PROJECT REPORT APPROVAL SHEET

IT IS CERTIFIED THAT THE PROJECT ENTITLED “ Liquidated damages for Breach of Contract” WAS COMPLETED BY MR. ADITYA MEHROTRA UNDER MY GUIDANCE DURING THE PERIOD WITH EFFECT FROM 14. JUN.2012 TO 14.JULY.2012. THE SAME IS HEREBY APPROVED.

MR. NIRAJ KUMAR

DEPUTY MANAGER (LAW)

GAIL(INDIA)LTD.

16 BIKAJI CAMA PLACE, R.K PURAM .

NEWDELHI-110066

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TABLE OF CONTENTS

List of Abbreviations Acknowledgement Contract

Introduction Essence of Time in a Contract

Damages Introduction Measure of Damage Liquidated Damages

Reasonableness of Liquidated Damages Release of Liquidated Damages Effect of architect’s final certificate on liquidated

damages Modes of Recovery Effect of extension of time Applicability and Enforceability

Quantum Meruit Cases of Gail(India) Ltd. related to liquidated damages

GAIL(India)Ltd. vs. Geo Miller and Co. Gail (India) Limited vs. Hindustan Construction

ONGC v Saw Pipes Bibliography

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List of Abbreviations

1. Sec……………………………………………….Section 2. Vs. ………………………………………………..Versus3. Illustration………………………………………….Illus.4. Adv…………………………………………….Advocate5. Engg……………………………………………Engineer6. Cl…………………………………………………Clause7. HC……………………………………………High court8. SC……………………………………… Supreme court9. HCC……………… Hindustan construction corporation10. GAIL…………………...Gas Authority of (India) Ltd.11. ONGC…………….. Oil and Natural Gas Corporation12. Co…………………………………………...company

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ACKNOWLEDGEMENT

First of all I want to give my deepest regards to respected Sir- Mr. Niraj Kumar to

trust me with this particular project and for his immense support.

The topic was a very important one from the perspective of Contract law.

Heartfelt thanks to Mr. S.B. Mitra, GM(Law) , Mr. P.K. Solanki, CM(Law) and

last but not the least GAIL (India) Ltd. for making my research enlightening and a

complete learning experience.

I would also like to thank UPES for paving this way for me.

Thank you.

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CONTRACT

INTRODUCTION

According to section 2(h) of the Indian contract act,1872 “An agreement enforceable by law is a contract. ” All agreements are not enforceable by law and therefore all agreements are not contract.

Factors which make essence of contract—

According to section 55 of Indian contract act 1872, if the intention of the parties was that time should be the essence of contract, then a failure to perform at the agreed time renders the contract voidable at the options of the opposing party. “time is generally considered to be the essence of the contract in the following 3 cases—

1. Where the parties have expressly agreed to treat it as of the essence of the contract.

2. Where the delay operates as an injury.3. Where the nature and necessity of the contracts requires it to be so

constructed, for ex, where a party asks for extension of time for performance.

TIME OF ESSENCE IN DIFFERENT SITUATIONS IN A CONTRACT

IN BUSINESS MATTERS— In business matters time is generally of essence. This is so because the business world requires certainly and also because “merchants are not in the habit of placing upon their contracts stipulations to which they do not attach some value and importance.

IN CONSTRUCTION CONTRACTS— Time schedule in a construction contract is likely to be of essence because construction is a commercial service.

IN SALE TRANSACTIONS-- In a contract of sales of good, the time of shipment is of essence.

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IN LAND AND PROPERTY DEALINGS— In a contract for sale of land or immoveable property , the supreme court has said down that “it would normally be presumed that time was not of essence of contract. Mere incorporation in the written agreement of a clause imposing penalty in case of default does not by itself evidence an intention to make time of the essence.”

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DAMAGES

INTRODUCTION

It is the most common remedy available to the injured party. This entitles the injured the party to recover compensation for the loss suffered by him due to the breach of contract, from the party who causes the breach.

Section 73 of the Indian contract act,1872 makes the following provisions regarding the right of the injured party to recover compensation for the loss or damage which is caused to him by the breach of contract.

