Arbitration clauses in an agreement should be drafted with caution

Jayant M Thakur

One of the standard clauses in many agreements is that “This agreement shall be subject to the relevant provisions of XYZ Act and all applicable rules and regulations”. What are the implications of such a clause? An interesting decision of the Bombay High Court reveals the extent of the implications that can follow [Newage Fincorp (India) Ltd V Asia Corp Securities Ltd (2000 4 CLJ 105 Bom)].

Often, the purpose of such a clause is twofold. Firstly, it is to make the agreement conditional to compliance of relevant provisions of law. Secondly, and closely interwoven with the first purpose is to make a reference to the applicable law.

In view of the fact that agreements cannot override the law, this clause is felt to be unnecessary. For that very reason, it is treated as an innocent clause and hence ignored by one or all the parties. The decision in the above case should at least make the parties think a little more and in some cases even insist on its removal. The facts of the case are relatively simple. Membership of the Bombay Stock Exchange was agreed to be transferred between the buyer and seller by an MOU. It was agreed under this MOU that the payment of the consideration for the transfer be made in phases and payments were made upto a certain stage and in the meantime, steps were taken for making application to the Bombay Stock Exchange and other authorities for the transfer of the membership.

It was contended by the seller that one of the remaining payments was not made and hence application made by it was withdrawn. It may not be worth going into the detailed facts of the dispute and coming to the subject matter of the issue, the buyer contended that the dispute with the seller be settled by arbitration as per the byelaws of the stock exchange.

Interestingly, there was no specific arbitration clause in the agreement. In fact, there was no reference even to the byelaws of the stock exchange. It is a basic and very fundamental principle, also embodied in law, that only if parties have agreed to refer their disputes to arbitration that they can be so decided. If not, the regular proceedings by way of litigation follow. Often parties may consciously decide not to refer their disputes to arbitration. However, it is perceived that since arbitration is by choice and agreement, there is no need to state that disputes shall not be decided by arbitration. Rather, it is felt that a non-inclusion of an arbitration clause is sufficient for arbitration to be ruled out. Till we find an apparently innocent clause such as referred to above.

In the words of the court, “The MoU arrived at between the parties specifically provides that the same shall be subject to the provisions of the Companies Act, 1956, or any other rules or regulations for the time being in force.”

It was contended by the buyer that this was sufficient to make the MOU subject to arbitration in accordance with and under the byelaws of the stock exchange. The reasoning, which may appear to be convoluted at first sight, was as follows:

The agreement was subject to “any other rules for the time being in force”. The Bombay Stock Exchange has formulated, with necessary approval, rules and byelaws for various matters. In the normal course, the contracts in securities are made subject to these byelaws.

Essentially, the objective is to regulate such contracts and transactions and also provide for arbitration carried out in a particular manner in case any dispute arises particularly between a member and a non-member. The rules also provide for the manner in which a membership of the stock exchange may be acquired.

Byelaw number 248 provides for arbitration. It provides that any differences and disputes between a member and a non-member arising out of contracts, etc made subject to the rules, byelaws, etc of a stock exchange shall be resolved by arbitration in the manner provided. The reasoning of the buyer (and also of the court) was that the MOU was “subject to any other rules for the time being in force”. Is the clause in the MOU stating that it shall be subject to “any other rules for the time being in force” adequate to make it subject to the rules of the stock exchange and hence make the matter subject to arbitration thereunder?

The court answered in the affirmative. Accordingly, the prayer of the buyer for an injunction on the seller not to transfer the membership to any other person till the arbitration was complete was granted.
To repeat, this case is a good example of the care needed in drafting agreements, particularly when one or more of the parties is a member of or is subject to rules made by a body. Often the parties may not be interested in settling disputes by arbitration, whatever may be their reason. If they are so interested, they may want to ensure that their disputes are settled by arbitration in accordance with a particular method or manner. It is not to derogate the arbitration rules of one body or the other but still parties may prefer one method over another.

Unwittingly, however, they may get subject to mandatory arbitration in accordance to a particular method. And, as is known and is also intended, arbitration excludes proceedings in court for resolving such disputes and is non-appealable also, except in extreme cases.

To conclude, this case also serves as a lesson for parties to ensure that if they wish that their disputes be resolved by arbitration, they should spell it out and if they do not seek settlement by arbitration it may now make sense to exclude arbitration.