Arbitration
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This article has been written by Hritika Jannawar, pursuing a Diploma in General Corporate Practice: Transactions, Governance, and Disputes from LawSikho.

Introduction

This case arose out of the challenge to an arbitral award dated 2nd May 1999 by the Appellant ONGC. It was heard by the bench of M.B Shah J. and Arun Kumar J. and proves to be one of the prominent topics to be discussed in the history of arbitration law in India because it tests the boundaries of the review of arbitral award at length on the grounds of public policy. One of the most important objectives of the Arbitration and Conciliation Act, 1996 is to obtain a resolution of disputes without any unnecessary delays and expense, the judicial intervention was limited to only subjects matter of public interest, but as the Hon’ble Supreme Court liberally interpreted ‘public policy’ under the said Act in this judgment thereby widened the scope of the subject matters to which the judiciary would have last say.

Where the scope of arbitral awards to have judicial interference increases it is pertinent to see to what extent the aforementioned interpretation holds good for the success of any alternate dispute resolution mechanism. In this article, we try to analyse the Court’s reasoning for this pronouncement, whether the said pronouncement was justified, and at last to conclude with what consequences it had.

Facts

Respondent Company Saw Pipes which dealt in the business of supply of equipment for offshore exploration of oil entered an agreement with the appellant ONGC to supply them with casing pipes. Due to the reason for worker’s strike all over Europe at that time, the raw material which was agreed by them, could not be acquired by the respondent in time to complete the order. This had been conveyed by the respondent to the appellant and the appellant in response to it extended the delivery date stipulating that the amount equivalent to liquidated damages for delay in supply of pipes would be recovered from the respondent. There was a clause in the contract that stated – for delay of every week the contractor will be charged 1% of the whole unit price of the order or the part which the contractor has failed to deliver and these liquidated damages can be recovered up to the ceiling limit of 10% of the whole price of the unit. It has also been agreed by the parties that the stipulated liquidated damages are genuine, pre-estimated, not in the form of penalty, and can be deducted from the bill of the payment.

Respondent had caused the delay and when the appellant withheld the US $ 3, 04,970.20 and Rs. 15, 75,559/- on account of customs duty, freight charges, sale tax by way of liquidated damages. The respondent disputed the deduction and the dispute was referred to the Arbitral tribunal. The Arbitral tribunal passed the award in favour of Respondent. Aggrieved by this Appellant filed an appeal challenging the arbitral award before the Bombay High Court which was dismissed and hence the present appeal was filed in Supreme Court.

Issues raised

  1. Whether the Supreme Court has jurisdiction under Section 34 of the Arbitration and Conciliation Act, 1996 to entertain the present appeal?
  2. Whether the award can be set aside if the tribunal has failed to follow the procedure prescribed under the Arbitration and Conciliation Act, 1996?
  3. Whether the award can be set aside on the grounds of ‘public policy’ if it violates provisions of substantial law under Section 34 of the Arbitration and Conciliation Act, 1996?

Judgment

The major and the foremost issue in the present case was the jurisdiction. Section 34 of the Arbitration and Conciliation Act, 1996 (hereinafter referred to as Act) provides various grounds giving power to the Court to set aside the arbitral award. To discuss the matter of jurisdiction, first, it is pertinent to discuss a few provisions of the Act.

  1. Tribunal is mandated under sub-section (1) (a) of Section 28 of the Act to decide the dispute in accordance with substantive law for time being force in India
  2. Under subsection (3) of Section 28 tribunal is directed to decide the dispute in accordance with the terms of the contract.

It states- ‘rule applicable to the substance of dispute’ provision of our interest is Sub-sec (3) of 28 which is as follows –‘ In all the cases, the arbitral tribunal shall decide in accordance with the terms of the contract and shall take into account the usages of the trade applicable to the transaction.

