Of blank interest clauses and coerced waivers in construction contracts | Indian Supreme Court

Zacarias Kanjirath Joseph†

Abstract

A recent judgment of the Indian Supreme Court (“Supreme Court”) in the case of M/s Oriental Structural Engineers Private Limited (“Contractor”) v State of Kerala (“Employer”),[1] illustrates the treatment of (common) instances in construction contracts where:

1. the clause regarding award of interest is left blank, i.e., “_____%” (“Blank Interest Clause”);

2. a contractor has by correspondence waived its claims for interest, during the pendency of the contract. (“Contractors Correspondence”).

The Supreme Court held that an arbitral tribunal was entitled to award interest despite such a Blank Interest Clause. The Supreme Court further upheld the arbitral tribunal’s finding that the Contractors Correspondence was issued under ‘coercion’.

Relevant Facts

The Contractor was awarded a contract by the Employer for the upgradation of two stretches of a state highway. The Contractor’s claim for interest for delayed payment under various heads was the only point of dispute before the Supreme Court. The agreement entitled the Contractor to claim interest compounded monthly, if the Employer failed to make payments within the time stipulated under the agreement. The rates of interest were as stated in the ‘Appendix to Bid’. The Contractor (being the bidder) was required to complete the Blank Interest Clause. The Contractor left the space for recording the rate of interest in the ‘Appendix to Bid’, blank. Further, the Contractor in previous correspondence had stated that “we confirm that there is no provision of interest on delayed payment in the Contract and hence interest will not be claimed.”. Further that their “commitment not to claim any interest on the said amount released by you be treated purely as a goodwill gesture so that our future payments are released to us without any delay.”. (emphasis supplied)

Award of the arbitral tribunal

The arbitral tribunal held in favour of the Contractor and awarded an interest at the rate of 1% per month compounded monthly, on the unpaid sums, for the period the sums remained unpaid. Further, interest of 12% per annum on the interest amount was directed to be paid on the sums awarded from the date of award, till date of payment (“Awarded Interest”). The tribunal, on an appreciation of the evidence, held that the aforesaid Contractor’s Correspondence was issued under coercion. The correspondence was therefore held to not be a waiver of the Contractor’s claim for interest.

Award partly set aside

On a challenge under Section 34 of the Arbitration and Conciliation Act, 1996 (“Arbitration Act, 1996”), the District Court, Ernakulam partly set aside the award of the arbitral tribunal on the point of interest on delayed payment. The court inter alia held that the Blank Interest Clause provided for 0% rate of interest. This judgment of the District Court was upheld by the Kerala High Court in appeal.

Question before the Supreme Court of India:

Whether the Contractor was entitled to interest for delayed payment, in the face of a Blank Interest Clause?

Findings:

The Supreme Court set aside the judgment Kerala High Court, holding:

1. The Blank Interest Clause did not imply an interest of 0%. The Supreme Court reasoned that there was no basis for the lower courts to come to such a finding. Imputing 0% rate of interest amounted to “rewriting the contract” and was beyond the terms of the contract. The absence of an express exclusion or ouster of interest on delayed payment, permitted the grant of award of interest as a compensatory or equitable measure.[2]

2. The award of interest in the absence of a clause granting interest, is governed by the principles laid down by the Constitution Bench of the Supreme Court in the case of Secretary, Irrigation Department, Government of Orissa & Ors. v G.C. Roy [(1992) 1 SCC 508] (“C. Roy”). This judgment inter alia held that the underlying principle guiding award of interest, is that interest payment is essentially compensatory in nature. The Supreme Court in the present judgment has held that the principles enunciated in Paragraph 43 of the G.C. Roy judgment, albeit passed in the context of the Arbitration Act, 1940, are applicable even in a proceeding under the Arbitration Act, 1996.[3]

3. The tribunal, on an appreciation of the evidence led before it, found that the Contractor’s Correspondence was issued at the time of receiving payment in respect of an Interim Payment Certificate. This suggested that Contractors Correspondence was given under coercion. Further, the Contractor’s continued requests for payment of interest before and after the Contractor’s Correspondence suggested that there was no waiver / relinquishment of Contractor’s right to claim interest. These were findings of fact. The tribunal, after a considering these facts, held that the Contractor’s Correspondence did not amount to waiver of its claim for interest on delayed payments. The Supreme Court found no reason to overturn this reasoning. [4]

4. The Supreme Court however found the Awarded Interest to be excessive. Given that the agreement was silent on the point of rate of interest, but provided for payment of interest on delayed payment, the Supreme Court awarded simple interest at the rate of 8% on unpaid sums, as an equitable measure.[5]

Comments:

1. Blank interest clauses and correspondence akin to Contractor’s Correspondence (described above) are frequently found in construction contract disputes. Contractors, at the time of bidding, consciously (or unconsciously) do not fill in the rate of interest in the bid documents. Further, contractors often in the interest of enabling liquidity in the short-term, address correspondence waiving claims to interest on delayed payment. The above judgment provides some guidance for claiming interest on delayed payments, in such a situation.

2. It appears that the Employer did not adequately plead a case of waiver of interest payments in the first instance before the arbitral tribunal.[6] Further, the Employer does not appear to have led evidence as to the competitive edge that Contractor obtained at time of bidding, by leaving the Blank Interest Clause, blank.[7] The Employer may have obtained a different outcome, were its pleadings and evidence on these aspects complete.

3. A compensatory approach underlies the award of pendent lite interest. Employers are frequently burdened with interest awarded on a compounded basis, as was held by the tribunal, despite the absence of a clause entitling such award of interest. The Supreme Court circumscribes the limits to the award of interest in the absence of a clause entitling such award, to the principles laid down by the Supreme Court in the G.C. Roy judgment (cited supra) and the present judgment.

4. It is worth noting that the present judgment relies on case law interpreting Section 34 of the Arbitration Act, 1996, prior to the 2015 amendment.[8] This is (perhaps) because the challenge before the District Court, Ernakulam under Section 34 of the Arbitration Act, 1996 was filed prior to the amendment. This author has previously discussed the Supreme Court’s interpretation of the effect of the 2015 amendment to Section 34 of the Arbitration Act, 1996, on this blog. This notwithstanding, the principles laid down in the present decision, will guide interpretation of Section 31 (7) of the Arbitration Act, 1996, in similar facts and circumstances.

† Zacarias Kanjirath Joseph is a Senior Associate, with the Dispute Resolution practice group, at Khaitan & Co, Mumbai. The views of the author in this article are personal and do not constitute legal / professional advice of Khaitan & Co. For any further queries or follow up please contact ergo@khaitanco.com.

[1] Civil Appeal No. 3454 of 2011, judgment dated 22 April 2021 (“Judgment”)

[2] Paragraph 14 of the Judgment

[3] Paragraph 17 of the Judgment; Also see Reliance Cellulose Products Limited v ONGC Ltd. [(2018) 9 SCC 266]; Union of India v Bright Power Projects (India) (P) Ltd. [(2015) 9 SCC 695]; Section 31 (7) of the Arbitration Act, 1996.

[4] Paragraph 14 of the Judgment

[5] Paragraph 17 of the Judgment

[6] Paragraph 7 of the judgment

[7] Paragraph 15 of the judgment

[8] ONGC Ltd. v Saw Pipes Ltd. [(2003) 5 SCC 705]