Unruly Horse on a Run

The ONGC v. Saw Pipes Judgment has been widely criticized by all quarters of the legal fraternity, and rightly so. This ruling, by expanding the ambit of ‘public policy’ as a ground for setting aside arbitral awards, has negated one of the primary purposes for which the Arbitration and Conciliation Act was formulated, i.e. of giving finality to a judgment and has subsequently, paved the way for second guessing arbitration decisions. This Article deals with the abovementioned case in depth vis-à-vis the scope and ambit of Section 34 of the Act. The authors, while pointing out the shortcomings in the decision, argue that this decision has defeated whole purpose of repealing the 1940 Act along with violating the “Non-Interventionist” stance adopted by the Courts in recent cases.

Emphasis has been laid on the repercussions and aftermath of this judgment and its effect on the Alternate Dispute Resolution Mechanism of the Country. In the Authors’ opinion, the adverse effect of this judgment can be largely cancelled out if a larger bench corrects it or if legislation like that of the Arbitration and Conciliation Bill 2003 is passed.

Introduction

Way back in 1824, Burrough, J., in Richardson v. Mellish [1] said: “Public policy is a very unruly horse, and when you get astride, you never know where it will carry you”. Little did he know that his anticipated fear would gradually turn into reality by various judgments, one of which is ONGC v. Saw Pipes [2] . Read literally, this judgment sets the clock back to the old position where an award could be challenged on merits rendering the Court as a Court of appeal. This case that brings a fresh ground of challenge under the head of “public policy” has paved the way for second guessing arbitration decisions on merits, and undermined the efficiency of dispute resolution in India.

Brief Facts

In the instant case, the respondent company was engaged in the business of supplying equipment for offshore oil exploration and maintenance. In response to a tender notice, the respondent offered to supply to the appellants, casing pipes. The appellant accepted the offer. As per the terms and conditions, the goods were required to be supplied on or before 14-11-1996. The contract deed provided that in case of failure to deliver the store or any instalment thereof within the scheduled time, the appellant would be entitled to recover from the respondent, as agreed, liquidated damages and not by way of penalty, a sum equivalent to 1% of the contract price of the whole unit per week for such delay, subject to the ceiling of 10%. The deed added that such liquidated damages would be recovered from the bill for payment of the cost of material submitted by the respondent, and any delay beyond sixty days on the part of the appellant, in making payments on undisputed claims would attract interest @ 1% per month but no interest would be payable on disputed claims.

During September/October 1996, Italian suppliers of the respondent could not supply the requisite raw material to the respondent on time due to a general strike of steel mill workers. Therefore, the respondent sought from the appellant an extension of forty-five days’ time for the execution of the order. The appellant granted the time with a specific statement inter alia that the amount equivalent to liquidated damages for delay in supply of pipes would be recovered from the respondent. The appellant made payment for the goods supplied after deducting an amount of US dollars 3,04,970.20 and Rs 15,75,559 as liquidated damages. This deduction was disputed by the respondent and, therefore the dispute was referred to the Arbitral tribunal under the Arbitration and Conciliation Act, 1996 (hereinafter “the Act”). The arbitral Tribunal held that for recovery of liquidated damages, it was for the appellant to establish that it had suffered any loss because of the non-supply of the goods within the prescribed time-limit on evidence, holding that the appellant had failed to do so, the Arbitral Tribunal held that the appellant had wrongfully deducted the said amount with interest at the rate specified in the award. After unsuccessfully approaching the High Court, the appellant approached the Apex Court.

Main Contention

The primary contention in this case dealt with the question as to whether the court would have jurisdiction u/s 34 of the Act to set aside an award passed by the Arbitral Tribunal which is patently illegal, or in contravention of the provisions of the Act or any other substantive law governing the parties or is against the terms of the contract. The relevant part of Section 34 for deciding the controversy reads as under:

Sec 34(2)(v)- the composition of the Arbitral Tribunal or the arbitral procedure was not in accordance with the agreement of the parties unless such agreement was in conflict with the provision of this part from which the parties cannot derogate, or, failing such agreement, was not in accordance with this Part.

Sec 34(2)(b)(ii)- the arbitral award is in conflict with the public policy of India.

It is therefore seen that Sec 34(2)(v) basically talks about:-

Composition of the Arbitral Tribunal

Procedure followed by the Arbitral Tribunal.