73. Compensation for the loss or damage caused by the breach of contract—when a contract has been broken , the party who suffers from such branch is entitled to receive, from the party who has broken the contract, compensation for any loss or damage caused to him thereby, which naturally arose in the usual course of things from such breach, or which the parties knew, when they made the contract, to be likely to result from the breach of it.such compensation is not to be given for any remote or indirect loss or damage sustained by reason of the breach.

Compensation for failure to discharge obligation for resembling those created by contract—when an obligation resembling those created by contract has been incurred and has not been discharged, any person injured by the failure to discharge it is entitled to receive the same compensation from the party in default , as if such person has contracts to discharge it and had broken his contract.

Illustration— A contracts to sell and deliver 50 maunds of saltpetre to B, at a certain price to be paid on delivery. A breaks his promise. B is entitled to receive A, by way of compensation, the sum , if any, by which the contract price falls short of the price for which B might have obtained 50 maunds of saltpetre of like quality at the time when the saltpetre ought have been delivered.

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Measures of Damage

After it has been established that a certain consequence of a breach of contract is proximate and not remote and the plaintiff deserves to be compensated for the same, the next question which arises is: what is the measure of damages for the breach of contract.

Damages are compensatory in nature. The objective of awarding damages to the aggrieved party is to put him in the same position in which he would have been if the contract had been performed.

Loss of profit on a sub-contract— When the seller does not supply goods to buyer and the buyer is not able to earn certain amount of profit which he could have made by supplying the goods further under a sub-contract , the buyer is not entitled to recover the loss of expected profit, but his right is only to recover the difference between the contract price and market price only.

Illustration- A contracts to deliver 50 maunds of saltpetre to B on the first of January , at a certain price. B afterwards , before the 1st of January , contracts to sell the saltpetre to C at a higher price than the market price on the 1st of January. A breaks his promise. In estimating the compensation payable by A to B, the market price on the 1st January and not the profit which would have arisen to B from the sale to C, is to be taken into account.

Damages in case of delivery by installments—When the goods are to be delivered by installments, the measure of damage is the difference between the contract price and the market price of a particular installment, on the final date of performance of that installment.

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LIQUIDATED DAMAGES

INTRODUCTION

If the compensation to be paid from the breach of contract is the genuine pre-estimate of prospective damages , is known as liquidated damages.

Liquidated Damages and Penalty— Sometimes the parties to a contract at the time of making the contract agree to the amount of compensation payable in the event of the breach of contract. The amount of compensation payable, which has been agreed beforehand, may be either liquidated damages or penalty.

If the compensation to be paid from the breach of contract is the genuine pre-estimate of prospective damages , is known as liquidated damages.

If the compensation agreed to be paid in the event of breach of contract is excessive and highly disproportionate to the likely loss, the amount is fixed in terrorem , with a view to discouraging breach of contract , it is known as penalty.

In Dunlop pneumatic tyre co. v. new garage and motor company ltd., the plaintiff who were the manufacturer of motor car tyres and tubes, etc. sold some of the goods to the defendants. The defendant agreed not to sell those goods further below the manufacturer’s list price. They also agreed to pay 5$ by way of liquidated damages for every tyre, tube, etc. sold below the list price. It was held by the house of lords that the sum of compensation payable on the breach of agreement was genuine pre-estimate of damages, and therefore, liquidated damages.The parties often agree that a liquidated sum shall be paid as damages for some breach of contract. A typical clause provides that if the contractor shall fail to complete by the date stipulated in the contract, or any amended date he shall pay or allow the employer to deduct liquidated damages at the rate of … per day or week for the period during which the work is uncompleted. Such a clause may result in a considerable saving of costs. Where there is such a clause and the contractor had failed to complete to time prime facie he is liable to a claim for the liquidated damages either by way of action or by deduction or by a set-off and there can be no enquiry into the actual loss suffered. But he may have a defence to the claim either by providing the agreed sum i.e penalty or by showing the existence of one or the

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other matters which can legally put in defence to such a claim. If he establishes such a defence it may still leave the employer the right to pursue a claim for unliquidated damages for delay. In such a case, liquidated damages and extension of time clauses in printed form of contract must be constructed strictly according to the principle of contra porfentum i.e if there is an ambiguity in a document which all the other methods of construction have failed to resolve so that there are 2 alternate meaning to certain words the court may construe the words against the party seeking to rely upon them and give effect to the meaning more favourable to the other party.

