Arbitration Clauses in Commercial Contracts: Mistakes Indian Businesses Keep Making

Arbitration clauses are standard in Indian commercial contracts. But a poorly drafted arbitration clause can cause more problems than it solves. Courts in India frequently have to deal with disputes about whether a valid arbitration agreement exists, who the arbitrators should be, where the seat is, and whether a particular dispute falls within the scope of the clause. Most of these disputes are entirely avoidable.

This article identifies the most common drafting mistakes and explains how to avoid them.

The "May Refer" Drafting Error

One of the most common mistakes is using permissive language in the arbitration clause. A clause that says disputes "may be referred to arbitration" is not a mandatory arbitration clause. It is an option that either party may or may not exercise. If one party wants to litigate rather than arbitrate, a permissive clause gives the other party no basis to compel arbitration.

The Arbitration and Conciliation Act, 1996 requires a written agreement to submit disputes to arbitration. A permissive clause may not satisfy this requirement. Arbitration clauses should always use mandatory language. Disputes "shall be referred to and finally resolved by arbitration."

Failure to Specify the Seat

The seat of arbitration determines the law applicable to the arbitration proceedings, which court has supervisory jurisdiction over the arbitration, and where any award can be challenged. Failing to specify the seat creates uncertainty about all three of these matters.

The Supreme Court in BALCO v. Kaiser Aluminium (2012) clarified the distinction between the seat and the venue of arbitration. The seat is a legal concept determining jurisdiction. The venue is simply where hearings are physically held. These can be different places, and the distinction matters enormously in practice.

Arbitration clauses should always specify both the seat and, if desired, the venue separately. "The seat of arbitration shall be Mumbai" and "hearings may be conducted at such locations as the tribunal determines" are the kind of provisions that avoid ambiguity.

Unclear Scope of the Arbitration Clause

The scope of the arbitration clause determines which disputes are covered. A clause that refers only to disputes "arising out of this agreement" may not cover disputes that arise "in connection with" the agreement, such as pre-contractual misrepresentation or post-termination obligations. A clause that covers disputes "arising out of or in connection with" the agreement is broader and is the standard formulation used in most institutional rules.

Equally, parties sometimes try to carve out certain types of disputes from arbitration, for example by reserving the right to seek injunctive relief from courts. These carve-outs need to be drafted carefully to avoid creating ambiguity about the scope of the obligation to arbitrate.

No Provision for Number of Arbitrators

Where the arbitration clause does not specify the number of arbitrators, Section 10 of the Arbitration Act applies. The default under Section 10 is that the parties can agree on any number that is not an even number. In the absence of agreement, a sole arbitrator is appointed. For high-value commercial disputes, a sole arbitrator may not be appropriate, and parties should specify three arbitrators where the contract value warrants it.

Institutional Rules vs. Ad Hoc Arbitration

Indian commercial contracts frequently provide for ad hoc arbitration without specifying any institutional rules. This means the parties and the tribunal must agree on procedural matters as they arise, which can be slow and contentious. Institutional arbitration under the rules of bodies such as the Mumbai Centre for International Arbitration, the Indian Council of Arbitration, or international bodies like SIAC or ICC provides a ready-made procedural framework and an appointing authority to resolve disputes about the constitution of the tribunal.

The choice between institutional and ad hoc arbitration depends on the nature of the transaction and the parties' preferences, but parties should make the choice deliberately rather than defaulting to ad hoc arbitration simply because no institution is specified.

Governing Law of the Contract vs. Governing Law of the Arbitration

These are two separate questions. The governing law of the contract determines the substantive rights and obligations of the parties. The governing law of the arbitration (the curial law) determines how the arbitration proceedings are conducted and which courts have supervisory jurisdiction. Both should be specified, and they need not be the same.

For cross-border contracts with Indian parties, it is common to specify Indian law as the governing law of the contract, with a neutral seat such as Singapore for the arbitration. This combination gives the parties the certainty of established Indian contract law for their substantive rights, while benefiting from Singapore's efficient arbitration infrastructure.