Understanding Scott v. Avery Clause

[Anubhav is an Advocate practicing before the Bombay High Court.]

The arbitration landscape in India has been witnessing numerous developments in the recent past which are focused on increasing the efficiency of the arbitration proceedings. The proceedings can be inter alia hindered through judicial intervention which acts as a major roadblock in ensuring a speedy disposal of a dispute. Courts may sometimes exercise its power to intervene with the proceedings and step into the shoes of an arbitrator; such intervention by the courts tend to eclipse the jurisdiction of an arbitral tribunal by deciding the core issues of the dispute. This anomaly has always been in the crosshairs of the pro-arbitration school of thought and the Judiciary.

The above-mentioned premise has been taken well into consideration  by the seven judge bench of the Hon’ble Supreme Court of India in NN Global Mercantile (Private) Limited v. Indo Unique Flame Limited, wherein the apex court inter alia held that an unstamped or insufficiently stamped arbitration agreements cannot be the ground for rendering an arbitration agreement void or void ab initio. Courts are henceforth devoid of the powers to make such declaration under applications filed under Section 11 or 8 of the Arbitration and Conciliation Act 1996 (Act) as such powers are vested with the arbitrator and such insufficient stamping of an arbitration agreement is a curable defect, thereby narrowing the jurisdiction of the courts.

The burgeoning of the party’s choice to arbitrate especially on an industry specific dispute is cemented on the belief that the panel of arbitrators or the sole arbitrator, as the case maybe, possess the expertise to deal and adjudicate on the matter based on the evidences furnished before the tribunal. This belief can be subverted if the courts were to go into the merits and step into the shoes of the arbitrator. The apex court has time and again reiterated and has reprimanded the subordinate courts in an application to set aside the award under Section 34 of the Act to go into the merits of the award when such introspection of the award is not called for. In 2019, the apex court, through the judgment of Parsa Kente Collieries Limited v. Rajasthan Rajya Vidyut Utpadan Nigam Limited, had held that the courts are not to act as courts of appeal in a Section 34 petition unless there exists a patent illegality or the award fundamentally goes against the public policy of India. The apex court further held that majority opinion of technical persons need not be subjected to a relook; this view was yet again affirmed recently in May 2024 by the apex court in NHAI v. Hindustan Construction Company Limited.

Scott v. Avery Clause

The endeavour to cure the defect of judicial intervention i.e., the courts stepping into the shoes of the arbitrator, is not something that has only raised the eyebrows in the recent past, the idea of an arbitration proceeding being a standalone proceeding is something that has been recognized even during the Victorian era.  

The English Judgment of Scott v. Avery [1855 5 HL Cas 811] had paved the way and upheld the validity of the clauses by virtue of which the contracting  parties could opt for a clause in their respective contracts, where an arbitration award would act as a condition precedent for the parties to enforce any rights by initiating any action or suit against each other in the court of law. It is very interesting to note that by enforcing and upholding the validity of such clauses, it is further ensured that the parties are in a way duty bound and obligated to arbitrate. 

As per the factual matrix of Scott v. Avery, the appeal was preferred by Scott before the House of Lords challenging the decision of the Court of Exchequer Chamber which had set aside the decision of the Court of Exchequer, where Scott had filed a declaration setting forth the policy, which stated that “…until the matters in dispute shall have been referred to and decided by arbitrators appointed as hereinbefore specified, and then only for such sum as the said arbitrators shall award; and the obtaining the decision of such arbitrators on the matters and claims in dispute is hereby declared to be a condition precedent to the right of any member to maintain any such action or suit...", thereby creating a condition precedent for any action to be enforced in a court of law. Lord Campbell had interestingly pointed out various anecdotes wherein the judges / courts were averse and were hostile to having arbitration clauses. He observed that the emoluments / salaries of the judges were not fixed and the judges had solely relied upon the fees that they received which was based on the number of litigation they adjudicated. Thus, there was a great competition amongst the judges to get maximum litigation in the Westminster hall.

Thus, arbitration as a mechanism for resolution of disputes was looked down upon and frowned by the judges and the courts, as the same would oust their jurisdiction. Lord Campbell also observed that just by the virtue of creating a condition precedent for enforcing rights, the parties must first arbitrate, and this condition in no way would oust the jurisdiction of the courts, as in the first place, the courts have no jurisdiction as no cause of action arises before there being any arbitral award in place. 