Reasonableness of Liquidated Damages-- There is a little doubt that the sum named as liquidated damages in order to be given effect must be reasonable in amount. To be sure, under the recent decisions of the most authoritative court , the primary questions seems to be – whether the parties honestly endeavoured to assess the damages is afforded by the damage stimulated for , and the nature of the breach upon which the stipulation is agreed to be operative. This is but saying in other words that the reasonableness or unreasonableness of the stipulation is decisive.

There are some damages in which it is impossible for the court to assess damages. The effect of section 74 of the contract act, is to disentitle the plaintiff to recover simplicitor the sum fixed in the contract whether penalty or liquidated damages. The plaintiff must prove damages suffered by him. When the court is unable to assess the damages the sum named by the parties if it is a genuine pre-estimate of damages may be taken into consideration as a measure of reasonable compensation but not if the sum named is in the nature of penalty.

Under section 74 , the contract act, the plaintiff must prove his damage in the general sense. The contract made by the parties estimating there damage is in itself evidence and there is no other evidence of damage , this evidence will be considered sufficient.

Release of liquidated damages or penalties in general—

a. By prevention of performance—Any failure by the building owner to allow the contractor the whole contract within which to execute the work will put an end to the contractors obligation to complete by the contract date,

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any relieve him off any obligation to pay the liquidated damages provided for by the contract. When in a contract time is prescribed within which the builder is to do the work , it means not only that he is to do it within that time, but it means also that he is to have that time within which to do it.where the failure of a contractor to complete the work by the specified day has been brought about by the act of other party to the contract, he is exonerated from the performance of the contract by that date, which has thus been rendered impossible.

b. Agreed sum is a penalty—If the agreed sum whatever it is called in the contract , is a penalty , it will not be enforced by the courts.

c. Necessary for definite date for which damages to run— It has been seen that the stipulated time for completion may cease to be applicable for a variety of reasons, including the ordering of extras or other interference or prevention by the employer. Where the liquidated damages are stipulated for at so much per day or per week, there must be a definite date from which they are to run. If no such date is fixed by the contract , or if by the operation of intervening circumstances the date fixed by the contract has ceased to be operative and there is provision in the contract by which another date can be substituted, all rights to recover the sum stipulated for as liquidated damages have gone.

d. Deductions from payments due – Where it is merely provided that the employer shall be entitled to deduct or retain such liquidated damages as and when they become due from any payments to be made to the contractor , without any independent covenant on the part of the contractor to pay the liquidated damages, the employer will lose his right to claim for liquidated damages which have already accrued if he does not so deduct them.

e. Waiver of liquidated damages—Liquidated damage cease to be payable where the employer has waived the right to insist upon them, eg. Where he has failed to deduct or retain them in cases where it is imperative on his part under the contract to do so. a building owner will not , apart from special provisions in the contract , lose the right to liquidated damages by paying the builders money otherwise due to him, or by permitting the completion of work after the due date for completion.

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f. Release by forfeiture— If the employer exercises his power to forfeit the contract , then, unless there is a provision that in that event the liquidated damages are still to run till the date of actual completion , he cannot claim liquidated damages after the date of forfeiture. A provision for payment of liquidated damages for delay in completion , applies only when the contractor completes , and does not apply to completion by the employer after suspension of the work by the contractor.

Effect of architect’s final certificate on liquidated damages— Where according to the terms of the contract the architect has a general power to extend the time for all causes, any to take any liquidated damages due from the builder into account in certifying for the final balance, the right to liquidated damage will be lost if the architect certifies for the final balance without taking the liquidated damages into account . in such a case, it will be presumed that the architect or engineer has extended the time for completion , unless it is proved that the matter has not been determined by him or implied within the jurisdiction. Modes of recovery of liquidated damages— Provision as to the mode of recovery of liquidated damages vary in different contracts , where they are only allowed to be deducted , no other mode of recovery is possible. Where there is an independent covenant on the part of contractor to pay them , they can be counter claimed in an action by the contractor for the price, or they may be made the subject of a separate action , even when there was a previous opportunity of raising the question by a counter claim as in the case of defective work.Where a contractor sues an employer for the price of the work , the employer’s right to damages operates as a defence to the contractor’s claim and if such defence exceeds the amount claimed, the amount will not be treated as failed.In case , where the builder sues in quantum meruit, and there has been defective work , it has been held that the true view is that nothing is payable or due for the defective work, and that , if other, work has to be undone to allow repairs of the defective works that other work should not be charged for. But this may not be the final word upon the subject, since it is not

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difficult to conceive of cases where the cost of repair and replacement may be greatly in excess of the cost of the defective work not charged for.

