THREAT OF ARBITRATION CLAUSES BEING RENDERED FUTILE IN GOVERNMENT CONTRACTS

I. Introduction

Government contracts, by virtue of being signed with a government entity, always have an element of public law and policy intertwined in them. This intersection of the subject-matter of these contracts with public interest often leads to the disputes arising out of these contracts to end up in civil courts, instead of an arbitral tribunal, despite the presence of an arbitration clause in these contracts. The High Courts [“HC”] and the Supreme Court [“SC”] have generally discouraged such litigation, directing parties to pursue arbitration. However, exception exists, such as the recent case of Union of India v. Reliance Industries Limited & Ors. [“RIL v. UOI”], wherein the arbitral award was set aside by the court under Section 34 of the Arbitration and Conciliation Act, 1996 [“the A&C Act”] for violating the public policy of India and being patently illegal. This was primarily due to the dispute involving petroleum exploration, which was the very subject matter of the government contract, a Product Sharing Contract [“PSC”].

As every government contract inevitably involves public interest in some way or another, cases like these can lead to a dangerous judicial precedent, effectively rendering arbitration clauses in certain government contracts meaningless. Though the importance of preserving the public policy of India or the sovereign powers of the government is not being contested, the Article argues that such judicial intervention must be as restrictive as possible to preserve the efficacy of arbitration clauses in government contracts. Part II of the Article outlines grounds for setting aside an arbitral award under Section 34 of the A&C Act that directly affect the government contracts owing to their inherently public interest nature. Part III analyses cases wherein the courts have rightly directed the parties to resolve the dispute through an arbitral tribunal. Part IV addresses cases deviating from this trend, where courts have either deemed disputes arising from government contracts as non-arbitrable or set the arbitral awards aside. Part V finally concludes the Article.

  II. Grounds of setting aside of an Arbitral Award concerning Government Contracts

Arbitration, being a private law mechanism, excludes disputes falling within the domain of public law, as these are considered non-arbitrable. Public policy reserves certain classes of proceedings for exclusive determination by public forums, and courts do not refer such suits to arbitration, even when the parties have entered into an arbitration dispute resolution agreement.

In accordance with this principle, the A&C Act allows the civil court to set aside an arbitral award if the subject matter of the award was non-arbitrable. One of the grounds is when the dispute is related to “inalienable sovereign and public interest functions of the State”, as held in the case of Vidya Drolia v. Durga Trading Corporation. Sovereign functions include the exercise of executive power in fields including commerce and economics, legislation, taxation, eminent domain and police powers such as maintenance of law and order, internal security, etc. Given such a broad understanding of sovereign functions, government contracts can easily fall victim to the above-mentioned ground for in-arbitrability and dodge invocation of arbitration clauses.

Further, the arbitral award may be set aside by the civil court for being against the public policy of India. The public policy of India is narrowly defined to include awards induced by fraud or corruption, those contrary to the fundamental policy of Indian law, or those against basic notions of justice or morality. A domestic arbitral award may be set aside on the grounds of patent illegality as well. While the explanation of these phrases is beyond the scope of this Article, it is important to note that the violation of Article 297 of the Constitution of India [“the Constitution”]  and of the public trust doctrine by an arbitral award is considered against the public policy of India, and such an award can be set aside. As per Article 297 of the COI, the Government of India is a depository, holding the natural resources as a trustee on behalf of the citizens of the country and without the explicit permission of the government, there can be no extraction of the said resources by anyone. The public trust doctrine primarily rests on the principle that certain resources like air, sea, waters and the forests are so important to people that it would be wholly unjustified to make them a subject of private ownership. The doctrine enjoins a duty to the government to protect the resources rather than to permit their use for private ownership or commercial purposes.

The PSC is an agreement under which the State, as the owner of the natural gas resources, engages a private company to provide technical and financial services for exploration and development operations for the oil in an undeveloped territory. As the very subject-matter of the PSC is covered within the scope of the public trust doctrine and Article 297 of the Constitution, it is an example of a government contract where an arbitral award could be set aside for being against the public policy and patently illegal. Government mining contracts, such as a Coal Mine Development and Production Agreement [“CMDPA”], through which coal mines are auctioned off, are another example where the dispute could be deemed non-arbitrable or subsequently set aside by the court on the grounds of public policy. Therefore, though these government contracts have arbitration clauses, these clauses are inherently ineffective. This is because the public law nature of the subject matter of the contracts can render the disputes arising from them non-arbitrable from the inception of the contracts thus, leading to any resulting arbitral award being subsequently set aside by a court.

