HomeLegal ColumnsJudicial interpretation of 'Interest' under Section 31(7) of the Arbitration and Conciliation...

Judicial interpretation of ‘Interest’ under Section 31(7) of the Arbitration and Conciliation Act, 1996

Introduction

Interest is defined as the return or compensation for the use or retention by one person for a sum of money belonging to or owned by any reason to another.[1] In essence, an award of interest compensates a party for its forgone return on investment, or for money withheld without a justifiable cause. The basic principle behind interest is that the creditor deserves to be compensated for being deprived of money that should rightfully have been tendered to it. Section 31(7) of the Arbitration and Conciliation Act, 1996 (“the Act”) provides for the payment of interest in the arbitral award that is passed in favour of a party. This article will deal with how the statutory and judicial interpretation of interest in the Act differs from that of the Code of Civil Procedure, 1908 (“CPC”). Moreover, this article will focus on how courts have interpreted as to what amounts to a “reasonable” rate of interest, and how this rate may differ in a domestic arbitration as opposed to an international commercial arbitration.

Interest under the Code of Civil Procedure, 1908

The payment of interest in a civil decree is enshrined under Section 34 of the CPC, which provides the following:

Where and in so far as a decree is for the payment of money, the Court may, in the decree, order interest at such rate as the Court deems reasonable to be paid on the principal sum adjudged, from the date of the suit to the date of the decree, in addition to any interest adjudged on such principal sum for any period prior to the institution of the suit, [with further interest at such rate not exceeding six per cent. per annum as the Court deems reasonable on such principal sum], from the date of the decree to the date of payment, or to such earlier date as the Court thinks fit.”[2]

The proviso to the aforementioned provision provides that:

Provided that where the liability in relation to the sum so adjudged had arisen out of a commercial transaction, the rate of such further interest may exceed six per cent. per annum, but shall not exceed the contractual rate of interest or where there is no contractual rate, the rate at which moneys are lent or advanced by nationalised banks in relation to commercial transactions.[3]

Thus, it is evident that Section 34 of CPC envisages three types of interest:

  • Pre-lite interest: This refers to the interest that has accrued from the date of the arising of the cause of action to the date of the institution of the suit.
  • Pendente-lite interest: This refers to the interest that accrues from the date of the institution of the suit to the date of the passing of the decree.
  • Post-lite interest: This refers to the interest which accrues from the date of the decree to the date on which payment is made by the judgment debtor.

It is also pertinent to note that in all such cases, the interest at each stage is to be calculated on the principal sum that is mentioned in the decree. In other words, the court cannot grant “interest on interest”.[4]

Interest under the Arbitration and Conciliation Act, 1996

  1. Pre-award interest

Section 31(7)(a) of the Act provides the following:

Unless otherwise agreed by the parties, where 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.”[5]

A bare perusal of the above-mentioned provision makes apparent the departure that the Act makes from the CPC. Firstly, the words “between the date on which the cause of action arose and the date on which the award is made” signifies that there is no distinction between pre-lite and pendente-lite interest in the Act. In other words, both these types of interest have been clubbed together as one category (“pre-award interest”).

Secondly, the use of the words “the arbitral tribunal may include in the sum for which the award is made interest” indicates that the Act provides for inclusion of the pre-award interest in the sum awarded in the award itself, unlike Section 34 of the CPC, which differentiates between the principal sum and interest of any kind. In other words, any reference to the word “sum” in an arbitral award also includes the amount of pre-award interest awarded to the award-holder.

Further, the words “on the whole or any part of the money” make it clear that the arbitral tribunal has discretionary powers to charge interest on either the whole or any part of the money, whereas under CPC, the court does not have such power to bifurcate the principal sum and charge interest only on specific parts of the principal sum.