Effect of extension of time on liquidated damages—It is common to provide an express power for the extension of time for completion and if an extension has been granted it operates wholly or partially as a defence to a claim for liquidated damages for the original completion date. The type of event for which provision is made falls under 2 heads- 1. Delay caused by the employer eg. Ordering of extras.2. Delay not caused by the employer. Eg- strikes, shortage of material or

labour.

Liquidated damages are provided in a contract for compensation for the loss suffered by the employer as a result of the breach by the contractor , without proof of actual loss but if no breach of contract is committed by the contractor in not completing the work in time, the employer will not be entitled to claim any damages which will naturally include the liquidated damages, from the contractor.

how liquidated damages is different from penalty ??the distinction between penalty and liquidated damage was thus explained by Lopes, j. in law. Vs. Redditch local board :The distinction between penalties and liquidated damages depends on the intention of the parties to be gathered from the whole of the contract. If the intention is to secure performance of the contract by the imposition of a fine or penalty; but if, on the other hand, the intention is to assess the damages for breach of the contract, it is liquidated damage.

According to English law, if the amount of compensation agreed to by the parties is by way of liquidated damages, the plaintiff will be entitled to recover the agreed amount of compensation, neither more nor less than that, without the plaintiff having to prove the exact amount of loss suffered by him by the breach of contract. On the other hand, if the compensation agreed upon is in the nature of penalty, the plaintiff will be indemnified to the extent of the actual loss suffered by him. The amount fixed by way of penalty is the maximum limit of damages, rather than making a pre-estimate of the same.

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Liquidated Damages--- Applicability and Enforceability

In all contracts, whether commercial or otherwise , breach often occurs due to failure of one contracting party to fulfill its contractual obligations. In law the party, which commits breach of contract, is required to pay damage to the other party. Such damages are calculated on the basis of legal principles. The party is also at liberty to provide in the contract that in the case of non-performance or delayed performance the pay in default shall pay a fixed sum called liquidated damages the amount of which may be calculated either by the lump-sum or on the scale varying with the impact of default. The Indian contract act,1872 provides a basic structure of the law of contract in india , its enforcement various provisions regarding non-performance and breach of contract. “liquidated damages” in the case of breach of contract. It is a genuine “pre-estimate of damages” likely to flow from the breach.

Indian Perspective—Section 74 of the Indian contract act read as follows—“when a contract has been broken , If a sum is named in the contract as the amount to be paid in case of such breach, or if the contract contains any other stipulations by way of penalty, the party complaining of the breach is entitled, whether or not actual damage or loss is proved to have been caused thereby, to receive from the party who has broken the contract reasonable compensation not exceeding the amount so named .

In fateh chand vs. balkishan das, the supreme court stated that –section 74 declares the law as to the liability upon breach of contract where compensation is by agreement of parties predetermined or where there is a stipulation by way of penalty. But the application of the enactment is not restricted to cases where the aggrieved party claims relief as a plaintiff. The section does not confer a special benefit upon any party. It merely declares the law that notwithstanding any term in the contract for determining the damages or providing for forfeiture of any property by way of penalty, the court will award to the party aggrieved only reasonable compensation not exceeding the amount stipulated.

the purpose of such clauses is to promote certainty, especially in commercial contracts. Parties to a contract would fix such a sum in advance at the time of making the contract because it facilitates calculation of risks and recovery of

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damages. It helps in assessment , even where the consequences of breach are ascertainable and avoids the risk of under compensation.

Section 74 of the Indian contract act, 1872 emphasis that in the breach of contract, the party complaining of the breach is entitled to receive reasonable compensation whether or not actual loss is proved to have seen caused by such breach. Therefore the emphasis is on reasonable compensation.

