Supreme Court Clarifies on Compound Interest in Arbitration Matters

Introduction 

A recent landmark judgement held by the Supreme Court of India cleared doubt regarding the provision of awarding compound interest in matters arising out of arbitration that comes under the purview of Arbitration Act, 1940. The Division Bench, composed of Justice P. S. Narasimha and Justice Pankaj Mithal examined the legal position to find out whether the Act allows the recovery of compounding Interest, Interest charged on the principal amount as well as on the interest accrued thereon where there is no express provision in the statute or the contract allowing the same. 

Case Background 

This case originated from a contractual dispute which started back in 1984-85 between the petitioner and the respondent. The Arbitrator issued an award on September 17, 1997, under the Arbitration Act, 1940, stipulating interest on the principal sum of Rs. 21,56,745 for two distinct periods:

• Pre-Award Period: From the date of completion of the works up to the award date simple interest at the rate of twelve per cent per annum. 
• Post-Award Period: Fifteen percent simple interest from the date of the award to the date of payment or the date of the court decree, whichever was earlier. 

Despite the latter the petitioner received the principal sum with the stipulated interest; yet the petitioner demanded further interest, asserting a deficit. The petitioner urged that the 12% interest awarded on the pre-award period should be charged on the principal sum thus forming the basis of computing the 15% of the post-award interest.

Decisions by Lower Courts 

The Principal Senior Civil Judge as well as the Gujarat High Court dismissed the petitioner’s argument in this regard stating that the Arbitrator had categorically awarded simple interest. Because there was no apparent guidance concerning compound interest; the courts held the view that the petitioner was eligible for simple interest charges of 12% for the pre-award period up to June 30, 2004, and 15% for the post-award period beginning July 1, 2004. 

Not satisfied with these judgments the petitioner filed a Special Leave Petition (SLP) in the Supreme Court of India. 

Supreme Court's Deliberation 

The Supreme Court paid much attention to the award and examined relevant legal provisions. It pointed out that under Section 29 of the Arbitration Act, 1940 the court is allowed to grant any interest on the principal sum adjudged, but interest which has accrued is not allowed. The Court also pointed out that the arbitration award under Section 17 of the 1940 Act has to be treated as a decree and this brings it within the CPC. 

Interpretation of Section 34 of CPC and the Interest Act, 1978 

The Court indicated Section 34(1) of the CPC under which interest may only be claimed on the principal amount and not on the interest that has already been claimed. The Court also relied on Section 3(3) of the Interest Act 1978 where it is unlawful to grant interest on interest unless as may be provided by law or agreement.
 

Legal status of compound interest 

The Court also recalled the principle that ordinary courts are not competent to award compound interest or interest on interest unless they are expressly authorized by statute or the contract . The Bench was quite categorical about the proposition that while compound interest may be ordered where a court has jurisdiction to do so, this has to be done in compliance with statute or the contract, as the case may be.

Critical Analysis 

The present case of the Supreme Court directs the courts and the legislature to provide the clear contortion in the stake of interest, in the arbitration matter in the contract or thus provision. Judgment of the Court strengthens the law that cannot compound interest be paid where the same has not been agreed by agreement in writing or where it is not provided by law. It means that certain burdens should not be shifted from one party to the other in an unfair manner assuming that these burdens were not envisaged at the start or were not agreed upon. It also reminds the litigants and legal practitioners to pay much attention in formulating and reviewing contracts in order to avoid any dispute regarding interest and future uncertainty regarding any term of the contract. With this ruling, legal operations become more systematic and foreseeable; however, the parties are required to execute more attention and detail to their agreements. 

Conclusion 

Referring to this legal regime to the case, the Supreme Court established that the Arbitrator’s award, as well as the decree based on it, fail to mention compound interest. The Court made it clear that the term “amount awarded” remained linked exclusively to the capital sum of the claim, being Rs. 21,56,745 notwithstanding interest during the pre-award period. Therefore, the Court dismissed any further interest that the petitioner sought to claim from the respondents. 

Therefore, the Supreme Court rejected the petition and supported the previous judgements of the other instances. This ruling upholds the legal granting of compound interest where it has been stated under the provisions of the law or under the contract hence brings Legal certainty on interest arbitrations under the Arbitration Act, 1940.

FAQs

Can the interest accrued be further charged on in the event the arbitrator awards me the case?

In normal circumstances, one cannot receive interest on interest in any given arbitration case, unless the law or the contract prohibited it from doing so. The Supreme Court added that it is expected that only a plain interest is recoverable in most cases, unless there is a provision for interest to be compounded.

If an arbitrator awards me interest how is it set or computed?

In case an arbitrator awards you interest it is usually done at simple interest basis on the principal sum. This means that the interest is calculated only on the principal sum awarded and not in respect of the interest on interest.

What should I do in case I feel that the interest offered to me was wrongly estimated?

In the event you consider the interest awarded as wrong or in a situation where the interest awarded doesn’t suit your expectation or where you considered things like compound interest, you can take the decision to another level, this is, to a higher court. But the Supreme Court in recent years has made it quite clear that compound interest is not usually allowed unless provided by statute or agreement.

I turn to the Supreme Court and they are saying no to compound interest, why?

The Supreme Court was quite clear in arguing that where there is no law or provision in the contract that envisages compound interest there can be no award of this kind by any court. In your case, since the contract and the law did not specify that compound interest could be awarded the Court allows only simple interest on the principal amount.

Under a contract that I signed, I did not get to agree on interest, so am I eligible to receive interest if I am victorious in an arbitration case?

However, if you have not agreed on interest in your contract, do not worry: the arbitrator can award simple interest on the principal sum. Though, this will, in most cases, be on simple interest and not on compound interest, unless a contract or by law, allows for it.