Government Contracts – Are the interests really balanced?

1. That the era of modernisation has brought about a radical change in the manner of functioning of not only private undertakings but also the Government. The functions of modern Government extend much beyond the sovereign functions such as legislating, and now the Government is a key functionary in the commercial arena as well, primarily by delegating infrastructure development to private entities by floating tenders.

2. The Government has now started delegating the task of infrastructure development to private entities which work directly under the supervision of the Government Departments concerned or any instrumentality of State, which now forms an essential part of the trade and commerce activities carried out by the Government. The power of the Government to enter into contracts has been recognised under Article 299 of the Constitution, which states as under:

299. Contracts.– (1) All contracts made in the exercise of the executive power of the Union or of a State shall be expressed to be made by the President, or by the Governor of the State, as the case may be, and all such contracts and assurances of property made in the exercise of that power shall be executed on behalf of the President or the Governor by such persons and in such manner as he may direct or authorise.

(2) Neither the President nor the Governor shall be personally liable in respect of any contract or assurance made or executed for the purposes of this Constitution, or for the purposes of any enactment relating to the Government of India heretofore in force, nor shall any person making or executing any such contract or assurance on behalf of any of them be personally liable in respect thereof.”

3. The above raises an important question as to whether the Government should be subjected to the same rigours as other individuals or does it have any special rights over and above the rights available with ordinary contracting parties under the Contract Act, 1872?

4. The State authorities which are then tasked with the responsibility of infrastructure development should be deemed to act reasonably even though they are acting in a private law capacity. The doctrine of arbitrariness should not only extend to testing the effect and enforcement of legislations but also to provisions of contracts, particularly, contracts whose enforcement is widespread.

5. It would also be relevant to point out here that most contracts entered into by government agencies are standard form contracts (typically referred to as General Conditions of Contract) which are completely non-negotiable, and contractors are required to sign the dotted line. Any subject-matter which is not covered under the provisions of the General Conditions of Contract, are then agreed upon in the form of an addendum typically referred to as the Additional Conditions of Contract or Special Conditions of Contract.

6. In this backdrop, the Supreme Court has set aside the arbitrary and one-sided provisions in several contracts, particularly Builder-Buyer Agreements. However, the contracts which are entered into by governmental agencies perhaps stand at a higher pedestal than those of private builders inasmuch as governmental contracts do not withstand the same level of scrutiny from our judiciary. Thus, for the purposes of this article, I would restrict the discussion to the following clauses which are commonly used in government infrastructure contracts:

  1. Escalation clauses
  2. Variation clauses vis-à-vis claims for loss of profit
  3. Extension of time and recovery clauses
  4. Dispute resolution clauses

Escalation Clause

7. In contracts involving large quantum of work, price escalation clauses are introduced to prevent increase of price during the fixed course of execution of the work entrusted to the contractor, on the ground that the price of the material or equipment being utilised has increased. In ordinary course, the duration of the contract increases much beyond the initial estimated duration (referred to as the ‘stipulated period of completion’) and often by several years. In these circumstances, where a tendered work is a fixed-price and fixed-time contract, the contractors cannot be bound to execute the work at the initial cost over a period which has increased multi-fold. The Supreme Court in Tarapore & Co. v. State of M. P.[1] has observed that “escalation is a normal incidence arising out of gap of time in this inflationary age”. The Court  further went on to hold that escalated rates could be awarded in arbitration even in the absence of any provision for escalation in the contract.

8. Further, the intent behind incorporating escalation clauses in infrastructure contracts is succinctly explained by the Delhi High Court in Deconar Services Pvt. Ltd. v. NTPC Ltd.[2], as under:

9. …   A fixed price contract would be a fixed price contract only during the original period and surely it is an absurdity to suggest that irrespective of the extension of the contract well beyond the original stipulated date of completion and more so when the same is on account of breaches/ delays by the objector, yet in such a case it can be contended that still no escalation would be paid…

