Supreme Court Clarifies Contract Formation in Tender Cases: South Eastern Coalfields Ltd. vs. M/s. S. Kumar’s Associates (2021)

Date of the Judgment: 23 July 2021

Citation: (2021) INSC 447

Judges: Sanjay Kishan Kaul, J. and Hemant Gupta, J.

Can a company claim breach of contract when a tender is awarded, some initial steps are taken, but the formal contract is not signed and mandatory security deposits are not made? The Supreme Court of India recently addressed this question in a case involving South Eastern Coalfields Ltd. and M/s. S. Kumar’s Associates. The court clarified the requirements for a valid contract in tender processes, emphasizing the importance of fulfilling all pre-conditions.

The Supreme Court bench consisted of Justice Sanjay Kishan Kaul and Justice Hemant Gupta. The judgment was authored by Justice Sanjay Kishan Kaul.

Case Background

South Eastern Coalfields Ltd. (appellant no.1), a government company, issued a tender on 23 June 2009 for hiring equipment to excavate overburden. M/s. S. Kumar’s Associates (respondent) was the successful bidder, and a Letter of Intent (LoI) was issued on 5 October 2009, for a total work of Rs. 387.40 lakh. The LoI directed the respondent to mobilize equipment, commence work immediately, deposit a performance security, and sign an Integrity Pact before the agreement. The respondent began work, but faced difficulties when their machinery broke down. The appellants alleged breach of contract and issued a show cause notice on 9 December 2009. The appellants also noted that the respondent had failed to submit the performance security deposit within 28 days of the LoI. The appellants terminated the contract on 15 April 2010 and sought to recover the differential cost of awarding the contract to another party. The respondent challenged this termination, arguing that no formal contract was ever executed.

Timeline:

Course of Proceedings

The respondent filed a writ petition in the Chhattisgarh High Court challenging the termination letter and recovery order. The High Court ruled that no valid contract existed between the parties because the respondent had not completed the necessary formalities, such as providing performance security. The High Court upheld the forfeiture of the bid security but disallowed the recovery of additional costs. The appellants then filed a Special Leave Petition in the Supreme Court, which was granted. The Supreme Court stayed the refund of the balance amount of Rs. 10 lakh (after deducting the bid security) to the respondent.

Legal Framework

The case primarily revolves around the interpretation of contract formation in the context of tenders, specifically concerning the Letter of Intent (LoI) and the fulfillment of conditions precedent. The relevant clauses of the Notice Inviting Tenders (NIT) are:

• Clause 29.2: States that “the notification of award will constitute the formation of Contract, subject only to the furnishing of a Performance Security/Security Deposit in accordance with clause 30.”
• Clause 30.2: Specifies that “failure of the successful bidder to comply with the requirement as above shall constitute sufficient ground for cancellation of the award of work and forfeiture of the bid security.”
• Clause 34: Requires the submission of an Integrity Pact document, and failure to do so may result in the tender being considered “as not substantially responsive and may be rejected.”
• Section 3, Clause 1(ix): Defines the “Contract” as “the notice inviting tender, the tender as accepted by the company and the formal agreement executed between the company and the contractor together with the documents referred to therein including general terms and conditions, special conditions, if any, schedule quantities with rates and amount, schedule of work.”

These clauses highlight that the formation of a contract is contingent upon the fulfillment of certain conditions, particularly the submission of performance security and the signing of the Integrity Pact.

Arguments

Appellants’ Arguments:

• The appellants argued that the requirement to deposit performance security and sign the Integrity Pact were “conditions subsequent,” not “conditions precedent.”
• They contended that the respondent’s commencement of work on 28 October 2009, indicated acceptance of the contract.
• The appellants cited the respondent’s letter dated 05 December 2009, acknowledging that they had removed a considerable amount of overburden, as proof that they had carried out substantial work.
• They argued that the absence of a formal contract did not negate their claim for breach of contract.
• The appellants relied on Jawahar Lal Burman v. Union of India [(1962) 3 SCR 769], where the Supreme Court held that the requirement of security deposit was a condition subsequent, not precedent, as the contract was concluded by its acceptance.
• They also cited Dresser Rand S.A. v. Bindal Agro Chem Ltd. & Anr. [(2006) 1 SCC 751], where the court discussed that a Letter of Intent (LoI) can be construed as a letter of acceptance if such intention is evident from its terms.

Respondent’s Arguments:

• The respondent argued that the LoI was merely an intention to enter into a contract, not a binding contract itself.
• They emphasized that the contract was subject to the completion of certain formalities, such as furnishing the performance security and signing the Integrity Pact, which were never completed.
• The respondent highlighted clause 29.2 of the NIT, which stated that the contract was subject to the furnishing of performance security.
• They also pointed out that the consequence of not furnishing the security deposit was the cancellation of the award and forfeiture of the bid security, as per clause 30.2.
• The respondent relied on Bhushan Power & Steel Ltd. v. State of Odisha [(2017) 2 SCC 125], where it was held that an LoI is a preliminary understanding between parties intending to make a contract.
• They also referred to State of Madhya Pradesh And Anr. v. Firm Gobardhan Dass Kailash Nath [AIR 1973 SC 1164], where the court held that a contract was not formed because an essential pre-condition of depositing 25% of the purchase price was not met.

Submissions of the Parties

Issues Framed by the Supreme Court

• Whether a concluded contract had been arrived at inter se the parties?

