A contract contingent on a third-party event is governed by Section 32 of the Indian Contract Act, not Section 56. Liquidated damages are enforceable as a genuine pre-estimate of loss, and arbitrators cannot award interest when the contract explicitly prohibits it.

Headnote:(A) Arbitration and Conciliation Act, 1996 - Section 34 - Indian Contract Act, 1872 - Sections 31, 32, 56, 74 - Contractual obligations - Frustration of contract - Liquidated damages - Pre-award interest.

(B) Scope of interference under Section 34 - Patent illegality - A court may set aside an arbitral award if it finds that the findings are perverse, contrary to the express terms of the contract, or suffer from patent illegality.

(C) Contingent contracts vs. Frustration - Where a contract contains implied terms regarding the dependency of supply on a third-party source, the contract is a contingent contract under Section 32, and not a case of frustration under Section 56.

(D) Liquidated damages - Proof of actual loss is not required if the stipulated amount is a genuine pre-estimate of damages; establishing legal injury is sufficient to enforce such clauses. (E) Interest - Where an agreement explicitly prohibits the grant of pre-award or pendente lite interest, an arbitrator lacks the authority to award such interest, as the arbitrator is a creature of the agreement.

Facts of the case:
The petitioner entered into a contract with the respondent for the supply of a critical chemical. The respondent failed to meet the delivery schedule, leading the petitioner to deduct liquidated damages. The respondent initiated arbitration, claiming the contract was frustrated due to the failure of a third-party source to supply raw materials. The arbitrator held that the contract was frustrated under Section 56 and rejected the liquidated damages, while also awarding interest and additional payments. The petitioner challenged this award.

Findings of Court:
The court found that the contract was contingent on the third-party supply, making Section 32 applicable rather than Section 56. The liquidated damages were a genuine pre-estimate of loss, and the petitioner had established legal injury. The court also identified double counting in the award and held that the arbitrator erred in granting interest contrary to the express terms of the contract.

Issues: The main issues were whether the contract was frustrated, whether the liquidated damages were enforceable, whether the award suffered from double counting, and whether the arbitrator had the power to grant pre-award interest despite a contractual prohibition.

Ratio Decidendi: A contract contingent on a third-party event is governed by Section 32, not Section 56. Liquidated damages are enforceable if they are a genuine pre-estimate of loss and legal injury is established. Arbitrators cannot override express contractual prohibitions on interest, as they are bound by the terms of the agreement.

Result: Petition allowed; award set aside.

ORDER

This is a petition filed by the petitioner – M/s.Oil and Natural Gas Corporation Limited challenging the award passed by the learned Arbitrator dated 02.5.2018.

2. Heard both.

3.The facts leading to filing of this petition are as follows :

(i) Vide tender dated 31.12.2010, the petitioner called for bids for supply of baryte powder for a total quantity of 3,19,912 MTs having specific gravity of 4.15. The respondent submitted their bid on 23.2.2012. The respondent became the successful bidder. Pursuant to that, a letter of award (LoA) dated 23.2.2012 was issued by the petitioner to the respondent for the supply of 45,360 MTs of baryte powder at an ex-works price of Rs.4,869/- per MT + applicable taxes. Thereafter, the petitioner and the respondent entered into a rate contract dated 16.4.2012 in this regard. The contract was for a duration of two years from the date of the LoA dated 23.2.2012 to 22.2.2014.

(ii) Vide letter dated 08.3.2012,The respondent furnished a performance bank guarantee for Rs.99,39,000/- in favour of the petitioner. Later, by means of an amendment to the rate contract dated 06.3.2014 marked as Ex.C.6, the contract was amended to extend the duration upto 30.9.2014.

(iii) The respondent supplied 16,250 MTs of baryte powder during the contract period till February 2014. Even during the extended period of time, 7,000 MTs were supplied by the respondent. Thus, in total, the respondent supplied 23,250 MTs as against their contractual obligation to supply 45,360 MTs.

(iv) On the grounds of short supply, supply of sub-standard material and delayed supplies, the petitioner made the following deductions as per the terms of the contract:

(1) Deduction to the tune of Rs.6,63,661.74 Ps. towards shortfall of the quantities supplied

(2) Deduction to the tune of Rs.53,25,855/- towards liquidated damages and

(3) Deduction to the tune of Rs.16,21,807/- towards supply of sub-standard material.

In total, a sum of Rs.76,11,323.74 Ps was deducted.

(v) The petitioner also took steps to invoke the performance bank guarantee and at that point of time, the respondent filed an application in O.A.No.1314 of 2015 against the petitioner and ICICI Bank, Nungambakkam before this Court under Section 9 of the Act and sought for an order of interim injunction against encashment of the performance bank guarantee till the completion of the arbitral proceedings. Later, the said application was allowed by order dated 07.4.2016 and once again, at the instance of the respondent, pursuant to a petition in O.P.No.445 of 2016 filed under Section 11 of the Act, an Arbitrator was appointed.

(vi) Thereafter, before the learned Arbitrator, the respondent filed the claim statement before the learned Arbitrator making the following claims:

(vii) The respondent also sought for payment of pendente lite interest at the rate of 18% per annum from the date of the claim till the date of payment.

(viii) Before the learned Arbitrator, the petitioner filed a statement of defence and justified the deductions made as per the terms of the agreement between the parties. The petitioner also sought for a counter claim in the following terms:

“(a) to declare that the claimant has failed to perform its obligations under the Rate Contractdated 16.4.2012 read with the ‘General Conditions of Contract’ executed between the parties and is in breach of the agreement between the parties;

(b) to declare that the invocation of the performance bank guarantee dated 08.3.2012 by the respondent vide communication dated 23.12.2015 was valid and legally enforceable;

(c) to render an award directing the claimant to pay to the respondent/counter claimant an amount of Rs.10,47,31,900/- (Rupees ten crores forty seven lakhs thirty one thousand and nine hundred only) towards damages/losses suffered by the respondent/ counter claimant on account of the non performance by the claimant of the contract between the parties; and

(d) for costs of the present arbitration proceedings as also all litigation costs i

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2025 Supreme(Online)(Mad) 69879

A contract contingent on a third-party event is governed by Section 32 of the Indian Contract Act, not Section 56. Liquidated damages are enforceable as a genuine pre-estimate of loss, and arbitrators cannot award interest when the contract explicitly prohibits it.

Cases Referred (6)