Infrastructure projects are the backbone of the Indian economy for they create basic organizational structures which are key to the nation’s operations. Illustratively, such infrastructure projects include construction, transportation, sewage, and mining, amongst others. Given that such projects are usually large-scale in their nature and operation, they are also highly cost intensive. In addition to the State, which ordinarily owns the natural resource, which forms a critical component of infrastructure projects, this sector is also dominated by key private players. Consequently, infrastructure projects are funded either publicly, privately or through public-private partnership.
While the State may choose to execute such projects either by employing its own agencies or through private third-party contractors, a contractual model which has recently risen to prominence is public-private partnership. A public-private partnership is a collaboration between the State and private entities to provide public assets. Concession Agreements are a popular form of public-private partnership whereby a private entity is granted license to provide an asset or service, traditionally provided by the State. For providing such services, the private party may receive the benefit of certain rights or remuneration from the State. Public-private partnerships are therefore viewed favorably as they combine public and private sector efficiencies to deliver cost and time bound services.
While the State may engage one private entity under the main contract, such entity may in turn appoint various sub-contractors to carry out tranches of its obligations under the main contract with the State. This creates back-to-back contractual arrangements between multiple parties in the same project. Such complexity of infrastructure contracts, coupled with the long lifecycle of an infrastructure project, offers a breeding ground for disputes. The present article specifically considers the dispute between the State entity and private parties on the forfeiture of security deposit.
Security Deposit in Infrastructure Projects
Infrastructure tenders floated by State entities often contain stipulations for payment of security deposit by bidders. Such security deposit is a proportion of the contract value and may or may not increase during the contractual period. Recently, the Supreme Court has also emphasized on the significance of security deposit clauses in infrastructure projects. TheApex Court held that in the absence of security deposit, the contract is not concluded between parties when the notice inviting tender specifically stipulates furnishing security deposit as a pre-condition to arrive at a concluded contract. The intent of such stipulations in contracts is to protect the interests of the State against poor performance or non-performance of contract by the bidder.
The security deposit is finally refunded upon completion of contractual obligations by the successful bidder. The bidder may also be required to obtain a no-dues certificate from the State entity. However, upon reconciliation of accounts by the State entity, if dues are found to be recoverable from the bidder, such dues are adjusted against the security deposit and the remaining amount is refunded to the bidder. In the event the dues exceed the security deposit paid, the deposit is forfeited. The deposit may also be forfeited in cases where the contract is not performed or partly performed by the bidder.
Ordinarily, disputes on part refund or non-refund of security deposit are sought to be resolved in accordance with the dispute resolution mechanism set out in the infrastructure contract (often arbitration). Akin to security deposit in other commercial contracts (illustratively, lease), security deposits in infrastructure contracts also do not carry any interest over the period of its deposit.
Extant law on the forfeiture of Security Deposit
Breach of contractual terms by a contractor entitles the State (& its entities) to rightfully forfeit security deposit provided, such forfeiture is demonstrable by actual loss suffereddemonstratedbyactuallosssuffered by the state. The statutory basis for such forfeiture is found in Sections 73-75 of the Indian Contract Act 1872 which make actual loss a pre-requisite for granting damages. For instance, in the case ofUnion of India v. Rampur Distillery and Chemical Co. Ltd, the State had forfeited the security deposit due to poor performance of the contract by the private party. Subsequently however, the private contractor performed the remainder of the contract at the same contractual rates. Given the State’s failure to demonstrate actual loss suffered due to breach of performance of contract (though timely completion of contact, is of essence in most infrastructure projects), the State could not sustain its forfeiture of security deposit.
A head of loss that may be claimed by the State entity to forfeit security deposit is the cost incurred in engaging an alternate contractor to complete the contracted work. TheState entity may be permitted to forfeit a portion of the security deposit limited to the extent of costs incurred for getting the work executed by an alternative contractor.
