S. 34 Arbitration Act |Mere Violation Of Law Won't Make Arbitral Award Invalid, Fundamental Policy Of Law Must Be Violated : Supreme Court

The Supreme Court recently explained the scope for judicial interference in arbitral awards under section 34 the Arbitration and Conciliation Act on the ground of violation of public policy, highlighting that it is very limited, particularly after the 2015 amendment.

A bench of Chief Justice of India DY Chandrachud, Justice JB Pardiwala, Justice Manoj Misra observed that mere violation of law is not enough to interfere with an award, but it must conflict with the most fundamental aspects of public policy, justice.

“The expression “in contravention with the fundamental policy of Indian law” by use of the word 'fundamental' before the phrase 'policy of Indian law' makes the expression narrower in its application than the phrase “in contravention with the policy of Indian law”, which means mere contravention of law is not enough to make an award vulnerable. To bring the contravention within the fold of fundamental policy of Indian law, the award must contravene all or any of such fundamental principles that provide a basis for administration of justice and enforcement of law in this country.”

Public Policy of India

The Court noted that after the 2015 amendment to the Act, the phrase “in conflict with the public policy of India” was accorded a restricted meaning under Section 34(2)(b)(ii) of the Arbitration Act. Mere contravention of Indian law does not make an award invalid. The contravention must involve a fundamental policy of Indian law.

“for an award to be against public policy of India a mere infraction of the municipal laws of India is not enough. There must be, inter alia, infraction of fundamental policy of Indian law including a law meant to serve public interest or public good.”

The Court said that under Explanation 1 of Section 34(2)(b)(ii), the award must violate 'fundamental' principles that are essential to the administration of justice in India, for example, breach of natural justice, disregarding binding judgments of superior courts, or violations of laws linked to public good or public interest.

Justice and Morality

Explanation 1 of Section 34(2)(b)(ii), an award can be set aside if it conflicts with the “most basic notions of justice or morality”. The Court highlighted that the 2015 amendment qualified “justice” with "most basic notions," limiting the scope of intervention by courts. The Court emphasized that this ground should be invoked only in exceptional circumstances where there is a breach of fundamental principles of justice that a prudent person, whether judicially trained or not, would recognize as violated.

“Suffice it to observe, they ought to be such elementary principles of justice that their violation could be figured out by a prudent member of the public who may, or may not, be judicially trained, which means, that their violation would shock the conscience of a legally trained mind. In other words, this ground would be available to set aside an arbitral award, if the award conflicts with such elementary/ fundamental principles of justice that it shocks the conscience of the Court.”

The Court noted that "morality" in judicial contexts has been primarily limited to sexual morality. If morality were to extend beyond this, it would apply to agreements that, while not illegal, conflict with societal norms. The Court clarified that interference based on morality would occur only if the matter "shocks the court's conscience."

Patent Illegality

The Court explained that patent illegality (Section 2A of the Act) is a specific ground for setting aside domestic arbitral awards (but not for international commercial arbitrations). The term refers to an award that contains errors apparent on the face of the award, such as violations of substantive provisions of Indian law or terms of the contract. However, reappreciation of evidence or mere errors in applying the law do not constitute patent illegality. An award can only be set aside if the illegality goes to the root of the matter.

The Court reiterated that courts do not sit in appeal over arbitral awards, and interference is permitted only on the limited grounds set out in Section 34 of the Arbitration Act. An arbitrator is the master of evidence, and as long as the award is based on a possible view of the facts, it should be respected, the Court observed.

“A possible view by the arbitrator on facts is to be respected as the arbitrator is the ultimate master of the quantity and quality of evidence to be relied upon. It is only when an arbitral award could be categorized as perverse, that on an error of fact an arbitral award may be set aside…Further, a mere erroneous application of the law or wrong appreciation of evidence by itself is not a ground to set aside an award as is clear from the provisions of sub section (2-A) of Section 34 of the 1996 Act”, the Court held.

The Court also discussed the scope of interference with an arbitral award on ground of insufficient, or improper/erroneous, or lack of reasons, and whether implied terms can be read into contracts.

Reasons for the Award – Impact of Lack or Inadequate Reasons

Section 31(3) of the Arbitration Act mandates that arbitral awards must state reasons unless the parties have agreed otherwise or the award is based on a settlement between the parties.

The Court reiterated from Dyna Technologies that reasons in an arbitral award must be:

• Proper: The reasoning must be logical and not flawed.
• Intelligible: It should make sense and be understandable.
• Adequate: The reasoning must address the complexity of the issues presented in the case.

The Court said that arbitral awards can be placed in three categories:

• No reasons or unintelligible reasons: Such awards are in conflict with Section 31(3) of the Act and can be set aside.
• Improper reasons: Awards where the reasoning is flawed, but these can only be challenged based on the grounds in Section 34.
• Inadequate reasons: Courts must carefully evaluate whether the reasons provided are sufficient based on the nature of the issues. If reasons are intelligible and adequate, the award will not be set aside merely for being incomplete.

“The Court must thereafter carefully peruse the award, and the documents referred to therein. If reasons are intelligible and adequate on fair-reading of the award and, in appropriate cases, implicit in the documents referred to therein, the award is not to be set aside for inadequacy of reasons. However, if gaps are such that they render the reasoning in support of the award unintelligible, or lacking, the Court exercising power under Section 34 may set aside the award”, the Court held.

Interpretation and Construction of a Contract

If the tribunal issues an award that contradicts the contract, it is considered patently illegal, the Court said. It added that the tribunal has the authority to interpret the contract based on its terms, the conduct of the parties, and surrounding circumstances.

“If the conclusion of the arbitrator is based on a possible view of the matter, the Court should not interfere. But where, on a full reading of the contract, the view of the arbitral tribunal on the terms of a contract is not a possible view, the award would be considered perverse and as such amenable to interference”, the Court held.

When Can Implied Terms Be Read into a Contract

The Court said that courts can read an implied term into a contract only when the term was clearly intended by the parties but was not explicitly stated. It is not enough to find that the term would have been accepted as reasonable by the parties; it must be a term that “goes without saying”, the Court held.

“An unexpressed term can be implied if, and only if, the court finds that the parties must have intended that term to form part of their contract. It is not enough for the court to find that such a term would have been adopted by the parties as reasonable men if it had been suggested to them. Rather, it must have been a term that went without saying, a term necessary to give business efficacy to the contract, a term which, although tacit, forms part of the contract”, the Court emphasised.

The Court outlined five conditions for reading an implied term into a contract:

“a. it must be reasonable and equitable;

b. it must be necessary to give business efficacy to the contract, that is, a term will not be implied if the contract is effective without it;

c. it must be obvious that “it goes without saying”;

d. it must be capable of clear expression;

e. it must not contradict any terms of the contract.”

Case no. – Civil Appeal Nos. 3981-3982 of 2024

Case Title – OPG Power Generation Pvt. Ltd. v. Enexio Power Cooling Solutions India Pvt Ltd. & Anr.

Citation : 2024 LiveLaw (SC) 738

Click Here To Read/Download Judgment