Arbitrator’s power to grant interest

Introduction

In July 2011, the Supreme Court of India (“SC”) in “Union of India vs M/S. Krafters Engineering and Ors.”¹ pronounced an important judgment pertaining to payment of interest under the Arbitration & Conciliation Act, 1996 (“Act”). The prime issue that the SC had to decide was whether interest can be paid by an arbitrator under section 31(7) of the Act if the parties had expressly agreed in their contract not to pay any such interest, i.e. can the arbitrator go beyond the scope of the arbitration agreement or the Act to grant interest contrary to the express understanding between the parties?

The present bulletin summarizes the aforementioned judgment, analyzes it’s potential impact on parties and concludes with recommending draft arbitration clause in view of the SC judgment.

1.0 Facts of the case

Krafters Engineering (“KE”) was awarded a contract by central railways for setting up certain infrastructural and engineering arrangements in stations falling within the jurisdiction of central railways. Upon completion of the contract, certain disputes regarding non- payment of money were raised by KE against central railways. The contract between the parties provided for an arbitration clause, and accordingly, KE filed an application before the High Court at Bombay (“High Court”) for appointing an arbitrator. The High Court directed the General Manager of Central Railways to appoint an arbitrator. The final arbitral award ruled 10 claims out of 14 in favour of KE and Central Railways filed an application in the High Court challenging the award and raised a ground that the arbitrator was not competent to award interest under section 31(7) of the Act since the arbitration agreement between the parties specifically excluded the scope of granting interest. Both the single bench as well as the division bench of the High Court dismissed Central Railways’ application, after which an appeal was filed with the SC.

The SC reviewed the clause pertaining to payment of interest which principally stated that interest will not be payable upon the earnest money or the security deposit or amounts payable to the contractor (i.e. Central Railways) under the contract. Accordingly, one of the key issues formulated by the SC was whether in view of the agreement between the parties specifically excluding the scope of any interest during the pendency of the arbitration, is the arbitrator empowered to still grant interest under the provisions of the Civil Procedure Code (“CPC”) of India?

2.0  The Supreme Court’s position

The SC held that where the agreement between the parties does not prohibit grant of interest and where a party claims interest and that dispute (along with the claim for principal amount or independently) is referred to the arbitrator, he shall have the power to award interest pendente lite, i.e. interest on the claim amount during the pendency of the proceedings. However, taking into consideration the specific exclusion of interest clause in the arbitration agreement, the SC held that no interest was payable to KE and the award allowing interest on the disputed amount was in breach of the express terms of the agreement executed between the parties. The SC over-ruled the order of the High Court which had allowed payment of interest during the period when the dispute was being adjudicated by the arbitrator. The SC further held that section 31(7) of the Act uses the phrase “unless otherwise agreed by the parties” and hence categorically clarifies that the arbitrator is bound by the terms of the contract for awarding interest from the date of cause of action to the date of award. Therefore, where the parties had agreed that no interest shall be payable, the arbitrators cannot go beyond the agreement between the parties and are bound to honour the commercial arrangement.

3.0  Analysis

The SC seems to have placed an unjustified stress and dependence upon the Act while interpreting the powers of the arbitrator to grant interest to the aggrieved party. An arbitrator is bound by the provisions of the agreement entered into between the parties and cannot adjudicate upon any issue falling outside the scope of agreement. In fact, section 34 of the Act that states grounds on which an award can be challenged, specifically recognizes that an arbitrator cannot go beyond the terms of the agreement, and if he/she does, the award can be set aside. Now, interestingly, while the arbitrator may not be permitted to grant interest, parties may still have a right to claim interest as per the provisions of the CPC. When any amount is wrongly withheld by one party, the aggrieved party has right to claim interest under section 34 of the CPC. ² Thus, if the arbitrator has no power to award interest on the disputed sum for the period during pendency of proceedings, the party claiming it would have to approach civil courts for that purpose, leading to multiplicity of proceedings and additional litigation expenses. Overall, this is not in the interest of the parties. Therefore, it is critical that any clause preventing a party to claim interest in arbitral proceedings also applies to civil proceedings in a court so that there remains no ambiguity between the Act and the CPC with respect to payment of interest.

Conclusion

The critical issue settled by this case is that when there is an express exclusion of payment of interest in the arbitration clause of an agreement, the aggrieved party will not be awarded any interest. If the parties intend to exclude payment of interest during the pendency of legal proceedings, the agreement should reflect that choice by stating that the aggrieved party will not be able to claim interest pending arbitration proceedings. In absence of the same, the arbitrator has the power to award interest for the period from the award to the date of payment, as also for pre-reference, pendency and post arbitral award period.

A suggested dispute resolution provision can be on the following lines:

“In case of any dispute, controversy or claim arising out of, or in connection with the present contract, and the same is referred for arbitration as per the provisions of the Arbitration & Conciliation Act 1996 at New Delhi, and no interest on the amount due to either party will arise during pre-reference, pendente lite and post arbitral award.”

In conclusion, if parties to a contract want to avoid payment of interest during the pendency of arbitral award or arbitral proceedings, they should expressly exclude the same in the agreement to avoid payment of excessive amount as interest.

Authored by:
Priyanka Das


1 Civil appeal no. 2005 of 2007
2 Section 34 of CPC says that where and a decree is for the payment of money, the court may order interest at such rate as it deems reasonable. Such interest is paid from the date on which the suit was commenced till it was decreed and is in addition to any interest that a party may be entitled to before the commencement of proceedings. Section 34 is essentially based on the principles of equity