Public Policy in Arbitration

Introduction
Arbitration has been widely recognized as an efficient and effective mode of dispute settlement
by the international community. Globalization, multifaceted growth of world economies and
an increase in international commercial activities has led to tremendous growth in
jurisprudence of arbitration law. Arbitration across the globe is based on certain fundamental
principles, which include inter alia party autonomy in choosing arbitrators, process of
arbitration and laws, finality of arbitral awards, and minimum judicial interference. However,
the autonomy of arbitration has often been subjected to intervention and subjugation of national
laws. The public policy of a country is one such ground upon which challenge to the validity
of arbitral award and its enforcement, can be made. Therefore, interpretation and
conceptualization of the term ‘public policy’ is vital to understand the extent and scope of its
applicability as a ground to challenge the arbitral awards.

The idea of “Public Policy” is notorious among judges and scholars as a concept not susceptible
to definition. Theory and practice generally agree that public policy reflects some moral, social,
economic or legal principles. Although heavily criticised as a vague and ambiguous concept,
the role of public policy is nevertheless said to be a fundamental one from the viewpoint of the
respective legal system. The purpose of the public policy exception is to protect the
fundamental principles of the society.

Public policy as a ground for setting aside an arbitral award sometimes overlaps with the
ground of in arbitrability of the subject-matter. Sometimes, violation of public policy refers to
procedural violation of minimum due process requirements.1 Although parties are free to enter
into any agreement as they like, but they cannot make a binding contract in violation of law or
of public policy. Public policy imposes certain restriction on the freedom to enter into contract.

1
Kr Gupta, A. (n.d.). Indian Journal of Arbitration Law A NEW DAWN FOR INDIA-REDUCING COURT
INTERVENTION IN ENFORCEMENT OF FOREIGN AWARDS.
I. Jurisprudence of Public Policy in a globalized world
The term “Public Policy” or the phrase “as opposed to the Public Policy” has not been defined
in the Indian Contract Act, 1872 or the Arbitration and Conciliation Act, 1996 (Hereinafter the
Act). The term “Public Policy” connotes the matter concerning the interest of public at large.

The Doctrine of Public Policy in the context of Contract is encapsulated in the Section 23 of
the Indian Contract Act, 1872. Section 23 of Indian Contract Act, 1872 states that “if the
consideration of the contract or agreement is fraudulent; or defeating the provisions of the Law;
or court regards it as immoral or opposed to public policy, such consideration will be declared
unlawful and will be void”.2 In the case of Gherulal Parakh v. Mahadeodas Maiya3, the
Supreme Court summarised the doctrine of public policy or the policy of the law as an illusive
concept, “untrustworthy guide”, “variable quality”, “unruly horse” etc. and crystallised the
same under different heads.

The Doctrine of Public Policy in the context of arbitration is encapsulated in the Sections 34
and 48 of the Arbitration and Conciliation Act, 1996 which are based on Article 34 of the
United Nations Commission on International Trade Law (UNCITRAL) Model Law, 1958.
Article 34(2)(b)(ii) of UNCITRAL Model Law, 1958 provides that an arbitral award can be set
aside if the court finds that the award is against the Public Policy of the State. 4 Section
34(2)(b)(ii) and Section 48(2)(b) of the Act also provide for the same conditions as that of the
UNCITRAL Model Law, 1958. As the phrase is susceptible to definitions, the Supreme Court
of India has interpreted the term “Public Policy” and the phrase “as opposed to the public
policy” many a times.

The first instance was back in the case of Renusagar Power Co. Ltd. v. General Electric Co.5
in which the apex court interpreted the term public policy as the principles of law of the country.
In this case, pursuant to provision of contract between Renusagar Power Co Ltd (‘Renusagar’)
and General Electronics Company (‘GE’), arbitration was initiated under the auspices of the

2
Section 23 of the Indian Contract Act, 1872: What consideration and objects are lawful, and what not.--The
consideration or object of an agreement is lawful, unless--The consideration or object of an agreement is lawful,
unless--" it is forbidden by law; or is of such a nature that, if permitted, it would defeat the provisions of any law;
or is fraudulent; or involves or implies, injury to the person or property of another; or the Court regards it as
immoral, or opposed to public policy. In each of these cases, the consideration or object of an agreement is said
to be unlawful. Every agreement of which the object or consideration is unlawful is void.
3
AIR 1959 SC 781.
4
Article 34(2)(b)(ii) of the UNCITRAL Model Law, 1958: An arbitral award may be set aside by the court
specified in article 6 only if: the court finds that the award is in conflict with the public policy of this State.
5
AIR 1994 SC 860.
International Chamber of Commerce (ICC) in Paris, against which Renusagar applied to the
Bombay High Court for injunction to prevent GE and the ICC from proceeding with the
arbitration. GE filed an application to obtain stay on judicial proceeding initiated by Renusagar
pursuant to section 3 of the Foreign Awards (Recognition and Enforcement) Act 1961. The
single judge found in favour of GE and, following Renusagar’s appeal, so did the Court of
Appeal. Renusagar appealed the decision of the Court of Appeal to the Supreme Court arguing
that the suit it filed was for a declaration that the dispute fell beyond the scope of the arbitration
agreement. The Supreme Court by referring to the Geneva Convention of 1927 and New York
Convention 1958 observed that the term public policy should be construed narrowly in the
sense that the principle of public policy must be applied in the field of private international
law. By applying the various observations, the Supreme Court held that a foreign award will
be set aside on the ground of public policy if the award is contrary to fundamental policy of
Indian law or the interests of India or justice or morality.

