Supreme Court on Liberal vs. Literal Interpretation of Contracts

[Paridhi Rastogi is 4th year B.Com. LLB (Hons.) student and Yagya Sharma a 4th year BA LLB (Hons.) student, both at the Institute of Law, Nirma University, Ahmedabad] 

On 11 May 2020, a three-judge bench of the Supreme Court gave its verdict in South East Asia Marine Engineering and Constructions Ltd. (SEAMEC Limited) v. Oil India Limited while dealing with certain aspects of arbitration and contract law. The highlight of the judgment was that “usually the Court is not required to examine the merits of the interpretation provided in the award by the arbitrator, if it comes to a conclusion that such an interpretation was reasonably possible.” This position is also found in Dyna Technologies Pvt. Ltd. v. Crompton Greaves Ltd. (2019). However, there are some other aspects of the judgment that we analyse in this post.

The appeal before the Supreme Court arose from the judgment of the Gauhati High Court in an arbitration appeal. The brief facts are that pursuant to a tender floated by Oil India in 1994,  SEAMEC was awarded the work order dated 20 July 1995. The purpose of the contract was well drilling and other auxiliary operations in Assam. The contract came into operation from 5 June 1996 and expired on 4 April 2000. During the subsistence of the contract, the prices of high-speed diesel (HSD), one of the essential materials for carrying out the operations, increased. SEAMEC then raised a claim that such a situation imposes an obligation on Oil India to reimburse. The claim was made relying on clause 23 of the contract, as an increase in price has triggered the “change in law.” The clause has been reproduced below:


Subsequent to the date of price of Bid Opening  if   there   is   a   change   in   or enactment of any law or interpretation of existing law, which results in additional cost/reduction in cost to Contractor on account   of   the   operation   under   the Contract,   the   Company/Contractor shall   reimburse/pay Contractor/Company   for   such additional/reduced   cost   actually incurred.”

On rejection of the claim by Oil India, the arbitration clause was invoked, and the dispute was referred to an arbitration tribunal. The majority opinion of the tribunal favoring SEAMEC held that an increase in HSD price through a circular issued under the authority of State or Union is not a “law” in the literal sense, but has the “force of law” and thus falls within the ambit of clause 23. The matter then went in appeal before the District Court under section 34 of the Arbitration and Conciliation Act, 1996, which upheld the arbitral award.

The High Court, however, allowed the appeal and set aside the award on the ground that the interpretation given by the tribunal to the terms and conditions of the contract is erroneous and against the public policy of India. The High Court, in its observation, went on to state that clause 23 is akin to a “force majeure clause,” and that it was inserted in furtherance of the doctrine of frustration. It is to be noted that section 56 of the Indian Contract Act, 1872 deals with the consequences of frustration under the Indian law, and it states that on the occurrence of an event that renders the performance impossible, the contract becomes void and the parties are exempted from further performance. Further, the Supreme Court in the landmark case of Satyabrata Ghose v. Mugneeram Bangur & Co. stated that section 56 is a rule of positive law; thus, the matter cannot be determined by the intention of the parties.

This post seeks to amplify the two different reasonings provided by the tribunal and the High Court. First, it will ascertain the application of section 56 and draw a parallel between section 65 and clause 23. Secondly, it will deal with the interpretation tools that the tribunal has adopted while concluding that circular issued by the authority of state or union can be included under the term “law” without even being statutory legislation, and highlight the views of the Supreme Court.

Application of Force Majeure

Force majeure, in Indian law, means the occurrence of an event, circumstance or situation, which is extraordinary in nature, and beyond the human control. Therefore, ‘force majeure’ is an event which cannot be anticipated or controlled. Such an event impedes the performance of the contract. Generally, a force majeure clause is found in various commercial contracts, as an express provision, wherein both the parties mutually recognize these events such as acts of war, riots, fire, flood, hurricane, earthquake, explosion, strikes, lockouts, slowdowns, prolonged shortage of supplies, governmental action prohibiting or impeding any party from performing its respective obligations under the contract causing its frustration. In some cases, it also specify the time period for which the performance of obligations under the contract is suspended as well as the consequences of frustration of the contract.

It must be noted that, where there is a stipulation in the contract, implied or express, with regard to a force majeure clause, the frustration of the contract takes place under section 32 of the Indian Contract Act, 1872 [Energy Watchdog v. Central Energy Regulatory Commission (2017) 14 SCC 80]. However, in cases, where no such clause has been expressed in the contract, the claim for force majeure is invoked under section 56 of the Indian Contract Act, 1872, and the frustration of contract takes place under the said provision [Energy Watchdog]. Under this section, when the performance of the act, for which the contract was made, becomes impossible due to an event beyond the control of the parties, the contract becomes void, and the parties are excused from the performance. Therefore, section 56 is two-fold in nature: (a) the force majeure clause, which describes a superior force event, and renders the act as impossible; and (b) doctrine of frustration, that relieves the parties from the performance of the contract, on account of the said impossibility. The Court in Satyabrata Ghose explained the implication of the term ‘impossible’ by stating: “This much is clear that the word ‘impossible’ has not been used here in the sense of physical or literal impossibility. The performance of an act may not be literally impossible but it may be impracticable and useless from the point of view of the object and purpose which the parties had in view; and if an untoward event or change of circumstances totally upsets the very foundation upon which the parties rested their bargain, it can very well be said that the promisor found it impossible to do the act which he promised to do.”

