Pre-Deposit Clauses in Arbitration and Section 38: The Question Santosh Associate Does Not Ask

[Shiva is a student at NALSAR University of Law.]

A reference to a larger Bench in M/s Santosh Associate Private Limited v. Haryana State Industrial and Infrastructure Development Corporation Limited (Santosh Associate) has reopened the enforceability of pre-deposit clauses in arbitration agreements. These are stipulations under which a party may not refer a dispute to arbitration without first depositing a percentage of the sum it claims. The six questions referred to the larger bench range across Article 14 of the Constitution, Section 18 of the Arbitration and Conciliation Act 1996 (Act), Section 28 of the Indian Contract Act 1872, and whether SK Jain v. State of Haryana (SK Jain) survives as binding authority.

The case law in this area has settled into a familiar shape. SK Jain upheld such a clause in 2009. ICOMM Tele Limited v. Punjab State Water Supply & Sewerage Board (ICOMM) struck down another in 2019, distinguishing the earlier decision on the basis of its refund mechanism, and Lombardi Engineering Limited v. Uttarakhand Jal Vidyut Nigam Limited (Lombardi) confirmed that the two cases stand on different footing. SK Jain is now treated as a narrow holding on unconscionability and the proportionality of quantum. The reference is also an opportunity to set it aside.

The debate has therefore been almost entirely constitutional. SK Jain, however, was also asked whether parties may contract out of the Act’s own provisions on the costs of an arbitration and the deposits fixed against them, and it answered that question. The reason it gave has gone unexamined, and none of the referred questions deal with it.

The Clause before the Larger Bench

A reference of this kind is ordinarily narrowed by the facts. If the clause differs materially from the one upheld earlier, that decision can be confined to the facts and left standing. Here, there is little room for that. The contract in Santosh Associate bars a contractor from referring a dispute unless it furnishes a security deposit to the satisfaction of the Executive Engineer in charge of the work, adjusted on termination against costs awarded against the claimant and otherwise refunded within a month of the award. That is the clause in SK Jain reproduced, the only difference being that the highest slab is 10% rather than 7%.

The resemblance now extends to the very features on which the cases had distinguished SK Jain. ICOMM held SK Jain inapplicable because the deposit there was set against costs and the remainder returned, while the clause before it permitted the balance to be forfeited to a respondent who had lost. Lombardi proceeded on the same understanding in finding no conflict between the two decisions, treating them as concerned with clauses of a different character. Refundability and adjustment against awarded costs were what separated the cases. The clause now before the court has both.

The Statutory Challenge in SK Jain

The pre-deposit stipulation reached the Supreme Court (SC) on three distinct challenges, of which only two are usually recalled. Alongside unequal bargaining power and the plea for a ceiling on quantum, the contractor argued that the Act does not permit parties to contract out of its mandatory provisions, and that the stipulation was for that reason in conflict with Section 31(8) read with Section 38.

It was the ground on which the writ petition had been framed before the Punjab and Haryana High Court, and it was renewed before the SC, where the argument was that the two sections had not been given their true effect. The court took it up as a discrete plea, setting out Section 31(8) and Section 38 in full (the definition of costs, the power to fix a deposit as an advance against them, the requirement that it be borne in equal shares, and the consequences of default) before disposing of the challenge in the same breath.

That extract, and its disposal, are the judgment’s only engagement with the Act itself. The rest of the judgment turns on contract and administrative law. That is the part later courts took up, and it is why the statutory holding has attracted so little notice.

The reasoning the court gave was a single sentence.

One Reason for Two Provisions

The statutory challenge was rejected by stating, “A bare perusal of the aforesaid provisions clearly shows that the provision is to operate in the absence of agreement with regard to costs. It cannot be pressed into service to get over sub-clause (7) of Clause 25-A.”

No further ground is offered, and the court draws no distinction between the two sections it had just set out.

Read against those sections, the sentence appears to answer both without much difficulty. Section 38(1) does not describe the deposit independently. It authorises the tribunal to fix an amount as an advance for the costs referred to in sub-section (8) of Section 31, and Section 31(8), as it then stood, opened with the words “Unless otherwise agreed by the parties”.