Treatment of the Issue by the Court

Authorities

The Supreme Court considered the following cases and legal provisions:

Judgment

The Supreme Court held that no concluded contract was formed between the parties. The Court emphasized that the terms of the NIT and the LoI must be considered to determine if a contract was formed. The Court noted that the respondent failed to fulfill the conditions precedent, such as submitting the Performance Security Deposit and signing the Integrity Pact. The Court distinguished the cases cited by the appellants, stating that those cases had different factual matrices and contractual terms. The Court upheld the High Court’s decision that the appellants could only forfeit the bid security amount and could not claim additional costs for awarding the contract to another party.

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

How each authority was viewed by the Court?

The Court analyzed the authorities to determine the nature of the contract, conditions precedent, and the effect of the Letter of Intent (LoI). The following points were emphasized:

• Jawahar Lal Burman v. Union of India [(1962) 3 SCR 769]*: The Court distinguished this case, stating that unlike in Jawahar Lal Burman, the present case had explicit conditions precedent that were not fulfilled. In Jawahar Lal Burman, the contract was explicitly concluded by acceptance, with the security deposit being a subsequent condition, which is not the case in the present matter.
• Dresser Rand S.A. v. Bindal Agro Chem Ltd. & Anr. [(2006) 1 SCC 751]*: The Court distinguished this case, stating that though the court recognized that an LoI can be construed as a letter of acceptance if such intention is evident from its terms, in the present case, the terms of the LoI did not clearly indicate an intention to create a binding contract without the fulfillment of conditions precedent.
• Rajasthan Coop. Dairy Federation Ltd. v. Maha Laxmi Mingrate Marketing Service (P) Ltd. [(1996) 10 SCC 405]*: The Court referred to this case to define what a Letter of Intent (LoI) is, stating that it merely expresses an intention to enter into a contract.
• Bhushan Power & Steel Ltd. v. State of Odisha [(2017) 2 SCC 125]*: The Court referred to this case to define what a Letter of Intent (LoI) is, stating that it is a preliminary understanding between the parties.
• State of Madhya Pradesh And Anr. v. Firm Gobardhan Dass Kailash Nath [AIR 1973 SC 1164]*: The Court referred to this case to emphasize that a contract was not formed because an essential pre-condition was not met.
• Clause 29.2 of the NIT: The Court emphasized that this clause clearly stipulates that the contract is formed “subject only” to the furnishing of performance security.
• Clause 30.2 of the NIT: The Court highlighted that this clause specifies the consequence of not furnishing the security deposit, which is the cancellation of the award and forfeiture of the bid security.
• Clause 34 of the NIT: The Court noted that failure to submit the Integrity Pact could lead to the tender being rejected.
• Section 3, Clause 1(ix) of the NIT: The Court noted that this clause defines the contract as including the formal agreement and other documents.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the following factors:

• Non-fulfillment of Conditions Precedent: The respondent’s failure to submit the Performance Security Deposit and sign the Integrity Pact was a critical factor. The court emphasized that these were not mere formalities but pre-conditions for the formation of a valid contract.
• Interpretation of NIT Clauses: The court closely analyzed the clauses of the Notice Inviting Tenders (NIT), particularly clauses 29.2, 30.2, 34, and Section 3, Clause 1(ix). These clauses clearly indicated that the formation of the contract was contingent on the fulfillment of these conditions.
• Nature of Letter of Intent (LoI): The court reiterated that an LoI typically indicates an intention to enter into a contract in the future, unless its terms clearly suggest otherwise. In this case, the LoI did not establish a binding contract without the fulfillment of the conditions precedent.
• Distinction from Precedents: The court distinguished the cases cited by the appellants, such as Jawahar Lal Burman and Dresser Rand S.A., by highlighting that those cases had different contractual terms and factual matrices.
• No Payment for Work Done: The court noted that the respondent had not been paid for the work done, which further supported the view that no binding contract existed.

The court’s reasoning was based on a strict interpretation of the contractual terms and the principle that a contract is not formed if essential pre-conditions are not met.

Sentiment Analysis of Reasoning

Fact:Law Ratio

Logical Reasoning

Key Takeaways

• Conditions Precedent are Crucial: In tender processes, fulfilling all conditions precedent, such as submitting performance security and signing integrity pacts, is essential for the formation of a valid contract.
• Letter of Intent (LoI) is Not Always a Contract: An LoI typically indicates an intention to enter into a contract in the future and does not automatically create a binding contract.
• Strict Interpretation of Contractual Terms: Courts will strictly interpret the terms of the NIT and LoI to determine whether a contract has been formed.
• Consequences of Non-Compliance: Failure to comply with conditions precedent can lead to the cancellation of the award and forfeiture of bid security.

Directions

The Supreme Court directed the appellants to deduct the bid security amount from the deposited sum of Rs. 10 lakh and refund the balance to the respondent within two months.

Development of Law

The ratio decidendi of the case is that a contract is not formed if essential pre-conditions, such as submitting performance security and signing the integrity pact, are not met. The Supreme Court clarified that a Letter of Intent (LoI) does not automatically create a binding contract and that the terms of the NIT and LoI must be strictly interpreted. This ruling reinforces the importance of fulfilling all conditions precedent in tender processes and clarifies the legal status of LoIs.

Conclusion

The Supreme Court’s judgment in South Eastern Coalfields Ltd. vs. M/s. S. Kumar’s Associates clarifies that a contract is not formed merely by issuing a Letter of Intent and commencing some preliminary work. The fulfillment of all conditions precedent, such as submitting performance security and signing the Integrity Pact, is essential for a valid contract. The court upheld the High Court’s decision that the appellants could only forfeit the bid security amount and could not claim additional costs. This case underscores the importance of adhering to all contractual terms and conditions in tender processes.