An overview of an arbitrator’s power to grant interest on interest in an award.

We find it necessary to examine the issue of whether the courts or the arbitrators have the power to grant interest on interest over the principal sum in an award or decree. We have written this article after the recent Supreme Court’s judgment in the case of M/S D. Khosla and Company vs. The Union of India (SPECIAL LEAVE PETITION (CIVIL) NO.812 OF 2014) delivered by Hon’ble Justice Pamidighantam Sri Narasimha and Justice Pankaj Mithal. This short judgment tends to deal with the power of an arbitrator or a court to grant interest on interest.

This article is primarily based on the aforementioned judgment. We do find that the present article and the above case law tend to help our professionals use this as a precedent when an award or decree is passed with a relief granting interest on interest towards the parties, or when arbitrators have the power to grant compound interest in the award. This article provides insights into when the arbitrator or court is provided with the power to grant interest on interest and when they do not have those powers.

At the outset, this article tends to interpret three legislations: the erstwhile Arbitration Act, 1940, the Code of Civil Procedure, and the new Arbitration Act, 1996. In a nutshell, the first and second legislations do not grant powers to the arbitrator or court to award or decree interest on interest or compound interest. However, the new Arbitration Act, 1996, tends to provide powers to the arbitrator to grant interest on interest or compound interest. In this article, you will find the clear distinctions made by our Supreme Courts through various case laws.

Arbitrator and Courts’ power to grant interest on interest or compound interest under the erstwhile Arbitration Act, 1940, and the Code of Civil Procedure (CPC).

The recent judgment of M/S D. Khosla and Company vs. The Union of India is a case where an award was passed under the erstwhile arbitration regime, which was critically analyzed. While analyzing the case, the Supreme Court made it clear that the courts or the arbitrator do not have the power to grant interest on interest. However, the court had enshrined some specific exceptions to such observations, which we have dealt with in the forthcoming paragraphs.

The relevant provisions are reproduced here for your reference:

Section 34 of the Code of Civil Procedure, Interest: (1) Where and in so far as a decree is for the payment of money, the Court may, in the decree, order interest at such rate as the Court deems reasonable to be paid on the principal sum adjudged, from the date of the suit to the date of the decree, in addition to any interest adjudged on such principal sum for any period prior to the institution of the suit, [with further interest at such rate not exceeding six per cent. per annum as the Court deems reasonable on such principal sum], from the date of the decree to the date of payment, or to such earlier date as the Court thinks fit.

Section 3(3)(c) of the Interest Act, 1978: (3) Nothing in this section, … (c) shall empower the court to award interest upon interest.

The Supreme Court had analyzed the above two provisions and categorically observed that the courts or the arbitrator do not have the power to award interest on interest, as the provisions only enable the interest to be awarded on the principal amount adjudged, and there is an explicit bar on the Interest Act, 1978, for the court not to provide interest on interest.

In connection with the above proposition, the Apex Court had cited certain precedents, which are as follows:

• Oil and Natural Gas Commission vs. M.C. Clelland Engineers S.A. (1999):

Gist: The Court held that interest is not permissible on interest awarded, but only on the original claim. However, if the claim itself includes interest as part of the damages or compensation, then interest can be awarded on such interest.

• State of Haryana and Others vs. S.L. Arora and Company (2010):

Gist: The Court observed that interest, unless otherwise specified, refers to simple interest and is payable only on the principal amount, not on any accrued interest. The court also held that compound interest can be awarded only if there is a specific provision in the statute or contract.

In view of the above precedents, the Apex Court had drawn the conclusion that interest on interest cannot be awarded or decreed by the arbitrator or the courts.

The court also had made certain exceptions to the above case in this regard. The scenarios are:

1. When the agreement or contract itself provides such a provision of levying interest on interest, or
2. When a specific statute provides for levying such interest on interest,

then an award to that effect can be made.

Now, another question arises as to whether the courts or the arbitrator are empowered to grant simple interest or compound interest to the parties. This is also where the courts have categorically stated that unless there is a specific provision in a statute or if there is a specific provision stipulated in the contract terms, they cannot grant such interest.

We can see that the case of M/S D. Khosla and Company vs. The Union of India deals with the interpretation of the erstwhile Arbitration Act, 1940, wherein there is no specific provision stipulated for providing interest through an award by the arbitrator. However, a conjoint reading of Section 17 of the erstwhile Act and Section 34 of the CPC clarified that the arbitrator was envisaged with the power to grant interest. Now the question arises as to whether this case law can be used for the new Act, i.e., the Arbitration Act, 1996, as well.

Arbitrator’s power to grant interest on interest and compound interest under the Arbitration Act, 1996.

When we peruse Section 31(7) of the Arbitration Act, 1996, it uses the phrase “sum directed to be paid by award” and does not explicitly use the word “principal” anywhere, as specified in Section 34 of the CPC.

To find out whether the phrase “sum directed to be paid” only means the principal amount or it includes the power to award interest on interest as well, was categorically clarified by the Supreme Court in the case of Hyder Consulting (UK) Limited, in which the Apex Court took a majority view comprising a five-judge bench. The majority view in the said judgment was:

The interest on interest or the compound interest can be awarded, as the phrase “sum directed to be paid” may include pre-award interest plus the principal amount, and the specification of any post-award interest over the sum (pre-award interest + principal) is well within the realm of the arbitrator. This proposition is followed by the UHL Power Company Limited vs. State of Himachal Pradesh (2022).

To answer this question further, we can also rely upon yet another recent judgment of the Hon’ble Supreme Court in the case of Pam Developments Pvt Limited versus The State of West Bengal and Anr (CIVIL APPEAL NOs. 9781-9782 of 2024), wherein, our Hon’ble Supreme Court had categorically held that the arbitrator is empowered to award pre-reference interest and pendente lite interest under the new arbitration act when the arbitration agreement does not contain any explicit bar restraining such interest. The court in this case had relied upon the following cases:

• Sayeed Ahmed and Company v. State of Uttar Pradesh (2009): Interpreted Section 31(7)(a) of the 1996 Act as restricting arbitrator’s power to grant interest when the agreement bars it.
• Central Bank of India v. Ravindra (2002): Distinguished between pre-reference interest (substantive law) and pendente lite interest (procedural law).
• Jaiprakash Associates Limited v. Tehri Hydro Development Corporation India Limited (2019): Clarified that arbitrators can award interest when the agreement is silent on the matter.
• Oriental Structural Engineers Private Limited v. State of Kerala (2021): Held that arbitrators can award interest when there’s no specific contractual prohibition.

Summary:

To summarize, it is now clear that the Apex Court had taken different views when it comes to different legislations. The powers of the arbitrator to grant interest on interest or compound interest in the erstwhile regime are restricted, as the legislation does have a specific bar on granting interest over the principal amount only. However, when it comes to the new Arbitration Act, 1996, the Apex Court had taken the view that the arbitrator is generally empowered to grant interest on interest or compound interest, as the words used in the new Act are “sum to be directed,” which includes the principal plus interest as well. However, the caveat here is that while granting interest on interest under the new legislation, the arbitrator is generally restrained when such is disallowed explicitly in the arbitration agreement.

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