Subject to certain obvious exceptions, every person has the right to use, invest and dispose of his or her personal wealth per his or her own will and intellect.
The majority of commercial legal disputes directly or indirectly involve the recovery of money from one party by another. A transaction culminating in arbitral proceedings often creates questions regarding the scope and power of an arbitral tribunal to grant appropriate relief to the successful party. One question that has vexed Indian courts relates to the power of arbitral tribunals to award compound interest to a successful party.
A successful claim for money assumes that the person against which such claim is enforced wrongfully withheld the money so recovered. Wrongful retention of money consequently deprives a successful claimant of the opportunity to use its money in the manner in which it wishes.
The following types of award may be issued in such proceedings:
- an award for the principal sum;
- an award for interest; or
- an award for both the principal sum and interest.
The question that arises when these awards are made is whether further interest can be imposed on the awarded sum. In other words, can interest be awarded on interest?
In M/s Hyder Consulting (UK) Ltd v Governor, State of Orissa Through Chief Engineer,(1) the Supreme Court had to decide whether an arbitral tribunal had the power to award compound interest under Section 31 of the Arbitration and Conciliation Act 1996.
A smaller bench of two Supreme Court judges asked the larger bench in Hyder to adjudicate on "the decision of this Court in State of Haryana v. S.L. Arora and Company, (2010) 3 SCC 690, wherein it is held that an award of interest on interest from the date of award is not permissible under sub-section (7) of section 31 of the Arbitration and Conciliation Act, 1996."
In State of Haryana v SL Arora(2) the Supreme Court had to decide the following two issues:
- Whether Section 31(7) of the Act authorises and enables Arbitral Tribunals to award interest on interest from the date of award?
- Whether the arbitral award granted future interest from the date of award, only on the principal amount found due to the respondent (that is, Rs 14,94,000) or on the aggregate of the principal and interest up to the date of award (Rs 31,98,879)?"
In Arora the court relied on Section 3 of the Interest Act 1978(3) to hold that nothing in Section 3 permits an arbitral tribunal to award compound interest. However, while relying on Renusagar Power Co Ltd v General Electric Co,(4) the court observed that awarding compound interest might not be against Indian public policy per se. The court caveated this by stating that compound interest can be awarded only where:
- the contract between parties provides as such; or
- the statue expressly provides for an award of compound interest.(5)
The petitioner relied on the following judgments to contend that an arbitral tribunal has the power to award compound interest:
- Oil & Natural Gas Commission v MC Clelland Engineers SA (1999) 4 SCC 327;
- McDermott International Inc v Burn Standard Co Ltd (2006) 11 SCC 181;
- UP Coo Federation Ltd v Three Circles (2009) 10 SCC 374; and
- Central Bank of India v Ravindra (2002) 1 SCC 367.
After analysing the above cases, the court concluded that McDermott did not consider – much less conclusively decide on – the power of an arbitral tribunal to award compound interest, and thus held that the court's reliance on McDermott in Three Circles was per incuriam (ie, a judgment that was made without reference to a relevant statutory provision or earlier judgment), due to an inadvertent erroneous assumption that McDermott was an authority on the subject:
"Thus it is clear that Section 31(7) merely authorises the Arbitral Tribunal to award interest in accordance with the contract and in the absence of any prohibition in the contract and in the absence of specific provision relating to interest in the contract, to award simple interest at such rates as it deems fit from the date on which the cause of action arose till the date of payment. It also provides that if the award is silent about interest from the date of award till the date of payment, the person in whose favour the award is made will be entitled to interest at 18% per annum on the principal amount awarded, from the date of award till the date of payment. The calculation that was made in the execution petition as originally filed was correct and the modification by the respondent increasing the amount due under the award was contrary to the award."(6)
The appellant in Hyder challenged Arora on the following grounds:
- Sums awarded under Section 31(7)(a) of the 1996 act are composite of both the principal and interest amounts.
- Sums awarded under Section 31(7)(b) of the 1996 act are inclusive pending litigation.
- Awards for interest only automatically attract 18% interest.
- Interest awarded under Section 31(7)(b) of the 1996 act is on an aggregate amount, due to the merger of principal and interest amounts.
- The absence of the phrase 'principal amount' (in contrast to Section 34 of the Code of Civil Procedure 1908) before the word 'sum' in Section 31(7)(a)(b) of the 1996 act indicates that the word 'sum' should be the aggregate of the principal amount and interest.
After considering the arguments, the Supreme Court, in a two-to-one majority vote, held that Arora was wrongly decided. Justice SA Bobde and Justice Abhay Manohar Sapre delivered the majority view and Chief Justice HL Dattu's judgment formed the minority view.
The majority held that within the 1996 act, the term 'sum' means a particular amount of money. Since Section 31(7) of the 1996 act adds no additional qualification (eg, 'principal') to the word 'sum', this particular amount of money includes interest from the date of the cause of action to the date of the award.
