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Ergo Update

20-May-2020

A three-judge bench of the Supreme Court of India (Supreme Court), comprising Hon’ble Justice N.V. Ramana, Hon’ble Justice Mohan M. Shantanagoudar and Hon’ble Justice Ajay Rastogi has, vide its judgment dated 11 May 2020 passed in the matter of South East Asia Marine Engineering and Constructions Ltd (SEAMEC Ltd) v Oil India Limited (Civil Appeal No. 673 of 2012), held that where the interpretation provided by an arbitral tribunal to a contractual provision  in an award was not reasonably possible upon a reading of the contract as a whole, the same was liable to be set aside under Section 34 of the Arbitration and Conciliation Act, 1996 (Arbitration Act).

FACTUAL BACKGROUND

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Pursuant to a tender floated by Oil India Ltd (OIL) in the year 1994, for the purpose of drilling and other auxiliary operations in Assam, the South East Asia Marine Engineering and Constructions Ltd (SEAMEC) was selected as the successful bidder and awarded the work order in July 1995. Subsequent thereto, a contract was entered into between the parties setting out the terms and conditions on which the contemplated works were to be carried out (Contract).

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Clause 23 of the Contract, which dealt with “Subsequently Enacted Laws”, provided that if there was inter alia any change in law “[s]ubsequent to the date of price of Bid Opening” which resulted in increase or reduction in cost incurred by SEAMEC for performing works under the Contract, OIL/SEAMEC would reimburse/pay SEAMEC/OIL the increased/reduced component in the cost on an actual basis.

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While the Contract was in force, there was an increase in the price of High Speed Diesel (HSD), which was a product essential for carrying out drilling operations. According to SEAMEC, such increase in price amounted to a “change in law” in terms of Clause 23 of the Contract and raised a claim with OIL for reimbursement of the increment. However, such claim was rejected.

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Upon rejection of its claims, the appellant invoked the arbitration clause contained in the contract vide letter dated 1 March 1999, pursuant to which the dispute was referred to an arbitral tribunal comprising three arbitrators.

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On 19 December 2003, the arbitral tribunal passed its award (Award), wherein the majority allowed the claim of SEAMEC. SEAMEC was awarded a sum of INR 98,89,564.33 along with interest at 10% p.a. from date of Award till recovery of money. The awarded amount was subsequently revised to INR 1,32,32,126.36 in March 2005. The majority held that while a circular issued by a State or the Union Government increasing the price of HSF would not be a “law” in the literal sense, it had the “force of law” and would therefore be covered by Clause 23 of the Contract.

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OIL challenged the award under Section 34 of the Arbitration Act before the District Judge, who, vide order dated 4 July 2006, did not find any reason to interfere with the Award and upheld the same.

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Aggrieved by the order of the District Judge, OIL filed an appeal under Section 37 of the Arbitration Act before the Gauhati High Court. Vide the impugned judgment dated 13 December 2007 (impugned judgment), the High Court allowed the appeal, setting aside the Award passed by the arbitral tribunal. The High Court held that it was a fit case for exercise of its power of judicial review under Section 37 since the Award was erroneous because it overlooked the terms and conditions of the Contract and was therefore against the public policy of India.

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Aggrieved by the impugned judgment, SEAMEC filed the instant appeal before the Supreme Court by way of a Special Leave Petition.

ISSUE FOR CONSIDERATION BEFORE THE SUPREME COURT

The Supreme Court sought to examine whether the arbitral tribunal’s interpretation of the Contract in the Award was reasonable and fair, such that the same passed the litmus test under Section 34 of the Arbitration Act.

MAIN CONTENTIONS OF SEAMEC

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The arbitral tribunal’s interpretation of Clause 23 of the Contract was correct and ought not to have been interfered with by the High Court.

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Where there were two possible views that could be taken on the same question of law, the High Court could not substitute the view of the arbitral tribunal and would have to defer to it. Reliance was placed on the case of McDermott International Inc v Burn Standard Co Ltd & Ors ((2006) 11 SCC 181).

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The answer to the question of law posed by the proceedings in the Award was neither against the public policy of India nor was it patently illegal and was beyond the scope of judicial review under the scheme of the Arbitration Act.

MAIN CONTENTIONS OF OIL

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The Award was perverse and illegal since its interpretation of the terms of the Contract amounted to virtual re-writing of the said terms. This was also in conflict with the public policy of India.

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The arbitral tribunal had overlooked the terms and conditions of the Contract in violation of Section 28(3) of the Arbitration Act and had thus exceeded its jurisdiction.

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This was not a case where the arbitral tribunal accepted one of two possible interpretations of a contract. The challenge to the Award was raised on the grounds of perversity and unreasonableness. Therefore, this was a case fit for judicial review under Section 34 of the Arbitration Act.

JUDGMENT

At the outset, it must be noted that the instant appeal was in respect of proceedings under Section 34 of the Arbitration Act instituted prior to the 2015 Amendment. The Supreme Court has held in Ssangyong Engineering & Construction Co Ltd v National Highways Authority of India ((2019) 15 SCC 131) (Ssangyong) that the post-amendment position shall not apply to applications related to Section 34, instituted before the 2015 Amendment, unless otherwise agreed by the parties. Therefore, the Supreme Court decided the present appeal in light of Section 34 as it stood prior to the 2015 Amendment. In this backdrop, the Supreme Court held as follows:

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Reliance was placed on the earlier decision of the Supreme Court in Dyna Technologies Pvt Ltd v Crompton Greaves Ltd (2019 SCC Online SC 1656), where the scope of interference with an award under Section 34 of the Arbitration Act as it stood prior to the 2015 Amendment, was laid down. The Bench recognised the limited scope of interfering with an award under Section 34 and held that usually, where two interpretations are possible, the Court shall defer to the reasoning of the arbitrator. The Court could only interfere if it found that the perversity in the award went to the root of the matter without there being scope for any alternative interpretation.

