Dont reinvent the wheel Infrastructure arbitration award set aside because it used an unknown formula for quantification of damages

The Delhi High Court (Court) passed an order dated 11 May 2020, in the matter of M/s SMS Ltd v Konkan Railway Corporation Ltd (O.M.P. (COMM) 279/2017), wherein it set aside an arbitral award (Award) pertaining to a dispute regarding the construction of a railway line in Jammu and Kashmir (Railway Project). The Award granted M/s SMS Limited (Claimant) compensation amounting to approximately INR 1.73 Crores, as against its aggregate claim of approximately 89 crores. The Court set the Award aside on the grounds that: (a) the Claimant was not at fault for the non-performance and consequent termination of the rate contract between itself and Konkan Railway Corporation Limited (Respondent); and (b) the compensation awarded was egregiously low. It further held that application of the ‘notional proportional loss’ formula by the arbitral tribunal was perverse.

Factual Background

The Respondent was responsible for the execution of a portion of the Railway Project and awarded the tender for the work in relation to a 5 km stretch of the Project to the Claimant. Accordingly, the parties executed a rate contract dated 23 January 2004 (Contract), which was scheduled to be completed by 26 December 2006 (with a completion period for 36.5 months). However, due to various delays due to the problematic terrain in the Himalayas, legal and regulatory issues, unrest in the surrounding population, etc., only 10% of the work envisioned under the Contract was completed on the scheduled date of completion.

Consequently, the Respondent did not levy any penalty, and granted the Claimant an extension till 31 December 2008. The Claimants rejected this extension, stating that any of their proposed workable solutions would require a 4-year extension at the very least (which would lapse in December 2011). Thereafter, the Claimant halted all work pertaining to the Project in May 2007 on the ground of technical impossibility, and the Contract was terminated in October 2007.

Thereafter, the Claimant initiated arbitration proceedings for inter alia the following claims: (i) compensation for machinery remaining idle; (ii) compensation for manpower remining idle; (iii) loss of profits, etc. For example, in an ordinary scenario, the Claimant would have worked-off 85% of the machinery costs under the Contract, i.e., 85% of approximately INR 16,00,00,000. Since it only managed to complete 10% of the work for no fault of its own, it believed that the Respondent was due to compensate it for its loss.

The arbitral tribunal came to the conclusion that the only delay in the execution of the Project which the Respondent was responsible for, was a 10-month delay in arriving at the decision to terminate the Contract, and the Claimant was largely responsible for every other loss it incurred qua the Railway Project. Accordingly, in order to quantify the compensation due to the Claimant, the tribunal applied a formula known as the ‘notional proportionate loss’ formula. Vide the application of the formula, the Claimant was awarded an overall amount of INR 1,73,70,790, which was significantly lower than its aggregate claim of INR 89,65,66,610. Consequently, the Claimant filed a petition before the Court under Section 34 of the Arbitration and Conciliation Act 1996 (Act), praying for either: (a) a declaration that the Award was illegal; or (b) an increase in the compensation awarded therein.

Explanation of the Formula

Calculation of damages is an integral part of any claim and ever since McDermott International Inc v Burn Standard Co Ltd & Ors ((2006) 11 SCC 181), the Indian judiciary has taken paid a lot of attention to the mode of computation of such damages. Different treatises like the ‘Standard Data Book of Morth’ or ‘Hudson’s Building and Engineering Contracts’ and other internationally accepted valuation mechanisms are thus used to arrive at the damages calculation and satisfactory evidence needs to be adduced for the same.

However, as stated hereinabove, the arbitral tribunal in the present case made use of a formula which was referred to as ‘notional proportionate loss’, to arrive at the damages claim. The example cited in the judgment for the operation of the formula for ‘notional proportionate loss’ was that of idling charges of the machinery. The arbitral tribunal took into account the following parameters: (1) Claimant’s overall machinery costs under the Contract: INR 16,00,00,000; (2) Percentage of the machinery costs which were expected to be worked off under the Contract: 85%; (3) Delay caused by the Respondent which merits compensation: 10 months; (4) Total time period envisioned for performance of the Contract: 96 months (the time period from January 2004 till December 2011, which is when the four-year extension after 2007 proposed by the Claimant would lapse); and (5) Apportionment of responsibility for delays and non-performance under the Contract to the Claimant: 50%.