The expressions ‘impossible’ and ‘frustration’ are often used interchangeably. The doctrine of frustration is inherent in section 56 of the Act. This doctrine is based on the idea of impossibility of performance of contract, wherein the parties are absolved from the performance of the said impossibility. Therefore, frustration is an aspect of the law of discharge of contract, and implies the discharge of parties from the performance of the contract, in light of the supervening impossibility.

What follows this impossibility and frustration are various harsh consequences upon the parties of the contract. In an attempt to ameliorate these consequences to some extent, section 65 provides for compensation to the parties. It states that, where a contract becomes void, either party who has received any advantage under such agreement or contract is bound to restore it, or to make compensation for it, to the other party from whom he received it. This prevents the parties from receiving any undue advantage over the other, given to the supervening impossibility.

In the present case, there is no application of section 56 for two reasons: (a) there is no frustration of the contract, i.e., it has not become void; and (b) the parties are not absolved of their performance of their obligations under the contract. Consequently, no compensation can be awarded to the parties under section 65 of the Act as, for the application of this provision, it is sine qua non for the contract to have become void. The same observation was made by the Supreme Court in the present case.

It is pertinent to delve into the nature of clause 23 of the contract. The clause states certain conditions, as a consequence of which there is incurrence of additional cost or there is reduction in cost to contractor on account of the operation under the contract, the company or contractor shall reimburse or pay to the other party for such additional or reduced cost actually incurred, as the case may be. On a perusal of this clause, it is clear that the said clause is intended to restore the position of the parties, in case either party has gained a benefit of an increase or reduction in the cost. It aims at ensuring that the contract still ought to be performed, without regard to the increase or reduction of cost, and any benefit received by either party as a consequence must be restored. It does not indicate towards absolving the parties from their obligations. Herein lies the difference between section 65 of the Act and clause 23, where section 65 provides for compensation only upon finding that the contract is void and the parties have been discharged. It is for this reason that clause 23 cannot be said to be in furtherance of the doctrine of frustration. Therefore, the High Court’s observation that clause 23 is akin to ‘force majeure’ and is pari-materia to the “doctrine of frustration and supervening impossibility” is flawed. This is because, in case of force majeure, the contract becomes void, the parties are absolved of its performance, and doctrine of frustration is inherent in this law.

Interpretation of Contracts

The tribunal, while granting its award, took the route of liberal interpretation in interpreting clause 23. The tribunal emphasized upon a consistent interpretation, making the contract workable and highlighted the need for reading a contract as a whole. The Court goes on to term clause 23 as “habendum clause”, wherein the rights granted to SEAMEC are to be construed broadly. The tribunal, while interpreting the expression “law”, digs deep to understand the intention behind inserting this clause. It noted that “at the time when the Cl. 23 was incorporated in the agreement the Oil India Ltd. was very much aware that change in oil price was never made by any Statutory Legislation but only by virtue of Government Order, Resolution, Instruction, as the case may be.” Therefore, the tribunal felt a need to give an extended meaning to the term “law” and asserted that it will include any statutory law as well as any order, instruction, resolution issued by the central government.

The interpretation of contracts has been extensively discussed in the past in both, foreign jurisdictions as well as in India. The test of five conditions, which were to be relied upon to read an implied condition into the contract was laid down in B.P. Refinery (Westernport) Proprietary Limited v. The President Councillors and Ratepayers of the Shire of Hastings. The relevant portion from the judgment regarding the requisite conditions to be satisfied is:

Such a term would be both reasonable and equitable. It is capable of clear expression. It does not contradict any express term of a contract, but adds to it; and it gives business efficacy to the contract. In the light of the provisions in the refinery agreement it was something so obvious that it went without saying, and if an officious bystander had asked whether that was the common intention of the parties the answer would have been “Of course”.

These principles find reference in Investors Compensation Scheme Ltd. v. West Bromwich Building Society decided in 1997 by the House of Lords. In India, the Supreme Court in Nabha Power Ltd. (NPL) v. Punjab State Power Corporation categorically issued a word of caution for the commercial courts to not resort to implied terms in a contract. A literal approach has to be adopted while interpreting a contract unless the above-mentioned five tests come into play.

