Thursday, September 16, 2010

Incorporation of arbitration clauses by reference: Guest post by Mr. Anirudh Wadhwa

Mr. Anirudh Wadhwa, a lawyer based in Delhi and one of the editors of Justice R.S. Bachawat's Law of Arbitration and Conciliation was kind enough to send us a guest post on incorporation of arbitration clauses by reference. The note centers around the decision of the Supreme Court of India in M.R. Engineers v Som Datt Builders [(2009) 7 SCC 696]. The following is the text of Mr. Wadhwa's post.

It is common for terms, including arbitration clauses, from one contract to be incorporated by reference into another. A strict standard of incorporation is generally preferred in respect of arbitration clauses for three reasons – First, an arbitration clause, is considered independent of the main contract.  Second, arbitration clauses preclude the parties from bringing disputes before judicial fora. Third, an arbitration agreement has to be a “written agreement”. In consideration of these, the accepted view is that a “general” incorporation of the conditions of a contract does not have the effect of incorporating an arbitration clause contained in that contract.
The Supreme Court in M.R. Engineers has consolidated the Indian legal principles in this area. 

Statutory Language:

The Arbitration and Conciliation Act, 1996 deals with incorporation by reference in S. 7(5)which states: “the reference in [a] contract to a document containing an arbitration clause constitutes an arbitration agreement if the contract is in writing and the reference is such as to make that arbitration clause part of the contract.” This language is in pari materia with the S. 6 (2) of the English Arbitration Act, 1996. The ambiguity as to when a reference can be said to be such as to make the clause part of the agreement has been highlighted in Russel on Arbitration.

English Judicial Decisions:

The opinion of the English Courts on this point has vacillated. The most famous decision that illustrates this divergence is perhaps Aughton Ltd v. MF Kent Services Ltd [1991] 57 B.L.R. 1. In this case, a sub-contractor’s order provided for a sub-sub-contract to be “on GC/Works/1” (a standard form contract used by the British government in public contracts). The Court of Appeal held that the reference to the “GC/Works/1” contract did not include a reference to the arbitration clause contained in such contract. The two judges however disagreed in their approaches. John Megaw, J concluded that for a valid incorporation there must be “distinct and specific” reference expressing the parties’ intention to make the incorporation. Ralph Gibson, LJ however, having reached the same conclusion on the facts of the case, recognised that express words of incorporation were “not always necessary” and in some instances “general words would be sufficient” for a valid incorporation. The English Courts have subsequently favoured the stricter approach outlined by Megaw J [Barett & Son (Brickwork) Ltd v. Henry Boot Management Ltd (1995) CILL 1026; Anonymous Greek Co of General Insurances (The “Ethniki”) v. AIG Europe UK [2000] 2 All ER 566]. The position however cannot be taken as settled in light of later authorities that have adopted a contrary approach [e.g., Roche Products Ltd v. Freeman Process Systems Ltd [1996] 80 B.L.R. 102].

The Decision of the Indian Supreme Court in M.R. Engineering:
The M.R. Engineers case arose out of a sub-contract which did not contain an arbitration clause, but referenced the “terms and conditions as applicable to the main contract”. Upon disputes arising between the parties, a question was posed as to whether the reference to the “terms and conditions” of the main contract had the effect of incorporating into the sub-contract, the arbitration clause in the main contract as well.

The Supreme Court followed the views of John Megaw, J in Aughton. Raveendran, J speaking for the court noted the words in the latter part of S. 7(5) – “the reference is such as to make that arbitration clause part of the contract”; and imputed that this “requires a conscious acceptance of the arbitration clause from another document, by the parties, as a part of their contract, before such arbitration clause can be read as a part of the contract between the parties.” Section 7(5) according to the Court only “makes it clear that where there is a reference to a document in a contract, and the reference shows that the document was not intended to be incorporated in entirety, then the reference will not make the arbitration clause in the document, a part of the contract, unless there is a special reference to the arbitration clause so as to make it applicable.”

In the given facts, the court held that there was no “special reference” to the arbitration clause. Further, the court’s finding that the incorporation of arbitration clause was not intended was supported by the fact that the main contract contained a bespoke arbitration clause, which was specific to the disputes and parties to that contract.

