Levy of Liquidated Damages by one party to a contract: When arbitrable? Comments in light of SC Judgment of Mitra Guha v. ONGC

Public sector undertakings, statutory/government bodies and even private parties (“the employer”) may execute contracts with other private parties (“the contractor”) for construction of various projects. While the models for such contracts would vary, the contractor’s obligation to timely complete the project remains a key term of such contracts. However, the contractor’s ability to complete the project within stipulated timelines is also contingent on the employer fulfilling its’ obligations on time, such as, inter alia, providing land for construction on time. A delay by either of the parties in fulfilling their obligations may entitle the other to be compensated for the loss suffered arising from such delay. Such contracts may also provide for dispute resolution through arbitration.

However, in accordance with Section 7 of the Arbitration and Conciliation Act, 1996, the parties have the freedom to refer all or only certain disputes for arbitration. If the parties have agreed to not refer certain disputes for arbitration, the same may be classified as ‘excepted’ matter and any dispute regarding the same would not be arbitrable. Many such construction contracts provide that the contractor will compensate the employer for the delay in completion of the project by payment of liquidated damages. Such liquidated damages may be decided by an employee of the employer such as a designated superintending engineer under the contract (“SE”), whose decision shall be final and binding in this regard. Question arises when there is a dispute between the parties regarding levy of liquidated damages by the employer in such cases. If the decision of the SE of the employer regarding levy of liquidated damages is final and binding, is this an excepted matter and not arbitrable? Further, what is the scope of such alleged excepted matter – whether only quantum of liquidated damages calculated is not arbitrable or even the issue of whether the delay is attributable to the contractor, which gives the employer the right to levy liquidated damages, is not arbitrable?

While these issues have been previously considered by the Supreme Court of India, the said issue was recently re-agitated in Mitra Guha Builders (India) Company v. Oil and Natural Gas Corporation Limited[1]  (“Mitra Guha v. ONGC”). This article seeks to analyse the judgment in Mitra Guha v. ONGC on the abovementioned issues.

Brief Facts

In this case, the respondent, Oil and Natural Gas Corporation Limited (“ONGC”) was the employer and it entered into contract for construction of flats and other works with the appellant, who was the contractor. There was delay in completion of the works and the contractor raised claims against the employer, which were refuted by the employer and consequently, the contractor invoked the arbitration clause as provided in the contract. The employer also levied liquidated damages and withheld amount for the same from the payment to the contractor, which was also sought to be challenged in the arbitration proceedings by the contractor.

In this regard, it is pertinent to note that Clause 2 of the contract provided that in event of delay by the  contractor, the “…contractor shall pay compensation on amount equal to ½% per week as the Superintending Engineer (whose decision in writing shall be final) may decide”. Further for special jobs, if a time schedule had been submitted and the contractor fails to comply with the schedule, “…he shall be liable to pay as compensation an amount equal to ½% per week as the Superintending Engineer (whose decision in writing shall be final) may decide on the contract value”. The entire value of compensation under this clause could not exceed 10% of the tendered cost of the work.

Further, Clause 25 of the contract provided for settlement of disputes by arbitration. It stated that all disputes, difference, question or disagreement shall be referred for arbitration. However, “the decision of the Superintending Engineer regarding the quantum of reduction as well as his justification in respect of reduced rates for sub-standard work, which may be decided to be accepted, will be final and binding and would not be open to arbitration…”

The learned arbitrator noted that both the parties were responsible for delay in completion of the project. However, it disallowed the claim for liquidated damages by the  employer on the grounds that under the garb of liquidated damages, what was sought to be imposed was penalty. Further, the arbitrator noted that the  employer was also liable for substantial delay in the project, and thus, could not collect such penalty belatedly. While hearing the challenge to the award, the Single Judge of the  High Court at Delhi (“the Delhi High Court”) re-affirmed the findings of the arbitrator and noted that since the  employer is also responsible for substantive part of delay (60% of the delay), hence the  employer is not entitled to recovery of such penalty. The said findings regarding levy of liquidated damages were overturned by the Division Bench of the Delhi  High Court , on the grounds that liquidated damages had been levied under Clause 2 of the contract, which provided that the decision of the SE is final and binding. Thus, the same was an excepted matter and not arbitrable. Further, the Division Bench noted that even the arbitrator had held the  contractor to be liable for some delay in the completion of the project and that the arbitrator had not given any reason as to why Clause 2 was in the nature of penalty and not a genuine pre-estimate of the loss suffered by the  employer.