Finally, even the private parties invoke writ jurisdiction in disputes arising out of government contracts, despite there being an explicit arbitration clause in such contracts. Unlike purely private contracts, one of the parties to a government contract is necessarily the State or its instrumentality. Consequently, even where such contracts contain an express arbitration clause, the possibility of invoking writ jurisdiction under Article 226 remains open. Since writ jurisdiction lies only against the State or its instrumentalities, this avenue is unavailable in wholly private contractual disputes. Although the existence of an alternative remedy, such as arbitration, operates as a bar to writ jurisdiction, this rule is discretionary rather than mandatory. In an appropriate case, the HC may still exercise its writ jurisdiction in at least three contingencies: where the writ petition seeks enforcement of any of the fundamental rights; where there is a failure of principles of natural justice; or where the orders or proceedings are wholly without jurisdiction or the vires of an Act is challenged. As a result, government contracts are inherently susceptible to parties bypassing the agreed arbitral mechanism by invoking writ remedies. In this light, the subsequent Parts analyse the judicial trend towards the arbitrability of disputes arising out of the government contracts.

III. Judiciary’s Positive Approach towards Arbitration Clauses in Government Contracts

The case law analysis shows that the HCs and the SC are generally hesitant to disregard the arbitration clauses in government contracts merely due to the presence of a public entity or subject matter of the dispute incidentally dealing with the public law domain.

In the case of TIL v. Mazgaon Dock Ship Builders, the arbitrability of the dispute was contested by the government entity due to there being allegations of fraud and corruption between the parties. The counsel claimed that, given that fraud herein concerns specifically a public sector entity, with siphoning of ‘public funds’, the dispute should be considered non-arbitrable. The HC rightly rejected this argument, stating that the government is entering into contracts for everything “from road building to the supply of curtains” and merely because such contracts are signed with a sovereign executive would not render a dispute non-arbitrable. The court also went on to state that every government entity is dealing with ‘public funds’, and that cannot be a reason to exclude arbitrability of a dispute, as accepting such an argument would lead to the untenable consequence of excluding all government contract disputes from the ambit of arbitration.

In another case, Spectrum Power Generation Ltd. v. Gail (India) Ltd., the private company disputed the passing of the GST/VAT liability placed onto Gas Authority of India Limited [“GAIL”] to its company. GAIL argued that the petitioner’s claim is non-arbitrable, as taxation is a sovereign matter. However, the court distinguished between a dispute in regard to the taxing powers of the State per se and the one therein, which was solely raised on the anvil of Article 10.6 of the government contract itself and the dispute was held to be arbitrable. Given that, challenges to imposed taxes are bound to arise in government contracts, not every such claim can be rendered non-arbitrable simply because the issue is incidentally tax-related.

In Reliance Industries v. UOI (2014), Reliance had entered into a PSC with the government. The arbitral claims of Reliance were related to the imposition of certain taxes on it, with the arbitration being conducted in London, as per the provisions of the PSC. The Government contended in the Delhi HC that these claims were not arbitrable as these matters were dealt with under specific statutes in India. But, the Delhi HC, while adopting a strict stance towards complying with the arbitration clauses in government contracts, clarified that the arbitration agreement cannot be disregarded merely because the public policy of India might be violated if the arbitral award is made against the Government of India.

A contract for electrification was executed, in pursuance of which the petitioner’s bid was accepted in the case of Ramjee Power Construction Ltd. v. UOI. The petitioner, however, furnished false securities in pursuance of the government contract and thereby, the contract was terminated. The termination was challenged by invoking writ jurisdiction, despite there being an arbitration clause in the contract. The Delhi HC took a strict approach in invoking writ jurisdiction in a contractual matter and clarified that the writ courts should not interfere in commercial transactions, unless there are very strong and compelling reasons for the same. In this case, since the termination was due to the fraud of the petitioner itself, the Court declined to exercise its writ jurisdiction.

