Supreme Court quashes debarment and penalty on transformer supplier: Isolators and Isolators vs. Madhya Pradesh Vidyut Vitran Company (2023)

Date of the Judgment: 18 April 2023

Citation: 2023 INSC 341

Judges: Dinesh Maheshwari, J. and Sanjay Kumar, J.

Can a government entity impose penalties and debar a supplier for failing to meet delivery schedules, especially when the entity itself had deferred the delivery? The Supreme Court of India recently addressed this question in a case involving a transformer supplier and a state electricity distribution company. The court examined the principles of natural justice and fairness in contractual disputes, ultimately ruling in favor of the supplier.

Case Background

Isolators and Isolators, a proprietorship firm, has been manufacturing and repairing transformers for 30 years, primarily supplying to distribution companies (Discoms). The firm received two purchase orders from Madhya Pradesh Madhya Kshetra Vidyut Vitran Company Limited (MPMKVVCL). The first order (TS-494) was for 586 Level-I distribution transformers, with a delivery period of six months from the third month after the order date. The second order (TS-532) was for 593 Level-II transformers.

The supplier faced delays in receiving the first purchase order, which was received 75 days late. They requested a modification of the delivery schedule and adjustment of rates due to the implementation of GST on 01.07.2017. Although a revised order incorporating GST was issued, the request for rescheduling was ignored. The supplier began delivering transformers, but the company imposed late supply penalties.

For the second purchase order, the supplier submitted drawings for approval, which were approved. They began manufacturing and offered 100 transformers for inspection, which were cleared. However, a severe storm caused the roof of their plant to collapse, destroying most of the raw material. They managed to supply 50 transformers that were ready for delivery.

MPMKVVCL later deferred the balance deliveries of 593 transformers under TS-532 and then cancelled the supply of 286 Level-I transformers under TS-494, and subsequently cancelled the supply of the remaining transformers under TS-532. The company then issued a show-cause notice to the supplier, asking why they should not be debarred from participating in further tenders due to non-supply.

Timeline

Course of Proceedings

The supplier initially challenged the debarment order dated 13.02.2020 in the High Court, which set aside the order and directed the company to pass a fresh order after giving the supplier an opportunity to be heard. After a video-conferenced hearing, the company maintained the debarment and also imposed a penalty. The supplier then filed another writ petition in the High Court, challenging both the debarment and penalty orders. The High Court upheld the debarment but modified its term to be effective from 13.02.2020. The supplier’s review petition was also dismissed. The supplier then appealed to the Supreme Court.

Legal Framework

The case revolves around the interpretation of contractual clauses related to delivery schedules, penalties, and debarment. The relevant clauses include:

• Clause 12 of Annexure-II of TS-494: Deals with delivery and supply of material.
• Clause 28 of Annexure-II of TS-494: Deals with cancellation of rate contract.
• Clause 4 of Annexure-IV of TS-532: Deals with delivery of material.
• Clause 17 of Annexure-III of TS-532: Deals with cancellation/termination of purchase order.

These clauses, as per the company, allowed them to cancel the purchase orders and impose penalties for non-supply. The company also relied on Clause 17 of Annexure-III of TS-532 which states that:

“The Purchaser may upon written notice of default, terminate/cancel the purchase order/contract in whole or for a part quantity with recovery of liquidate damages at the rate of 10% of ex-works price(s) of stores not delivered by them or liability on account of risk and cost, whichever is higher in the circumstances detailed hereunder: – 17.1. If in the opinion of the Purchaser, the supplier fails to deliver the material within the time specified or during the period for which extension has been granted by the Purchaser. 17.4. In pursuance to clause no. 17.1, 17.2 &17.3 above, Purchaser may debar the supplier/contractor for further business with Purchaser for a declared period on breach of the Purchase Order.”

Arguments

Appellant’s Arguments:

• The show-cause notice was only about debarment, not penalty.
• The penalty imposed was the maximum possible (10%) without any justification.
• The High Court only considered the debarment and not the penalty.
• The supplier had been supplying transformers since 1989 without any issues.
• The delay in execution was due to reasons explained by the supplier, including the late receipt of the purchase order and the storm.
• The company deferred the delivery on 18.09.2019, and there was no subsequent communication for withdrawal of the deferment.
• The cancellation of the contract was arbitrary and unreasonable.
• The action of debarment and imposition of maximum penalty was disproportionate and too harsh.
• The supplier had supplied 300 out of 586 transformers under TS-494 and all 63 KVA transformers under TS-532.

Respondent’s Arguments:

• The supplier did not comply with the terms and conditions of the contract.
• The company issued notices regarding the delay.
• The company had the right to defer, reduce, or reschedule the supply as per the requirement.
• The company cancelled the purchase order due to the supplier’s failure to make the requisite supplies.
• The company imposed the penalty as per the terms and conditions of the contract.
• The debarment order was passed after giving full opportunity to the supplier.
• The supplier failed to provide information regarding the force majeure within 15 days as required by the terms of the contract.

