A-Z of ADR: Unilateral Option Clauses

-Vidisha Singh (IIIrd Year, NLSIU Bangalore)

A unilateral option clause (UOC) is a dispute resolution clause which gives only one party the discretion to elect a specific dispute resolution method – most often, between arbitration and litigation. Some UOCs also allow one party to pursue litigation in multiple jurisdictions while restraining the other party to a single jurisdiction. An example of a UOC, in a Sales Agreement, is as follows:

Section X. Dispute Resolution

a) The courts in XYZ country shall have exclusive jurisdiction over any dispute arising out of this contract, subject to BUYER’s right to elect arbitration in clause (b).

b) The BUYER has the right to refer any dispute arising out of this contract to arbitration under the BIMACC Institutional Arbitration Rules, which rules are deemed to be incorporated by reference into this clause.
…

In case of such a multi-tiered clause, either party has the right to litigate, but only the buyer (one of the parties) can refer the matter to arbitration. At the outset, there seems to be an inherent imbalance in the position of the two parties when it comes to UOCs. Allowing only one party to choose between multiple fora for dispute resolution, while restricting the other party gives off the impression of being manifestly unfair. Yet, such UOCs are gaining popularity in various commercial contexts.

Such UOCs are predominantly found in financing and loan agreements, where the lender often has the option of pursuing legal action in multiple jurisdictions, but the borrower may have a restricted choice. This is because the lender undertakes a substantial risk in such transactions and needs to be able to pursue legal recourse in a jurisdiction from which it can recover its debt.[1] However, the use of UOCs is now widespread in contracts between various commercial entities. As the suitability of a specific dispute resolution method depends on the particularities of an individual case, the party with the stronger bargaining power may seek the flexibility of a UOC. Arbitration may be favourable as an arbitral award is enforceable in a much larger number of countries, due to the wide-spread acceptance of the New York Convention than a court judgement would be. In cases where the party would prefer confidential proceedings to protect their goods, they may opt for arbitration; whereas in cases where the matter is not arbitrable[2] or if the party favours a public proceeding, it may refer the matter to litigation in public courts.

Potential issues with UOCs
The inherently imbalanced nature of UOCs has raised many questions about the validity of such clauses on multiple grounds. Across the world, there seem to be varying decisions on this question. Countries such as the UK,[3] Singapore,[4] Hong Kong,[5] and Spain have held such clauses to be valid, while France,[6] Russia,[7] and Bulgaria have struck down these clauses. These decisions on the questions of the validity of UOCs are often about balancing party autonomy and mandatory rules of the arbitral process. Some common contentions with respect to the validity of UOCs are discussed below.

Equality: The most fundamental principle of arbitration is that the parties must be treated equally and must have an equal opportunity to present their case before the Tribunal.[8] When a UOC is challenged for violating equality, the success of such a challenge depends on how widely the principle of equality is treated under the law of the arbitration agreement.[9] On the face of it, a UOC is imbalanced as it caters to the interest of only one party and compels the other party to adhere to the choice of dispute resolution fora of the first. One of the recurring arguments has been that such clauses violate the mandatory principle of equality and the right to present one’s case. However, the principle of equality, as exists in the Arbitration and Conciliation Act and the UNCITRAL Model Law, is only procedural equality applicable to the proceedings only. One of the tests to determine a breach of equality is to check whether one party has a greater opportunity to influence the outcome of the case.

A standard UOC would allow one party to choose a forum, but accords equal rights to the parties once the arbitral procedure begins, such as allowing them to select an equal number of arbitrators, making their written and oral submissions and producing evidence. In other words, any imbalance is effectively cured by the initiation of the proceedings and no unfair procedural advantage accrues to one party over the other. The choice of forum cannot influence the verdict of the case by itself.[10] Therefore, a UOC would not violate equality as envisaged in the Indian Arbitration act or the UNCITRAL Model Law.

Unconscionability: Arbitration clauses are ultimately contractual clauses and therefore, must satisfy all the conditions for a valid contractual term. Some courts have considered UOCs to be unconscionable if the party with the restricted choice is compelled to agree to manifestly unfair terms, due to its weaker bargaining position. For such a claim to succeed, the UOC needs to satisfy two elements – Procedural unconscionability, wherein the process of reaching the agreement was riddled with oppression due to unequal bargaining power; and substantive unconscionability, wherein the contractual terms agreed upon are manifestly unfair and one-sided.

