Arbitrator's Authority To Award Interest Despite Contractual Restrictions

The author is Ashish Kumar, a fifth year student at NMIMS University.

Recently, the Delhi High Court (“DHC”) in M/s Mahesh Construction v. Municipal Corporation of Delhi & Anr in an appeal filed under Section 37 of the Arbitration and Conciliation Act, 1996 (“Act”) has held that the existence of a clause in contract which prohibits the payment of interest on delayed payments does not prevent an arbitrator from awarding pre-reference, pendente-lite, and post-award periods’ interest under Section 31(7) of the Act and the court has also explained that such clauses only restrict the parties to claim interest from delayed payments.

Factual Scenario and Contentions

M/s Mahesh Construction (“Mahesh Construction”) was awarded a work order by the Municipal Corporation of Delhi (“MCD”) for de-silting drains in Delhi. Mahesh Construction claimed that they did not receive payment after completing the work and having their bills examined with proper enquiries and test checks by the concerned staff. The MCD contended that Mahesh Construction failed to provide the necessary proof, such as dumping receipts, photographs, and videography, to demonstrate that the silt was properly disposed of at the designated site and providing the above-mentioned proof was required by the contractor. Being aggrieved by the same, Mahesh Construction initiated arbitration proceedings to claim their unpaid dues. The arbitral tribunal awarded interest on the claimed amounts, covering pre-reference, pendente-lite, and future (post-award) periods. Following the arbitration proceedings, the MCD (Municipal Corporation of Delhi) decided to challenge the arbitral award and filed a section 34 application with the district court, seeking to have the arbitral award set aside. The district court examined the matter and reached the conclusion that the contractor, Mahesh Construction, had failed to fulfill the contractual obligations related to providing evidence of drain de-silting. As a result, the court granted the request and set aside the arbitration award. Subsequently, Mahesh Construction lodged a section 37 appeal before the Delhi High Court to challenge the district court's decision.

Issue

Whether it is permissible for an arbitrator to grant interest under section 31(7) of the act when there is a clause restraining payment of interest on delayed payments. The other issue which the DHC answered was whether the insufficiency of the evidence cannot be a ground for setting aside an award under section 34 of the act.

Delhi High Court Judgement

The Delhi High Court referred to NHAI v. M/s. BSC-RBM-Pati Joint Venture and Union of India v. Sikka Engineering Company, which established the principle that interference under sections 34 and 37 of the Act should be minimal and confined to the grounds specified in Section 34 of the Act. However, in this case, the district court overstepped its jurisdiction by substituting its own opinion for that of the Arbitral Tribunal and interfering with the tribunal's observations. The Delhi High Court observed that the Arbitral Tribunal had correctly determined that the dumping of silt in locations other than the designated ones did not constitute a breach of contract, and the measurement book had been submitted as evidence of the work carried out by the contractor. The district court erred by reevaluating the measurement book as secondary evidence and concluding that the arbitral award, which was based on no evidence, was vitiated by patent illegality. Referring to the case of Associate Builders v. Delhi Development Authority, the Delhi High Court noted that the Arbitral Tribunal has the authority to assess the quality and quantity of evidence to arrive at factual findings. The court emphasized that there was sufficient evidence and material on record supporting the contractor's claim and criticized the district court for improperly reassessing the adequacy of the evidence, which falls outside the scope of Section 34 of the Act.

The court acknowledged that the Arbitral Tribunal possesses the authority to grant interest for the pre-reference, pendente-lite, and post-award periods, as established by legal precedent. It referred to the Supreme Court of India (“SCI”)ruling in Reliance Cellulose Products Ltd v. ONGC (“Reliance Case”), which established that interest serves as compensation and is contingent upon the principal amount. Drawing from the ruling in the Reliance case, the court reached the conclusion that the arbitrator possesses the authority, as provided by Section 31(7) of the Act, to award interest for all three periods, unless expressly prohibited by the contract. The court emphasized that a contractual clause prohibiting the payment of interest on delayed payments does not restrict the arbitrator from granting interest under Section 31(7) of the Act. Such a clause only limits the contracting party's entitlement to claim interest on delayed payments. As interest serves a compensatory purpose, the arbitrator's power remains unaffected by such narrowly worded clauses in the contract.

