Editor's Column

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This Blog is written by Amrith R. | Column Editor

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COURT: The Hon’ble Supreme Court of India

CITATION: 2020 SCC OnLine SC 451

CASE NUMBER: Civil Appeal No. 673 of 2012

DELIVERED ON: May 11, 2020

BENCH: N.V RAMANA, MOHAN M SHANTANAGOUDAR, AJAY RASTOGI, JJ.

INTRODUCTION:

A three-judge bench of the Hon’ble Supreme Court of India, comprising Hon’ble Justice N.V. Ramana, Hon’ble Justice Mohan M. Shantanagoudar and Hon’ble Justice Ajay Rastogi has, vide its judgment dated 11 May 2020 passed in the matter of South East Asia Marine Engineering and Constructions Ltd (SEAMEC Ltd) v Oil India Limited (Civil Appeal No. 673 of 2012), held that where the interpretation provided by an arbitral tribunal to a contractual provision in an award was not reasonably possible upon a reading of the contract as a whole, the same was liable to be set aside under Section 34 of the Arbitration and Conciliation Act, 1996 (Arbitration Act). Upholding the decision of the Gauhati High Court (HC), the SC held that the interpretation of the contract by the arbitral tribunal could not be a possible interpretation since it was entirely inconsistent with the wording and purpose of the contract. The SC set aside the arbitral award on the grounds that the tribunal’s interpretation of the underlying contract was implausible and perverse and, therefore, is against the public policy of India.

FACTUAL BACKGROUND OF THE CASE:

SEAMEC was awarded a work order by OIL for carrying out drilling and other ancillary operations in Assam after duly signing a Contract and the tender process. The Contract contained a ‘change in law clause’ (“Clause 23”) which read as follows:

“23. SUBSEQUENTLY ENACTED LAWS: Subsequent to the date of price of Bid Opening if there is a change in or enactment of any law or interpretation of existing law, which results in additional cost/reduction in cost to Contractor on account of the operation under the Contract, the Company/Contractor shall reimburse/pay Contractor/Company for such additional/reduced cost actually incurred.” 

During the subsistence of the Contract, there was an increase in the price of high-speed diesel (HSD) – a material essential for the SEAMEC’s drilling operations. The price change was caused by a circular issued by a governmental authority which would amount to an Executive Order.

SEAMEC claimed that an increase in price of the HSD was caused by a ‘change in the existing law’ within the meaning of Clause 23 and, as such, called upon OIL to reimburse the increased amount. OIL refused, claiming that the effect of an Executive Order cannot be termed as a change or enactment of ‘law’. Aggrieved, SEAMEC invoked arbitration against OIL in terms of the Contract.

The Arbitral Award

The arbitral tribunal allowed SEAMEC’s claim. It was held that although an increase in price of the HSD by way of a circular is not ‘law’, it however, has the ‘force of law’. It was held that the Executive Order could therefore trigger the provisions of Clause 23. While arriving at its decision, the arbitral tribunal applied the principles of harmonious interpretation. The Award passed by the arbitral tribunal in 2003, allowed the claim of SEAMEC and awarded them a sum of INR 98,89,564.33 along with interest at 10% p.a. from date of Award till recovery of money. The awarded amount was subsequently revised to INR 1,32,32,126.36 later in 2005. The Tribunal held that while a circular issued by a State or the Union Government increasing the price of HSF would not be a “law” in the literal sense, it had the “force of law” and would therefore be covered by Clause 23 of the Contract.

In order to interpret to the scope of Clause 23, it was observed that the entire Contract must be looked at; and exclusion must not be readily inferred unless it is clearly stated. On a liberal construction of the Contract, the arbitral tribunal held that the expressions ‘law’ or ‘change in law’ in Clause 23 meant to include escalation of price of HSD caused by the Executive Order. Clause 23 was therefore identified as a ‘Habendum Clause’.

