The Supreme Court has referred to a larger Bench the contentious question of whether contractual clauses requiring contractors to make a substantial pre-deposit before invoking arbitration are legally valid.
The dispute arose from a contract for execution of storm water drainage systems and contingent works at Sector-35, Udyog Vihar, Phase-VII, Gurugram. The respondent had invited e-tenders on November 7, 2016, and the contract was ultimately awarded for ₹5.14 crore on May 17, 2017.
The arbitration agreement contained Clause 25-A(vii), which stipulated that where a contractor raised a claim exceeding ₹1 lakh, the contractor could not refer the dispute to arbitration unless a security deposit equivalent to 10% of the claim amount was furnished. The clause further provided that the amount would be adjusted against costs, if any, awarded against the claimant and that the balance would be refunded after the arbitration proceedings.
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The project subsequently faced site-related difficulties, resulting in a substantial reduction in its scope. The contract value was revised to approximately ₹2.40 crore in January 2021. After completion of the reduced scope, disputes emerged regarding final payment and settlement.
The Punjab and Haryana High Court appointed a retired Judge as the Sole Arbitrator under Section 11(6) of the Arbitration and Conciliation Act, 1996. At the threshold of the arbitral proceedings, the respondent challenged the maintainability of the claims on the ground that the contractor had failed to furnish the mandatory 10% security deposit.
The Arbitrator directed the contractor to deposit 10% of the claim amount within 15 days. Following the contractor’s refusal to comply, the entire claim was dismissed. The Commercial Court at Gurugram subsequently dismissed the contractor’s challenge under Section 37(2), holding that the Arbitrator’s view was plausible and supported by the Supreme Court’s earlier decision in S.K. Jain v. State of Haryana.
Contractor Challenges Clause Under Article 14
Before the Supreme Court, the contractor argued that the pre-deposit requirement was unconstitutional and violated Article 14 of the Constitution because it imposed the financial burden exclusively on contractors invoking arbitration, while the State was not subject to a corresponding requirement.
It was argued that a mandatory 10% deposit had no rational connection with the objective of preventing frivolous claims. According to the contractor, whether a claim was frivolous could be determined during or at the conclusion of arbitration, with costs serving as an appropriate mechanism under Section 31(8) of the Arbitration Act.
The financial impact of the clause was also highlighted. In respect of a claim of ₹1.77 crore, the contractor would have been required to furnish a security deposit of ₹17.70 lakh. Counsel pointed out that the ad valorem court fee payable on a civil suit involving the same amount in Haryana would be approximately ₹7.16 lakh.
The contractor further relied upon the Supreme Court’s decisions in ICOMM Tele Ltd. v. Punjab State Water Supply and Lombardi Engineering Ltd. v. Uttarakhand Jal Vidyut Nigam Ltd., as well as the Constitution Bench judgment in Central Organisation for Railway Electrification (CORE). The argument was that party autonomy in arbitration cannot extend to contractual provisions that violate fundamental rights or impose unreasonable barriers to accessing arbitration.
State Defends Refundable Deposit Clause
The respondent, on the other hand, maintained that S.K. Jain remained binding and directly covered the issue. It argued that the clause in the present case was materially different from the clauses considered in ICOMM Tele and Lombardi Engineering because the 10% deposit was refundable and was not intended to operate as a punitive forfeiture.
According to the respondent, the purpose of such a condition was to deter frivolous or unmeritorious claims while preserving the claimant’s right to recover the deposit at the conclusion of arbitration. It therefore contended that the Arbitrator and Commercial Court had correctly applied the law laid down in S.K. Jain.
The respondent also placed before the Court a comparative analysis of the arbitration clauses considered in S.K. Jain, ICOMM Tele and Lombardi Engineering. The comparison highlighted differences concerning the percentage of deposit, the manner of refund and the consequences attached to the deposit.
Supreme Court Examines Conflicting Precedents
The Bench of Justice Manmohan and Justice Manoj Misra undertook a detailed examination of the line of authorities dealing with pre-deposit requirements.
