WHEN AUTONOMY MANIFESTS IN INEQUALITY: THE SUPREME COURT’S MISSTEP ON UNCONSCIONABILITY

  I.                  Introduction

The Supreme Court in Central Organisation for Railway Electrification v. M/s ECI SPIC SMO MCML [“CORE II”] has settled a longstanding point of contention: whether unilateral appointment of an arbitrator is permissible? Over the years, several High Courts and benches of the Supreme Court have adopted divergent approaches. The matter reached its summit when the Supreme Court in Union of India v. Tantia Constructions [“Tantia Constructions”] referred it to the larger, Constitution Bench. The Constitution Bench in CORE II, unanimously held that arbitration agreements with unilateral appointment clauses are invalid and an ineligible arbitrator cannot nominate another arbitrator. However, Justice Hrishikesh Roy and Justice P.V. Narsimhan rendered separate dissenting opinions concerning the blanket ban of such clauses.  The majority opinion upheld the primacy of Section 18 of the Arbitration and Conciliation Act, 1996 [“Arbitration Act”] in appointment processes and deemed unilateral appointment clauses as violative of Article 14 of the Constitution. Meanwhile, the separate minority opinions backed the majority opinion in terms of upholding impartiality and equality, however, denied the suitability of constitutional provisions in substantiating equality in appointment processes. Notably, both the majority and the minority opinions concurred in refuting the relevance of the doctrine of unconscionability in striking down unilateral appointment clauses. This article attempts to contextualise the dispute and summarise the reasoning of both opinions. Further, it underscores the importance of the doctrine of unconscionability in striking down unilateral appointment clauses and derives insights from foreign jurisdictions.

  II.                  Dissecting the Judgment in CORE II

A. Background of the dispute

The Supreme Court in Voestalpine Schienen GmbH v. Delhi Metro Rail Corporation Ltd first encountered the situation of unilateral curation of the arbitral panel. It prescribed the government entity to create “broad based panels” to ensure independence and impartiality in the constitution of tribunal. In a short time, the Supreme Court in TRF Ltd. v. Energo Engg. Projects Ltd [“TRF”] invalidated a clause allowing an ineligible appointee to nominate another arbitrator. The Supreme Court layered its approach based on TRF in Perkins Eastman Architects Dpc & Another v. HSCC (India) Ltd.[“Perkins Eastman”] in TRF, the clause authorized the Managing Director to act as the sole arbitrator or appoint his nominee, while in Perkins Eastman, the arbitrator was to be appointed by the CMD of HSCC. The Supreme Court identified the difference in situations and categorized two instances of appointment of arbitrators: first, where the arbitrator itself is ineligible to appoint; and second, where the appointing authority is not the arbitrator, but has the sole prerogative to appoint an arbitrator, exclusive of the rights of the other party. The common point in both categories was the possibility of inducement of bias due to vested interest in the dispute. Hence, in Perkins Eastman, the Supreme Court deduced the principle from TRF and consequently held that even if the appointing authority does not become a sole arbitrator, but has the unilateral power to appoint the sole arbitrator, such power will not be valid. A counter-balancing effect must be evident by permitting both the disputing parties to appoint their arbitrators.

However, a divergence from the settled position emerged in Central Organisation for Railway Electrification v. ECI-SPIC-SMO-MCML (JV) a Joint Venture Company [“CORE I”]. Precisely, clause 64(3)(b) of the General Conditions of Contract [“GCC”] required the Railways to send a panel of at least four names of railway officers as railway arbitrators. Out of these four, the private entity was allowed to give at least two names, out of which the General Manager of the Railways would select at least one in the constitution of tribunal. The Supreme Court premised its rationale on Perkins Eastman, holding that sufficient ‘counter-balance’ could be exerted by the Respondent, hence, the terms of the GCC were considered valid. Later, the Supreme Court in Tantia Construction expressed prima facie disagreement with CORE I and referred the matter to the Constitution Bench. The Constitution Bench in CORE II primarily dealt with whether an interested party can reserve unilateral powers to appoint an arbitrator or curate a panel of arbitrators and whether the principle of equality finds relevance at the appointment stage of proceedings.