Challenge to the award at the District Court and High Court

When the award was challenged under Section 34 of the Arbitration and Conciliation Act 1996, the District Judge found that the tribunal’s findings were not against the public policy of India. The award did not suffer from a patent illegality and, as such, did not warrant judicial interference. The award was thus upheld. However, under Section 37 of the Arbitration Act, OIL challenged the District Court’s decision before the Guwahati High Court.

In appeal, the Guwahati HC observed that the arbitral tribunal had overlooked the terms of the contract and incorrectly interpreted its terms. It was further observed that Clause 23 was akin to a ‘force majeure’ clause and must have been included in the contract keeping in mind Section 56 of the Indian Contract Act, 1872. Surprisingly, however, the High Court made this observation despite the fact that ‘force majeure events’ were explicitly recognized under a separate clause of the Contract.

The HC held that the interpretation of the terms of the Contract by the Arbitral Tribunal was erroneous and was against the public policy of India. Accordingly, the High Court reversed the District Court’s decision and set aside the arbitral award. SEAMEC challenged the High Court’s decision before the Supreme Court.

ISSUE:

Whether the interpretation of the contract provided by the Arbitral Tribunal was reasonable and fair, so that the same passes muster under Section 34 of the Arbitration Act?

ARGUMENTS ADVANCED BY SEAMAC:

1. The arbitral tribunal’s interpretation of Clause 23 of the Contract was correct and ought not to have been interfered with by the High Court.

2. Where there were two possible views that could be taken on the same question of law, the High Court could not substitute the view of the arbitral tribunal and would have to defer to it. Reliance was placed on the case of McDermott International Inc v. Burn Standard Co Ltd & Ors.[1].

3. The answer to the question of law posed by the proceedings in the Award was neither against the public policy of India nor was it patently illegal and was beyond the scope of judicial review under the scheme of the Arbitration Act.

ARGUMENTS ADVANCED BY OIL:

1. The Award was perverse and illegal since its interpretation of the terms of the Contract amounted to virtual re-writing of the said terms. This was also in conflict with the public policy of India.

2. The arbitral tribunal had failed to notice the terms and conditions of the Contract in violation of Section 28(3) of the Arbitration Act and had thus exceeded its jurisdiction.

3. This was not a case where the arbitral tribunal accepted one of two possible interpretations of a contract. The challenge to the Award was raised on the grounds of perversity and unreasonableness. Therefore, under Section 34 of the Arbitration Act, this was a case fit for judicial review.

JUDGEMENT OF THE HON’BLE SUPREME COURT:

OIL argued that the arbitral award does not consider the contract as a whole; and thus, failing to follow the cardinal principle of interpretation of contract. In addition, it was also submitted that the tribunal’s interpretation of Clause 23 was in conflict with the terms of the contract; thereby making the arbitral award contrary to the public policy of India.

However, interestingly, the Supreme Court disagreed with not only the view taken by the Arbitral Tribunal, but also that of the High Court.

While the Supreme Court agreed with the tribunal’s decision to undertake a harmonious interpretation of the Contract, it was observed that the Tribunal failed in its endeavor to apply the same standard while interpreting Clause 23. As per the Contract, the contract price was payable to the ‘contractor’ (i.e. SEAMEC) for full and proper performance of its contractual obligations. The rates, terms and conditions of the said contract were to be in force until the completion or abandonment of the last drilling operation.

On this basis, the Supreme Court inferred that the contract contemplated a fixed rate for SEAMEC. The Supreme Court also noted that other terms of the Contract require that all fuel would be supplied by the ‘contractor’ at its own cost. There was no specific language in the Contract to indicate that change in price amounted to change in law. Further, SEAMEC failed to lead adequate evidence to prove that Clause 23 was meant to have an expansive meaning to bring within its ambit change in rate of HSD. Accordingly, the Supreme Court held that price fluctuations were beyond the scope of Clause 23. SEAMEC would not be entitled to any reimbursement for the price increase in HSD.