In 2002, the Indian Supreme Court decided, in Bhatia International v Bulk Trading SA6 that
Indian courts had exclusive jurisdiction to test the validity of an arbitral award made in India
even when the proper law of the contract was the law of another country. The court interpreted
section 2 of the Indian Arbitration and Conciliation Act, 1996 to mean that Part I of the Act
applied even to arbitrations seated outside India, thereby giving the Indian courts broad scope
to intervene in foreign arbitrations. This was widely regarded as a low point for arbitration in
India.

In Oil and Natural gas Corporation (ONGC) Ltd v. Saw Pipes7, an arbitral award, rendered
with regard to a dispute relating to supply of equipment for offshore oil exploration by the
Respondent, was challenged. The delivery was delayed due to a general strike of mill workers
in Europe, which could not be complied with even after extension of time. The Arbitral
Tribunal while deciding the matter rejected the contention of Saw Pipes relating to force
majeure but at the same time held that Oil & Natural Gas Corporation Limited (ONGC) could
not establish real damage. ONGC challenged the arbitral award as it was contrary to public
policy. Supreme Court accepted this contention and set aside the award, holding that in addition
to the grounds laid down in Renusagar, an award would be contrary to public policy if it were
‘patently illegal’. The Court further defined patently illegal as being ‘contrary to law’. Public
policy was interpreted in light of principles underlying the 1996 Act, the Indian Contract Act,

6
(2002) 4 SCC 105.
7
AIR 2003 SC 2629.
1872, and the Constitutional Provisions. The apex court found that public policy concerns
public good and public interest matters and not the policies of a particular government. The
Court also concluded that a wider meaning of the term public policy was necessary so that a
patently illegal arbitral award could be set aside.

The judgement given by the Supreme Court in the case of Saw Pipes was widely criticised on
various grounds such as:8

1. The inclusion of term “patent illegality” has led to diluted the spirit of the 1996 Act. It
is the same as retaining the grounds for challenge that were already available in section
30 of the 1940 Act.
2. Act of 1996 already provided two conditions for setting aside the award, contrary to the
express provisions of the contract and substantive law, under sections 34(2)(a)(iv) and
34(2)(a)(v), respectively, if it dealt with a dispute not contemplated by or not falling
within the terms of the submission to arbitration and if the composition of the arbitral
tribunal or the arbitral procedure was not in accordance with the agreement of the
parties. Therefore, to include illegalities under a new head of public policy was
unnecessary.
3. The judiciary failed to adhere to the principles of the separation of power and did not
pay head to the parliamentary intention behind the 1996 Act. When enacting the 1996
Act, Parliament followed Model Law in an attempt to reduce the supervisory role of
the court in the arbitral process and to give more powers to the arbitrators. These aims
are clearly defeated by introducing a new ground under public policy, which increases
the scope of judicial intervention.
4. The Saw Pipes judgment has clearly impinged upon arbitration as an effective method
of dispute resolution and has undermined certain benefits of Arbitration, namely those
of speed and efficiency and the finality of award.

Despite being criticised widely, the Supreme Court followed the judgement of Saw Pipes in
several judgements where the Court rejected the contention of non-interference of the courts
and held that the arbitral award can be challenged on the ground of public policy.9 The Court
further tried to explain the term ‘patently illegal’ as something being against the terms of the
contract or affecting the rights of the parties. Illegality must go to the root of the matter and if

8
9
Oil and Natural Gas corporation Ltd. v. Western Geco International Ltd.
it is of a trivial nature then the award cannot be held to be against public policy. Award can
also be set aside if it is so unfair and unreasonable that it shocks the conscience of the Court.10

In 2012, in Bharat Aluminium v Kaiser Aluminium Technical Services11, a five-judge

constitutional bench of the Supreme Court overruled these controversial decisions. The court
in Bharat held that Part I of the Act only applies to arbitrations seated within India and
therefore, Indian courts cannot order interim relief in support of foreign seated arbitrations5.
The court further ruled that awards rendered in foreign seated arbitrations are only subject to
the jurisdiction of Indian courts when they are to be enforced in India under Part II of the Act.
This set the tone for reduced intervention by the Indian courts in arbitrations seated outside
India. The decision reflects the principles of certainty, commerciality and party autonomy.