Accordingly, the compensation due for the loss caused from the machinery remaining idle as per the ‘notional proportionate loss’ formula = (85 / 100) x 16,00,00,000 x (10/96) x (50/100) = INR 70,83,000. Other compensation, such as the amount due for manpower remaining idle, was also computed in a similar fashion.

View of the Court

The Court drew multiple conclusions regarding the intricate facts of the case, the most pertinent of which were: (i) for the computation of any compensation due to the Claimant, the relevant overall time period for performance of the Contract cannot be 96 months, because the Contract was conclusively terminated in October 2007 (and not the potential extension till December 2011); and (ii) the overall delay caused to the Claimant by virtue of technical impossibility or the Respondent’s own defaults was much greater than 10 months, and it had to be compensated accordingly.

However, the most pertinent legal element of this judgment is the Court’s ruling on the ‘notional proportionate loss’ formula for quantification of compensation. The Court held that this formula both imputes incorrect variables to its parameters (such as 96 months for the overall time period for performance of the contract, or 10 months for the overall delay), and moreover, such a formula was “unknown”. The Court also noted that the methodology applied for the computation of compensation in such a case was usually that of the Standard Data Book of Morth or the ‘Hudson Formula’, which the present Award failed to account for. The Court held that this Award was not sustainable in law because the decision-making matrix of applying ‘notional proportionate loss’ by the arbitral tribunal was perverse, and accordingly, it was liable to be set aside on the ground of patent illegality under Section 34 of the Act. In this regard, the Court relied on the Supreme Court’s authoritative ruling in Ssangyong Engineering & Construction Co Ltd v National Highways Authority of India (AIR 2019 SC 5041) (Ssangyong).

Comment

The Court has clearly stated that ill-conceived formulae with no precedential backing or industry standard-level of acceptance, such as the formula of ‘notional proportionate loss’ cannot be the basis of quantification of damages in infrastructure arbitrations. It also took specific note of the fact that the formulae propounded in the ‘Standard Data Book of Morth’ or ‘Hudson’s Building and Engineering Contracts’ were not consider by the Tribunal, despite them being relied on in cases like National Highways Authority of India v Hindustan Construction Co (2016 (2) ArbLR 1 (Delhi)), Associate Builders v Delhi Development Authority ((2015) 3 SCC 49), and McDermott International Inc v Burn Standard Co Ltd & Ors ((2006) 11 SCC 181).

This judgement’s reliance on Ssangyong has reiterated the fact that ‘patent illegality’ is a ground for setting aside of a domestic award and the judgment also goes on to: (1) conclusively state that a court may look into factors such as the method of quantification of compensation employed by the tribunal when conducting an analysis of whether an award may be set aside under Section 34 of the Act; and (2) further cements Ssangyong’s place as the leading recent judgment on the challenge of an arbitral award on public policy grounds, as can also be seen in cases like National Agricultural Co-Operative Marketing Federation of India v Alimenta S.A., (Civil Appeal No 667 of 2012 in the Supreme Court) and Vijay Karia & Ors v Prysmian Cavi E Sistemi SRL & Ors (Civil Appeal No. 1544 of 2020 in the Supreme Court). It would be interesting to see how parties and lawyers read this judgment and if it is argued that this amounts to widening the scope of Section 34 proceedings.

The key issue which also merits consideration is whether in such situations, courts can modify an award, if it is just about a wrong calculation of the damages. Post the 2015 Amendment, the scope of Section 34 has been narrowed further, and there has been a fair amount of deliberation on the fact that the Court in Section 34 proceedings is not to hear the proceedings as if in an appeal. It remains to be seen how courts will exercise their powers in such cases going forward.

-          Raj R. Panchmatia (Partner), Manavendra Mishra (Principal Associate), and Rajeswari Mukherjee (Associate)

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