Interest For Pre-Reference Period Under Section 31(7)(a) of Arbitration and Conciliation Act — Power or Right?

Recently, in Oriental Structural Engineers (P) Ltd. v. State of Kerala¹, the Supreme Court held that, unless otherwise agreed by the parties, the Arbitral Tribunal can award interest on the amount ordered to be paid, at reasonable rate from the date of cause of action till the date of award.

This article analyses Section 31(7)(a) of the Arbitration and Conciliation Act, 1996 (“the Act”) in respect of pre-reference period. The question is whether that section confers a power upon the Arbitral Tribunal to grant interest for the pre-reference period and that the power has to be exercised in accordance with the contract or the law or applicable trade usage; or whether the section itself is a source of right to claim interest for the pre-reference period and a party can claim interest based on this section irrespective of whether there is any right under the contract, or in law, or according to applicable trade usage, to claim such interest. There is a line of judgments which adopts the latter view, namely, the section itself is a source of right to claim interest for the pre-reference period and a party can claim interest based on this section irrespective of whether there is any right under the contract, or in law, or according to applicable trade usage, to claim such interest. This article opines that the correct view is the former view, namely, the section confers a power upon the Arbitral Tribunal to grant interest for the pre-reference period and that the power has to be exercised in accordance with the contract and/or the law and/or applicable trade usage.

SECTION 31(7)(a) OF ARBITRATION AND CONCILIATION ACT, 1996

The relevant part of the section reads:

31. (7)(a) Unless otherwise agreed by the parties, where and insofar as an arbitral award is for the payment of money, the Arbitral Tribunal may include in the sum for which the award is made interest, at such rate as it deems reasonable, on the whole or any part of the money, for the whole or any part of the period between the date on which the cause of action arose and the date on which the award is made.

JUDGMENTS OF COURTS

The judgments discussed below lay down that the section itself is a source of right to claim interest for the pre-reference period and a party can claim interest based on this section irrespective of whether there is any right under the contract, or in law, or according to applicable trade usage, to claim such interest.

The Bombay High Court, in Vastu Invest & Holdings (P) Ltd. v. Gujarat Lease Financing Ltd.² has, inter alia, held as follows : (SCC OnLine Bom paras 43-44)

43. He then drew our attention to the findings of the Arbitral Tribunal in para 22. He contends that the Arbitral Tribunal has held that the provisions of the Interest Act, 1978 are applicable to the facts of the case. Consequently, he contends that the interest awardable under the Interest Act alone could have been awarded and nothing more. Section 3 of the Interest Act, 1978 is relied upon to contend that either the interest agreed upon in the agreement, or at any rate at a rate not exceeding the current rate of interest, was permissible. That the current rate of interest as defined in Section 2(b) would be highest of the maximum rates payable on a deposit with a bank. Since, at no point of time the banks paid interest of 16.5% or 18%, Mr Diwan contends that this is an illegal direction.

44. In our view, this contention proceeds on a misapprehension. It is true that, prior to the coming into force of the 1996 Act, there was doubt, debate and discussion (inside Courts and outside) as to what was the interest payable during the pre-reference period, during the period of arbitration, and the post-award period. Different judgments, at different times, by different Courts took different views. Fortunately, the 1996 Act, which is a consolidating and amending Act, cuts this Gordian knot by providing in Section 31(7) that, in the situation where the parties have not agreed upon a rate of interest, the Arbitral Tribunal when awarding payment of money, may include in the sum for which the award is made interest at such rate as it deems reasonable on the whole or any part of the money, for whole or any part of the period between the date on which the cause of action arose and the date on which the award is made. Thus, under the 1996 Act the matter of interest is left entirely to the discretion of the Arbitral Tirbunal. True, that the Arbitral Tribunal has referred to the provisions of the Interest Act. A careful perusal of the findings of the tribunal in para 22 would suggest that it has drawn inspiration from the provisions of the Interest Act only to ascertain the point of time from which the deposit in the hands of the appellant would fetch interest.

Thus, notwithstanding the provisions of the Interest Act, the Court upheld grant of interest at a rate much higher than what was permissible under the Interest Act, by holding that this was possible and permissible under Section 31(7)(a) of the Act. In other words, Section 31(7)(a) was treated as a source of a right to claim interest, without reference to any other statute or contractual provision or custom or usage.

The Bombay High Court, in Haresh Advani of Mumbai v. Suraj Jagtiani³, has, inter alia, held as follows : (SCC OnLine Bom para 145)

145. In my view there is thus no substance in the submission of the learned Senior Counsel for the petitioner that the Arbitral Tribunal could not have awarded any interest on the claim for compensation/damage up to the date of award. In my view, the respondent was not required to issue any notice under the provisions of Interest Act, 1978 for making the claim for interest on damages. The Arbitral Tribunal is empowered to award interest on damages from the due date till the date of award and even to award future interest even if no notice under the provisions of Interest Act, 1978 is issued by the claimant. In my view, since the Arbitral Tribunal has been granted such power by the legislature under Section 31(7) of the Arbitration and Conciliation Act, 1996, the claimant is not required to comply with the provisions of Interest Act, 1978 for the purpose of claiming interest for the past period on the compensation/damages.

