Supreme Court Upholds Levy of Supervision Charges in Sal Seed Supply Contract: State of Chhattisgarh vs. M/S Sal Udyog Private Limited (2021) INSC 745 (08 November 2021)

Date of the Judgment: 08 November 2021
Citation: (2021) INSC 745
Judges: N.V. Ramana, CJI, Surya Kant, J., Hima Kohli, J.

Can a State Government levy supervision charges on a private company for the supply of forest produce, even if the company has been paying these charges without protest for years? The Supreme Court of India recently addressed this question in a dispute between the State of Chhattisgarh and M/S Sal Udyog Private Limited. The core issue revolved around whether the Arbitral Tribunal and the High Court were correct in disallowing the State from recovering supervision charges from the company, despite a clear contractual agreement allowing such charges. The Supreme Court bench, comprising Chief Justice N.V. Ramana and Justices Surya Kant and Hima Kohli, delivered a unanimous judgment authored by Justice Hima Kohli, setting aside the High Court’s decision and upholding the State’s right to levy supervision charges.

Case Background

The case originates from a contract between the State of Madhya Pradesh and M/S Sal Udyog Private Limited, where the company was to receive 10,000 tonnes of Sal seeds annually for 12 years, starting from 30th August, 1979. In 1987, the State of Madhya Pradesh decided to annul all forest produce agreements, enacting a law to that effect. However, this law was only notified on 1st January, 1997. Before the notification, the agreement was renewed on 30th April, 1992, extending it till 29th April, 2004.

After the law was notified in 1996, the State of Madhya Pradesh terminated the agreement on 21st December, 1998, under Section 5A of the newly notified law. M/S Sal Udyog Private Limited, aggrieved by the termination, invoked the arbitration clause on 6th December, 1999, claiming a refund of Rs. 1,72,17,613, arguing that this amount was overpaid to the State for Sal seeds supplied between 1981-82 and 31st December, 1998.

Timeline:

Course of Proceedings

M/S Sal Udyog Private Limited filed an application under Section 11(6) of the Arbitration and Conciliation Act, 1996, before the Jabalpur Bench of the Madhya Pradesh High Court, seeking the appointment of an Arbitrator. Due to the Madhya Pradesh Re-organisation Act, 2000, the application was transferred to the High Court of Chhattisgarh at Bilaspur. With the consent of both parties, a Sole Arbitrator was appointed on 21st March, 2002.

The Arbitrator, on 17th February, 2005, ruled in favor of M/S Sal Udyog Private Limited, awarding them Rs. 7,43,46,772, which included interest at 18% per annum until February 2005, and future interest at the same rate from 1st March, 2005. The State of Chhattisgarh then filed a petition under Section 34 of the Arbitration and Conciliation Act, 1996, before the District Judge, Raipur. The District Judge modified the award on 14th March, 2006, adjusting the interest period but upholding the rest of the award.

Both parties appealed the District Judge’s order. The State of Chhattisgarh filed an appeal under Section 37 of the Arbitration and Conciliation Act, 1996, while M/S Sal Udyog Private Limited filed a cross-appeal. The Chhattisgarh High Court, on 21st October, 2009, partly allowed the State’s appeal by reducing the interest rate from 18% to 9% and dismissed the company’s appeal. The State of Chhattisgarh then approached the Supreme Court of India.

Legal Framework

The case primarily concerns the interpretation and application of the Arbitration and Conciliation Act, 1996, specifically Sections 34 and 37, which deal with setting aside and appealing arbitral awards. The Supreme Court also examined the scope of “patent illegality” as a ground for challenging an arbitral award, as defined in the context of Section 34(2A) of the Arbitration and Conciliation Act, 1996.

The relevant contractual clauses include Clause 6(b) of the agreement between the parties, which states that the price payable by the purchaser for the Sal seeds shall include “all expenses incurred by the Governor each year, till the delivery of the Sal Seeds to the Purchaser, which shall include the cost of collection and/or the Purchase price paid to growers, as well as handling supervision charges, commission to agent, cost of storage, transportation etc.”

The Court also considered a Circular dated 27th July, 1987 issued by the Government of Madhya Pradesh, which provides for the imposition of 10% supervision charges on the amount calculated after deducting the actual expenditure on Sal seeds.

The Supreme Court referred to Section 28(3) of the Arbitration and Conciliation Act, 1996, which mandates that the Arbitral Tribunal shall decide in accordance with the terms of the contract and shall take into account the usages of the trade applicable to the transaction.

