The True Final Word on Compound Interest in Arbitral Awards?

4th August, 2022 - 9:52 am Categories: Legal Issues 0 Comments

The Arbitration and Conciliation Act, 1996 allows arbitral tribunals to award interest on the money payable under an award, running from the date on which to the cause of action arose, to the date on which the award was made. The Act also empowers tribunals to award post-award interest, which accrues until the award has been realised. In UHL Power Company Ltd v State of Himachal Pradesh, the Supreme Court of India decided whether the Act empowers arbitrators to award compound interest, and whether post-award interest can be calculated on top of the pre-claim interest. This article discusses the Supreme Court’s decision, as well as significant preceding developments on this topic.

Facts of the Case

UHL Power Company Ltd. (UHL) entered into a Memorandum of Understanding (MoU) and an implementation agreement with the State of Himachal Pradesh, with the objective of undertaking a hydro-electric power project in Himachal Pradesh. A dispute arose, and was referred to a sole arbitrator (Retired Justice R.K. Mahajan) as per the arbitration clause incorporated in the implementation agreement. The arbitrator awarded a sum of Rs. 26,08,89,107.35 to UHL. This sum included expenses incurred by UHL, along with pre-claim compound interest on the expenses at the rate of 9% per annum. Further, in case the State failed to pay the awarded amount to UHL within 6 months of the date of the award, UHL would be entitled to interest calculated on the entire awarded amount (with pre-claim interest) at the rate of 18% per annum.

The award was challenged by the State before a Single Judge of the Himachal Pradesh High Court under Section 34 of the Arbitration and Conciliation Act, 1996 (Hereinafter, “the Act”). The Single Judge set aside the award passe din UHL’s favour in its entirety. UHL appealed against this order to a Division Bench of the High Court under Section 37 of the Act. The Division Bench modified the award, reducing the sum payable by the State to UHL to Rs. 9,10,26,558.74. This sum consisted of the expenses claimed by UHL, as well as simple interest calculated on top of the expenses at the rate of 6% per annum, from the date UHL filed its claim to the date it received full payment. The Division Bench placed reliance on the Supreme Court’s judgement in State of Haryana v S.L. Arora while doing away with the pre-claim compound interest and interest on interest. Both parties filed appeals against the Division Bench’s order.

Contentions of the Parties

UHL relied on the Supreme Court’s recent decision in Hyder Consulting (UK) Ltd. v Governor, State of Orissa to affirm the validity of the arbitrator’s decision to award pre-claim compound interest. UHL argued that compound interest and interest on interest should be allowed in light of the new judgement.

The State argued that the Division Bench’s decision to overturn the Single Judge’s order was incorrect, as the Division Bench had failed to notice that the implementation agreement and the MoU were separate documents containing distinct arbitration clauses. The State also argued that an award should not have been made in UHL’s favour in the first place, as the State had not incorrectly terminated the agreement.

Legal Developments Leading up to this Decision

Historically, High Courts and the Supreme Court have maintained that the Act does not empower arbitrators to award compound interest or interest on interest in the absence of a clause in the contract explicitly allowing it. The decision in S.L. Arora is arguably the most important in this string of judgements. In this case, a two Judge Bench of the Supreme Court held that the “sum” referred to in Section 31(7) of the Act refers only to sums awarded by the arbitral tribunal on substantive claims, and did not include interest. As Section 31(7) only empowers the arbitrator to award interest on top of this sum, and the sum does not include interest, the arbitral tribunal is not empowered to award compound interest or interest on interest.

Subsequently, another two Judge Bench of the Supreme Court disagreed with the decision in S.L. Arora in Hyder Consulting (UK) Ltd. v Governor, State of Orissa. This decision had to be referred to a larger bench to resolve the resulting conflict.

Before the three Judge Bench had delivered its judgement, the Law Commission of India published a report recommending an amendment to Section 31(7) that clarified that arbitrators were empowered to award compound interest, even when it was not explicitly allowed by the contract. The Report noted that while compound interest had not been allowed under the Arbitration Act, 1940, the language of the 1996 Act is much broader. The report also referred to the Supreme Court’s judgement in Renusagar Power Co Ltd v General Electric, where it had held that compound interest is not against the public policy of India, and that in some cases it was necessary to ensure full restitution for the aggrieved party.

Finally, the much-awaited decision of the three Judge Bench in Hyder Consulting overruled S.L. Arora, highlighting that Section 31(7)(a) of the Act uses the language, “the arbitral tribunal may include in the sum for which the award is made interest”. Therefore, the sum did in fact include interest, and was not just the money payable on substantive claims. Interestingly, this was not a unanimous decision, but was supported by a majority of two judges. Justice H.L. Dattu, the dissenting judge, was in complete agreement with S.L. Arora, and reiterated that interest could not be considered to be a part of the sum on which interest can be awarded under Section 31(7)(b).

Decision of the Court

The High Court’s Division Bench relied on S.L. Arora in 2011, three years before it was overruled by Hyder Consulting. While deciding the present appeals, the Supreme Court took note of this important development. As the law had already been settled in Hyder Consulting, the Court overruled the Division Bench’s order through a unanimous decision. The Court held that arbitral tribunals are empowered to award compound interest and interest on interest, even when the agreement does not expressly allow it. Therefore, the arbitral award made in UHL’s favour was restored.

Another noteworthy aspect of this opinion is its emphasis on the narrowness of the scope of inquiry under Sections 34 and 37 of the Act. The Court observed that while hearing the State’s challenge under Section 34 of the Act, the Single Judge of the High Court had acted as a court of appeal and had re-appreciated the sole arbitrator’s findings. In this vein, the Court referred to Dyna Technologies (p) Ltd. v Crompton Greaves Ltd, where it had held that if a contract has two possible constructions, the court cannot substitute its own view for the arbitrator’s while hearing a Section 34 application.

Conclusion

Hyder Consulting overruled S.L. Arora through a 2:1 majority judgement. In a purely legalistic sense, the decision in Hyder Consulting settled the issue of compound interest. However, it still left many unsatisfied, as in practice, only two judges had overruled the decision of another two Judge Bench. The present decision is significant because it marks the first time three judges of the Supreme Court have unanimously held that arbitrators are empowered to award compound interest and interest on interest, even when the contract does not explicitly provide for it.

Another important characteristic of this opinion is that it went out of its way to strike a note of caution about restricting the scope of judicial review in a Section 34 application. Minimal judicial interference is one of the cornerstones of a strong arbitration regime, and the Indian legislature has been making strides towards achieving this goal. Therefore, the comments of the Bench are welcome.

Author: Aasil Singh – a 3^rd Year Student at MNLU, Mumbai, in case of any queries please contact/write back to us via email chhavi@khuranaandkhurana.com or at Khurana & Khurana, Advocates and IP Attorney.