Findings of Supreme Court

The Supreme Court affirmed the findings of the Division Bench and held that by virtue of Clause 2 of the contract, the SE was not only conferred with a right to levy compensation but also for determining the liability/quantum of compensation. Since Clause 2 attaches finality to such decision of the SE, the same cannot be the subject-matter of arbitration and Clause 2 provides for the complete mechanism for levy of liquidated damages. In para  18[2], it states that, ‘any’ decision of SE cannot be referred for arbitration and any other meaning to the finality clause would make the agreed Clause 2 and Clause 25 redundant. Thus, in paras 20 and 26[3], it states that delay in completion of work and the levy of liquidated damages could not have been determined by the arbitrator and the only recourse available is in ordinary course of law. The Supreme Court relied on the judgment of interalia Vishwanath Sood v. Union of India[4] (“Vishwanath Sood”) to support its interpretation to Clauses 2 and 25.

The appellant contractor contended that the finality attached in Clause 2 is on quantification of liquidated damages. However, for levy of liquidated damages, there has to be delay and to determine who is responsible for delay, the said issue will have to be determined by an arbitrator. Reliance was placed on BSNL v. Motorola India (P) Limited[5](“BSNL v. Motorola”). However, the Supreme Court rejected the same and held that the case of BSNL v. Motorola is distinguishable on account of different wording of the relevant clauses. The Supreme Court  noted that in BSNL v. Motorola, the entitlement of the party was to recover liquidated damages. Linkage of compensation, in BSNL v. Motorola, to “value of delayed quantity” and “for each week of delay” showed that it was necessary to find out whether there has been delay on part of the supplier. Thus, Clause 16.2 in BSNL v. Motorola did not envisage a complete process for adjudication of the issue. However, in the present case, the Supreme Court held that Clause 2 of the present agreement is a complete mechanism. Thus, the ‘right to levy damages’ is exclusively conferred upon the SE and is final and binding and not arbitrable.

Analysis

It is submitted that while finality can be attached to quantification of damages by SE, however this right to levy liquidated damages by SE is a secondary power, for which the primary issue required to be determined is whether the  contractor had caused any delay to invite levy of liquidated damages. Determination of such a primary issue ought to be arbitrable and in this regard, the reasoning of the Supreme Court in Mitra Guha v. ONGC, should be read in context of the issues highlighted in the following paragraphs.

Party to the agreement cannot be an arbiter in its own cause

The right to levy liquidated damages does not exist in a vacuum and arises only upon breach by the  contractor i.e. when the delay is attributable to the  contractor. Thus, the right to levy liquidated damages is a subsidiary and consequential power and not a primary power to even determine question of breach by the  contractor. The same was also held by the Supreme Court  in State of Karnataka v. Shree Rameshwara Rice Mills[6] (“Rice Mills”) in para 7. While the Supreme Court in Rice Mills case noted that the wording of the relevant clause did not confer finality to the power of officer of the employer to determine question of breach, it held that, in any event, such a power could not be conferred. The same was on the basis that a party to the agreement cannot be an arbiter in his own cause. It held that, “interests of justice and equity require that where a party to a contract disputes the committing of any breach of conditions, the adjudication should be by an independent person or body and not by officer party to the contract.”  However, the Supreme Court in Rice Mills case did note that if the contractor has admitted delay or there is no dispute regarding the same, then such officer of the employer would be well within his rights to assess the damage. The same was also followed by the Supreme Court in BSNL v. Motorola[7], however, Mitra Guha v. ONGC did not deal with this issue and only sought to distinguish the case of BSNL v. Motorola on the grounds of wordings of the relevant clause. This dicta in Rice Mills case and BSNL v. Motorola has been followed in J.G. Engineers Private Limited v. Union of India[8] (“J.G. Engineers”), which dealt with a contractual clause similar to the one in Mitra Guha v. ONGC. However, while Mitra Guha v. ONGC, in interpreting Clauses 2 and 25 of the contract, placed reliance on Vishwanath Sood, however, it did not consider the case of J.G.Engineers. Further, even Vishwanath Sood did not have the occasion to consider  Rice Mills case. The dicta that a party to the agreement cannot be an arbiter in its own cause has been further re-affirmed by a three-Judge Bench of the Supreme Court  in  Tulsi Narayan Garg v. M.P. Road Development Authority[9], which was dealing with the question of whether the State could have levied liquidated damages and initiated recovery proceedings for the same, when the dispute was pending before the Arbitral Tribunal.

Reading of Clauses 2 and 25 in light of J.G. Engineers and Rice Mills

The above interpretation is also in consonance with the interpretation of Clauses 2 and  25 of the contract. The Supreme Court  in J.G. Engineers while interpreting Clause 2 (worded similarly to the one in Mitra Guha v. ONGC) noted that “…his decision is not made final in regard to the question as to why the work was not commenced on the due date or remain unfinished by the due date of completion and who was responsible for such delay”.[10] Further, it stated that the said clause does not attach finality to the “question as to whether the contractor had failed to complete the work or portion of work within the agreed time schedule, whether the contractor was prevented by any reasons beyond its control or by the acts or omissions of the respondents, and who is responsible for the delay.”[11]

The Supreme Court in J.G. Engineers noted that the consequential decision of the SE in regard to quantification/levy of liquidated damages, is made final “if there is no dispute as to who committed the breach. That is if the contractor admits that he is in breach or if the arbitrator finds that the contractor is in breach”. Further, Clause 25 in Mitra Guha v. ONGC, excludes the decision of SE regarding ‘quantum’ of reduction of rates ‘in case of sub-standard work’ as excepted matter. The same cannot be read to expand the scope of ‘excepted matter’ to include the dispute on whether the contractor is responsible for the delay, thereby inviting levy of liquidated damages.

