Supreme Court clarifies price adjustment formula in highway contracts: National Highway Authority of India vs. M/S. ProgressiveMVR (JV) (23 February 2018)

Date of the Judgment: 23 February 2018
Citation: Civil Appeal No. 458 of 2018
Judges: A.K. Sikri, J., Ashok Bhushan, J.
Can a contractual clause be interpreted in a way that leads to unrealistic price adjustments? The Supreme Court of India recently addressed this question in a dispute between the National Highway Authority of India (NHAI) and several contractors. The core issue revolved around the interpretation of a ‘Price Adjustment Formula’ within their contracts, specifically concerning the calculation of material costs like bitumen, cement, and steel. The bench comprised of Justice A.K. Sikri and Justice Ashok Bhushan, with the judgment authored by Justice A.K. Sikri.

Case Background

The National Highway Authority of India (NHAI) awarded contracts to various contractors for road construction projects. These contracts included a ‘Price Adjustment Formula’ to account for fluctuations in material costs during the project. A dispute arose over the interpretation of a specific clause, sub-clause 70.3 (xi), which deals with calculating the cost of bitumen, cement, and steel. The contractors argued that the ‘actual cost’ of these materials should be the current market rate at the time of payment, while NHAI contended it should be the base rate, i.e., the rate prevailing 28 days before the submission of the bid.

The dispute first arose when M/s. ProgressiveMVR (JV), one of the contractors, raised an objection regarding price adjustment during the submission of their 9th Interim Payment Certificate (IPC) on April 13, 2008. The NHAI rejected this objection, leading to the contractor invoking the dispute resolution mechanism.

Timeline

Course of Proceedings

The Dispute Resolution Board (DRB) initially rejected the contractor’s claim, supporting NHAI’s interpretation. Subsequently, the contractor invoked arbitration. The Arbitral Tribunal, by a majority, ruled in favor of the contractor, stating that the term ‘cost’ should be interpreted as the actual expenditure incurred by the contractor, based on current invoices. However, one member of the tribunal dissented, arguing that the ‘cost’ should be based on the base rates.

NHAI challenged the Arbitral Tribunal’s award in the High Court of Delhi under Section 34 of the Arbitration and Conciliation Act, 1996. The High Court dismissed NHAI’s objections, citing a previous similar case where the court had upheld the Arbitral Tribunal’s interpretation. The High Court also noted that the interpretation given by the Arbitral Tribunal was a possible interpretation and hence should not be interfered with. The Supreme Court noted that there were conflicting awards by different Arbitral Tribunals on the same issue, leading to the present appeal.

Legal Framework

The core of the dispute lies in the interpretation of sub-clause 70.3 of the Conditions of Particular Application (COPA) of the contract, specifically sub-clause 70.3(xi), which outlines the price adjustment formula. This clause is crucial for determining how fluctuations in the cost of labor, materials, and other inputs are accounted for during the execution of the contract.

Sub-clause 70.3(xi) states:

“The following percentages will govern the price adjustment for the local currency portion (RI) of the contract:

1. Labour – P1 20%

2. Plant and Machinery and Spares – Pp 20%

3. POL – Pf 10%

4. Bitumen – Pb X %

5. Cement – Pc Y %

6. Steel – Ps Z %

7. Other materials – Pm 50-(X+Y+Z)%

Total 100%

(Note: X, Y, Z are the actual percentage of cost of bitumen, cement and steel respectively used for execution of work as per the Interim Payment Certificate for the month)”

The dispute centers around the “Note” following sub-clause 70.3(xi), particularly the phrase “actual percentage of cost.” The contractors interpret ‘cost’ as the current market price, while NHAI interprets it as the base rate, which is the rate prevailing 28 days prior to the submission of the bid.

The definition of ‘cost’ as per the contract is:

“Cost means all expenditure properly incurred or to be incurred, whether on or off the site, including overhead and other charges properly allocated thereto but does not include any allowance for profit”.

Sub-clause 70.5 of the contract defines base cost indices or prices as those prevailing on the day 28 days prior to the closing date for submission of bids.

Arguments

The contractors argued that the term ‘cost’ in the note of sub-clause 70.3(xi) should be interpreted as the actual expenditure incurred by them, based on current market rates. They contended that if the intention was to use base rates, it would have been explicitly mentioned in the contract. They also argued that calculating the price adjustment using current rates would provide a more realistic figure of the work done.

NHAI argued that the ‘actual percentage of cost’ refers to the percentage of the component (bitumen, cement, steel) and not the actual cost itself. They contended that the Interim Payment Certificates (IPCs) are worked out on base rates, and therefore, the ‘cost’ in the note should also refer to base rates. NHAI also presented a mathematical formula to support their contention, arguing that using current rates would lead to incorrect percentages and unrealistic price adjustments.

NHAI further argued that the definition of ‘cost’ does not mean that it should always be construed as current or actual cost. They stated that the word ‘cost’ is used in various sub-clauses of Clause 70 which clearly demonstrate that it would mean ‘the base cost’.

The arguments of the parties can be summarized as follows:

The innovativeness of the argument from the contractors lay in their interpretation of the word ‘cost’ as actual expenditure, which they argued was the plain reading of the contract. They also emphasized the need for a realistic calculation of work done. The NHAI’s argument was innovative in its emphasis on the need for consistency with base rates in the IPCs and the mathematical implications of using current rates.

Issues Framed by the Supreme Court

The Supreme Court framed the following issue:

1. What is the correct interpretation of the note in sub-clause 70.3(xi) of the contract, specifically whether the ‘actual percentage of cost’ should be based on the current market rate or the base rate of bitumen, cement, and steel?

