Supreme Court Upholds Compound Interest in Arbitration, Dismisses State’s Appeal: UHL Power Company Ltd. vs. State of Himachal Pradesh (2022)

Introduction

Date of the Judgment: 07 January 2022

Citation: (2022) INSC 19

Judges: N.V. Ramana (CJI), A.S. Bopanna J., Hima Kohli J.

Can an arbitral tribunal award compound interest, and what happens when a preliminary agreement is followed by a more comprehensive one? The Supreme Court of India recently addressed these questions in a dispute between UHL Power Company Ltd. and the State of Himachal Pradesh. This case clarifies the power of arbitrators to award compound interest and addresses the relationship between a Memorandum of Understanding (MoU) and a subsequent Implementation Agreement. The judgment was delivered by a three-judge bench comprising Chief Justice N.V. Ramana and Justices A.S. Bopanna and Hima Kohli, with the opinion authored by Justice Hima Kohli.

Case Background

The dispute arose from a project for the development of a hydroelectric power project. UHL Power Company Ltd. (UHL) and the State of Himachal Pradesh (the State) entered into a Memorandum of Understanding (MoU) on 10th February, 1992, for UHL to carry out detailed investigations for the UHL-III Hydro-electric Project. Subsequently, on 22nd August, 1997, they entered into an Implementation Agreement. The project faced delays and disputes, leading to UHL claiming expenses and interest. The State terminated the Implementation Agreement, which UHL contested, leading to arbitration.

Timeline:

Course of Proceedings

The Sole Arbitrator initially awarded UHL ₹26,08,89,107.35, which included compound interest. However, the Single Judge of the High Court of Himachal Pradesh set aside the entire award. On appeal, the Division Bench of the High Court awarded UHL ₹9,10,26,558.74, the principal amount, along with simple interest, rejecting the compound interest awarded by the arbitrator. The Division Bench relied on the Supreme Court’s judgment in State of Haryana v. S.L. Arora and Co., which had held that compound interest could only be awarded if explicitly stated in the contract or statute.

Legal Framework

The case primarily revolves around the interpretation of the Arbitration and Conciliation Act, 1996, specifically regarding the power of an arbitral tribunal to award interest.

Section 31(7)(a) of the Arbitration and Conciliation Act, 1996, deals with the power of the arbitral tribunal to award interest.

Section 37 of the Arbitration and Conciliation Act, 1996, deals with appealable orders.

Section 34 of the Arbitration and Conciliation Act, 1996, deals with application for setting aside arbitral awards.

The Supreme Court also considered the contractual terms between the parties, particularly the clauses relating to the merger of the MoU into the Implementation Agreement and the conditions for the project’s commencement.

Arguments

UHL’s Arguments:

• UHL argued that the High Court erred in disallowing the pre-claim interest awarded by the Arbitrator.
• UHL contended that the Arbitrator was correct in awarding compound interest, and the decision in State of Haryana v. S.L. Arora and Co. was incorrectly applied.

State of Himachal Pradesh’s Arguments:

• The State argued that the MoU did not merge into the Implementation Agreement, as they were distinct documents with separate arbitration clauses.
• The State contended that the Implementation Agreement was not prematurely terminated, and the Arbitrator’s findings were incorrect.
• The State argued that the extension of time for the project was only applicable to the conditions in Clause 4.1(a) and (b) of the Implementation Agreement, and not to the other conditions.

Issues Framed by the Supreme Court

✓ Whether the Arbitral Tribunal was empowered to grant compound interest or interest upon interest.

✓ Whether the MoU dated 10th February, 1992, merged into the Implementation Agreement dated 22nd August, 1997.

✓ Whether the Implementation Agreement was prematurely terminated by the State.

Treatment of the Issue by the Court

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

Authorities

Cases Relied Upon:

• State of Haryana v. S.L. Arora and Co. (2010) 3 SCC 690 (Supreme Court of India): This case was overruled by the Supreme Court. It had previously held that compound interest could only be awarded if there was a specific contract or statute, and that arbitrators did not have the power to award interest upon interest.
• Hyder Consulting (UK) Ltd. V. Governor, State of Orissa through Chief Engineer (2015) 2 SCC 189 (Supreme Court of India): This case overruled S.L. Arora and held that an arbitrator can award post-award interest on the interest amount awarded.
• MMTC Limited v. Vedanta Limited (2019) 4 SCC 163 (Supreme Court of India): Explained the limited scope of interference by courts under Section 34 of the Arbitration Act.
• K. Sugumar v. Hindustan Petroleum Corporation Ltd. (2020) 12 SCC 539 (Supreme Court of India): Reiterated the limited power of the court to interfere with an arbitral award.
• Dyna Technologies (P) Ltd. V. Crompton Greaves Ltd. (2019) 20 SCC 1 (Supreme Court of India): Highlighted the limitations on courts while exercising powers under Section 34 of the Arbitration Act.
• Parsa Kente Collieries Limited v. Rajasthan Rajya Vidyut Utpadan Nigam Limited (2019) 7 SCC 236 (Supreme Court of India): Stated that the construction of contract terms is primarily for the arbitrator.
• McDermott International Inc. v. Burn Standard Co. Ltd. And Others (2006) 11 SCC 181 (Supreme Court of India): An arbitral tribunal must decide in accordance with the terms of the contract.
• Rashtriya Ispat Nigam Ltd. V. Dewan Chand Ram Saran (2012) 5 SCC 306 (Supreme Court of India): An arbitral tribunal must decide in accordance with the terms of the contract.
• South East Asia Marine Engg. & Constructions Ltd.[SEAMAC Limited] V. Oil India Ltd. (2020) 5 SCC 164 (Supreme Court of India): Reiterated that courts should not interfere with an award merely because an alternative view exists.

