Abstract

There is an increasing tendency to introduce exclusion clauses in construction and infrastructure contracts. Such an exclusion clause can either be a limitation clause, which, limits the pecuniary liability of each party, or an exclusion clause which excludes certain kind of liabilities and claims. Often such clauses are found in standard form contracts or by incorporation through special conditions, wherein the economically stronger party has drafted it and the economically weaker party only has a take-it-or-leave-it option.

In construction contracts specifically, where contracts are drafted by employers, or by the contractors wrt the sub-contractors, the operative clauses of the contract are often disadvantageous and onerous for contractors or the sub-contractors respectively. Construction is capital intensive; physically executed over a long period carrying uncertainties of site, design, approvals, funds, unforeseen physical conditions, environmental issues, change in law, changing scope or requirements, unexpected variations, political and natural risks, government regulations, and local bylaws and involving multiple players and third parties. Though the risk should be with the party which is in the best position to undertake it, unbalanced risk allocation is possible in a commercial arrangement. Unfair terms in the contract go beyond freely negotiated risk allocation and exempt a party from liability arising out of its own breach or negligence.

A few examples of ‘Onerous Clauses’

Some onerous clauses which limit liabilities of employers and impose strenuous obligation on contractors are:

1. “No-claim” provision in extension of time clauses prohibiting claim of compensation by the contractor for disruption or delay caused by the employer for whatsoever reasons

2. Price adjustment clauses limiting the payment of price escalation due to rise in price of material and labour for prolongation of contract for reasons attributable to the employer

3. Convenience termination clauses that entitle the employer to terminate the contract without cause while limiting/ excluding compensation for such termination

4. Contract requiring mandatory deployment of man and machinery by the contractor with penal provisions in case of default while exempting any liability on the part of employer for idling of such resources for delay or disruption caused by the employer

5. “Pay if” or “pay when” clauses without right to suspend work by the contractor/ sub-contractor

6. Clauses authorizing one of the parties to decide on the interpretation of contract or the issue of breach and making the same final and binding on the other party

7. The right of employer to recover damages, forfeit security deposit and /or performance bank guarantee of the contractor, even when there is a disputed question of breach

8. Provision requiring the contractor to deposit unconditional bank guarantees

9. Time bar clauses which prescribe onerous time limits for claiming damages or other reliefs under the contract, rigorous notice requirements and forfeiture of rights under the contract on failure to comply with such requirements

10. Clauses that debar claim of interest on any amount due to the contractor or on disputed amounts to be adjudicated by arbitrators

11. “No claim” undertakings in advance in printed forms for seeking extension of time even when the employer is responsible for delay

12. “No due certificate” required to release final bill payments of work done discharging the employer from all liability even when the contractor has other legitimate claims

13. One sided arbitration clause that empowers the employer to appoint the sole arbitrator or decide the composition of the panel of arbitrators

14. Arbitration clauses that require the claimant to pre-deposit a certain percentage of claim amount for reference to arbitration 

Inadequacy of statutes and precedents in checking use of unfair terms

Free consent is the sine qua non for a valid contract. In standard form contracts, free consent is only symbolic in nature that is parties have the freedom to choose to enter or leave a contract, but no freedom to negotiate the terms of the contract. The Indian Contract Act (“ICA”) provides no direct recourse for unfair terms. The precedents concerning the use of unfair terms are disjointed and often fail to provide dependable protection to the disadvantaged party.

The ICA provides various reliefs for an innocent party to get compensation in case of breach of contract by the other party. The ICA declares certain agreements between the parties as void. Section 23 of ICA [1] provides that any contract or part of it whose object or consideration is unlawful or of such nature that if implemented will defeat provisions of law or is deemed to be immoral by the court is against public policy and can be declared void. However, the section does not refer to unconscionability specifically, to restrict freedom of contract or private dealings by the law for the good of the community.  

Section 23 was used to deal with unfair terms for the first time in Central Inland Water Transport Corporation Ltd. v. Brojo Nath Ganguly [2]. In this case, the SC held that gross inequality of bargaining power together with terms unreasonably favourable to the stronger party is an indication that the weaker party had no meaningful choice except for accepting the terms of the contract. The termination clause was declared void as it was against public policy. However, the Brojo Nath case does not apply to commercial contracts. In absence of a direct statutory remedy for unfair terms in the contract, the judiciary has resorted to using of various other methods to render justice, including relying on the limited scope of interference under public policy grounds to set aside an arbitral award. 

