GRANT OF PRE-REFERENCE INTEREST IN ARBITRATION

[Mr. M. GOVINDARAJAN]

Pre-reference interest is the interest that accrues on the awarded sum from the date the cause of action arises until the date the dispute is referred to the arbitral tribunal. The award of such interest is rooted in the principle of just compensation. A party deprived of its rightful dues loses not only the principal amount but also the potential interest on that amount. Pre-reference interest aims to compensate for this loss of opportunity and place the aggrieved party in the financial position it would have been in had the breach not occurred.

Under Arbitration Act, 1940 there was no specific provision to award interest by the Arbitrator.  The Supreme Court, through various judgments, has affirmed the power of the Arbitrator to grant pre-reference, pendente lite and post award interest.  The award of interest a person who has been deprived of the use of his legitimate money to which he is legitimately entitled has a right to be compensated for the loss. 

Section 31(7) of the Arbitration and Conciliation Act, 1996 (‘Act’ for short) provides that unless otherwise agreed by the parties, where and in so far 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.  A sum directed to be paid by an arbitral award shall, unless the award otherwise directs, carry interest at the rate of 2% higher than the current rate of interest prevalent on the date of award, from the date of award to the date of payment.

The current rate of interest is the highest of the maximum rates at which interest may be paid on different classes of deposits (other than those maintained in savings account or those maintained by charitable or religious institutions) by different classes of scheduled banks in accordance with the directions given or issued to banking companies generally by the Reserve Bank of India under the Banking Regulation Act, 1949. 

In SECRETARY, IRRIGATION DEPARTMENT, GOVT. OF ORISSA VERSUS GC. ROY - 1991 (12) TMI 268 - SUPREME COURT, the Supreme Court held that when the agreement does not prohibit the grant of interest and a party claims interest, it is presumed that interest is an implied term of the agreement and therefore the Arbitrator has the power to award the same.

Section 31(7) has two parts-

• The Arbitrator can award interest for the period between the date of cause of action to the ate of award, unless otherwise agreed by the parties.
• Unless award directs otherwise, the sum directed to be paid by an arbitral award shall carry interest @ 2% higher than the current rate of interest from the date of the award to the date of payment.

Section 31(7) makes a departure from the Arbitration Act in the following ways-

• It does not make an explicit difference between the pre-reference and pendente lite interest as both of them are provided under Section 31(7)(a).
• It sanctifies party autonomy and restricts the power to grant pre-reference and pendente lite interest the moment the agreement bars payment of interest, even if it is not a specific bar against the Arbitrator.

The power of the Arbitrator to award pre-reference and pendente lite interest is not restricted when the agreement is silent on whether interest can be awarded or does not contain a specific term that prohibits the same.

The pendente lite interest is a matter of procedural law.  The pre-reference interest is governed by substantive law.  Therefore, the grant of pre-reference interest cannot be sourced solely in Section 31(7) of the Act, a procedural law but must be based on agreement between the parties express or implied, statutory provision (Section 3 of the Interest Act, 1978 or proof of mercantile usage.

The State of West Bengal awarded Pam Developments Private Limited a contract for a road-widening and strengthening project. Subsequent delays in the project led Pam Developments to raise claims for various losses, including interest on delayed payments. The dispute was referred to arbitration, and the arbitrator awarded Pam Developments a sum of INR 1,37,25,252 along with interest.   The State challenged the award under Section 34 of the Act and the District Judge partly allowed the challenge, setting aside certain claims. Both parties appealed to the Calcutta High Court under Section 37 of the Act.  The High Court further modified the award, setting aside the pre-reference interest component as awarded by the Arbitral Tribunal.

Pam Developments then approached the Supreme Court, challenging the High Court decision. The Supreme Court upheld the arbitrator’s power to award pre-reference interest, emphasizing that such power stemmed from Section 31(7)(a) of the Act and could only be restricted by a clear and unambiguous clause in the agreement between the parties explicitly prohibiting the grant of pre-reference interest. The Apex Court also clarified the distinction between the power of the Arbitral Tribunal to award interest and the right of a party to claim such interest, stating that the right to claim should be grounded in the agreement/contract, substantive law, or applicable trade usage. The Supreme Court restored the arbitrator’s award that had granted the pre-reference interest.

The Supreme Court’s decision in the Pam Developments case serves as a watershed moment in the jurisprudence on pre-reference interest, considering it reaffirmed the arbitrator’s power to award such interest, even when the contract was silent on the matter. The Court held that the power to grant interest stemmed from Section 31(7)(a) of the Act and could only be curtailed if a clear and unambiguous clause in the agreement between the parties explicitly prohibited the granting such interest.

The judgment in Pam Developments is particularly significant because it clarifies the interplay between the arbitrator’s power and the parties’ contractual freedom. It emphasizes that the Act empowers the arbitrator to award interest, but this power is not absolute and is subject to the parties’ right to exclude such power contractually. However, for such exclusion to be effective, it must be clear, specific, and unambiguous.’

 The Pam Developments case has provided a comprehensive understanding of the law on pre-reference interest in India. It has reinforced the arbitrator’s authority to grant such interest while emphasizing the importance of party autonomy and the need to incorporate the claim for interest in substantive law or contractual provisions.

Reference:

1. https://disputeresolution.cyrilamarchandblogs.com/2024/09/the-evolving-landscape-of-pre-reference-interest-in-indian-arbitration-regime/.