Similarly, in another case, the Orissa HC dismissed the writ petition filed on the grounds of wrongful termination of the government contract by the government instrumentality, as it was held that the government instrumentality was justified in terminating the contract, thereby no violation of fundamental rights and principles of natural justice could be proven. In the case of RKI India Limited v. State of Meghalaya, the Meghalaya HC dismissed the writ petition due to the termination of the contract being made based on an elaborate decision-making process, and therefore, there was no violation of the principles of natural justice.

These cases highlight the difference in the threshold for invoking writ jurisdiction for matters related to administrative actions of the government vis-à-vis claims involving a government contract between the parties. In the latter case, the scope of judicial review is more severely restricted than in the former, thereby highlighting the significance of dispute resolution clauses in government contracts.

                                  IV. Cases deviating from the trend

Despite the judiciary adopting a strict approach in declaring a dispute non-arbitrable merely due to the presence of a government entity or relation to public funds or the subject matter incidentally dealing with public interest, there are cases where disputes arising out of a government contract have been deemed non-arbitrable or set aside for being against public policy.

In the case of Rapid MetroRail Gurgaon v. Haryana Mass Rapid Transport, concession agreements were signed for the development and operation of the Rapid Metro Rail System in Gurgaon by RMGL and RMGSL (collectively referred to as the concessionaires). The project encountered severe financial difficulties, and the concessionaires issued a notice of termination, citing alleged breaches by the government instrumentalities, HSVP and HMRTC. The HC intervened and ordered the government instrumentalities to take over the project. This was disputed due to there being an arbitration clause, but even the SC upheld this decision, citing that a ‘fundamental issue of public interest’ was involved due to there being a disruption of metro lines in Gurgaon, which is used as a vehicle of mass transport by the general public. However, any dispute arising out of the concession agreements herein would have led to some disruption of the metro rail. Consequently, even though the government contract had an arbitration clause, it was inherently futile from the very beginning.

In yet another case, M.K. Dhiroomal Associates JV v. Union of India, involving a private contractor and the railways authority, the writ petition had been filed on the plea that the vitiation amount imposed on the private contractor was in contradiction to the contract signed between them. The HC accepted the writ petition for the petitioner’s claim, despite there being an agreement to arbitrate between the parties, merely because such a breach was committed by a government entity.

In the latest case of UOI v. RIL, the RIL had signed a PSC with the government. A dispute arose regarding the petroleum gas trespassing the land under RIL’s possession from adjacent land, and thereby RIL reaping benefits out of it. The arbitral tribunal decided in favour of RIL. However, the Delhi HC interfered and set aside the arbitral award, citing it to be against Article 297 of the Constitution and the public trust doctrine and hence, being patently illegal and against the public policy of India. It must be noted herein that the PSC’s very subject matter dealt with the exploration of petroleum, a natural resource, and was within the ambit of the public trust doctrine from its inception. Therefore, civil courts will, more often than not, end up having the final say in the matter arising out of such contracts, hence defeating the purpose of the arbitration clauses in these contracts, as happened in this case as well.

The courts have to be mindful of the fact that these public-private government contracts will invariably be touching upon public interest and thus, must be extremely cautious while deciding upon a Section 34 petition to set aside awards arising from these contracts. A similar caution has to be maintained while adjudicating upon writ petitions filed due to disputes arising from government contracts. The applicability of an arbitration clause should not be bypassed simply because one of the parties is a public authority. It must always be borne in mind that such petitions would not have been maintainable had the dispute involved two private parties, even if the underlying facts remained identical. Additionally, dispute resolution mechanisms in government contracts, such as the PSC requires reconsideration, as these are inherently incompatible with arbitration given the constitutional and doctrinal framework in India.

V. Conclusion

In conclusion, while Indian courts have largely upheld the importance of arbitration clauses in government contracts, declining to interfere in arbitral awards or accepting writ jurisdictions, there are notable cases highlighting judicial intervention in those awards or accepting the writ jurisdiction to preserve the public policy and sovereign functions of the State. While it is uncontested that this preservation is necessary, such interference risks undermining the sanctity of arbitration agreements, particularly in government contracts and rendering them merely symbolic in nature. Ultimately, an effectively futile arbitration clause in a contract will not be beneficial to either of the parties.