Wednesday, July 13, 2011

Arbitrators cannot award interest where the contract prohibits it - Supreme Court's latest decision

Yesterday (12th July, 2011), the Supreme Court came out with a decision clarifying the law on award of interest by arbitrators when the contract prohibits it. In Union Of India vs M/S.Krafters Engineering, a dispute that arose from a construction contract, the sole question before the Supreme Court was: "whether an arbitrator has jurisdiction to grant interest despite the agreement prohibiting the same?"

The contract between the parties stated: "Interest on Amounts - No interest will be payable upon the Earnest Money or the Security Deposit or amounts payable to the Contractor under the Contract but Government Securities deposited in terms of clause 1.14.4 will be repayable with interest accrued thereon". However, the umpire, who was called in to arrive at a decision as the arbitrators could not resolve the dispute within the stipulated time frame, awarded interest pendente lite. The Union of India challenged this award of interest before the Supreme Court. The respondent sought to argue that the arbtirators have power to award interests not-withstanding any stipulation in the contract to the contrary, relying on Board of Trustees for the Port of Calcutta vs. Engineers-De-Space-Age, (1996) 1 SCC 516 and Madnani Construction Corporation Private Limited vs. Union of India and Others, (2010) 1 SCC 549.

The Court started its discussion with a brief summarisation of the principles governing the award of interest where the contract is silent. These principles, as summarised in Secretary, Irrigation Department, Government of Orissa and Others vs. G.C. Roy, (1992) 1 SCC 508 are as follows:

"(i) A person deprived of the use of money to which he is legitimately entitled has a right to be compensated for the deprivation, call it by any name. It may be called interest, compensation or damages. This basic consideration is as valid for the period the dispute is pending before the arbitrator as it is for the period prior to the arbitrator entering upon the reference. This is the principle of Section 34, Civil Procedure Code and there is no reason or principle to hold otherwise in the case of arbitrator.

(ii) An arbitrator is an alternative form (sic forum) for resolution of disputes arising between the parties. If so, he must have the power to decide all the disputes or differences arising between the parties. If the arbitrator has no power to award interest pendente lite, the party claiming it would have to approach the court for that purpose, even though he may have obtained satisfaction in respect of other claims from the arbitrator. This would lead to multiplicity of proceedings.

(iii) An arbitrator is the creature of an agreement. It is open to the parties to confer upon him such powers and prescribe such procedure for him to follow, as they think fit, so long as they are not opposed to law. (The proviso to Section 41 and Section 3 of Arbitration Act illustrate this point). All the same, the agreement must be in conformity with law. The arbitrator must also act and make his award in accordance with the general law of the land and the agreement.

(iv) Over the years, the English and Indian courts have acted on the assumption that where the agreement does not prohibit and a party to the reference makes a claim for interest, the arbitrator must have the power to award interest pendente lite. Thawardas has not been followed in the later decisions of this Court. It has been explained and distinguished on the basis that in that case there was no claim for interest but only a claim for unliquidated damages. It has been said repeatedly that observations in the said judgment were not intended to lay down any such absolute or universal rule as they appear to, on first impression. Until Jena case almost all the courts in the country had upheld the power of the arbitrator to award interest pendente lite. Continuity and certainty is a highly desirable feature of law.

(v) Interest pendente lite is not a matter of substantive law, like interest for the period anterior to reference (pre- reference period). For doing complete justice between the parties, such power has always been inferred."

The Court went on to examine Port of Calcutta case on which the respondents heavily relied. In that case, based on the power of the arbitrators to interpret the arbitration clause, the Court had held that the bar on interest in the contract was a mere bar on the Government and departments against paying interest and it did not preclude the arbitrators from awarding interest. However, this very proposition was examined later in Sayeed Ahmed and Company vs. State of Uttar Pradesh and Others, (2009) 12 SCC 26 in which a similar argument was rejected stating: "Whether the provision in the contract bars the employer from entertaining any claim for interest or bars the contractor from making any claim for interest, it amounts to a clear prohibition regarding interest. The provision need not contain another bar prohibiting the arbitrator from awarding interest." Based on this, the Court held that reliance of the respondent on Port of Calcutta was misplaced as that case was overruled in Sayeed Ahmed.

Based on the above discussion, the Court arrived at the following conclusion: "We reiterate that where the parties had agreed that no interest shall be payable, the arbitrator cannot award interest for the amounts payable to the contractor under the contract. Where the agreement between the parties does not prohibit grant of interest and where a party claims interest and the said dispute is referred to the arbitrator, he shall have the power to award interest pendent elite. As observed by the Constitution Bench in G.C. Roy's case (supra), in such a case, it must be presumed that interest was an implied term of the agreement between the parties. However, this does not mean that in every case, the arbitrator should necessarily award interest pendente lite."

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