if the Court enlarged its jurisdiction under Section 11(6) of the Act at the arbitrator nomination stage, it misapplied the law and produced an undesirable result.
The main worry is how pre-arbitration deposits, especially large ones, might make it hard for less wealthy parties to get justice. Also, since these deposits are often a percentage of the claimed amount, poorer parties can’t ask for the full damages. Right now, the arbitration system doesn’t protect against this when both sides are private companies. However certain relaxation has been there at the discretion of the court as in the case of Goodyear India Limited v. Norton Intech Rubbers Private Limited
the court held that If the court of appeals determines that compelling the appellant to deposit 75% of the awarded sum as a pre-deposit all at once would impose an undue hardship, it may allow the pre-deposit to be deposited in instalments, taking into account any prospective hardship that may be submitted to the court.
Equitable Handling of the Parties
Let’s catch up with an illustration -Let’s say there are two companies: X, which started in 1998 with assets worth INR 25 crores, and Y, which began in 2021 with assets worth INR 40 lakhs. After Y’s start, it faced unfair competition and lost clients, causing its assets to shrink. X, however, was doing well. A took advantage of Y’s situation by offering a contract worth INR 20 lakhs, giving Y only one day to decide. Despite knowing about a clause requiring a deposit, Y rushed into signing. This clause demanded that if a dispute went to arbitration, the party making the claim had to pay 8% upfront. Later, X broke the contract, refusing to pay for the products it ordered.
Since the pre-deposit constituted a sizable portion of Y’s assets, it became apparent when it approached the tribunal for arbitration that it would not be able to afford to deposit 8% of the claim. On the other hand, X would have been in a far better position than Y to deposit such a sum had it been X that was required to send the dispute to arbitration. Nevertheless, it would still have to do so. Referring the dispute to arbitration would consequently be deemed convenient.
The idea of treating all parties fairly is upheld by both Section 18 of the Act and Article 18 of the Model Law. In order to prevent arbitral tribunals from acting arbitrarily, they declare that every party shall have an equal opportunity to submit their case. Some contend that while it may appear fair in principle, it is not always fair in practice when one side is less wealthy than the other and still must pay the same sum to submit a disagreement to arbitration. This is a result of the parties’ disparate financial circumstances not being taken into consideration. Thus, although each party must provide the same amount or percentage, their capacity to do so differs.
The above-mentioned “X” and “Y” case is an example of the significant difference in finances that can exist between the contracting parties in different circumstances. In these instances, one-sided contracts lead to the inclusion of pre-deposit clauses in arbitration agreements. These clauses originate from and continue, the unbalanced contractual dynamics, thus leaving the financially weak parties with no choice of taking their cases to arbitration. Thus, it is for the concerned parties to make the decision if they want to follow such conditions.
Conclusion
The huge difference in bargaining power between big and small businesses during the contract negotiations cannot be overlooked. It is vital to treat pre-arbitral deposits as optional in order to make sure that all parties have the same opportunities for arbitration and that no party is at a disadvantage because they cannot pursue their claim. Courts for arbitration should be allowed to look into the specific facts of each case, like the complexity of the dispute and the finances of the parties, and to find out the actual intentions of the parties in contracts. The tribunal should fasten this process by following the pre-deposit standards and stipulating those situations in which some parties are to be released from pre-arbitral deposit obligations, depending on their financial situation. These regulations may set an asset requirement or a minimum turnover which will be the basis to identify a business as the one that is obliged to abide by the pre-deposit laws, by including factors such as a stable financial situation. The decision on whether the organisation should be subjected to the deposit requirement should be made on the basis of the evaluation of these factors on an individual level.
Even though it is necessary to state that the tribunal can demand the financially weaker companies to comply with the deposit, this decision should be made after considering the factors that have been mentioned above.