The Supreme Court  in Mitra Guha v. ONGC has stated in paras 19 and 20[12] that if further adjudication under Clauses 2 and 25 is allowed, it will render the agreement meaningless and redundant. It further notes in para 26 that remedy against the decision of SE in Clause 2 shall lie in ordinary course of law and not arbitration. In this regard, first it is reiterated that the scope of finality attached to decision of SE in Clause 2 read with Clause 25 is on the levy/quantification of liquidated damages. The same is consequential to and distinct from the primary power of adjudicating the issue of the party responsible for such breach and for this, the employer cannot be an arbiter in his own cause. Second, the Supreme Court has not considered that even if the claim against levy of liquidated damages is not referred to the arbitrator, the  contractor may refer other claims such as escalation on account of delay caused by the employer to the arbitrator. In such case, the arbitrator will be required to determine the party responsible for delay in completion of the contract. In the event finality is attached to the SE’s decision on the  contractor being responsible for delay for levy of liquidated damages, there may be contrary findings on the said issue by the SE and the arbitrator. Further, even if recourse is taken to the ordinary course of law, the same may lead to multiplicity of proceedings and contrary findings on the same issue of determining the party responsible for delay. Thus, even in Rice Mills and J.G. Engineers, the Supreme Court stated that the SE’s decision to levy liquidated damages can attain finality only if there is no dispute on breach by the contractor. It is to be noted that in Mitra Guha v. ONGC, the arbitrator had recorded a finding that both the parties were responsible for the delay, which was not upset by any of the courts. However, the arbitrator had faulted with SE for imposition of liquidated damages on other grounds. 

Sole Reliance upon Vishwanath Sood 

The Supreme Court in Mitra Guha v. ONGC relied upon Vishwanath Sood to come to its findings as Clause 2 being considered was similar in both cases. However, the Supreme Court did not discuss the case of J.G.Engineers which also had a similarly worded clause for levy of liquidated damages. Vishwanath Sood stated that Clause 2 provides a complete mechanism and the SE has the discretion to determine the liquidated damages within a permissible range after considering the pleas of the contractor, which may include any mitigating circumstances being pleaded by the contractor. Thus, the decision of the SE is a considered decision. However, in this regard, the same has to be read in light with decision of the Supreme Court in Rice Mills and J.G. Engineers and considered to be applicable to a situation only where there is no dispute by the contractor on the question of breach by the contractor. It is not clear whether the judgment of J.G. Engineers was brought on record before the Supreme Court  in Mitra Guha v. ONGC. On previous occasions, the Delhi High Court and the  High Court of Madhya Pradesh (“the MP High Court”) had the occasion to consider J.G. Engineers and Vishwanath Sood together.

The Delhi High Court in Winner Constructions Private Limited v. Union of India[13], read down the scope of Vishwanath Sood by reading it with J.G. Engineers and BSNL v. Motorola to hold that “the issue of non-arbitrability is only upon the question of any compensation, which the Government might claim in terms of Clause 2 of the Contract. In other words, the issue whether the contractor had delayed the project would still be arbitrable.[14]

It further relied upon para 10 of Vishwanath Sood  to come to the said conclusion, which itself stated that,

“10. We may confess that we had some hesitation in coming to this conclusion. As pointed out by the Division Bench, the question of any negligence or default on the part of the contractor has many facets and to say that such an important aspect of the contract cannot be settled by arbitration but should be left to one of the contracting parties might appear to have far reaching effects. In fact, although the contractor in this case might object to the process of arbitration because it has gone against him, contractors generally might very well prefer to have the question of such compensation decided by the arbitrator rather than by the Superintending Engineer. But we should like to make it clear that our decision regarding non arbitrability is only on the question of any compensation which the Government might claim in terms of clause 2 of the contract …We have already pointed out that this is a penalty clause introduced under the contract to ensure that the time schedule is strictly adhered to…This is not an undefined power. The amount of compensation is strictly limited to a maximum of 10% and with a wide margin of discretion to the Superintending Engineer, who might not only reduce the percentage but who, we think, can even reduce it to nil, if the circumstances so warrant. It is this power that is kept outside the scope of arbitration. We would like to clarify that this decision of ours will not have any application to the claims, if any, for loss or damage which it may be open to the Government to lay against the contractor, not in terms of Clause 2 but under the general law or under the Contract Act.