In the case of General Manager Northern Railways v. Sarvesh Chopra [3], where the contract barred the respondent from claiming compensation for delays caused by the appellants, the SC held that irrespective of such exclusion the respondent had the right to pursue relief under Section 55.  

However, Sarvesh Chopra only concerns itself with contracts where time is of the essence. This precedent is helpful only to a handful of contracts as most construction contracts contain provisions for Extension of Time. In Hind Construction Contractors v. State of Maharashtra [4], it was held that clauses which allow extension of time in certain contingencies or penalty for an extended time will land the contract outside the purview of contracts where time is of the essence, even where the contracting parties have explicitly provided for the same. Besides, in infrastructure and construction contracts, having heavily invested in the project and blocked resources including the deposit of unconditional bank guarantees without a chance of getting injunctive relief, it is impractical to suggest that a contract can be avoided by the innocent party under section 55 of ICA, on expiry of the original time.  

In Ramnath International Construction (P) Ltd. v. Union of India, [5] while dealing with clause 11 of the MES contract, the Supreme Court resorted to the strict interpretation of the contract and held that a party is not entitled to claim damages if a clause to contrary is present in the agreement. But later in M/S Asian Tech Ltd v. Union of India, [6] which contained the same clause 11, the Supreme Court upheld the award of compensation for damages. However, unlike in Ramnath International, in Asian Tech the arbitration was under the Arbitration Act 1940 and the court had very little scope of interference in a non-speaking award. 

In Simplex Concrete Piles v. Union of India [7], the Delhi HC was faced with the task of reconciling these two conflicting decisions by SC. The issue was whether a party who is guilty of the breach under Section 73 and Section 55 can escape such liability due to the presence of an exemption clause barring such damages. The judge held that contracting out of some applicable provisions of ICA is permissible provided it does not deal with matters of public policy. The concerned exemption clause was void on grounds of public policy by virtue of Section 23 as protecting rights of contracting parties by Sections 73 & 55 was a matter of public policy.

Similarly, in K.N. Sathyapalan v. State of Kerala [8] the question before the court was whether, in the absence of any price escalation clause in the original agreement and a specific prohibition to the contrary in the supplemental agreement, the appellant could have made any claim on account of escalation of costs. The court relied on P M Paul v. Union of India [9] while distinguishing other judgments and refused to make a rigid interpretation of the terms of contract in the Supplemental Agreement and held: 

“Ordinarily, parties would be bound by terms agreed upon in contract, but in event one of parties to contract is unable to fulfil its obligations under contract which has a direct bearing on work to be executed by other party, Arbitrator is vested with authority to compensate second party for extra costs incurred by him as a result of failure of first party to live up to its obligations.” 

In the recent case of Assam SEB v. Buildworth [10] under the Arbitration Act, 1940, where a party has challenged the arbitrators right to award price escalation beyond the ceiling provided in the contract, the court upheld the award as the decision of the arbitrator was based on the construction of a provision of contract, correspondence between the parties and the conduct of the respondent, for prolongation of the contract. The court followed the PM Paul case and the Sathyapalan case to uphold the award of compensation.  Similarly, in Ktech v. Union of India [11], it was held that a party cannot be permitted to take advantage of a situation brought about by itself when it has ordered several changes resulting in a delay in completion of a project.

However, there have been many cases where the courts have held that arbitrators have to strictly abide by the terms of contract. In ONGC v. Sawpipe [12], the SC held that an award which contravenes the agreement between the parties can be set aside. Similarly, in ONGC v. Wig Brothers[13] the court held that an arbitrator’s award should be within the terms of the agreement and cannot go beyond it. 

