AKB LEX Indian arbitration law firm

07/06/2014

COMPOUND INTEREST BY ARBITRATOR IN INDIA

By Dr. Ashwinie Kumar Bansal, Advocate[1]

Payment of interest arises in different circumstances. It can be the consideration paid by a borrower to a lender for use of the money lent or made available by the lender. It can be the return given by a bank, financial institution or a company on amounts deposited or invested with them by a customer or constituent. It can be the compensation paid by a person who withholds or defaults in paying an amount or in discharging a liability, when it is due and payable. Interest may be payable in pursuance of a contract, or a provision in a statute, or the fiat of a court or tribunal. It is usually quantified in terms of a percentage of the `principal' or the `investment' or the `amount of liability'. Interest unless otherwise specified, refers to simple interest, that is interest paid on only the principal and not on any accrued interest.

Compound interest refers to a method of charging interest where interest is computed not only on the principal, but also the accrued interest. For the purpose, periodical rests are provided for computation of interest, say yearly, or quarterly or monthly. At the end of the first rest, the interest accrued till then is added to the principal, so that for the second interest bearing period, the aggregate of the original principal and interest thereon becomes the enhanced principal. AT the end of the second rest, the accrued interest on the enhanced principal is added to the enhanced principal so that such further enhanced principal becomes the principal for charging the interest for the third period. It goes on in this manner until repayment, by progressively enlarging the principal base by adding interest at regular interval. As a result, the debtor is made to pay interest not only on the original principal, but on the interest on the principal, and on the interest upon the interest on the principal and so on. A variant of compound interest, involves limited compounding, where interest is not added to the principal with periodical rests, but only once or twice at agreed stage. For example, where a loan is repayable within one year, if a provision is made in the contract that in the event of the loan not being repaid within one year, the interest which had accrued during the one year period will be added to the principal, and as a consequence, after one year, interest will be payable on the aggregate of the principal and the interest for one year, it is a provision for interest upon interest.

Compound interest can be awarded only if there is a specific contract, or authority under a Statute, for compounding of interest. There is no general discretion in courts or tribunals to award compound interest or interest upon interest.

Whether section 31(7) of the Arbitration and Conciliation Act, 1996 authorizes and enables arbitral tribunals to award interest on interest from the date of award, is an important question answered by the Supreme Court in State of Haryana v. S.L. Arora & Company 2010(3) SCC 690.

Section 3 of the Interest Act, 1978 enables the courts and arbitral tribunals to award interest from the date of cause of action to the date of institution of legal proceeds or initiation of arbitration proceedings. Sub- section (3) (c) of section 3 of the Interest Act, 1978 makes it clear that nothing in the said section shall empower the Court for arbitrator to award interest upon interest.

Supreme Court in Renusagar Power Co. Ltd v. General Electric Co. [1994 Supp. (1) SCC 644] held that award of interest on interest was not opposed to the public policy of India, but could be awarded only if authorized by contract or statute. Supreme Court observed :

"Merely because in Section 3(3)(c) of the Interest Act, 1978, the court is precluded from awarding interest on interest does not mean that it is not permissible to award such interest under a contract or usage or under the statute. It is common knowledge that provision is made for the payment of compound interest in contracts for loans advanced by banks and financial institutions and the said contracts are enforced by courts. Hence it cannot be said that award of interest on interest, i.e., compound interest, is against the public policy of India. We are, therefore, unable to accept the contention that award of interest on interest i.e. compound interest is contrary to public policy of India."

[emphasis supplied]

In State Bank of India v. Ganjam District Tractor Owners Association - 1995(1) R.R.R. 114 : 1994 (5) SCC 238, Supreme Court again observed that in the absence of a provision for compound interest or interest with periodical rests in the agreement between a bank and the borrower, the bank cannot claim such interest.



In Central Bank of India v. Ravindra - 2002(1) R.C.R.(Civil) 49 : 2002 (1) SCC 367, a constitution bench of Supreme Court, after exhaustive consideration of the case law, summarized the legal position regarding compound interest thus :



"The English decisions and the decisions of this court and almost all the High courts of the country have noticed and approved long established banking practice of charging interest at reasonable rates on periodical rests and capitalising the same on remaining unpaid. Such a practice is prevalent and also recognised in non-banking money lending transactions. Legislature has stepped in from time to time to relieve the debtors from hardship whenever it has found the practice of charging compound interest and its capitalization to be oppressive and hence needing to be curbed. The practice is permissible, legal and judicially upheld excepting when superseded by legislation. There is nothing wrong in the parties voluntarily entering into transactions, evidenced by deeds incorporating covenant or stipulation for payment of compound interest at reasonable rates, and authorising the creditor to capitalise the interest on remaining unpaid so as to enable interest being charged at the agreed rate on the interest component of the capitalised sum for the succeeding period. Interest once capitalised, sheds its colour of being interest and becomes a part of principal so as to bind the debtor/borrower."

