July 25, 2021

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Arbitration to solve partnership disputes

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This article is written by Yukta Joshi pursuing Certificate Course in Arbitration: Strategy, Procedure and Drafting from LawSikho.

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Arbitration is the most emerging trend in dispute resolution. It has proved efficacious in solving many commercial disputes and partnership disputes are no exception. When the partnership agreements are signed and executed, there is every possibility that disputes or differences will arise, that is the reason why there is mostly a dispute resolution clause in the partnership agreements. The parties to the agreement can prefer arbitration, mediation, negotiation, or the traditional litigation method to solve their disputes. Litigation might end the dispute but not solve and settle it. Settlement can be only done by choosing ADR mechanisms. 

Generally, the partnership agreements contain an arbitration clause because arbitration is considered to be the best method to solve partnership disputes. In this article, the author intends to highlight the importance and benefits of choosing arbitration to solve partnership disputes with the help of some examples and case laws. The article further highlights the reasons giving rise to partnership disputes and discusses some common partnership disputes. In the end, the author suggests some ways to avoid such disputes altogether.

A partnership is defined as the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all. According to Section 4 of the Partnership Act, 1932, “Persons who have entered into a partnership with one another are called individually “partners” and collectively “a firm”, and the name under which their business is carried on is called the “firm name”

Forming partnerships are often great ways to advance your business. Two or more is always better than one in business. But more partners mean more differences of opinions, more liabilities along with rights, and more responsibility. If a partner fails to comply with his fiduciary duties under the contract or misuses funds, gains secret profit, or in any way breaches the contract, it can affect the entire business in terms of its reputation, growth, and profits and may give rise to disputes between the partners of the firm.

Some of the most common disputes that arise in business partnerships are:

Fraud means the intentional misrepresentation or concealment of an important fact upon which the victim is meant to rely, and in fact, does rely upon the harm of the victim. If a partner intentionally misrepresents a particular thing knowing it to be false, or deceives the other partners, or intentionally conceals an important fact, he is said to commit fraud. 

  • Breach of contract

Non-compliance with any of the terms and conditions agreed under the partnership agreement by any of the partners, leads to breach of contract. Partners rely on each other keeping their commitment to advance the business and keep their business’s needs first. If one partner breaches his fiduciary duty under the agreement, a dispute will arise.

  • Revealing confidential business information

Many businesses rely on confidential information that helps them gain an edge over their competitors. This can include proprietary information on technology, formulas, processes, etc. If one person reveals this information or uses it in an unauthorized way or without permission, a dispute will arise.

  • Misappropriation of funds

Misappropriation or embezzlement occurs when a person uses funds for a different purpose than they were intended to be used. For example, embezzlers might create bills and receipts for activities that did not occur and then use the money paid for personal expenses.

  • Financial management disputes

If the partnership agreement is ambiguous about the division of assets and profits and handling liabilities, then serious financial management disputes may occur.

Once the dispute has arisen between the partners regarding some issue pertaining to their agreement, they should talk about it and negotiate before adopting the official procedures of dispute resolution agreed under their partnership agreement.  You being in such a situation should focus on preserving your relationship but at the same time not compromising your interests. You should focus on the solution rather than the problem. You should talk about the outcome you want and which could be best for the business, and see how you will persuade your partner to adopt it. You may have this mutual discussion about the issues over a coffee meet or a meal. This might create a positive environment and will be beneficial in creating more opportunities to resolve the dispute. However, if the dispute worsens then consider adopting the dispute resolution mechanism as per your agreement. 

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Partnership disputes are commercial in nature and require fast adjudication. The delay in addressing the issues between the partners in business and the continuous deadlock status may severely harm the business. Therefore, often the partners look for quick resolution of their disputes and in this Arbitration comes to their rescue.

In Booz-Allen & Hamilton Inc v. SBI Home Finance Ltd &Ors (2011), the Supreme Court held that all civil and commercial disputes based on a contract or otherwise falling within the jurisdiction of civil courts can be resolved through arbitration. The court mainly ruled that all disputes relating to the rights in personam i.e. right attached to a specific individual would generally be arbitrable, while those relating to the rights in rem would not, as they affected the world at large and involved public interest. Therefore, it could not be decided by an arbitrator privately.

A similar position is reiterated by the apex court in the landmark judgment of Vidya Drolia v. Durga Trading Corporation. The court held that disputes are not arbitrable when the cause of action;

  1. Relates to actions in rem, that does not relate to subordinate rights in personam arising from rights in rem;
  2. Affects third party rights, have erga omnes effect, require centralized adjudication, and mutual adjudication would not be appropriate;
  3. Relates to an inalienable sovereign and public interest functions of the State; and
  4. Is expressly or by necessary implication non-arbitrable under a specific statute.

From the above judgments, it is amply clear that partnership arises the rights in rem and hence can be arbitrable if parties mention so in their agreement, 

Arbitration is often advocated as a faster and less expensive alternative to litigation with the additional benefit of resulting in a final and binding award that is not subject to appeal and the grounds for challenging an arbitration award in the court after the arbitration concludes are narrow and rarely successful. This finality element may help the partners choose arbitration as the forum for resolving partnership disputes to end the dispute without having it linger on. 