However, since the 2015 amendment to Section 28(3) of the Arbitration & Conciliation Act, 1996 (A & C Act), any contravention of terms of the contract by the tribunal will not ipso facto result in rendering the award becoming capable of being set aside[14]. The Supreme Court in Ssangyong Engineering & Construction Co. Ltd. v. NHAI [15] notices the change in S.28(3) as one of the important amendments in the Arbitration Law, consequent to the 246th Report of the Law Commission of India (LCI), undoing the law laid down in Saw Pipes in this regard. This opens the window for contextual construction of construction contracts under the factual matrix. Mc Dermott International Inc v. Burn Standard Co Ltd.[16] recognizes that the conduct of the parties shall be taken into account in the interpretation of the contracts. Ssangyong also redefines the narrow scope of public policy ground for the challenge of arbitral awards considering the amendment to the Arbitration Act in 2015 regarding the observation made earlier in Associate Builders v. Delhi Development Authority, [17] in the pre-amendment regime.  

Another frequently used unfair practice is of obtaining “no-claim” undertakings by employers while granting extension of time in construction contracts and “no-dues” certificate for release of final bill payment.  These may either be part of contract or insisted by the employer later. The Delhi High Court in P C Sharma v. Delhi Development Authority [18] recognised that if the appellant would not give such undertaking, it would face absence of extension of time and other consequences, even when the respondent is in breach of contract causing delay; and upheld the decision of the arbitrator that the undertaking was obtained by force and hence invalid.

Similarly, in R L Kalathia and Co v. State of Gujarat [19] referring to NTPC Ltd. v. Reshmi Constructions [20] and Ambica Construction v. Union of India [21], the Supreme Court held that merely because the contractor has issued “no-dues certificate”, if there is an acceptable claim, the court cannot reject the same on the ground of “no-dues certificate”. It held that a genuine claim cannot be absolutely barred by such certificates. In Reshmi Constructions the Supreme Court observed that it cannot shut its eyes on the ground realties for reasons why a contractor has to issue such certificates. In Ambica Construction the Supreme Court tested the efficacy of such clauses in contract requiring “no-claim certificates”. 

In cases where employers have obtained no-due certificates by withholding payments or security deposits, the contractors can sometimes find relief in doctrines of Undue Influence and Economic Duress. If a clause in a contract provides that a contractor has to submit a no-claim certificate before any payment is made to him, the courts can invalidate such a clause and allow an arbitrator to adjudicate upon the claims if the undertaking was given under undue influence/economic duress[22]. With the amendment in Section 11 of the A & C Act, this issue shall now fall within the purview of the Arbitrator.

Regarding clauses authorizing one of the parties to levy damages compensation alleging breach of contract, the SC in J. G. Engineers Pvt Ltd v. Union of India [23] relied on State of Karnataka v. Shree Rameshwara Rice Mills [24] to state that one of the parties to an agreement cannot reserve to himself the power to adjudicate whether the other party has committed breach; when who has committed breach is not admitted and is disputed. In Rameshwara Rice Mills, the SC had held that the right to assess damages arising from a breach of condition does not include a right to adjudicate upon a dispute relating to the very breach of conditions. This was relied by the SC in BSNL v. Motorola[25]. 

In Union of India v. Raman Iron Foundry, [26] it was held that a claim of damages which have not been adjudicated by appropriate forum and awarded, does not become a “debt due” and cannot be recovered from the other party. This was later partially overruled by the SC in Kamaluddin Ansari [27] to allow withholding a sum by the government till adjudication, subject to such a provision in the contract.

In S K Jain v. State of Haryana, [28] the Supreme Court upheld the agreement of the parties wherein the party seeking arbitration had to make substantial amount of prior deposit of money. However, more recently in M/S ICOMM Tele Ltd.  v. Punjab State Water Supply & Sewerage Board & Anr, [29] the Supreme Court while distinguishing the above judgment on the touchstone of the Article 14 of the Constitution of India, held “Deterring a party to an arbitration from invoking this alternative dispute resolution process by a pre-deposit of 10% would discourage arbitration, contrary to the object of de-clogging the Court system, and would render the arbitral process ineffective and expensive.”  It referred to ABL International Ltd. v. Export Credit Guarantee Corporation. of India Ltd., [30], to state “this Court has held that even within the contractual sphere, the requirement of Article 14 to act fairly, justly and reasonably by persons who are state authorities or instrumentalities continues.” 