B. Majority Opinion

The majority opinion in CORE II highlighted the intersection of equality and party autonomy. Section 18 of the Arbitration and Conciliation Act, 1996 [“Arbitration Act”] mandates equal treatment of parties and fair opportunity of hearing to parties. Significantly, it supersedes the party autonomy in deciding the procedure for arbitration under Section 19 and is wide in scope to cover all the stages of the proceedings. The majority opinion stated that, as per the legislative scheme, unilateral appointment clauses are antagonistic to the principles of equality. Additionally, the majority opinion considered arbitral tribunal to be quasi-judicial in nature since it decides parties’ rights and liabilities. Considering this, the majority opinion placed reliance on Article 14 of the Constitution of India to ensure procedural fairness at the stage of appointment of arbitrators. Lastly, the majority opinion rejected the applicability of the doctrine of unconscionability as arbitration agreements were executed by equally positioned commercial entities.

C. Minority Opinion

However, the minority opinion, separately rendered by Hrishikesh Roy and P.V. Narasimhan JJ., clarified that unilateral appointment clauses are not per se prohibited as per the scheme of the Arbitration Act. Importantly, the Arbitration Act does not expressly prohibit unilateral appointments. As per Justice Hrishikesh Roy, if the arbitrator fulfils the notions of independence and impartiality within Section 12(5) r/w Schedules V and VII of the Arbitration Act, equality between parties is not skewed. Section 12(5) allows the parties to waive concerns regarding impartiality and independence after a dispute is raised. Hence, the legislative scheme, at the outset, does not bar unilateral appointment clauses. Additionally, he drew a pivotal distinction between ineligibility and unilateral appointments and distinguished previous judgements like Perkins Eastman and TRF from CORE II. On the other hand, the minority opinion drafted by Justice Narasimha determined the inapplicability of the doctrine of unconscionability to arbitration agreements. Justice Narasimha emphasized that unconscionability is not applicable in cases where equal bargaining power exists and hence would not cover commercial transactions between businessmen. He presumed equality of bargaining power between the commercial entities to the arbitration agreement. Hence, the doctrine remains inapplicable.

However, outright dismissal of the applicability of the doctrine on arbitration agreements precludes the possibility of an additional ground for challenging a unilateral appointment clause. It is erroneous to assume that all corporations are levelled equally in terms of bargaining power. Surrounding factors such as commercial realities and the size of the corporation are pivotal factors in determining unconscionability. For small contracting parties, this doctrine enables wider negotiation powers during contract formation.

  III.                  Doctrine of Unconscionability: International Perspectives and the Indian Position

A. International Perspectives from USA and Australia

The United States of America [“USA”] has a rich jurisprudence centred around the doctrine of unconscionability. Primarily dealing with consumer and employment disputes, the USA courts have recognized the doctrine of unconscionability under the Uniform Commercial Code [“UCC”]. In addition to individuals, commercial entities have widely invoked the defence of unconscionability in the USA. Besides assertions in different areas, the defence of unconscionability is available to parties to an arbitration agreement. The same was recognized in Mobile Home Fact Outlet v. Butler, wherein the court stated that the parties can invoke defences available under the contract law even if it is an arbitration agreement. The comment appended to Section 2-302 of the UCC highlights several factors concerning the application of the doctrine. Particularly, clauses must be assessed against the backdrop of commercial needs and background and the prevailing circumstances at the time of the making of contract.

In Australia, Section 9(1) r/w Section 9(2)(l) of the Contract Review Act, 1980 [“The Act”] mandates the courts to consider ‘unjust contracts’ against the ‘setting, purpose and effect’ of the contract without expressly excluding commercial entities from the scope. Not to mention, Section 17(1) of the Act fetters parties from excluding the applicability of the Act by agreement. Additionally, Section 17(5) of the Act vests the courts with discretionary powers to hear claims or issues which are to be referred to arbitration. Hence, the courts can adjudicate on claims relating to unconscionable arbitration agreements. Similarly, the Australian Parliament passed the Treasury Laws Amendment (More Competition, Better Prices) Act, 2022. It extended unconscionability as a ground for small businesses to obtain compensation orders and nullify contracts. The courts in Australia have stretched the unfair terms regime to B2B transactions (eg. franchising agreements) and considered arbitration clauses contained therein to be unfair too.

