Arbitration Clause in General Insurance Policies A Legal Gimmick to Avoid Liability


Author: Narendra Sharma, Consultant (Legal)



If parties to a contract have agreed to something unreasonable, they should be treated as if they have not agreed at all and be released. This happens in the case of general insurance contracts and is dealt with here in the light of a recent decision.


(a)        Purpose of Arbitration Act : The purpose of Arbitration and Conciliation Act, 1996 (˜the Act™)  is to provide quick redressal to commercial dispute by private Arbitration. Quick decision of any commercial dispute is necessary for smooth functioning of business and industry. Internationally, it is accepted that normally commercial disputes should be solved through arbitration and not through normal judicial system. An arbitrator is basically a private judge appointed with consent of both the parties. He is expected to give his decisions quickly as he is not bound by the technical formalities of a court. In India, the need of arbitration is more because of very heavy burden on the judicial system and huge backlog of pending cases.

(b)       Arbitration Agreement The foundation of an arbitration is the arbitration agreement between the parties to submit to arbitration all or certain disputes which have arisen or which may arise between them. Thus, the provision of arbitration can be made at the time of entering the contract itself, so that if any dispute arises in future, the dispute can be referred to arbitrator as per the agreement. It is also possible to refer a dispute to arbitration after the dispute has arisen. Arbitration agreement may be in the form of a arbitration clause in a contract or in the form of a separate agreement. Section 7 of the Act provides that the agreement must be in writing and must be signed by both parties. The arbitration agreement can be by exchange of letters, document, telex, telegram etc.

(c) Arbitration Clause :  It is quite common to include an arbitration clause in the main contract itself. The clause usually reads as follows

˜All disputes and differences arising under or in connection with this contract will be settled in accordance with provisions of Arbitration and Conciliation Act, 1996, and the award made in pursuance thereof shall be binding upon both parties thereto™.

(d)       Alternate Dispute Resolution (ADR) :        Arbitration is termed as ˜Alternate Dispute Redressal™ mechanism. It is expected to relieve burden on judiciary. In India, we had a system of ˜Panchayat™ where five senior people from village would resolve disputes between the parties. However, as per section 28 of Indian Contract Act, 1872, any agreement restricting the enforcement of right under a contract by usual legal proceedings is void. Thus, the Contract Act envisaged that all contractual disputes will normally be resolved in courts. The only exception is the Arbitration Agreement.

(e)       Advantages of Arbitration : Advantages of arbitration are (i) Quick decisions (b) Minimum legal technicalities and formalities. Hence decisions are fast and costs are lower, (iii) Flexibility regarding procedures, venue, language etc. (iv) Arbitrator is usually expert in the subject matter and hence, can understand the dispute quickly and thoroughly. A judge in the court may not be able to fully appreciate the problem, if it is of intricate technical nature, (v) Cost of court fees and other expenses can be quite high, (vi) Once the matter goes to court, adverse publicity in press cannot be avoided.

(f)        Disadvantage of Arbitration :          The disadvantages are (i) No power to Arbitrator to issue summons, examine witnesses, taking evidence etc. (ii) Chances of bias of arbitrator are high as the arbitrator is appointed by the parties themselves. One of the parties which is in dictating position may force the arbitrator of his choice, (iii) enforcement of Arbitration award can be only through Court.

A Case Study : However, it is surprising to note that almost all the General Insurance Companies have incorporated in their policies an identical arbitration clause, which is couched in such a language that the insurance companies are able to avoid their liability to the detriment of the trusting customers. In this regard it will be advantageous to go through the facts of a case as detailed below :

Facts of the Case

1. Recently, the Karnataka High Court in E-Spring Building Systems (I) Pvt. Ltd., Bangalore vs. Regional Manager, Tata AIG General Insurance Company Ltd., Bangalore 2006(3) Kar. L.J. 317 (decided on 22.3.2006) dismissed a petition under section 11(6) of the Arbitration and Conciliation Act, 1996 (˜the Act™) seeking appointment of an arbitrator to enter into reference and adjudicate the dispute between the parties.

2. The respondent M/s. Tata AIG General Insurance Company Ltd. had issued an All Risk Insurance Policy in favour of the petitioner and a certain claim has been put forth by the petitioner under the terms of the policy. However, the claim itself having been rejected by the respondent, the petitioner had issued legal notice calling upon the respondent for appointment of an arbitrator, but the respondent remained silent, hence the petitioner filed a petition praying for intervention of the Court invoking section 11(6) of the Act.