  1. Arbitral tribunal bound by agreement between parties in case of pre-award interest

The words “unless otherwise agreed by the parties” signify that an agreement between the parties to the arbitration agreement can bar the levy of pre-award interest. In Sri Chittaranjan Maity v. Union of India,[6] the Supreme Court of India (“Supreme Court”) held that if an agreement between the parties prohibits the award of interest for the pre-award period, the arbitrator cannot award interest for the said period. Further, in Jaiprakash Associates Ltd. v. Tehri Hydro Development Corporation India Ltd,[7] the Supreme Court held that Section 31(7) of the Act sanctifies agreements between the parties and states that the moment the agreement says otherwise, no interest becomes payable right from the date of the cause of action until the award is delivered.

The reasonability of the rate of pre-award interest as decided by the parties, cannot be adjudicated by the arbitral tribunal. The Delhi High Court in Turner Morrison Limited v. Rani Parvati Devi[8] has held that the arbitral tribunal is bound by the terms of the agreement with respect to pre-award interest, and if the agreement had stipulated interest at the rate of 36% p.a., the arbitral tribunal had no authority to alter this rate.

However, in the absence of any agreement between the parties regarding the pre-award interest rate, it is open for the arbitral tribunal to grant interest at a rate which it deems to be reasonable. In Ashi Limited v. Union of India,[9] the Delhi High Court upheld the decision of the arbitral tribunal to grant pre-award interest at a rate of 9% p.a.

  1. Post-award interest

Section 31(7)(b) of the Act provides the following:

A sum directed to be paid by an arbitral award shall, unless the award otherwise directs, carry interest at the rate of two per cent. higher than the current rate of interest prevalent on the date of award, from the date of award to the date of payment.[10]

Thus, under the scheme of the Act, the arbitral tribunal has the power to grant post-lite interest (“post-award interest”) on the sum of the award. Unlike pre-award interest, which is subject to agreement between the parties, post-award interest is statutorily provided, and cannot be barred by way of an agreement between the parties.

  1. Interest on interest

The question as to whether post-award interest could be charged only on the principal sum adjudged in the award, or on the principal sum added with the pre-award interest, was raised before the Supreme Court in Hyder Consulting (UK) Ltd. v. Governor, State of Orissa (“Hyder Consulting”).[11] The Supreme Court, by a majority of 2:1, held that the word “sum” used in Section 31(7) of the Act refers to the principal sum adjudged in the award + pre-award interest, and thus post-award interest could be levied on this aggregate sum by the arbitral tribunal. The Supreme Court judgment in State of Haryana and Others. v. S.L. Arora & Co (“S.L. Arora”),[12] which had ruled that post-award interest could only be charged on the principal sum and not on pre-award interest, was held to be incorrect by the majority decision in Hyder Consulting. It is pertinent to note that the S.L. Arora judgment was passed by a two-judge bench, and since only two of the three judges in Hyder Consulting held that S.L. Arora was per incuriam, it is unclear whether S.L. Arora has been overruled.

Therefore, arbitral tribunals have the power to grant “interest on interest”, while such corresponding power is not available to courts under Section 34 of the CPC. However, the Supreme Court in Hyder Consulting cautioned against using the phrase “interest on interest” as the pre-award interest merges with the principal sum of the award, ceases to exist as interest and is included in the “sum” as defined under Section 31(7) of the Act.

  1. Rate of post-award interest

In case of post-award interest, the Act has fixed that interest can be charged at a rate 2% higher than the “current rate of interest” which has the same meaning as assigned to it under clause (b) of section 2 of the Interest Act, 1978.[13] Prior to the Arbitration and Conciliation (Amendment) Act, 2015, the rate of post-award interest was 18% per annum, unless otherwise directed by the arbitral tribunal.

A. Principles governing post-award interest

The rules with respect to award of post-award interest were crystallized by the Supreme Court in Vedanta Ltd. v. Shenzhen Shandong Nuclear Power Construction Co. Ltd (“Vedanta”).[14] The Supreme Court in this case held that in an international commercial arbitration seated in India, in the absence of an agreement between the parties on interest, the rate of interest would be governed by the Act. It was further held that the arbitral tribunal while granting interest must take into consideration factors such as:

  • the ‘loss of use‘ of the principal sum;
  • the types of sums to which the interest must apply;
  • the time period over which interest should be awarded;
  • the internationally prevailing rates of interest;
  • whether simple or compound rate of interest is to be applied;
  • whether the rate of interest awarded is commercially prudent from an economic stand-point;
  • the rates of inflation, and
  • proportionality of the count awarded as interest to the principal sums awarded.