B. Position in India

In the author’s opinion, the Supreme Court missed the mark in considering the doctrine of unconscionability as a ground for striking down unilateral arbitration clauses. The Supreme Court in Central Inland Water Transportation Ltd. & Anr. v.Brojo Nath Ganguly [“Brojo Nath”], held that the doctrine of unconscionability will not apply where the ‘bargaining power of the contracting parties is equal or almost equal.’ In furtherance of this, it immediately uses ‘may’ in terms of the application of the doctrine. The judgement subsequently signals the vast disparities in situations arising out of commercial contracts. To prevent misapplication of the doctrine, it underscores the importance of assessing each case based on circumstantial evidence and highlights the importance of bargaining power. Hence, it is reasonable to infer that the Supreme Court allows the applicability of the doctrine of unconscionability as per the facts.

In addition to this, the 199th Law Commission Report [“Report”] had delineated the scope of unconscionability in detail. The Report proposed the adoption of Unfair (Procedural and Substantive) Terms in the Contract Bill, 2006, clarifying the standards of procedural unconscionability and substantive unconscionability. Primarily, the report underscored the widespread use of standard contracts, which involved both individual and commercial entities (regardless of the size). In reference to standard-form contracts, the Report deemed unilateral appointment clauses in standard-form contracts as imprudent, since the parties fail to be on an equal footing in the negotiation process (p. 56). Further, the Report contextualized Brojo Nath and questioned the non-applicability of equality provisions in the Constitution to contracts between non-state entities and private contracts. Besides the Report, there have been instances where the Supreme Court has invalidated a unilateral arbitration clause on the grounds of unconscionability. For example, in Lombardi Engineering Limited v. Uttarakhand Jal Vidyut Nigam Limited the court relied upon the doctrine of unconscionability to invalidate the use of pre-deposit clauses for invoking the arbitration.

The elements of GCC in government contracts appear to satisfy the requirements of a standard form contract. These forms of contracts, even though not always, can expose opposite parties to the possibility of unequal negotiation conditions. This becomes concerning since it is not always the case that only large corporations engage with the government. Small companies and startups regularly engage with government undertakings for business purposes. The concern about power imbalance was also raised in the minority opinion penned by Justice Hrishikesh Roy (¶38). By referring to CORE I, he highlights the likelihood of an imbalance in bargaining power when public sector undertakings or large corporations are involved. Hence, the size of the corporation and commercial realities are material in determining the application of the doctrine of unconscionability. This is in line with the initial tests laid down in Brojo Nath. To increase resistance to prospective indiscriminate usage of this ground, judicial guidance must necessitate the presence of procedural unconscionability as well as substantive unconscionability in claims. As per CORE II: “In determining procedural unconscionability, the court is concerned with factors such as the relative bargaining power of the parties and whether the parties had a meaningful choice. Substantive unconscionability is geared towards pitting the substance of the contractual terms against the legitimate interests of the parties and considerations of public policy.”

        IV.                  Conclusion

CJI Chandrachud had initially opined on day two of the proceedings, about the lack of negotiating power for a small ‘bitumen’ supplier. It illustrates that the inequality in bargaining power can affect commercial entities as well. Such imbalance can manifest in one-sided arbitration clauses. For instance, in the context of franchising agreements, franchisees are usually less protected in the face of a large franchisor. A study showed that due to an uneven playing field,82% of the franchising agreements require arbitration to take place in the franchisor’s home location (p. 734). Unconscionability typically underlines the circumstances under which the consent was given to the contract. The interests of companies with lesser bargaining power are endangered if they are not included in the negotiations. In light of this, blanket exclusion of commercial entities from the scope of the doctrine of unconscionability may restrict the ability of small companies to challenge oppressive terms. Against this backdrop, the Supreme Court or the legislature, must either clarify the distinctions in the applicability of the doctrine or carefully recognize accompanying circumstances before dismissing an application invoking the doctrine.