A similar view has been expressed in some other judgments of various High Courts⁴.

The Arbitral Tribunals have been granting interest based on Section 31(7)(a) alone for the pre-reference period, without any reference to whether the contract or law or trade usage provides for payment of such interest.

SUBMISSION — ERROR IN THE ABOVE APPROACH

It is respectfully submitted that the law as laid down in the above judgments, and the same approach adopted by the Arbitral Tribunals, is erroneous.

It is respectfully submitted that the section confers a power upon the Arbitral Tribunal to grant interest for the pre-reference period and that the power has to be exercised in accordance with the contract or the substantive law or applicable trade usage. The reasons are as follows:

The law is that grant of interest for pre-reference period is governed by substantive law

It is well settled that grant of interest for the period prior to the commencement of a legal proceeding (pre-reference period in an arbitration) is governed by substantive law. Procedural law governs the grant of interest pendente lite and for the post-award period.

In Irrigation Deptt., State of Orissa v. G.C. Roy⁵, the Supreme Court laid down five principles based on the authorities which were considered in the judgment. Principle (v) reads as follows : (SCC p. 533, para 43)

43. … (v) Interest pendente lite is not a matter of substantive law, like interest for the period anterior to the reference (pre-reference period).

In Hindustan Construction Co. Ltd. v. State of J&K⁶, the Supreme Court held as follows : (SCC p. 220, para 5)

5. … while award of interest for the period prior to an arbitrator entering upon the reference is a matter of substantive law, the grant of interest for the post-award period is a matter of procedure.

In Dhenkanal Minor Irrigation Division v. N.C. Budharaj⁷, the Supreme Court referred to the five principles laid down in Secretary, Irrigation Irrigation Deptt., State of Orissa v. G.C. Roy⁸, and held as follows : (Dhenkanal Minor Irrigation Division case⁷, SCC p. 742, para 23)

23. What difference would it make and what consequences would follow, if Principle (i) is read along with Principle (v), be it even that, interest for the pre-reference period is a matter of “substantive” law, unlike the interest for the period pendente lite, which ultimately came to be allowed applying the principles engrafted in Section 34 of the Code of Civil Procedure, would next deserve our consideration. “Substantive law”, is that part of the law which creates, defines and regulates rights in contrast to what is called adjective or remedial law which provides the method of enforcing rights. Decisions, including the one in Jena case while adverting to the question of substantive law has chosen to indicate by way of illustration laws such as Sale of Goods Act, 1930 [Section 61(2)], Negotiable Instruments Act, 1881 (Section 80), etc. The provisions of the Interest Act, 1839, which prescribe the general law of interest and become applicable in the absence of any contractual or other statutory provisions specially dealing with the subject, would also answer the description of substantive law.

In MSK Projects (I)(JV) Ltd. v. State of Rajasthan⁹, the Supreme Court has given a similar finding.

The above law has not changed subsequent to 1996 or by virtue of the Act.

Therefore, the above High Court judgments are in error in holding that interest for the pre-reference period can be granted irrespective of whether a right to such interest is made out under the substantive law, that is the prevailing statutes.

The Act is a procedural law

The Act is a procedural law¹⁰, and not a part of substantive law. In the words of the judgment in N.C. Budharaj¹¹, it is an “adjective or remedial law which provides the method of enforcing rights”. As a part of providing for the mechanism of arbitration for enforcing rights, the Act also defines the powers of the Arbitral Tribunal to be constituted under the provisions of the Act.

The Act does not create, define or regulate substantive rights of parties to a dispute. In any event, at least Section 31(7)(a) is a procedural law, dealing with the powers of the tribunal to be constituted under the provisions of the Act. Therefore, Section 31(7)(a), not being substantive law, and not purporting to create, define or regulate substantive rights, cannot be the basis for grant of interest for the pre-reference period, if no right to such interest is made out in substantive law or in the contract between the parties or in applicable trade usage.

All powers vested in an Arbitral Tribunal have to be exercised in accordance with the contract, the substantive law and applicable trade usage

An Arbitral Tribunal has many powers. It has almost the same powers as a court of law in the matter of grant of final reliefs in the disputes referred to it — it has powers to grant declaratory reliefs, to grant specific performance, to grant monetary reliefs, to grant damages, to grant permanent injunctions, etc. However, it goes without saying that all these powers have to be exercised by the Arbitral Tribunal in accordance with the contract, the substantive law and applicable trade usage.

Arbitral Tribunal cannot grant any of the reliefs mentioned in the paragraph above, if an entitlement/right to the relief is not made out by the party seeking the relief, in accordance with the contract, the substantive law and applicable trade usage. Arbitral Tribunal cannot grant any of the reliefs simply based on the fact that it has the power to do so, by ignoring the fact that no such right has been made out under the contract, the substantive law and applicable trade usage.