Legal Provisions Considered:

• Section 37 of the Arbitration and Conciliation Act, 1996: Deals with appeals against orders made under Section 34.
• Section 34 of the Arbitration and Conciliation Act, 1996: Deals with applications for setting aside arbitral awards.
• Section 31(7)(a) of the Arbitration and Conciliation Act, 1996: Deals with the power of the arbitral tribunal to award interest.

Authorities Table

Judgment

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

How each authority was viewed by the Court?

✓ State of Haryana v. S.L. Arora and Co. was overruled by the Supreme Court. The Court held that the previous ruling was incorrect in holding that an arbitral tribunal cannot award compound interest.

✓ Hyder Consulting (UK) Ltd. V. Governor, State of Orissa through Chief Engineer was followed by the Supreme Court. The Court relied on this case to support its decision that an arbitrator can award post-award interest on the interest amount awarded.

✓ MMTC Limited v. Vedanta Limited was followed by the Supreme Court to highlight the limited scope of interference by courts under Section 34 of the Arbitration Act.

✓ K. Sugumar v. Hindustan Petroleum Corporation Ltd. was followed by the Supreme Court to reiterate the limited power of the court to interfere with an arbitral award.

✓ Dyna Technologies (P) Ltd. V. Crompton Greaves Ltd. was followed by the Supreme Court to highlight the limitations on courts while exercising powers under Section 34 of the Arbitration Act.

✓ Parsa Kente Collieries Limited v. Rajasthan Rajya Vidyut Utpadan Nigam Limited was followed by the Supreme Court to state that the construction of contract terms is primarily for the arbitrator.

✓ McDermott International Inc. v. Burn Standard Co. Ltd. And Others was followed by the Supreme Court to state that an arbitral tribunal must decide in accordance with the terms of the contract.

✓ Rashtriya Ispat Nigam Ltd. V. Dewan Chand Ram Saran was followed by the Supreme Court to state that an arbitral tribunal must decide in accordance with the terms of the contract.

✓ South East Asia Marine Engg. & Constructions Ltd.[SEAMAC Limited] V. Oil India Ltd. was followed by the Supreme Court to reiterate that courts should not interfere with an award merely because an alternative view exists.

What weighed in the mind of the Court?

The Supreme Court focused on several key aspects while reaching its decision:

The Court emphasized that the Hyder Consulting (UK) Ltd. case had overruled the S.L. Arora case, thereby clarifying that arbitrators do have the power to award compound interest.

The Court observed that the Implementation Agreement explicitly included the MoU as Appendix A, indicating an intention to merge the two documents.

The Court noted that the termination of the Implementation Agreement by the State was premature and based on a flawed interpretation of the contract’s clauses.

The Court reiterated that the scope of judicial interference in arbitral awards is limited, and courts should not act as appellate bodies.

The Court also highlighted the importance of respecting the arbitrator’s interpretation of contractual terms, provided it is a plausible one.

The Supreme Court’s reasoning was heavily influenced by the need to uphold the finality of arbitral awards and to respect the autonomy of parties in choosing arbitration as a dispute resolution mechanism. The Court’s decision was also driven by its interpretation of the specific contractual terms and the need to ensure that the parties’ intentions were given due effect.

Fact:Law Ratio

Logical Reasoning

Judgment

The Supreme Court partly allowed the appeal filed by UHL and dismissed the appeal filed by the State of Himachal Pradesh. The Court held that the Arbitral Tribunal was empowered to grant compound interest, and the MoU merged into the Implementation Agreement. The Court also upheld the finding that the Implementation Agreement was prematurely terminated by the State.

The Court’s reasoning was that the judgment in State of Haryana v. S.L. Arora and Co., which had been relied upon by the High Court, had been overruled by a larger bench in Hyder Consulting (UK) Ltd. V. Governor, State of Orissa through Chief Engineer. The Court also noted that the Implementation Agreement explicitly referred to the MoU as Appendix A, and the definition of “Agreement” included all its appendices and annexures. The Court further held that the termination of the Implementation Agreement by the State was premature and based on a misinterpretation of the relevant clauses.