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In the instant case, the question which arose for consideration was whether the interpretation to the Contract by the tribunal was reasonable and fair, and passed muster under Section 34 of the Arbitration Act. If the Court came to a conclusion that the interpretation was reasonable, the merits of such interpretation would not be gone into.

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The Supreme Court was not in complete agreement with the finding of the High Court that Clause 23 of the Contract was pari materia to “the doctrine of frustration and supervening impossibility” and that Clause 23 appeared to have been included in the Contract, keeping in mind section 56 of the Indian Contract Act, 1872 (Contract Act). The Supreme Court went on to consider the consequences of a force majeure clause in India and in Common Law. With specific reference to the matter at hand, it was observed that Section 56 of the Contract Act would apply when the parties have not stipulated the consequences of an event rendering performance of a contract impossible under Section 32 of the Contract Act. In cases where Section 56 does apply, it renders the contract void. In such cases, Section 65 of the Contract Act also provides a mechanism to mitigate consequences of such frustration by making it incumbent on a person who has received any benefit under a void contract to restitute or compensate the person from whom the benefit was received. In the instant case, clause 44.3 of the Contract specifically recognised “force majeure” events to include “systems and acts and regulations of the Government of India and other clauses”. Further, the parties had also agreed for payment of a temporary force majeure rate under Clause 22.23 of the Contract. The parties had, in their commercial wisdom chosen to mitigate the risk under Clause 23 of the Contract. This was not in line with the effect of frustration as contemplated under Section 56 of the Contract Act, under which all future obligations of parties stood discharged.

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The Bench went on consider the arbitral tribunal’s interpretation to hold that the increase in price of HSD would constitute a “change in law” under Clause 23 of the Contract. It was held that the arbitral tribunal, by providing a wide interpretation to Clause 23, had ignored the basic tenet of interpretation that a contract should be read as a whole, to render the various provisions mutually explanatory. Analysing the provisions of the Contract, the Supreme Court concluded that the Contract was premised on a fixed rate which SEAMEC had entered into after mitigating the risk of an increase in prices of materials. As such, the interpretation of the tribunal was not a possible one since it would render the terms of the Contract otiose. Price fluctuations, such as in the instant case, could not be brought within the meaning of Clause 23, i.e., “a change in law”, in the absence of specific language indicating the same.

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The ruling in the case of Sumitomo Heavy Industries Ltd v Oil and Natural Gas Corporation Ltd ((2010) 11 SCC 296), where the Supreme Court had interpreted an indemnity clause to hold that an additional tax burden would be covered by it, was inapplicable to the facts of the instant case, since it was based on the appreciation of evidence on record in that case. In the instant case, the evidence did not suggest that the parties had agreed to a broad interpretation of Clause 23 of the Contract.

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The Supreme Court also examined other provisions of the Contract, including one which indicated that the fuel would be supplied by the contractor at his expense, to conclude that the interpretation of the Contract by the tribunal was perverse.

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In light of the aforesaid, the Supreme Court declined to interfere with the impugned judgment of the High Court setting aside the award and dismissed the appeal filed by SEAMEC.

COMMENT

As mentioned above, since the matter pertained to Section 34 proceedings initiated prior to the 2015 Amendment, the Bench applied Section 34 of the Arbitration Act as it stood prior to the amendment, when “patent illegality” was not statutorily defined and was one of the planks to raise a challenge to an award as being violative of public policy. Further, the decision was rendered in the context of Section 28(3) of the Arbitration Act as it stood prior to the amendment, which provided that the “arbitral tribunal shall decide in accordance with the terms of the contract”. This approach relates back to an epoch in which Indian courts were heavily criticised for their interventionist approach in relation to arbitration proceedings. It is important to note that the 2015 Amendment led to the introduction of Section 34(2A), whereby the contours of “patent illegality” were statutorily defined and given the status of a ground of challenge independent of “public policy”. Post the amendment, it has been clarified that patent illegality must appear on the face of the award.  Additionally, the award cannot be set aside merely on the ground of erroneous application of law or by re-application of evidence. This is essentially the same test as laid down in the instant case. Section 34(2A) has been introduced with a view to defining and limiting the scope of interference with an arbitral award on the ground of patent illegality. Further, Section 28(3) was amended to require the arbitral tribunal to merely “take into account” the terms of the contract while deciding and making an award. In Ssangyong, the Supreme Court elaborated on the concept of “patent illegality” post the 2015 Amendment and has expanded its sweep through an interpretation of Section 28(3) of the Arbitration Act which is similar to that of the Supreme Court in the instant case, i.e.,  the construction of the terms of a contract is the arbitrator’s exclusive domain and can be interfered with on the ground of “patent illegality” only if the view is one which is impossible to take. However, it must be borne in mind that post the 2015 Amendment, the requirement of the arbitral tribunal to mandatorily decide in accordance with the terms of the contract has been diluted, giving the tribunal more leeway to decide based on other factors. As such, while adjudicating challenges to arbitral awards raised post the 2015 Amendment on the ground of patent illegality on account of impossibility of the interpretation provided to a contract, courts must set a higher standard for interference with the award. Else, there will be no difference in the Pre-Amendment and Post-Amendment position in relation to “patent illegality”, thereby nullifying attempts made by way of the 2015 Amendment to reduce scope for interference of courts with the arbitral process.

-       Padam Khaitan (Partner) and Srinjoy Bhattacharya (Associate)

For any queries please contact: editors@khaitanco.com

Padam Kumar Khaitan (executive_team,partners)

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