Abstract

We quite often come across judgments of the High Court and the Supreme Court of India (“SCI”) in their jurisdiction under Section 34 or 37 of theArbitration and Conciliation Act, 1996 (or an appeal to the SCI underArticle 136 of the Constitution of India), wherein the Courts are not inclined to interfere and set aside the award passed by the arbitral tribunal. The reason being that the courts are of the opinion that an award, while interpreting a contract, is based on a plausible view, or maybe contains an error of law not so egregious that it violates public policy. This principle however forms the bedrock of arbitration jurisprudence in India and has been developed to increase the confidence of the stakeholders on arbitration proceedings as a system of resolution of commercial disputes. This signifies that there must exist several judgments of High Courts and the SCI, wherein the awards have not been set aside as the same was a plausible view and the Courts did not want to supplant their view in the challenge process.

The Indian legal system is obsessed with precedents, which is good if we follow the rules of identifying precedents correctly and rely only on the ratio of the judgments to be bound by and not the obiter dicta. Loosely relying on certain paragraphs of a judgment without looking into the final verdict and the discussion surrounding the issue can be dangerous. Further, it becomes immensely challenging to convince the stakeholders in an arbitration ecosystem that a judgment of the High Court or SCI on a challenge of an award, does not necessarily bind them, as the same does not hold precedential value.

Introduction

I am going to discuss the judgment of the SCI inWelspun Specialty Solutions v. ONGC. The judgment of the SCI is praiseworthy for not interfering with the impugned arbitral award. Primarily because the arbitral tribunal came to the right conclusion while dealing with the matter at hand. However, I shall still dissect the correctness of the reasons given by the arbitral tribunal on the legal principles of contract law, because they are severely flawed and could set a dangerous trend of future arbitral tribunals blindly relying on these reasons, based on the premise of precedential value of a Supreme Court Judgment upholding an award of the arbitral tribunal.

In this piece, I wish to guide the reader through the principles of damages available for prolongation of the contract as governed bySection 55 of the Indian Contract Act, 1872 (“ICA”), and its relationship with the liquidated damages clause underSection 74 of the ICA. I shall explore the question of waiver of liquidated damages, and whether such damages can be imposed in subsequent extensions when the same has been waived in the previous extensions of time for completion of the contract. This discussion also becomes relevant in the sphere of construction disputes, as most claims by contractors in arbitrations for construction disputes are based on compensation for losses caused due to prolongation of time in completion of the contract.

Case Brief

The contractor was granted a contract for supply of stainless-steel casing pipes. The delivery period in the contract was between 16-40 weeks from the date of signing the contract. Further, the contract mentioned that the time was supposed to be of the essence. While it provided for the imposition of liquidated damages for delay in supply of the goods, the employer had the right to waive such damages if a clear intention regarding the same was shown.

Certain delays occurred in the supply of the goods, and the contractor sought extension of time. The employer extended the terms of completion of the contract on 7 occasions. It did not impose damages on the first two extensions. However, it imposed damages on the next 5 occasions and deducted the sum named in the contract from the eventual payment made to the contractor.

The contractor invoked arbitration against the employer, inter alia, on the ground of wrongful deduction of liquidated damages by the employer. The arbitral tribunal in its award held as follows:

1. That time was not of the essence for the contract, as there existed a clause for the imposition of liquidated damages and extension of time which indicated as much.

2. Since time was not of the essence of the contract, there was no breach of contract due to delay in supply, and consequently the liquidated damages clause could not be invoked by the employer.

3. That damages, if any, would be payable on ‘actual losses’ underSection 55 paragraph 2 of the ICA, based on the delay in supply of the goods by the contractor.

The Hon’ble District Court did not interfere with the award and upheld the same. The Hon’ble High Court of Uttarakhand at Nainital, however, set aside the award on the grounds that the arbitral tribunal had gone beyond the terms of the contract in not awarding liquidated damages to the employer. The SCI held that the conclusion of the arbitral tribunal was based on a plausible view of the contract and construction of the law, and hence could not be set aside. Therefore, the Supreme Court upheld the arbitral award and set aside the judgment of the High Court which had set aside the award.