2.1 The arbitration clause as contained in the policy reads as follows:

Clause 7: If any dispute or difference shall arise as to the quantum to be paid under this policy (liability being otherwise admitted) such difference shall independently of all other questions be referred to the decision of a sole Arbitrator, to be appointed in writing by the parties to or, if they cannot agree upon a single Arbitrator within 30 days of any party invoking arbitration, the same shall be referred to a panel of three Arbitrators comprising of two Arbitrators one to be appointed by each of the parties to the dispute / difference, and the third Arbitrator to be appointed by such two Arbitrators and arbitration shall be conducted  under and in accordance with the provisions of the Arbitration and Conciliation Act, 1996.

It is clearly agreed and understood that no difference or dispute shall be referable to arbitration as hereinbefore provided, if the Company has disputed or not accepted liability under or in respect of this policy.

It is hereby expressly stipulated and declared that it shall be a condition precedent to any right of action or suit upon this policy that the award by such Arbitrator/ Arbitrators of the amount of the loss or damage shall be first obtained.

2.2 It transpires that the respondent had in fact disputed the liability for settling the claim or appointment of an arbitrator  on the premise that under the policy they were not liable to settle third party claims in terms of their reply dated 16.2.2006 which reads thus  ¦¦.. that as per policy conditions the arbitration can be invoked only when there is no dispute  on admission of liability under the subject policy. Any dispute relating to liability under the policy cannot be decided through arbitration ¦¦   (emphasis supplied)

2.3 The court observed that the arbitration clause provides for appointment of an arbitrator in the situation of a dispute relating to the quantum of compensation payable in respect of a claim i.e.  a referable dispute, which is a dispute relating to the quantum and (not) on the liability by the insurer.

2.4 The High Court held that in the present case the insurer is denying the liability itself and therefore the arbitration clause does not spring into action, i.e., it is as if there is no arbitration clause  for a dispute of this nature. If such is the agreement providing for the very appointment of an arbitrator the question of appointing an arbitrator either by the volition or by the intervention of the court does not arise at all.  Situation is not one which fits into the situation contemplated under section 11(6). No occasion to entertain this petition, CMP is dismissed.

2.5 It is interesting to note that almost all the General Insurance Companies have incorporated in their policies an identical arbitration clause as quoted above. Now to unearth the mischief one has to note the ingredients of the arbitration clause as follows :

(a)        If any dispute or difference shall arise as to the quantum to be paid             under this policy; liability being otherwise admitted.

(b)        It is clearly agreed and understood that no dispute shall be referable to       arbitration if the Company has disputed or not accepted liability under or      in respect of this policy.

(c)        It is hereby expressly stipulated and declared that it shall be a condition      precedent to any right of action or suit upon this policy that the award by            such Arbitrator/ Arbitrators of the amount of the loss or damage shall be             first obtained.  (emphasis supplied)

2.6 A careful reading of the components of the arbitration clause reveals that if the insurance company has accepted the liability then only the dispute relating to the quantum of compensation can be referred to arbitration. In other words, in case the insurance company has not accepted the liability then no dispute in respect of the policy can be referred to arbitration, this has also been upheld by the aforesaid judgment of the Karnataka High Court. Further, if one wants to file a civil suit in the court he is bound to first obtain an award of the arbitration tribunal.

2.7 In the result a strange situation arises that in case the insurance company has not accepted the liability one can neither refer the dispute for arbitration nor file a suit in the court. In effect the insured is remediless if the insurance company does not accept its liability under the policy.

Restriction on Legal Proceedings

3. Pursuant to section 28 of the Indian Contract Act, 1872 every agreement in restraint of legal proceedings is void. This section applies to agreements which wholly or partially prohibit the parties from having recourse to a court of law. If, for instance, a contract were to contain a stipulation that no action should be brought upon it, that stipulation would be void, because it would restrict both parties from enforcing their rights under the contract in the ordinary legal tribunals. Therefore it stands concluded that aforesaid component (c) of the arbitration clause is void being in violation of section 28 of the Indian Contract Act, 1872.

Serious terms of a contract must be specifically brought to the notice of the parties

4. The Bombay High Court in Road Transport Corpn Vs. Kirloskar Bros Ltd (AIR 1981 Bom 299) said that it is for the carrier to plead and prove that the print on the receipt was brought to the notice of the consignor and that he had agreed to and accepted the same. The Court held that it is necessary that serious terms of a contract must be specifically brought to the notice of the parties whose rights are sought to be curtailed. In Oriental Fire and General Insurance Co Vs. New Suraj Transport Co (AIR 1985 All 136) the consignment note was not even signed by the booking party or his agent, the Allahabad High Court held that the consignor was not bound by a printed term about the exclusive jurisdiction. The Court said that something more must be done than merely printing the terms on consignment documents.