The Supreme Court also rejected the High Court’s view that Clause 23 was similar to a force majeure clause or that it attracted Section 56 of the Contract Act. Rather, it was observed that under the Indian contract law, doctrine of frustration discharges parties from all future obligations. This could not have been the parties’ intent for including Clause 23. On the contrary, Clause 23 was inserted in the contract so as to mitigate the risk of harsh consequences of frustration as well as to uphold the sanctity of the contract.

The Supreme Court, in Dyna Technologies Pvt. Ltd. v. Crompton Greaves Ltd.[2], had observed that courts should not interfere with arbitral awards merely because an alternative view exists; unless the award portrays a perversity defer to the view taken by the arbitral tribunal even if the reasoning provided in the award is implied unless such award portrays a perversity that is ‘unpardonable’ under Section 34 of the Act.

The Supreme Court relied on Dyna to further clarify that where two views are possible, the Court cannot interfere in the plausible view taken by the arbitrator supported by reasoning. Such reasoning may be implied. However, that said, the Supreme Court found that the arbitral tribunal’s interpretation of Clause 23 was not even a possible one.

Particularly, the tribunal’s decision to accord a wide interpretation of Clause 23 was not accepted since, in the court’s view, the thumb rule of interpretation is that the contract must be read as a whole and mutually explanatory to the extent possible. It was found that the tribunal had ignored this basic rule in interpreting Clause 23. Having assessed the other terms of the Contract, the Supreme Court opined the Contract was in fact based on a fixed price. It was therefore held that the tribunal’s expansion of Clause 23 to include a price change in HSD could not have been a possible interpretation since SEAMEC did not adduce any evidence to prove this.

Ultimately, whilst disagreeing with its reasoning, the Supreme Court refused to interfere with the High Court’s decision to set aside the arbitral award.

ANALYSIS:

After a perusal of the facts and circumstances of the case and case precedents, it could be said that the arbitral tribunal’s view was erroneous as it defeated the purpose and intent of the rule of harmonious interpretation. A court or tribunal must strive to harmoniously interpret the terms of a contract to advance the intention of the parties. It is settled law that intention of the parties can be gathered from the terms of the contract. However, in the present case, the arbitral tribunal ignored those terms of the said contract which clearly indicated that change in price of the fuel would not accrue any additional entitlement to the affected party. Hence, the arbitral tribunal’s interpretation of Clause 23 rendered otiose several other provisions of the Contract.

While the High Court rightly set aside the arbitral award, the Court reasoned wrongly in equating Clause 23 with a ‘force majeure’ clause. This is mainly because there the Contract already contained a clause which explicitly recognized the impact of force majeure events. The case of SEAMEC is a not a unique one where contractors have faced reluctance on part of the judiciary to acknowledge and implement change in law to the former’s benefit. In Energy Watchdog v. Central Electricity Regulatory Commission,[3] even though the price of imported Indonesian coal was raised astronomically by the Indonesian Government, the Supreme Court refused to grant relief by way of compensatory tariff citing the Change in Law clause, stating that change in foreign law could not invoke said clause.

