Unravelling the Conundrum Behind the Interpretation of Interest Clauses vis-à-vis the Arbitrator’s Power to Award Interest

Introduction

In the realm of commercial arbitration, the question surrounding interest often becomes an area of conflict. Can a party pay the principal amount without paying any interest on the period of deprivation, simply by invoking the “no interest” clause? The answer is wholly contingent upon the wording of the interest clause.

The draftsman of the contract firmly believes that the wording “no interest” would save the parties from any interest payable in case of any outstanding liability. The actual position may not be the same, since the courts have duly exercised their powers to award interest in some form or the other, despite a no interest clause. Similarly, even Section 31(7)¹ of the Arbitration and Conciliation Act, 1996 (1996 Act) empowers the arbitrators to award interest, but subject to the terms of the agreement between the parties. However, there are possible aspects where an arbitrator can award interest despite the contract prohibiting the same.

The article focuses on the recent judgments that help understand how the interpretation of interest clauses has evolved over time.

Types of interest

Interest is divided into three different stages, which need to be understood:

(1) Pre-reference interest: From the date the cause of action arose until the commencement of arbitral proceedings.

(2) Pendente lite interest: From the date of the commencement of arbitral proceedings till the date of the award.

(3) Post-award interest: From the date of the award till recovery/realisation.

Evolution of arbitrator’s powers under arbitration law

Pre-reference and pendente lite interest

The Arbitration Act of 1940 (1940 Act)² was silent on an arbitrator’s power to grant any kind of interest. When it comes to pre-reference or pendente lite interest, prior to the introduction of the 1996 Act³, the 1940 Act⁴, as stated, did not contain any express provision that governed an Arbitral Tribunal’s power to award pre-reference or pendente lite interest. However, the Supreme Court intervened and, in Irrigation Deptt., Govt. of Orissa v. ⁵, held that arbitrators have the power to award pendente lite interest unless expressly barred by the contract between the parties.

With the promulgation of the 1996 Act, Section 31(7)(a)⁶ was introduced, giving arbitrators the inherent power to award pre-reference and pendente lite interest, provided it has not been agreed otherwise by the parties.

Before the introduction of Section 31(7)(a)⁷, the Supreme Court in G.C. Roy case⁸ granted arbitrators the authority to award pendente lite interest. However, this was contingent upon the presence of an express bar. The Court emphasised the need for a clear and specific prohibition on interest; a general statement, such as “no interest is payable at any time”, was deemed insufficient. Meaning thereby, in case of any prohibition, parties had to be explicit about any particular restriction on the payment of interest, and an all-encompassing bar was not sufficient.

Whereas, with the introduction of Section 31(7)(a)⁹ and evolving judicial position, an all-encompassing bar was considered enough to curtail an arbitrator’s power to grant interest, thereby giving precedence to one of the integral pillars of arbitration — party autonomy.

Post-award interest

In case of post-award interest, the 1940 Act¹⁰ only gave such power to a court executing the award to grant post-award interest under Section 29¹¹ of the 1940 Act.

Subsequently, the Interest Act of 1978¹² was enacted, which now forms the cardinal legislation that governs the awarding of interest by courts or tribunals and helped shape the current position surrounding an arbitrator’s power to grant interest under the 1996 Act¹³.

Under Section 31(7)(b)¹⁴ of the 1996 Act, interest at the rate of two per cent higher than the current rate of interest prevalent on the date of the award, from the date of the award till the date of realisation, must be paid unless otherwise stated in the award.

The phrase “current rate of interest” originates from Section 2(b)¹⁵ of the Interest Act, 1978, which refers to the highest rate of interest on deposits offered by different scheduled banks in accordance with the directions of Reserve Bank of India under the Banking Regulation Act, 1949¹⁶.

This statutory interplay between the two Acts ensures that a standardised benchmark is applied by the arbitrators while awarding post-award interest in case the parties have not agreed otherwise.

Decoding the applicable interest — pivotal role of judicial pronouncement

The interpretation of interest-related clauses in contracts has been scrutinised significantly by the judiciary.

In Ferro Concrete Construction (India) (P) Ltd. v. State of Rajasthan¹⁷, arbitrator proceeding commenced in 1991. Hence, the Arbitration Act of 1940¹⁸ was applicable. Considering the 1940 Act, a more stringent approach was taken regarding an arbitrator’s power to award interest, which is limited only when there is a clear and express prohibition on the type of interest and nature of payment involved. Considering this, despite a clause prohibiting interest on “any payment, arrears, or balance that may be found due to him at any time”, the Court held that the same does not explicitly bar pendente lite interest. Accordingly, it was considered that the arbitrator has the authority to grant such interest.

