Arbitral awards bound by contract

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Arbitral awards bound by contract

The Indian Supreme Court has set aside an arbitral tribunal’s award for acting beyond the confines of a contract executed between parties. The court held that the power of courts and arbitral tribunals was limited to the terms of the contract and if the underlying contract specified a fixed rate of interest, an arbitrator could not reinterpret the contract’s terms and award a higher amount.

In Indian Oil Corporation Ltd v Shree Ganesh Petroleum Rajgurunagar, the Indian Oil Corporation (lessee) and Shree Ganesh Petroleum (lessor) signed a 29-year lease agreement in which the lessee established a retail outlet to sell its petroleum products for a monthly payment of INR1,750 (USD22). The parties signed a dealership agreement in which the lessor was appointed as a dealer for the retail outlet.

Under the lease agreement, any issue was to be addressed to Indian Oil’s managing director or, if the MD was unable to act, an appointee. The dealership agreement provided for sole arbitration by the lessee’s marketing director, who might participate as an arbitrator or designate another officer to arbitrate. Accordingly, the parties entered into two distinct agreements, the lease agreement and the dealership agreement, both of which are independent of each other.

The dealership agreement was terminated by Indian Oil and an arbitrator was appointed to resolve disputes under that agreement. However, the arbitrator passed an award on issues arising out of the lease agreement, increasing the monthly rent and reducing the duration of the lease.

While the arbitral tribunal had no authority to lower the lease length, the district court found the increase in rent to INR10,000 a month, with a 10% increase every three years, was appropriate. Both parties appealed against the district court’s decision to the High Court of Bombay under section 37 of the Arbitration and Conciliation Act, 1996, which upheld the district court decision. Finally, the lessee appealed against the high court decision to the Supreme Court.

Relying on its earlier decision in Associate Builders v Delhi Development Authority, the court observed that the award was against India’s public policy in the following circumstances:

  1. The award appears to be in patent violation of a statutory provision;
  2. The arbitral tribunal did not adopt a judicial approach to resolving the disputes;
  3. The award contravenes the principles of natural justice;
  4. The award is unreasonable or perverse;
  5. The award patently contravenes the provisions of any substantive law of India, or the Act; and
  6. The award is contrary to the interests of India, or against justice or morality.

Calling an arbitral tribunal a creature of contract, the Supreme Court held that it was bound to act in terms of the contract under which it was constituted. The court held that an award could be said to be patently illegal where an arbitral tribunal had failed to act in accordance with the terms of a contract or had ignored the specific terms of a contract.

The limits and scope of patent illegality in India have evolved over time. The Supreme Court’s findings in Indian Oil clarify the distinction between fallacious contractual interpretation and failure to act in accordance with a contract. However, the rationale of the court to confine the award to the four walls of the contract must not be interpreted in an absolutely strict sense. The court, while providing for limitations to the interpretation of the tribunal, observed that courts ordinarily do not interfere with a tribunal’s interpretation unless it is patently unreasonable or perverse. The Supreme Court further opened the realm of the tribunal to interpret contractual provisions where they are ambiguous or capable of being interpreted in different ways. The present judgment, while limiting the powers of the arbitral tribunal, gave a further direction to the purview of patent illegality of arbitral awards.

The dispute digest is compiled by Numen Law Offices, a multidisciplinary law firm based in New Delhi & Mumbai. The authors can be contacted at support@numenlaw.com. Readers should not act on the basis of this information without seeking professional legal advice.