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Amendment to Section 28(3) of Arbitration and Conciliation Act, 1996 - Are Exclusionary Clauses in Government Contracts now Redundant?

INRODUCTION

When parties enter into a contract, it is assumed that they have taken into consideration all the terms of the contract and are willing to be bound by such terms, whether they are beneficial to them or not. Illustratively, if a contract entered between the parties specifically bars a relief in the form of damages, then the parties cannot be granted damages by the adjudicating authority. Such clauses of contracts, more commonly known as exclusionary/prohibition clauses, restricts an adjudicatory body, like an arbitral tribunal, to go beyond the terms of the contract and grant that relief, which is specifically barred under the contract.

Such exclusionary/prohibition clauses have time and again been upheld by Courts of law all over India1. Section 28(3) of the Arbitration and Conciliation Act, 1996 (the “Act”) also mandated the arbitral tribunal to decide “in accordance with the terms of the Contract”.

However, the recent amendment to the Act in the year 2015 (the “2015 Amendment Act”) has completely changed the landscape of interpreting exclusionary/prohibition clauses.

As explained below, the 2015 Amendment Act has watered down the scope of Section 28(3) of the Act and given supremacy to Section 28(1) of the Act. Effectively, this would enable an arbitral tribunal to grant damages under Section 73 of the Indian Contract Act (the “Contract Act”) upon proof of violation of the terms of the contract.

BACKGROUND

Before going into the current position of law, it is important to understand the background that led to the creation of the law as it stands today.

As per Section 28(3) of the Act, as it stood prior to the 2015 Amendment Act, the arbitral tribunal had to mandatorily decide a dispute as per the terms of a contract2, which meant that the arbitral tribunal was restricted to the four corners of the contract3. Any diversion from the contract by the arbitral tribunal made the award liable to be set aside under Section 34 of the Act. In the judgement of ONGC v. Saw Pipes4, the Hon’ble Supreme Court set aside an award passed by the arbitrator, since it was in teeth of the terms of contract which specifically restricted the arbitrator to interpret the question of law. Similarly, in the case of ONGC v. Wig Brothers, Hon’ble Supreme Court set aside an award by which the arbitral tribunal had granted damages that were specifically barred under the Contract.

BEGINNING OF A PARADIGM SHIFT: LAW COMMISSION’S 246TH REPORTACKGROUND

The law laid down in ONGC v. Saw Pipes was followed consistently till the year 20156, when the Law Commission of India, in its 246th report7 (the “LCR”), proposed a shift to overcome the decision in ONGC v Saw Pipe8.

The LCR proposed9 that “…the amendment to section 28(3) has similarly been proposed solely in order to remove the basis for the decision of the Supreme Court in ONGC vs. Saw Pipes Ltd, (2003) 5 SCC 705 – and in order 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. The Commission believes no similar amendment is necessary to section 28(1) given the express restriction of the public policy ground (as set out below).

The LCR proposed that the scope of Section 28(3) of the Act should be narrowed such that the awards passed by arbitral tribunals should not be ipso jure set aside by an appellate court merely because the arbitral tribunal had passed an award that did not conform to the terms of the contract.

Soon after the LCR was released, in the case of Associate Builders v. DDA, the Hon’ble Supreme Court revisited the law and held that Section 28(3) must be read with a caveat and that the interpretation of a contract by an arbitrator must not be disturbed/set aside by the courts, as long as the interpretation is reasonable and just.

STATUATORY RECOGNITION TO THE LCR’S RECOMMENDATION: THE 2015 AMENDMENT ACT

The recommendations suggested by the LCR, and as recognized by Associate Builders v. DDA, was given statutory recognition by way of the 2015 Amendment Act. In essence, the changes recommended by the LCR to Section 28(3) of the Act can be appreciated from the table below:

PRE-AMENDMENT
In all cases, the arbitral tribunal shall decide in accordance with the terms of the contract and shall take into account the usages of the trade applicable to the transaction.

POST AMENDMENT
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.