The procedure followed by the Arbitral Tribunal was in dispute in this case. The question arose as to whether the award could be set aside, if the Arbitral Tribunal has not followed the mandatory procedure prescribed under Sections 24, 28 or 31(3), which affects the rights of the parties. In the case of M.V. Elisabeth v. Harwan Investment & Trading (P) Ltd [3] the Court observed that where substantive law demands justice for the party aggrieved and the statue has not provided the remedy, it is the duty of the Court to devise procedure by drawing analogy from other systems of law in practice. Similarly, in Dhannalal v. Kalawatibai [4] this Court observed that wrong must not be left unredeemed and right not left unenforced.

The Court therefore interpreted clause (v) in conformity with the settled principle of law that “there cannot be any wrong without a remedy”. It held that if the Arbitral Tribunal has not followed the mandatory procedure prescribed under the Act, it would mean that it has acted beyond its jurisdiction and thereby the award would be patently illegal which can be set aside u/s 34. The legislative intent could not be that if the award is in contravention of the provisions of the Act, it could still not be interfered with.

The next clause which came for consideration before the Court was clause (ii) of sub-section (2) (b) of Sec 34 which provides that the Court may set aside an arbitral award if it is in conflict with the “public policy of India”. For this purpose, the meaning and nature of the term “public policy” was extensively discussed.

“Public policy” has been defined by Winfield as “a principle of judicial legislation or interpretation founded on the current needs of the community”. [5] Public Policy connotes some matter which concerns the public good and the public interest. The concept of what is for the public good or in the public interest or what would be injurious or harmful to the public good or the public interest has varied for time to time. [6] It is therefore considered to be vague, susceptible to narrow or wider meaning depending upon the context in which it is used.

The Court referred to the two schools of thought, namely- ‘the narrow view’ school and ‘the broad view’ school for the interpretation of the term “public policy”, The ‘narrow view’ says that courts cannot create new heads of public policies and it should not invalidate a contract on the ground of public policy unless that particular ground has been well established by authorities. The ‘broad view of thought’ school supports judicial law making in this area. Public policy does not remain static in a given community. It would be almost useless if it were to remain in fixed moulds for all times. [7]

The Court drew an analogy to the case of Renusagar Power Electric Co. v. General Electric Co. [8] in which the narrow view was adhered to. It was held that “enlarging the field of enquiry to include public policy of the Courts, whose law governs the contract or of the country of place of arbitration, would run counter to the expressed intent of the legislation.” [9] However, the learned Senior Counsel for the appellant contended that in Renusagar case, the question involved was with regard to the execution of award which has obtained finality, and not where the validity of the award in itself in question. In a case where validity of award in itself challenged, wider meaning should be given to the term ‘public policy of India’. The contention was accepted by the Court, and it opined that if narrow meaning is given, some of the provisions of the Act would become nugatory, and that wider meaning should be given so that ‘patently illegal award’ passed by the Arbitral Tribunal could be set aside.

Further, the learned Senior Counsel for the respondent contended that if the legislature wanted to give wider jurisdiction to the Court, it would have done so by adopting provisions similar to Sections 68, 69 and 70 of the Arbitration Act, 1996 applicable in England. Section 68 provides for challenging the award in case of a serious irregularity. Similarly, Section 69 provides that appeal on the point of law would be maintainable and the procedure thereof is also provided. Section 70 provides supplementary provisions.

However, the Court rejected the contention, quoting the opinion of Sr. Advocate Late Mr. Nani Palkhiwala [10] which reads as follows:

….The new arbitration law has been brought in parity with statues in other countries, though I wish that the Indian law had a provision similar to Section 68 of the English Arbitration Act, 1996 which gives power to the court to correct errors of law in the award.

…. 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 right in upholding the challenge to the award on the ground that it is in conflict with the public policy of India.”

Therefore, the court held that the phrase ‘public policy of India’ used in Sec 34 is required to be given a wider meaning. The result was that an award could be set aside if it is contrary to:

fundamental policy of Indian law; or

the interest of India; or

justice or morality; or

in addition, if it is patently illegal.

Illegality must go to the root of the matter. It cannot be held that an award is against the public policy if it is of trivial nature. Further, an award could also be set aside if it is so unfair and unreasonable that it shocks the conscience of the court. Such an award is opposed to public policy and is required to be adjudged void.

Other Contentions

The next argument put forward was that the parties had expressly agreed that recovery of damages for breach of contract was not by way of penalty but by a genuine pre-estimate of damages, therefore it is neither justifiable nor necessary for the purchaser to prove that the loss suffered is because of delay in supply of pipes. Furthermore, as per section 28(3) of the act, the Arbitral Tribunal has to decide the dispute in accordance with the terms of the contract. The agreement between the parties provides that without prejudice to any other right or remedy, if the contractor fails to deliver the stores within the stipulated time, the appellant would be entitled to recover from the contractor, as agreed, liquidated damages equivalent to 1% of the contract price of the whole unit per week for such delay, the ceiling limit being 10%. The contract also stated that the damages would be deducted from the bill and that they are not by way of penalty but a genuine pre estimate of damages. The decision of the Arbitral Tribunal goes totally against this term in the contract.