9. The difficulty which arises in pressing these claims is that all the pronouncements give liberty to the arbitrator to determine a reasonable measure of compensation while deciding the claims, so even if the escalated amount of the claims are calculated as per the formula provided in the agreement between the parties, the Tribunal is free to reject the calculation and decide any amount which it considers to be reasonable. This again is an exception to the series of judgments which state that “The arbitrator, being the prisoner of the contract, is bound to remain within the four corners of the contract[3]. On the other hand, if there is no escalation clause (and therefore, no formula for calculation), the Arbitral Tribunal is free to determine the amount to be paid towards escalation by any means which are ‘reasonable’. This results in a precarious position where the Arbitral Tribunal has the discretion to apply any method that it deems fit coupled with the varying levels of discretion that are appended to the term ‘reasonable’.

Variation clauses vis-à-vis claims for loss of profit

10. Variation clauses are inserted into the agreement for a prudent reason and fixing the price of the contract up to a reasonable limit. When the project which involves the use of large quantities of material and equipment, there might arise a situation that the quantity of some material differs from what had been mentioned in the Bill of Quantities/Schedule of Quantities. Thus, it is prudent to introduce and keep a variation clause in the agreement to deal with the exigent situation of difference in quantities which are actually utilised for execution of the project as compared to what was estimated in the Bill of Quantities. For ease of reference, Clause 12 of the General Conditions of Contract[4], published by the Central Public Works Department is being reproduced hereunder:

The Engineer-in-Charge shall have the power (i) to make alteration in, omissions from, additions to, or substitutions for the original specifications, drawings, designs and instructions that may appear to him to be necessary or advisable during the progress of the work, and (ii) to omit a part of the works in case of non-availability of a portion of the site or for any other reasons and the contractor shall be bound to carry out the works in accordance with any instructions given to him in writing signed by the Engineer-in-Charge and such alterations, omissions, additions or substitutions shall form part of the contract as if originally provided therein and any altered, additional or substituted work which the contractor may be directed to do in the manner specified above as part of the works, shall be carried out by the contractor on the same conditions in all respects including price on which he agreed to do the main work except as hereafter provided.

(emphasis supplied)

11. Per contra, in the event that the work is substantially curtailed from what had been originally awarded, the contractors are at liberty to raise a claim under the head ‘loss of profit’. This head of claim finds its inception in the judgment of the Supreme Court in T. Brij Paul Singh v. State of Gujarat[5] which has been reiterated several times and the judgment in Dwaraka Das v. State of M. P.[6] concisely elucidates the subject claim as under:

9…. This Court in A. T. Brij Paul Singh v. State of Gujarat[7] while interpreting the provisions of Section 73 of the Contract  Act, 1872 has held that damages can be claimed by a contractor where the Government is proved to have committed breach by improperly rescinding the contract and for estimating the amount of damages, the Court should make a broad evaluation instead of going into minute details. It was specifically held that where in the works contract, the party entrusting the work committed breach of contract, the contractor is entitled to claim the damages for loss of profit which he expected to earn by undertaking the works contract. Claim of expected profits is legally admissible on proof of the breach of contract by the erring party.

12. The question which frequently arises for consideration before the arbitrators is balancing the rights of the parties where one pleads loss of profit on account of curtailment of the scope of works after awarding the tender and the other takes a defence stating that the contract allows them to modify and amend the scope of work up to a certain extent while relying on the variation/deviation clause. The intent behind the variation/deviation provisions is to meet the exigencies which arise on account of some peculiar situations at the project work site and definitely not to cover up the mismanagement or lack of planning/decision-making on the part of the governmental agencies.

13. These clauses are being misused as a defence to contest claims for loss of profit and conceal the mismanagement on the part of the government agency, which is not considered by Arbitral Tribunals. The Arbitral Tribunals ought to consider the intent behind the provisions rather than mechanically applying them in the manner as is being contended by the government agency.

Extension of time and recovery clauses

14. The third area of friction which really comes up in infrastructural arbitrations is the fact of extension of time, which later becomes the basis for imposing a penalty on the contractors as well as making deductions from the sums due to the contractors as being liquidated damages.

