In a recent judgment that might serve as a guideline for drafting future construction contracts, the Supreme Court has said that whether or not time is of essence in a contract, for claiming liquidated damages, depends more on the circumstances of the case than on any provision in the contract.
In other words, you may put in your contract with the supplier of a construction service a covenant that says, “if you don’t complete the supply by this date, you shall be liable to pay liquidated damages”. But that won’t help you. The mere existence of such a provision is not enough.
The judgment also brings into focus an important legal doctrine – contra proferentem – which says that if there is an ambiguity in the wording of a contract, it should be interpreted against the entity that created the clause.
The Supreme Court judgment relates to a dispute between ONGC and Welspun Specialty Solutions Ltd and its origins date back to 1995 when ONGC placed an order on Remi Metals (which later became Welspun) for the supply of 393 km of seamless steel pipes. The contract specifically mentioned that the time and the date of the delivery shall be the essence of the contract.
There were many delays in the execution of the purchase orders and ONGC kept giving extensions while also deducting liquidating damages from the payment – which led to the dispute.
The dispute reached the Arbitral Tribunal. The Tribunal ruled in favour of Welspun. It held that merely having a clause in the contract making time the essence of it “would not be determinative”, rather, an overall view having regard to all the terms of the contract are to be taken into consideration. It also said that “generally, under construction contracts, time is not of the essence.”
In a telling judgment, the Apex Court presided by the Chief Justice of India, NV Ramana, observed that “whether the time is of the essence in a contract has to be culled out from the reading of the entire contract as well as the surrounding circumstances. Merely having an explicit clause may not be sufficient to make time the essence of the contract”.
Two provisions in the contract seemed in conflict. One, the mention that time is of the essence, and two, the existence of an extension procedure. The existence of the extension procedure and the imposition of liquidated damages (the Arbitral Tribunal held and the Supreme Court upheld) were good indicators that time was not the essence of the contract.
This was the argument of the counsel for Welspun, Shyam Divan, and the Apex Court found merit in it. ONGC had wanted to deduct $8,07,804 and ₹1.05 lakh, while the Arbitral Tribunal would only go as far as to award as compensation only the actual loss suffered by ONGC, which was ₹2.09 crore.
‘No precise language’
The setting aside of the liquidated damages in favour of the actual loss was also sustained because of the “absence of precise language allowing for the reimposition of the liquidated damages,” the judgment says. Here is where the doctrine of contra proferentem enters the picture.
If there is a lack of clarity in the wordings of a contract, the interpretation goes against the entity that introduced it – a penalty for drafting it poorly. Typically, it is the party with bigger bargaining power in a contract that introduces clauses such as for liquidated damages.
In this case, ONGC had used a template for its contract. The case was also argued by ONGC on the basis of Section 34 of the Arbitration Act, which says that an arbitral award could be set aside “if it is in conflict with the public policy of India”. Chief Justice Ramana would have none of it. “The phrase ‘public policy’ does not indicate ‘a catch-all provision’ to challenge awards before an appellate forum on infinite grounds,” he says in the judgment.
“The purpose of Section 34,” Justice Ramana observes, “is to strike a balance between the Court’s appellate powers and the integrity of the arbitral process.”
Writing in Mondaq , Ashima Obhan and Seerat Bhutani, advocates with Obhan & Associates, recommend that “parties should ensure that their conduct is consistent with the understanding of the contract where time is of the essence.”
Abhishek Subbiah, Managing Partner, Bridge Legal, observes in an article in Apex Jurisprudence that “the conduct of parties has begun to become increasingly more critical to the judicial process of determining the actual contours of what is the quintessentially complex contractual relationship.”
Noting that the judgment provides insights on “how to better draft our contracts,” Subbiah says, “time isn’t of essence only because you say it is.”