This article is written by Avik Sarkar pursuing Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from Lawsikho.

Introduction

Section 34 of the Arbitration and Conciliation Act, 1996 is considered the most important and contentious section of all. The concept of patent illegality has been recently added in Section 34 of the Act through the 2015 amendment. Since the inception of the concept of patent illegality, there has been a series of landmark cases that have described the applicability of the concept quite holistically. Though this concept is in a very embryonic stage of its interpretation and it is speculated that more is yet to come. One such interpretation was done through the judgement given in the case of Oriental Structural Engineers Pvt. Ltd. v. the State of Kerala. Further, this piece provides an inept analysis of the judgement and tries to crystallise the applicability of patent illegality in this particular scenario so that it helps in demystifying future conundrums of a similar kind.

The Arbitration and Conciliation Act, 1996 has always been in vogue due to its policy of least judicial interference. Parties always find it easy to resolve their disputes amicably and according to ways in which they want it to dispose of. But in order to keep up with the societal developments and mindsets each and every statutory enactment goes through various amendments. And the same applies to the Arbitration and Conciliation Act, 1996. There have been regular changes that are made to Section 34 of the Act. It is considered as one of the most contentious sections of the Act as it deals with issues relating to ‘grounds for setting aside of arbitral awards.’

‘Patent Illegality’ is considered as an established ground for setting aside arbitral awards under Section 34 of the Arbitration Act. In a recent dictum given by the Supreme court in the matter of   Oriental Structural Engineers Pvt. Ltd. v. the State of Kerala,  the court had ruled the right of an arbitral tribunal to award interest to the aggrieved party despite there being no explicit mention of the same in the agreement. And the action would not amount to ‘patent illegality. It was observed that in order to decrease judicial intervention the scope of patent illegality was narrowed by the 2015 Amendments. And the dictum given in the present case has further narrowed the applicability of patent illegality for setting aside arbitral awards.

Factual matrix

Oriental structural engineer Pvt Ltd (hereinafter referred to as OSEPL) was entrusted with a contract by the State of Kerala to upgrade state highways between two towns. The contract had explicit mention of entitlement of interest on delayed payments. Though, the rate of interest was not mentioned by OSEPL.

Eventually, a dispute arose due to delayed payment by the state. The arbitration clause was invoked as per the terms of the contract and a three-member arbitral tribunal was formed. The state contended that as there was no mention of the rate of interest in the contract. Therefore, they treated it as ‘nil’. And further stating that OSEPL has made a waiver of their rights of receiving interest. Rejecting the above claims of the state the tribunal passed the award in favour of OSEPL and had further directed the state to pay the interest due to delayed payments. 

While delivering its judgement the tribunal relied on a Supreme Court judgment  Secretary, Irrigation Department, Government of Orissa v. G.C. Roy which stated that a person who is deprived of his entitled money is supposed to get compensation for the delay. And this compensation may also be termed as interest, compensation or damages.

The Arbitration Court’s dictum

The state appealed for patent illegality under Section 34 of the Arbitration and Conciliation Act, 1996 before the District Court, Ernakulam (Arbitration Court). Here, the court gave a decision in favour of the state thereby setting aside the award passed by the tribunal. The case was further appealed to the High Court by OSEPL.

The High Court’s dictum

The High Court upheld the decision given by the Arbitration Court. To support its dictum, firstly the court stated that as there was no explicit mention of the rate of interest that is to be paid due to delayed payment which made it difficult for the state to decipher the provision of the rate of interest to be paid. Therefore, the state was not erroneous in not paying interest. Secondly, the court also speculated that the omission of payment of interest clause in the bid of OSEPL may have led the state to think that they would not charge any interest towards delayed payments. Thereby making OSEPL’s bid strong amongst its fellow competitors’ bids. The case was further appealed by OSEPL to the Supreme Court.

The Supreme Court’s dictum

The Supreme Court had reversed the decision of the High Court and stated that its findings were completely extraneous. The court stated that there was no specific clause in the contract regarding the exclusion of payment of interest on delayed payments. 

According to the court, the mere mention of the interest clause was enough to state that payment of interest is to be made on delayed payments. And in the present case, it was only the rate of interest that was not specifically mentioned. But such trivial omission can never be a reason for a party to not pay damages. 

The Supreme Court relied on certain judgements in order to ossify its standpoint with regards to the present case. Firstly, it relied on the judgment of ONGC v. Saw Pipes, where it was explicitly stated that ‘patent illegality’ is supposed to be used as a part of the ‘public policy exception’ under Section 34 of Arbitration and Conciliation Act, 1996. Secondly, it moved onto the judgement of Associate Builders v. Delhi Development Authority, where it was stated that an award will be declared void only when it is passed in contravention to the substantive law of the country. The illegality of trivial nature cannot be a material reason to set aside an award. Thirdly, the Supreme Court moved on to the Roy judgement where the agreement was silent about payment of interest due to delayed payments and despite that, the interest awarded was valid. But it must be noted that the Roy judgement was given under the 1940 Act which also empowered arbitrators to grant pre-reference interest. Lastly, they referred to Union of India v. Bright Power Projects it was held that under Section 31(7) of the Arbitration Act, 1996 the tribunal has the right to award reasonable interest as per delay. And from all the above statements the apex court of the country concluded that payment of interest can only be omitted when such omission is explicitly mentioned in the contract.

Analysis of the judgement 

The High Court was incorrect in construing the blank space that was present in the contract as the underlying principle behind awarding interest is compensatory in nature. It can be easily concluded that the rationale used by the high court to reach a conclusion in the present case was totally erroneous in nature. Therefore, the Supreme court stepped in and crystallized the fact that an award passed by a tribunal cannot be set aside unless there is explicit mention of exclusion in the contract.

It must also be noted that in situations where the 2015 amendment is not applicable, in those cases the principles laid down in various judgements such as the Roy case, as well as the present case (Oriental case), can be used to prove the same.

It was through the  246th Law Commission Report that the concept of ‘patent illegality’ was first recommended to be used to set aside arbitral awards. Though, it must be noted that this concept is only limited to domestic awards and not international awards. Further, to avoid a judicial intervention the report stated that no award can be set aside due to error in the application of the law. And this was added in Sub-section 2A of Section 34 of the Arbitration Act. But on the contrary, it must also be noted that the arbitral award passed must be just and reasonable otherwise it will clearly suffer from ‘patent illegality’ and the award will be set aside.

Since the inception of the concept of ‘patent illegality,’ there has been a surge in the number of cases where the arbitral award used to be set aside. The introduction of the 2015 Amendments narrowed down the scope of judicial intervention pertaining to patent illegality. And then followed by various judgements including the judgement in the present case where the scope of judicial intervention is even further narrowed down. It is anticipated that such judgment upholds the essence of arbitration as there is supposed to be the least amount of judicial intervention in arbitration matters. 

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