INTRODUCTION:

This case arose out of a challenge to an arbitral award rendered with regard to a dispute relating to supply of equipment for offshore oil exploration by the respondent. The case was heard by M.B Shah and Arun Kumar JJ. The judgment was written by Shah J.

Facts

Oil and Natural Gas Commission had placed an order on Saw Pipes for supply of equipment for offshore exploration, to be procured from approved European manufacturers. The delivery was delayed due to general strike of steel mill workers in Europe. Timely delivery was the essence of the contract. ONGC granted extension of time, but it invoked the clause for recovery of Liquidated Damages by withholding the amount from the payment to the supplier. ONGC deducted from the payment $3,04,970.20 and Rs 15,75,557 towards customs duty, sales tax and freight charges. Saw pipes disputed the deduction and matter was referred to arbitration. While the arbitral tribunal rejected Saw Pipe’s defense of force majure, it required ONGC to lead evidence to establish the loss suffered by breach and proceed to hold, in absence of evidence of financial losses, that the deduction of Liquidated damages was wrongful. The award was challenged by ONGC; inter alia as being opposed to public policy ONGC’s case was that the arbitral tribunal failed to decide the dispute by not applying the prevailing substantive law, ignoring the terms of the contract and customary practices of usage of trade in such transactions. ONGC challenged the award as being patently illegal. The single judge and division bench of Bombay High Court dismissed the challenge. The Supreme Court set aside an arbitration award directing ONGC to refund $3,04, 970.20 and Rs 15.76 Lakhs towards liquidated damages retained by it while making payment to the company.

Issues raised

1. Whether ONGC had the right to Liquidated Damages.

2. Whether Patent illegality could be used as a ground to assail the award under section 34.

Judgment

The Hon’ble Court first extensively discussed the court’s jurisdiction to set aside an award under Section 34 of the Arbitration and Conciliation Act 1996 and the various grounds on which interference was permissible. Passing over to the question of damages, the Hon’ble Court opined that when the words of the contracts are clear, there is nothing that the court can do about it. If the parties had agreed upon a sum as being pre- estimated genuine liquidated damages there was no reason for the tribunal to ask the purchaser to prove his loss.

It further opined that when the court concludes that stipulation for damages is by way of penalty, it can grant reasonable compensation upon proof of damage. However, where an agreement has been executed by experts in the field, the court should be slow to construe a clause providing for liquidated damages as penalty. At paragraph 49, citing Maula Bux v Union of India¹ (the court concludes that this is especially true where the court is unable o assess compensation or such assessment is fraught with difficulties. In such cases the burden of proof would be on party who contends that the stipulation amount is not reasonable. There was no such contention raised in the instant case.

As regards forfeiture, after considering its decision in Union of India v Rampur Distillery² the court states the forfeiture clause can be construed either as liquidated damages or as a penalty, depending on the reasonableness of the amount to be forfeited. Therefore, as regards Liquidated Damages and penalties, the primary conclusion of the court appears to be that Liquidated Damages should be regarded as reasonable compensation, while penalties should not. Further, it also appears to have concluded in case of penalty damages will have to be proved. The Hon’ble court reaffirms that no compensation at all be awarded if the court concludes that no loss is likely to occur because of the breach.

Critical appraisal

The 2 errors of great magnitude in this case were:-

While reviewing the merits of the ONGC case the court failed to consider the labour strike in entire European continent, something which was neither under the control nor could be predicted by Saw Pipes. This particular aspect has been overlooked by the court.

The decision of the two judges Bench in ONGC has bypassed the ruling of the three judges Bench of Supreme Court in the Renusagar Power Plant Ltd v Gen Electric Co.³ case. That shows both judicial indiscipline and violation of the binding precedent of a larger Bench. While the Bench in Renusagar case held that the term ‘public policy of India’ was to be interpreted in a narrow sense, the Division Bench went ahead unmindful of the prior precedent and expanded the same to such an extent that arbitral awards could now be reviewed on their merits. This is a huge step backwards in laws relating to alternate dispute resolution in the era of globalization.

Mr Fali. S. Nariman, one of the greatest lawyers of our generation, remarks on the judgments as having ‘virtually set at naught the entire Arbitration and Conciliation Act of 1996. To have introduced by judicial innovation – a fresh ground of challenge and placed it under the head of public policy was first contrary to the established doctrine of precedent. The division of 3 judge bench binding on a bench of 2 judges. It was also contrary to the plain intent of the 1996 the new need of finality in alternative method of dispute resolution without court interference. If courts continue to hold that they have the last word on facts and on law not facts and on law not withstanding consensual agreements to refer matters necessarily involving facts and law to adjudication by arbitration the 1996 Act might as well be scrapped if courts continue to hold that the last words on facts and on law not withstanding consensual agreements to refer matters necessarily involving facts and law to adjudication by arbitration the 1996 Act might as well be scrapped. The division bench of 2 judges of the court has altered the entire road map of arbitration law and put the clock back to where we started under the old 1940 Act.”

CONCLUSION:

The use of words penalty or Liquidated Damages does not necessary mean that a clause is either a penalty or a Liquidated Damages clause. The court will review the clause in light of the circumstances at the time of entering into contract. However, even in English law a liquidated damages clause will result in plaintiff recovering stipulated sum without being requested to prove damages and irrespective of any actual damage, even when actual damage is demonstrably smaller than the stipulated sum. It is stated in the Chitty that the purpose of fixing a sum is to facilitate recovery of damage without difficulty and expense of proving actual damage or to avoid the risk under compensation where the rules on remoteness of damage might not cover consequential, indirect or idiosyncratic loss or to give the promise an assurance that he may safely rely on the fulfillment of the promise. A distinction is drawn between contracts which accelerate an existing liability to pay and those which create or increase a liability to pay. The latter are penal, the former are not. In this context it’s also relevant to consider contracts which provide for forfeiture of amounts already paid. If the sum paid is penal and is unconscionable for the payee to retain the money, equitable relief may be available. However, the genuine pre-establishment of damages test does not apply in these cases. Nonetheless courts will take in to account whether the sum to be forfeited is much greater than the damage caused by the breach.

BIBLIOGRAPHY:

1. AIR 1970, SC 1955

2. AIR 1973, SC 1098

3. AIR 1994 SC 860

Received on 04.02.2014 Modified on 11.03.2014

Int. J. Ad. Social Sciences 2(1): Jan. –Mar., 2014; Page 18-19