Arguments

Appellant (State of Chhattisgarh) Arguments:

• The State argued that Clause 6(b) of the agreement explicitly includes supervision charges as part of the expenses recoverable from the respondent-Company.
• They contended that the Arbitrator had wrongly rejected the inclusion of supervision charges, despite the clear terms of the agreement.
• The State relied on a Circular dated 27th July, 1987, issued by the State Government, which mandates a 10% supervision charge on the cost of Sal seeds.
• The State highlighted that the respondent-Company had paid supervision charges without objection for many years, indicating an acceptance of this term.
• The State argued that the High Court failed to address the issue of supervision charges, despite it being a ground in the appeal under Section 37 of the Arbitration and Conciliation Act, 1996.
• The State cited Delhi Airport Metro Express Pvt. Ltd. v. Delhi Metro Rail Corporation Ltd. to argue that patent illegality is a valid ground for reviewing a domestic award.

Respondent (M/S Sal Udyog Private Limited) Arguments:

• The respondent-Company argued that the State had not raised the specific objection regarding supervision charges in its Section 34 petition, and therefore, waived its right to take such a plea in the Section 37 petition or before the Supreme Court.
• They cited State of Maharashtra v. Hindustan Construction Company Limited to support their argument that the State had waived its right to raise new objections.

Submissions Table

Issues Framed by the Supreme Court

The Supreme Court framed the primary issue as:

1. Whether the Arbitral Award was liable to be interfered with on the ground that the learned Arbitrator as also the High Court had ignored the binding terms of the contract governing the parties relating to recovery of ‘supervision charges’ from the respondent-Company and the Circular dated 27th July, 1987 issued by the State Government on the same lines which as per the appellant-State, goes to the root of the matter.

Treatment of the Issue by the Court

Authorities

Cases Relied Upon by the Court:

• Associate Builders v. Delhi Development Authority [2015] 3 SCC 49 (Supreme Court of India): The Court referred to this case to define “patent illegality” as a ground for setting aside an arbitral award. The Court reiterated that “patent illegality” broadly falls under the head of “Public Policy” which has been divided into three sub-heads.
• Ssangyong Engineering and Construction Company Limited v. National Highways Authority of India (NHAI) [2019] 15 SCC 131 (Supreme Court of India): This case was cited to emphasize the limited scope of judicial interference in reviewing arbitral awards under the 1996 Act.
• Delhi Airport Metro Express Pvt. Ltd. v. Delhi Metro Rail Corporation Ltd. 2021 SCC Online SC 695 (Supreme Court of India): This case was cited to further elaborate on the facets of patent illegality.
• Lion Engineering Consultants v. State of Madhya Pradesh and Others [2018] 16 SCC 758 (Supreme Court of India): This case was referred to address the objection raised by the respondent that the appellant had not taken a specific ground in the Section 34 petition on the aspect of refund of ‘supervision charges’.

Legal Provisions Considered by the Court:

• Section 34 of the Arbitration and Conciliation Act, 1996: This section deals with the setting aside of arbitral awards.
• Section 37 of the Arbitration and Conciliation Act, 1996: This section pertains to appeals against orders passed under Section 34.
• Section 28(3) of the Arbitration and Conciliation Act, 1996: This section mandates that the Arbitral Tribunal shall decide in accordance with the terms of the contract.

Authorities Table

Judgment

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

How each authority was viewed by the Court?

The Supreme Court relied on Associate Builders v. Delhi Development Authority [2015] 3 SCC 49* to define “patent illegality” and stated that the Arbitral Tribunal’s decision was in contravention of the terms of contract, therefore, the award was vitiated by patent illegality. The Court also relied on Ssangyong Engineering and Construction Company Limited v. National Highways Authority of India (NHAI) [2019] 15 SCC 131* to reiterate the limited scope of judicial interference in arbitral awards. The Court used Delhi Airport Metro Express Pvt. Ltd. v. Delhi Metro Rail Corporation Ltd. 2021 SCC Online SC 695* to further elaborate on the facets of patent illegality. The Court referred to Lion Engineering Consultants v. State of Madhya Pradesh and Others [2018] 16 SCC 758* to meet the objection raised by the respondent that the appellant did not take a specific ground in the Section 34 petition on the aspect of refund of ‘supervision charges’.

The Court considered Section 34 of the Arbitration and Conciliation Act, 1996, which deals with the setting aside of arbitral awards and Section 37 of the Arbitration and Conciliation Act, 1996, which pertains to appeals against orders passed under Section 34. The Court also considered Section 28(3) of the Arbitration and Conciliation Act, 1996, which mandates that the Arbitral Tribunal shall decide in accordance with the terms of the contract.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily driven by the principle that an arbitral award must adhere to the terms of the contract between the parties. The Court emphasized that the Arbitrator had overlooked the explicit terms of the agreement, which included supervision charges as part of the expenses to be borne by the respondent-Company. This oversight was considered a “patent illegality” that went to the root of the matter. The fact that the respondent-Company had consistently paid these charges without protest for years further solidified the Court’s view that the Arbitrator’s decision was flawed. The Court also noted the High Court’s failure to address this issue, which further necessitated the Supreme Court’s intervention.

