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  • Tarasha Gupta

Analysing Lombardi Engineering: Article 14 and Invalidating Pre-Conditions to Arbitration

[Tarasha is a student at Jindal Global Law School.]


Recently, the Supreme Court in Lombardi Engineering Limited v. Uttarakhand Jal Vidyut Nigam Limited (Lombardi Engineering) held that a clause between the parties requiring a pre-deposit as a pre-condition to invoking arbitration is manifestly arbitrary and violative of the Article 14 of the Constitution of India. Relying on Kelsen’s pure theory of law, the court held that the Constitution of India is the grundnorm. Arbitration agreements are subordinate to the Arbitration and Conciliation Act 1996 (A&C Act), which is, in turn, subordinate to the Constitution of India. It thus created the precedent that arbitration clauses can be struck down as being violative of constitutional norms.


This article makes three criticisms of this judgment. First, it misapplies Kelsen’s pure theory of law. Second, it creates an unwarranted distinction between the doctrine of unconscionability and the scope of Article 14, which has the counter-intuitive implication of restricting claims of invalidity of such clauses. Finally, the court did not need to rely on Kelsen’s pure theory of law; it could have simply adopted the doctrine of unconscionability, application of which has already been recognized under Section 23 of the Indian Contract Act 1872 (ICA) in Central Inland Water Transport Corporation v. Brojonath Ganguly (Brojonath Ganguly).

 

Misapplication of Kelsen’s Pure Theory of Law


There are two ways in which Kelsen’s pure theory of law was misapplied in Lombardi Engineering.


First, as Shweta Kushe points out, Kelsen himself created a distinction between the grundnorm and the Constitution of India. The grundnorm is a foundational basic norm on the basis of which all law is validated. Therefore, the Constitution of India cannot be the grundnorm, insofar as it also traces its validity from a set of basic norms. The grundnorm is the reason for the validity of the Constitution of India, not the Constitution of India itself.


Second, the court treats the grundnorm as a prescriptive theory, when it is actually a descriptive one. The grundnorm is not created by the real act of will of a legal organ, but is an abstract presupposition lying at the apex of acts created by legal organs, from which such acts derive validity. It is not a prescriptive element of law in and of itself; it simply inspires the norms underlying prescriptive, positive law elements of a legal system. It is not merely another positive law.


The court’s justification for invoking Article 14 based on Kelsen’s pure theory of law thus falls flat. Instead, the court could have applied the doctrine of unconscionability, as will be argued later in this article.

 

Unwarranted Distinction Between Unconscionability and Article 14


The court also considered whether there is any direct conflict between SK Jain v. State of Haryana (SK Jain) and ICOMM Tele Limited v. Punjab State Water Supply and Sewerage Board (ICOMM Tele Limited), and answered this question in the negative.


In SK Jain, the Supreme Court of India upheld a clause requiring a deposit of certain percentage(s) of the claimed amount as a deposit before invoking arbitration, observing that there was a logic behind the pre-condition (to prevent frivolous and inflated claims). In ICOMM Tele Limited, the Supreme Court of India struck down a clause requiring a deposit of 10% of the claimed amount before invoking arbitration as being arbitrary and thus violative of Article 14. In Lombardi Engineering, the court held that there is no conflict between the two, by citing the reasoning given in ICOMM Tele Limited differentiating itself with SK Jain. One such reason was that the court in SK Jain was not presented with an argument regarding the invalidity of the clause on account of arbitrariness under Article 14, but instead was faced with the plea that the ratio of Brojonath Ganguly warrants capping the quantum payable as a pre-deposit.


This necessarily implies that there is a difference between the invalidity of a clause on the grounds of Article 14, and by way of unconscionability. This distinction is confusing, however, given that the doctrine of unconscionability was brought into Indian jurisprudence using Article 14. Brojonath Ganguly observed that Article 14 guaranteed equality before the law and equal protection of laws, and a deducible principle is that courts will strike down an unfair and unreasonable clause in a contract between parties who have unequal bargaining power. The court also considered the arbitrariness of the impugned clause in holding that it was violative of Article 14 and void under Section 23 of the ICA. Thus, the distinction created between the ratio of Brojonath Ganguly and invalidity under Article 14 that has been upheld in Lombardi Engineering appears to be unwarranted.


What the judgment does as a result of creating this distinction, therefore, is it uses Article 14 as grounds for holding the pre-condition for arbitration clause as invalid, and not the doctrine of unconscionability. The implication is that this judgment imposes the standard of Article 14 to challenge such clauses. This has counter-intuitive consequences, because Article 14 is only enforceable against the state as defined under Article 12 of the Constitution of India; however, the doctrine of unconscionability seems to have a wider applicability.


