Supreme Court Clarifies Arbitrability of Liquidated Damages in Government Contracts: BSNL vs. Motorola (2008)

Introduction

Date of the Judgment: September 15, 2008

Citation: Civil Appeal No. 5645 of 2008 [Arising out of SLP(C) No. 3459 of 2007]

Judges: Tarun Chatterjee, J., Lokeshwar Singh Panta, J.

When can a dispute be resolved outside of court-ordered arbitration? The Supreme Court of India addressed this question in a case between Bharat Sanchar Nigam Ltd. (BSNL) and Motorola India Pvt. Ltd. The core issue was whether the levy of liquidated damages by BSNL, for delays in a project by Motorola, could be referred to arbitration, or whether it was an “excepted matter” as defined in their contract. The judgment was delivered by a two-judge bench comprising Justice Tarun Chatterjee and Justice Lokeshwar Singh Panta.

Case Background

In January 2001, Bharat Sanchar Nigam Ltd. (BSNL) issued a notice inviting tenders for a turnkey project involving the planning, engineering, supply, installation, and commissioning of an Indian Mobile Personal Communications System across the telecom circles of Kerala, Karnataka, Tamil Nadu, and Andhra Pradesh. Motorola India Pvt. Ltd. responded to this tender.

After evaluating the technical, commercial, and financial bids, BSNL awarded the tender to Motorola. On September 5, 2001, BSNL issued an Advance Purchase Order (APO) for Phase I and Phase II of the project. The purchase order outlined terms for payment and a schedule for the delivery of goods. It also included provisions for liquidated damages in case Motorola failed to meet the agreed-upon delivery schedule.

Clause 16.2 of the tender document specified that if Motorola failed to deliver the goods and services within the prescribed period, BSNL could recover liquidated damages. These damages were set at 0.5% of the value of the delayed quantity of goods and services for each week of delay, up to 10 weeks. After this period, the rate would increase to 0.7% for each additional week of delay, up to another 10 weeks.

BSNL claimed that Motorola failed to complete Phase I and Phase II of the project according to the schedule. Consequently, the Tamil Nadu Circle of BSNL imposed liquidated damages on Motorola on May 21, 2004, citing Clause 16.2 of the tender document. BSNL argued that the quantification of these damages was beyond the scope of the arbitration agreement.

Motorola disputed the allegations of delay and objected to the imposition of liquidated damages. Despite this, on March 24, 2006, Motorola invoked the arbitration clause, sending a letter through its counsel to BSNL, seeking resolution through arbitration. BSNL refused, maintaining that the imposition of liquidated damages was justified.

Following BSNL’s refusal, Motorola filed an arbitration application before the High Court of Kerala at Ernakulam under Section 11 of the Arbitration and Conciliation Act, 1996, seeking the appointment of an arbitrator to resolve the dispute over the liquidated damages.

In its counter-affidavit before the High Court, BSNL contended that the liquidated damages assessed and quantified under Clause 16.2 of the tender document constituted an “excepted matter” under Clause 20.1 of the document, and therefore, was not subject to arbitration.

Timeline

Legal Framework

The Supreme Court considered the following clauses and sections to determine whether the dispute was arbitrable:

• Clause 16.2 of the General Conditions of the Tender Document: This clause outlines the conditions and rates for liquidated damages applicable if the tenderer fails to deliver goods and services on time. It states:
  
  “16.2. Should the tenderer fail to deliver the goods and services on turn key basis within the period prescribed, the purchaser shall be entitled to recover 0.5% of the value of the delayed quantity of the goods & services, for each week of delay or part thereof, for a period upto 10 weeks and thereafter at the rate of 0.7% of the value of the delayed quantity of the goods and services for each week of delay or part thereof for another 10 weeks of delay. In the present case of turn key solution of supply, installation and commissioning, where the delayed portion of the delivery and provisioning of services materially hampers effective user of the systems, Liquidated Damages charged shall be levied as above on the total value of the concerned package of the purchase order. Quantum of liquidated damages assessed and levied by the purchaser shall be final and not challengeable by the supplier.”
• Clause 20.1 of the Tender Document (Arbitration Clause): This clause specifies the process for resolving disputes, with an exception for matters for which a decision is specifically provided under the agreement. It states:
  