Submissions Table:

Issues Framed by the Supreme Court

The Supreme Court did not explicitly frame issues in a numbered list but addressed the following key questions:

• Whether the debarment order and the imposition of penalty were justified given the facts of the case.
• Whether the show-cause notice was adequate, specifically if it indicated the proposed action of imposing a penalty.
• Whether the High Court erred in its assessment of the case.
• Whether the company could hold the supplier solely responsible for the delay or default in supply after the company had deferred the delivery.

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:

Judgment

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

How each authority was viewed by the Court?

• UMC Technologies Private Limited v. Food Corporation of India and Anr. [CITATION]: The court relied on this case to emphasize the need for a specific show-cause notice in debarment cases and the principles governing such actions.
• Nasir Ahmad v. Custodian General, Evacuee Property [CITATION]: The court used this to emphasize that the notice should specify the grounds for the proposed action.
• Erusian Equipment & Chemicals Ltd. v. State of W.B. [CITATION]: The court highlighted the severe consequences of blacklisting and the need for natural justice.
• Raghunath Thakur v. State of Bihar [CITATION]: The court cited this to emphasize the need for a hearing before blacklisting.
• Gorkha Security Services v. State (NCT of Delhi) [CITATION]: The court used this case to describe blacklisting as stigmatic and having severe consequences.
• A.P. State Financial Corporation v. C.M. Ashok Raju and Ors. [CITATION]: The court used this to justify the maintainability of the appeal despite the earlier withdrawal.

What weighed in the mind of the Court?

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

• Procedural Fairness: The court emphasized the importance of following principles of natural justice, particularly the need for a clear show-cause notice specifying all proposed actions, including penalties.
• Factual Context: The court took into account the specific circumstances of the case, including the company’s deferment of delivery and the supplier’s efforts to fulfill the contract despite challenges.
• Proportionality: The court found the debarment and maximum penalty to be disproportionate, especially given the supplier’s long-standing relationship with the company and the reasons for the delay.
• Impact of Deferment: The court noted that the company’s deferment of delivery shifted the responsibility and that the supplier could not be held solely accountable for the non-supply.

Sentiment Analysis of Reasons Given by the Supreme Court:

Fact:Law Ratio

Logical Reasoning:

The court reasoned that the company’s actions were not justified due to the lack of a specific show-cause notice for the penalty, the company’s own deferment of delivery, and the disproportionate nature of the penalty.

The court considered alternative interpretations but rejected them because the company failed to adhere to the principles of natural justice and fairness. The court emphasized that the company could not impose penalties and debar the supplier without proper procedure and justification.

The majority opinion was delivered by Justice Dinesh Maheshwari, with Justice Sanjay Kumar concurring. There were no dissenting opinions.

The court’s decision sets a precedent for similar cases involving government contracts, emphasizing the need for transparency, fairness, and adherence to principles of natural justice. It also highlights the importance of considering the specific circumstances of each case before imposing penalties and debarment.

“The basic principle of natural justice is that before adjudication starts, the authority concerned should give to the affected party a notice of the case against him so that he can defend himself.”

“Specifically, in the context of blacklisting of a person or an entity by the State or a State Corporation, the requirement of a valid, particularised and unambiguous show-cause notice is particularly crucial due to the severe consequences of blacklisting and the stigmatisation that accrues to the person/entity being blacklisted.”

“The written submissions on behalf of the respondents do not answer the root question in the matter as to how the appellant could have been made solely responsible for delay or default in supply after the communication dated 18.09.2019 when the respondents themselves informed the appellant that taking of balance delivery was being deferred (until further instructions).”

Key Takeaways

• Government entities must adhere to principles of natural justice when taking action against contractors.
• Show-cause notices must clearly specify all proposed actions, including penalties.
• Penalties and debarment must be proportionate to the default and justified by the circumstances.
• Government entities cannot hold contractors solely responsible for delays when the entity itself has contributed to the delay.
• This judgment emphasizes the need for fairness and transparency in government contracts.

Directions

The Supreme Court directed that:

• The debarment order is annulled and shall not operate against the supplier in any future tender process.
• The penalty order is set aside, and no recovery shall be made from the supplier.
• If any amount has been recovered, it shall be refunded to the supplier within a month with 9% interest per annum if the refund is not made within a month.

Development of Law

The ratio decidendi of this case is that a government entity cannot impose penalties and debar a supplier without a specific show-cause notice for the penalty, especially when the entity itself has deferred the delivery. This judgment reinforces the principles of natural justice and proportionality in government contracts. There is no change in the previous position of law, but the judgment clarifies the application of these principles in cases where the government entity is also partly responsible for the default.

Conclusion

The Supreme Court’s decision in Isolators and Isolators vs. Madhya Pradesh Madhya Kshetra Vidyut Vitran Co. Ltd. quashed the debarment and penalty imposed on the transformer supplier. The court emphasized the need for procedural fairness, proportionality, and consideration of the factual context. This judgment serves as a reminder for government entities to act fairly and transparently in contractual matters, ensuring that suppliers are not penalized unjustly.