The presence and invocation of a Price Variation clause could have been beneficial in these cases. The Supreme Court has duly observed and held in the matter of Food Corporation of India v. AM Ahmed & Co.[4] that even if there is no clause pertaining to price escalation, the contractor shall be entitled to the same if the delay was attributable to the employer. In this case, the Arbitral Tribunal found that there was escalation by way of statutory wage revision and therefore, came to the conclusion that it was reasonable to allow escalation under the same. A similar precedent was set by the Supreme Court in JG Engineers Pvt. Ltd. v. Union of India[5] wherein it upheld an award entitling the contractor to price escalation despite it being conditional in term of the contract for the extended period of the contract, wherein delay was attributable to the employer. Even if the courts seem more inclined toward granting relief under a Price Escalation clause, it has to be borne in mind that an arbitrator must apply terms of the contract for determining the valuation of claim if it is a result of price variation of materials. In Bedi Construction Co. v. Delhi Development Authority,[6] it was held that if an increase in prices of material purchased by contractor or labor rate is more than 10% of the value of the contract, then the contractor can only make a claim in respect of the increase in prices that also for the amount which goes beyond 10% of the contract value. Thus, to a contractor, it may seem more feasible to invoke a Price Variation clause to compensate for the statutory increase of prices of materials given that the drafting of this clause is usually more forthcoming than a Change in Law clause, even though there is always a threshold to the relief that can be granted under a Price Variation clause as opposed to a Change in Law clause.

INTERPRETATION OF ‘PERVERSITY’ OF AWARDS:

It is a settled rule of arbitration that reasoning taken by the Arbitral Tribunal should not be interfered with even if it differs from the view the Bench would have taken unless the reasoning portrays perversity which is unpardonable under Section 34 of the Arbitration and Conciliation Act, 1996. The Court cannot sit in an appeal on the Arbitral Award and its only scope of inquiry is to check that the interpretation of the Tribunal is not absurd or perverse.

It may be noted that “perversity” as a ground for interference with awards was present even in the cases under the Arbitration Act, 1940.[7] “Public policy” in the 1996 Act was given an expansive interpretation to include patently illegal cases in ONGC v. Saw Pipes.[8] In ONGC Ltd. v. Western Geco International Ltd.,[9] this ground of perversity was enumerated as a valid ground under violation of “public policy” to set aside awards. By including “patent illegality” separately in sub-section (2A) to Section 34 on the recommendations of the 246^th Report of the Law Commission,[10] the Arbitration and Conciliation (Amendment) Act, 2015 sought to limit “perversity” as a ground of setting aside domestic awards only by taking it away from the ambit of “public policy”. Thus, as clarified in Ssangyong Engineering & Construction Co. Ltd. v. NHAI,[11] a perverse finding on an arbitral award is a ground covered by “patent illegality” and not “public policy”. This implies that foreign awards given after October 23, 2015, i.e. the date on which the Amendment Act comes into force, shall be free from exploitative use of “perversity” as a ground (under public policy) to set them aside. This ground is only available in the context of domestic awards.[12]

In Triveni Rubber & Plastics v. CCE,[13] the Supreme Court held that a ‘perverse’ finding is one that is not only against the weight of the evidence but is based on no evidence. The standard of a ‘perverse’ finding is thus, very strict. In practice, however, this exercise of enquiring whether the interpretation is reasonable and fair is itself, an interpretative endeavor. In SEAMEC, the Supreme Court stated that the Arbitral Tribunal had not been very circumspect of the contract terms and conditions. “If the purpose of the tender was to limit the risks of price variations, then the interpretation placed by the Arbitral Tribunal cannot be said to be possible one, as it would completely defeat the explicit wordings and purpose of the contract.” Relying upon this interpretation of the terms of the contract, the Court reassessed and re-appreciated the evidence on record, effectively sitting in an appeal over the award.

In Rashtriya Ispat Nigam Limited v. Dewan Chand Ram Saran,[14] even when the Court was of the opinion that the interpretation in arriving at the Arbitral Award was not a plausible one, since it was a ‘possible’ interpretation, the Division Bench refrained from sitting in judicial review over the Award. It was held that an error in construction of the contract cannot be said to be a jurisdictional error.[15] These precedents in favor of upholding arbitral awards have, unfortunately, not been followed by SC in its judgement in the SEAMEC vs. OIL case.