Treatment of the Issue by the Court

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

Authorities

The Supreme Court considered the following authorities:

The court also considered the following legal provisions:

• Section 3 of the National Highways Authority of India Act, 1988: This section deals with the constitution of the National Highways Authority of India.
• Section 16 of the National Highways Authority of India Act, 1988: This section outlines the functions of the NHAI, which include developing, maintaining, and managing national highways.
• Section 34 of the Arbitration and Conciliation Act, 1996: This section deals with the procedure for setting aside an arbitral award.

Judgment

The Supreme Court held that the ‘actual percentage of cost’ of bitumen, cement, and steel in sub-clause 70.3(xi) should be calculated based on the base rate, i.e., the rate prevailing 28 days before the submission of the bid, and not the current market rate. The court reasoned that the very nature of price adjustment is to account for variations from the base price quoted by the contractor.

The Court also noted that sub-clause 70.3(v) uses the base rate for bitumen and that using current rates would lead to unrealistic price adjustments, including negative percentages for other materials. The court agreed with the analysis of the Dispute Review Board (DRB) which had also held that the base rate should be used for calculating the price adjustment.

The Court also observed that the payments were not consistently made on the basis of current cost, and hence, no such intention of the parties can be discerned.

The court determined how each submission made by the parties was treated:

The court also determined how each authority was viewed:

The Supreme Court overruled the interpretation given by the Arbitral Tribunal, stating that the award was contrary to the contractual terms.

The court clarified that the principle of issue estoppel would only apply in cases where matters have attained finality and no judicial proceedings are pending.

The court observed that:

“Once we interpret the formula in the manner indicated above, the necessary consequences would be to hold that the Arbitral Tribunal(s) did not decide the cases with the correct application of the formula and further that the claim for price adjustment in respect of bitumen laid by the contractors was not correct. Therefore, it can be held that the Award(s) are contrary to the contractual terms.”

The court also observed that:

“In such an eventuality, view taken by a particular Arbitral Tribunal in favour of the Contractor would be upheld as plausible view. Likewise, the Court will have to uphold the view taken by a particular Arbitral Tribunal in favour of NHAI as well, as a plausible view. Therefore, the purpose is to avoid such a situation which cannot be permitted as it would result in upholding both kinds of arbitral awards interpreting the same clause, whether they go in favour of the employer or they go in favour of the contractor.”

What weighed in the mind of the Court?

The Supreme Court’s decision was influenced by several factors. Firstly, the court emphasized the importance of adhering to the contractual terms and the need for a consistent interpretation of the price adjustment clause. The court also considered the practical implications of each interpretation, noting that using current costs would lead to unrealistic price adjustments and negative percentages for other materials. The court also relied on the analysis of the DRB, which had also concluded that the base rate should be used for calculating price adjustment.

The ratio of fact to law in the court’s decision is as follows:

The court’s reasoning can be summarized in the following flowchart:

The court rejected the alternative interpretation of using current costs, stating that it was not supported by the contractual terms and would lead to an absurd outcome. The court also reasoned that the word “actual” in the note relates to the percentage and not to the cost.

The court’s reasoning was based on the following points:

• The very nature of price adjustment suggests that such variation would have relevance with the price which was indicated in respect of these components at the time of submitting the tender by the successful contractor and, in that sense, it can have reference only to the base price.
• The formula for price adjustment uses the base rate for bitumen in sub-clause 70.3(v).
• Using the current cost would lead to unrealistic price adjustments, including negative percentages for other materials.
• The DRB had also concluded that the base rate should be used for calculating the price adjustment.

The court’s decision was unanimous, with both judges agreeing on the interpretation of the clause.

The court observed that:

“The very nature of this price adjustment suggests that such variation would have relevance with the price which was indicated in respect of these components at the time of submitting the tender by the successful contractor and, in that sense, it can have reference only to the base price.”

The court also observed that:

“In the present case, we find that the intention in the formula as well is to keep in mind the base cost while arriving at the price adjustment.”

The court also observed that:

“As mentioned above, the word “actual” in the note under sub-clause 703(xi) of COPA relates to the percentage and not to the cost.”

Key Takeaways

• Price adjustment clauses in contracts must be interpreted strictly based on the contractual terms.
• The base rate, as defined in the contract, should be used for calculating price adjustments unless explicitly stated otherwise.
• Courts may intervene in arbitral awards if they are found to be contrary to the contractual terms.
• Conflicting arbitral awards on the same contractual provision can prompt the Supreme Court to provide a definitive interpretation.

Directions

The Supreme Court set aside the impugned judgments and the awards given by the Arbitral Tribunals on the claim pertaining to the price adjustment of bitumen.

Development of Law

The ratio decidendi of the case is that the ‘actual percentage of cost’ of bitumen, cement, and steel in sub-clause 70.3(xi) should be calculated based on the base rate, i.e., the rate prevailing 28 days before the submission of the bid, and not the current market rate. This decision clarifies the interpretation of price adjustment clauses in contracts and provides a uniform approach for Arbitral Tribunals dealing with similar disputes. The Supreme Court has overruled the previous position of law as it was leading to conflicting awards by different Arbitral Tribunals.

Conclusion

The Supreme Court’s judgment in National Highway Authority of India vs. M/S. ProgressiveMVR (JV) provides clarity on the interpretation of price adjustment clauses in highway construction contracts. The court held that the base rate, not the current market rate, should be used to calculate the ‘actual percentage of cost’ for bitumen, cement, and steel. This decision ensures a consistent approach in interpreting similar clauses and prevents unrealistic price adjustments, thereby upholding the sanctity of contracts.

CASE TYPE: Arbitration, Contract Law

LEGAL ISSUE: Interpretation of price adjustment formula in construction contracts.