The Supreme Court in Perkins Eastman Architects v. HSCC(India) Ltd. [31] referring to various other judgments interpreting Section 12(5) of the A & C Act introduced in 2015 has restricted the power of a party to appoint a sole arbitrator, despite such a provision in the arbitration agreement.  However, the law allowing one of the parties to suggest a small panel as per the arbitration clause from which to choose three arbitrators, is in a flux, consequent to the decision of a 3 judges bench of SC in Central Organization for Railways v. M/S ECI-SPIC-SMO-MCML[32] This decision in essence is contrary to earlier judgments mandating a broad-based panel of arbitrators and defeats the amendment to section 12 of the A & C Act to give an unfair advantage to one of the parties. 

The agreement sometimes restrains absolutely a party’s legal rights and remedies. Section 28 of ICA makes such agreements void to that extent. The amendment through Section 28(b) of ICA prohibits any such bar in agreement with respect to the right of a party to make claims till the limitation period as per law. Such time barring clauses in the agreement has been held to be void in most judgments (See B L Kashyap & Sons v AAI DHC [33]). 

The cost of capital is very high in the construction industry and the claim of interest is substantial considering the time taken in obtaining an arbitral award, including a lengthy pre-arbitral process.  Under Arbitration Act 1940, courts have allowed arbitrators to award interest despite the prohibition on awarding of interest under the contract. However, under the 1996 Act, when the parties have agreed under the terms of the agreement that interest shall not be payable, the Arbitrator cannot award pendente lite interest or pre-reference interest. [34] This is due to the phrase “Unless otherwise agreed by the parties in Section 31. (7) (a), which allows the parties to make their own arrangements with regards to awarding of interests. 

The most difficult form of unfair terms of the contract is unconditional bank guarantees, against which the scope of injunctive relief is very remote, due to the high threshold fixed by the courts. However, the Supreme Court in Gangotri Enterprises[35], gave relief on the specific facts of the case, where it was held encashment against the claim of damages, which are not a debt due till adjudicated, is not permissible. Similar relief is rare in other cases. 

The courts have also overlooked provision contained in saving to Section 1 of ICA which provides that an agreement will not be affected by ICA unless it is inconsistent with its provisions; meaning thereby, that terms in derogation with provisions provided in ICA will be hit by the saving and are capable of being declared ineffective. 

Similarly, despite the provisions in S.51, 53, and 54 of ICA codifying the law of reciprocal promises and prevention principle, the right of suspension of work by the contractor for non-payment of running bills, is generally not upheld, following the practice as per English common law, which itself has changed in the UK as per the HGCRA, 1996. 

Thus, the statutory protection from unfair terms of contract in India for commercial contracts is inadequate. The law on unfair terms in contracts as per the judicial precedents is unsettled and uncertain; and depends on the factual matrix of each case and on the construction of the terms of contract.   

Other jurisdictions

There has been a concerted effort in many countries to limit the scope of unfair terms in contracts to protect weaker parties.  Countries have enacted statutes to ensure fairness in contracts, especially contracts where there is an imbalance of bargaining power. 

In the United Kingdom in 1977 introduced the Unfair Contract Terms Act (UCTA) to regulate contracts by limiting the extent to which one party can avoid liability through the use of exclusion clauses. Section 11(1) of UTCA permit limitation of liability clauses only when they are fair and reasonable to be included having regard to the circumstances which were, or ought reasonably to have been known to the parties at the time the contract was entered into. The act is however plagued by a lack of clarity on terms such as exclusion clause and test for reasonableness.  

In the United States, the Uniform Commercial Code (UCC) allows the court to refuse to enforce the unconscionable terms in contracts. The courts rely on both substantive and procedural unfairness to determine unconscionability.  Both types of unfairness need not be present to the same degree. Rather, “the more substantively oppressive the contract term, the less evidence of procedural unconscionability is required to come to the conclusion that the term is unenforceable and vice versa.” [36]. However, the UCC only applies to the sale of goods. Unfair terms in other types of contracts are governed by common law principles.  