In the present case, the Supreme Court subscribed to the views of tribunal to the extent that the contract needs to be interpreted taking into consideration all the terms of the contract. However, the Court observed that tribunal failed to consider the same condition while interpreting clause 23 of the contract. The Court expressed that the “thumb rule of interpretation is that the document forming a written contract should be read as a whole and so far as possible as mutually explanatory” and this basic rule was overlooked by the tribunal in its decision while interpreting clause 23.

The Court highlighted the conditions such as the contract price was payable to the ‘contractor’ for full and proper performance of its contractual obligations and clause 14.7 and 14.11 of the contract stated that “the rates, terms and conditions were to be in force until the completion or abandonment of the last well being drilled. clause of the contract.” Thus, it was inferred from these conditions that the contract was based on a fixed rate and SEAMEC should have expected such increase in the price of HSD before entering the tender process. The conclusion drawn by the Supreme Court was:

If the purpose of the tender was to limit the risks of price variations, then the interpretation placed by the Arbitral Tribunal cannot be said to be possible one, as it would completely defeat the explicit wordings and purpose of the contract. There is no gainsaying that there will be price fluctuations which a prudent contractor would have taken into margin, while bidding in the tender. Such price fluctuations cannot be brought under Clause 23 unless specific language points to the inclusion.

In the light of the above observations, the Court was conclusive in its assessment of the contract clause while holding that the interpretation given by the arbitral tribunal is not a possible one and the meaning of clause of 23 cannot be expanded to include the change in price of HSD.

The Court, however, overlooked the need for explaining that why judicial interference was justified on the part of the High Court and why is the arbitral award contrary to the public policy. The courts have tried to interfere with the arbitral awards by providing a wider interpretation to “public policy” and, with an aim to restrict the courts from doing so, an amendment was introduced in 2015 in the Arbitration and Conciliation Act. Subsequent to the amendment, courts have refrained from providing a wider interpretation to the public policy as it has been witnessed in Venture Global Engineering LLC v. Tech Mahindra Ltd and Sutlej Construction v. The Union Territory of Chandigarh. The Supreme Court in Venture Global observed that “the Award of an arbitral Tribunal can be set aside only on the grounds specified in Section 34 of the AAC Act and on no other ground. The Court cannot act as an Appellate Court to examine the legality of Award nor it can examine the merits of claim by entering in factual arena like an Appellate Court.” In such a scenario, the Court in the present case appears incautious while interpreting section 34.

Conclusion and Suggestions

The judgment throws light on the critical aspects of contract law which will be essential in understanding a contract, in a post-Covid world, as there will be unprecedented rise in contractual disputes with reference to the ‘force majeure’ clauses. It is made clear that although the force majeure clause 44.3 included systems and acts and regulations of the Government of India and other clauses beyond the control of the parties, there was no effect of impossibility and frustration. Therefore, there is no application of the force majeure clause, and its remedies as identified under the contract. Similarly, there was no applicability of section 56 or section 65 of the Act, in the present case, for there was no event that would absolve the parties of the performance of the contract. The High Court’s interpretation of clause 23 and calling it akin to force majeure is therefore erroneous.

It must be noted that the tribunal adopted the harmonious approach, and used beneficial construction to interpret clause 23. The aim of the tribunal was to make the document workable and advance remedies to the parties. It expanded the meaning of the term “law” by including executive orders, which are not law in the literal sense, but have the “force of law”. It construed the contract in a way that it believed was intended by the parties while inserting the clause. However, the interpretation of the tribunal was amiss on several grounds. First, the condition for liberal interpretation has been reiterated in the case of Nabha Power that an implied term must not contradict any express term of the contract. However, the inclusion by the tribunal would have contradicted the express terms of the contract, wherein the fuel was to be provided by the contractor, at its own expense, and the contract was a fixed rate contract where the tender price was to be paid on completion of the contract. Second, when the Court draws an interpretation based on the intention of parties, it has to ensure that there was consensus ad idem between both the parties regarding that interpretation of the clause, and the tribunal tried to exceed the contract, by implying terms. Third, the tribunal did not read the contract as a whole while interpreting clause 23, as the interpretation rendered by the tribunal would have prevented the contract from being workable, in light of other clauses of the Act. These shortcomings in the reasoning of the tribunal have been highlighted by the Hon’ble Supreme Court while setting aside the award.

It is pertinent to note that the decision of the Supreme Court relied upon a literal interpretation of the contract. It focused on the purpose of the contract by stating that it was a fixed rate contract. Further, the contractor ought to have taken price fluctuations in regard while bidding the tender, as the purpose of the tender was to limit the risk of price fluctuations and mitigate the risk beforehand. As a result, it renders clause 23 to become redundant. The effect of the language of the clause is such that Oil India has surpassed its obligation to reimburse or pay the contractor any advantage gained due to change in cost on account of operations under the contract. This has resulted in no advantage being received by SEAMEC.   

Paridhi Rastogi & Yagya Sharma

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