Escalation Clauses - Directory or Mandatory? Dissecting the Position under Indian Law
[Priyanshu is a student at National Law University, Jodhpur.]
Commercial contracts often contain clauses which state that, once a dispute has arisen, the parties should engage in mediation, conciliation, or discussion before referring the dispute to arbitration. Such clauses are called ‘escalation clauses’ or ‘multi-tiered clauses.’ In the absence of any specific statutory principles governing such clauses, their exact nature and ramifications remain points of contention and confusion. The author makes an attempt to dissect the position of such escalation clauses under Indian law vis-à-vis the prevalent position in model law jurisdictions.
Position under Model Law Jurisdictions — Not Mandatory
In Republic of Sierra Leone v. SL Mining Ltd , the parties’ agreement stated that they may submit to arbitration only after indulging in a “good faith endeavour to reach an amicable settlement ” of their disputes. Rather than doing this, the defendant directly referred the dispute to arbitration. As a result, the claimant applied to set aside the award that was made contending that the arbitral tribunal lacked “substantive jurisdiction” under Section 67 of English Arbitration Act 1996. The English High Court cited Gary Born’s International Commercial Arbitration (3rd Ed 2021) and ruled that, “absent contrary evidence,” pre-conditions to arbitration are questions of admissibility, not jurisdiction. That is, matters pertaining to such escalation clauses are to be decided by the arbitrator(s); they do not concern the tribunal’s jurisdiction. This position was reaffirmed by the English High Court in NWA & FSA v. NVF & others , which held that considering a consensual process like mediation to be mandatory “would be absurd and would not give the clause business common sense; nor would it give it a construction that rational businessmen would have intended.”
In C v. D , the Hong Kong High Court cited Republic of Sierra Leone v. SL Mining Ltd  to hold that pre-conditions to arbitration are questions of admissibility, not jurisdiction. Moreover, the court stated that an exception to this general rule would operate when the parties expressly mention that non-compliance of such pre-arbitration requirement would exclude the tribunal’s jurisdiction.
Position under Indian Law — Hybrid Approach?
The Supreme Court of India (SCI) has given conflicting views on the nature of escalation clauses. Some decisions seem to indicate that such clauses should be interpreted in a strict manner. For instance, in Oriental Insurance Company v. M/s Narbheram Power and Steel  (reaffirmed in United India Insurance Co. v. Hyundai Engineering and Construction Co. ), the SCI stated that:
“[i]t does not need special emphasis that an arbitration clause is required to be strictly construed. Any expression in the clause must unequivocally express the intent of arbitration. It can also lay the postulate in which situations the arbitration clause cannot be given effect to. If a clause stipulates that under certain circumstances there can be no arbitration, and they are demonstrably clear then the controversy pertaining to the appointment of arbitrator has to be put to rest.”
On the other hand, other SCI decisions, such as VISA International Limited v. Continental Resources (USA) Limited  and Tulip Hotel v. Trade Links Limited , indicate that the parties’ intention to act or not to act on pre-arbitration conditions (like conciliation) decides the nature of such conditions. For instance, in Demerara Distilleries Private Limited v. Demerara Distillers Limited , the parties’ agreement required the disputes to be first resolved by ‘mutual discussions’ and then by ‘mediation;’ invocation of arbitration was contemplated on the failure of mediation. One of the parties directly invoked arbitration. The SCI rejected the opposing party’s plea that the arbitration was premature because of non-compliance of pre-arbitration conditions by stating that “the elaborate correspondence by and between the parties, as brought on record of the present proceeding, would indicate that any attempt, at this stage, to resolve the disputes by mutual discussions and mediation would be an empty formality.”
In isolation, the SCI decisions suggest that the law pertaining to escalation clauses is unsettled or even unpredictable. However, in addition to the SCI decisions, if we look closely at certain recent High Court (HC) decisions, a pattern can be discerned: courts have interpreted pre-arbitration conditions in escalation clauses to be strict/mandatory (general rule) unless the parties’ acts and/or intentions indicate that compliance to such conditions would be an ‘empty formality’ or, in its simplest sense, unnecessary (exception). For instance, in Quick Heal Technologies Limited v. NCS Computech Private Limited , the Bombay HC, while acknowledging the mandatory nature of the pre-arbitration mediation clause, refused to hold that the reference to arbitration was premature because the correspondence and the circumstances between the parties indicated that there was no scope for an amicable settlement.
Furthermore, in this regard, the Delhi HC’s decision in M/S IMZ Corporate Private Limited v. MSD Telematics Private Limited , is important. In this case, the parties had agreed to engage into mutual negotiations before commencing arbitration; this pre-condition was not adhered to by one of the parties. The Delhi HC, while assessing the factual-matrix and the intentions of the parties, stated that:
“[i]t is surprising and irreconcilable that, on the one hand, MSD has initiated criminal proceedings by filing an FIR against IMZ and on the other hand, it looks forward to mutually resolve the disputes through negotiation. Moreover, in the opinion of the court, having regard to ongoing litigation between the directors of the parties before NCLT, the criminal proceedings, and the conduct of the parties, relegating them to mutual negotiation to resolve the disputes would be an empty formality. The directors of both the parties having initiated criminal action against each other which clearly indicates that parties do not intend to come to any kind of resolution. In such a situation, insistence on negotiation as a pre-condition to arbitration should not get in the way of the dispute resolution process agreed upon between the parties. Therefore, this objection is completely devoid of merit and would not come in the way for the Court to allow the present petition.”
Although this Delhi HC decision seems to tip the balance in favour of the exception, another recent Delhi HC decision of Sanjay Iron and Steel Limited v. Steel Authority of India  seems to have solidified the above-mentioned pattern. In this case, the parties had agreed to carry out conciliation in case of any dispute in accordance with the rules of Scope Forum of Conciliation & Arbitration, New Delhi (SFCA). A reference to arbitration was to be made only after the failure of such conciliation. After a dispute arose, one of the parties refused to make a payment to SFCA because it felt the fees for conciliation were exorbitant. It may be noted that, unlike the previous cases where parties had significantly aggravated their relationship (through criminal complaints, multiple suits, confrontational conduct, etc.), the parties in this had only raised grievances and replies in their correspondence. The Delhi HC, in its decision, directed the parties to carry out the conciliation to which they had agreed to as a pre-condition. It is important to note that the Delhi HC did not differ in view from the previously mentioned decisions that gave importance to parties’ intention and scope of conciliation/settlement. In fact, the Delhi HC acknowledged those precedents [particularly Visa International (supra) and Demerara Distillieries (supra)] and stated that, unlike the confrontational relationship the parties had in these cases, the parties, in this case, had not even discussed anything that indicates that conciliation would be an empty formality.
As it can be seen, the waters pertaining to pre-arbitration conditions are no longer muddy. Rather than taking a linear approach (like the one taken by above-mentioned model law jurisdictions), Indian courts have crafted, albeit amidst legal uncertainty, a useful set of legal principles: first, the court looks at the relevant contractual clause and strives to hold the parties liable to the same; second, if there is no scope of such pre-arbitration condition being fruitful, it waives such a pre-condition. This approach balances the two sides of the same coin: party autonomy and expeditious dispute resolution.