Illustration—In Aditya mass communication pvt. Ltd. vs. A.PS.R.T.C Hyderabad , it has been held that if an offer has been withdrawn before opening of a tender, the earnest money deposited by the tenderer has to be refunded. Moreover, if there is unreasonably delay in refunding the earnest money, intrest on the same has to be only paid.

Nominal damage— in the absence of any concrete material to show the extent of damages suffered by plaintiff, it is said as nominal damages.

Illustration—the Karnataka high court in Vikas electricity service v. Karnataka electricity board, said that merely because the plaintiff failed to produce evidence sufficient to ascertain the extent of damage he suffered ,he could not be denied damages. The court explained that “technically law requires not damage , but an injuria or wrong upon which to base a judgment for the plaintiff and therefore an injuria, although without loss or damage would entitle the plaintiff to a judgment.”

QUANTUM MERUIT

If a person having agreed ,to some work or render some services, has done only a part of what he was required to do, he cannot claim anything for what he has done.

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When a person agrees to complete some work for a lump-sum , non-completion of the work does not entitle him to any remuneration even for the part of work done. But the law recognizes an important exception to this rule by way of an action for quantum meruit. Under this action, if A and B have entered into a contract, and A, who has already performed a part of contract, is then prevented by B from performing the rest of his obligation under the contract , A can recover from B reasonable remuneration for whatever he has already done.

When one party has absolutely refused to perform , or has rendered himself incapable of performing his part of the contract, he puts it in the power of the contract, he puts it in the power of other party either to sue for the breach of it or to rescind the contract and sue on quantum meruit for the work actually done.

It may be noted that this remedy is only available only for the part of work done by the party other than the one making breach of contract. If the party making the breach of contract has done a part of work in connection with it, he cannot claim anything in respect thereof under this remedy.

Cases of Gail(India) Ltd. related to liquidated damages

Gail(India) Limited vs Geo Miller & Company Ltd on 30 August, 201116

Author: Vikramajit Sen

IN THE HIGH COURT OF DELHI AT NEW DELHI

GAIL(INDIA) LIMITED ...Appellant through Mr. Jagjit Singh, Adv.

Vs.

GEO MILLER & COMPANY LTD. ...Respondent through Mr. S.D. Singh & Mr. Rahul Singh, Advs.

Date of Hearing : August 11, 2011

Date of Decision: August 30, 2011

Judgment

The neat question which arises for our consideration in this Appeal is whether the Arbitrator as well as the learned Single Judge fell into error in awarding the sum of ` 22,29,840/-, avowedly withheld by the Appellant on account of liquidated damages. According to Mr. Jagjit Singh, learned counsel for the Appellant, the Award was facially in excess of the jurisdiction and the powers reposed in the Arbitrator as it transgressed Clause 27 of the Contract dealing with compensation for delay (liquidated damages).

The learned Single Judge has concluded that Clause 27 of the Contract has not been violated, and we think rightly so. The Claim of the Respondent, simply stated, is for payment of amounts illegally withheld by the Appellant. No evidence has been led before the Engineer Incharge or the Arbitrator, or for that matter before the learned Single Judge (as it could not have been done), disclosing that the Engineer Incharge had computed "actual loss or damage caused by such delay/breach."

In order to justify the withholding of this payment, it was essential for the Appellant to provide proof before the Arbitrator that the Engineer Incharge had consciously gone into this question and was satisfied that the loss or damage had

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actually occurred in circumstances where the owner/appellant was not blameworthy, and also that force majeure had not occurred. There is not even a shred or iota of proof sustaining this claim. It is wholly insufficient for the Appellant to merely assert that delay had occurred. The appropriate adjudicating forum was legally bound to arrive at an informal conclusion. Clause 27 accords finality to the decision of the Engineer Incharge in clear Contra distinction to the Arbitrator whose jurisdiction with regard to this determination has been removed. The decision of the Engineer Incharge has been rendered impervious to any challenge before the Arbitral Tribunal. Stipulations such as those articulated in Clause 27 are variously termed as excluded or exempted matters which, simply stated, remove their consideration or determination from the Arbitral Tribunal or the Court and place them in the exclusive province of the nominated indicated adjudicator that the party claiming liquidated damages was not itself responsible for the breach of the contract and that the said claimant was not acting in terrorem by enforcing a penalty. This does not, however, mean that even in the absence of any determination, the principal can unilaterally withhold amounts masquerading them to be within the domain of damages.