The above legal standing shifted with the introduction of Section 31(7)¹⁹ of the 1996 Act. In Union of India v. Manraj Enterprises ²⁰, the relevant clause in the contract provided that “no interest would be payable on earnest money, security deposit or amounts payable under the contract”. The arbitrator, negating this clause, awarded pendente lite interest and post-award interest. Setting aside the award, the Supreme Court held that the arbitrator had exceeded their jurisdiction and the phrase “amounts payable under the contract” is wide enough to cover all types of sums due, including damages; therefore, there exists a contractual bar that cannot be overlooked.

Considering the above positions, an all-encompassing contractual bar like the above leaves no room for arbitral discretion under the 1996 Act²¹ to award interest, which was not the position under the 1940 Act²².

In ONGC Ltd. v. G&T Beckfield Drilling Services (P) Ltd.²³, the relevant clause in the contract merely provided that “no interest shall be payable on delayed payments”. The Supreme Court held that on plain reading of the clause, the phraseology of the clause indicates that the bar on interest payable is limited only to delayed payments and cannot be construed as a blanket prohibition against pendente lite interest.

In ONGC case²⁴, relying on Union of India v. Ambica Construction²⁵, the Court stated that the bar to award of interest on delayed payments cannot be construed as a bar to award pendente lite interest by the Arbitral Tribunal. Therefore, the arbitrator’s power to grant interest would entirely depend on clause to clause and whether or not such a clause, without any shadow of doubt, explicitly takes away the power of an arbitrator to grant pendente lite interest.

Together, these decisions highlight a balanced judicial approach where contracts are given utmost importance, but at the same time, courts will not stretch the meaning and intent of a particular clause to extinguish arbitral discretion unless such a bar leaves no scope for ambiguity.

The Delhi High Court in Modi Construction Co. v. Ircon International Ltd.²⁶, took a similar judicial approach wherein the dispute revolved around the awarding of compound interest by way of a clause which mentioned that compound interest is to be awarded. However, the said clause did not specify the rate of interest. In this case, the majority of the arbitrators awarded simple interest and declared the interest clause in the agreement void due to ambiguity in the wording of the clause; however, one other arbitrator dissented and awarded compound interest.

In the aforesaid case²⁷, the Court upheld the awarding of simple interest, stating that the absence of the specified rate and the uncertainty surrounding the clause rendered it unenforceable. Therefore, the arbitrators’ view was considered to be reasonable. This judgment²⁸ cements the principle that when an interest clause is left ambiguous or incomplete, an arbitrator has the discretion to interpret such a clause, and the same cannot be interfered with by the courts.

The Indian courts have further taken one step forward in holding that an arbitrator can award compound interest i.e. interest upon interest, in cases unless agreed otherwise by the parties. In a landmark judgment, Hyder Consulting (UK) Ltd. v. State of Orissa²⁹, the Supreme Court has held that the interpretation of “award amount” under Section 31(7)(a)³⁰ of the 1996 Act, regardless of whether or not it includes pre-reference or pendente lite interest, constitutes “sum”. Under Section 31(7)(b)³¹ of the 1996 Act, the arbitrator has the power to grant interest on this “sum” unless the award states contrary.

Therefore, in case of absence of a clear, holistic bar, the Arbitral Tribunal not only has the power to grant pre-reference or pendente lite interest on the principal amount forming the “sum” under the 1996 Act³², but can also grant interest on this sum amounting to compound interest payable post-award.

Conclusion

The catena of judgments clarifies the legal position in terms of various interest clauses and their interpretation, but it all boils down to the same issue, which often might seem like an airtight and irrefutable clause in reality might be leaving room for arbitral discretion.

Businesses mostly function on standardised worded clauses when it comes to drafting contracts, but these judgments serve as a reminder that ambiguity often works against the draftsmen, which takes us back to the foundation of contract drafting — phraseology of an agreement and the importance of surgical precision in wording of a clause.

The position under the 1940 Act³³ provided that until an express bar particularly limiting the scope of interest awarding is specified, there cannot be a blanket ban. However, under the 1996 Act³⁴, even a general holistic contractual bar on any interest payable under the contract will be construed as a bar without the contention of ambiguity being raised.

Basis the current position under the 1996 Act³⁵, in case no interest is to be awarded, an all-encompassing contractual bar is sufficient to deter the powers of the arbitration to award interest. However, if the intent is otherwise, a well-drafted interest clause must be adopted, which defines the scope, rate and period of interest. Most importantly, it must categorically specify if such an interest is payable on delayed payments or damages and whether the interest applies pre-reference, pendente lite or post-award. Any ambiguity only leaves room for arbitral discretion. In arbitration, where delay and deprivation of money are inevitable, an explicit interest clause can make all the difference between a fair award and protracted litigation.