On the other hand, the laws relating to the arbitration in countries like France, USA, UK etc.
provide for limited scope of the judicial intervention and also limits the grounds of challenging
the arbitral award. For instance the English Court in the case of Dalmia Dairy Industries Ltd.
v. National Bank of Pakistan12 refused to extend the doctrine of public policy to embrace the
principle that the English courts should refuse to enforce an award arising out of a contract
between persons who are nationals of foreign States which were at war with each other but
each of which was in friendly relationship with England. In support of the applicability of the
doctrine, it was argued that it would be harmful to international relations of the United
Kingdom with friendly countries if it were to allow the machinery of its courts to be used to
enforce a judgment, or an arbitral award in favour of a national of one foreign State friendly to
the United Kingdom, against the national of another foreign State, also friendly to the United
Kingdom, when the two foreign States are enemies of one another.

In France, a distinction is made between international public policy ("order public

international") and the national public policy. Under the new French Code of Civil Procedure,
an international arbitral award can be set aside if the recognition or execution is contrary to
international public policy. In doing so it recognises the existence of two levels of public policy
the national level, which may be concerned with purely domestic considerations, and the
international level, which is less restrictive in its approach.13

10
McDermott international Inc. v. Burn standards Co. Ltd.
11
Civil Appeal No. 7019 of 2005.
12
[1978] 2 Lloyd’s Rep. 223
13
The view was given by the Supreme Court in the judgement of Renusagar Power Co. Ltd. v. General Electric
Co. AIR 1994 SC 860.
The approach of the American courts to the doctrine of public policy in its application to
recognition and enforcement of foreign arbitral awards under the New York Convention is
reflected in the decision of the US Court of Appeals in Parsons & Whittemore Overseas Co.
Inc. v. Societe Generale De L'Industrie Du Papier (Rakta) and Bank of America 14 wherein it
has been observed: "The general pro-enforcement bias informing the Convention and
explaining its supersession of the Geneva Convention points toward a narrow reading of the
public policy defense”. Further the court stated that: “We cannot have trade and commerce in
world markets and international waters exclusively on our terms, governed by our laws, and
resolved in our Courts.”

14
508 F 2d 969 (1974).
II. Opinion
Arbitration in India has definitely travelled a long way since 1940s but the recent judicial
interpretations of public policy have pushed Indian law backwards. Initially, the basic grounds
for setting aside arbitral award was an act of mischief which was also furthered in the 1996 Act
to include other grounds like bias, procedural irregularities, illegal composition, excluded
subject matter, etc. The Saw Pipes judgment reinforced the existence of concurrent grounds in
1996 Act and the ambit of public policy today is so wide that other grounds of challenge come
within it. Liberal interpretation of the grounds of challenge of an award by the judiciary is
harmful for the parties and tends to make India an arbitration-unfriendly state. There is no doubt
that the Saw Pipes judgment needs to be reconsidered.
The term public policy has varied interpretation across the globe. Generally, while construing
it, courts have kept the national morals and values in mind. Internationally, it is very common
to construct the term narrowly and limited options are left to widen the scope of the term. The
Supreme Court of India, by widening the scope of the term public policy has made judicial
intervention much easier. It is for the judiciary to show substantial faith in arbitration process
as parallel of dispute settlement, especially in commercial matters. Enlarging the scope has the
capacity to terminate the advantage inscribed in the very purpose of resorting to arbitration.
Certain recommendation could be as follows:
1. Specialized benches for dealing with arbitration matters could be a very viable solution
to scrutinize the ambit of public policy defence. Such benches could be formed with a
panel of judges, which would look into petition related to Arbitration. This would help
in the speedy disposal of cases and development of clear jurisprudence related to the
interpretation of public policy.
2. Another recommendation is the need for a supervisory and regulatory body to regulate
the practice of arbitration. Also, the need for trained and professional arbitrators and
mediators, including non-lawyers, cannot be overemphasized.
III. Relation Between Public Goods in Economics and Public Policy in
Arbitration
Pure public goods have two defining features. One is ‘non‐rivalry,’ meaning that one person’s
enjoyment of a good does not diminish the ability of other people to enjoy the same good. The
other is ‘non‐excludability,’ meaning that people cannot be prevented from enjoying the good.
Air quality is an important environmental example of a public good. Under most circumstances,
one person’s breathing of fresh air does not reduce air quality for others to enjoy, and people
cannot be prevented from breathing the air. Public goods are defined in contrast to private
goods, which are, by definition, both rival and excludable. A sandwich is a private good
because one person’s consumption clearly diminishes its value for someone else, and
sandwiches are typically excludable to all individuals not willing to pay.

