Arbitrator’s Award of Interest not ‘Patently Illegal’ Unless Contract Precludes

[Anujay Shrivastava is a law graduate (class of 2020) from Jindal Global Law School, O.P. Jindal Global University, Sonipat]

It is a well-settled principle that ‘patent illegality’ is a valid ground for a court to set aside an arbitral award under section 34 of the Arbitration and Conciliation Act, 1996. Previously, I had jointly examined the position of law on ‘patent illegality’ as a ground to set aside an award under section 34, within the settled jurisprudence in both the unamended 1996 Act and after the 2015 amendments were adopted by the Parliament.

In an interesting judgment, a division bench of the Supreme Court speaking through Bose, J. in Oriental Structural Engineers Pvt. Ltd. v. State of Kerala (April 22, 2021) held that an arbitral tribunal’s award of interest to a party in a contract (under whose terms the rate of ‘payment of interest’ is not expressly provided for) is valid, unless the contract specifically excludes it. Consequently, such an award of interest by a tribunal cannot be subject to judicial interference on ground of ‘patent illegality’.

Notably, the decision in Oriental has been rendered in a case where a challenge to the domestic award was made prior to October 23, 2015 (the day from which the 2015 amendments came into force). In this post, I shall examine the Oriental decision, which has further narrowed the scope of ‘patent illegality’ as a ground to interfere with a tribunal’s award (where the relevant law being applicable is the law judicially settled prior to the 2015 amendments).

Background

On November 7, 2002, Oriental Structural Engineers Pvt. Ltd. (“OSEPL”) was awarded a contract by the State of Kerala for upgradation of a state highway between two towns. While the contract did provide for ‘entitlement’ of the contractor to interest on delayed interim payment under a clause, OSEPL had left blank the space available for recording the ‘rate of interest’ for payment to be made in local currency.

Eventually, a dispute arose between the parties over delayed payment by the State which, failing resolution by a Disputes Review Board as per the contract, was referred to a three-member arbitral tribunal. By a 2:1 majority, the tribunal passed the award in favour of OSEPL, directing the State to pay ‘interest’ on delayed payment according to the local currency provided for under the agreement. The tribunal rejected the State’s claim that the rate of interest on delayed payment had to be treated as “zero” or “nil”. It also rejected the State’s claim that in terms of two of the earlier communications made by OSEPL to it, there was waiver of the claim of interests by OSEPL. Contrarily, it recorded that OSEPL also continued to raise demand for interest subsequent to the issue of those two communications. Moreover, relying on the Supreme Court’s Constitution Bench judgment in Secretary, Irrigation Department, Government of Orissa v. G.C. Roy, which was rendered under the erstwhile Arbitration Act, 1940, the tribunal held that “a person deprived of the use of money to which he is legitimately entitled has a right to be compensated and such compensation may be called interest, compensation or damages” [emphasis mine].

The State challenged this award on the ground of ‘patent illegality’ under section 34 of the 1996 Act before the District Court, Ernakulam (“Arbitration Court”). The Arbitration Court set aside the award on the point of interest and held in favour of the State. On appeal, a Division Bench of the Kerala High Court upheld the Arbitration Court’s decision in its order dated September 17, 2009.

The High Court’s Order

In its order, the High Court maintained the view that as OSEPL did not fill up the blank space with the rate of interest, the contract could not be construed to contain provisions for interest on delay of payment. Moreover, it opined that had OSEPL intended to retain its entitlement to interest on delayed payment under the relevant head, it should have filled the blank space in the “appendix to bid”.

Strangely, the High Court further stated that the State may have been able to persuaded to accept OSEPL’s bid in the first place on a basis that it would not claim any interest on delayed payment in such a payment, making OSEPL’s bid more competitive, as a reason to support the Arbitration Court’s decision. Consequently, the Arbitration Court’s decision was upheld by the High Court order. OSEPL appealed this order before the Supreme Court.

Precedents Considered

While commencing its analysis, the Supreme Court examined its earlier precedents rendered prior to the 2015 amendment. First, it mentioned the decision in ONGC v. Saw Pipes, which had judicially read ‘patent illegality’ as a part of the ‘public policy’ exception, for the enforcement of a domestic award under section 34. Second, it considered the decision in Associate Builders v. Delhi Development Authority, where it was held that an award would be invalidated on the ground of ‘patent illegality’, if it was in contravention of the substantive law of the country or any provisions of the 1996 Act itself.