  “20.1 In the event of any question, dispute or difference arising under this agreement or in connection there-with (except as to the matters, the decision to which is specifically provided under this agreement), the same shall be referred to the sole arbitration of the CGM, Kerala Telecom Circle, BSNL or in case his designation is changed or his office is abolished, then in such cases to the sole arbitration of the officer for the time being entrusted (whether in addition to his own duties or otherwise) with the functions of the CGM, Kerala Telecom Circle, BSNL or by whatever designation such an officer may be called (hereinafter referred to as the said officer), and if the CGM Kerala Telecom Circle or the said officer is unable or unwilling to act as such, then to the sole arbitration of some other person appointed by the CGM, Kerala Telecom Circle or the said officer. The agreement to appoint an arbitrator will be in accordance with the Arbitration and Conciliation Act, 1996. There will be no objection to any such appointment on the ground that the arbitrator is a Government Servant or that he has to deal with the matter to which the agreement relates or that in the course of his duties as a government servant he has expressed his views on all or any of the matters in dispute. The award of the arbitrator shall be final and binding on both the parties to the agreement. In the event of such an arbitrator to whom the matter is originally referred, being transferred or vacating his office or being unable to act for any reason whatsoever, the CGM, Kerala Telecom Circle, BSNL or the said officer shall appoint another person to act as an arbitrator in accordance with the terms of the agreement and the person so appointed shall be entitled to proceed from the stage at which it was left out by his predecessors.”
• Clause 15.2 of Section III of the Tender Document: This clause deals with delays in the supplier’s performance and the sanctions that may be imposed. It states:
  
  “Delay by the Supplier in the performance of its delivery obligations shall render the Supplier liable to any or all of the following sanctions, forfeiture of its performance security, imposition of liquidated damages, and/or termination of the contract for default”.
• Clause 62 of Section IV of the Tender Document: This clause discusses liquidated damages and incentives. It states:
  
  “The bidder shall be charged liquidated damages at the rates as defined in the General conditions of contract as contained in Section III for any delay in the turnkey job entrusted to the bidder. However he shall be provided an incentive @ 0.5% of the cost of the network of each service area (Telecom Circle), for each week of early commissioning of the entire network in that service area, subject to a maximum of 3% of the value of the contract of the circle”.
• Section 11 of the Arbitration and Conciliation Act, 1996: Pertains to the appointment of arbitrators by the High Court, in case the other party does not agree to appoint an arbitrator.
• Section 12 of the Arbitration and Conciliation Act, 1996: Pertains to the impartiality and independence of the arbitrator.
• Section 28 of the Indian Contract Act: States that agreements in restraint of legal proceedings are void.
• Section 74 of the Indian Contract Act: Deals with compensation for breach of contract where penalty is stipulated for.

Arguments

Arguments by BSNL (Appellant):

• BSNL contended that Clause 16.2, when read with Clause 20.1, clearly indicated that the levy of liquidated damages was an “excepted matter” and thus not subject to arbitration.
• BSNL argued that the High Court erred in distinguishing between the decision on the liability for liquidated damages and the quantification of such damages. They maintained that the respondent had agreed to all clauses of the agreement without objection and could not later claim immunity from these obligations.
• BSNL relied on the case of Food Corporation of India Vs. Sreekanth Transport 1999 (4) SCC 491, which outlined principles relating to “excepted matters,” stating that these matters do not require further adjudication since the agreement itself provides a named adjudicator whose decision is final and binding.
• BSNL argued that it had the unilateral right to determine liquidated damages under Clause 16.2, and the quantum decided by BSNL should be final and not challengeable.

Arguments by Motorola (Respondent):

• Motorola refuted BSNL’s allegations of delay, asserting that any delay was due to BSNL’s failure to supply necessary inputs. They maintained that they had performed their part of the contract in time and were not liable for liquidated damages.
• Motorola contended that the dispute over the levy of liquidated damages did not fall outside the arbitration agreement as an excepted matter.
• Motorola argued that BSNL’s interpretation of Clause 16.2 would mean that one party could demand any amount of damages without recourse to a remedy, which would violate Section 28 and Section 74 of the Indian Contract Act.
• Motorola asserted that BSNL had lost its right to appoint an arbitrator because it failed to respond to the notice requiring appointment within the time prescribed under the Arbitration and Conciliation Act, 1996.
• Motorola contended that Clause 62, referring to special clauses, had an overriding effect on Clause 16.2.

Issues Framed by the Supreme Court

The Supreme Court addressed the following key issues:

1. Whether the levy of liquidated damages under Clause 16.2 of the tender document is an “excepted matter” in terms of Clause 20.1 of the said document, such that it cannot be referred to arbitration or reviewed by an arbitrator.
2. Whether Clause 62 of the special conditions of the tender document prevails over Clause 16.2 of the general conditions of the contract.

