Using Proportionality as a Tool for Tidying the Vicissitudes of Exclusionary Clauses

Introduction

An exclusionary clause is a beneficial contractual arrangement made by a party to the contract in anticipation of future contingencies that might hinder or prevent performance.¹ The primary aim is to accommodate consequences arising out of non-performance, part-performance, or negligent performance of a contract. Though such clauses may take different forms, the objective is to have an effect of immunising, restricting, or exempting a party from liability, which it would have borne had it not been for the clause. For example, an exclusionary clause might contain specific procedures for making claims, allocating liabilities between the parties, limiting the right to terminate the contract on breach, or restricting the amount and time period to claim damages on breach.

The legal analysis of the exclusionary clauses has witnessed a flip-flop judicial approach in India. In the earlier times, judicial thinking went in opposite direction by looking into such clauses from different prisms and thereby coming out with conflicting answers. However, over a period, the legal position could not be settled due to conflicting judgments by the courts. This article attempts to argue that a pragmatic judicial approach is the need of the hour for tidying the muddled jurisprudence of construing such clauses. It also makes a case for using proportionality as a methodological tool for solving this vicissitude. Let us start this analysis with the interpretation of exclusionary clauses by courts on the question of jurisdiction of Arbitral Tribunals.

Exclusionary clauses: The question of jurisdiction

As such exclusionary clauses in the contract are only a bar on the parties and not on the Arbitral Tribunal. Once it is held that one of the parties is in breach of the contract, Section 73² of the Contract Act comes into play and there can be no bar to adjudicate the same under Section 23³ of the Contract Act. The Supreme Court has dealt with clauses limiting the liability of a party under the contract in multiple judgment(s). In Associated Engg. Co. v. Govt. of A.P.⁴, the Supreme Court upheld the High Court judgment setting aside claims which were not supported by the agreement between the parties and held that the arbitrator travelled outside the contract in awarding those claims. The Supreme Court concluded by saying that, the error arose not by misreading, misconstruing, or misunderstanding the contract by the arbitrator, but by acting in excess of what was agreed. It was an error going to the root of their jurisdiction because the arbitrator had asked himself the wrong question, disregarded the contract and awarded in excess of their authority.

Similarly, in Ramnath International Construction (P) Ltd. v. Union of India⁵, an exclusionary clause in an employment contract relating to extension of time stipulated that no claim in respect of compensation would be admitted as a result of the said extensions. The Court while interpreting the said clause held that, even if the employer is at fault, yet these provisions bar the entitlement of the contractor to damages and the Arbitral Tribunal cannot award the same. A completely different view on the question of jurisdiction of the Arbitral Tribunal was taken in Asian Techs Ltd. v. Union of India⁶ (Asian Techs). Here, the Supreme Court, while interpreting a similar provision in the contract came to the conclusion that notwithstanding such a clause limiting liability of one party, the other party could raise a claim for further amount and the Arbitral Tribunal was within its jurisdiction to award the same.

By the reasoning of the Court in Asian Techs⁷ judgment, it is clearly visible that the Supreme Court did not consider the held in Ramnath International⁸ while deciding Asian Techs⁹. This is relevant especially in light of the fact that the Supreme Court in its subsequent judgment of ONGC v. Wig Bros. Builders & Engineers (P) Ltd.¹⁰, relied on Ramnath International¹¹ which was reiterated in KSS KSSIPL Consortium v. GAIL (India) Ltd.¹² holding that in view of the exclusionary clause in the said agreement, the claim for “extended stay compensation” was not an arbitrable dispute.

However, apart from Asian Techs¹³ judgment, there are various judgments wherein the courts have held that in the event of cost escalation on account of the delays attributable to the employer, the burden on overhead expenses is increased. Thus, if the contractor is not compensated for such escalation, it would not only result in wiping off the margin but would also cause loss to the contractor. On this reasoning, the courts have granted compensation and/or damages notwithstanding such clauses in the abovementioned decisions.

The Supreme Court had previously in Board of Trustees for the Port of Calcutta v. Engineers-De-Space-Age¹⁴ dealt with the issue that, whether the Arbitral Tribunal had awarded interest pendente lite notwithstanding the prohibition contained in the contract against the payment of interest on delayed payments. The Court had held that if there was a dispute as to whether the Arbitral Tribunal was prohibited from awarding interest pendente lite under this term of the contract, that was a matter that fell within the jurisdiction of the Arbitral Tribunal, as the Tribunal would have to interpret and decide whether the prohibition clause of the contract prohibits them from awarding interest pendente lite. The Court finally concluded by saying that in such cases, it cannot be said that the Arbitral Tribunal acted outside of the contract by denying them the jurisdiction to decide the question of interest payment pendente lite.

Similarly, in State of W.B. v. Pam Developments (P) Ltd.¹⁵, the High Court of Calcutta referring to the Supreme Court’s judgment in Associated Construction v. Pawanhans Helicopters Ltd.¹⁶, observed that the prohibitory clause will not govern the period of extension when the contract has been carried out by the contractor for the proposition that prohibitory clauses may operate during the stipulated period of the contract. In the series of judgments referred above, there is a dichotomy in opinion which leaves a lot of grey area for the Arbitral Tribunals to go with a construction of their choice regarding treatment of exclusionary clauses on the question of jurisdiction.

The deepening vicissitude

The Delhi High Court in Vivek Sharma v. Cargill Global Trading India (P) Ltd.¹⁷, has gone to the extent of declaring such a clause as void, being violative of Section 23 of the Contract Act, 1872. The final verdict by the Supreme Court on this aspect is still awaited. This dehors the issue as to whether exclusionary clauses are hit by Section 23 of the Contract Act or not, the courts have been able to create a niche by diluting the rigours of exclusionary clauses, thereby balancing the interest of both the sides.

Further, the amendment made in the Arbitration and Conciliation Act in the year 2015¹⁸ has also contributed to the already muddled jurisprudence of exclusionary clauses. Section 28¹⁹ of the Act, as amended, gives specific power to the Arbitral Tribunal to decide the dispute in accordance with the substantive law for the time being in force. Sub-section (3) of Section 28²⁰ has also been amended, where after the words “tribunal shall decide”, the words “in accordance with” are deleted and substituted with the words “having regard to”. It has made material difference as post Amendment the Arbitral Tribunals have larger preview of interpretation.

This Amendment was intended to overrule the effect of ONGC v. Saw Pipes Ltd.²¹ where the Supreme Court had held that any contravention of the terms of the contract would result in the award falling foul of Section 28²² and consequently, being against public policy. The aforesaid effect of the amendment was specifically considered by the Supreme Court in Ssangyong Engg. & Construction Co. Ltd. v. National Highways Authority of India²³. In the instant case, the Court held, quoting the 246th Report of Law Commission of India²⁴ that any contravention of a term of the contract by the Tribunal should not ipso jure result in rendering the award becoming capable of being set aside. It was opined that no similar amendment is necessary to Section 28(1)²⁵ given the express restriction of the public policy ground.

Tidying the vicissitudes: Using proportionality as a methodological tool

As is evident from the foregoing, the Indian courts have developed the jurisprudence around exclusionary clauses by leaning in favour of rights of a party which suffers damages on account of breach of contract by the other party. For instance, when the contract is not completed within the stipulated time, and fault is attributed to the employer, the contractor can refuse to perform the work beyond the initial contract period. In Asian Techs²⁶ the Court found that the execution of the contract was solely due to the default of the respondent. While in T.A. Choudhary v. State of A.P.²⁷ , the Court took the view that an exclusionary clause is not applicable on the extended period but only on account of delay in discharging a particular obligation which happens within the period of contract itself.

This shows that the approach of the court(s) is to give sanctity to the provisions of the Contract Act, wherever possible. But while doing this, the courts unfortunately could not develop a methodological tool to carry this analysis forward and thereby prosing a test for similar situation(s). It is submitted that if we apply the necessity test of proportionality on the exclusionary clause’s nucleus, a proper relationship between the benefit obtained from accomplishing the proper purpose and the damage caused due to abrogation of the contractual right can be best determined/or balanced. In this manner, all future court(s)/Tribunal(s) will have a touchstone to carry out the balancing of exclusionary clauses.

As Advocate General Nicholas Emiliou writes in his treaties²⁸ on Proportionality in European Law, the necessity test of proportionality refers to the requirement of “the less restrictive means approach”. According to this test, the adjudicator has to choose – of all those means that may advance the purpose of the limiting clause – that which would least limit the legal right(s) in question. This proportionality test is predicated on the premise that the use of the law’s means – or the requirement to use such means – is required only when the purpose cannot be accomplished through the use of alternative (hypothetical) contractual means that satisfy the rational connection test and have a lower level of restriction on the contractual right in question.

The way forward and conclusion

No doubt, the agreement entered into between the parties is also to be accorded sanctity. However, the courts have chosen the path by deftly crafting the legal position relating to exclusionary clauses, which are usually included in the contracts by a dominating party, by restricting the effect of such clauses. If the proportionality approach is adopted in the judicial thinking, it certainly has the tendency to become a potent methodological tool while dealing with interpretation of exclusionary clauses.

Finally, it is undisputed that the Arbitral Tribunal is not only required to consider contractual provisions but is also authorised to take a holistic view of the situation, taking into account other legal provisions, such as the Contract Act and trade usages. This perspective has afforded the Arbitral Tribunal a degree of flexibility, which balances the debatable aspect of the Tribunal’s adjudicatory competence qua exclusionary clauses. The outcome of the preceding discussion would be to conclude that, despite exclusionary clauses, the Arbitral Tribunal has the authority to award legal compensation. At this juncture, it is apposite to again accentuate that the abovementioned proportionality test is the best possible method which can be used as a tool for balancing the interests.