[This guest post is authored by Pranika Correa. She is currently studying in the fourth year at Gujarat National Law University. ]

Analysing the Validity of Unilateral Arbitration Clauses

The major advantages of arbitration are flexibility and autonomy, permitting parties to tailor the terms for their practical and commercial benefit. A unilateral arbitration clause (UAC) is a product of such advantages.

UACs are one-sided dispute resolution clauses which give one party the advantage of choosing between litigation and arbitration, while the other is restricted to only one forum.  These clauses are usually incorporated in financing transactions or contracts where the beneficiary of such a clause is undertaking a high risk.

Whether such clauses are valid and enforceable is still unsettled in India and several other jurisdictions. The problem with UACs arises due to the intrinsic imbalance created between the parties; by giving only one party the right to choose arbitration. In the process, it also acts as a bar on the other party to approach a court – since the counterparty can always ask for a reference to arbitration.  

In this post, I will discuss the validity of UACs. First, I will look at whether UACs violate the principle of equality. Second, I will analyse whether one party has an unfair advantage. Finally, I will determine whether such clauses can be invalidated due to lack of mutuality and consideration. 

Do UACs Violate the Principle of Equality?

Party autonomy in arbitration allows parties to tailor their dispute resolution clauses as per their requirements. However, this freedom is arguably limited by the principle of equality and equal treatment of parties guaranteed under Article 18 of the 1985 UNCITRAL Model Law.

It states that “parties shall be treated with equality and each party shall be given a full opportunity of presenting his case.” From the text, it appears that this protection of equal treatment extends to equal treatment by the arbitral tribunal and equal opportunity to present one’s case, and not to the parties’ treatment of each other and the choice of forum. Therefore, it can be argued that Article 18 comes into play once the arbitration begins and not at the time of choosing the forum.

On the other hand, the  1984 report prepared by an UNCITRAL Working Group suggests that Article 18 applies not only to the tribunal but also to the parties while laying down any rules of procedure. Therefore, the parties’ procedure may also be subject to Article 18.

In Siemens v. BKMI and Dutco, [1] the French Cour de Cassation highlighted the importance of procedural equality by finding that inequality in appointment of arbitrators comes within the purview of this protection. Similarly, the New Zealand Court of Appeals in Methanex Motunui v. Spellman  expanded the principle of equality to apply during an appeal against the arbitral award.

On the other hand, courts in the United Kingdom and several other common law jurisdictions have upheld UACs as a reflection of parties’ negotiations. In NB Three Shipping v. Harebell Shipping, the England and Wales High Court (EWHC) observed that UACs simply give the beneficiary a better right of choosing between litigation and arbitration, depending on which would be more beneficial for their claim. It does not amount to the clause being invalid.

Similarly, in Mauritius Commercial Bank v. Hestia Holding Ltd.,  the EWHC held that the guarantee of equal access to justice was directed at access to justice within the forum; and not to the choice of forum.

One could argue that choosing arbitration as the forum constitutes procedure, and therefore is subject to the protection of Article 18. In India, Section 21 of the Arbitration and Conciliation Act, 1996 (Arbitration Act) provides that arbitral proceedings will be deemed to have commenced on the date on which a notice of request for referring the dispute to arbitration is received by the respondent.

Hence, unlike the appointment of arbitrators, the choice of forum may not constitute procedure. Further, once a forum has been chosen, parties are at equal footing with equal opportunities during the process. Therefore, even assuming that Article 18 is expansive enough to cover the parties’ procedural agreement, it is unlikely for a court to hold that their choice of a forum under a UAC is a matter of procedure.

Are UACs Unconscionable?

The asymmetry in UACs is often the product of difference in the parties’ bargaining power. A notable safeguard in this regard is contained in the UNIDROIT Principles 2010.

Article 3.2.7 protects a party from being taken advantage of due to the dependence on its counterparty, economic distress, urgent needs, improvidence, ignorance, inexperience or lack of bargaining skill. It allows such clauses to be invalidated if there is a gross disparity between the parties or an unfair advantage against the weaker party.

UACs have been invalidated by courts in the USA on this basis. For instance, in Orville Arnold and Maxine Arnold v. United Companies Lending Corporation, the Supreme Court of Appeals of West Virginia invalidated a UAC on the grounds of unconscionability, which was considered a general contract law principle based on equity. However, such an argument is only sustainable when a UAC results from a genuine difference in bargaining power.