Unlike equality, a claim of unconscionability depends on the facts of the individual case. Broadly speaking, Courts across the world have generally rejected claims of unconscionability between commercial entities. This is because these entities engage in extensive contractual negotiations, which reduces the chances of establishing procedural unconscionability. Further, their agreements may include a number of imbalanced clauses, favouring either party. Invaliding contractual clauses merely because of their one-sided nature would result in invalidating a large number of clauses, which may favour one party over the other.[11] However, in cases of consumer and employment contracts, UOCs may be found to be unconscionable if they are included as standard terms in a contract or if they prevent the other party from seeking any legal recourse altogether.[12] Thus, claims of unconscionability of a UOC depend on the nature of the contract and the parties.

Lack of mutuality: Invalidating UOCs for lack of mutuality stems from the common law doctrine of mutuality, which states that ‘either both must be bound, or neither is bound’.[13] In these cases, the challenge is based on the fact that the weaker party does not receive any consideration for agreeing to a UOC. Such a narrow view arises if the UOC is viewed standalone from the rest of the contract. However, Courts have looked at the contract as a whole to come to the conclusion that contractual provisions need not give parties the exact same positions.[14] It would seem illogical to require this because the basis of a contract is that value is given to both parties. If the law required that every contractual term be exactly symmetrical, no exchanges between parties would take place. This ground has been rejected in a majority of the jurisdictions for invalidating UOCs.[15]

Public Policy: The public policy concerns with respect to UOCs are twofold – that of the law of the arbitration agreement and that of the jurisdiction of enforcement. Public policy grounds are intrinsic to the country and can be wide-ranging. While some countries might have domestic laws that do no permit UOCs, some countries might refuse to enforce awards arising out of such clauses. In India, an arbitral award may be set aside if it is in conflict with the public policy of India.[16] At the stage of enforcement of an award, the court shall not review the merits of the dispute and shall only set aside an award if it shocks the conscience of the court.[17]

Indian position on Unilateral Option Clauses
In India, the discourse on UOCs is conflicting and riddled with misunderstandings of the law. The only notable decisions have been rendered by the Delhi and Madras High Courts. However, an analysis of the cases and the applicable law shows that Indian law should favour the validity of UOCs.

The Delhi High Court, in Bhatia Cutler Hammer v AVN Tubes,[18] invalidated a UOC stating that a party could have an exclusive right to initiate arbitration as the Arbitration and Conciliation Act, 1996 envisaged a mutual arbitration agreement with opportunity for bilateral invocation. However, the Madras High Court relied on section 7 of the Act to state that the law did not require arbitration clauses to necessarily have mutuality and upheld the UOC in Castrol India Ltd. v. Apex Tooling Solutions.[19] Section 7 of the Arbitration Act lists out the requirements for a valid arbitration clause. It requires an ‘agreement by the parties’, meaning that the parties should have consented to it, and not mutuality of invocation or consideration. This is in line with Madras High Court’s reasoning. However, it is observed that the insistence of the Delhi High Court on mutuality of consideration stems from Section 25 of the Indian Contract Act, which invalidates contracts lacking consideration.[20] However, this issue is resolved when an arbitration agreement is viewed in the context of the whole contract, where substantive concessions and benefits may be given to the other party in exchange of the UOC. However, in the absence of a clear authority on this point, uncertainty continues to exist in this regard.

In another case,[21] the Delhi High Court invalidated a UOC as it restrained one party’s recourse to legal proceedings and contravened section 28 of the Contract Act. It also stated that the UOC was against the public policy in India.  However, post the 2015 Amendment of the Arbitration Act, the scope of public policy has been drastically narrowed. Thus, it is doubtful if UOCs would be invalidated on such grounds anymore. With respect to the argument on Section 28 of the Contract Act, it states that agreements restraining legal proceedings are invalid. However, this provision is attracted only when there is an absolute restraint on legal proceedings and not a partial one. In cases of UOCs, the option of a party to approach arbitration does not undermine the other party’s right to approach the default forum for dispute settlement. Thus, in light of these provisions and legislative changes, Indian law seems to favour the validity of UOCs. However, caution must be exercised in the absence of an authoritative word in this regard.

Practical Steps while dealing with Unilateral Option Clauses
Although UOCs are finding widespread acceptance internationally, there are potential legal pitfalls associated with them. Therefore, careful consideration should be paid to their inclusion and drafting. Some practical considerations to be mindful of are:[22]

• Always seek specialist advice about unilateral dispute resolution options, including their validity in various jurisdictions such as law governing the arbitration agreement, law of the seat of the arbitration and the law of the jurisdiction of enforcement of award;
• Assess the benefits of the UOC and whether that outweighs the costs and risks associated with the option;
• Draft the UOC precisely and clearly, and draft the arbitration and litigation aspect of the UOC as separate clauses to ensure that each of them can operate on their own, in case they are severed;
• In case the UOC fails, make sure that the default position is acceptable and adequate;
• The beneficiary of an option to arbitrate should avoid taking any substantive step in court proceedings before exercising the option in order to limit the risk of the clause becoming unenforceable. Similarly, the beneficiary of an option to litigate should avoid taking any substantive step in an arbitration before exercising its option;
• The UOC should only restrict the initiation of proceedings to one party, but should not confer any procedural advantages on one party over the other;
• The UOC should not absolutely restrict any party from legal recourse.

