[Madhvi Sharma is a 4th Year B.A. LL.B. (Hons.) student at National Law School of India University, Bangalore.]
The Supreme Court of India’s judgment in Union of India v. Larsen & Toubro Limited (2026 INSC 203) raises pertinent issues in relation to arbitral interest. The judgment has been received as a definitive restatement of the law on the contractual bars to interest under the Arbitration and Conciliation Act, 1996 (Arbitration Act). That reception may be premature, for at least three reasons: firstly, the judgment conflates contractual interest with compensation under the Indian Contract Act, 1872 (Contract Act); secondly, it does not engage with ONGC v. M/S G and T Beckfield Drilling(2025 INSC 1066), which held that a contractual bar on interest does not oust the power of an Arbitral Tribunal (AT) to award pendente lite interest unless the exclusion is explicit or arises by necessary implication; and thirdly, it creates a moral hazard in public procurement arbitration. The concern is that the judgment appears to produce consequences that are difficult to reconcile with the Court’s own prior jurisprudence.
The facts of the case warrant careful consideration. Larsen & Toubro’s (L&T) 2011 turnkey project with North Central Railways faced a 40-month delay across ten extensions. L&T incurred substantial borrowing costs while admitted dues went unpaid and sought compensation through arbitration. The AT recognised the validity of these grievances and awarded compensation for the financial delays and unpaid bills, framing them as damages. However, it explicitly rejected pendente lite interest in direct acknowledgement of the contractual bar. The AT observed that denying compensation on an admitted principal sum that was simply not paid would be a travesty of justice.
The Supreme Court characterised this as an attempt to violate the contractual bar, set aside all three pre-award heads, and reduced post-award interest from 12 to 8 percent. Two clauses of the General Conditions of Contract (GCC) drove the outcome. The GCC formed part of the Agreement dated 27 January 2011 (No. CME/NCR/JHSW/MOD/2010) between the parties, and also contained the arbitration agreement itself at Clause 64. Clause 16(3) barred interest on amounts payable to the Contractor under the Contract, and Clause 64(5) barred interest on any award for any period till the date on which the award is made. Under section 31(7)(a) of the Arbitration Act, a tribunal can award pre-award interest only absent a contrary agreement. The Court held that since the AT is a creature of the contract, the GCC bar displaces section 31(7)(a) and extinguishes arbitral jurisdiction over interest, regardless of how the claim is labelled. This reasoning is unsound for the three reasons noted at the outset. The following sections take each in turn.
The False Equivalence of Interest and Compensation
The Court’s reasoning proceeds from an unestablished premise, i.e., a contractual bar on interest simultaneously bars compensation for the wrongful withholding of money. The two need to be separated.
Interest, as governed by clauses 16(3) and 64(5) of the GCC, is predetermined or a statutory return on a principal sum for the use of money over time. The power of the AT to award this interest is regulated by section 31(7)(a) of the Arbitration Act. Conversely, compensation is governed by section 73 of the Contract Act, acting as the remedy for loss from a breach of contract. Although interest clauses may function either as primary terms or as contractually agreed secondary remedies under section 74, a general bar on interest cannot automatically extinguish secondary claims for unliquidated losses under section 73.
The Supreme Court interpreted the GCC’s bar on interest as automatically extinguishing L&T’s claim. The Court accepted the appellants’ submission (recorded at para 20 of the judgment) that section 73 permits parties to contract out of compensation “unless the contract provides otherwise”. However, this characterisation appears only in submissions, not in the text of section 73 itself. To be sure, parties can validly limit damages. In Bharti Knitting v. DHL (1996), the Court confirmed that it will enforce an agreed limitation clause according to its terms, and will not read beyond those terms. The contract in Bharti contained an express clause excluding “consequent damages”. However, in the present case both clauses 16(3) and 64(5) exclude only interest; they contain no express language barring compensation. Absent explicit language addressing that distinct head of loss, an interest bar cannot be stretched by implication to cover all financial losses pertaining to the breach.
Such a broad waiver, if construed as extinguishing the remedy of compensation altogether, sits uneasily with the Supreme Court’s ruling in BSNL v. Motorola India Pvt. Ltd. (2008). In that case, the Court held that a clause rendering the assessment of damages ‘final and not challengeable’ to be a restraint on the enforcement of legal proceedings under section 28. In the present case, the Court should instead have recognised that financing costs incurred due to withheld payments constitute a distinct head of damages under section 73, unaffected by a bar on contractual interest. Indeed, in McDermott International Inc. v. Burn Standard C. Ltd. (2006), the Supreme Court affirmed that financing overheads resulting from delay represent direct losses.