Treatment of the Issue by the Court

The following table demonstrates as to how the Court decided the issues:

Authorities

The court considered the following authorities:

Judgment

How each submission made by the Parties was treated by the Court?

How each authority was viewed by the Court?

• Vishwa Nath Sood vs. UOI [(1989) 1 SCC 657]: The court distinguished this case, noting that it involved a situation where the Superintendent Engineer acted as a revisional authority with adjudicatory powers, which is not the case in the present dispute.
• General Manager, Northern Railway vs. Sarvesh Chopra [(2002) 4 SCC 45]: The court distinguished this case, noting that it involved a “no claims” clause, where the contractor had given up the right to claim breach, which is different from the present situation.
• Food Corporation of India Vs. Sreekanth Transport 1999 (4) SCC 491: The court referred to this case for principles relating to “excepted matters,” but ultimately distinguished it in its application to the present case.
• State of Karnataka vs. Shree Rameshwara Rice Mills, (1987) 2 SCC 160: The court relied upon this case to distinguish between adjudicating a breach of contract and assessing damages, noting that the power to assess damages is subsidiary to the primary power of adjudicating the breach.
• Datar Switchgear vs. Data Finance Lt. [(2000) 8 SCC 151]: The court relied upon this case to support the view that the appellant/BSNL has now lost its right to appoint any arbitrator for settling the disputes under the agreement.
• Punj Llyod Ltd. vs. Petro net MHB Ltd. [(2006) 2 SCC 638]: The court relied upon this case to support the view that the appellant/BSNL has now lost its right to appoint any arbitrator for settling the disputes under the agreement.

What weighed in the mind of the Court?

The Supreme Court’s decision in the BSNL vs. Motorola case was primarily influenced by the interpretation of the contract clauses and the legal principles surrounding arbitration and contract law. The court emphasized that for a matter to be considered an “excepted matter” and thus not arbitrable, the agreement must specifically provide an adjudicatory process for resolving the dispute.

The court found that Clause 16.2 of the tender document, which dealt with liquidated damages, did not provide such a process. The clause only addressed the quantification of damages, not the determination of liability for the breach of contract. The court highlighted that the question of whether Motorola was actually in breach of contract and liable for damages was a separate issue that needed to be resolved before Clause 16.2 could be invoked.

Additionally, the court considered the principles of natural justice, emphasizing that a party to a contract cannot be an arbiter in its own cause. The court also noted that BSNL had already taken a decision on the matter, making it unsuitable to appoint an arbitrator.

Fact:Law

Ratio table for showing the sentiment analysis of the Supreme Court to show the ratio of fact:law percentage that influenced the court to decide. Fact is defined as “percentage of the consideration of the factual aspects of the case” and Law is defined as “percentage of legal considerations”.

Logical Reasoning:

For every [ISSUE], explain the court’s logical reasoning in a responsive flowchart using down arrows, boxes and text with an appealing formal look.

Key Takeaways

• Arbitrability of Disputes: Disputes over liquidated damages are arbitrable unless the contract specifically provides an adjudicatory process for resolving such disputes.
• Interpretation of Contract Clauses: Courts will carefully examine contract clauses to determine whether they provide a mechanism for resolving disputes or merely address the quantification of damages.
• Principles of Natural Justice: A party to a contract cannot be an arbiter in its own cause, and decisions must be made impartially.
• Right to Appoint Arbitrator: Appointing authority loses the right to make the appointment, once a minimum of 30 days is expired and a petition is filed to the court.

Development of Law

The ratio decidendi of the case is that for a dispute over liquidated damages to be considered an “excepted matter” and thus not arbitrable, the contract must specifically provide an adjudicatory process for resolving the dispute. The mere quantification of damages is not sufficient to exclude the dispute from arbitration.

This judgment clarifies the interpretation of arbitration clauses in government contracts and reinforces the principle that disputes should be resolved through an impartial process. It also emphasizes that the right to appoint an arbitrator is lost if the appointing authority fails to act within the prescribed time.

Conclusion

In conclusion, the Supreme Court dismissed BSNL’s appeal, affirming the High Court’s decision to allow arbitration in the dispute over liquidated damages. The court clarified that the levy of liquidated damages was not an “excepted matter” under the contract and that Motorola was entitled to have the dispute resolved through arbitration. This judgment reinforces the importance of clear and specific language in contract clauses and upholds the principles of impartiality and fairness in dispute resolution.