  • The court held that the decision of the arbitral tribunal led to the violation of the Indian Contract Act, 1872  as it failed to consider Sections 73 and 74 of the Indian Contract Act and the ratio laid down in Fateh Chand v. Balkishan Das and passed the decision in favor of Saw Pipes on the grounds that ONGC did not prove the loss suffered due to the breach even though the contract stipulated the liquidated damages. The Hon’ble Court relied on Fateh Chand’s decision wherein it was specifically held that jurisdiction of the Court to award compensation in case of breach of contract is unqualified except as to the maximum stipulated, and compensation has to be reasonable. 
  • Under Section 73, when a contract has been broken, the party who suffers from such breach is entitled to receive compensation for any loss caused to him which the parties knew when they made the contract to be likely to result from the breach of it. This section is to be read with Section 74, which deals with penalty stipulated in the contract, inter alia [relevant for the present case] provides that when a contract has been broken, if a sum is named in the contract as the amount to be paid in case of such breach, the party complaining of breach is entitled, whether or not actual loss is proved to have been caused, thereby to receive from the party who has broken the contract reasonable compensation not exceeding the amount so named. If the compensation named in the contract is by way of penalty, consideration would be different and the party is only entitled to reasonable compensation for the loss suffered. But if the compensation named in the contract for such breach is the genuine pre- estimate of loss which the parties knew when they made the contract to be likely to result from the breach of it, there is no question of proving such loss or such party is not required to lead evidence to prove the actual loss suffered by him.
  • The tribunal while passing the Award also ignored the terms of the contract which had clearly provided for pre-estimated genuine liquidated damages and not as a way of penalty in case of breach; violating the terms of the contract, further violating Section 28(3) of the Act. Moreover, when the agreement has been executed by the experts in the field it is difficult to conclude that the intention of the party was different than the language used therein.
  • At this point the question that arose was if the said award has violated the provisions of the Arbitration Act as well as provisions of the substantial law, then whether such award on its face is so erroneous that it could be set aside on the grounds of ‘Public Policy’ under Section 34 of the Act?
  • On this, the court held that if legislative intent is sought by reading other provisions with Sec 34 of the Act, it appears that violation of the provisions of the Act as well as the substance has occurred leading to miscarriage of justice. Not following the procedure by not giving due consideration to the terms of the contract would mean that the Tribunal has acted beyond its jurisdiction and therefore the award would be patently illegal and could be set aside under Section 34 on the grounds of ‘Public Policy’ as it considerably affects the rights of the party.
  • Further, to what extent the term public policy should be interpreted as one of the significant points of discussion. Analysing the past judgments and the constitutional spirit the court came to the conclusion that ‘Public Policy’ cannot be restrained and has to be interpreted liberally thereby including one more aspect to the public policy i.e. ‘patent illegality’. Moreover, the court took in stride the comments by jurist and Sr. Advocate late Mr. Nani Palkhiwala wherein he stated that “if the arbitral tribunal does not dispense justice, it cannot truly be reflective of an alternate dispute resolution mechanism. Hence, if the award has resulted in an injustice, a court would be well within its rights in upholding the challenge to the award on the ground that it is in conflict with public policy in India.”
  • Furthermore, force majeure clauses also could not be invoked in the present case in the face of labour strikes all over Europe because the clause in the contract did not enumerate the possibility of a strike. In a nutshell, the Hon’ble Supreme Court herein set aside the award passed by the tribunal on grounds of patent illegality violating ‘public Policy.’

Critical analysis

Burrough J. once said, “Public Policy is a very unruly horse, and when once you get astride it you never know where it will carry.” The objective of the Arbitration and Conciliation Act, 1996 was to provide finality to the arbitral award and minimal court interference, thereby reducing the workload on the courts at least in the cases of commercial disputes. To maintain this objective of the Arbitration Act, the approach adopted to interpret ‘Public Policy’ has been narrow. The narrower approach reduces interference of the courts and it has been a settled international thought that widening the scope of the ‘public policy’ will necessarily mean opening the floodgates to challenging the arbitral Award, diminishing the very objective of why such a Statute has been brought in the first place. 

The Hon’ble Court in the present case came up with the principle of ‘Patent illegality’ and thereby widened the scope of the Public Policy and took a contrary stand to the narrower approach taken in Renusagar case, which had limited the scope of public policy under following heads- Fundamental Policy of Indian Law, Interest of India, Justice or morality. Patently Illegal could mean – an error of law that goes to the root of the matter; or violation of the constitution or statutory provisions. This broader interpretation was taken from the case of RattanChand Hira Chand v Askar Nawaz Jung (Dead) By L.Rs as the court observed that the contract which has the tendency to injure public interests or welfare is one against public policy. What constitutes an injury to public interest differs from time to time, to these changing conditions the legislature cannot always catch up and it remains the duty of the judiciary to exercise their authority to fill in this lacuna and when they perform these functions they legislate judicially. By doing this, they prevent the perversion of the goals and values of society and also prevent the frustration of the legislation. 