In other words, had the Engineer Incharge made a determination of damages which were payable by the Respondent to the Appellant because of delay caused by and attributable to the Respondent, and if such exercise has been rendered futile by a contrary conclusion of either the Arbitral Tribunal or the learned Single Judge, the decision of the Engineer Incharge would have to be upheld since it holds the field. This is not what has happened in the case before us.

Furthermore, admittedly, the Contract was delayed for a period of eleven weeks. If Clause 27 is to be applied, only 5.5 per cent of the value of the Contract could have been ascertained as damages, not unilaterally and without authority by the Appellant, but we reiterate by the Engineer Incharge.

The highhandedness of the Appellant is manifest from the fact that the sum of ` 22,29,840/- corresponds to ten per cent of the value of the subject contract which was accordingly incorrect and, therefore, unsustainable by any determination.

For these manifold reasons, we find no error in the impugned Order or in the impugned Award. The Arbitrator has awarded interest at the rate of eighteen per

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cent per annum which has been reduced by the learned Single Judge to eight per cent per annum, predicated on Krishna Bhagya Jal Nigam Ltd. -vs- G. Harschandra Reddy, AIR 2007 SC 817.

The Appeal is wholly devoid of merit and is dismissed with costs of ` 50,000/-. Public Sector Undertakings such as the Appellant should not needlessly exhaust the scarce time of the courts by filing frivolous appeals. Costs should have been punitive but we restrict them to the aforesaid sum. The amount deposited by the Appellant with the Registrar-General of this Court be released to the Respondent forthwith.

Vikramajit Sen, Siddharth Mridul -- JUDGE

Gail (India) Limited vs Hindustan Construction ... on 9 January, 2012.

IN THE HIGH COURT OF DELHI AT NEW DELHI

Reserved on: December 2, 2011

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Decision on: January 9, 2012

GAIL (INDIA) LIMITED, (Formerly known as

GAS AUTHORITY OF INDIA LTD)...... Petitioner Through: Mr. Rajiv Bansal with Mr. Rahul Bhandari, Advocates.

Vs.

HINDUSTAN CONSTRUCTION CORPORATION ..... Respondent Through: Mr. Anurag Kumar, Advocate.

JUDGE:- JUSTICE S. MURALIDHAR

Judgment

GAIL (India ) Ltd. (formerly Gas Authority of India Limited) (hereafter `GAIL') has, in this petition under Section 34 of the Arbitration and Conciliation Act, 1996 (`Act') challenged an Award dated 11th August 2003 passed by the learned Sole Arbitrator in the dispute between GAIL and Hindustan Construction Corporation (`HCC').

The two parties were in negotiation as regards the settlement of the final bill and there was no compulsion on HCC, much less any coercion, to issue an NCC. The learned Arbitrator has failed to consider this important aspect while concluding that: "In the present case the NCC was demanded before the bill was finalized and before the amount of final payment intimated to claimants- HCC. Accordingly I do not agree that the NCC constitutes sufficient cause for denying consideration of the claims made by Claimants-HCC before me." The said conclusion is contrary to the evidence which shows that the NCC was issued after HCC's condition for issuing it was acceded to by GAIL. Also, in terms of the law as explained in the above decisions, the learned Arbitrator failed to notice that HCC had not issued the NCC under coercion or duress. The NCC issued by HCC to GAIL constituted 'accord and satisfaction' of HCC's claims and there was therefore no arbitrable dispute.

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For the aforementioned reasons, this Court sets aside the impugned Award dated 11th August 2003. The petition is allowed with costs of Rs. 5,000/- which should be paid by HCC to GAIL within a period of four weeks from today.

S. MURALIDHAR, J.

JANUARY 9, 2012

ONGC v Saw Pipes

This case arose out of a challenge to an arbitral award rendered with regard to a dispute relating to supply of equipment for off shore oil exploration by the respondent. The case was heard by M.B Shah and Arun Kumar JJ. The judgment was written by Shah J.

