Oriental Judgment: How Objective is “Just and Equitable” Interest Rate Modification?

[Anujay Shrivastava is a law graduate (class of 2020) from Jindal Global Law School, O.P. Jindal Global University, Sonipat. He is grateful to Professor Manasi Kumar for providing her valuable comments on an earlier post, which were inspiration for the present post]

Previously, I had examined the Supreme Court’s Division-bench decision in Oriental Structural Engineers Pvt. Ltd. v. State of Kerala. Readers may review the earlier post to appreciate the factual background and analysis of the Oriental decision. Importantly, the Supreme Court had clarified the law on setting aside domestic arbitral awards on the ground of ‘patent illegality’ under section 34 of the Arbitration and Conciliation Act, 1996. It held that an arbitral tribunal’s award of interest to a party in a contract is valid, where contractual terms are silent on the rate of payment of interest. Consequently, such an award does not constitute ‘patent illegality’, unless there is an active contractual preclusion or ouster of the payment of interest.

Curiously, the Court had modified the interest rate awarded by the tribunal to the award-holder (i.e. Oriental Structural Engineers Pvt. Ltd. (“OSEPL”)), holding that the payment of interest rate imposed on the losing party (i.e. State of Kerala), was “excessive” in its view. Consequently, the Court reduced the interest rate to a simple 8% per annum on the sum left unpaid, finding it to be “just and equitable”. Another peculiar fact about this modification of the interest rate is that the Court had concomitantly held the tribunal’s view to be both a “reasonable and possible” view. In this post, I only intend to analyse and critique the Court’s modification of interest rate granted in the tribunal’s award.

Award of Interest by Arbitrators

The pre-amendment section 31(7) of the 1996 Act (renumbered without textual modifications as section 31(7)(a) after the 2015 amendments), provides that:

Unless otherwise agreed by the parties, where and in so far as an arbitral award is for the payment of money, the arbitral tribunal may include in the sum for which the award is made interest, at such rate as it deems reasonable, on the whole or any part of the money, for the whole or any part of the period between the date on which the cause of action arose and the date on which the award is made.” [emphasis mine]

In terms of this provision, wherever parties have not contractually agreed to preclude grant of interest rate in an arbitral award or mentioned a specific interest rate, a tribunal is empowered to include an interest on the payment of money by losing party to the award-holder. It is up to the tribunal to determine what a “reasonable” rate of interest is. There is no legislative guidance for a tribunal on what constitutes a “reasonable” interest rate under the 1996 Act. The Delhi High Court in Turner Morrison Ltd. v. Rani Parvati Devi had recently held that an arbitral tribunal cannot reduce an interest rate which it deems “high”, where parties to the contract already agreed to such interest rate.

Recently, a division-bench of the Delhi High Court in V4 Infrastructure Pvt Ltd v. Jindal Biochem Pvt Ltd had reduced the interest rate awarded by the tribunal, holding that an arbitrator has to consider ‘market rates’ and ‘trade practice’ while awarding a ‘reasonable’ interest rate as stipulated in section 31(7). Interestingly, Jindal Biochem was a case where the contractual stipulations were silent on both a refund of the consideration by the other party and the interest rate itself. This is unlike the Oriental case, where there was no express mention of a rate of interest, but the contractual stipulations provided for an ‘entitlement’ of parties to payment of interest.

Critiquing the Oriental Decision

In Oriental, while modifying the tribunal’s award of interest, the Court mentioned that the tribunal’s exercise of fixing the interest rate should have been on the principle laid down paragraph 43.1 of its constitution-bench precedent in Secretary, Irrigation Department, Government of Orissa v. G.C. Roy. The relevant part of the principle from the Roy decision reads: “A person deprived of the use of money to which he is legitimately entitled has a rightto be compensated for the deprivation, call it by any name. It may be called interest, compensation or damages…”

Referring to Roy, the Court in Oriental had remarked that interest payment is essentially “compensatory” in nature. It is undisputed that award of interest under arbitration has to be compensatory in nature. In fact, an earlier division-bench precedent of the Supreme Court in Vedanta Ltd. v. Shenzhen Shandong Nuclear Power Construction Co. Ltd., had affirmed this principle in context of an international commercial arbitration (having its seat in India and being governed by Part I of the 1996 Act).