In 2016 The Australian Consumer Law was extended to apply to all standard form contracts entered by small businesses. Under the Law for a term to be unfair, it must cause a significant imbalance in the parties’ rights and obligations, such imbalance should not be reasonably necessary to protect the legitimate interests of the party advantaged by the term, and it must cause financial or other detriments to a small business if it were relied on[37]. Terms such as unilateral changes, limiting rights, penalties, unilateral assignments are explicitly covered in Section 24 of Australian Commercial Law. However, the protection only extends to those parties which come within the narrow scope of small business.  

In Civil Law countries such as France and Germany, the principle of good faith has been considered a limit on the freedom to contract and a valuable instrument to determine the existence of an abusive clause in contracts. One of the obligations arising from good faith is the “duty of loyalty”, which consists of the abstention from all unfair behavior [38]. The Principle of Good Faith is applied by courts to avoid harsh or inequitable results arising out of unfair terms in a contract. However, due to ambiguities arising out of the principle of good faith, countries like France and Belgium, and Switzerland, the legislators have chosen ‘a significant imbalance’ as the criteria to determine unconscionability. Other countries like Germany have retained the principle of good faith as a yardstick for measuring unfairness[39].

Conclusion and Suggestions

The construction sector is in distress due to a liquidity crisis. The PPP model has failed in India partly due to unbalanced risk allocation. Long-term construction contracts and contracts with heavy investments in the infrastructure sector in India need more cooperative and less adversarial contracts based on good faith and balanced risk allocation. Clauses like convenience termination with unilateral power to terminate a contract at will shall discourage private investment. Hence having fair terms in contracts is a policy imperative. 

Unlike many countries, unfair contractual terms in India continue to be governed by precedents, which are often in conflict with each other. The 103rd Report of the Law Commission of India suggested the incorporation of Section 67A into ICA with two sub-sections invalidating exclusion of liability for negligence and for breach of contract. The 199th report of LCI suggested the enactment of a new statute to deal with this issue. The proposed statute divides unfair terms into procedural and substantive unfairness. A contract or a term is procedurally unfair if it has resulted in an unjust disadvantage to one party due to the conduct of the other party or the circumstances under which the contract has been entered into[40]. A contract or term is substantively unfair when it is harsh oppressive or unconscionable.  

The proposed Act enlists the circumstances under which and the substantive provisions which will indicate unfairness in contract or its terms. The proposed Act also allows courts and arbitral tribunals to declare the contract void, vary the terms of the contract, order payment of damages and issue injunctions among other reliefs. 

The inability of the present legal landscape to safeguard the interest of weaker contracting parties w.r.to unfair contract terms calls for legislative reform. The recommendations of the LCI, which has not been acted upon by successive governments, if enacted will be a welcome step in protecting the commercial interests of economically weaker parties.

About the Authors

Ganesh Chandra Kabi, FCIArb is the Managing Partner of Kabi & Associates, New Delhi. He was formerly a Chief Engineer at the Central Public Works Department (CPWD) and is a seasoned arbitrator, having rendered 175+ awards.

Mitali Kshatriya is a 3rd Year Law Student at the Ram Manohar Lohiya National Law University (RMLNLU), Lucknow. She is an Associate Editor at the Indian Journal of Projects, Infrastructure, and Energy Law (IJPIEL).  

Editorial Team

Managing Editor: Naman Anand

Editors-in-Chief: Akanksha Goel & Samarth Luthra

Senior Editor: Aakaansha Arya

Associate Editor: Mitali Kshatriya

Junior Editor: Amrith R.

Preferred Method of Citation 

Ganesh Chandra Kabi, FCIArb & Mitali Kshatriya ‘Checks on Unfair Terms in Construction Contracts: Examining the Current Legal Landscape’ (IJPIEL, 7 October 2020)

 <https://ijpiel.com/index.php/2020/11/27/checks-on-unfair-terms-in-construction-contracts-examining-the-current-legal-landscape/>

Endnotes  

[1] Section 23, Indian Contract Act, 1872.

[2] Central Inland Water Transport Corporation Ltd. v. Brojo Nath Ganguly, 1986 AIR SC 1571.

[3] General Manager Northern Railways v. Sarvesh Chopra, (2002) 4 SCC 45.

[4] Hind Construction Contractors v. State of Maharashtra, (1979) 2 SCC 70.