In S.K. Jain, a three-Judge Bench had upheld a contractual provision requiring a contractor to deposit 7% of the claimed amount before arbitration. The Court had considered the condition a balancing mechanism intended to prevent frivolous and inflated claims and had found a nexus between the quantum of security and the amount claimed.
The position was subsequently examined in ICOMM Tele. A two-Judge Bench there held that pre-deposit requirements could discourage parties from pursuing arbitration and therefore undermine the objective of alternative dispute resolution and reducing the burden on courts. It also found that a 10% pre-deposit requirement imposed before any determination of whether the claim was frivolous lacked a direct nexus with that objective.
In Lombardi Engineering, a three-Judge Bench held that party autonomy could not be extended to contractual provisions infringing fundamental rights. At the same time, the Court held that there was no conflict between S.K. Jain and ICOMM Tele, as the respective arbitration clauses were materially different.
The Constitution Bench in CORE subsequently treated Section 18 of the Arbitration Act as mandatory and non-derogable, requiring equal treatment of parties at all stages of arbitration. In summarising ICOMM Tele and Lombardi Engineering, the Constitution Bench noted the concern that excessive and disproportionate pre-deposit requirements could deter parties from invoking arbitration and defeat its purpose.
Two-Judge Bench Says It Cannot Overrule Three-Judge Bench
A significant aspect of the judgment was the Bench’s recognition of the limits imposed by judicial discipline.
The Supreme Court observed that although it was prima facie in agreement with the reasoning in ICOMM Tele, that decision was rendered by a two-Judge Bench and therefore could not override the principle laid down by the three-Judge Bench in S.K. Jain. The Court further noted that Lombardi Engineering, itself a three-Judge Bench decision, had expressly held that there was no conflict between the two earlier judgments.
Consequently, the present Bench declined to hold that S.K. Jain had become ineffective or had been decided sub silentio. The Court emphasised that neither Lombardi Engineering nor the Constitution Bench in CORE had declared S.K. Jain to be no longer a good law.
Right to Sue Cannot Be Made Illusory
At the same time, the Bench raised a broader concern regarding access to justice and the effect of onerous contractual conditions.
The Court referred to the settled principle that the right to sue inheres in every individual unless expressly barred by law. It also referred to Section 28 of the Indian Contract Act, 1872, which generally declares void agreements that absolutely restrain a party from enforcing contractual rights through ordinary legal proceedings, subject to the statutory exception concerning arbitration.
Against this background, the Bench made an important observation: an arbitration clause cannot impose a pre-deposit condition so onerous that it makes the right to pursue a claim at the threshold effectively illusory or nugatory.
The Court reasoned that requiring a substantial percentage of the claim amount before arbitration could suppress legitimate claims and deter parties from choosing alternative dispute resolution, thereby defeating the very purpose for which arbitration exists.
Six Questions Referred to Larger Bench
Finding that the issue required authoritative reconsideration, the two-Judge Bench decided to place the matter before a larger Bench.
The Court requested the Chief Justice of India to consider whether the following issues, or other related questions, should be referred for determination:
- Equal treatment under Section 18: Whether requiring only the contractor to make a pre-deposit before arbitration violates Section 18 of the Arbitration Act, which mandates equal treatment of parties.
- Impact on alternative dispute resolution: Whether pre-deposit conditions discourage arbitration and undermine its objective of reducing the burden on courts.
- Article 14 and right to sue: Whether such pre-deposit requirements are arbitrary and violate Article 14, the right to sue and Section 28 of the Contract Act.
- Connection with frivolous claims: Whether requiring a pre-deposit has any rational connection with preventing frivolous claims when, at the stage of reference, it cannot yet be determined whether the claim is frivolous and costs can potentially address such claims at the conclusion of arbitration.
- Refundable deposits: Whether a pre-deposit requirement can be considered valid merely because the deposited amount is refundable after completion of arbitration.
- Validity of S.K. Jain: Whether the judgment in S.K. Jain continues to constitute valid and binding precedent.
Matter Now Before Chief Justice for Appropriate Directions
The Supreme Court did not finally decide the constitutional validity of the 10% pre-deposit clause in the present proceedings. Instead, it directed the Registry to place the civil appeal before the Chief Justice of India for appropriate directions concerning constitution of a larger Bench.
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