15. The importance of the extension of time provisions in infrastructure contracts is based on the termination of contract (particularly, by efflux of time). Since, infrastructure projects contain a stipulated period for completion of the works, failing which penalty is imposed on the contractor by the State instrumentality. However, there are certain exceptions to extending the time without imposition of any penalty which stem from there being circumstances beyond the control of the parties due to which the project work could not be executed e.g. the nationwide lockdown. The same applies vice versa as well i.e. in the event, time for completion of the works is extended without imposition of any penalty, it is presumed that there was no breach of contract or non-performance on the part of the contractor. The High Court of Delhi in N. Kharbanda & Son v. Delhi Development Authority[8] has observed as under:

9….However, it is not in dispute that the time period of the contract was extended by the respondent without any penalties on the petitioner and such an occasion would only arise if the fault was not attributable to the petitioner…

16. However, one contentious issue which often arise for consideration is what is the consequence of non-extension of the time period for completion of the project? Ordinarily, the contract would be deemed to have been terminated by efflux of time, but if the parties continue to perform their obligations without any extension, the same should tantamount to it becoming a concluded contract in terms of Section 8 of the Contract Act, 1872.

17. What is even more intriguing in these matters is that the governmental agency in these contracts has conferred upon itself the power to impose penalty upon the contractor. Most government contracts confer upon a senior officer of its agency the power to determine whether the contractor is guilty of breach of contract and the power to impose penalty after determination of guilt. Even though, this issue has come before the Courts several times over, the Courts have not considered the factum that ultimately the official making the so-called analysis of guilt or innocence is an employee on the rolls of that very agency which would later become a party to that lis. In my opinion, the same falls foul of fundamental principles of natural justice, particularly, nemo judex in sua causa (no person shall be a Judge in his/her own cause). The Courts intervene to a limited extent by checking whether the contractor was given an opportunity to present its case before the appointed official.

18. Further, the same bears similarity to the provision contained in Article 371-D(5) of the Constitution, which was struck down by a Constitution Bench of the Supreme Court in Sambamurthy v. State of Andhra Pradesh [9] as being violative of the rule of law which is a part of the basic structure of the Constitution. It can be said that the powers conferred upon the official of the government agency to impose penalty should also be ultra vires as the agency itself, as a party to the lis, is then deciding the extent of breach by the other side and is empowered to effect a recovery without any adjudication whatsoever. Ordinarily, the agency ought to initiate a claim/counter-claim before the Arbitral Tribunal or the Court to decide the breach of contract and damages, rather than equipping its own self to pass a decision in a matter where it has economic interest. The said position of law was reiterated by the Supreme Court in Gangotri Enterprises Ltd. v. Union of India[10] where it was held that until the demand of the Government was crystallised or adjudicated upon, the Government cannot withhold the money of the contractor. However, in a recent decision in State of Gujarat   v. Amber Builders[11], the decision in Gangotri Enterprises has been declared per incuriam, but it has been reiterated that any recovery effected by the Government is subject to further adjudication by the Arbitral Tribunal, which would independently decide the merits of imposition of the financial penalty.

19. In ordinary commercial transactions, it has become trite law that one-sided or arbitrary provisions in agreements are struck down if they favour one-party or constitute an unfair trade practice, but it seems that perhaps because the Government is deemed to act in a reasonable and rational manner, that contracts entered into by governmental agencies do not bear similar scrutiny.

Dispute resolution clauses

20. Most contracts now contain a dispute resolution clause, whereby the parties are bound to refer any disputes arising out of the agreements, to arbitration. The primary reason for introduction of such clauses was the delay which comes about in the regular adjudicatory process before the Courts in India.

21. Government contracts in particular, contain a dispute resolution clause, which is not only limited to arbitration, but prescribes several pre-requisite measures to be adopted before a request for appointment of an arbitrator can be made before the appointing authority i.e. persona designata, who again is an official of the governmental agency itself. Most Government contracts provide for a proceeding before some senior officials akin to mediation of the disputes, and more often than not, such mediation fails simply because the presiding officer is an official of the government agency itself.

