An arbitration clause is a small paragraph with a very large consequence: it takes your dispute out of the civil court and puts it before a private tribunal whose award is binding and only narrowly challengeable.
What makes it valid
Section 7 of the Arbitration and Conciliation Act, 1996 requires an arbitration agreement to be in writing. That is satisfied by a clause in a contract, by an exchange of letters or electronic communications recording the agreement, or by an exchange of pleadings in which the existence is alleged and not denied. What the courts look for is a clear intention that disputes will be finally and bindingly decided by a private tribunal. A clause saying the parties "may consider arbitration" or "may approach a mediator" usually fails that test.
The consequence: Section 8
If a party files a civil suit despite the clause, the other side can apply under Section 8 and the judicial authority shall refer the parties to arbitration, unless it finds prima facie that no valid arbitration agreement exists. The application must be made not later than the date of submitting your first statement on the substance of the dispute. Miss that point and you may be taken to have waived the clause.
The seat fixes the legal home of the arbitration and therefore which court has supervisory jurisdiction over it. The venue is merely where hearings are physically held. Clauses that say "arbitration shall be held at Bengaluru" without specifying a seat have generated years of litigation about which court can hear a Section 34 challenge. Say it explicitly: "the seat of arbitration shall be Bengaluru".
What a well-drafted clause fixes
- Seat, and separately the venue if different
- Number of arbitrators, and how they are appointed. A sole arbitrator is cheaper and faster for most commercial disputes
- Whether it is institutional (administered by an institution under its rules) or ad hoc. Institutional arbitration costs more up front and avoids a great deal of procedural fighting later
- Governing law of the contract, and the language of the proceedings
Two things worth knowing
First, the arbitration clause is treated as separable from the main contract, so an allegation that the contract is void does not by itself destroy the clause. Second, a clause naming a person as arbitrator who is disqualified under the Seventh Schedule, such as an employee or officer of one party, will not hold; that ineligibility cannot be contracted around except by an express written waiver after the dispute arises.