One of the best advantages in choosing arbitration is party autonomy. The parties can custom-design the kind of arbitration they want. They can set their procedures of conducting the proceedings, they can choose a venue to conduct them unlike litigation, and can even choose which court will have jurisdiction to hear their challenge to the arbitral award.  For example, you can decide if you want fast-track arbitration where no oral hearing is required and which can be completed within six months, or whether you want oral hearings and examination of witnesses. You can also decide in your arbitration agreement or arbitration clause, which matters will be submitted to arbitration and which will go to the court. 

A sample arbitration clause is shown here:

“All disputes arising between the partners as to the interpretation, operation, or effect of any clause in this partnership deed or any other difference arising between the partners, which cannot be mutually resolved, shall be referred to the arbitration of a sole arbitrator within 15 days of notice of commencement of the arbitration. The arbitration shall be conducted on a fast-track basis in the English language. The laws of India shall apply to this deed. The seat and venue shall be in New Delhi. The decision of such an arbitrator shall be binding on the partners.”

Moreover, arbitration offers confidentiality to the parties. The proceedings are held in private and the documents which might contain confidential information about the parties and the businesses, are kept confidential unlike litigation, where the documents, petitions, etc. are available to the public. Arbitration gives protection to the reputational concerns of partners and their businesses. A dispute might affect their goodwill if brought in front of the public and might affect their future business deals. So, if a business partner wants to protect his business and avoid having future partnership disputes subject to public scrutiny, he should probably choose arbitration or mediation.

Arbitration is one of the most effective and convenient methods of dispute resolution. It plays a vital role in resolving partnership disputes. From the very nature of the partnership disputes, arbitration is the most suitable option to resolve such disputes as it offers confidentiality, speediness, cost-effectiveness, flexibility, and finality. However, it can be just as costly and time-consuming as litigation if parties did not impose any limits on the scope and amount of the discovery that parties are permitted to obtain before the arbitral tribunal and also on the length of the arbitration hearing.  For example, the arbitration terms may put a limit on the examination of the number of fact and expert witnesses from each side, the number of written discovery requests, the number of days for oral hearings, etc.

These restrictions and limitations help to reduce the costs in arbitration as the number of days and witnesses is reduced. These also compel the parties and their counsels to be more efficient and to the point. 

In arbitration, it is the arbitrator who plays a major role. He has wide powers to give an award that stands on the same footing as a final adjudication and is equivalent to a judgment. He acts as a judge and decides the issues and claims between the parties. He can even order the dissolution of a partnership and can order a party to make the discovery of documents and answer interrogations.

When there is a partnership between two or more individuals, differences or disputes may arise between them. But the good news is they can be avoided. Here are some ways and suggestions to avoid such disputes: 

  1. Have a written agreement, make it detailed for clarity, and specify the below-mentioned details in the partnership agreement to avoid any disputes in the future among the parties to the agreement (in this case partners of the firm):
    • Who has control and how much;
    • Each partner’s role;
    • Each partner’s duties and obligations;
    • Capital contributions and of what kind;
    • How additional capital contributions will be handled, if necessary;
    • Compensation and distributions;
    • What procedures the business will adopt and follow for making decisions;
    • Worst-case scenarios, such as what happens when there is a conflict, the removal of co-founders or partners, whether and when a partner can withdraw, and how ownership percentages change if an existing partner or a new partner invests additional money in the business; and
    • When and under what circumstances the relationship between the partners, or the business, can end or be terminated. 
  2. Include a dispute resolution clause in your partnership agreement. For example, many partnership agreements contain an arbitration clause or an arbitration agreement. 
  3. Take the assistance of a lawyer to draft your partnership agreement. Do not just rely on an online template and make necessary modifications. This will expose you to the risk of having unwanted procedures mentioned in the templates. Each business, its approach, goals, and objectives are different, and therefore, you might want to take the help of a lawyer to draft a personalized partnership agreement for you tailored to your business, goals and needs, and personality traits to help you avoid any headaches in future. 

Conclusion 

Arbitration’s confidentiality, speediness, finality, and flexibility make it increasingly the norm in the partnership context and those qualities are likely to continue to influence how partners and partnerships address their disputes. One of the best things about arbitration is that there is no appeal to the final award. It can only be challenged and that too under very rare circumstances and on very limited grounds specified under Section 34 of the Arbitration and Conciliation Act, 1996. So, if a party fails to prevail at the hearing on the merits of the claims presented, it cannot appeal and secure a review or do-over on the merits of the case. Instead, the winning party can convert the arbitration award into a final, enforceable decree of the court after 3 months of passing the award (Section 36 of Arbitration Act, 1996).

  • Ambalal Sarabhai Enterprises and others vs K.S. Infraspace LLP, Appeal (Civil), 7843 of 2018.
  • Sheo Narain v Beni Maho (1901) 20 All 285; Lal Das v Bai Lala (1909) 11 Bom LR 20.
  • Kursell v Timber Operations, Ltd. (1932) 2 KB 302.
  • Erach Mehta v. Minoo Mehta AIR 971 SC 1653.
  • Pannalal Paul v. Padmabati AIR 1960 Cal 693.
  • Re Babaldas Khemchand (1921) 45 Bom 1.
  • Abdul Ghani v Sirajuddin AIR 1399 Lah 154.

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