Although some judgments subsequent to Brojonath Ganguly, such as Binny v. Sadasivam, held that the doctrine cannot apply to private bodies, other judgments have held differently. In Pioneer Urban Land and Infrastructure v. Govindan Raghavan, for example, the Supreme Court of India held terms in a contract between a builder and a flat purchaser as unconscionable. In Kalpraj Dharamshi v. Kotak Investment Advisors, it held that where a person has no meaningful choice but to assent to a contract, or sign on the dotted line in a prescribed or standard form contract, courts can strike down unreasonable and unconscionable clauses, even in the context of parties which are, unlike in Brojonath Ganguly, not statutory corporations.


Thus, it may be gauged that, especially when it comes to standard form contracts and/or parties acting under statutory provisions, the scope of applicability of the doctrine set out in Brojonath Ganguly may be wider than that of ‘state’ or statutory corporations under Article 12. A claim under Article 14 might not lie in such cases, though it may lie under the doctrine of unconscionability. Thus, it is counter-intuitive to the court’s aim of protecting against arbitrary clauses to have created a distinction between Article 14 and the doctrine of unconscionability, and then preferred to use the former over the latter to hold the impugned clause as invalid.

 

Applying the Doctrine of Unconscionability to the Present Case


The court need not have reasoned an intervention under Article 14 by way of Kelsen’s pure theory of law, but could have simply used the doctrine of unconscionability (which, in any case, is founded on Article 14) to strike down the impugned clause. Notably, the foreign judgments cited by the court all pertain not to the interference in arbitration clauses on the grounds of the doctrines of equality or arbitrariness enshrined by Article 14, but of unconscionability.


Brojonath Ganguly defined an unconscionable bargain or contract as one which is irreconcilable with what is right or reasonable, or with terms so unfair and unreasonable to shock the court’s consciousness. In KC Cinema v. State of Jammu and Kashmir, it was observed that a contractual term may be unfair or unreasonable if it is one-sided or lacking in commercial logic. The key reasoning to invalidating the impugned clause in Lombardi Engineering is that there was nothing provided in the contract as to how the pre-deposit would be ultimately adjusted at the end of the arbitral proceedings, and, in any case, the arbitral tribunal can always award costs under Section 31A of the A&C Act if the claim is found to be frivolous. This means the clause was lacking in commercial logic, and one-sided/unfair on account of not providing for adjustment against the final award.


The doctrine can be applied notwithstanding the fact that the impugned clause part of a commercial transaction. In LIC v. Consumer Education & Research Centre, it was observed that unfair terms in commercial contracts, if made by the government or its state instrumentalities or where there is a public element, are amenable to judicial review. In Lombardi Engineering, the respondent is a wholly owned corporation of the Government of Uttarakhand, and the subject matter of the contract has to do with a river project, a matter of public interest. The same reasoning for applying Article 14 to the contractual arrangement would also apply in this regard, seeing as Article 14 can only be invoked against the state.


Justifying intervention by Article 14, the court reasoned that party autonomy cannot be stretched to an extent where it violates fundamental rights under the Constitution of India, and that for an arbitration clause to be legally binding, it must be in consonance with the operation of law (including the grundnorm, erroneously equated with the Constitution of India). However, it has already been pointed out that Section 11(6) of the A&C Act, under which the present case was heard, intends to limit judicial interference in arbitration proceedings and give primacy to party autonomy. Using principles of contract law instead would have, therefore, prevented the dilution of party autonomy by maintaining the limited scope of judicial interference under Section 11(6); it is already a recognized principle that arbitral proceedings are a creature of contract, and arbitration is based on contract law considerations. Furthermore, the court’s acknowledgment that the validity of arbitration clauses is subject to the “operation of law” reads similar to Section 23 of the ICA, under which unconscionability was recognized in Brojonath Ganguly.


At the same time, adoption of the doctrine would balance freedom to contract against public interest concerns by restricting the contract where it eats away at another party’s rights and freedoms. Instead of circumscribing the parties’ autonomy, applying the doctrine of unconscionability would uphold the level of equity required for both parties to substantively and meaningfully exercise their freedom to contract through the agreement’s clauses. For instance, cases such as Delhi Transport Corporation v. DTC Mazdoor Congress observe how freedom of contract is illusory when it comes to standard form contracts. Additionally, although Brojonath Ganguly recognized unconscionability under Section 23 of the ICA, it has been argued that it was the drafters’ intention to incorporate it under Section 16 instead; the implication being that ‘free consent’ to contract under Section 14, the basis for freedom to contract, is not present in unconscionable contracts.

 

Conclusion


Lombardi Engineering posed a situation that would have allowed the position of the doctrine of unconscionability to be strengthened in the law of contracts and arbitration. Instead, by finding grounds for the court to intervene in arbitration agreements under Article 14, the judgment has further muddled the jurisprudence. The precedent exists for unconscionability to be applied in arbitration agreements, and it ought to have been applied in this case. This would have prevented the dilution of party autonomy and upheld parties’ freedom to contract in an equitable manner.

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