Therefore, the court determined that the Arbitral Tribunal's award of interest for the pre-reference, pendente-lite, and post-award periods was neither in violation of the contract terms nor in breach of Section 31(7) of the Arbitration and Conciliation Act, 1996.

Comments and Conclusion

In Sayeed Ahmed and Company v. State of Uttar Pradesh & Ors, it was established that Section 31(7)(a) of the Act outlines an arbitrator's authority to grant interest. According to this provision, if the contract explicitly prohibits interest payments, the arbitrator is not vested with the power to award any interest. The SCI observed that the contract between the parties contained a clause “No claim for interest or damages will be entertained by the Government with respect to any money or balance which may be lying with the Government or any become due owing to any dispute, difference or misunderstanding between the Engineer-in-Charge on the one hand and the contractor on the other hand or with respect to any delay on the part of the Engineer-in-charge in making periodical or final payment or any other respect whatsoever”. On this, the court held that such a clause was valid and binding on the parties and that the arbitrator had no power to award interest for pre-reference period and pendente lite when the contract prohibited it. In the current case, the Delhi High Court’s (DHC) observation that the contractual clause, which expressly restricts interest on delayed payments, does not explicitly bar the “arbitrator” from awarding interest under Section 31(7) of the Act is contrary to Sayeed Ahmed case. Recently, the Supreme Court of India while dealing with a similar clause prescribing “Clause 17: No interest shall be payable by BHEL on Earnest Money Deposit, Security Deposit or on any moneys due to the contractor” in Garg Builders v. Bharat Heavy Electrical observed that the arbitrator cannot grant pendente lite interest as the clause expressly bars payment of interest under Section 31(7) of the Act. In both the cases of Sayeed Ahmed and Gargi Builders, the respective clauses barred payment of interest but did not explicitly bar the arbitrator from granting the same.

Section 31(7)(a) contains a non-obstante clause, which states "unless otherwise agreed by the parties." This clause takes precedence over all other provisions related to interest throughout the arbitration process. The arbitrator's power to grant interest is governed and regulated by the combination of the non-obstante clause and the agreed clause. Essentially, this non-obstante clause overrides the entire framework for the arbitrator's authority to award interest at any stage. Parties have the autonomy to agree on waiving or restricting interest and/or the rate of interest for the entirety or a portion of the sum involved, or for the whole or any part of the duration between the accrual of the cause of action and the date of the award, including interest on the awarded amount. If the agreement explicitly stipulates that neither party is entitled to interest on the award amount, the arbitrator is bound by this provision, as opined in the case of Oil and Natural Gas Corpn. Ltd. v. Dolphin Offshore Enterprises (I) Ltd.

However, in Mahesh Construction case, the DHC erred in interpreting the Reliance case and wrongly observed that the arbitrator can grant interest for all three periods, unless expressly prohibited by the contract. The DHC erred in interpreting the rationale of Reliance case by observing that the arbitrator can grant interest unless the clause prohibits the same. In the Reliance case, the appeal was filed under the 1940 Act but since then the position of law in granting pre- reference and pendente lite interest has changed and the arbitrator cannot grant pendente lite interest if the parties have agreed to not have any interests awarded in their contract. In the 1940 Act, there wasn't an explicit provision preventing the arbitrator from granting interest for the periods of pre-reference, pendente lite or post award period. However, Section 31(7) of the Act encapsulates if the agreement prohibits the granting of interest for the period before the award, the arbitrator is restricted from awarding interest for that specific period. The Gargi Builders case and Sayeed Ahmed case lay down the correct position of law that the arbitrator is not entitled to grant interest if the clause bars the same.

On Issue 2, on the basis of current position of law as opined in Association Builders, the court has correctly observed that the district court has erred in examining the evidence and merits of the case as it is beyond the scope of the court under section 34 of the Act. However, it is pertinent to note that if the Arbitral Tribunal fails to appreciate evidence correctly during the arbitral proceedings, then the aggrieved party doesn’t have any other remedy to challenge the arbitral award on the failure of the arbitral tribunal in appreciation of evidence. This is one major drawback in the Indian Arbitration Jurisprudence.