Grant of Escalation Charges by Arbitrator: Navigating Beyond the Realms of Contract

“Arbitrators and Arbitral Tribunals are creatures not of statute but of contract[1].”

Universally arbitration is recognised as one of the most noteworthy alternative dispute resolution processes. Arbitration provides a much-needed respite to ailing litigants to seek redressal of their grievances by an autonomous process, with limited or no judicial intervention. In fact, the perquisites of arbitral proceedings are too profuse to be chronicled in a few words. The Supreme Court in Govt. of Orissa v. G.C. Roy[2], while distinguishing the process of determination of disputes through judicial means, in contrast with, arbitration proceedings, observed, “…resolution of dispute by court, through judicial process is costly and time consuming … alternative method of settlement of dispute through arbitration is a speedy and convenient process….” Similarly, in Shailesh Dhairyawan v. Mohan Balkrishna Lulla[3], the Supreme Court acknowledged that the parties choose arbitration as a dispute resolution mechanism, “keeping in view that it offers a timely, private, less formal and cost-effective approach for the binding determination of disputes. It provides the parties with greater control of the process than a court hearing.” Consequently, endorsing the numerous benefits which may ensue from an arbitration proceeding, it is quite understandable that the Indian Courts[4] have repeated avowed that the said process needs to be encouraged, considering the, “high pendency of cases in the courts and cost of litigation.”

 Customarily, the genesis of arbitration proceedings lies under a contract or an “arbitration agreement[5]” wherein the parties agree to submit to arbitration, “all or certain disputes which have arisen or which may arise between them in respect of a defined legal relationship, whether contractual or not.” As per Section 7(4) of the Arbitration and Conciliation Act, 1996 (Arbitration Act) such an agreement, in turn, may be in a form of a document signed by the parties or an exchange of letters, telex, telegrams or other means of telecommunication, including communication through electronic means, which provide a record of the agreement or an exchange of statements of claim and defence in which the existence of the agreement is alleged by one party and not denied by the other. In fact, it is trite law[6] that there is no prescribed format/form of an arbitration agreement and the only prerequisite is the ascertainment of the fact, “whether the parties have agreed that if disputes arise between them in respect of the subject-matter of contract such dispute shall be referred to arbitration, then such an arrangement would spell out an arbitration agreement.” Regardless of the manner and form in which an arbitration agreement may be constructed, it is, however, an established fact that where the parties willingly submit to arbitration as a mode of their dispute resolution, the scope of such proceedings and the confines of arbitrator’s jurisdiction get contractually defined. As a corollary, an arbitrator is expected to exercise his power and authority within the terms and confines of contract, as executed between the parties to a dispute, and cannot, under a guise of doing justice[7], “award contrary to the terms [thereof]”. It is, in fact, a settled law[8] that an arbitrator cannot act arbitrarily, irrationally, capriciously or independent of the contract and in a case where an arbitrator transgresses beyond contractual limitations, “he would be acting without jurisdiction, whereas if he has remained inside the parameters of the contract, his award cannot be questioned on the ground that it contains an error apparent on the face of the record.” As per the Supreme Court[9], jurisdiction of the arbitrator is confined within the four corners of an arbitration agreement for, “he can only pass such an order which may be the subject-matter of reference”.

 Irrespective of the contractual limitation on arbitral proceeding, it is not quite uncommon that during such proceeding, parties may elevate certain claims which may fall outside the purview of their contract(s). One of such commonly invoked claims pertains to the escalation cost or escalation charge, being the monetary claim arising pursuant to inflation, as a result of time gap in the performance of any contract. Generally, the parties to an agreement make specific provisions pertaining to the grant or refusal of escalation cost(s)/charge(s) under their agreement. However, difficulty arises in a case where no such stipulation is envisaged or foreseen by contracting parties. Nonetheless, even in these states of imbroglio, courts have not abrogated their responsibility of extricating the layers of incertitude and providing a needed lucidity on the subject.

Undoubtedly, there can be no occasion for ambiguity in cases where there is an explicit prohibition under a contract regarding the claims pertaining to escalation cost. In fact, in this regard, the Supreme Court in New India Civil Erectors (P) Ltd. v. Oil & Natural Gas Corpn.[10] has firmly voiced its disapproval regarding the grant of any amount against price escalation, despite an explicit contractual embargo towards the agitation of such claims. Similarly, the Supreme Court in Continental Construction Co. Ltd. v. State of M.P.[11], struck down the award of an arbitrator for extra claim resulting due to price escalation by, inter alia, observing, “there are specific clauses referred to hereinbefore which barred consideration of extra claims in the event of price escalation”. At the same time, the Supreme Court in State of Orissa v. Sudhakar Das[12], considering a scenario of absence of escalation cost clause under a contract, inter alia, observed:

  1. It is not disputed that the arbitration agreement contained no escalation clause. In the absence of any escalation clause, an arbitrator cannot assume any jurisdiction to award any amount towards escalation. That part of the award which grants escalation charges is clearly not sustainable and suffers from a patent error. The decree, insofar as the award of escalation charges is concerned, cannot, therefore, be sustained.

