Decision of the Constitution Bench on Unilateral appointment of arbitrator: Impact on the financial sector arbitration

Prelude: -

The Constitution Bench of Supreme Court presided over by the Hon’ble Chief Justice of India (as he then was) Mr. D Y Chandrachud has answered the reference on the issue concerning Unilateral appointments of Arbitrator in Central Organization for Railway Electrification Vs ECI SPIC SMO MCML – (JV) A Joint Venture Company (CORE) . The majority view authored by the Hon’ble Chief Justice Mr. D Y Chandrachud made it clear that the unilateral appointments clause in Public private contracts is violative of Art. 14 of the Constitution and further confirmed the dictum in TRF and Perkins on the situation dealing with sole arbitrators.

Background:-

IN CORE, a three judges’ bench of the Hon’ble Apex Court held that nomination of a panel of arbitrators by one party giving option to the other party to choose arbitrator from the panel is not against law laid down in Perkins Eastman which declared that person interested in the outcome of an arbitration proceeding cannot nominate the arbitrator. Another three judges’ bench presided over by Hon’ble Mr. Justice Rohinton Fali Nariman, in Union of India Vs Tantia Constructions , disagreed with a view taken in CORE and referred the matter to the Chief Justice for constitution of a larger bench to decide the issue.

Answer to the Reference:

The Constitution bench in its majority view by 3 judges held that unilateral appointment of Arbitrator in Public Private contracts is violative of Article 14 of the Constitution. It further upheld the decision in TRF and Perkins. However, Mr. Justice Hrishikesh Roy dissented with the view taken by the majority and held that the Unilateral appointment of arbitrators is permissible as per the legislative scheme of Arbitration Act. Mr. Justice P S Narasimha delivered almost concurring but a separate judgment and held that the courts cannot make advance declaration that all such agreements which enable one of the parties to constitute a tribunal will be void per se and the same can be tested by the courts only on an application under Sec. 11, 14 or 34 of the Act.

IMPACT OF THE DECISIONS IN FINANCIAL SECTOR ARBITRATION:-

The majority view is that the decisions in TRF & Perkins, which deals with the situation of appointment of the Sole Arbitrator have held the field for years and thus upheld the said decisions. Interestingly, TRF & Perkins were dealing with an objection under Section 11 by a party who was at the receiving end on the unilateral appointment clause. Both the decisions arose in a situation where the other party was to challenge the unilateral appointment. Another notable factor is that in small value arbitrations, which had a reference in the separate judgement authored by Justice P S Narasimha, one of the parties would usually incorporate unilateral appointment clauses in the printed agreements. Predominantly, financial sector arbitrations, in the retail financing segment, would usually involve unilateral appointment clauses wherein a bank or finance company would retain with them the right to appoint the arbitrator. Some of the cases would be decided ex parte. Questions arose here as to whether appointment procedure in this arbitration clause would automatically become void or the arbitral tribunal should wait to see if the other party appears and agrees to waive the applicability under the proviso Section 12(5). Probably, this thought would have provoked Mr. Justice Narasimha to hold that unilateral appointments would not automatically become void, and each case must be tested on the facts and circumstances. The majority view does not deal with such situations and hence, it is understood that Justice Narasimha had expanded the scope of majority view while admitting that unilateral appointment would be bad, but only when the other party agitates the same by filing an appropriate petition.

We have come across several instances wherein the Execution courts refused to enforce the arbitration awards on the grounds of unilateral appointment of the arbitrators in such proceedings. The issue here is whether the Execution courts can suo moto declare that the awards are inexecutable on the ground of the unilateral appointment of arbitrators. Though the majority view does not explicitly deal with such a situation, the view of Justice Narasimha adds value to the said proposition in interpreting the majority view to conclude that the Execution courts cannot suo moto reject execution of awards unless the said awards are set-aside by the courts on an application filed by the aggrieved parties under Section 34.

It is understood that several thousand awards have been held non-executable by various Execution Courts suo moto on the grounds of unilateral appointment of arbitrators. If the above interpretation is a valid one, all the execution applications will be filed again by the respective decree holders. Or if the interpretation is that all the awards by unilaterally constituted tribunals are void per se, it will drive the parties, without any alternative, to file several thousands of Sec. 11 applications for appointment of arbitrators before the High Courts to re-initiate the process which would, in effect, clog the judicial system. As such, the decision of the Constitution Bench will open flood gates to further litigation which would eventually upset the ADR mechanism. In any event, the decision has not put a full stop, but a comma.