Further, by definition, the term 'sum' simply means an amount of money, whatever this may include (eg, principal, interest or both). Thus, according to Section 31(7)(b) of the 1996 act – where it provides that the sum to be paid by an arbitral award "shall carry interest" from the date of the award to the date of the payment (ie, the relevant sum post-award) – the term 'sum' must be read to mean the aggregate of the principal and interest amounts.
The majority decision went on to state that Section 31(7)(b) of the 1996 act mandates that the awarded sum, whether inclusive or exclusive of interest, carry interest at the rate of 18% per year for the post-award period, unless otherwise ordered.
When Section 31 of the 1996 act is contrasted with Section 34(6) of the Civil Procedure Code – wherein courts can award compound interest – the word 'sum' has deliberately not been qualified by using the word 'principal' before it; therefore, 'sum' refers to the aggregate of the amounts that the arbitral tribunal directs to be paid, not merely the principal sum without interest.
According to the majority's view, no distinction exists between a sum with interest and a sum without interest. Once interest is included in an awarded sum, the original sum and the interest cannot be segregated or seen as independent of one another. The interest component loses its character as interest and simply becomes the sum for which the award was made.
Further, the majority held that in terms of post-award interest, Section 31(7)(b) of the 1996 act uses the phrasing "a sum directed to be paid by an arbitral award". Sub-clause b uses the words 'arbitral award', not arbitral tribunal. The arbitral award is made in respect of a sum that includes interest. Therefore, under Section 31(7)(b) of the 1996 act, only the sum is "directed to be paid by an arbitral award", not any other amount, including interest. In such a situation, what is being granted under Section 31(7)(b) is not compound interest; instead, interest is granted on the sum directed to be paid by an arbitral award, wherein the sum is nothing more than what is arrived at under Sub-clause a.
The minority view held that the word 'sum', as per its most common usage, means 'money'. In Section 31(7) of the 1996 act, the term 'money' is used interchangeably with the word 'sum'.
The minority held that the sum for which the arbitral award was made could thus be read as allowing interest to be awarded on the money for which the arbitral award was made; therefore, the term 'money' refers to the money that is the result of adjudication by the arbitral tribunal, based on the claims of the parties, to be paid under the award. In other words, it refers to the principal amount so awarded and not interest, which is merely a consequence – not a result – of adjudication.
According to the minority view, interest is imposed in order to compensate for a party's refusal to pay money that rightfully belongs to another party under the agreement governing the arbitration proceedings; therefore, the term 'interest' is distinct from the principal amount on which it is imposed.
Under Section 31(7)(a)(b) of the 1996 act, the word 'sum' is used in the context of what is to be paid per the arbitral award.
In the minority's opinion, in order for interest to be merged with the principal amount, it must be within the physical and actual possession of the party so entitled to it; only then can interest be said to have merged with the principal amount.
Both Oil & Natural Gas Commission and Three Circles pertain to awards given under the Arbitration Act 1940. As the 1940 act contains no specific provision regarding an arbitrator's power to grant interest, these cases do not apply to arbitration held under the 1996 act.(7)
Further, the minority view held that Central Bank of India dealt with Section 34 of the Civil Procedure Code; therefore, it did not wholly apply to cases under the 1996 act. Even if the principle in Central Bank of India was applicable to the 1996 act, it would support only the view endorsed in Arora.
Thus, the minority found that the Law Commission(8) should not have relied on Oil & Natural Gas Commission and Three Circles to conclude that Arora was wrongly decided. Since both cases involved an interpretation of the 1940 act, they could not be relied on while interpreting the 1996 act.
The court was right to negate Hyder while ruling in Arora that once an arbitral tribunal reaches a decision with regard to the liability of the payee under an arbitral award, any delay in satisfying that arbitral award must also attract interest. Further, interest awarded from the cause of action until the date of award is considered, from a commercial standpoint, as the natural compensation for the beneficiary of the award on its principal amount so blocked by the payee. The court rightly held that the natural compensation (ie, the interest merged with the principal amount) is what should be due to the successful party.
The minority view reasoned that interest was a separate sum – one that did not merge with the principal sum and thus retained a separate identity. The minority supported its view by holding that interest is awarded for wrongful retention of a principal sum and not on the interest accrued on such principal sum; therefore, granting compound interest is not permissible. However, the majority view used a literal interpretation to conclude that interest merges with a principal sum and that such compounded sum is due and, in aggregate, can attract further interest.
From now on, all monetary awards that carry interest apart from the principal sum will attract 18% interest unless otherwise awarded by the tribunal. To encourage a decision in its favour, a judgment debtor may argue that the interest awarded by the tribunal, both pre-award and post-award, only partially covers the difference and that it would have made more money had it invested the awarded sum.
As far as domestic and international arbitrations seated in India are concerned, successful parties may claim pending litigation and post-award interest.
This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.