The Court also considered the fact that the Circular dated 27th July, 1987, issued by the Government of Madhya Pradesh, supported the imposition of the 10% supervision charge. The Court was not convinced by the respondent’s argument that the State had waived its right to raise this objection by not including it in the Section 34 petition. The Court held that the patent illegality on the face of the award was sufficient to warrant intervention.

Sentiment Analysis Table:

Ratio Table (Fact:Law):

Logical Reasoning Flowchart:

The Supreme Court rejected the respondent-Company’s argument that the State had waived its right to raise the objection about supervision charges. The Court stated that the “patent illegality” in the Arbitral Award was sufficient to warrant intervention. The Court emphasized that the expression “the Court finds that” in Section 34(2A) of the Arbitration and Conciliation Act, 1996, empowers the Court to act on its own if it finds that an award is vitiated by patent illegality.

The Court stated, “In our opinion, this is the patent illegality that is manifest on the face of the Arbitral Award inasmuch as the express terms and conditions of the Agreement governing the parties as also the Circular dated 27th July, 1987 issued by the Government of Madhya Pradesh have been completely ignored.”

The Court further noted, “We are, therefore, of the view that failure on the part of the learned Sole Arbitrator to decide in accordance with the terms of the contract governing the parties, would certainly attract the “patent illegality ground”, as the said oversight amounts to gross contravention of Section 28(3) of the 1996 Act, that enjoins the Arbitral Tribunal to take into account the terms of the contract while making an Award.”

The Court also stated, “Notably, the expression used in the sub-rule is “ the Court finds that ”. Therefore, it does not stand to reason that a provision that enables a Court acting on its own in deciding a petition under Section 34 for setting aside an Award, would not be available in an appeal preferred under Section 37 of the 1996 Act.”

Key Takeaways

• Arbitral awards must strictly adhere to the terms of the contract between the parties.
• Ignoring explicit contractual terms constitutes “patent illegality” and can lead to the award being set aside.
• A party’s past conduct, such as paying charges without protest, can be a significant factor in interpreting contractual obligations.
• Courts can intervene in arbitral awards if they find a “patent illegality” on the face of the award, even if the issue was not specifically raised in the initial petition.
• The scope of judicial review is limited in arbitration matters, but “patent illegality” is a valid ground for intervention.

Directions

The Supreme Court partly allowed the appeal, quashing the portion of the Arbitral Award that permitted the deduction of supervision charges. The Court modified the impugned judgment of the High Court to this extent.

Development of Law

The ratio decidendi of this case is that an arbitral award that ignores the explicit terms of a contract is vitiated by “patent illegality” and can be set aside. This judgment reinforces the principle that arbitrators must strictly adhere to the terms of the contract and cannot disregard them based on their own interpretation. The Supreme Court also clarified that the court can intervene in an arbitral award if it finds a “patent illegality” on the face of the award, even if the issue was not specifically raised in the initial petition. This reinforces the importance of upholding contractual obligations in arbitration proceedings.

Conclusion

In conclusion, the Supreme Court’s judgment in State of Chhattisgarh vs. M/S Sal Udyog Private Limited underscores the importance of adhering to contractual terms in arbitration proceedings. The Court’s decision to set aside the portion of the Arbitral Award that disallowed supervision charges highlights the principle that arbitrators must respect the explicit terms of the contract and that a “patent illegality” is a valid ground for judicial intervention. This case serves as a reminder that contractual obligations must be upheld and that parties cannot avoid them simply because they were not raised in the initial petition.

Category

Parent Category: Arbitration and Conciliation Act, 1996
Child Categories:

• Section 34, Arbitration and Conciliation Act, 1996
• Section 37, Arbitration and Conciliation Act, 1996
• Section 28(3), Arbitration and Conciliation Act, 1996
• Patent Illegality
• Contract Law

FAQ

Q: What is “patent illegality” in the context of arbitration?

A: “Patent illegality” refers to an error in an arbitral award that is obvious and goes to the root of the matter. It includes situations where the arbitrator ignores the terms of the contract or contravenes the law.

Q: Can a court interfere with an arbitral award?

A: Yes, a court can interfere with an arbitral award if it finds that the award is vitiated by “patent illegality” or if it contravenes public policy.

Q: What is the significance of contractual terms in arbitration?

A: Contractual terms are paramount in arbitration. Arbitrators are bound to decide disputes in accordance with the terms of the contract.

Q: What does the Supreme Court’s decision mean for businesses?

A: The Supreme Court’s decision means that businesses must ensure that they adhere to the terms of their contracts. Arbitrators are bound to decide disputes in accordance with the terms of the contract, and ignoring explicit contractual terms can lead to an arbitral award being set aside.

Q: What should I do if I believe an arbitral award is incorrect?

A: If you believe an arbitral award is incorrect, you can challenge it under Section 34 of the Arbitration and Conciliation Act, 1996, on grounds such as “patent illegality” or contravention of public policy.