[1] Mauritius Commercial Bank v Hestia Holdings [2013] EWCH 1328 (Comm).
[2] ‘Arbitrability’ of the subject matter means that only those disputes arising out of the contract that are capable of being settled by arbitration must be adjudicated upon by the Tribunal.
[3] Mauritius Commercial Bank (n 1).
[4] Wilson Taylor Asia Pacific Pte Ltd v. Dyna-Jet Pte Ltd [2017] SGCA 32.[5] China Merchants v JGC Corp [2001] 3 HKC 580.
[6] Mme. X v. Banque Privée Edmond de Rothschild, French Supreme Court, First Civil Chamber, 26 September 2012.
[7] Russian Telephone Company v Sony Ericsson Mobile Communications, Ruling no. 1831/12 Arbitrazh Court of the Russian Federation, 19 June 2012
[8] UNCITRAL Model Arbitration Law, Article 18; The Arbitration and Conciliation Act 1996, Article 18.
[9] Deyan Draguiev, Unilateral Jurisdiction Clauses: The Case for Invalidity, Severability or Enforceability, 31 J. Int’l Arb. 19, 41 (2014).
[10] NB Three Shipping v. Harebell Shipping [2004] All ER (D) 152 (Oct).
[11] Hans Smit, The Unilateral Arbitration Clause: A Comparative Analysis, 20 American Rev. Int. A. 391, 401 (2009).
[12] Harris v Green Tree Financial Corp, 183 F.3d 173 (3d Cir. 1999).
[13] Cristopher Drahozel, Nonmutual Agreements to Arbitrate, 27 J. Corp. L. 537, 538 (2002).
[14] Wilson Taylor (n 4).
[15] Youseef Nassar, ‘Are Unilateral Option Clauses Valid?’ (Kluwer Arbitration Blog, 13 October 2018) http://arbitrationblog.kluwerarbitration.com/2018/10/13/are-unilateral-option-clauses-valid/?doing_wp_cron=1596352432.9275839328765869140625 accessed on 1 August 2020.
[16] The Arbitration and Conciliation Act 1996, s. 34(2)(b)(ii).
[17] Associate Builders v Delhi Development Authority 2014 (4) ARBLR 307.
[18] 1995 (33) DRJ 672.
[19] (2015) 1 LW 961 (DB).
[20] Nishanth Vasanth and Rishabh Raheja, ‘Examining the validity of Unilateral Option Clauses in India: A brief overview’ (Kluwer Arbitration Blog, 10 October 2017) http://arbitrationblog.kluwerarbitration.com/2017/10/20/examining-validity-unilateral-option-clauses-india-brief-overview/?doing_wp_cron=1596007334.5024650096893310546875 accessed on 1 August 2020.
[21] Emmsons International Ltd. v. Metal Distributors2005 (80) DRJ 256.
[22] Please note that this does not count as legal advice and a specialist must be consulted before including such clauses in any contract.

-Vidisha Singh (IIIrd Year, NLSIU Bangalore)

Vidisha Singh is a Third Year Law Student at the National Law School of India University (NLSIU), Bangalore.

BIMACC expresses its gratitude towards the author and to the members of the Legal Services Clinic, National Law School of India University (NLSIU) for their support in our collaborative efforts to promote ADR with this series titled “A-Z of ADR”. The purpose of this series is to increase the understanding of certain fundamental concepts of Alternative Dispute Resolution.

The Legal Services Clinic is a student-run committee that provides free legal services to the socially and the economically backward sections of the society who have difficulty accessing the judicial system. It also has a mandate of spreading legal awareness and providing free legal assistance to those who cannot afford it.
Website: www.legalservicesclinic.org/
Facebook: @legalservicesclinic  
Email: lsc.nlsiu@gmail.com
Phone Number: 073586 73214

Disclaimer: The views and opinions expressed in this blog are those of the author and do not necessarily reflect the official policy or position of BIMACC, any of the members of the Board, or the empanelled neutrals. This blog is for informative purpose only and does not constitute legal advice in any manner whatsoever.