Another argument advanced was that when the respondent asked for 45 days extension, time was extended, provided that liquidated damages would be recovered by the appellant. Despite this condition, the respondent supplied the goods indicating that the respondent was agreeable to payment of liquidated damages.

The appellant further contended that on reading Sections 73 and 74 it can be held that when a contract has been broken, then the party adversely affected can claim compensation for any loss that he may incur as a result of such breach. Therefore, it is inferred that if parties knew on making the contract that a particular loss is likely to result from such breach, they can agree for payment of compensation beforehand, in such cases there will be no need to lead evidence to prove damages, unless the court decides that no loss could occur from such breach. In case the court arrives at the conclusion that such anticipatory damages is by way of penalty then it may grant reasonable compensation.

It was also submitted that for the purpose of construction of contracts, it is necessary to understand the intention of the parties by looking into the words used in the contract [11] . If the words are unambiguous and upon reading the document as a whole it can be fairly inferred that the parties agreed on a particular term then there is nothing in law that prevents them from setting up that term [12] .

As opposed to this, Counsel for the Respondent submitted that it is a settled principle of law that in order to attract the provisions of Section 74 of the Contract Act and to claim compensation or damages therein, it would have to be proved by the plaintiffs that the loss so suffered is due to the breach in contract.

This principle has been laid down in 1929 in Bhai Panna Singh v. Bhai Arjun Singh [13] , wherein the Privy Council held that “the effect of Section 74 of the Contract Act is to disentitle the plaintiff to recover compensation, by penalty or liquidated damages. The plaintiffs must prove the damages suffered.”

Referring to various decisions on the subject, in Fateh Chand [14] , the Court referred to Section 74 of the Indian Contract Act and observed that section 74 deals with the measure of damages in 2 classes of cases (i) where the contract names a sum to be paid in case of breach and (ii) where the contract contains any other stipulation by way of penalty and explained that the section basically says that the aggrieved party has a right to claim compensation from the party who has committed breach, therefore one need not prove the actual damage suffered, however when there is no breach, there will be no award for compensation. The court further observed that in all cases where there is a stipulation by way of penalty in the contract, then court can pass the order for the same as long as it is reasonable. The aforesaid was referred in Maula Bux v. Union of India [15] and Rampur Distillery and Chemical Co. Ltd [16] .

However, in Maula Bux case, it was also added that in case of breach of some contracts, it may not be possible to assess damages. In these cases, the sum named by the parties, if it is a genuine pre-estimate, may be considered, but only if it is not by way of penalty. Where loss in terms of money can be determined, party claiming compensation must prove the loss suffered by them.

The tribunal after considering the decisions rendered in the aforesaid cases had arrived at the verdict that it was for the respondents to establish that they had suffered any loss because of the breach committed by the claimant in the supply of goods under the contract, and from Maula Bux it is clear that if loss in terms of money can be determined, party claiming compensation must prove the loss and since the appellant failed to do so, the amount was asked to be refunded.

The Appellate Court held that the Arbitral Tribunal failed to consider Sections 73 &74 of the Indian Contract Act and the ratio laid down in Fateh Chand case [17] , which supports the reasoning taken by the Court that in the instant case, it would be difficult to prove exact damages or loss caused by breach, and since the parties had pre-estimated the damages and specified the same in the contract, the appellant would be entitled to compensation, whether actual loss is proved or not.

The next contention of the Appellant was that the arbitrator committed error of law, the Court attempted to decide this question by examining the reference made to the arbitrator, thereby saying that if there is a general reference for deciding the dispute between the parties and the award is based on wrong proposition of law then the Courts can interfere. However if a specific question of law is submitted to the arbitrator, an erroneous decision in point of law does not by itself make the award liable to be set aside, unless it is proved that the arbitrator proceeded illegally.

The Counsel for the appellant argued that a wrong proposition of law was proceeded on as the decision goes against 28(3) of the Act, since it violates the terms of the contract, and this was a general reference submitted to the arbitrator, there was no specific question of law involved. The decision referred to in this regard was Champsey bhara and Co. v. Jivraj Balloo Spg. And Wvg. Co. Ltd [18] . There is also elaborate discussion on this aspect in Union of India v. A.L. Rallia Ram [19] wherein the Court observed that an award is bad on the ground of error of law on the face of it, when the award itself or in a document actually incorporated in it, there is found some legal proposition which is the basis, and is erroneous. Reliance was placed on recent cases which reiterate the same [20] .

