Contract barring payment of interest is not ultra vires in terms of Section 28 of the Indian Contract Act, 1872

The Supreme Court of India in Garg Builders Versus Bharat Heavy Electricals Ltd.1 recently considered (i) whether an arbitrator could grant pendente lite interest when the contract contained a specific clause that expressly barred the payment of interest and (ii) its ultra vires in terms of Section 28 of the Indian Contract Act, 1872. The Civil Appeal arose from concurrent judgements passed by a Single Bench and Division Bench of the Delhi High Court wherein the pendente lite interest on the award amount was denied to the Appellant.

The Respondent had floated a tender for construction of a boundary wall and the Appellant submitted its bid which was subsequently accepted. The parties thereafter entered into a contract which, inter alia, contained the interest barring clause stating:

Clause 17: No interest shall be payable by BHEL on Earnest Money Deposit, Security Deposit or on any moneys due to the contractor.

Disputes arose between the parties and subsequently the Appellant filed a petition under Section 11 of the Arbitration and Conciliation Act, 1996 (hereinafter referred to as “the Act”) before the Delhi High Court wherein a sole Arbitrator was appointed. The Appellant in the claim petition, apart from claiming various amounts under different heads, inter alia claimed pre-reference, pendente lite and future interest at the rate of 24% on the value of the award. The Arbitrator concluded that there was no prohibition in the contract and Letter of Intent regarding payment of interest for the pre-suit, pendente lite and future period and consequently awarded pendente lite and future interest at the rate of 10% p.a. to the Appellant on the award amount from the date of filing of the claim petition till the date of realization of the award amount.

The Respondents challenged the same under Section 34 of the Act before the Delhi High Court wherein first the Learned Single Judge and thereafter the Division Bench held that the Arbitrator fell in error in holding that the aforesaid clause only prescribed pre-reference interest and not pendente lite interest and in terms of Section 31(7)(a) of the Act, the power of the arbitral tribunal to award pre-award interest is contingent to the parties not agreeing to the contrary. It further held that pre-award interest includes both pre-reference interest as well as pendente lite interest and therefore, the conclusion of the Arbitrator that award of pendente lite interest was not prescribed by Clause 17 was held to be not sustainable and therefore set aside the pendente lite interest.

The Supreme Court observed that the provisions of the Act give paramount importance to the contract entered into between the parties and categorically restricts the power of an Arbitrator to award pre-reference and pendente lite interest when the parties themselves have agreed to the contrary. Section 31(7)(a) of the Act stated that if the contract prohibits pre-reference and pendente lite interest, the Arbitrator cannot award interest for the said period. It further held that in the present case, clause barring interest is very clear and categorical as it uses the expression “any moneys due to the contractor” by the employer which includes the amount awarded by the Arbitrator.

The next question that arose was whether Clause 17 of the contract was ultra vires in terms of Section 28 of the Indian Contract Act, 1872. According to Section 28, a contract is void to the extent it restricts absolutely a party from enforcing his rights by usual proceedings in ordinary courts or if it limits the time within which he may enforce his rights. Exception I to this Section contains a rule that a contract by which two or more persons agree that any dispute which has arisen or which may arise between them in respect of any subject or class of subjects shall be referred to arbitration is not illegal. No cause of action then accrues until the Arbitrator has made the award and the only amount awarded in such arbitration is recoverable in respect of the dispute so referred. Section 31(7)(a) of the Act which allows parties to waive any claim to interest including pendente lite and the power of the Arbitrator to grant interest is subject to the agreement of the parties.

The Court further discussed the provision of Section 3(3) of the Interest Act, 1978 which explicitly allows the parties to waive their claim to an interest by virtue of an agreement. Section 3(3)(a)(ii) states that the Interest Act will not apply to situations where the payment of interest is “barred by virtue of an express agreement”. Thus, the Division Bench held that when there is an express statutory permission for the parties to waive claim on interest and the same is done so without any vitiation of free consent, it is not open for the Arbitrator to grant pendent lite interest and therefore Clause 17 of the contract was not ultra vires in terms of Section 28 of the Indian Contract Act, 1872.

1. CIVIL APPEAL NO.6216 OF 2021

By - Lakshmi Raman