Can Arbitral Tribunal Override Contractual Interest Clauses? SC Clarifies Scope of S. 31(7)(a) of Arbitration Act

The Supreme Court has clarified that an arbitral tribunal can exercise discretion to grant interest under Section 31(7)(a) of the Arbitration and Conciliation Act only when there is no agreement between the parties providing otherwise.

A bench of Justices J B Pardiwala and Sandeep Mehta explained that once parties have agreed on any aspect covered under Section 31(7)(a), including the rate or manner of payment of interest, the arbitral tribunal loses all discretion on those aspects. In such cases, the tribunal is bound to follow the terms agreed between the parties.

The bench observed that where an agreement clearly specifies that interest shall be payable at a particular rate, the arbitral tribunal cannot deviate from it. “Once there is an agreement between the parties which provides that interest shall be at a particular rate, the arbitral tribunal thereafter is left with no discretion,” court said.

Emphasising the opening words of Section 31(7)(a) [“unless otherwise agreed by the parties”], court said this reflects the principle of party autonomy, which lies at the core of the arbitral process. This autonomy, court noted, will prevail in all cases except where a legal provision is strictly non-derogable, such as limitation.

Court further held that the principle of unconscionability does not apply to voluntary commercial agreements entered into by parties with equal bargaining power. Referring to the Indian Contract Act, 1870, the bench reiterated that courts will not interfere merely because the terms of a contract appear harsh.

According to the court, a claim of unconscionability can succeed only where it is shown that one party was in a position to dominate the will of the other and used that position to gain an unfair advantage. Even then, the court must be satisfied that the bargain itself is unconscionable. Only when both these conditions are clearly established can a contractual provision be declared unenforceable on the ground of unconscionability, the bench stressed. 

Court observed that if parties knowingly and willingly enter into a contract, courts will not step in to relieve them of their contractual obligations merely because the terms are claimed to be unconscionable.

Explaining the law on interest clauses, court said that where parties agree that failure to pay interest on time would attract a higher rate of interest, such a clause does not amount to a penalty under Section 74 of the Indian Contract Act. Such agreements must be interpreted in line with the intention of the parties and enforced according to their terms, unless they are shown to be unconscionable or fraudulent at the time they were entered into.

In the appeal filed by BPL Ltd, court held that the arbitral tribunal had rightly rejected the argument that the transaction was governed by the Usurious Loans Act, 1918, as amended by the Punjab Relief of Indebtedness Act, 1934. This view was correctly affirmed by the high court while dealing with proceedings under Sections 34 and 37 of the Arbitration Act.

Both the arbitral tribunal and the high court had found that the transaction between the parties was neither a loan nor a debt, but a commercial transaction. The parties had voluntarily and consciously entered into a bill discounting facility agreement, court noted.

Court also upheld the finding that the interest terms agreed between the parties through sanction letters dated December 27, 2002 and June 11, 2003 could not be termed unconscionable, arbitrary or excessive, even in cases of default beyond the due date.

Rejecting BPL Ltd’s contention that interest could not be added to the principal amount, court held that the contract expressly provided for compounding of interest on a monthly basis. As a result, the respondent was entitled to claim interest in accordance with the agreed terms, at the rate of 36 per cent per annum with monthly rests.

The bench further held that the maxim verba chartarum fortius accipiuntur contra proferentem had no application in the present case, as the interest clause was part of a bilateral commercial contract mutually agreed upon by the parties.

Significantly, court noted that the contract provided for a concessional rate of interest as an incentive for timely repayment. Withdrawal of this concession in case of default, and the consequent levy of a higher rate with compounding, could not be characterised as penal.

Accordingly, the Supreme Court dismissed the appeal.

Case Title: BPL Ltd Vs Morgan Securities And Credits Private Limited

Bench: Justices J B Pardiwala and Sandeep Mehta