Section 28 of the Act, inter alia, provides:

28. Rules applicable to substance of dispute.—(1) Where the place of arbitration is situate in India,—

(a) in an arbitration other than an international commercial arbitration, the Arbitral Tribunal shall decide the dispute submitted to arbitration in accordance with the substantive law for the time being in force in India;

(b) in international commercial arbitration,—

(i) the Arbitral Tribunal shall decide the dispute in accordance with the rules of law designated by the parties as applicable to the substance of the dispute;

(ii)-(iii)***

(2) ***

(3) While deciding and making an award, the Arbitral Tribunal shall, in all cases, take into account the terms of the contract and trade usages applicable to the transaction.

For the same reason, Arbitral Tribunal cannot grant interest for the pre-reference period simply because it has the power to do so, and ignoring the fact that no such right has been made out under the contract, the substantive law and applicable trade usage. The power to grant interest for the pre-reference period under Section 31(7)(a) has to be exercised only when a right to claim the same is established by a party.

Power is different from right

Power is vested in Arbitral Tribunal. Power of Arbitral Tribunal means its authority. It defines what Arbitral Tribunal is authorised to do, what is within the scope of its authority.

Right, on the other hand, vests in a party appearing before the Arbitral Tribunal. In order to be able to obtain a relief, the party seeking it has to establish a right to the relief. A party derives its right either from the terms of the contract it has entered into, or from the substantive law, or from trade usage.

Whenever a right exists, there also exists a corresponding obligation. If one party before Arbitral Tribunal has a right to claim interest, then correspondingly, the opposite party is under an obligation to pay interest.

A party cannot have a right to a relief merely because Arbitral Tribunal has the power to grant that relief.

Section 31(7)(a) merely grants authority or power to Arbitral Tribunals to grant interest for the pre-reference period. That, by itself, does not mean that any party appearing before Arbitral Tribunal obtains a right under Section 31(7)(a) to claim interest from the opposite party; or that any party appearing before Arbitral Tribunal comes under an obligation to pay interest to the opposite party.

Genesis of Section 31(7)(a)

The Arbitration Act, 1940, did not contain any specific provision regarding the power of Arbitral Tribunal to grant interest for different periods.

Prior to the enactment of the Act, for a period of time, there was uncertainty about whether Arbitral Tribunal could award interest for the pre-reference period — whether it had the power to do so.¹²

In order to make the position clear and beyond any doubt, Section 31(7)(a) was inserted in the Act, making it clear that Arbitral Tribunal has power to grant interest for the pre-reference period. The object of this insertion was only to set at rest the uncertainty that prevailed in this regard for a period of time prior to the Act. The object was not to create a new right in parties to claim interest when they did not otherwise have a right to so claim, or to create a corresponding obligation.

Any other interpretation would mean that the rights of a party are different in a court and in arbitration on this aspect

Section 31(7)(a) applies only to Arbitral Tribunals, and not to courts. Courts are governed by the Code of Civil Procedure. In the Code of Civil Procedure, there is no provision relating to interest prior to the filing of the suit, similar to the provision for interest for pre-reference period as contained in Section 31(7)(a). If Section 31(7)(a) is construed as a source of a right to claim interest for the pre-reference period (irrespective of whether such a right is made out under any other statute or contract or trade usage), it will mean that a party resorting to arbitration has an additional right, as compared to a party resorting to a court of law; that a party resorting to court cannot get interest for the period prior to the suit if it does not make out a right to it under the law, contract or trade usage, but a party resorting to arbitration is entitled to interest for pre-reference period irrespective of whether it makes out a right to it under the law, contract or trade usage. This is anomalous. The powers of the court and arbitrator to grant interest are and ought to be the same.

In Dhenkanal Minor Irrigation Division v. N.C. Budharaj⁷, the Supreme Court held that the power of the arbitrator to grant interest is the same as that of the courts. In para 23 of the judgment, it is held as follows : (SCC p. 743)

23. … Once it is construed and considered that the method of redressal of disputes by an alternative forum of arbitration is agreed to between the parties, with or without the intervention of court is only a substitute of the conventional civil courts by forums created by consent of parties, it is but inevitably necessary that the parties must be deemed to have by implication also agreed that the arbitrator shall have power to award interest the same way and in the same manner as courts do and would have done had there not been an agreement for arbitration.

CONCLUSION

For the reasons discussed above, Section 31(7)(a) confers a power upon the Arbitral Tribunal to grant interest for the pre-reference period and the power has to be exercised in accordance with the contract or the law or applicable trade usage.

None of the High Court judgments mentioned at the beginning of this article consider or discuss the points raised above. The above points are material and relevant for the purpose of decision. For the reasons stated above, the High Court decisions and the approach of the Arbitral Tribunals ought to be reviewed.

There may be a case for saying that whenever a party is found owing an amount to another, the latter should, in all cases, get interest on the amount that it is deprived of. However, that is not what the law in India provides as of today. This is a matter for the legislature to consider.

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