With the coming into effect of the 2015 Amendment Act, there has been a sea-change in the law relating to exclusionary clauses in contracts. The difference in the language of the provision, though subtle to the eye, have far-reaching consequences. The amendment to Section 28(3), and the retention of Section 28(1) as it is, has effectively given supremacy to the substantive law of India in the decision-making process before an arbitral tribunal.

The 2015 Amendment Act has not just armed the arbitral tribunal with the power to pass an award with substantial freedom keeping in mind the overall intent and effect of the contract but has also given it adequate judicial discretion to decide a dispute in light of the overall facts and circumstances, keeping in mind the substantive law and applicable trade usages, rather than being a slave of the terms of the contract.

CONCLUSION: NEW ERA IN ARBITRATION LAW

Unlike the pre-amended Act, wherein the arbitral tribunal was bound to strictly follow the terms of the contract, after the 2015 Amendment Act, Section 28(3) only mandates the arbitral tribunal to “take into account the terms of the contract”.

As a direct result, the approach towards exclusionary/prohibition clauses would now stand on a completely different footing. Illustratively, if a language of an exclusionary/prohibition clause is loosely worder, such that there is scope to reject its applicability, or if the arbitral tribunal reasonably believes that the exclusionary/prohibition clauses will restrict them in giving sufficient relief to the parties, then the arbitral tribunal would be within its powers to reject the applicability of such exclusionary/prohibition clauses. In such cases, the arbitral tribunal would be empowered under the substantive law of India to grant appropriate relief under, for example, Section 73 of the Contract Act.

This increased discretion of the arbitral tribunal will have a dramatic impact especially in government contracts, which are usually unilaterally drafted / standard form contracts by the government authorities, with little-to-no-involvement of the other contracting party.

To illustrate the impact, the arbitral tribunal can now apply the principles of contra proferentem to hold that the government authority would not be allowed to take benefit of the exclusionary/prohibition clause(s) and thus, grant damages to the private party under Section 73 of the Contract Act. Prior to the 2015 Amendment, this would not have been possible because the arbitral tribunal was mandated to remain within the boundaries of the contract. However, with this newly introduced flexibility, the arbitral tribunal can now override exclusionary/prohibition clauses and grant damages under Section 73 of the Contract Act. In such cases, the arbitral tribunal would now derive its power to grant damages under Section 28(1) of the Act, which mandates the arbitral tribunal to decide the dispute submitted to arbitration in accordance with the substantive law for the time being in force in India.

As a matter of fact, in the case of G. Ramachandra Reddy and Co. v. Union of India, the Hon’ble Supreme Court held that the question of damages under Section 73 of the Contract Act cannot be the subject matter of contract. With the amendment to Section 28(3), and the retention of Section 28(1), the law laid down in the G. Ramachandra Reddy Case has now become the operative principle of law.

Even the Hon’ble High Court of Delhi, in Simplex Concrete Piles (I) Ltd. vs Union of India13, held that Section 73 would override any exclusionary/prohibition clauses in contracts.

With the amendment to Section 28(3), the arbitral tribunal would be empowered to grant damages under Section 73 of the Contract Act despite the presence of a term in a contract that otherwise excludes such damages.

With the amendment to Section 28(3), the arbitral tribunal would be empowered to grant damages under Section 73 of the Contract Act despite the presence of a term in a contract that otherwise excludes such damages.

Effectively, in case of conflict between the substantive law and the terms of the contract, the former would prevail, given that the arbitral tribunal has to adjudicate “in accordance with the substantive law”, but only “take into account” the terms of the contract. Therefore, the terms of the contract now remain below the substantive law in terms of hierarchy.

The 2015 Amendment Act will, thus, play a major role in disputes arising out of government contracts where the opposite party has no option but to sign a standard form contract drafted by the government with an intent to protect the latter’s interests. The amended Section 28(3) will help in strengthening the faith of litigants in the alternation dispute resolution process and usher in a new era to uplift the arbitral tribunal to a proper fora of dispute resolution empowered with statutory powers to grant just and proper reliefs in accordance with the substantive law of India.