[emphasis supplied]

In the Arbitration Act, 1940 (`old Act' for short) there was no provision dealing with the power of arbitral tribunals to award interest. Section 29 of the old Act merely provided for post-decree interest and authorized the court to direct in the decree, where the award was for payment of money, payment of interest from the date of decree at such rate as the court deemed reasonable, to be paid on the principal sum as adjudged by the award and confirmed by the decree. The power of arbitral tribunals to award interest was governed by the provisions of Interest Act, 1978 and the law enunciated by courts.

The Arbitration and Conciliation Act, 1996, on the other hand contains a specific provision dealing with the power of the arbitral tribunal to award interest The said provision is incorporated in sub-section (7) of Section 31 which deals with the form and contents of arbitral awards. The said sub- section (7) is extracted below :-

"31(7)(a) Unless otherwise agreed by the parties, where and insofar as an arbitral award is for the payment of money, the arbitral tribunal may include in the sum for which the award is made, interest, at such rate as it deems reasonable, on the whole or any part of the money, for the whole or any part of the period between the date on which the cause of action arose and the date on which the award is made.

(b) A sum directed to be paid by an arbitral award shall, unless the award otherwise directs, carry interest at the rate of eighteen percent per annum from the date of the award to the date of payment."

Section 31(7) makes no reference to payment of compound interest or payment of interest upon interest. Nor does it require the interest which accrues till the date of the award, to be treated as part of the principal from the date of award for calculating the post-award interest. The use of the words "where and in so far as an arbitral award is for the payment of money" and use of the words "the arbitral tribunal may include in the sum for which the award is made, interest'...... on the whole or any part of the money" in clause (a) and use of the words "a sum directed to be paid by an arbitral award shall carry interest" in clause (b) of sub-section (7) of section 31 clearly indicate that the section contemplates award of only simple interest and not compound interest or interest upon the interest. `

A sum directed to be paid by the award' refers to the award of sums on the substantive claims and does not refer to interest awarded on the `sum directed to be paid by an award' In the absence of any provision for interest upon interest in the contract, the arbitral tribunals do not have the power to award interest upon interest, or compound interest, either for the pre-award period or the post- award period.

The long pendency of arbitration matters either due to prolonged arbitration proceedings or due to litigations (both intervening and post-arbitral), has the unfortunate effect of swelling the interest payable on the amount awarded and costs to very substantial amounts. In many arbitral awards for money, the interest awarded often exceeds the amount awarded, by several times.

Leisurely arbitrations, avoidable judicial interventions, and indecisiveness on the part of decision makers in government and statutory bodies in accepting and settling genuine claims either at the stage when the claim is made or at least at the stage when the award is made have resulted in undue emphasis and importance being bestowed upon interest and costs. However substantial their quantum may be in given case, interest in particular interest from the date of the award, and costs are ancillary issues and are not substantive disputes.

If that was the legislative intention, there would have been no need for vesting discretion in Arbitral Tribunals, in the matter of interest, under section 31(7)(a). The principles relating to award of interest, in general, are not different for courts and arbitral tribunals, except to the extent indicated in section 31(7) of the Act and CPC. A comparatively high rate of post-award interest is provided in section 31(7)(b) of the Act, not because 18% is the normal rate of interest to be awarded in arbitrations, but purely as a deterrent to award-debtors from avoiding payment or using delaying tactics. In fact a provision similar to section 31(7)(b) of the Act, if provided in section 34 of Code of Civil Procedure, will considerably reduce the travails of plaintiffs in executing their decrees in civil cases.

The difference between clauses (a) and (b) of section 31(7) of the Act may conveniently be noted as under:

(i) Clause (a) relates to pre-award period and clause (b) relates to post-award period. The contract binds and prevails in regard to interest during the pre-award period. The contract has no application in regard to interest during the post-award period.

(ii) Clause (a) gives discretion to the Arbitral Tribunal in regard to the rate, the period, the quantum (principal which is to be subjected to interest) when awarding interest. But such discretion is always subject to the contract between the parties. Clause (b) also gives discretion to the Arbitral Tribunal to award interest for the post-award period but that discretion is not subject to any contract; and if that discretion is not exercised by the arbitral Tribunal, then the statute steps in and mandates payment of interest, at the specified rate of 18% per annum for the post-award period.

(ii) While clause (a) gives the parties an option to contract out of interest, no such option is available in regard to the post-award period.

