A civil construction dispute is invariably a smorgasbord of contentious issues like price escalation, variation in quantities and/or costs, force majeure events and technical hindrances. Given the complex nature of a construction dispute and the claims involved, arbitration is increasingly becoming the preferred choice of parties as an ADR mechanism because of the flexibility and effectiveness it offers. However, the arbitrator(s) in such disputes must wear the hat of a legal interpreter, economist and a mathematician, a vocation few will be envious of.
In the recent decision of Satluj Jal Vidyut Nigam v. M/s Jaiprakash Hyundai Consortium & Ors.[i] (“Satluj v. JP”), the Hon’ble Delhi High Court highlighted the duty of care expected from arbitrators in complex construction contracts involving mathematical formulae. The Court navigated through the web of numbers weaved by the parties and concluded that re-writing of contractual clauses was not allowed at the stage of arbitration. Importantly, Satluj v. JP contemplates the heavy consequences of applying arbitrary methodologies in complex construction contracts carrying a huge financial burden on either of the parties.
ISSUES AND ANALYSIS OF THE COURT
The issue arose from the incremental increase in the minimum wages of labour vide successive notifications of the State Government. The Claimant (Contractor) contended that such increase could not have been foreseen at the time of tendering and that the increase was not contemplated in the indexing of any inputs to the Price Adjustment Formula.
The Court agreed with the findings of the Tribunal that notifications issued by the State Government revising the minimum wages under the Minimum Wages Act, 1958 amount to ‘subsequent legislation’ as defined in the contract. The Court regarded the settled legal position that interpretation of the contract is the domain of the arbitral tribunal and arrived at its finding. However, the Court did not appreciate the findings of the Tribunal regarding the calculations.
Alternate Hypothesis of the Claimant: Actual Cost v. Mathematical Derivation
The subject of Court’s consternation was the determination of additional costs claimed by the Claimant. In its Statement of Claim (“SOC”), the Claimant sought to alter/substitute the contractual formula by replacing one set of inputs/indices with another. The Court agreed with the Tribunal’s view that calculations by way of a formula not provided in the contract, were not permitted. However, the Court deprecated the Tribunal’s approach of accepting an alternate hypothesis of the Claimant regarding actual payments, which was unsupported by any pleading or evidence.
The Claimant, without amending its SOC, had proffered an alternate hypothesis before the Arbitral Tribunal. The Claimant had calculated the additional costs of unskilled labour not on basis of actual expenditure, but on the premise that labour expenditure amounts to 10% of the total work done under the contract. This cost was also proportionately increased with the increase in minimum wages to reach the final additional cost of unskilled labour. The Claimant had although labelled this additional expenditure as actually paid’, however, the Court observed that the same was not based on actuals but only a mathematical derivation unsupported by evidence of actual amount expended by the Claimant. The Court carefully considered the Claimant’s assertions that it could base its damages on a formula recognised by various judgments of the Apex Court.[ii] However, the Court distinguished this argument by opining that in the instant case, the mathematical formula was being used to calculate an ‘actual payment’, which would be perverse.[iii]
The Court also noted that the Tribunal itself had rejected a different formula deployed by the Claimant in its SOC, which varied from the contractual formula. However, contrarily, the Tribunal unflinchingly accepted a mathematical derivative to calculate the actual expenditure.
Faulty methodology for adjustment of payments already made to the Claimant
The Court further expressed its doubts on the methodology accepted by the Tribunal for determining net claim of the Claimant after adjusting the payments already made to the Claimant. From the ‘actual’ expenditure of the Claimant, two components needed to be subtracted (i) the Bill of Quantities item rates (“BOQ”) of the Claimant given at the time of tendering which factored in labour wages and (ii) payments already made to the Claimant by the Respondent for price escalation. It so happened that the sum of these two components well exceeded the amount claimed by the Claimant for additional costs of labour, rendering them unable to raise a claim.
However, the Court observed that in order to circumvent this unfavourable circumstance, the Claimant had resorted to adopting another novel technique. At the time of bid, the Claimant had assessed the labour component to be 10% of the contract value. The additional cost paid to the Claimant by the Respondent vide the price escalation formula was based on 30% of the contract value. The Claimant contended that that the price escalation had to be proportionally scaled down (by 1/3rd) and the Claimant should be considered to have paid a notional reduced value. The Tribunal accepted the contention of the Claimant, which the Court proceeded to reject on the basis of being perverse, unreasoned and amounting to re-writing the contract. The Court reasoned that it would be absurd to proportionally and notionally reduce the sum paid to the Claimant in this manner, even though the Claimant had actually pocketed a larger sum.