From an economics perspective, public goods are of public interest because--unlike private
goods--they are a source of market failure. The problem is ‘free riding’: individuals have little
incentive to voluntarily provide public goods when they can simply enjoy the benefits of non‐
rival and non‐excludable pubic goods provided by others. To see free riding at work, consider
the challenge of constructing a bridge where the societal benefits of doing so would exceed the
costs. How successful do you think a campaign would be to finance the bridge with voluntary
donations? It is not hard to imagine how such a campaign would fail, because many (if not
most) individuals would choose to make no donation, hoping others would contribute enough
to finance the bridge for everyone to enjoy. In this scenario, the market failure would be that
no bridge is constructed despite the fact that a bridge would make everyone better off.

Public goods include national defence, law enforcement, air, primary education, primary health
services etc. The defence of a country from foreign aggressors is a classic example of public
good. Once the country is defended, it is impossible to prevent any single person from enjoying
the benefit of this defence. Moreover, when one person enjoys the benefit of national defence,
he does not reduce the benefit to anyone else. Thus, national defence is neither excludable nor
rival in consumption. The same applies to law enforcement also as it is a duty the of the State
to maintain law and order in the area to which the State cannot exclude anybody from the
protection of law. Also, the law enforcement does not reduce the benefit of one person when
others are enjoying the same.
Through these examples one can observe that these examples contain an element of interest of
public at large. As held by the Supreme Court in the cases of Renusagar15 and Saw Pipes16, the
term public policy was categorised in fundamental policy of India, interest of public, justice
and morality. The interest of public acts as a bridge between public goods and public policy.
For example, a dispute arose between Steel Manufacturing Company and Hindustan
Aeronautics Limited regarding the manufacture of HAL Tejas fighter and the matter is taken
to the arbitration where the arbitral award hampers the production of the said fighter which is
an important part of the Indian Air Force. Therefore, the same arbitral award can be set aside
on the grounds of being contrary to the public policy of India as the same award in affecting
the interest of public at large. Another example with reference to defence and law enforcement
can be that of regarding the supply of ammunition and basic equipment to the Police force and
Army posted in the State of Jammu and Kashmir. As we all know Jammu and Kashmir faces
serious issues regarding enforcement of law and order, therefore the enforcement agencies like
Police and Army require ammunition and equipment in heavy amount. Now a dispute arose
between the supplier and the manufacturing unit of the ammunition and the same is resolved
by an arbitrator by deciding an arbitral award which affects the supply of the ammunition and
equipment to the Police and Army which also leads to the worsening of the situation in the
State of Jammu and Kashmir. The said award can be set aside by the Supreme Court by
applying principles laid under the case of Renusagar and Saw Pipes, and under relevant
provisions of the Arbitration and Conciliation Act, 1996.

Third example (apart from National Defence) can be that of primary health services that are
provided by the Government hospitals. If a dispute arises between the Administration of Govt.
Hospital and Supplier of Oxygen Cylinders regarding the supply of oxygen cylinders to the
hospital and the arbitral award is such that the company stops the supply of the cylinders with
the immediate effect then the said award can be set aside under Section 34 of the Arbitration
and Conciliation Act, 1996 as the same award can lead to chaos if some emergency situation
arises in the hospital while searching for a new supplier of the oxygen cylinders.

15
Supra note 4.
16
Supra note 5.
Conclusion
The government and various authors have regarded the term Public Policy as an unruly horse
which is which is open to interpretations. The Supreme Court in a catena of judgements has
ruled that arbitral awards can be set aside on the grounds of public policy on the count of
violation of an existing law, patent illegality, violation of the fundamental policy of Indian law,
an anything so unreasonable which shocks the consciousness of the court. There is a lot of
jurisprudence surrounding public policy, but the researcher concludes that public policy is a
term which has been really misused and therefore public policy is one of the basic structure
which reflects the fundamental principles and morality of a society.

Dictating public policy is one of the most important things which can be made out in account
of the continuation of the major policies of the government but due to public policy the
government is able to dictate the terms of the distribution of resources. Therefore, in conclusion
the public policy bar is quite high, and it has been one of the terms which has been repeatedly
interpreted and defined by the judiciary since time immemorial therefore the researcher
concludes that there needs to be a drafting of some constant guidelines which completely define
the term “public policy”. There needs be limited judicial interference with regard to the setting
aside of arbitral awards on the ground of public policy.