Further, it is imperative that forfeiture stipulations be expressly incorporated in infrastructure contracts by State entities.Courts have time and again clarified that the power of the State entity to forfeit security deposit is premised on the existence of a forfeiture clauses within the contract. In the absence of a stipulation permitting forfeiture, the State entity may not be entitled to forfeit any part of the security deposit.
Predicament of Private Parties and the State
While forfeiture of security deposit is rightly permitted in certain contracts and has been upheld by courts, in some others, such forfeiture may cause financial distress to both, public and private players alike.
In certain cases, parties are unable to perform their contractual obligations owing to unforeseen circumstances or factors beyond their control. Equally, in cases where the performance of contractual obligations by one party is premised on the performance of reciprocal obligations by the other, the contractor may be unable to timely perform the contract should the State fail to perform its end of the bargain. In such cases, the private contractor prematurely suffers a forfeiture of security deposit at the hands of the State. A similar factual position arose before the Supreme Court inJai Durga Finvest (P) Ltd. v. State of Haryana & Ors, wherein the performance of contract by the private party was dependent on the performance of obligation by the State entity. The issue to be considered was the justifiability and legality of forfeiture of security deposit where the contract stood frustrated due to non-performance of reciprocal obligations by the State. The Supreme Court disagreed with the findings of the High Court in permitting forfeiture of security deposit and remanded the matter for reconsideration by the High Court on the point of frustration of contract at the instance of the State entity.
A contracting party may also be disadvantaged in cases where security deposit is forfeited by the State entity stating that there are outstanding dues to be recovered under the contract, while failing to give any computation of such dues. In such an event, the only recourse available to the contracting private party is to invoke the dispute resolution mechanism set out within the contract (mostly, arbitration) and await the outcome (spanning over years). To further complicate matters, in cases of sub-contracting arrangements and back-to-back contracts, disputes between sub-contractors and the contractor are likely to impact performance and operations under the main contract with the State, therefore exposing the contractor to greater possibilities of forfeiture under the main contract.
It has also been noticed that in some cases, policies and executive orders have been framed directing a complete refund of security deposit, while granting relaxations in the terms of the contract. What follows is that the State entity is statutorily not permitted to forfeit any part of the security deposit. By way of an illustration, the Madhya Pradesh Sand Mining Policy, 2017 stipulates a complete refund of security deposit upon surrender of sand mines by a successful bidder. Executive orders and administrative policies such as the Madhya Pradesh Sand Mining Policy, become the applicable law governing and regulating the sector and by operation, necessarily supersede any contractual right that the State has under a contract with a private party. It is incumbent upon the State to strictly comply with such policies and orders, as the applicable law.
While such policies may be viewed as being favorable for the private contractor, they may have the effect of making the State entity not profitable. It is therefore imperative to reconcile the contractual rights of State entities with statutory obligations.
What falls from the foregoing is the increasing need to balance the interests of State entities and private parties in forfeiture clauses. Perhaps, a solution may be to introduce provisions in the infrastructure contract which stipulate deposit of the disputed security amount in an interest-bearing account until resolution of disputes between the parties. This could ensure that the monies are not lost and securely deposited for the party which may ultimately stake a claim on the amount.
Remedies against arbitrary adjustment & forfeiture of Security Deposit: Judicial interference in Writ Jurisdiction
Infrastructure contracts with State entities typically contain a dispute resolution clause and disputes on part refund or non-refund of security deposit would therefore be resolved as per the dispute resolution mechanism set out in the infrastructure contract (often arbitration). Such dispute resolution mechanism is however likely to be both time and cost intensive. The question that therefore merits consideration is whether disputes on adjustment or forfeiture of security deposit can be agitated within the writ jurisdiction of the Courts.