The Court also emphasized the limited scope of judicial interference in arbitral awards, stating that courts should not act as appellate bodies and should respect the arbitrator’s interpretation of contractual terms.

The Supreme Court quoted from Hyder Consulting (UK) Ltd. V. Governor, State of Orissa through Chief Engineer:

“In the result, I am of the view that S.L. Arora case is wrongly decided in that it holds that a sum directed to be paid by an Arbitral Tribunal and the reference to the award on the substantive claim does not refer to interest pendente lite awarded on the “sum directed to be paid upon award” and that in the absence of any provision of interest upon interest in the contract, the Arbitral Tribunal does not have the power to award interest upon interest, or compound interest either for the pre-award period or for the post-award period.”

The Supreme Court also quoted from Hyder Consulting (UK) Ltd. V. Governor, State of Orissa through Chief Engineer:

“The arbitral award, as held above, is made in respect of a “sum” which includes the interest. It is, therefore, obvious that what carries under Section 31 (7)(b) of the Act is the ” sum directed to be paid by an arbitral award” and not any other amount much less by or under the name “interest”. In such situation. it cannot be said that what is being granted under Section 31(7)(b) of the Act is ” interest on interest “. Interest under clause (b) is granted on the ” sum ” directed to be paid by an arbitral award wherein the ” sum” is nothing more than what is arrived at under clause (a).”

The Supreme Court also quoted from MMTC Limited v. Vedanta Limited:

“As far as Section 34 is concerned, the position is well- settled by now that the Court does not sit in appeal over the arbitral award and may interfere on merits on the limited ground provided under Section 34(2)(b)(ii) i.e. if the award is against the public policy of India.”

Key Takeaways

• Arbitral tribunals have the power to award compound interest on the principal amount and interest, overturning the previous stance in State of Haryana v. S.L. Arora and Co..
• A Memorandum of Understanding (MoU) can merge into a subsequent Implementation Agreement if the terms of the latter indicate such an intention.
• Courts have a limited scope of interference in arbitral awards and should not act as appellate bodies.
• The interpretation of contractual terms by an arbitrator should be respected, provided it is plausible.
• Parties should carefully draft contracts to clearly define the relationship between preliminary and subsequent agreements.

Directions

The Supreme Court directed that the arbitral award dated 05th June, 2005, be restored to the extent of the interest component.

Development of Law

The ratio decidendi of this case is that an arbitral tribunal has the power to award compound interest on the principal amount and interest, and a Memorandum of Understanding (MoU) can merge into a subsequent Implementation Agreement if the terms of the latter indicate such an intention. This judgment marks a significant change in the legal position regarding the power of arbitral tribunals to award compound interest, overturning the previous stance in State of Haryana v. S.L. Arora and Co..

Conclusion

The Supreme Court’s decision in UHL Power Company Ltd. v. State of Himachal Pradesh clarifies important aspects of arbitration law, particularly the power of arbitrators to award compound interest and the relationship between preliminary and subsequent agreements. The judgment reinforces the limited scope of judicial interference in arbitral awards and emphasizes the importance of respecting the arbitrator’s interpretation of contractual terms. The Supreme Court partly allowed the appeal filed by UHL and dismissed the appeal filed by the State of Himachal Pradesh.

Category

Parent Category: Arbitration Law

Child Categories:

• Arbitration and Conciliation Act, 1996
• Section 37, Arbitration and Conciliation Act, 1996
• Section 34, Arbitration and Conciliation Act, 1996
• Section 31(7)(a), Arbitration and Conciliation Act, 1996
• Compound Interest
• Merger of Agreements
• Judicial Review of Arbitral Awards

FAQ

Q: Can an arbitrator award compound interest?

A: Yes, the Supreme Court has clarified that an arbitrator has the power to award compound interest on the principal amount and interest.

Q: What happens when a Memorandum of Understanding (MoU) is followed by an Implementation Agreement?

A: The MoU can merge into the Implementation Agreement if the terms of the latter indicate such an intention, as was the case here where the MoU was referred to as Appendix A.

Q: Can a court interfere with an arbitral award?

A: Courts have a limited scope of interference in arbitral awards and should not act as appellate bodies. They should respect the arbitrator’s interpretation of contractual terms.

Q: What was the main point of contention in this case?

A: The main points of contention were whether the arbitrator could award compound interest, whether the MoU merged into the Implementation Agreement, and whether the Implementation Agreement was prematurely terminated.

Q: What is the significance of this judgment?

A: This judgment is significant because it clarifies the power of arbitrators to award compound interest and reinforces the limited scope of judicial interference in arbitral awards.