This conflation is compounded by the Court’s silence on the Constitution Bench in Secretary, Irrigation Department, Government of Orissa v. G.C. Roy ((1992) 1 SCC 508), which held that a right to compensation “may be called interest, compensation or damages”, the label being legally irrelevant to entitlement. If that proposition holds, the AT’s choice to call its award ‘financing charges’ cannot of itself determine whether it falls within the contractual bar.
This analytical gap deepens when considering admitted sums, amounts the Railways did not dispute were owed. Clause 64(5) bars interest till the date on which the award is made, language that presupposes a genuine dispute requiring arbitral resolution. When a debt is admitted, the AT ought to enforce it rather than adjudicate upon it. The judgment therefore fails to address that weaponising a dispute-resolution clause to deny restitution for the wrongful retention of undisputed money produces a commercially absurd result.
The Selective Reading of the Precedent
The non-engagement with Beckfield is equally telling. Prior to Larsen, two competing lines of authority had coexisted uneasily. The restrictive tradition, running through Sree Kamatchi Amman Constructions v. Railways ((2010) 8 SCC 767), Union of India v. Bright Power Projects ((2015) 9 SCC 695), and Union of India v. Manraj Enterprises ((2022) 2 SCC 331), holds that where parties have contracted out of interest, the AT has no jurisdiction to award it under any name. The liberal equitable tradition, rooted in G.C. Roy and developed through Ambica Construction v. Union of India((2017) 14 SCC 323) and Raveechee and Company v. Union of India (2018 INSC 574), holds that a general contractual bar on interest does not automatically extinguish the arbitrator’s jurisdiction to award pendente lite interest.
In Larsen, the Court dismissed Ambica and Raveechee as decided under the 1940 Act. That dismissal might have been defensible had the Court engaged with Beckfield, an Arbitration Act decision reaffirming the same liberal principle. By ignoring it, the Court left its most directly applicable authority unaddressed.
Beckfield established a clause-specific test, holding that an AT’s power to award pendente lite interest is negated only if the contractual exclusion is either explicit or follows by necessary implication. In Larsen, the Court failed to apply this standard. Had it done so, clause 16(3), which simply bars interest on amounts payable to the contractor under the contract, would struggle to explicitly or implicitly exclude the AT’s jurisdiction to award secondary damages under section 73, even applying the Beckfield test by extension.
The Court’s treatment of clause 64(5) of the GCC compounds the problem. It read clause 64(5) narrowly to permit post-award interest (noting the bar operated only “till the date on which the award is made”), yet it simultaneously read clause 16(3) expansively to block all pre-award compensation. The resulting prohibition was assembled from the interaction of two clauses that, individually, fail the Beckfield test. Whether this was contractual interpretation or judicial supplementation is a question the Court left unanswered.
The Moral Hazard: What the Judgment May Now License
Beyond doctrine, the practical implications of the judgment are serious. Enforcing these bars shifts the entire cost of the delay onto the contractor. A mere nominal repayment without adjustment for costs fails to fulfil the foundational principle of contract damages, i.e., to place the innocent party in the position they would have occupied had the contract been duly performed – recognised since Robinson v. Harman (1848).
This creates a moral hazard within the public procurement ecosystem, referring to an actor’s incentive to take on greater risk, or behave more carelessly, when insulated from the costs of doing so. A government department withholding admitted dues now faces zero pre-award interest liability regardless of how long arbitration takes, therefore emboldening state entities to withhold payment with near impunity. The withheld funds operate as an interest-free loan. Pre-award delay, in other words, transforms into a financially productive strategy for the defaulting party. That this was intended seems unlikely; that it is foreseeable is hard to dispute.
The asymmetry in the Court’s own reasoning makes this harder to defend. The Court invoked the principle of just compensation, and the need to avoid excessive financial burden on the judgment-debtor, citing Gayatri Balasamy v. M/s. ISG Novasoft Technologies Limited (2025 INSC 605) to reduce post-award interest from twelve to eight percent for the North Central Railway’s benefit. Equitable considerations were deployed to protect North Central Railway from an excessive post-award rate. Yet those same considerations were not applied to protect L&T from a pre-award rate of zero. While the statutory footing of post-award interest under section 31(7)(b) of the Arbitration Act may justify treating it differently, that basis required an articulation the judgment does not provide.
Conclusion
To conclude, Larsen does deliver a degree of legal certainty to the interpretation of standard-form government contracts. However, it leaves significant questions unanswered, specifically about the relationship between contractual interest bars and damages under section 73 of the Contract Act.
By conflating these issues, the judgment weaponises GCC clauses to deny compensation even for admitted debts. Further, the non-engagement with the Beckfield test leaves lower courts without coherent guidance on interpreting exclusionary clauses. The questions Larsen leaves open are too consequential to the credibility of public procurement arbitration in India to remain unaddressed for long. Resolving these tensions is imperative to ensure that the arbitral process serves as a forum for substantive justice, rather than a mechanism for formalising State immunity.
– Madhvi Sharma
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