Even viewing from the strict principles of the Indian Contract Act 1872 (Contract Act), per section 28 of the Contract Act, ousting the jurisdiction of courts makes a contract illegal and void. The said principle finds its foundation on the rule which was also recognized by Lord Campbell in the judgement i.e. “..Where an action is indispensable you cannot oust the court of its jurisdiction over the subject, because justice cannot be done without a plea. This is the foundation of the doctrine that the courts are not to be ousted of their jurisdiction...” The exception to the abovementioned principle is arbitration; even having a Scott v. Avery clause does not ipso facto oust the court of jurisdiction but only creates a condition that the cause of action would only arise if there is an arbitral award.

Lord Campbell, to further buttress his stance, had drawn inspiration from the words of Lord Coke which were “.. If a man makes a lease for life, and by deed grant that if any waste or destruction be done it shall be redressed by neighbours, and not by suit or plea, notwithstanding an action of waste shall lie, for the place wasted cannot be recovered without a verdict of the neighbour being first had and obtained..."  

In the due course of time, the clauses in a contract which stipulated for the decision of an arbitrator to be a condition precedent for enforcing any right in the court were termed to be Scott v. Avery clauses.

Scott v. Avery Clause through the Lens of Indian Judiciary

The arbitration landscape in India as mentioned above is marred with its own shares of shortcomings; the Indian judiciary in its essence has only in its few judgments explicitly relied on the Scott v. Avery clause and have held it to be a valid and an enforceable clause.

In a 1975 judgment of the Hon’ble Supreme Court of India in Vulcan Insurance Company Limited v. Maharaj Singh, the apex court had recognized the validity of Scott v. Avery clause and held that a clause like one in Scott v Avery would bar any action or suit if commenced for determination of a dispute covered by arbitration clause. The maintainability of an action would only arise if there is an arbitration award. However, if a dispute at the outset is non-arbitrable, the Scott v. Avery clause is rendered inoperative and cannot be pleaded as a bar to maintainability of the legal action or suit for determination of the dispute which was outside the arbitration clause.

In  subsequent judgments of M/s P.S Manohar Reddy v. Maharashtra Krishna Valley and United India Assurance v. Hyundai Engineering and  Constructions among others, the apex court has upheld the validity of Scott v. Avery clause and further observed that it does not in any way violate the rights of the parties to initiate an action or a suit in a court of law. The only caveat is that the clause would not be applicable if the dispute is non-arbitrable in nature, as a non-arbitrable claim would in itself oust the jurisdiction of an arbitral tribunal to adjudicate any dispute and hence it would render the Scott v. Avery clause in that case invalid.

Interestingly, the 176th Law Commission report of 2001 had acknowledged the validity and enforceability of Scott v. Avery clause and had proposed a Section 8(6) to the Act drawing its inspiration from Section 9(5) of the English Arbitration Act of 1996, which states that if the court refuses to grant a stay on a legal proceeding on the ground of the arbitration agreement being null, void or inoperative, then any provision in the arbitration clause stating that an award would be a condition precedent (that provision being a Scott v. Avery clause) would have no effect. 

The proposed subsection would have power to set aside the arbitration agreement when the arbitration agreement is either null and void or not capable of enforcement or inoperative qua being against any statute in force. Thus, if at all the court is faced with such a situation, it may set aside the agreement, and in such a case, the Scott v. Avery clause would fail to find its applicability. The 2015 amendment to the Act has in essence dealt with the abovementioned suggestion by empowering the judicial authorities under Section 8 of the Act to not refer the parties to arbitration if the agreement prima facie appears to be invalid, thus holding that any invalid arbitration agreement would lead to the Scott v. Avery clause being invalid and unenforceable.

Concluding Remarks

To bolster the idea of reducing the intervention of courts in an arbitration proceeding, the principles of Scott v. Avery clause is one of the means, as the clause would ensure that firstly, the parties ought to arbitrate before approaching the courts to enforce any right, and secondly, as arbitration is a creature of a contract which has been ratified by the parties, the court would be duty bound to not to interfere with such dispute until and unless such dispute is not arbitrable or prima facie invalid.