‘Prohibition’ Clauses no more? A Brief Examination of the amended Section 28 (3) of the Arbitration Act

Arbitration and Conciliation
Arbitration and Conciliation

Amit George

The recent judgment of the Supreme Court in Jaiprakash Associates Ltd. v. Tehri Hydro Development Corporation India Ltd. has once again brought into focus ‘prohibition clauses’, and the effect thereof on the power of an Arbitral Tribunal to award necessary relief to the parties before it.

To put it simply, a prohibition clause can be described as a clause in a contract which stipulates an express bar on the power of the Arbitral Tribunal to award a specific claim or relief sought by either of the parties. For instance, the prohibition clause in question in Jaiprakash Associates Ltd. (supra), proscribed the power of the Arbitral Tribunal to award interest.

What the Supreme Court held on grant of pendente lite interest by Arbitrator

Read the Judgment in Jaiprakash Associates Ltd. v. Tehri Hydro Development Corporation India Ltd delivered by Justices AK Sikri, S Abdul Nazeer and MR Shah

Similarly, there is a more controversial genre of prohibition clauses to be found in various contracts which prohibit the award of claims in the nature of damages such as escalation, prolongation costs in the extended period of the contract etc. (It has been argued that interest-prohibition clauses can be said to draw some legitimacy from the phrase ‘unless otherwise agreed by the parties’ appearing at the beginning of Section 31(7)(a) of the Arbitration and Conciliation Act, 1996, which otherwise empowers the Arbitral Tribunal to award interest.)

The treatment of prohibition clauses by the Courts, whilst examining their impact on the power of the Arbitral Tribunal to award relief, has not been uniform. The more conservative view has construed such clauses as representing an absolute bar and a fetter on the power of the Arbitral Tribunal to award a claim proscribed by the said prohibition clause and has espoused the position that an Arbitral Tribunal is a creation of the contract between the parties, and its power is thus necessarily ring-fenced by the contract between the parties.

A more liberal view has, however, prevailed in certain cases wherein it has been held that the inherent power of the Arbitral Tribunal to award a claim, which is otherwise legitimate and justifiable under the applicable law such as the Indian Contract Act, 1872, cannot be sought to be defeated by a contractual provision. 

While an examination of the aforesaid diversity in judicial opinion on this topic merits a detailed discussion in itself, the present piece seeks to bring to the forefront a crucial amendment relevant to the issue that has been brought about by the Arbitration and Conciliation (Amendment) Act, 2015, and which specific amendment has till date been largely overlooked in favor of the more ‘famous’ amendments such as the amendments in relation to independence and impartiality of arbitrators, time-limits for arbitration proceedings, lack of automatic stay of an award upon challenge etc. 

The amendment in question pertains to Section 28 (3) of the Arbitration and Conciliation, 1996. Section 28 of the Arbitration and Conciliation, 1996, in general, mandates the applicable rules which an Arbitral Tribunal must follow while arriving at a determination on the disputes before it, and Section 28 (3) specifically deals with the treatment of the terms of the contract and usages of trade. With the above background in mind, in order to better understand the change that has been brought about in Section 28 (3), it would be appropriate to juxtapose the text of the pre-amended Section with the text of the amended Section as under:

Pre-amendment Post-amendment 
In all cases, the arbitral tribunal shall decide in accordance with the terms of the contract and shall take into account the usages of the trade applicable to the transaction.While deciding and making an award, the arbitral tribunal shall, in all cases, take into account the terms of the contract and trade usages applicable to the transaction.

(emphasis in bold supplied)

The difference in language which has been brought about through the aforesaid amendment, though seemingly subtle in nature, has significant consequences. Whereas as per the pre-amended Section, the Arbitral Tribunal was necessarily required to decide the dispute strictly ‘in accordance’ with the terms of the contract, while being entitled to merely ‘take into account’ the usages of trade; under the amended Section, the necessity to decide ‘in accordance’ with the contract has been done away with and replaced with a softer approach requiring the Tribunal to ‘take into account’ the terms of a contract just as it would ‘take into account’ usages of the trade.

This represents a significant shift in legislative intent, from a regime which expressly forbade any deviation from the agreed terms of a contract to a regime which gives the Arbitral Tribunal more leeway in deciding a dispute in the light of the overall facts and circumstances and the applicable law. Such an interpretation of the amended Section is further strenghtened by the corresponding similar recommendations in the 246th Report of the Law Commission of India, which resulted in the relevant amendment to Section 28(3) of the Arbitration and Conciliation, 1996. (Where a particular amendment is the result of the recommendation of a Report of the Law Commission of India, it is permissible to refer to the relevant Report to ascertain the legislative intention behind the amendment. Reference in this regard may be made to Mithilesh Kumari & Anr. v. Prem Behari Khare).

The recommendation expressly sought to proscribe a challenge to an Arbitral Award on the ground that the same was contrary to the contract between the parties. The relevant recommendations of the Law Commission of India in this regard are as under:

“(ii) In sub-section (3), after the words “tribunal shall decide” delete the words “in accordance with” and add the words “having regard to” 

[Note: This amendment is intended to overrule the effect of ONGC Ltd. v. Saw Pipes Ltd., (2003) 5 SCC 705, where the Hon’ble Supreme Court held that any contravention of the terms of the contract would result in the award falling foul of Section 28 and consequently being against public policy.]”

Amit George is an Advocate at the Delhi High Court.
Amit George is an Advocate at the Delhi High Court.

In light of the aforesaid amendment to Section 28 (3), the approach towards prohibition clauses and their treatment under the law, therefore requires a radical re-look. The oft-quoted argument that the Arbitral Tribunal is a creation of the contract and that, therefore, a finding contrary to the contract is necessarily to be interfered with by a Court hearing a challenge to an Arbitral Award, can no longer be said to be an uncontested proposition.

This is not to say that the amended Section 28 (3) gives the Arbitral Tribunal a license or carte-blanche to ride roughshod over the contract or that a determination can be made totally de-hors the contract. However, in an appropriate case, if the Arbitral Tribunal were to find that in the facts and circumstances obtaining between the parties and in terms of the applicable law, a well-reasoned departure from a contractual prohibition clause is warranted, then the resulting Arbitral Award cannot be interfered with on the sole ground that the same is contrary to the contract, if the reasoning of the Arbitral Tribunal in this regard is otherwise rational and appealing.

Prohibition clauses, it can therefore be argued, no longer prohibit absolutely, and in an appropriate case, an Arbitral Tribunal might be perfectly justified in over-looking such a contractual fetter if the facts of the case before it, and the applicable law, warrant such a departure. 

Amit George is an Advocate at the Delhi High Court.

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