(emphasis supplied)

Similarly, even the MP  High Court in  Shridhar Dubey v. Union of India[15] read down the scope of a similarly word Clause 2 and the impact of Vishwanath Sood by reading it together with the case of J.G. Engineers, Rice Mills and BSNL v. Motorola. The MP High Court held that, “prima facie, the liability for compensation arises when the contractor has failed to maintain the deadline for completion…Thus, in case where there is dispute as regards to the quantum of compensation, the respondent may be within their right to say that the same is “excepted” from being arbitered…it is in this context the decision rendered by Supreme Court in Vishwanath Sood v. Union of India[16], and the Coordinate Bench in Pawan Kumar Jain[17]  is relevant” to hold that,  had the J.G. Engineers and Rice Mills been also discussed by the Supreme Court  in Mitra Guha v. ONGC, it is arguable that findings could have been different.

It is also to be noted that the dispute resolution envisaged through arbitration in Clause 25 in Vishwanath Sood and J.G. Engineers started with the words, “except as otherwise provided in the contract, all questions and disputes…shall be referred to the sole arbitration”. The phrase ‘except as otherwise provided’ was relied upon by the Supreme Court in Vishwanath Sood to hold that Clause 2 is excepted under Clause 25. However, Clause 25 in Mitra Guha v. ONGC does not contain such an exception and the exception provided in Clause 25 is to the decision of SE for “quantum” of reduction as well as his justification for reduced rates “for sub-standard work” and not for delay in completion of work.

Conclusion

The Supreme Court in Mitra Guha v. ONGC while holding that Clause 2 is a complete mechanism to decide on whether there was a delay in completion of work and on levy of liquidated damages by SE, did not have occasion to consider the principles enunciated in Rice Mills and J.G. Engineers as such the judgment does not seem to have been relied upon by the parties. Thus, it expands the scope of ‘excepted matter’ by a broad reading of Clause 2 to include even the determination of party responsible for delay as ‘excepted matter’ and hence not arbitrable. It is to be noted that the arbitrator in this case had attributed delay to both parties but had sought to deny the levy of liquidated damages on other grounds and not because the arbitrator held that the contractor was not responsible for any delay. ONGC had pleaded that out of delay of 640 days, a delay of 273 days was attributable to the  contractor, which was also taken into consideration by the Single Bench of the Delhi High Court in upholding the findings of the arbitrator. Thus, the expansion of the scope of the finality attached to the decision of SE in levy of liquidated damage, to include decision on the party responsible for delay in completion of work was not warranted as the same was not the primary issue before the Supreme Court in Mitra Guha v. ONGC. Thus, as a precedent Mitra Guha v. ONGC, may still be distinguishable and it can be argued that finality attached to SE’s decision is restricted to quantification of damages. However, this right to levy liquidated damages by SE is a secondary power, which is consequential to the primary issue of whether the contractor had caused any delay to invite levy of liquidated damages. The latter primary issue ought to be arbitrable in light of the principles discussed in Rice Mills, J.G. Engineers and BSNL v. Motorola, which the Supreme Court has not considered in Mitra Guha v. ONGC.


 *Partner at L&L Partners, Litigation, Delhi

**Associate at L&L Partners, Litigation, Delhi

[Authors’ Note: The views expressed are personal and do not represent views of the firm.  The views expressed do not constitute legal advice.]

[1] (2020) 3 SCC 222

[2] Ibid.

[3] Ibid

[4](1989) 1 SCC 657

[5] (2009) 2 SCC 337

[6](1987) 2 SCC 160

[7] (2009) 2 SCC 37, para 24.

[8](2011) 5 SCC 758, paras 19-21

[9] 2019 SCC OnLine SC 1158

[10]J.G. Engineers Pvt. Ltd. v. Union of India, (2011) 5 SCC 758, para 17.

[11]Ibid, para 17.

[12] (2020) 3 SCC 222

[13] 2016 SCC OnLine Del 2494

[14]Ibid, para  20.

[15] 2016 SCC OnLine MP 8013

[16] (1989) 1 SCC 657

[17] Pawan Kumar Jain v. Union of India, 2009 SCC OnLine MP 398

2 comments

  • Absolute correct analysis. Presently Superintending Engineer’s rate for bribe etc is sky rocketed by this Mitra Guha . Agreement completed with extensions without liability clause like clause 5 of CPWD, PWD, Clause 17A, (railway) is been penalized with LD. Foreclosure under clause 5 is also attracted with penalty even after 7 years from date of fore closure. I personally advised my clients not to participate any Government tender. I am sure INDIA will be the bottom most underdeveloped country with in short span. I am a very small fry and do not have the right to tell any thing. Please save the county.

  • Hi

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