In this piece, I shall provide my analysis of the correctness of the reasons and conclusions of the arbitral tribunal as highlighted above.

Whether Time is not of the Essence of the Contract due to Presence of Liquidated Damages and Extension of Contract Clauses

The reasoning that since time is not of the essence of the contract, there cannot be breach of contract due to delay in supply, is incorrect. Time as the essence of contract does not mean that there cannot be a breach of the contract if the work is not complete within the prescribed time.

The purpose ofSection 55 of the ICA should be understood correctly.Section 55 has only introduced a provision under paragraph 1, where a contract is deemed to be voidable if time is of the essence of the contract and one-party delays in its performance. Hence, this provision gives the innocent party the right to rescind the contract since the same is deemed to be voidable. For eg., if a contract has been made for the purchase of certain goods to be delivered at the port by a certain date, and if the same are not delivered, it will make the contract voidable because the purchaser of the goods needed to transport the goods by a ship, and the ship has already sailed if the delivery is delayed. Hence, in such contracts, time is of the essence and it gives the purchaser a right to rescind the contract as such contracts are deemed voidable by virtue of paragraph 1 ofSection 55.

Whether there cannot be Breach of Contract for Extension of Time if Time is not of the Essence of the Contract

However,Section 55 does not make any difference in contracts where time is not of the essence. It just allows damages to be payable for prolongation of the contract under paragraph 2, on the same lines as damages for breach of the contract underSection 73.

I agree with the arbitral tribunal and the SCI that the fact that there exists a liquidated damages clause would mean that time is not of the essence of the contract. This is an affirmation of a long-standing principle laid down by the SCI inHind Construction Contractors v. State of Maharashtra (1979).

Hence, if time is not of the essence, it does not mean that the time has been set at large or that time for completion of the contract is not to be adhered to. The arbitral tribunal was incorrect to hold that delay in completion of the contract will not amount to a breach of the contract.

Whether Damages for Extension of Time under Section 55 Paragraph 2 can be Awarded at actuals in the Presence of Liquidated Damages Clause

Based on the principles discussed above, since the delay in completion of contracts where time is not of the essence will amount to a breach of a contract, damages for such breach can be limited by a liquidated damages clause. Hence, I do not agree with the conclusion of the arbitral tribunal that damages for delay in performance of contract have to be given only at actuals underSection 55 even in the presence of a liquidated damages clause limiting the same. The conclusion of the arbitral tribunal in this case, and the affirmation of the same by the Supreme Court, could set a dangerous precedent for future disputes on construction arbitrations. In cases where the delay is attributable to the employer, the contractors would be able to claim unliquidated damages even in the presence of a liquidated damages clause, which would be totally against the well-known principles of contract law.

InChunni Lal V. Mehta v. Century Spinning Mills, it has been held by the SCI that once a particular breach has provided for liquidated damages, unliquidated damages cannot be granted for the same. I can understand the apprehension of the arbitral tribunal to not grant the entire liquidated damages since the actual loss suffered by the employer seemed considerably less that the liquidated damages provided. Hence, the arbitral tribunal tried to award damages at actuals underSection 55 in disregard of the liquidated damages clause. It also considered the fact that the employer had waived the liquidated damages on the first two occasions of granting extension of time. Further, I also understand that the arbitral tribunal at the time of granting of the award did not have the judgment of the SCI of India in Kailash Nath v. DDA for its guidance. I believe if this arbitration had taken place after the present decision of the SCI, the route taken by the arbitral tribunal could have been different.

InKailash Nath Associates v. Delhi Development Authority, referring to the language ofSection 74 of the ICA clarified that the expression “whether or not actual damage or loss is proved to have been caused thereby” means that where it is possible to prove actual damage or loss, such proof is not dispensed with. It is only in cases where damage or loss is difficult or impossible to prove, that the liquidated amount named in the contract, if a genuine pre-estimate of damage or loss, can be awarded.