It is well established through judicial precedent that writ jurisdiction under Article 226 of the Constitution of India, 1950 is very limited. Itcannot be invoked in cases where the relationship between the State and private parties is governed only by terms of the contract. Writs or orders under Article 226 of the Constitution can thereforenot be issued to compel the State to remedy breach of contract pure and simple. This is because, upon execution of a contract, the State entity functions contractually and is no longer governed by constitutional provisions, rather, by the contract which determines the rights and obligations of the partiesinter se. Therefore, a party claiming refund of security deposit (which requires enforcement of a contractual right) may not be entertained in writ jurisdiction and would be required toapproach a competent civil court or pursue the mechanism stipulated in the dispute resolution clause under the contract. That said, this limitation of ouster of writ jurisdiction appears to be restricted to cases which purely involve allegations of breach of contract.
In certain cases, however, the right to obtain a refund of security deposit may arise out of an executive order or administrative policy whereby the State entity may be directed to fully refund the security deposit. Illustratively, Clause 20 of the Madhya Pradesh Sand Mining Policy, 2017 directs Madhya Pradesh State Mining Corporation to refund the entire amount of security deposit upon surrender of sand mine while making relaxations in the terms of the contract. In such cases, the right to receive complete refund of security deposit is statutory in nature and it is incumbent upon the State entities to act as mandated by the statute. Where the State fails to act in accordance with its statutory duties, theaggrieved party has a legal right under the statute to enforce its performance. Private contractors may therefore consider filing writs of mandamus seeking compliance of statutory duty to obtain complete refund of security deposit. As the very purpose of mandamus lies inenforcement of statutory provisions and executive orders, private contractors are likely to obtain expeditious and cost-effective relief through the writ mechanism.
That said, the position of law in relation to the contracts executed by State entities appears to have undergone a significant change. Specifically, the Supreme Court inABL International Ltd. & Anr. v. Export Credit Guarantee Corporation has held that even in cases of commercial contracts, State entities are obligated to act justly and reasonably in the performance of contractual obligations. An arbitrary, unfair, unreasonable, or unjust act of the State entity is a violation of Article 14 of the Constitution, and the aggrieved party may invoke writ jurisdiction. Private contractors may therefore consider filing writs under Article 226 seeking refund of security deposit. The maintainability of such writs would depend on the facts and circumstances of the case and specifically, the ability of the private contractor to establish that the action of adjustment or forfeiture of security deposit is arbitrary.
Initiatives by the State for smooth refund of security depositRecognizing the predicament of private parties in non-performance of contracts due to COVID-19, the Ministry of Finance recently promulgated the Vivad Se Vishwas I – Relief for MSMEs scheme in February 2023. In terms of this scheme, 95% of the security deposit forfeited from MSME’s would be refunded in cases of contracts where the delivery period was between 19 February 2020 to 31 March 2022.
To receive such refund, the MSME vendor would be required to register on the Government e-Marketplace (“GeM”) portal and enter relevant details of the contract. The GeM portal will notify nodal officers to verify the claim of the MSME vendor. Pursuant to due diligence, the nodal officer will refund the due amount and update the portal with the amount, date, and transaction details of the payment.
Prior to this, the Ministry of Finance in November 2020 had reduced the security deposit required in government contracts. While government contracts ordinarily require bidders to deposit 5-10% of the contract value towards security deposit,this proportion was reduced to 3%. The benefit was also extended by the Ministry in December 2021for all contracts concluded up till 31 March 2023. The intent of introducing and extending the scheme was to aid private parties’ tide over the liquidity crunch post the COVID-19 pandemic. It was intended that the additional resources will be deployed by private parties in proper and timely execution of infrastructure projects.
Views expressed in the article are personal and do not reflect the views of the Firm.
About the Authors
Ms. Shreya Sircar is a Partner at Luthra and Luthra Law Offices, India.
Ms. Sanjukta Roy is an Associate at Luthra and Luthra Law Offices India.
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Preferred Method of Citation
Shreya Sircar and Sanjukta Roy, “Forfeiture of Security Deposit in Infrastructure Projects: Balancing State and Private Interests” (IJPIEL, 30 May 2023)