Supreme Court Upholds Forfeiture of Security Deposit and Modifies Interest Rate in Construction Contract Dispute: Indian Railway Construction Company Limited vs. M/s National Buildings Construction Corporation Limited (2023) INSC 248 (17 March 2023)

Date of the Judgment: 17 March 2023
Citation: (2023) INSC 248
Judges: M. R. Shah, J. and M.M. Sundresh, J.
Can a contractor’s security deposit be forfeited if they fail to complete work, even if the termination notice cites an incorrect clause of the contract? The Supreme Court of India addressed this question in a recent appeal concerning a construction project, ultimately ruling in favor of the Indian Railway Construction Company Limited (IRCON). The court upheld the forfeiture of the security deposit and modified the interest rate on an advance, clarifying the interplay between different clauses of a construction contract. The bench comprised Justices M. R. Shah and M.M. Sundresh, with the judgment authored by Justice M. R. Shah.

Case Background

The dispute arose from a contract between the Indian Railway Construction Company Limited (IRCON) and M/s. National Buildings Construction Corporation Limited (NBCC). On 05 April 1990, NBCC was awarded a contract to construct a Railway Station cum Commercial Complex at Vashi, Navi Mumbai, for Rs. 3042.91 lakh, with a completion period of 30 months. NBCC failed to complete the work on time, leading to supplementary agreements between the parties. IRCON, after consultation with CIDCO, agreed to grant a special advance of Rs. 68 lakhs at 18% interest per annum, against a Bank Guarantee, as per a supplementary agreement dated 17 December 1991. However, the work was delayed and practically abandoned by NBCC. Consequently, IRCON terminated the contract on 21 February 1994, citing Clause 60.1 of the agreement.

Timeline

Course of Proceedings

Following the termination of the contract, NBCC invoked the arbitration clause. The Arbitral Tribunal rejected NBCC’s claim for a refund of two security deposits (Claim Nos. 33 and 34), holding that while the termination under Clause 60.1 was invalid, the termination was justified under Clause 17.4 of the contract. The Tribunal also partly allowed IRCON’s Counter Claim No. 3, related to interest on advances given to NBCC. NBCC then challenged the Arbitral Tribunal’s award before the Delhi High Court under Section 34 of the Arbitration and Conciliation Act, 1996, limited to Claim Nos. 33 and 34 and Counter Claim No. 3. The Single Judge of the High Court set aside the rejection of Claim Nos. 33 and 34 and the award on Counter Claim No. 3. The Division Bench of the High Court partly allowed IRCON’s appeal under Section 37 of the Arbitration Act, upholding the interest on the special advance but affirming the rest of the Single Judge’s order.

Legal Framework

The Supreme Court examined the following clauses of the agreement between IRCON and NBCC:

• Clause 17.4: “The time for completion of the works by the date or extended date fixed for completion shall be deemed to be the essence of the contract and if the contractor shall fail to complete the works within the time prescribe the Company IRCON shall, if satisfied that the works can be completed by the contractor within a reasonably short time thereafter be entitled without prejudice to any other right or remedy available on that behalf to recover by way of ascertained liquidated damages…If the Company (IRCON) is not satisfied that the works can be completed by the contractor and in the event of failure on the part of the contractor to complete the works within the further extension of time allowed as aforesaid the Company (IRCON) shall be entitled, without prejudice to any other right or remedy available in that behalf, to appropriate the contractor’s security deposit and rescind the contract, whether or not actual damage is caused by such default.” This clause specifies that time is of the essence and outlines the consequences of failing to complete work on time, including the right to forfeit security deposits and rescind the contract.
• Clause 59.1: “The Company (IRCON) shall be entitled to determine and terminate the contract at any time should in the Company’s (IRCON) opinion, the cessation of work become necessary owing to paucity of funds or from any cause whatsoever, in which case the value of approved materials at site and of work done to date by the contractor will be paid for in full at the rates specified in the contract.” This clause allows IRCON to terminate the contract due to lack of funds or other causes, with payment for work done.
• Clause 60.1: “If the contractor should: (vi) abandon the contract, or (viii) fail to adhere to the agreed programme of work by a margin of 10% of the stipulated period…Then and in any of the said cases, the Project Manager on behalf of the Company (IRCON) may serve the contractor with a notice in writing to that effect and if the contractor does not within 7 days after the delivery to him of such notice proceed to make good his default…the Company (IRCON) shall be entitled after giving 48 hours notice in writing…to rescind the contract, of which rescission notice in writing to the contractor under the hand of the Project Manager shall be conclusive evidence, in which case the security deposit of the contractor shall stand forfeited to the Company IRCON without prejudice to the Company’s (IRCON) right to recover from the contractor any amount by which the cost of completing the works by any other agency shall exceed the value of the contractor.” This clause details the conditions under which IRCON can terminate the contract due to the contractor’s default, including abandoning the work, and the right to forfeit the security deposit.
• Section 31(7)(a) of the Arbitration and Conciliation Act, 1996: This provision allows an arbitral tribunal to award interest on the sum for which the award is made, unless otherwise agreed by the parties, for the period between the cause of action and the date of the award.