In the current case, the actual damages had been shown by the employer as well, which means it could be quantified. Hence, even in the presence of a liquidated damages clause, actual damages need to be shown. And if the same can be shown, only actual damages would be awarded as long as it is not more than the amount mentioned in the liquidated damages clause. Only in case the damages cannot be quantified can the sum named be awarded. Hence, although the arbitral tribunal reached the correct conclusion of awarding damages at actuals, based on interpretation ofSection 55, it would have been better if the arbitral tribunal rather did an analysis and interpretation ofSection 74 and eventually allowed damages underSection 74 to the extent of actual damages.

Whether Liquidated Damages Clause can be Re-Imposed on Subsequent Extension when it has been waived while granting the First Extension

In the facts of the case, it was relevant to note that the first 2 extensions were granted without imposition of liquidated damages, however, in the subsequent extensions, liquidated damages have been imposed by the employer. The arbitral tribunal held that such imposition of liquidated damages after the waiver of the same in the first place has to be made unequivocally. Since the same was not made clear, the arbitral tribunal went ahead and allowed damages at actuals only during the period in which damages were not previously waived. Hence, when the actual losses were shown as INR 3,80,64,833, the arbitral tribunal only awarded damages to the extent of INR 2,09,28,995 as the imposition of liquidated damages to the tune of INR 1,71,35,838 were excluded as being waived.

The aforesaid is a sound reasoning as far the principle regarding re-imposition is concerned. Hence, contractors and employers should be mindful that if they have initially provided extension of time without imposition of damages, while providing subsequent extensions of time, they should make their intention to impose such damages absolutely clear in their communications.

Relevant Jurisprudence regarding Section 74 and Liquidated Damages Clauses

In addition to the discussion regarding liquidated damages above, certain further jurisprudence regarding the treatment of liquidated damages clauses underSection 74 of the ICA also needs to be highlighted. First, the party will have to prove that some loss has been caused to it. InFateh Chand v. Balkishan Dass, the 5 Judge Constitution bench held that if the party is unable to show loss due to the breach, the party will not be granted the sum named as liquidated damages in the contract. It may then have to refund the liquidated damages if it has already deducted the same from the payments. The SCI further held that a named sum should be a genuine pre-estimate of damages, and not in the nature of a penalty. If the same is a penalty, the court would be within its rights to only award reasonable damages and not the sum named as a penalty. Finally, inONGC v. Saw Pipes, the Supreme Court held that difficulty in providing a precise assessment of damages further strengthens the fact that the sum named is a genuine pre-estimate of damages and the same can be awarded by the arbitral tribunal or the court to the innocent party.

In the case at hand, the SCI was dealing with a matter where the party defending its right to claim damages also had led some proof of actual quantification for the damages. However, quite often there might be situations where the party intent to deduct liquidated damages from the payment may not have evidence of the  amount of loss suffered by it. In such a case, the SCI inKailash Nath Associates v. DDA  has held that even if the innocent party deducts liquidated damages, at the time of resolution of the disputes, such party will have to prove that the damages cannot be quantified, post which the arbitral tribunal, or the court, can award the damages as named in the contract if the same is a genuine pre-estimate.

It should also be noted that the sum named does not necessarily have to be a fixed amount and the same can be determined by way of a formula to be calculated by the parties having pre-defined variables. Hence, any such clauses in the contract which have payment of compensation due to a breach, either a fixed amount or based on a calculation, the principles ofSection 74 of the ICA on liquidated damages will apply.

Conclusion

Hence, to summarize, it should be noted that the principles of contract law should always be kept in mind and argued accordingly before the arbitral tribunal, as the courts while dealing with the same during a challenge may not interfere with the award. Further, the parties should always be cautious of such judgments of the High Court and Supreme Court which uphold the award, and should not allow the opposite party to use the same as precedents before the arbitral tribunal.

Finally, on the aspect of damages available for extension of time for performance of the contract, it is well known that time is not of the essence in construction contracts. However, the same does not mean that there cannot be a breach of the contract if the time for performance has not been followed. Damages will also be available for such breach and can be limited in accordance with a liquidated damages clause andSection 74 of the ICA.

Disclaimer

The views of the author are personal and should not be considered as legal advice. For specific legal advice, the author may be contacted at gaurav@thearbitrationconsultant.in.

About the Authors

Mr. Gaurav Rai is a Senior Associate at Legafin Law Associates.

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