Clearly, these precedents and the observations made therein are harmonious with the general principle of arbitration that the powers of an arbitrator are bounded within the contractual realms. Accordingly, in the event of an explicit prohibition under a contract pertaining to the grant of escalation charges, as a rule, or in the absence of any clause/term pertaining to such claims under an agreement, ordinarily, it would not be within the domain of an arbitrator to award any amount towards escalation.

However, it is to be noted that there have been several instances, wherein the courts, despite the absence of an explicit cause pertaining to the grant of escalation charge under an agreement, have favoured grant thereof, weighing the factors such as the; implicit and inherent meaning and interplay of various terms of/stipulations under the contract, lack of any prohibitive clause under contract to such conferment, facts and circumstances involved, equity, etc. In one such instance[13], the Supreme Court, while acknowledging that escalation is, “a normal incident arising out of gap of time in this inflationary age in performing any contract”, upheld an arbitral award which, inter alia, permitted/granted escalation cost despite the absence of an unequivocal provision/price escalation clause under arbitration agreement/ reference. Significantly, the reasons which governed the said conclusion of the Court, inter alia, were that since in the instant case, “[o]nce it was found that the arbitrator had jurisdiction to find that there was delay in execution of the contract due to the conduct of the respondent, the respondent was liable for the consequences of the delay, namely, increase in prices. Therefore, the arbitrator had jurisdiction to go into this question.” The said reasoning of the Court can be discerned in light of its earlier observation in Tarapore & Co. v. State of M.P.[14], inter alia, to the effect that even in the absence of any explicit contractual term, an arbitrator is within his power to exercise jurisdiction in cases where something follows as a necessary concomitant to what was agreed upon by parties under a contract. In fact, as per the Court,

“it cannot be held that the arbitrators had no jurisdiction to make the award because of lack of specific provision permitting the claim at hand. This does not conclude the matter. It has to be seen whether the term of the agreement permitted entertainment of the claim by necessary implication.”

Significantly, though, the Court dismissed the argument to the effect that whatever is not excluded specifically by the contract can be subject-matter of claim by a contractor on the ground that the same, “will mock at the terms agreed upon”, however, held, “Of course, if something flows as a necessary concomitant to what was agreed upon, courts can assume that too as a part of the contract between the parties.”

In another illustration, the Supreme Court in K.N. Sathyapalan v. State of Kerala[15], being specifically posed with the issue, “whether in the absence of any price escalation clause in the original agreement and a specific prohibition to the contrary in the supplemental agreement, the appellant could have made any claim on account of escalation of costs”, inter alia, observed:

  1. Ordinarily, the parties would be bound by the terms agreed upon in the contract, but in the event one of the parties to the contract is unable to fulfil its obligations under the contract which has a direct bearing on the work to be executed by the other party, the arbitrator is vested with the authority to compensate the second party for the extra costs incurred by him as a result of the failure of the first party to live up to its obligations. Significantly, these observations were, subsequently, reiterated and affirmed by the Court in Assam SEB Buildworth (P) Ltd.[16] Noticeably, a perusal of these dictates would demonstrate that the reasons for upholding the grant of escalation cost under the said circumstances appears to be premised on the principle of equity and the absence of any explicit embargo to the grant of escalation charges under a contract. Reasonably, under the circumstances where delay in performance of its obligations by one of the parties to a contract have a direct nexus on the deferment of contractual compliance by another, in the absence of an explicit prohibition, grant of escalation charges by an arbitrator may not only sensible, rather, equitable and fair.

In a related context the Supreme Court in Associated Construction v. Pawanhans Helicopters Ltd.[17], inter alia, dealt with the issue, “whether the contractual prohibitions regarding the grant of escalation cost can be extended beyond the duration of such an agreement”. Significantly, in the instant case, though, on one hand, there were specific clauses under the contract which explicitly prohibited claims pertaining to fluctuation in price and compensation for the subsequent increase in cost of material, etc., however, it was noted by the Court that the contracting parties had stipulated under their agreement that there, “could be a situation where the contractor had suffered loss for whatever reasons which was required to be reimbursed as per procedure prescribed in Clause 43. Clause 43(2) also specifically provided that Clause 43 was without prejudice to any other rights and remedies that the contractor might possess.” At the same time, while acknowledging that timely performance of contractual obligations was agreed to be the essence of the contract in this specific instance, the Court, opined, “even assuming for a moment that there could be no price escalation during the period of 4 months i.e., during the pendency of the contract, such embargo would not be carried beyond that period as time was of the essence of the contract.” Accordingly, the Court approved the grant of additional claims towards escalation cost/ charges, in favour of one of the participants to the said contract, against the work performed by it beyond the agreed term/duration, for the reasons of delay solely attributable to the conduct of the other party. Significantly, the said remarks are in stark contrast with the  Court’s observations in New India Civil Erectors (P) Ltd. case[18], inter alia, to the effect:

  1. …stipulation provides clearly that there shall be no escalation on any ground whatsoever and the said prohibition is effective till the completion of the work. The learned arbitrators, could not therefore have awarded any amount on the ground that the appellant must have incurred extra expense in carrying out the construction after the expiry of the original contract period … Merely because time was made the essence of the contract and the work was contemplated to be completed within 15 months, it does not follow that the aforesaid stipulation was confined to the original contract period.

Notably, though, the Supreme Court in Associated Construction case did not have an occasion to deal with its earlier decision in New India Civil Erectors (P) Ltd. case, however, there are certain explicit distinguishing features of these precedents. Firstly, in the former case, the delay in performance of contract by the claimant was attributable due to the defaults committed by the other contracting party, which was not the situation in latter. At the same time, though, in Associated Construction case, the claims for escalation cost beyond the period of contract were held to be justified on a general clause/term regarding reimbursement of losses under the contract involved, however, no such similar clause was cited/noted by the Court in New India Civil Erectors (P) Ltd. case. Nevertheless, it would be an appreciated stride, in case, the extraneous/illusive conflict between these dictates is resolved by a larger Bench of the Supreme Court.

Determinately, resolutions pertaining to the grant or refusal of escalation cost/charges, akin to other claims, inter alia, revolve on[19], “the construction of the contract in that case, the evidence placed before the arbitrator and other facts and circumstances of the case.” Undoubtedly, the grant of escalation cost in utter negation of an explicit contractual prohibition to the said effect, contradicts the fundamental and core principles of arbitration and the jurisdiction of an arbitrator. However, in contrast, failure of an arbitrator to exercise its authority to grant such costs/in appropriate cases/instances, where no contractual prohibitions exist, would certainly negate the principles of justice, equity and fairness. It is trite law[20] that that, though, an arbitrator is required to decide on issues within contractual terms, however, “if an arbitrator construes a term of the contract in a reasonable manner” that, cannot, by in itself become a reason for setting aside of an arbitral award. Consequently, while roving through the rugged terrains of arbitral proceedings, an arbitrator is required to not only adopt an approach of caution and circumspection, rather, must be equipped with a thorough knowledge of law and skills to appreciate the contractual terms in their exact spirit and intent, in order to establish an equilibrium between divergent assertions. Further, it is quite understandable that it is not enough that an arbitrator does not transgresses his contractually defined restraints, rather, must have astuteness to appreciate an agreement in its true form so as to not out rightly negate claims, which are necessarily concomitant to such agreements and at the same time imminent, valid, just and equitable.

Advocate, Supreme Court and High Court(s), e-mail:

[1] HMJ V. Ramasubramanian in 4G Identity Solutions (P) Ltd. v. Bloom Solutions (P) Ltd., 2018 SCC OnLine Hyd 22.

[2] (1992) 1 SCC 508.

[3] (2016) 3 SCC 619.

[4] Refer to State of J&K v. Dev Dutt Pandit, (1999) 7 SCC 339.

[5] Refer to S. 7(1) of the Arbitration and Conciliation Act, 1996.

[6] Refer to Rukmanibai Gupta v. Collector, (1980) 4 SCC 556.

[7] State of Rajasthan v. Nav Bharat Construction Co., (2006) 1 SCC 86.

[8] Refer to Bharat Coking Coal Ltd. v. Annapurna Construction, (2003) 8 SCC 154.

[9] Army Welfare Housing Organisation v. Sumangal Services (P) Ltd., (2004) 9 SCC 619.

[10] (1997) 11 SCC 75.

[11] (1988) 3 SCC 82.

[12] (2000) 3 SCC 27.

[13] P.M. Paul v. Union of India, 1989 Supp (1) SCC 368 [Refer also to Food Corporation of India v. A.M. Ahmed & Co., (2006) 13 SCC 779].

[14] (1994) 3 SCC 521.

[15] (2007) 13 SCC 43.

[16] (2017) 8 SCC 146.

[17] (2008) 16 SCC 128.

[18] (1997) 11 SCC 75.

[19] Refer to NTPC v. Deconar Services (P) Ltd., 2021 SCC OnLine SC 498

[20] Refer to Associate Builders v. DDA, (2015) 3 SCC 49.

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