Arbitration : Supreme Court Refers Bharat Drilling's Interpretation of Contractual Prohibitory Clauses to Larger Bench

Supreme Court highlights the need for clarity on the applicability of prohibitory clauses in contracts in arbitration cases.

In a significant move, the Supreme Court of India has referred the decision in Bharat Drilling & Foundation Treatment Pvt. Ltd. v. State of Jharkhand to a larger bench for reconsideration. The referral comes in light of concerns about the interpretation of prohibitory clauses in contracts, specifically those clauses that prevent claims such as idle labor, machinery, or business loss. This decision, delivered by a bench comprising Justices Pamidighantam Sri Narasimha and Atul S. Chandurkar, underscores the necessity of clarity and consistency in the application of such clauses within the framework of party autonomy and freedom to contract.

The State of Jharkhand appealed against a High Court decision that restored an arbitral award, which had been previously set aside by a Civil Court. The Civil Court had annulled certain claims under Section 34 of the Arbitration and Conciliation Act, 1996, on the basis that they were explicitly prohibited by the contractual agreement between the parties. The High Court, however, reinstated these claims, citing the Supreme Court's ruling in Bharat Drilling.

The Supreme Court bench noted that the High Court's reliance on Bharat Drilling was misplaced, as the case did not appropriately address the contractual clauses in question. The bench highlighted that contractual clauses limiting claims are based on the principle of party autonomy, which is a fundamental aspect of arbitration. It emphasized that the parties to a contract have the freedom to agree on the terms, and these terms form the guiding principle for arbitral tribunals.

The court further observed that the Bharat Drilling case had applied a precedent from the Port of Calcutta case, which dealt with the grant of interest, a matter distinct from prohibitory clauses in contracts. The court pointed out that Bharat Drilling's application of the Port of Calcutta decision was inappropriate for issues concerning prohibitory clauses.

In its judgment, the court stressed that the power of an arbitrator to grant interest is governed by Section 31(7) of the Arbitration and Conciliation Act, 1996, which is separate from the contractual provisions regarding prohibitory clauses. This distinction is crucial for ensuring that arbitral decisions align with the contractual agreements of the parties involved.

Given these considerations, the Supreme Court determined that the principles established in Bharat Drilling require reconsideration to align with recent judicial interpretations and maintain consistency in arbitration jurisprudence. The court has directed the registry to present the judgment before the Hon'ble Chief Justice for referral to a larger bench.

This judgment is expected to have a significant impact on arbitration proceedings in India, particularly in cases involving government contracts, where prohibitory clauses are common. The decision to revisit the Bharat Drilling ruling reflects the judiciary's commitment to upholding the integrity of contractual agreements while ensuring that arbitration remains a viable and fair mechanism for dispute resolution.

Statutory provisions: Arbitration and Conciliation Act, 1996, Sections 31(7), 34, 37

State of Jharkhand v. Indian Builders Jamshedpur, (SC) : Law Finder Doc Id # 2818283