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FACTS

Oil and Natural Gas Commission had placed an order on Saw Pipes for supply of equipment for off shore exploration, to be procured from approved European manufacturers. The delivery was delayed due to general strike of steel mill workers in Europe. Timely delivery was the essence of the contract. ONGC granted extension of time, but it invoked the clause for recovery of Liquidated Damages by withholding the amount from the payment to the supplier. ONGC deducted from the payment $3,04,970.20 and Rs 15,75,557 towards customs duty, sales tax and freight charges. Saw pipes disputed the deduction and matter was referred to arbitration. While the arbitral tribunal rejected Saw Pipe’s defence of force majure, it required ONGC to lead evidence to establish the loss suffered by breach and proceed to hold, in absence of evidence of financial losses, that the deduction of Liquidated damages was wrongful. The award was challenged by ONGC; inter alia as being opposed to public policy ONGC’s case was that the arbitral tribunal failed to decide the dispute by not applying the prevailing substantive law, ignoring the terms of the contract and customary practices of usage of trade in such transactions. ONGC challenged the award as being patently illegal. The single judge and division bench of Bombay High Court dismissed the challenge. The Supreme Court set aside an arbitration award directing ONGC to refund $3,04,970.20 and Rs 15.76 Lakhs towards liquidated damages retained by it while making payment to the company.

Issues Raised

1) Whether ONGC had the right to Liquidated Damages.

2) Whether Patent illegality could be used as a ground to assail the award under section 34.

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Decision Of The Supreme Court

The Hon’ble Court first extensively discussed the court’s jurisdiction to set aside an award under Section 34 of the Arbitration and Concilliation Act 1996 and the various grounds on which interference was permissible.

Passing over to the question of damages, the Hon’ble Court opined that when the words of the contracts are clear, there is nothing that the court can do about it. If the parties had agreed upon a sum as being pre- estimated genuine liquidated damages there was no reason for the tribunal to ask the purchaser to prove his loss.

It further opined that when the court concludes that stipulation for damages is by way of penalty, it can grant reasonable compensation upon proof of damage. However, where an agreement has been executed by experts in the field, the court should be slow to construe a clause providing for liquidated damages as penalty. At paragraph 49, citing Maula Bux v Union of India (the court concludes that this is especially true where the court is unable o assess compensation or such assessment is fraught with difficulties. In such cases the burden of proof would be on party who contends that the stipulation amount is not reasonable. There was no such contention raised in the instant case.

As regards forfeiture, after considering its decision in Union of India v Rampur Distellery the court states the forfeiture clause can be construed either as liquidated damages or as a penalty, depending on the reasonableness of the amount to be forfeited.

Therefore, as regards Liquidated Damages and penalties, the primary conclusion of the court appears to be that Liquidated Damages should be regarded as reasonable compensation, while penalties should not. Further, it also appears to have

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concluded in case of penalty damages will have to be proved. The Hon’ble Court reaffirms that no compensation at all be awarded if the court concludes that no loss is likely to occur because of the breach.

Critical Appraisal

The 2 errors of great magnitude in this case were:-

While reviewing the merits of the ONGC case the court failed to consider the labour strike in entire European continent, something which was neither under the control nor could be predicted by Saw Pipes. This particular aspect has been overlooked by the court.

The decision of the two judges Bench in ONGC has bypassed the ruling of the three judges Bench of Supreme Court in the Renusagar case. That shows both judicial indiscipline and violation of the binding precedent of a larger Bench. While the Bench in Renusagar case held that the term ‘public policy of India’ was to be interpreted in a narrow sense, the Division Bench went ahead unmindful of the prior precedent and expanded the same to such an extent that arbitral awards could now be reviewed on their merits. This is a huge step backwards in laws relating to alternate dispute resolution in the era of globalization.

Mr Fali. S. Nariman, one of the greatest lawyers of our generation, remarks on the judgments as having ‘virtually set at naught the entire Arbitration and Concillation Act of 1996….To have introduced by judicial innovation – a fresh ground of challenge and placed it under the head of public policy was first contrary to the established doctrine of precedent. The division of 3 judge bench binding on a bench of 2 judges. It was also contrary to the plain intent of the 1996 the new need of finality in alternative method of dispute resolution without court interference.