In Navodaya Mass Entertainment Ltd. v. J.M. Combines,[16] the Supreme Court had held that “Once the arbitrator has applied his mind to the matter before him, the court cannot reappraise the matter as if it were an appeal and even if two views are possible, the view taken by the arbitrator would prevail.” Despite the jurisprudence laid down in Navodaya case, in  SEAMEC judgment, both the High Court and the Supreme Court failed to appreciate the interpretation of Clause 23 that was adopted by the Arbitral Tribunal and instead provided its own interpretation of the said clause to conclude that the award passed by the Arbitral Tribunal was perverse, erroneous and against the public policy of India.

COMMENT:

Essentially, what had to be determined was whether the Tribunal’s interpretation was a possible one. The SC acknowledged the permissible scope of interference in an arbitral tribunals award as laid down in the Dyna case; however, on a perusal of the facts of the case, it observed that Clause 23 could not have been interpreted so broadly as to bring within its scope a price increase – one that was effected by a means other than a change in law. It also noted that there was no evidence to suggest that the parties intended for the clause to have a broad meaning. Accordingly, the SC dismissed SEAMEC’s appeal and stated that they were not inclined to interfere with HC’s judgment.

It is important to restate the mandate of Section 34 of the ACA, and while doing so, to revisit a few important cases that help explain when a finding of an arbitral tribunal would be perverse. It is well-settled law that where two views are possible, the court cannot interfere in the plausible view taken by the arbitral tribunal. It would thus follow that only a perverse view that may not be considered a reasonably possible view. Therefore, the pertinent question is, “what would constitute a perverse view?” or rather “how high is this threshold of perversity?”

Two judgments of the SC help to answer these questions. First, as held in H.B. Gandhi v. Gopi Nath & Sons,[17] a finding would only be perverse if it were arrived at by ignoring relevant material or if the finding were so outrageously illogical that it suffered from the vice of irrationality. Second is the case of Kuldeep Singh v. Commr. of Police,[18] wherein the court observed that a broad distinction has to be maintained between decisions that are perverse and those which are not. The court went on to hold that a decision would not be perverse, and the findings should not be interfered with if they are arrived at based on some evidence that is reliable, regardless of how compendious it may be.

Two important facets of the Tribunal’s award need to be highlighted. First, the Tribunal utilized the liberal interpretation rule while interpreting Clause 23. Second, in doing so, it placed reliance on the testimony of OIL’s witness when he stated that change in HSD prices were never done by way of statutory enactment by either the Parliament or the State Legislatures. Accounting for this and interpreting Clause 23 liberally, the Tribunal held that the price change in question would fall under the ambit of the clause. The SC disagreed with the interpretation of the Tribunal and stated that the rule of thumb would be to read a contract as a whole and mutually explanatory. Further, and perhaps overlooking the testimony of OIL’s witness, it stated that no evidence was adduced to show that the intention of the parties was for Clause 23 to have a broad meaning.

It is settled law that a particular arbitral award can be set aside on the ground of ‘public policy’ would depend on factors such as a) disregarding orders of superior courts; b) lack of judicial approach, or an arbitrary approach; c) lack of application of principles of natural justice; d) a decision is so perverse or so irrational that no reasonable person would have arrived at the same conclusion. From the judgment, it could be averred that the SC failed to test the award on the aforesaid judicially developed contours.

In the instant case, the SC held that broad interpretation of clause 23 of the Contract is not the possible interpretation as it would defeat the purpose of the contract.  It is apposite to note that said reasoning does not specify whether narrow or broad interpretation would invite the Court’s intervention to set aside the arbitral award. Moreover, interpretation of the contract, irrespective of narrow or broad, would not itself entail the triggering of violation of public policy or perversity of the award. It is also imperative to note that Court did not categorically specify under which ground of Section 34 of the Act, the impugned award is set aside as Court merely set aside an arbitral award on the pretext that a broad interpretation of the clause 23 is not possible one, thus judgment suffers from the legal infirmity.