The Supreme Court further held that courts may reduce the interest rate awarded by an arbitral tribunal where such interest rate does not reflect the prevailing economic conditions, or when it is found to be unreasonable. In this case, the arbitral tribunal had levied a dual rate of post-award interest, at 9% p.a. from the date of the award till 120 days, and at 15% p.a. post 120 days from the date of the award, if payment was not made within 120 days.

The Supreme Court held this dual rate of interest to be invalid, stating that interest is meant to be compensatory and not punitive in nature. The Supreme Court also held that the interest rate of 15% was extremely exorbitant from an economic standpoint and was out of sync with the existing economic climate. Accordingly, the Supreme Court awarded post-award interest at the uniform rate of 9% p.a.

Additionally, the Supreme Court also held that a uniform interest rate on two distinct types of currencies was unjustified, and accordingly applied varying interest rates for the two currency components in the award, namely INR and Euro.

B. Applicability of Vedanta

Two judgments of the Bombay High Court have held that the decision in Vedanta is not applicable while deciding the rate of post-award interest in domestic arbitrations. In Ashirwad Projects v. Addhar Mercantile Pvt. Ltd,[15] the Bombay High Court has held that the award of 12% p.a. post-award interest in a domestic arbitration was reasonable, and did not warrant interference. Further, in Maa Ashish Textile Industries Private Limited v. National Insurance Company Limited,[16] the Bombay High Court held that the grant of 12% p.a. post-award interest and an additional 12% p.a. interest in case the award debtor does not make payment within one month of the award, was valid. In this case, the Bombay High Court held that the judgment in Vedanta pertained to international commercial arbitrations, and thus was not applicable in the current case.

Conclusion

It is pertinent to note that the definition of a “reasonable” rate of interest would depend upon a myriad of factors, not least of all on whether the arbitration is a domestic one or an international commercial one.

Furthermore, while raising claims for interest, parties should take into account the Vedanta principles. It is important to note that many arbitral awards are overturned at the setting aside stage with respect to the interest component awarded, which occurs due to the award of exorbitant interest rates by tribunals. This happens when tribunals are divorced from economic realities of the day. Parties are advised to avoid raising unreasonable claims for interest, in order to avoid future surprises at the setting aside stage.


[1] 32 Halsbury’s Laws of England, para 106 (4th Ed., 1980).

[2] The Code of Civil Procedure, 1908, Section 34(1).

[3] The Code of Civil Procedure, 1908, proviso to Section 34(1).

[4] Central Bank of India v. Ravindra and Others, (2002) 1 SCC 367.

[5] The Arbitration and Conciliation Act, 1996, Section 37(7)(a).

[6] (2017) 9 SCC 611.

[7] AIR 2019 SC 5006.

[8](2009) 165 DLT 703.

[9] O.M.P. 200/2015, O.M.P. 210/2015 and I.A. No. 4969/2015, decided on 19.05.2020.

[10] The Arbitration and Conciliation Act, 1996, Section 37(7)(b).

[11] (2015) 2 SCC 189.

[12] (2010) 3 SCC 690.

[13] The Arbitration and Conciliation Act, 1996, explanation to Section 37(7)(b).

[14] (2019) 11 SCC 465.

[15] Arbitration Petition No. 1295 of 2015.

[16] 2019 (4) ABR 451.

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Nabeel Wasim Malik
Nabeel Wasim Malik
Nabeel Wasim Malik is an Associate at AKS Partners, a Delhi-based dispute resolution firm. Nabeel specialises in domestic and international arbitration law, and civil litigation.
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