State-run firms in a bind as apex court clips powers to appoint arbitrators

New Delhi: The Supreme Court's move to slash the powers of state-run companies to unilaterally appoint arbitrators on Chief Justice D. Y. Chandrachud's last day in office leaves the country's public sector units (PSUs) in a cloud of uncertainty. 

The ruling by a constitution bench, delivered on Friday, follows a finance ministry push to cut PSU arbitration costs. 

It puts state-run firms in a bind—if they arbitrate disputes, they lose their advantage of appointing arbitrators; if they do not arbitrate, India risks losing ground in its mission to become a global arbitration hub.

The ruling was delivered by a five-judge constitutional bench comprising, Chandrachud and justices Manoj Mishra, Hrishikesh Roy, Pankaj Mithal and P.S. Narasimha.

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Tushar Kumar, an advocate at the Supreme Court, said, “Together, these measures refine India’s business milieu, establishing a framework where contractual commitments are honored with a robust sense of fairness and dependability.” 

While the judgement came on Chandrachud's last working day, the finance ministry push came much earlier in June, asking all arms of the government, including PSUs to refrain from arbitration if the disputed value exceeded ₹10 crore. 

The government has earned the moniker of being the country's biggest disputant, and state-run firms cutting down on arbitration may slow India's bid to compete with arbitration hubs such as London, Singapore and Dubai, experts and practitioners said.

Going with push

Already, state-run firms have doubled down on the finance ministry push and amended their general conditions of contract.

Mint earlier reported that two of India's petroleum PSUs—Oil India Ltd and Oil and Natural Gas Corporation Ltd—had pared their exposure to arbitration after the finance ministry advisory.

PSU arbitration is back in fray as the top court, in order to protect the rights of private contractors, clipped the PSU practice of appointing arbitrators via a panel of its own arbitrators. 

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“For PSUs, the implications of this judicial decision are far-reaching, urging a re-assessment of dispute management strategies to avert the financial strains often inherent in lengthy arbitration processes,” said advocate Kumar.

The top court struck down this practice as it could result in arbitrators being biased. The court noted that when one party, particularly a government entity, has the sole authority to appoint an arbitrator, it creates a power imbalance that undermines the fairness of the arbitration process. 

Chandrachud stated that the arbitration process must be genuinely fair, not just appear fair, to maintain confidence in the system.

"This judgment will give relief to private contractors who will now have more discretion and control in appointing their arbitral tribunal and more faith in their arbitrators," said Shaneen Parikh, partner and head of international arbitration, Cyril Amarchand Mangaldas.

Few options

Shiv Sapra, partner at Kochhar and Co., said that even though it seems arbitration law is followed because both parties agree to unilateral appointment, “the reality is that parties seldom have much option when it comes to agreements with little to no scope of negotiation”.

While the majority opinion was clear, two judges offered partially dissenting views. Roy argued that not all unilateral appointments should be invalidated, as long as the appointed arbitrator meets the criteria for independence and impartiality under Section 12(5) of the Act. He suggested that the judiciary should not automatically nullify arbitrator appointments unless there is evidence of bias or ineligibility.

Narasimha agreed that unilateral appointments need scrutiny but cautioned against judicial overreach, saying the court should not interfere unless a party challenges the appointment process.

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The origin of the issue lies in the Law Commission of India's 246th Report, which stressed that while party autonomy is a fundamental principle in arbitration, it should not override the need for impartiality and independence in the arbitration process. To address concerns about conflicts of interest, the Commission recommended the automatic disqualification of arbitrators whose relationship with the parties fell within certain categories.

This recommendation led to the Arbitration and Conciliation (Amendment) Act, 2015, which introduced Section 12(5). This provision made individuals ineligible to be appointed as arbitrators if their relationship with the parties involved in the dispute fell under any of the categories specified in the Seventh Schedule of the Act.

Following this amendment, parties began filing applications under Section 11(6) of the Arbitration and Conciliation Act, seeking to invalidate arbitration clauses where one party had unilateral control over the appointment of arbitrators. This was especially common in contracts involving public sector entities, where such clauses often gave one party, particularly government entities, the sole authority to appoint arbitrators.

The turning point

The specific case that led to the 2024 Supreme Court ruling began with concerns over unilateral arbitrator appointments by public sector entities, notably the Indian Railways. In 2019, a three-judge bench upheld an arbitration clause in a contract that allowed the General Manager of the Railways to appoint three arbitrators, all of whom had to be serving or retired railway officers. This raised concerns about the impartiality of the process, as the Railways had exclusive control over the selection of arbitrators, creating a potential conflict of interest.

In 2021, the issue was revisited by another bench, which raised doubts about whether the General Manager, who would be disqualified from acting as an arbitrator due to potential bias under the Arbitration and Conciliation Act, should be allowed to appoint the entire panel of arbitrators. This led to a reference to a larger bench, which eventually resulted in this judgement.

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The apex court's decision on Friday assumes importance as arbitrations between PSUs and private contractors have been a costly affair. In Hindustan Construction Co. vs Union of India in 2019, the top court noted that PSUs had paid over ₹3000 crore in arbitration dues from 2008-2019. The finance ministry also disclosed to the Lok Sabha in July this year that as many as 60% of arbitrations undertaken by PSUs such as National Highways Authority of India Ltd and NTPC Ltd ended up being challenged or appealed, leading to extra costs.

The judgment marks a defining change in the judiciary's approach to public funds moving to private entities in arbitral awards. In April this year, the top court intervened in an arbitration case where a public entity, Delhi Metro Rail Corporation (DMRC) Ltd, was set to pay about ₹7,600 crore to a private entity, Delhi Airport Metro Express Pvt Ltd, finding judgements made by the High Court division benches to be a miscarriage of justice.

Spotlight on mediation

This may shift the out-of-court dispute resolution spotlight towards mediation, which the government has touted as a cost-effective method as compared to arbitration in the finance ministry's June advisory. 

"Mediation is gaining popularity in private commercial disputes and it is heartening that the biggest litigant in the country, the government, is giving an impetus to out of court, amicable dispute resolution, and settlement. While I do not think arbitration will stop being a popular and sensible dispute resolution mechanism, I am hopeful that PSUs will have the courage to settle a matter and make payment under an award voluntarily, rather than carrying every matter up to the Supreme Court, now that the government has blessed Mediation," said Parikh of Cyril Amarchand Mangaldas.

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Sapra of Kochhar and Co. also agreed, indicating that unilateral appointments may no longer be an option under such agreements moving forward and mediation is expected to be given more weightage.

With the passage of the Mediation Act in 2023, more PSUs may find this process better. “The government’s stance indicates a discernible pivot towards mediation, further emphasized by the recent enactment of the Mediation Act—a statute that promotes the values of consensual, respectful, and swift resolution of conflicts. Mediation thus offers PSUs a refined path that reduces financial exposure while harbouring a spirit of mutual respect and cooperation between parties,” added Kumar, the Supreme Court lawyer.