CONCLUSION AND WAY FORWARD:

In conclusion, there certainly appears to have been enough reason for the SC to uphold the validity of the award and reverse the decision of the HC. While it is unfortunate that this award was set aside, what remains to be seen is if subsequent benches of the SC will follow suit. Faith in arbitration in India is on the rise, and the last thing we would need is for courts to begin substituting the interpretations of tribunals with their own. One hopes that this incident was a one-off that occurred because of the peculiar circumstances of the case and that subsequent courts continue to defer to the wisdom of arbitral tribunals.

Court through the said judgment uprooted the settled position of law that interpretation of the contract is the task of the arbitrator and cannot interfere unless suffers from grave perversity which goes to the root of the matter. The consequence of the said judgment would be that Section 34 would now be susceptible to misuse by the parties, as the issue involved in the instant case regarding interpretation of the contract, is a common issue in most of the contractual matters of arbitration and therefore would broaden the ambit of Section 34 of the Act which is not intended by the Legislature. This will further prolong the dispute under Section 34 of the Act and the parties will unnecessarily drag the arbitral award to the appellate court on the sole ground of interpretation of the contract, thereby diluting the sanctity of the arbitral tribunal.

The decision in State of A.P. v. A.P. Jaiswal may be aptly quoted here, “Consistency is the cornerstone of the administration of justice. It is consistency which creates confidence in the system and this consistency can never be achieved without respect to the rule of finality.”[19]  Judges presiding over arbitration matters should be conscious of the harms that entail arbitrary interference with awards. The judgment in SEAMEC will open a floodgate of challenges under Section 34, which the Courts will now have to deal with, once more, shifting the focus of arbitration away from Tribunals and bringing settlements into the domain of courts.

A thin line separates the boundaries between whether an interpretation is reasonably possible or not at all possible. Courts must exercise caution when treading the line, so as to not makeshift balance in a way that vitiates the objectives of resolving disputes using the mechanism of arbitration.

REFERENCES

[1] McDermott International Inc v Burn Standard Co Ltd & Ors ((2006) 11 SCC 181).

[2] Dyna Technologies Pvt. Ltd. v Crompton Greaves Ltd (2019) SCC Online SC 1656

[3] Energy Watchdog v. Central Electricity Regulatory Commission ((2017) 14 SCC 80)

[4] Food Corporation of India v. AM Ahmed & Co (AIR 2007 SC 829)

[5] JG Engineers Pvt. Ltd. v. Union of India (AIR 2011 SC 2477)

[6] Bedi Construction Co. v. Delhi Development Authority ((2009) ILR Supp. 8 Del 52)

[7] Arosan Enterprises Ltd. v. Union of India, (1999) 9 SCC 449

[8] ONGC v. Saw Pipes (2003) 5 SCC 705.

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

[10] 246th Report of the Law Commission, available at: http://lawcommissionofindia.nic.in/reports/Report246.pdf

[11] Ssangyong Engineering & Construction Co. Ltd. v. NHAI – Civil Appeal No. 4779 of 2019 (Arising out of Special Leave Petition (Civil) No.19033 of 2017)

[12] Board of Control for Cricket in India v. Kochi Cricket Pvt. Ltd. and Etc., Civil Appeal Nos. 2879-2880 of 2018 along with other civil appeals.

[13] Triveni Rubber & Plastics v. CCE AIR 1994 SC 1341.

[14] Rashtriya Ispat Nigam Limited v. Dewan Chand Ram Saran (2012) 5 SCC 306

[15] MSK Projects India (JV) Limited v. State of Rajasthan, (2011) 10 SCC 573.

[16] Navodaya Mass Entertainment Ltd. v. J.M. Combines (2015) 5 SCC 698

[17] H.B. Gandhi v. Gopi Nath & Sons, 1992 Supp (2) SCC 312

[18] Kuldeep Singh v. Commr. of Police Civil Appeal No. 6359-6361 of 1998

[19] State of A.P. v. A.P. Jaiswal, (2001) 1 SCC 748, para 24