Third, the Supreme Court considered its precedents in Roy and Reliance Cellulose Products Ltd. v. ONGC Ltd.. As discussed previously, the Roy decision was substantially relied on by the tribunal, while the decision in Reliance was cited by OSEPL to generally support the tribunal’s findings on the grant of interest. In the Roy decision, the Supreme Court was dealing with a case where the agreement was silent about the award of interest. Recording that Roy was rendered under the 1940 Act, which then empowered an arbitrator to have jurisdiction to grant pre-reference interest under the Interest Act, 1978 (as well as pendente lite and future interest), the Supreme Court in Oriental noted that such jurisdiction could then have been curbed only if the contractual terms expressly precluded the payment of interest. Lastly, the precedent in Union of India v. Bright Power Projectswas considered, where the Supreme Court, highlighting the position of law on grant of interest under section 31(7) of the 1996 Act, opined that the arbitral tribunal can award interest at reasonable rate for “a period commencing from that date when the cause of action arises till the date of the award.”

The Supreme Court’s Holdings

The Supreme Court in Oriental then recorded that there was no specific exclusion of ‘payment of interest’ on delayed payment. Moreover, the specific term of the agreement entered by and between OSEPL and the State provided for payment of interest on ‘delayed payment’ under terms of the contract. Therefore, the Court recorded that the parties had not specifically agreed only about the ‘rate’ at which such interest would be paid. Consequently, it was held that the High Court order was incorrect in construing the blank space left by OSEPL in the appendix to the bid as cancellation of the clause providing for payment of interest of delayed release of funds. Further, the High Court’s holding that OSEPL’s leaving of the blank portion would imply ‘zero’ or ‘nil’ interest was not only flawed, it also constituted an interpretation which was contrary and beyond the contractual terms. This form of interpretation would constitute rewriting the contract itself and was impermissible. In addition, the Supreme Court held that an “active exclusion of payment of interest” under the relevant head was necessary to have been incorporated in the agreement.

Moving forward, recalling the general proposition of law held in Roy and referred to by the tribunal in its award, the Supreme Court held that the underlying principle guiding award of interest is essentially compensatory in nature. Since entitlement of interest on delayed payment formed a part of the contract itself, the Court held that the agreement did not expressly exclude payment of interest on delayed payment, whether on component of payment in local currency or foreign currency. Moreover, the tribunal’s finding which rejected the State’s claim for OSEPL’s waiver was upheld as correct. Therefore, on these counts, it was held that the tribunal was correct in awarding interest as a compensatory or equitable measure, as long as there was no clause in the contract providing for ‘exclusion’ or ‘ouster’ of interest payment on delayed payment. Further, the High Court’s rationale that the interest column being left ‘blank’ by OSEPL may have resulted in acceptance of its bid was found unacceptable and unsubstantiated on facts of the case.

The Outcome

The Supreme Court in Oriental held that the High Court order and by extension the decision of the Arbitration Court, both of which set aside the tribunal’s award, were incorrect in interfering with the award on ground of ‘patent illegality’ and breached the permissible boundaries for encroaching upon an award as laid in Saw Pipes. Consequently, the Supreme Court upheld the tribunal’s award finding it to be both reasonable and possible view, although it modified the rate of interest awarded by the tribunal, deeming it excessive and bringing it down to interest rate of 8% on the sum left unpaid.

Comments

Through the Oriental decision, the Supreme Court has made it unambiguously clear that judicial authorities cannot interfere with an award of interest by the tribunal, where the contract itself does not expressly exclude payment of interest. Moving forward, in disputes to which the 2015 amendments are inapplicable, the scope of ‘patent illegality’ which is governed by Saw Pipes and subsequent judicial pronouncements (prior to adoption of the amendment) has been significantly curtailed, furthering a pro-enforcement regime. As long as there is no express exclusion on payment of interest in the contract, any award of interest by an arbitrator or the arbitral tribunals will be valid.

While the Oriental decision has been rendered in a case where the 2015 amendments are inapplicable, the general principles laid down by Supreme Court in Roy and Oriental decision would be equally applicable to cases which are dealt under the amended section 34(2A) (as inserted by the 2015 amendments), where the scope of judicial interference on the ground of ‘patent illegality’ is narrower than the pre-amendment regime. Contract drafters should therefore consider expressly excluding payment of interest to avoid a situation where the losing party would have to pay additional interest on payments.

Interestingly, given the fact that the recent decision in Patel Engineering v. North Eastern Electric Power Corporation Ltd. has reaffirmed judicial intervention in cases (post 2015 amendments) where “the arbitrator’s decision is found to be perverse, or so irrational that no reasonable person would have arrived at the same decision” [emphasis mine], a tribunal has to ensure that its award on rate of interest applicable to payments by the losing party to the award-holder (where contractual terms are silent on the interest rate) is fair and reasonable. Else, limited judicial interference on ground of ‘patent illegality’ would be justifiable on counts of perversity or irrationality of the interest rate awarded. This is also supported by the fact that the Supreme Court in Oriental decision did modify the interest rate awarded by the tribunal, finding the earlier interest rate awarded as excessive.

Anujay Shrivastava


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