Contract Depriving a Party of Interest: Immorality and Public Policy

following guest post is contributed by Amitav
, a fourth-year student at the National University of Advanced Legal
Studies (NUALS), Kochi]
In a recent decision in Union of India v. M/s NK Garg & Co. (“NK Garg”), decided on 2 November, 2015, a single judge of the Delhi
High Court (“Court”) held that any agreement by which a party is deprived of
interest would be void on the ground that it is immoral and violates public
policy. It is a classic example of judicial adventurism since the Court traversed
a new path by disregarding several Supreme Court (“SC”) judgements to drive its
point home.
Before embarking upon the analysis of the
decision it is important to note the facts. The issue before the Court came up
for consideration when the Appellant filed an application under Section 34 of
Indian Arbitration Act, 1996 (“Act”) to set aside the impugned award to the
extent that the Arbitrator has awarded interest in favour of the respondent.
Appellant contended that respondents are not entitled to any interest because
of a contractual clause to that effect. However, the Court, accepting the
contention of the respondents that the clause itself is void being violative of
the third limb of section 23 of Indian Contract Act, 1872 (“Contract Act”)
which deals with public policy and morality, upheld the award. After analysing
couple of decisions of the SC, the Court extended the scope of public policy
and morality by stating that depriving the respondent of interest which he
otherwise would be entitled to but for an agreement is immoral and violative of
public policy.
In support of its contention, the Appellant
relied on five decisions of the SC where it was decided that when there is a
contractual clause which provides that interest will not be payable, then, on
account of such a clause, the respondent is not entitled to payment of interest
on the amount awarded in his favour by a decree. The Court, circumventing these
decisions, declared that the said contractual clause is void and therefore felt
no need to follow them. An arbitrator derives his power to award interest from Section
31(7) of the Act which begins with the phrase “unless otherwise agreed by the
parties” thereby restricting the power of an arbitrator. The SC in Union
of India v Krafters Engineers
relying on a similar clause as the one in dispute in NK Garg and Section 31(7) of the Act, held that the “arbitrator
ceases to have the power to grant interest and the clause is absolute”.  Interestingly, the Court did not mention the
said section even once to support its conclusion, and instead heavily relied on
the Interest Act, 1978. It is beyond one’s understanding as to why in a matter
relating to arbitration the Court instead of relying on the provisions of the
Act relied on some other statute.
The Court also relied on paragraph 43 of Secy.,
Irrigation Deptt., Govt. of Orrisa v. GC Roy
decided by Constitution Bench of the SC wherein it was held that “a
person whose moneys have been wrongly withheld, is rightfully entitled to be reimbursed”.
However, the Court failed to appreciate that in the same judgement the SC also
held that ‘where the agreement between
the parties does not prohibit grant of interest
arbitrator shall have the power to award interest pendent lite”. This
principle was also approved by the SC in Krafters
and in several other decisions.
Therefore, it is a settled position that if there is an agreement curtailing
the power of an arbitrator to grant interest, he cannot grant interest.
At this juncture, it is also important to
examine whether the Court was correct in holding that non-payment of interest because
of a clause in agreement can under no circumstances be justified in today’s
world and will amount to immorality and violation of the public policy. The
Court relied on Gherulal Parakh v. Mahadeodas Maiya &
 (“Gherulal”) decided by
the SC wherein it was held that “no universal standard can be laid down for a
fluid concept of morality, even though, legislature’s intention was to give it
a restrictive meaning i.e. “sexual
immorality””. The Court thought that, according to the SC the scope of morality
can be extended depending upon time and age.
However, the failed to consider yet another
decision of the SC in Associate Builders v. Delhi Development
(“DDA”) wherein a narrow scope of ‘public policy’ and ‘morality’
was adopted. In DDA it was clarified
by the SC that morality has been confined to ‘sexual morality’ by the the SC as
far as Section 23 of Contract Act is concerned, and “if it is to go beyond
sexual morality an agreement would have to be against prevailing mores of the
day”. The SC also cautioned in the same judgment that “interference on this ground would also be only if something shocks the
court’s conscience
. It is not
clear as to how non-payment of interest would shock the court’s conscience. Moreover,
the concept of morality being a branch of common law would largely depend upon
the judicial decisions to bring in new heads under it as held in Gherulal. The Court did not cite a
single judicial decision to support its view to bring non-payment of interest
within the ambit of ‘immorality’.
The Courts in India and England have been
quite reluctant to extend the scope to “public policy” or “morality” to a
contract type to which it has never been applied before. Because of such
restriction it is expected of the Court to not develop its own idiosyncratic
conception of these concepts as happened in the said case. The decision to
strike down a clause in an agreement which restricted the power of an
arbitrator to grant interest in order to circumvent the decisions of the SC, which
the Court was bound to follow, could leave matters open to debate.
– Amitav Singh

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

1 comment

  • To share own thoughts but with a different stroke:

    This is a matter on which a firm final judicial view has remained to be taken, albeit crying loud for long. That, as viewed, could be by applying the general common law concepts/ principles , principally, – EQUITY and NATURAL JUSTICE; in short, on ideally better grounds of LEGITIMACY and GOOD CONSCIENCE , rather than LEGALITY in its absolute or utopian sense that needs to be given a go bye as being outdated,with no more procrastination. It is here that the not-so-often -canvassed principle of interpretation known as ‘UPDATING CONSTRUCTION’ ( to know more, see Law Lexicon) might come to aid, requiring to be invoked and applied.

    Of contextual relevance herein is a recent central legislation in pipeline; that is, for regulating the notorious REALTY SECTOR.

    For ready reference (excerpts):

    “The Union Cabinet on Wednesday approved amendments to the Real Estate Bill, which was first proposed in 2013. The Bill will now be taken up for consideration by the Parliament. The provisions of the Bill are aimed at protecting buyers and bringing in transparency in the sector.”

    As listed in the media Report under, -“Here is a 10-Point Cheat-Sheet”, a provision that aims at ‘protecting buyers’ as avowed, hence stands out, reads-
    “4) The developer will be liable to pay interest at the same rate in case of delay in possession as it is charging from the buyer in case of delayed payment.”

    Anyone interested may care to additionally look up the Blog:

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