The last point of contention of the appellant was whether the claim of refund of the amount deducted by the appellant from the bills is ‘disputed’ or ‘undisputed’ claim. In this regard the Court held that since the award which ordered the appellant to refund the amount recovered was set aside, the question of granting interest on it is inconsequential. The main contention of the respondent that since the amount was deducted from undisputed invoice bills, it cannot be said to be a “disputed claim” was held to be unreasonable and it was decided that the fact that the appellant claimed to recover damages in case of delay in supply of pipes and the respondent, in event of this, claimed it back, makes it a “disputed claim” and since the terms of the contract stated that no interest would be payable on disputed claims, the award is violative of Section 28(3) and hereby set aside.

Unruly horse- on a run!

If by including Section 34(2)(b)(ii) in the new Act, the legislature had any inclination to provide grounds of challenge to award, on the basis of it being against substantive law or express terms of the contract, then it would have retained Sec 30 [21] of the 1940 Act.

Under Section 34(2)(a)(iv) awards can be challenged as being against the terms of the Contract, under the garb of disputes relating to matters beyond scope of submission to arbitrator, provided that such objection is raised. Therefore, it is not necessary to include this under the head of ‘public policy.’

As far as award being contrary to the Act itself is concerned, say an unreasoned award, without an agreement to that effect, would be a ground of challenge under Section 34(2)(a)(v) as being against arbitral procedure agreed upon by parties. This too, was not required to be included under the ambit of ‘public policy.’

The Saw Pipes judgment has rightly been criticised by both domestic and international fraternity. To begin with, it is clearly contrary to the plain language of the Act, and also the very purpose for which the act was formulated i.e. finality to the alternate methods of dispute resolution without Court’s interference. The parties should ideally be prepared to abide by the decision of the arbitration, even if it is wrong, as long as correct procedure in conducting the arbitration is followed. This judgment has reduced arbitration to merely the first stage in the process of successive appeals, which ultimately leads to the highest appellate court.

If the disputes are to end up in the Courts anyway, the losing party would easily find spurious grounds to unwind arbitral awards in the name of ‘public policy’ and there will be no incentive for parties to incur the time and expense for arbitration at the first instance. This will be a huge setback to the arbitral process in a country like India where the Courts are already bogged down with enormous workload and the parties to litigation are continually encouraged to resort to alternate methods of dispute resolution.

Further, Art 34 of the UNCITRAL Model Law on which Sec 34 of the Act is based, regulates only the means of recourse to the Court for setting aside the award on the grounds set forth in it. It is important to note that the legislature has not made many changes while adopting Article 34 of the UNCITRAL Model Law. It has not incorporated exhaustive grounds for challenging the awards passed by the Arbitral Tribunal on the ground on which appeal against the order of the Court would be maintainable. It had not provided “error of law” as a ground of challenge to the arbitral award under Sec 34 of the Act.

The Legislature has now introduced in the Parliament, the Arbitration and Conciliation (Bill), 2003 in order to clarify that public policy does not have the extended meaning as given by the Supreme Court in this case. To remove doubts, the Bill provides an Explanation to the words “contrary to public policy” in Sec 34 to mean contrary to (i) fundamental policy of India; or (ii) interests of India; or (iii) justice or morality [22] , thus retaining the meaning given by the Supreme Court in Renusagar case. However, the Bill was reverted back and it was recommended that the Government should consider bringing in a fresh comprehensive legislation before the Parliament. [23]

The Saw Pipes judgment was severely criticized, however, with the recent ruling of Venture Global v. Satyam Computer Services [24] , the situation worsened as it extended the power to set aside awards to international arbitration matters also. Parties now can challenge foreign awards on the basis of it being against Indian Statutory Provisions and Indian Public Policy. The aftermath of this is that now parties will come up with frivolous grounds to challenge awards, undermining the tribunal’s original decision. The only respite is that the Supreme Court acknowledged that parties can limit the scope of judicial review by an agreement to that effect.

Conclusion

Eminent jurist and lawyer, Mr Fali.S.Nariman commented that this judgment has

“virtually set at naught the entire Arbitration and Conciliation Act of 1996…” [25]

Rightly so, the decision in this case has opened Pandora’s Box, and will have a deterring effect on parties wishing to resort to arbitration in the long run. Now since the attempt of the Legislature to restore the old position has gone futile, the only recourse now seems to be that a larger bench of the Apex Court corrects the interpretation given to the term “public policy” in this case, otherwise, the growth of Alternate Dispute Resolution system of the country would be nipped at the bud.