What Is an Arbitration Clause and Why Every Commercial Contract Needs One

  Articles, Arbitration & ADR

When commercial disputes arise, as they inevitably do in complex business relationships, the choice of dispute resolution mechanism determines whether resolution takes months or years, whether litigation occurs in the parties’ preferred forum, and whether awards are enforceable across borders. An arbitration clause in a commercial contract India is the instrument that directs disputes away from overcrowded courts toward a private, party-controlled process governed by the Arbitration and Conciliation Act 1996. A well-drafted arbitration clause is not boilerplate, it is a substantive commercial decision with consequences for costs, timelines, enforceability, and the neutrality of the decision-maker. A poorly drafted clause, what practitioners call a “pathological clause”, can render the dispute resolution mechanism unworkable or void.

What an Arbitration Clause Is and What It Must Contain

An arbitration clause is a contractual provision in which parties agree that disputes arising out of or in connection with their contract will be submitted to arbitration rather than litigation. Under the Arbitration and Conciliation Act 1996, an arbitration agreement must be in writing (Section 7) and must reflect a clear intention to submit disputes to arbitration.

A minimum viable arbitration clause should contain:

Pathological Clauses: What Courts Have Struck Down

A pathological clause is one so defective that the arbitration mechanism fails to operate or is rendered invalid. Indian courts have dealt with several categories:

1. Contradictory Jurisdiction Provisions

Clauses that both refer disputes to arbitration and confer exclusive jurisdiction on a specific court, creating an irreconcilable conflict. Courts must determine whether the arbitration clause or the jurisdiction clause prevails. The safest drafting practice is to include the jurisdiction clause only for matters relating to interim relief under Section 9 and enforcement proceedings under Section 36, not for the substantive dispute.

2. Unilateral Appointment Rights, Post-Perkins Eastman

The most significant invalidated clause type is one that gives one party (especially the party with greater bargaining power, such as a government PSU) the unilateral right to appoint the sole arbitrator. This was definitively addressed by the Supreme Court in Perkins Eastman Architects DPC vs HSCC (India) Ltd (2019) 20 SCC 760 (see separate article ARB-04): where one party has an interest in the outcome of the dispute, it cannot unilaterally appoint a sole arbitrator. Such clauses are now void.

3. Even Number of Arbitrators

Section 10(1) of the Arbitration and Conciliation Act 1996 provides that parties may not agree to an even number of arbitrators. A clause providing for two arbitrators (without a presiding arbitrator mechanism) is invalid.

4. Non-Existent Arbitral Institution

Clauses referring disputes to an institution that does not exist, has been dissolved, or is not identifiable create problems for commencing arbitration. Use full, correct institutional names.

Institutional Arbitration vs Ad Hoc Arbitration: The Trade-Offs

Institutional arbitration is conducted under the rules of a recognised arbitral institution, which administers the proceedings, appoints arbitrators if parties cannot agree, sets timelines, and charges administrative fees.

Ad hoc arbitration follows the Arbitration and Conciliation Act 1996 directly (Part I), with parties handling procedural steps independently or by reference to UNCITRAL Rules.

Commonly used institutions in India-related arbitrations:

• DIAC (Delhi International Arbitration Centre), Delhi High Court-administered institution
• MCIA (Mumbai Centre for International Arbitration), India’s premier international arbitration institution
• SIAC (Singapore International Arbitration Centre), most common for India-seated international arbitration
• ICC (International Chamber of Commerce), global institution, Paris-based
• LCIA (London Court of International Arbitration), London-based, preferred for London-seated arbitrations

Seat vs Venue: The Most Critical Distinction

The seat of arbitration is its legal home, it determines:

• Which court has supervisory jurisdiction over the arbitration
• Which procedural law (curial law) governs the proceedings
• Whether Part I or Part II of the Arbitration and Conciliation Act 1996 applies

The venue is merely the physical location where hearings are held, it has no jurisdictional significance.

The Supreme Court in BGS SGS SOMA JV vs NHPC Ltd (2019) 21 SCC 704 definitively clarified that where parties designate a “place” for arbitration without any contrary indication, that place is the seat, not merely a venue, and the courts at that seat have exclusive supervisory jurisdiction.

Critical drafting guidance: Always specify the seat explicitly: “The seat of arbitration shall be [city], India”, do not confuse it with “the hearings may be held at…” which indicates venue only.

The Three-Law Framework for International Contracts

For contracts involving parties from different countries, three separate governing laws must be considered:

1. Law governing the substantive contract: The law that determines rights and obligations under the main agreement (e.g., Indian law, English law)
2. Law governing the arbitration agreement: Usually the same as the contract’s governing law, but may differ if the arbitration agreement is a separate instrument, the Sulamerica test from English courts asks whether the parties intended a different law for the arbitration clause
3. Curial law (lex arbitri): The procedural law of the seat, determines how the arbitration is conducted, court powers, and challenge/enforcement framework

For India-seated arbitrations, the curial law is the Arbitration and Conciliation Act 1996 (Part I). For foreign-seated arbitrations, Part II applies (enforcement of foreign awards).

Sample Best-Practice Arbitration Clause

The following is a framework for drafting a robust arbitration clause. This is provided for informational purposes only, specific language should be tailored with professional guidance to the particular transaction:

“Any dispute, controversy or claim arising out of or relating to this Agreement, or the breach, termination, or invalidity thereof, shall be finally settled by arbitration in accordance with the [Rules of the relevant institution]. The number of arbitrators shall be [one/three]. The seat of arbitration shall be [City], India. The language of the arbitration shall be English. The governing law of this Agreement shall be the laws of India.”

For government or PSU contracts, the appointment mechanism must be structured to avoid unilateral appointment by one party, referral to an institutional appointment process or mutual agreement with court appointment as backstop under Section 11 of the Arbitration and Conciliation Act 1996 is recommended.

Key Takeaways

• Every commercial contract in India should contain an arbitration clause specifying the seat (not just venue), number of arbitrators, appointment mechanism, institution (if institutional), and governing law, omitting the seat creates jurisdictional uncertainty.
• Clauses giving one party unilateral appointment rights for a sole arbitrator are void after the Supreme Court’s ruling in Perkins Eastman (2019); institutional appointment mechanisms or mutual appointment with court backstop are the legally safe alternatives.
• For cross-border transactions, the three-law distinction, governing law of the contract, law of the arbitration agreement, and curial law of the seat, must be addressed deliberately in drafting.

This article is for informational purposes only and does not constitute legal advice. Readers should seek appropriate professional counsel for their specific circumstances.

META TITLE: Arbitration Clause in Commercial Contracts India: Drafting Guide

META DESCRIPTION: What every commercial contract in India needs in its arbitration clause, essential elements, pathological clauses to avoid, institutional vs ad hoc.