4.1 In Road Transport Organisation of India vs. Barunai Powerloom Weaver™s Coop Society Ltd (1994 84 Cal LT 174) the Calcutta High Court held that the law requires that before making a person bound by any such term ( a clause in a consignment note as to exclusive jurisdiction ) it must be proved that the same was brought to the knowledge of the consignor in such a way that it should seem to be the result of a mutual assent. In Grandhi Pitchaiah Venkatraju & Co vs. Palukuri Jagannadham & Co (AIR 1975 AP 32) where a consignment way bill contained the words subject to Calcutta jurisdiction,  the Andhra Pradesh High Court ignored it since it was not one to which the plaintiff assented.  Following these principles in East India Transport Agency vs. National Insurance Co (AIR 1991 AP 53 FB) the Andhra Pradesh High Court came to the conclusion that a term as to the place of suit was not binding on the insurer who had paid out the consignee and who was then suing the carrier for the negligent loss of the goods unless it could be proved that the insurer too was made or was otherwise aware of the terms.

Judicial intervention for rescuing parties from unreasonable terms

5. In Central Inland Water Transport Corpn vs. Brojo Nath Ganguly (1986 3 SCC 156, 206)  the Supreme Court has noted that the word unconscionable means something as shows no regard for conscience and which is irreconcilable with what is right or reasonable. The matter before the court was a service contract. A clause in the contract empowered the employer (a Govt. undertaking) to remove an employee by three months™ notice or pay in lieu. The employee, who contested the validity of this clause, was removed by handing him over a three months™ pay packet. The Supreme Court regarded the clause to be constitutionally as well as contractually void. The court added that any term which is so unfair and unreasonable as to shock the conscience of the court would be opposed to public policy therefore also void under section 23 of the Contract Act. The contract was not based upon a real consent. It was rather an imposition upon a needy person. The term was unconstitutional because it was so absolute that any officer could be made a target irrespective of his conduct, good or bad.

5.1 Commenting upon this expanding power of the court to relieve a party from the consequences of his own contract, a learned writer J H Baker says that freedom of contract turns out to be a misleading guide when so many contracts are not free in the economic sense. The notion of contract as private legislation appears less attractive when legislation is always drawn up one-sidedly. Judges are empowered to read in terms which are not there, or read out terms which are there. They are to impose reasonableness. Whatever is not reasonable is not law. If the parties have agreed to something unreasonable, they should be treated as if they have not agreed at all and released.


6. The law plays in this respect the role of a parent. A person who would give away too much of his own liberty must be protected from himself, no matter how rational his decision or compelling the circumstances. Therefore, it is expected that the courts shall take suo motu cognizance of the legal gimmick being played by the General Insurance Companies in drafting their arbitration clause and if the insured has agreed to something unreasonable, he should be treated as if he has not agreed at all, and released.  (END)

Note: the views expressed are my personal and a view point only.



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About Narendra Sharma

Narendra Sharma | Consultant (Legal)

I am a B.Sc., MA, LL.B, from Jiwaji University, Gwalior and CS (Intermediate) from Institute of Company Secretaries of India, New Delhi. Was in service past 20 years initially as Deputy Company Secretary in 1989 and retired as GM (Legal) in 2009. I am holding membership of Indian Council of Arbitration, New Delhi. Bagged the ‘Best Opinion Provider’ award for 2005 from the website and listed as Panel Arbitrator thereon. Possess expert knowledge of law in Arbitration Proceedings. Got published many Articles on Company law and Arbitration in various renowned legal magazines such as Chartered Secretary, Corporate Law Adviser, Arbitration Law Reporter and Chartered Accountant Practice Journal. My elder son is a Judicial Magistrate, presently posted at Shajapur (MP).

Now, I am (aged 60) working from home as a part time Consultant with a Solicitor Firm viz. DRT Legal Solutions, Indore (MP) and drafting Counter Claims under the Law of Torts against Banks/Financial Institutions on behalf of sick companies facing recovery actions under DRT Act, 1993 and/or Securitisation Act, 2002. I am enough experienced and competent to be appointed as an Independent Director or an ARBITRATOR. I am looking for Part-time specific legal assignments, especially if they can be handled via e-mailing and/or traveling outstations, when necessary, for consultations/meetings for attending specific complicated legal problems and finding their solutions, as and when required.

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