In a nutshell, in regard to pre-award period, interest has to be awarded as specified in the contract and in the absence of contract as per discretion of the Arbitral Tribunal. On the other hand, in regard to the post-award period, interest is payable as per the discretion of the Arbitral Tribunal and in the absence of exercise of such discretion, at a mandatory statutory rate of 18% per annum.

The Supreme Court had attempted to set out the legal position regarding award of interest by the arbitral tribunals, as emerging from section 31(7) of the Act to remove some confusion as to what section 31(7) authorizes and what it does not authorize.

The provision for interest in the Act contained in section 31 is dealing with the form and contents of arbitral award. It employs two significant expressions "where the arbitral award is for payment of money" and "the arbitral tribunal may include in the sum for which the award is made, interest..... on the whole or any part of the money". The legislature has thus made it clear that award of interest under sub-section (7) of section 31 (and award of costs under sub-section (8) of Section 31of the Act) are ancillary matters to be provided for by the award, when the arbitral tribunal decides the substantive disputes between the parties. The words `sum for which the award, is made' and `a sum directed to be paid by an arbitral award' contextually refer to award on the substantive claims and not ancillary or consequential directions relating to interest.

The authority of the arbitral tribunals to award interest, under section 31(7)(a) is subject to the contract between the parties and the contract will prevail over the provisions of section 31(7)(a) of the Act. Where the contract between the parties contains a provision relating to, or regulating or prohibiting interest, the entitlement of a party to the contract to interest for the period between the date on which the cause of action arose and the date on which the award is made, will be governed by the provisions of the contract, and the arbitral tribunal will have to grant or refuse interest, strictly in accordance with the contract. The arbitral tribunals cannot ignore the contract between the parties, while dealing with or awarding pre-award interest. Where the contract does not prohibit award of interest, and where the arbitral award is for payment of money, the arbitral tribunal can award interest in accordance with Section 31(7)(a) of the Act, subject to any term regarding interest in the contract.

If the contract provides for compounding of interest, or provides for payment of interest upon interest, or provides for interest payable on the principal upto any specified stage/s being treated as part of principal for the purpose of charging of interest during any subsequent period, the arbitral tribunal will have to give effect to it. But when the award is challenged under Section 34 of the Act, if the court finds that the interest awarded is in conflict with, or violating the public policy of India, it may set aside that part of the award.

Where an arbitral tribunal awards interest under section 31(7)(a) of the Act, it is given discretion in three areas to do justice between the parties. First is in regard to rate of interest. The Tribunal can award interest at such rate as it deems reasonable. The second is with reference to the amount on which the interest is to be awarded. Interest may be awarded on the whole or any part of the amount awarded. The third is with reference to the period for which the interest is to be awarded. Interest may be awarded for the whole or any part of the period between the date on which cause of action arose and the date on which the award is made.

The Act does away with the distinction and differentiation among the four interest bearing periods, i.e., pre-reference period, pendente lite period, post-award period and post-decree period. Though a dividing line has been maintained between pre-award and post-award periods, the interest bearing period can now be a single continuous period the outer limits being the date on which the cause of action arose and the date of payment, subject to however the discretion of the arbitral tribunal to restrict the interest to such period as it deems fit.

Clause (b) of Section 31(7) is intended to ensure prompt payment by the award-debtor once the award is made. The said clause provides that the "sum directed to be paid by an arbitral award" shall carry interest at the rate of 18% per annum from the date of award to the date of payment if the award does not provide otherwise in regard to the interest from the date of the award. This makes it clear that if the award grants interest at a specified rate up to the date of payment, or specifies the rate of interest payable from the date of award till date of payment, or if the award specifically refused interest, clause (b) of Section 31 will not come into play. But if the award is silent in regard to the interest from the date of award, or does not specify the rate of interest from the date of award, then the party in whose favour an award for money has been made, will be entitled to interest at 18% per annum from the date of award. He may claim the said amount in ex*****on even though there is no reference to any post award interest in the awards. Even if the pre-award interest is at much lower rate, if the award is silent in regard to post-award interest, the claimant will be entitled to post-award interest at the higher rate of 18% per annum. The higher rate of interest is provided in clause (b) with the deliberate intent of discouraging award-debtors from adopting dilatory tactics and to persuade them to comply with the award.



[1] Author: Dr. Ashwinie Kumar Bansal, LLB, FCS, Ph.D.; Advocate, Supreme Court of India, New Delhi and Arbitrator & Mediator, Punjab and Haryana High Court, Chandigarh, India. He has authored nine books and many articles on Arbitration, Building & Engineering Contracts and Construction Law.