CONCLUSION: ARBITRATOR’S DUTY OF CARE IN COMPLEX TRANSACTIONS
In Satluj v. JP, the Court highlighted the duty of care that arbitrators must exercise in dealing with financial claims in complex construction contracts. The Court took aid of Mustill and Boyd: Commercial Arbitration[iv]and Gary B. Born: International Commercial Arbitration[v]to highlight thearbitrator’s moral obligation to perform his/her duties and to apply skill, ability and diligence to complex disputes.
The Court makes pertinent observations in Satluj v. JP that are likely to have a meaningful impact in the construction arbitration space. It is only but a reality that construction arbitrations involve complex calculations based on formulas that have been pre-determined in contracts. Price escalation clauses in construction contracts are of particular importance as they tackle the issues of price uncertainty on account of inflation and help with budgeting of a project.[vi] The cushion of a price escalation clause keeps the ship afloat in uncertain times of fluctuating costs of materials and labour. Since price escalation is based on multiple economic variables, it is important that these clauses are supported by sound price indices to provide certain fixed measures. The parties’ consent to the use of these formulas at the time of entering into the contract is important. Naturally, it would render such clauses meaningless if the parties were to unilaterally offer a variation at the time of dispute – an issue highlighted and discussed in Satluj v. JP.
Even if the variation in formulas is sound and based on logic, it is well-settled that arbitrators cannot traverse beyond the confines of a contract. However, the arbitrators have wide powers to ‘interpret’ the contract.[vii] But the Court in Satluj v. JP found that the Tribunal’s findings were not interpretation but re-writing of the contract. The Court also repeatedly observed that the Claimant’s contentions were neither rooted in pleadings nor in evidence – a valuable observation on the procedure and conduct of arbitral proceedings. It is often observed that the rigors of procedural statutes like the Civil Procedure Code, 1908, The Evidence Act, 1872, etc., do not usually apply to arbitrations in the traditional sense. . The awards challenged on the basis of procedural irregularity often face scrutiny, if such irregularity has prejudiced the other side considerably.
Often it is seen that a complex civil construction dispute is adjudicated upon by a three-member Tribunal partly consisting of expert arbitrator(s). However, even with the expertise of the arbitrator(s), the parties may feel the need to present their case with the aid of experts in order to equip the arbitrators with all prevailing viewpoints. The tribunals are also increasingly resorting to the know-how of experts and appointing them on their own to better adjudicate a dispute – a positive and a welcome trend. In such cases, where the materials have been tested at evidence and evaluated by the experts, there are more chances of the tribunal’s duties being delineated and allaying the burden of mathematical prowess. This is likely to result in an award which would not be so vulnerable to challenge. However, it is not uncommon that civil construction disputes may only involve the services of party representatives/pleaders and an arbitrator, leaving the parties to their own devices. The arbitrators in such cases have an increased burden of duty of care, as highlighted in Satluj v. JP, a judgment which will be significant while decoding mathematical jargon often seen in construction arbitrations.
For further information, please contact:
Gauhar Mirza, Partner, Cyril Amarchand Mangaldas
gauhar.mirza@cyrilshroff.com
[i] O.M.P. (COMM) 170/2017 [Judgment dated 12.07.2023; Delhi HC].
[ii] McDermott International Inc. v. Burn Standard Co. Ltd., (2006) 11 SCC 181.
[iii] H. B. Gandhi, Excise and Taxation Officer-cum-Assessing Authority, Karnal & Ors.v. M/s Gopi Nath &Sons & Ors., 1992 Supp (2) SCC 312; Associate Builders v. Delhi Development Authority, (2015) 3 SCC 49.
[iv] Sir Michael J. Mustill, Stewart C. Boyd – Commercial Arbitration (Second Edition), PP. 224.
[v] Gary B. Born, International Commercial Arbitration, Second Edition, PP. 1992.
[vi] See Dr. N. B. Chaphalkar, Ms. Sayali S. Sandbhor, ‘Wholesale Price Index and its effect on Price Escalation of materials for Indian construction industry’; (IJERT) Vol. 1 Issue 3, May – 2012.
[vii] Supra Note ii; Dyna Technologies Pvt. Ltd. v. Crompton Greaves Ltd., 2019 SCC OnLine SC 1656
