Legal Opinion – Incorporating arbitration clauses
Legal Opinion – Incorporating arbitration clauses by ‘reference’
Quite often contracts create obligations by reference to other contracts – are such references enough to incorporate agreements to arbitrate? Shourav Lahiri considers this issue and the significance of a recent ruling
It is not uncommon for the main contractor on a project to compromise or settle claims made against it by the employer and to then seek a contribution from the relevant subcontractor.
The issue in most of these main contractor/sub contractor disputes is proof of how much of the settlement sum related to claims for which the sub contractor is liable, and whether the settlement for those claims was reasonable.
There is quite a lot of case law and discussion on this issue, which is not limited only to main contractors and subcontractors and applies to any set of parties in the contractual chain. A recent addition to the corpus is the decision of the High Court of England and Wales in Building Technologies FE Ltd v Supershield Ltd  EWCH 927. It is important for parties to a construction contract to be sure of the forum in which its disputes will be resolved – in court or in
arbitration. But quite often, contracts create obligations by reference to other contracts – are such references enough to incorporate agreements to arbitrate?
Let us consider this issue and the significance of a recent ruling from the Supreme Court of India in MR Engineers & Contractors Pvt. Ltd v Som Datt Builders Ltd. (Civil Appeal No. 4150 of 20009 (arising out of SLP [C] No. 11117 of 2006).
We often find subcontracts requiring the subcontractor to carry out its works in accordance with the terms of the main contract. Strange, but true. It happens in circumstances where the main contractor wants to ensure that all of its obligations are passed on ‘back to back’ to the subcontractor but is too lazy to pick out the relevant obligations in the main contract and write them into the subcontract. So, they insert an obligation in the subcontract that states that (a) the subcontractor is deemed to have full knowledge of the terms of the main contract and (b) it should carry out its work in accordance with those terms.
In most instances, this does not create many problems in relation to general obligations – for example, submission of payment applications, compliance with drawings and specifications etc.
However, if the general reference in the subcontract to the main contract is also intended to refer to the dispute resolution clause in the main contract, but no specific reference is made, it can create problems. This is particularly if the context of the reference to the main contract is such as to indicate a more limited reference than the incorporation of the main contract terms as a whole.
This issue has been looked at both by statute and the Indian courts, and the position is similar to that taken by the English courts.
The Arbitration and Conciliation Act 1996 (the ‘Act’)
Section 7(5) of the Act states that reference in a contract to a document containing an arbitration agreement is a valid arbitration agreement if it is writing and the reference is such as to make that arbitration clause part of the contract.
The problem for parties relying on this sub-section is how they can show that the reference to the arbitration agreement was “such as to make the arbitration clause part of the contract”. The Supreme Court of India recently had occasion to construe section 7(5) of the Act in MR Engineers & Contractors Pvt Ltd v Som Datt Builders Ltd. In this case, the Public Works Department (‘PWD’) had entered into a contract with Som Datt Buildings Ltd (‘SDBL’) for construction works including construction of a directorate building for the National Highway Four Laning Project. SDBL subcontracted the works for the directorate building to MR Engineers & Contractors Pvt. Ltd (‘MREC’).
The main contract between PWD and SDBL contained an arbitration clause (under clause 67.3 of the general conditions of contract). The subcontract between SDBL and MREC stated that the works would be carried out under the terms and conditions of the main contract unless otherwise stated.
PWD commissioned MREC directly to carry out additional works, for which MREC did not receive payment. MREC asked SDBL to claim for the payment of the works. This claim, along with a number of other claims that SDBL had, was referred by SDBL to arbitration against PWD. SDBL was awarded monies to be paid by PWD and MREC contended they were entitled to a significant part of these monies.
When the money was not paid, MREC sought to commence arbitration against SDBL on the basis that the arbitration agreement in the main contract was incorporated by reference. The Supreme Court held that there was no such incorporation. This was principally because the reference to the subcontract being carried out on the terms of the main contract appeared in the context of the specific scope of work that the subcontractor had to carry out. Therefore, the court held, the reference to the main contract terms were to only such terms as were relevant to the scope of works – it did not extend to all the terms of the main contract (and therefore, did not include the arbitration clause).
The court said that under Section 7(5) of the Arbitration Act, the words “such as to make the arbitration clause part of the contract” required an intention by the parties to incorporate the arbitration agreement.
Furthermore, the arbitration agreement under the main contract in this case was tailor-made and specific to the main contract (for example, there was a reference to the need for an Engineer’s Decision prior to starting arbitration, which could not apply to the subcontract as there is no ‘Engineer’ in the subcontract) and therefore it could not practically apply to the subcontract.
However, there is an exception.
Where parties refer to standard form terms and conditions of a trade association or regulatory institutions which are well known within their circle of trade, it may be sufficient to incorporate also the arbitration agreement contained in those standard terms.
Support from English statute and case law
The ruling refers to and is supported by English case law and legislation. Section 6(2) of the English Arbitration Act 1996 contains a similar provision to section 7(5) of the Act. The English courts have interpreted Section 6(2) in terms that that general words of incorporation are not significant or sufficient to enable incorporation by reference. Therefore an arbitration agreement will only be treated as effective and incorporated if the reference to another document is specific.
The lesson to be learnt
Arbitration agreements are curious animals. Even though they are contained within a contract, they are considered to be a separate stand alone agreement. If, for example, the other terms of the contract are unenforceable, the arbitration agreement is deemed to subsist so as to enable disputes in relation to the enforceability of the contract terms to be brought to arbitration.
It must be remembered that parties have to agree to go to arbitration; without which the forum for dispute resolution is the court. If parties want to have dispute dealt with in arbitration, they should make a effort to incorporate an arbitration clause into their agreements by writing or making specific reference to the part of a separate document containing this arbitration agreement.
The author, Shourav Lahiri is a Partner in the international law firm Pinsent Masons LLP. He wishes to thank Ms Helen Turner for her assistance with this article. The author can be reached at firstname.lastname@example.org.