[5] Ramnath International Construction (P) Ltd. v. Union of India, (2007) 2 SCC 453.

[6] M/S Asian Tech Ltd v. Union of India, (2009) 10 SCC 354.

[7] Simplex Concrete Piles v. Union of India, LR (2010) II Delhi 699.

[8] K.N. Sathyapalan v. State of Kerala, (2007) 13 SCC 43.

[9] P. M. Paul v. Union of India, (1989) Supp (1) SCC 368.

[10] Assam SEB v. Buildworth, (2017) 8 SCC 146.

[11] Ktech v. Union of India, LR 2015 SCC OnLine Del 13369.

[12] ONGC v. Sawpipe, (2003) 5 SCC 705.

[13] ONGC v. Wig Brothers, (2010) 13 SCC 377.

[14] ONGC Ltd. v. Western Geco International Ltd., (2014) 9 SCC 263.

[15] Ssangyong Engineering & Construction Co. Ltd. v. National Highways Authority of India, (2019) 15 SCC 131.

[16] Mc Dermott International Inc v. Burn Standard Co Ltd., (2016) 11 SCC 181.

[17] Associate Builders v. Delhi Development Authority, (2015) 3 SCC 49.

[18] P.C. Sharma v. Delhi Development Authority, 2011 SCC OnLine Del 5149.

[19] R.L. Kalathia and Co v. State of Gujarat, (2011) 2 SCC 400.

[20] Chairman and MD, NTPC Ltd. v. Reshmi Constructions, Builders, and Contractors, (2004) 2 SCC 663.

[21] Ambica Construction v. Union of India, (2006)13 SCC 475.

[22] Union of India v. Parmar Constructions, (2019) 15 SCC 682.

[23] J.G. Engineers Pvt Ltd v. Union of India, (2011) 5 SCC 758.

[24] State of Karnataka v. Shree Rameshwara Rice Mills, (1987) 2 SCC 160.

[25] Bharat Sanchar Nigam Limited v. Motorola India Pvt. Ltd., (2009) 2 SCC 337.

[26] Union of India v. Raman Iron Foundry, (1974) 2 SCC 231.

[27] Kamaluddin Ansari v. Union of India, (1983) 4 SCC 417.

[28] S.K. Jain v. State of Haryana, (2009) 4 SCC 357.

[29] M/S ICOMM Tele Ltd.  v. Punjab State Water Supply & Sewerage Board, (2019) 4 SCC 401.

[30] ABL International Ltd. v. Export Credit Guarantee Corporation. of India Ltd., (2004) 3 SCC 553.

[31] Perkins Eastman Architects v. HSCC(India) Ltd., 2019 SCC OnLine SC 1517.

[32] Central Organization for Railways v. M/S ECI-SPIC-SMO-MCML, 2019 SCC OnLine SC 1635.

[33] B.L. Kashyap & Sons v. AAI DHC, 2016 SCC Online Del 5473.

[34] Chittaranjan Maity v. Union of India, (2017) 9 SCC 611.

[35] Gangotri Enterprises v. Union of India, (2016) 11 SCC 720.

[36] Baltazar v. Forever21, Inc., 62 Cal. 4th 1237 (2016).

[37] Determining whether a contract term is unfair, ACCC https://www.accc.gov.au/business/business-rights-protections/unfair-contract-terms/determining-whether-a-contract-term-is-unfair (last visited Oct. 20, 2020)

[38] Ejan Mackaay, Good faith in civil law systems. A legal-economic analysis, (July 2012), Sceilo https://scielo.conicyt.cl/scielo.php?script=sci_arttext&pid=S0718-80722012000100004#:~:text=It%20refers%20here%20to%20not,all%20civil%20law%20systems17 

[39] Chapter 5: Good Faith, LegisCompare https://www.legiscompare.fr/web/IMG/pdf/13._CH_5_Good_faith.pdf(last visited Oct. 20, 2020).

[40] Law Commission of India – 199th Report Unfair (Procedural & Substantive) Terms in Contract, Law Commission of India, https://www.legiscompare.fr/web/IMG/pdf/13._CH_5_Good_faith.pdf(last visited Oct. 20, 2020).