On that reading Section 38 has no field of its own. It operates upon costs as Section 31(8) constitutes them, so that where the parties have made their own arrangement, that provision yields and Section 38 has nothing left to attach to. The shift from “provisions” in the first clause to “the provision” in the second would be deliberate rather than careless, and the two sections would be treated as one because they operate as one. 

Everything turns on the cross-reference in Section 38(1), so it is worth asking what that cross-reference carries. Section 38(1) borrows from Section 31(8) an account of what costs are: arbitrators’ fees, legal fees, institutional charges, the expenses of the proceedings and the award. The borrowing tells the tribunal what the deposit is an advance against.

The opening words of Section 31(8) do something else. They govern whether the tribunal fixes costs at all, and on whose terms. A provision that adopts a definition does not, without more, adopt a condition attached to the exercise of a separate power.

Section 38(2) then supplies operative language of its own: the deposit referred to in sub-section (1) shall be payable in equal shares by the parties. That obligation is engaged by the fixing of a deposit under sub-section (1), and it carries no qualifying words.

If the court’s single reason fits Section 31(8) better than Section 38, the judgment leaves open whether Section 38 can be contracted out of.

Section 31(8) after 2015

Section 31(8) was amended after this case, and is no longer the same as the court had read it. The Arbitration and Conciliation (Amendment) Act 2015 substituted Section 31(8), which now provides only that the costs of an arbitration shall be fixed by the arbitral tribunal in accordance with Section 31A, a self-contained costs regime inserted by the same amendment. Section 38 was not amended.

The words “Unless otherwise agreed by the parties” therefore no longer appear in the provision from which the qualification was drawn. Section 31(7)(a) retains them, so their removal from sub-section (8) was not part of a general removal of the phrase from the Act. The flexibility Section 38 was understood to carry in 2009 came from those words, and they are no longer there.

The Constitution Bench in Central Organisation for Railway Electrification v. ECI-SPIC-SMO-MCML (JV) (CORE) has since addressed how the derogable provisions of the Act are to be identified. The presence of the phrase “unless otherwise agreed by the parties” indicates derogability, since it gives priority to party agreement. The use of “shall” points the other way, though CORE is careful to say that “shall” is not the sole indicator.

Section 38 has never carried the phrase, and sub-section (2) is cast in mandatory terms. Section 39(1), which follows immediately and concerns the tribunal’s lien for unpaid costs, is expressed to be subject to any provision to the contrary in the arbitration agreement. Parliament wrote that qualification into the adjoining section and left it out of Section 38.  None of this shows that Section 38 is mandatory. It does, however, mean that the court in 2009 was reading a Section 31(8) that has since been rewritten.

The Turn to Article 14

As challenges to pre-deposit clauses came to be litigated through Article 14, the statutory issue received little attention. No later decision rejected it, and it did not arise in them.

ICOMM set that direction. Examining SK Jain to answer a constitutional question, it produced an account of the decision as one about unconscionability and the proportionality of quantum, and neither Section 31(8) nor Section 38 is mentioned. Lombardi inherited that account rather than returning to the judgment, reconciling the two decisions by reference to their clauses and taking the Act no further than Section 31A.

The reference in Santosh Associate is framed on the same understanding. Its questions are directed to equal treatment, arbitrariness, the right to sue and the effect of refundability, with Section 31(8) entering only as the source of a costs award at the close of proceedings.

The reference takes up the constitutional challenge and has left Section 38 where the 2015 amendments left it.

Conclusion

Santosh Associate principally raises constitutional questions about the validity of pre-deposit clauses, and the answers the larger Bench gives will settle a controversy that has occupied the courts for some years.

A narrower point sits alongside them. Having set out Sections 31(8) and 38, the court in SK Jain rejected the statutory challenge for a reason drawn from words that Section 31(8) then contained and no longer does. That is not the question the reference has asked and therefore it will not be answered. 

The larger bench may well settle whether pre-deposit clauses can stand. Whether Section 38 allows the parties to displace it is a separate matter, and a ruling under Article 14 will not deal with it. Unless it is taken up alongside the questions referred, it stays where the 2015 amendments left it, and the statutory argument will have to be made from scratch the next time such a clause is argued before the courts.