SOLUTION:

The decision can be bifurcated into two categories, one relating to Public-Private contracts involving PSUs and another a contract between two private individuals. For the first category of arbitration involving PSUs, the majority view was that unilateral appointment clauses are violative of Article 14 of the Constitution, where in the second category, the decision was not so. As far as the arbitration of a sole arbitrator is concerned, the bench made it clear that TRF & Perkins have held the field for years, but not declared that they were violative of Article 14 of the Constitution. The largest stake holder in the second category is the financial sector where Banks and NBFCs initiate several lakhs of arbitrations every year predominantly of small value claims. In the first category, unilateral appointment clauses were per se void, but in the second category there is no such declaration. The majority decision further held that principle of express waiver contained in the proviso to Section 12(5) also applies to situations where the parties seek to waive the allegation of bias against an arbitrator appointed unilaterally by one of the parties; after the disputes have arisen, the parties can determine whether there is a necessity to waive the nemo judex rule. Applying the said proposition and the minority view of Justice Narasimha, it is clearly established that in financial sector arbitrations where both the parties are private, the unilateral arbitration clauses would not become ipso facto void and there is every chance that the other party, after unilateral appointment of the arbitrator by one party, may waive the nemo judex rule. The proviso to Sec. 12 (5) reinforces the party autonomy. Therefore, the unilateral appointment clauses are voidable at the option of the other party and hence the courts cannot suo moto reject any arbitration culminated from unilateral appointment arbitration clause. This point is very crucial as when a different interpretation is taken, lakhs and lakhs of arbitration proceedings initiated by the financial sector after 2015 amendment would automatically become a nullity. Therefore, keeping the same in mind, it is presumed that the majority view made the law prospectively to the three member tribunals and let the issue open to the courts to decide the validity of the unilateral appointment clause in sole arbitration clauses on a case-to-case basis. Justice Narasimha’s decision, though being a minority view, was not a dissent from the majority view but only expanded or explained the scope of the majority view being not in conflict with the majority view and can be a supplemental decision to the majority view. As held by Allahabad High Court in Sudha Tiwari Vs. Union of India , the minority view will be binding on the courts on a point which is not in conflict with the majority view. From this, it clearly emerges that the arbitration initiated by the financial sector on a unilateral appointment clause is not void per se and hence, cannot be dismissed by the arbitral tribunal or the courts suo moto without foreseeing a situation wherein the aggrieved party expressly waives the nemo judex rule as per the proviso of Sec 12(5). It is also very important to understand the scope of the phrase “after disputes have arisen” that the same pertains to at any stage of the proceedings till the dispute gets settled. It means that even at the execution stage, the aggrieved party may come and waive the applicability of nemo judex Rule. Unless this interpretation is accepted, there will be utter chaos leading to filing of lakhs and lakhs of petitions under Section 11 before the High Courts.

PROSPECTIVE OVER-RULING: -

The majority decision made it clear that the law laid down in the reference will apply prospectively to the three member tribunals. The reason given was that the commercial relations are structured on the basis of law and any change in law may have the effect of distorting the established rights and commercial bargains between the parties. However, the majority view did not express any view of the prospective overruling to situations dealing with sole arbitrators stating that TRF & Perkins have held the field for years. The question arises whether the prospective overruling applies to sole arbitrators on unilateral appointment clauses from the date of decision in Perkins. Since the agreements in financial sector arbitrations are pre-printed documents, another question arises whether the prospective applicability will be from the date of agreements or the date of appointment of arbitrator. These points are kept open without any decision though the financial sector and industry bodies have intervened the reference before the Constitution Bench and made request for prospective overruling in case the bench did not agree with unilateral appointment clause. The majority view is that the decision will apply prospectively to all arbitrator appointments from the date of the decision by the constitution bench with respect to three member tribunals. Since the reference was only on cases involving three member tribunals, if the same logic is applied to sole arbitrations, all arbitration appointments before the date of Perkins should be saved. However, these questions were not dealt with by the bench, though the principle of ‘change in law distorting the established rights and the commercial bargains between the parties’ is equally applicable to sole arbitration as well. This may lead to a lot of complications and future litigation on this issue.

CONCLUSION: -

The decision of the Constitution bench has thus left the issues open ended and has not resolved the issue fully. As stated, the financial sector will have a tough time in dealing with the repercussions of the decision, leading to continued litigation. If the courts are convinced that the minority view of Justice Narasimha is not in conflict with the majority view, the industry will come out of the stalemate.