Arguments

Appellant (IRCON)’s Submissions:

• IRCON argued that the Arbitral Tribunal correctly found that NBCC abandoned the work, justifying the rescission of the contract and forfeiture of security deposits.
• They contended that the High Court took a technical view by focusing on the incorrect clause (60.1) cited in the termination notice, rather than considering the overall justification for termination under Clause 17.4.
• IRCON submitted that Clauses 17.4 and 60.1 should be read together, and the key factor was NBCC’s failure to complete the work.
• They argued that the Arbitrator has the power to award interest, unless specifically barred, and relied on the Supreme Court’s decision in Raveechee and Company vs. Union of India [(2018) 7 SCC 664].
• IRCON submitted that the Division Bench of the High Court erred in setting aside the award of interest on the amount advanced against hypothecation of equipment.

Respondent (NBCC)’s Submissions:

• NBCC argued that IRCON specifically invoked Clause 60.1 to rescind the contract, and the Arbitral Tribunal itself found this invocation unjustified.
• They contended that once the Arbitral Tribunal found the termination under Clause 60.1 invalid, it could not then justify the termination under Clause 17.4.
• NBCC argued that the High Court rightly set aside the award of interest on the amount advanced against hypothecation of equipment, as there was no specific provision in the contract for such interest.
• NBCC relied on the fact that the Arbitral Tribunal’s finding that the contract could not be rescinded under Clause 60.1 had attained finality.

Issues Framed by the Supreme Court

The Supreme Court addressed the following issues:

1. Whether the High Court was right in setting aside the award passed by the Arbitral Tribunal rejecting Claim Nos. 33 and 34 with respect to forfeiture of the security deposits.
2. Whether the High Court was right in setting aside the award passed by the Arbitral Tribunal awarding interest at 18% on advance for hypothecation of equipment.

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?

• The Supreme Court followed Raveechee and Company vs. Union of India [(2018) 7 SCC 664]* , reiterating that an arbitrator has the power to award interest unless specifically barred by contract.
• The Court considered Clause 17.4 and Clause 60.1 of the agreement, noting that both clauses allowed for forfeiture of security deposits upon failure to complete work.
• The Court also considered Section 31(7)(a) of the Arbitration and Conciliation Act, 1996, which allows an arbitral tribunal to award interest on the sum for which the award is made, unless otherwise agreed by the parties.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the fact that NBCC failed to complete the work within the stipulated time, and even abandoned the work. The Court emphasized that the termination was justified under Clause 17.4 of the contract, regardless of the initial invocation of Clause 60.1. The Court also considered the Arbitral Tribunal’s finding that IRCON was justified in rescinding the contract due to NBCC’s failure to complete the work. The Court also noted that there was no specific bar in the contract to award interest and therefore the arbitrator was within his powers to award interest.

Logical Reasoning:

The court rejected the argument that the Arbitral Tribunal could not rely on Clause 17.4 after finding the invocation of Clause 60.1 unjustified. The Supreme Court emphasized that the focus should be on the failure to complete the work, not the specific clause cited in the termination notice. The court also clarified that an arbitrator has the power to award interest unless specifically barred by the contract. The Supreme Court held that the High Court exceeded its jurisdiction under Section 34 of the Arbitration Act by setting aside the well-reasoned award passed by the Arbitral Tribunal.

The Court quoted the following from the judgment:

• “The learned Arbitral Tribunal as such was absolutely justified in considering whether IRCON was justified in rescinding the contract, may be either under Clause 60.1 or under Clause 17.4.”
• “Thus, both, under Clause 17.4 and 60.1, on failure of the contractor to complete the work, the IRCON is justified in rescinding the contract and forfeit the security deposit.”
• “…unless there is a specific bar under the contract, it is always open for the arbitrator / Arbitral Tribunal to award pendente lite interest.”

There was no minority opinion in this case.

Key Takeaways

• A contractor’s security deposit can be forfeited if they fail to complete work on time, even if the termination notice cites an incorrect clause of the contract, provided the termination is justified under another clause of the contract.
• Arbitrators have the power to award interest on monetary claims unless specifically barred by the contract.
• Courts should not interfere with well-reasoned arbitral awards unless there is a clear violation of the law.
• The focus should be on the substance of the breach of contract, rather than the technicalities of the termination notice.

Directions

The Supreme Court directed that the award passed by the Arbitral Tribunal rejecting Claim Nos. 33 and 34 is restored. The Court also restored the award of interest on advance for hypothecation of equipment, but modified the interest rate to 12% pendente lite instead of 18%.

Development of Law

The Supreme Court clarified that a termination of contract can be justified under a clause of the contract even if the termination notice cites an incorrect clause. The Court also reiterated the principle that arbitrators have the power to award interest unless specifically barred by the contract, as established in the case of Raveechee and Company vs. Union of India [(2018) 7 SCC 664]. This case reinforces the importance of adhering to contractual obligations and provides clarity on the powers of arbitrators to award interest.

Conclusion

The Supreme Court allowed the appeal, setting aside the High Court’s judgment that had quashed the Arbitral Tribunal’s award regarding the forfeiture of security deposits. The Court upheld the forfeiture of security deposits by IRCON due to NBCC’s failure to complete the work. The Court also restored the award of interest, but modified the rate to 12% on the advance for hypothecation of equipment, emphasizing that arbitrators have the power to award interest unless specifically barred by the contract. This judgment reinforces the importance of fulfilling contractual obligations and clarifies the scope of arbitrators’ powers in awarding interest.