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If courts continue to hold that they have the last word on facts and on law not facts and on law not withstanding consensual agreements to refer matters necessarily involving facts and law to adjudication by arbitration the 1996 Act might as well be scrapped if courts continue to hold that the last words on facts and on law not withstanding consensual agreements to refer matters necessarily involving facts and law to adjudication by arbitration the 1996 Act might as well be scrapped. The division bench of 2 judges of the court has altered the entire road map of arbitration law and put the clock back to where we started under the old 1940 Act.”

Ramification Of This Case :-

The Supreme Court in Saw Pipes confined the expansion of public policy to domestic awards as an earlier larger bench decision of the court in case of Renu Sagar Power Co vs General Electricals had construed narrowly this ground as limited to fundamental policy of Indian Law.

The Saw pipes judgment has come in for sharp criticisms from several quarters . Read literally, the judgment sets the clock back to the old position where an award could be challenged on merit and indeed renders the court as a court of appeal.

Some judicial decisions have tried to reign in this effect of Saw Pipes. One instance of this is the Supreme Court decision in case of Mc Demott International vs. Burn Standard Co Ltd. Where the court somewhat read down Saw Pipes. It held that-

“1996 Act makes provision for supervisory roles of courts, for the review of the arbitral award only to ensure fairness. Intervention of the court is envisaged. In few circumstances only, like in case of fraud or bias by the arbitrators, violation of natural justices etc. The court can not correct the errors of the arbitrators. It can only quash the award leaving the parties to begin the arbitration again if it is desired. So, the scheme of this provision aims at keeping the supervisory role of

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the court at minimum level and this can be justified as parties to the agreement make a consciousness decision to exclude the court’s jurisdiction by opting for arbitration as they prefer the expediency and finality offered by it.”

Commenting on Saw Pipes it held – “We are not unmindful that the decision of this court in ONGC had invited considerable adverse comments but the correctness or otherwise of the said decision is not in question before us. It is only for a larger bench to consider the correctness or otherwise of the said decision the said decision is binding on us and has been followed in many cases.

A few High Courts have also sought to narrowly read Saw Pipes on the ground that a literal construction of the judgment would expand judicial review beyond all limitations contained not only under the 1996 Act but even under the old regime. The High Court decisions have (rightly) held that the judgment of the Supreme Court cannot render naught the entire law on the subject.

The HC of Bombay in the case of Indian Oil Corp v Langkawi Shipping Ltd held that to accept a literal construction on Saw Pipes:-

Would be to radically alter the statutorily and judicially circumscribed limits to the court’s jurisdiction to interfere with arbitration awards. It would indeed confer a first appellate court’s power on a court exercising jurisdiction under s. 34 of the 1996 Act. There is nothing in the 1996 Act which indicates such an intention as the part of the legislature. That the intention is contrary is clear inter alia, from the Arbitration and Conciliation Bill 1995 which preceded 1996 Act which stated as one of its main objectives the need ‘to minimize the supervising role of courts in Arbitral process…’

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In the circumstances, the aforesaid principles laid down consistently by the Supreme Court and the various High Courts can not be said to be longer good law in view of the 1996 Act. Nor can it be said that observation of the Supreme Court in Oil and Natural Gas Corporation v Saw Pipes have expressly or impliedly rendered the aforesaid judgment and the principles contained therein no longer good law in view of the 1996 Act. The principles apply with equal force under the 1996 Act.

The HC of Guwahati followed the above Bombay High Court decision held:-

The observations of the Apex Court in ONGC v Saw Pipes did not necessarily or impliedly render the ratio decidendi on the issue contained in a plethora of judgments and the laid down principles therein non established. On a due consideration of the entire gamut of the provisions of the Act and the precedential law, we unhesitantly subscribe to the view expressed in the IOC supra. The decision in Saw Pipes, supra, does not depart from the judicially evolved precepts bearing on the authority and jurisdiction of an arbitrator in determining a dispute referred to him, the norms and measures to be applied for assessment of damages and the scope of court’s interference . The above decision does not intend according to our construction, to efface the time tested legal propositions and judicial tenets on arbitration and this ought not to be construed away from the well established trend set by a string of decisions preceding the same.

BIBLIOGRAPHY

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