Article 6 of the European Convention of Human Rights recognises the essential right of ‘access to justice’. However, the asymmetry of UACs often hinders this right. The Supreme Arbitrazh Court of Russia in the Russian Telephone Company CJSC v Sony-Ericsson Mobile Communications Rus LLC held that UACs are invalid on grounds that parties cannot agree that one of them can choose to apply to State courts while the other is left without this choice. [2] It was also observed that UACs are violative of the balance of parties’ rights.[3]

Similarly, in Emmsons International Ltd. v. Metal Distributors, the Delhi High Court observed that UACs restrain the other parties’ legal recourse, which is a contravention of Section 28 of the Indian Contract Act, 1872.

Where a UAC limits one party to litigation, while giving the other an option between arbitration and litigation, it may result in a situation where the proceedings initiated by the disadvantaged party are at the risk of being stayed if the beneficiary decides to go for arbitration. This effectively gives the beneficiary the power to unilaterally affect the legal position of the other party. Thus, there is a possibility of UACs being invalidated for restricting a party’s right to access justice.

Do UACs Lack Mutuality?

In Lucent Technologies Inc. v. ICICI Bank Ltd, a UAC was declared void on grounds that it lacked mutuality and certainty. It was held to be an infringement of a party’s right to legal recourse.

Further, the Delhi High Court in Bhartia Cutler Hammer v. AVN Tubes observed that the Arbitration Act requires the existence of a bilateral arbitration agreement where both parties can initiate arbitration.

However, this may be taking a restrictive view of observing consideration only within the arbitration clause by completely severing the clause from the contract as a whole. Besides, Section 7 of the Arbitration Act lays down the requirements of an arbitration agreement which does not mandate mutual or equal consideration.

Often UACs are just a product of strategic negotiations. For instance, where one party wants a UAC, the other may agree to it in exchange for an entire agreement clause and limitation on liability being included in the agreement.  Therefore, when parties are capable of understanding and negotiating terms of the agreement, UACs may not be invalidated despite their asymmetry.

Further, it can also be argued that consideration should be present, however, it need not be adequate. In fact, Article 3.2.1 of the UNIDROIT Principles states that there is no need for consideration at all in commercial contracts as parties almost always undertake some obligation.

Conclusion

While there seems to be a larger acceptance of UACs and solid arguments to uphold their validity, there is still a risk associated with the employment of such clauses.

Firstly, some jurisdictions continue to invalidate such clauses based on public policy considerations. This could result in problems with enforcement of consequent awards in jurisdictions that consider UACs against public policy. For instance, while UACs have been previously upheld, the position in India continues to remain ambiguous. However, given the pro-arbitration aim of the 2015 Amendment to the Arbitration Act, it can be argued that court should respect and uphold party autonomy. In any case, it is imperative for the Supreme Court to lay down the law on this since such clauses are becoming increasingly popular and an ambiguity in the law can pose a risk during the enforcement of an award in India.

Secondly, consider the above-mentioned circumstance where one party is bound to litigate and the beneficiary decides to initiate arbitration while court proceedings by the other party are ongoing. The proceedings could potentially get stayed, resulting in the loss of time, money and resultantly restricting the disadvantaged party’s access to a forum.

Thirdly, there is often an imbalance in the position of parties entering into the agreement. The beneficiary must not take excessive advantage of the other parties’ weaker bargaining power or position, as it could be detrimental for the validity of the agreement.

 While UACs may seem commercially attractive, parties should consider all their potential pitfalls before including one in their contract.

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[1] XV Yearbook Com. Arb. (1992) 124 et seq, decided on 7 January 1992

[2] Case no BAC1831/12; See also, Pavlo Malyuta, Compatibility of Unilateral Option Clauses with the European Convention on Human Rights’ at footnote 22. Available here: https://discovery.ucl.ac.uk/id/eprint/10073244/1/UCLJLJ%208(1)%20MASTER_final_PM.pdf.

[3] See, Yelena E. Archiyan, Fate of the Unilateral Option Clause Finally Decided in Russia, New York University Journal of International Law and Politics, available here: https://www.nyujilp.org/fate-of-the-unilateral-option-clause-finally-decided-in-russia/#FN0.