However, with all due respect, what is problematic about the Oriental decision is the fact that while modifying the interest rate awarded by the tribunal, the Supreme Court itself does not mention any objective factors such as prevalent market rate or trade practices. Instead, the Court simply termed the interest rate awarded by the tribunal as “excessive”, while terming its own reduction of the original interest rate as being “just and equitable”. The Court did not mention the basis on which the original interest rate was determined as excessive, although its allusion to the principle of “compensatory” nature of the interest indicates that it found the original interest rate to be ‘punitive’ in nature or leading to ‘unjust enrichment’. One could, however, contrarily argue that since arbitral tribunals have been empowered to determine “reasonable” interest rates under section 31(7) of the 1996 Act, the reliance of the Court in its Roy decision (which was rendered under the erstwhile Arbitration Act, 1940) to allude to the previously mentioned principle on compensatory nature of interest  is misplaced and does not provide any basis for its modification of the interest rate. In fact, a valid purposive interpretation to the adoption of section 31(7) could be that the legislature may have left it to the arbitral tribunals to decide what a ‘reasonable’ interest rate is. This is presuming that since arbitral tribunals can comprise of both legal professionals and non-legal professions with technical expertise of other disciplines, the tribunal itself would be capable of determining what the relevant factors to be considered while awarding interest rates are.

Therefore, the modification of the interest rate by the Court in Oriental case appears to substitute its own subjective opinion of what is a “just and equitable” interest rate, rather than discussing objective factors which merit any modifications. Since the contractual terms in Oriental decision expressly mentioned the entitlement of the parties to payment of interest, even absent a mention of the specific interest rate in the contract, this modification of interest rate by the court negatively affects the party autonomy of OSEPL and the State. Should courts in pending or future cases resort to modification of an interest rate awarded by a tribunal only on a flimsy ground such as their modifications being “just and equitable”, they will further risk expansion of judicial incoherence and thus defeat the very objective of India being a pro-enforcement or arbitration-friendly regime.

Concluding Remarks: The Way Forward

I have sought to establish that the modification of interest rate by the Court in the Oriental decision is problematic. Let us, however, set that aside for now. Much like how judicial authorities could err while deciding interest rates on payments in a civil lawsuit, the reasoning of an arbitral tribunal in reaching its determination of an interest rate itself could be flawed and merit judicial intervention. Arbitrators may not always make an objective determination. What is then the way forward? I believe that there are two solutions.

First, I believe that the approach taken by the Delhi High Court’s Division Bench in Jindal Biochem, where it modified the tribunal’s award of interest rate on the objective basis of prevalent ‘market rates’ and ‘trade practices’, is to be applauded. Judicial authorities should consider such objective factors, rather than use flimsy grounds such as “just and equitable” modification, when exercising judicial review on award of interest rates by arbitral tribunals. This would be in line with the legislative intent of furthering an arbitration-friendly regime, as parties would be likely to accept such judicial modifications as being reasonable and not negatively impacting their party autonomy.

Second, wherever a judicial authority reaches an identical or substantially similar finding on calculation of interest rate using any objective factors, it should not modify the award of interest rate by the tribunal. Moreover, where a judicial authority, on a challenge made to the tribunal’s award of interest rate by a party, finds it difficult to review the interest rate awarded, it should uphold the tribunal’s award. This would both honour party autonomy and maintain a pro-enforcement approach.

Using the two above-mentioned approaches, I believe that courts will be able to both intervene and modify the interest rate awarded in appropriate cases on the basis of objective factors, as well as succeed in avoiding judicial incoherence.

Anujay Shrivastava

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