In light of this, the court in the case of ONGC vs. Saw Pipes observed that the award which is in violation of statutory provisions cannot be said to be in the public interest and if the court does not exercise its authority to set aside such awards it would adversely affect the administration of justice. Hence the wider interpretation connoted to the phrase ‘Public policy’ is justified. This interpretation of the ‘public policy’ proved to be a lethal blow to the development of Arbitration law post-1996 by amplifying the possibilities for judicial review. Consequently, this shows that the judiciary has failed to adhere to the principles of ‘separation of powers’ by not paying heed to parliamentary intent behind the 1996 Act, to reduce the supervisory role of the judiciary, and to get quick relief in such commercial disputes wherein almost all cases time is of utmost importance. The question that follows is whether the Indian Judiciary which has already been plagued with a large number of suits will be able to sustain this additional responsibility that it has brought upon itself by adopting a broader interpretation of Public Policy?

Further, a significant criticism is that when the ground for challenging the said arbitral award was present under Section 34(2)(a)v which states that the arbitral award can be challenged if the procedure is not adhered to like in the present case, the need to interpret the public policy in broad light and adding a fourth head to the grounds earlier enumerated was not required. Furthermore, elevating the principle to prove the loss or damage to the pedestal of public policy of India has significantly put a blemish on the operation of the whole Act. The parties who have opted for the mechanism of alternate dispute resolution should be prepared to accept the decision of the Tribunal whatever it may be until the procedure under the Act has been strictly adhered to because if the courts interference increases it will be a failure of Alternate Dispute Resolution mechanism.

It is pertinent to discuss at this juncture the consequences of this judgment and what has parliament proceeded to do towards damage control. Following the trend in the ONGC v. Saw pipes the Hon’ble Supreme Court in ONGC v. Western Geco International Ltd., and Associate Builders v. Delhi Development Authority further widely interpreted ‘fundamental policy of India’  as: 

(i) adopting a judicial approach, 

(ii) following natural justice, and 

(iii) absence of perversity or irrationality tested on the touchstone of Wednesbury principle of reasonableness.

This decision of the Supreme Court rather than minimizing its power has expanded it immensely and to rectify this issue law commission in the 246th report sought to curb the wide interpretation of ‘public policy’ because if it would have not done so the review of arbitral awards would have been on merits of the case. These recommendations by the law commission were adopted by parliament and amended the Act effectively from 23rdof October 2015. While providing for the amendment the law commission admitted that the SC’s decision in ONGC v. Saw Pipes though widely criticised, awards violating the statutory provisions would never be in the public interest. Therefore, sub-sec(2A) in Section 34 of the Act provided patent illegality will be one of the grounds of violating public policy only in cases of domestic arbitral awards. The proviso added makes it more clear stating that this ground cannot be invoked in case of erroneous application of law or by re-appreciation of the evidence. For narrowing the interpretation of the fundamental policy of India Explanation 2 is inserted, clarifying that such a challenge does not entail a review of the merits of the dispute. This narrowed the concept of public policy more and hence legislature brought us to a point from where we had started, that is to Renusagar’s case.

Conclusion

One important aspect which has not been primarily discussed but nevertheless remains prominent is the art of drafting Force Majeure clauses and how one can never put it elaborately enough. But looking at the aforementioned dispute it is advisable that one should always try to cover all the bases of one’s business while drafting a force majeure clause. ONGC V. Saw pipes opened the doors for the review of the arbitral awards on the basis of merits of cases rather than technicalities due to wide and liberal interpretation attributed by Hon’ble Supreme Court to ‘public policy’ which was later rectified by the successive amendment to the Act of 1996 and ultimately preserved the objective sought by it. This case is a lesson learned in the history of Arbitration law that how the independence of alternate dispute resolution mechanism has to be maintained to an extent or otherwise it does not require much for everything to go south.

References

  • Fateh Chand v. Balkishan Das (1964) 1 SCR 515 at 526
  • Richardson v. Mellish (1824) 2 Bing 229, 252
  • Renusagar Power Co. Ltd v. General Electric Co. 1994 Supp.(1) SCC 644
  • RattanChand Hira Chand vs Askar Nawaz Jung (Dead) By L.Rs. …1991 SCR (1) 327
  • ONGC v. Western Geco International Ltd. (2014) 9 SCC 263
  • Associate Builders v. Delhi Development Authority (2015) 3 SCC 49
  • Ranjit Shetty and Rahul Dev, Argus Partners, available on https://www.argus-p.com/papers-publications/thought-paper/arbitration-law-article-on-fundamental-policy-of-laws/ last seen 27/07/2021

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