Wednesday, September 30, 2009

Incorporation of an Arbitration Clause by Reference

One of the most controversial and interesting questions in contemporary arbitration law is incorporation by reference. It is a common practice in some industries, particularly shipping and construction, for the contractual relationship between the parties to be composed of several documents. It sometimes happens that a dispute arises with reference to one of these documents, while the arbitration clause is contained in another. Common law rules have evolved to ascertain whether the parties intended to incorporate the arbitration clause in one document into another, and the normal rule is that “general” incorporation to the other document does not suffice.

The Supreme Court has recently considered this issue in a well-reasoned and comprehensive judgment, in M.R. Engineers v. Som Datt Builders, 2009 (9) SCALE 298. In this case, Som Datt Builders Ltd. [“SDBL”] had entered into a contract with the Kerala PWD. Clause 67.3 of this contract contained an arbitration clause which provided that disputes would be referred to a Committee of three arbitrators to be nominated by various Government departments. SDB sub-contracted a part of its obligations to MR Engineers Pvt. Ltd. [“MREPL”]. The work order provided that “This sub- contract shall be carried out on the terms and conditions as applicable to main contract unless otherwise mentioned in this order letter.

Disputes arose between MREPL and SDBL over payments allegedly owed to MREPL, and MREPL eventually filed an application under s. 11 of the Arbitration and Conciliation Act, 1999, seeking the appointment of an arbitrator. MRE argued that Clause 67.3 of the contract between the Kerala PWD and SDBL stood incorporated into the contract between SDBL and MREPL by virtue of the language extracted above. The Kerala High Court dismissed the application, holding that incorporation was insufficient and that there was consequently no arbitration agreement between MREPL and SDBL.

In the Supreme Court, Justice Raveendran referred to the provisions of s. 7(5) of the Arbitration Act, which provides that “[t]he 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.” The Court rightly noticed that the words “such as to make that arbitration part of the contract” meant that mere reference is insufficient. Clearly, s. 7(5) required “conscious acceptance” of the arbitration clause, and the Court held that this question would have to be answered in accordance with the normal rules of document construction, in the absence of statutory guidelines.

The primary indicator of this intention is the language of the incorporating clause. The Court noticed that contracts sometimes incorporate other contracts in their entirety, using language along the lines of “all the terms and conditions…” or “this contract shall be governed by the provisions of…” etc. In such cases, the arbitration clause is also incorporated. Where, however, the incorporating clause refers to a specific aspect of another contract, the presumption is that it was not intended to incorporate the arbitration clause. This proved to be extremely important in the case, because the incorporating clause used the phrase “this sub-contract shall be carried out…” The Court held that the use of words “carried out” indicated the intention of the parties to confine incorporation to matters of performance and execution, and that it could consequently not extend to clauses outside this sphere, such as security deposits and arbitration clauses.

The second important proposition in this case is a distinction that the Court made between “standard form contracts” and other contracts. Relying on observations in Russell on Arbitration, the Court held that general reference may suffice if the reference was to a standard form of terms and conditions of “trade associations or regulatory institutions”. The reasoning is that parties that accept the terms and conditions of such well-known associations and institutions are presumably aware of the existence of the arbitration clause, particularly since these terms and conditions are almost always published. On this basis, the Court distinguished two of its prior decisions where incorporation was accepted in the context of the General Conditions of Contract of the Grain & Food Trade Association and the General Conditions of the Fertilizer Association of India. In this case, the Court observed that the reference was general and not to a standard form of a trade association. It was therefore regarded as insufficient on the facts of the case.

A final reason to reject the incorporation argument is the source for another important legal proposition – the arbitration clause, after incorporation, must remain consistent with the contract into which it is incorporated. In this case, the arbitrators were to be appointed by various Government Departments, which could clearly not apply to a contract to which the Government was not a party.

In sum, the following important propositions emerge from the judgment:

  1. Mere reference is insufficient for the purposes of s. 7(5), which mandates an inquiry into the intention of the parties on the basis of the normal rules of construction of contracts.
  2. General reference to another contract is normally insufficient, except where the reference is to the standard terms and conditions of a “trade association or regulatory institution”.
  3. The language of the incorporating clause is a crucial factor – if it refers to a specific aspect of another contract, such as supply or execution, the arbitration clause is not arbitrated, whereas incorporation in its entirety is sufficient to incorporate the arbitration clause as well.
  4. Incorporation fails if the arbitration clause on incorporation will be inconsistent with the terms or scheme of the contract into which it is incorporated.

Another analysis of this judgment is available here.

No comments: