Arbitration Award Granting Damages in Absence of Proven Loss Can be Set Aside

The Delhi High Court (“Court“) recently set aside an arbitration award that granted damages without proof of loss or injury, on the ground of patent illegality under Section 34 of the Arbitration and Conciliation Act, 1999 (“Arbitration Act“) in Indian Oil Corporation Limited vs. M/s Fiberfill Engineers Limited¹.

Background

Fiberfill Engineers Limited (“Fiberfill“) and Indian Oil Corporation Limited (“IOCL“) entered into an agreement on January 11, 2007, for designing, supplying, installation, testing and commissioning of high mast signage systems of various heights and types at various IOCL retail outlets in the State of Tamil Nadu and Union Territory of Pondicherry. Delays in execution of installation of the high mast signages resulted in IOCL withholding an amount of Rs. 22,08,528/- (“Claim Amount“) from the amounts payable to Fiberfill under the provisions of the General Conditions of the Contract (GCC) and the Special Instructions to Tenderers (SIT).

Fiberfill claimed that the delays were beyond its control and included IOCL’s delays in appointing a Third Party Inspection Agency (TPI Agency). Fiberfill requested the release of Rs. 8,38,581/- for the work done, but IOCL refused, stating the deductions were for liquidated damages. Despite repeated demands and a legal notice, IOCL did not respond. Thereafter, Fiberfill commenced arbitration and called upon IOCL to furnish a panel of 3 (three) arbitrators to enable it to nominate an arbitrator, however, since IOCL failed to cooperate, Fiberfill filed a petition under Section 11(6) of the Arbitration Act before the Court, leading to the constitution of an arbitral tribunal comprising of a sole arbitrator (“Arbitral Tribunal“).

Before the Arbitral Tribunal, Fiberfill raised 5 (five) claims: (i) the Claim Amount, deducted by IOCL towards price adjustment from the bills raised by Fiberfill for the work done; (ii) interest at the rate of 18% (eighteen percent) on the Claim Amount from the date the amounts were withheld by IOCL till the actual date of release; (iii) Rs. 75,50,000/- towards escalation; (iv) Rs. 1,50,00,000/- towards loss of business opportunity; and (iv) Rs. 80,00,640/- towards manpower retention. The Arbitral Tribunal in its award (“Award“) rejected all the aforesaid claims and found that Fiberfill was not entitled to any relief. Fiberfill then challenged the Award under Section 34 of the Arbitration Act, confining its challenge to the denial of the Claim Amount and interest.

Single Judge’s Ruling 

The single judge partially set aside the Award, ruling that Fiberfill was entitled to the Claim Amount along with interest at the rate of 8% (eight percent) per annum from the date the amounts were withheld till the date of release. The judge held that the Arbitral Tribunal erred in accepting IOCL’s contention that the deductions were compensation on account of delay in execution of the works, without determining whether IOCL had suffered damages on account of delay or if the amount withheld was a reasonable compensation for the delay in execution of the work on the part of Fiberfill. The judge found the Award to be vitiated by patent illegality, as it ignored the relevant material and also awarded liquidated damages by way of price adjustment without recording a finding as to whether IOCL had suffered any loss or injury. IOCL appealed this decision, leading to the present proceedings before a 2 (two) judge bench of the Court.

Court’s Analysis

Scope of Section 34 of the Arbitration Act

The Court emphasized that Section 34 of the Arbitration Act limits judicial intervention to set aside arbitral awards on the grounds as set out in Section 34(2) and 34(2A) of the Arbitration Act. The court’s jurisdiction does not extend to modifying the arbitral award or to pass a decree in respect of the claims that were the subject matter of the arbitral proceedings. The single judge’s decision to award interest at the rate of 8% (eight percent) per annum was beyond the scope of the judge’s jurisdiction under Section 34 of the Arbitration Act. 

IOCL’s Liquidated Damages Claim 

IOCL argued that Clause 4.4.2.0 of the GCC read with Clause 9 of the SIT provided a pre-estimate of damages for delays and was enforceable under the contract. It asserted that liquidated damages were justified without needing to prove actual loss. However, Fiberfill contended that the clause amounted to a penalty rather than reasonable compensation.

The Court noted that the Arbitral Tribunal failed to address whether Clause 4.4.2.0 of the GCC constituted a genuine pre-estimate of damages as claimed by IOCL. IOCL had also not claimed specific losses in its submissions. The Court observed that IOCL’s argument that delays inconvenienced its staff and customers, was unsupported by evidence or raised before the Arbitral Tribunal. Fiberfill had countered this argument, citing contractual provisions requiring work execution without inconvenience to customers. 

Court’s Findings 

The Court found that the Arbitral Tribunal awarded liquidated damages to IOCL without determining whether IOCL had suffered a loss or if the deduction was reasonable compensation for delays. The Arbitral Tribunal did not analyze the relevant contract clauses. This omission rendered the Award patently illegal. 

In conclusion, the Court held that the award of liquidated damages without evidence of loss was vitiated by patent illegality. The Court upheld the single judge’s decision to set aside the Award regarding the Claim Amount and interest thereon but overruled the grant of interest at the rate of 8% (eight percent) per annum stating that the single judge’s decision to award interest at the rate of 8% (eight percent) per annum exceeded judicial authority under Section 34 of the Arbitration Act. It reiterated that courts under Section 34 cannot re-adjudicate disputes or modify awards but only determine if an award should be set aside on specific grounds.

¹ FAO (OS)(COMM) 114/2019 and CM No. 24305/2019.