The court laid down five broad propositions, which were helpfully summarised by Raveendran, J as follows:  

  1. An arbitration clause in another document, would get incorporated into a contract by reference, if the following conditions are fulfilled: (i) The contract should contain a clear reference to the documents containing arbitration clause, (ii) the reference to the other document should clearly indicate an intention to incorporate the arbitration clause into the contract, (iii) The arbitration clause should be appropriate, that is capable of application in respect of disputes under the contract and should not be repugnant to any term of the contract.
  2. When the parties enter into a contract, making a general reference to another contract, such general reference would not have the effect of incorporating the arbitration clause from the referred document into the contract between the parties. The arbitration clause from another contract can be incorporated into the contract (where such reference is made), only by a specific reference to arbitration clause.
  3. Where a contract between the parties provides that the execution or performance of that contract shall be in terms of another contract (which contains the terms and conditions relating to performance and a provision for settlement of disputes by arbitration), then, the terms of the referred contract in regard to execution/performance alone will apply, and not the arbitration agreement in the referred contract, unless there is special reference to the arbitration clause also.
  4. Where the contract provides that the standard form of terms and conditions of an independent Trade or Professional Institution (as for example the Standard Terms & Conditions of a Trade Association or Architects Association) will bind them or apply to the contract, such standard form of terms and conditions including any provision for arbitration in such standard terms and conditions, shall be deemed to be incorporated by reference. Sometimes the contract may also say that the parties are familiar with those terms and conditions or that the parties have read and understood the said terms and conditions.
  5. Where the contract between the parties stipulates that the Conditions of Contract of one of the parties to the contract shall form a part of their contract (as for example the General Conditions of Contract of the Government where Government is a party), the arbitration clause forming part of such General Conditions of contract will apply to the contract between the parties.


It is interesting to note that courts in other jurisdictions (at least, in the context of the New York Convention) do not always adopt the strict standard of a “distinct and specific” reference (in English law) or a “special reference” (in Indian law) for a valid formation of the arbitration agreement through incorporation by reference. The Swiss Federal Supreme Court, for instance, applies different tests depending upon the sophistication and experience of the parties, and any applicable trade usages in that particular business [Tradax Export SA v. Amoco Iran Oil Co 11 Y.B. Comm. Arb. 532 (1986); Campagnie de Navigation et Transports SA v. Mediterranean Shipping Co 21 Y.B. Comm. Arb. 690 (1990); Tribunal Federal 11 Y.B. Comm. Arb. 532 (1986)]. American courts have also placed great emphasis on the status of the parties and their awareness about the consequences of incorporation of the arbitration clause [JMA Investments v. C Rijkaart BV 11 Y.B. Comm. Arb. 578 (1986); Metallgessellschaft v. Montrose Second Circuit 17 Y.B. Comm. Arb. 672 (1992)]. In these jurisdictions, it will thus be more difficult for sophisticated business parties to challenge the arbitration agreement on the ground of an invalid incorporation.

Be that as it may, the Supreme Court in M.R. Engineers could not have been clearer. There is no requirement for the courts in India to have any regard to the sophistication of the parties, or the standard practices in the industry (unless of course there is a reference in the contract to such standard terms and conditions, or parties display an unmistakeable intention in favour of a valid reference of the arbitration clause by expressly recording their “understanding” of the applicable terms and conditions). It seems unlikely that foreign precedent contrary to the decision in M.R. Engineers will be of any practical relevance for Indian lawyers, unless the courts have a sudden change of heart. Lawyers can however helpfully rely on English precedents, where the test of “distinct and specific reference” laid down by Megaw J in Aughton seems materially similar to the “special reference” test laid down by Raveendran J in M.R. Engineers.

However elegantly drafted a contract may be, and however much paper work may be reduced by intelligent referencing, if disputes arising out the parties have to be ultimately settled through a long drawn judicial process, the contract loses much of its value. A simple contract may end up escalating the legal costs for the parties if care is not taken on this issue. An arbitration clause is perhaps the most important part of the contract, but it is the one that is least debated in commercial negotiation. It is expected that this decision of the Supreme Court will make legal advisers and their clients aware of the disastrous consequences of not giving due importance to the validity and enforceability of the arbitration clause. It is essential that an arbitration clause achieve the objectives that it is intended to serve. Any result to the contrary, cannot obviously be good for anyone involved. 

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