Freedom Of Contract And Interest Barring Clauses: Does Section 31(7)(A) Of The Arbitration Act Need A New Approach?

Under section 31(7) of the Act, the arbitral tribunal has the competence to levy interest on the arbitral award. However, section 31(7)(a) of the Act begins with the phrase 'Unless otherwise agreed by the parties'; this brings a material change to the scheme of the power of the arbitrator to award interest. In such a scenario, when the parties have agreed that no interest shall be levied, the arbitral tribunal is rendered incapacitated even if there exists a compelling circumstance to award interest. An additional point that needs consideration is section 3 of the Interest Act, 1978 which deals with the power of the court to allow interest. Sub section (3)(a)(ii) impedes the court to do so in the wake of a clear agreement between the parties regarding non-payment of interest. This at times results in a situation wherein one of the parties takes unfair advantage of the prevalent circumstance(s). This article examines the said premise in the light of the existing laws and in the process attempts to traverse through it.

It is crucial to lay out the latest Supreme Court decision in this regard at the very outset of our analysis. The Supreme Court in the case of Garg Builders vs. Bharat Heavy Electricals Limited(BHEL), (CIVIL APPEAL NO.6216 OF 2021) has ruled that,

"Section 31(7)(a) of the 1996 Act which allows parties to waive any claim to interest including pendente lite and the power of the Arbitrator to grant interest is subject to the agreement of the parties……The provisions of Section 3(3) of the Interest Act, 1978 explicitly allows the parties to waive their claim to an interest by virtue of an agreement. Section 3(3)(a)(ii) states that the Interest Act will not apply to situations where the payment of interest is "barred by virtue of an express agreement. Thus, when there is an express statutory permission for the parties to contract out of receiving interest and they have done so without any vitiation of free consent, it is not open for the Arbitrator to grant pendent lite interest."

Thus, the law on the issue is straight as an arrow with almost no-scope of further interpretation. Moreover, the wordings of the A&C Act, 1996 are crystal clear and warrants no further deliberation by the courts. As a result, the arbitral tribunal cannot intervene and grant interest under such circumstances.

'Interest', by the very nature of it, is a form of compensation that is given in case of defaults with respect to the terms of contract. It is understood that in arbitration the autonomy of the parties is paramount. Nonetheless, a clause that subdues the very genesis of compensation (in this case interest) is prima facie colourable and thereby demands a meticulous scrutiny.

In cases of government contracts wherein an interest barring clause is engrafted in the agreement, it is necessary to look at the outlook in toto. In these types of contracts, the parties are on an unequal footing. This is because of the fact that one entity is an awfully big enterprise (for e.g. a PSU) while the other contracting party has a considerably lessor bargaining power in front of it. This creates a situation where the party having an upper hand can conveniently demand a favorable contractual term on its sole will and without much opposition from the other party. This essentially erodes the component of free choice from the contract as the weaker party gives into the contract out of fear. The fear stems from the fact that there are numerous market players who can easily replace the weaker party in question. Hence, there is almost no alternative available in these cases and as a result a contract waiving the right to claim interest is signed between the parties. This unsavory framework is completely governed by the arbitration act itself and there is almost nothing that the arbitral tribunal can do.

It is unreasonable for a party to completely escape its liability of paying interest just because of an agreement to that effect. This position of law is arbitrary as the parties are not placed at the same pedestal while entering the contract. Thus, what may seem like a free consent may not really be so. In our opinion striking down the phrase 'Unless otherwise agreed by the parties' from section 31(7)(a) will be an 'up to scratch' approach in the current state of affairs.

It is agreed that an arbitrator is the creature of an agreement. However, this per se cannot be a plausible ground to render him impotent whenever a case like this comes for adjudication. Interest essentially is a form of damages which a party is entitled to receive and an agreement waiving that in its entirety is despotic in nature. Party autonomy and the liberty to contract must work within the chassis of mutual respect and honest commitment towards the contract. Escaping one's liability on the behest of legal provisions is not good for the market as the parties are left with almost no douceur to perform. The legislature has time and again stepped in and curtailed such liberty to contract in order to protect the interests of the weaker sections and others not placed at an equal footing (for e.g. the labor laws, employment laws etc.). Likewise, here the parties that do not have equal bargaining power before the big players of the market need protection. Rendering the interest barring clauses inutile will go a long way in securing the rights of the parties involved in a contract. This will further boost India's ease of doing business and in turn will compel the parties to fulfill their contractual obligations in a meaningful way. In conjunction with being a sound public policy measure, removing the impugned phrase from section 31(7)(a) will give the arbitral tribunals the full discretion to award interest whenever a case so demanding arises. India, being a developing country, needs such pragmatic measures in order to secure a favorable and effective business environment. The practical considerations and on-ground heuristics can in no way be ignored or buried in fine legal print.

Section 23 of the Indian Contract Act also states that contracts that go against public policy are not tenable in law. It is our case that this position must be looked from the lens of public policy because under no circumstance can a party be compelled to forgo their right to claim interest.

Views are personal.