22. The Courts also refuse to entertain petitions for appointment of arbitrators in the event the party approaches the Court, primarily on the ground that the ‘mandatory pre-requisite’ conditions imposed by the Dispute Resolution Clause have not been complied with. This leaves aside all scope for claiming urgent relief against governmental agencies in infrastructure contracts[12].

23. The Supreme Court in Perkins Eastman Architects DPC v. HSCC (India) Ltd.[13] has held that a person who has an interest in the outcome or decision of the disputes must not have the power to appoint a sole arbitrator. In my opinion, the persona designata, who is mostly a senior employee of the same government agency would have an interest, albeit indirect, in the outcome of the dispute. To my utter dismay, even the latest edition of the General Conditions of Contract as formulated by the Central Public Works Department does not reflect this changed position of law and continues to have its own official as the persona designata.

24. The second problem which arises while complying with the myriad pre-requisites in these long-drawn arbitration clauses is the concept of delay in appointment of arbitrators. In certain situations, the persona designata has delayed the appointment of arbitrators so that the formalities for imposition of penalty can be completed by the agency and the Tribunal does not stay the imposition of the penalty under Section 17 of the Arbitration and Conciliation Act, 1996[14]. In certain situations, the persona designata, calls for the list of claims proposed to be raised by the contractor, and chooses to refer only a few of them rather than all claims, by virtue of which he has effectively usurped the powers of the Arbitral Tribunal and decided the claim on his own.[15]

Conclusion

25. What constitutes a major hitch for the parties presently, is the narrow scope of intervention by Courts in the arbitral process as well as in the awards. Particularly, the recent judgment of the Supreme Court in SsangYong Engineering & Construction Company Ltd. v. National Highways Authority of India[16] which has crystallised and narrowed down the scope of interference under Section 34 in light of the amendments made to the Act in 2015.

26. In view of all of the foregoing, though it can be said that the Courts have exercised their judicial powers to balance the equities between the parties, much is left to be desired in the judicial scrutiny of governmental contracts. Even though, the Government is obligated to act in a fair, non-arbitrary and reasonable manner even while acting in a private law capacity, the same remains to be mere sermons and directives in the law reports. Government contracts should not be protected from judicial scrutiny, particularly, when the Constituent Assembly chose to not grant any special protection or status to the contracts entered into by the Government under the Constitution. Moreover, now that the Supreme Court has propounded the doctrine of arbitrariness to test the validity of legislations[17], it is the appropriate time to apply the same to private law and test the validity of contractual provisions.

27. Therefore, it is optimal time that the judicial scrutiny of governmental contracts is done at par with private commercial contracts and the conduct of the Government is analysed objectively to determine the breach of contract and consequential damages.


*Advocate

[1] (1994) 3 SCC 521

[2] 2009 SCC OnLine Del 4108

[3] Republic Construction Co. v. Delhi Development Authority, 2009 SCC OnLine Del 1902

[4]Available at https://cpwd.gov.in/Publication/GCC_Constructions_works_2020.pdf, last accessed on 15.06.2020

[5] (1984) 4 SCC 59

[6] (1999) 3 SCC 500

[7] (1984) 4 SCC 59

[8] 2006 SCC OnLine Del 1871

[9] (1987) 1 SCC 362

[10] (2016) 11 SCC 720

[11] (2020) 2 SCC 540

[12] Although in exceptional situations, the Courts have intervened, in writ petitions where patent illegality can be seen on the face of the record

[13] 2019 SCC Online SC 1517

[14] The  Supreme Court in the celebrated judgment of J. G. Engineers v. Union of India(2011) 5 SCC 758, has clearly stated that decision of the Superintending Engineer imposing penalty on the contractors is not adjudication

[15] Earnest Builders (P) Ltd. v. Union of India, 2007 SCC OnLine Del 678; Rajeev Traders v.  South Central Railway, 2002 SCC OnLine AP 628

[16] (2019) 15 SCC 131

[17] Shayara Bano v. Union of India, (2017) 9 SCC 1

One comment

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    Great Work. Keep it up. Long way to go. Rightly said that all the Government Contracts are One Sided and even Courts also do not interfere very much.

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