2025 (12) TMI 553 - SC - Indian Laws

SC backs contractual 36% compound interest in bill discounting, limits Usurious Loans Act via Sections 31(7)(a), 74

SC upheld the characterisation of the transaction as a bill discounting facility, not a loan, holding the Usurious Loans Act inapplicable. Emphasising ... Nature of commercial contracts between the parties - bill discounting arrangements - transaction between the parties was a loan or a debt, or it was simply in the nature of a commercial transaction? - Grant of interest under the Award and Impugned Orders is opposed to public policy in terms of Section 34(2)(b)(ii) of the Arbitration Act read with Section 80 of the Negotiable Instruments Act, 1881 or not - Section 31(7)(a) and (b) respectively of the Act, 1996 - Is penal interest on penal interest opposed to public policy - Applicability of the maxim 'Verba Chartarum Fortius Accipiuntur Contra proferentem, in the present case - Application of Section 74 of the Contract vis-a-vis Section 31(7)(a) of the Arbitration Act, 1996. Nature of commercial contracts between the parties - HELD THAT:- The crucial difference is that a bill discounting facility is a short-term financing option where a business sells its unpaid invoices to a financial institution for immediate cash, while a business loan is a traditional debt obligation where the business receives a lump sum and is responsible for repaying it with interest. High interest rates are prescribed in a contract, relating to a bill discounting facility primarily due to the higher risk profile of the financing, its nature as a short-term unsecured funding source and the need for the financial institution to compensate for the associated costs and potential for non-payment. The higher rate is a trade-off for the business, which gains immediate liquidity and operational flexibility by paying a premium to offload the waiting period and associated payment risks to a financial institution. In other words, contracts relating to a bill discounting facility typically contain high rates of interest primarily due to the higher risk profile for the lender, the unsecured and short-term nature of the financing, and the quick and hassle-free access to cash it provides. Keeping the fine distinction between a loan and a bill discounting facility in mind, the High Court did well to take the view that the provisions of the Usurious Loans Act, 1918 would not be applicable in the present case. The High Court said so because in the present litigation the commercial transaction was one relating to the bill discounting facility and not a loan. The Usurious Loans Act, 1918 would apply to a loan and not to transaction relating to bill discounting facility. Section 31(7)(a) and (b) respectively of the Act, 1996 - HELD THAT:- From a conjoint analysis of Section 31(7)(a) and Section 31(7)(b) of the Act, 1996 respectively what is discernible is that insofar award of interest from the date on which the cause of action arose till the date of the award is concerned, the legislative intent is that the parties possess the autonomy to determine the interest and the rate of interest for the aforesaid period. Clause (a) i.e. discretion of the arbitral tribunal to award interest is subject to agreement by and between the parties. Therefore, party autonomy takes precedence over the discretion of the arbitral tribunal. However, clause (b) is subject to award of interest by the arbitral tribunal. In other words, as per clause (b), the ‘sum’ directed to be paid under an arbitral award shall carry interest at the rate of 18% p.a. from the date of the award to the date of payment ‘unless the award otherwise directs’. Therefore, this provision is subject to award of interest by the arbitral tribunal. If it awards interest, then the same shall be applicable from the date of the award till the date of payment; if not, then the ‘sum’ as adjudged under clause (a) shall carry interest at the rate of 18%. After the amendment in 2015 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. A two-Judge Bench of this Court in S.L. Arora [2010 (1) TMI 1261 - SUPREME COURT] considered the question as to whether Section 31(7) of the Act, 1996 authorises and enables arbitral tribunals to award interest on interest from the date of the award? In the facts of that case, the consequential question formulated was as to whether the arbitral award granted future interest from the date of award, only on the principal amount found due to the respondent or on the aggregate of the principal and interest up to the date of the award? After an analysis of the aforesaid provision, the Bench observed that Section 31(7) makes no reference to payment of compound interest or payment of interest upon interest. It was held that in the absence of any provision for interest upon interest in the contract, arbitral tribunals do not have the power to award interest upon interest or compound interest either for the pre-award period or for the post-award period. The view of the court is clearly discernible in that the discretion to grant interest would be available to the arbitral tribunal under clause (a) of sub-section (7) of Section 31 only when there is no agreement to the contrary between the parties. When the parties agree with regard to any of the aspects covered under clause (a) of subsection (7) of Section 31, the arbitral tribunal would cease to have any discretion with regard to the aspects mentioned in the said provision. Only in the absence of such an agreement, the arbitral tribunal would have the discretion to exercise its powers under clause (a) of sub-section (7) of Section 31 of the Act, 1996. Is penal interest on penal interest opposed to public policy - HELD THAT:- Public policy is dictated by the law-making power the legislature, and is found in the general tenor of statutes, and in direct enactments. When the legislature, within the powers conferred by the constitution, has declared the public policy, and fixed the rights of the people by statute, the courts cannot declare a different policy or fix different rights. Section 74 of the Indian Contract Act explicitly bars any liquidated damages to be paid which is in the nature of penalty. However, the Act does not define “penalty”. A clause is considered to be in the nature of penalty if it provides for “a payment of money stipulated as in terrorem of the offending party” or, if the clause's contractual nature is “deterrent rather than compensatory”. On the other hand, a clause is said to be one of liquidated damages if it is a genuine endeavour by the parties to stipulate the loss arising out of the breach in advance. The nature of the clause would also depend on its construction and the encompassing circumstances during the time of entering into the contract or at the time of doing the material variation in the contract. It is well settled that a contract is a commercial document between the parties, and it must be interpretated in such a manner so as to give efficacy to the contract rather than to invalidate it in the name of public policy, unconscionability etc. It is equally well settled principle that the terms of the contract executed between two parties, are not open to judicial scrutiny unless the same is arbitrary, discriminatory, mala fide or actuated by bias. The courts should not strike down the terms of a contract because it feels that some other terms would have been fair, wiser or logical. The appellant was in need of finance and on its own will and volition approached the respondent for the same and knowingly entered into the bill discounting facility agreement. Had the appellant abided by the terms and conditions of repayment it could have availed facility of concessional rate as provided in the agreement, however, the appellant just shut its eyes and declined to make the payment for years together. In such circumstances the conditions stipulated in the agreement of compound interest at the rate of 36% monthly rest cannot be termed as burdensome or oppressive in any manner - The grant of pendente lite interest depends upon the phraseology used in the agreement, clauses conferring power relating to arbitration, the nature of claim and dispute referred to the arbitrator, and on what items the power to award interest has been taken away and for which period. Also, the position under Section 31(7) of the 1996 Act, is wholly different, inasmuch as Section 31(7) of the 1996 Act sanctifies agreements between the parties and states that the moment the agreement says otherwise, no interest becomes payable right from the date of the cause of action until the award is delivered. Applicability of the maxim 'Verba Chartarum Fortius Accipiuntur Contra proferentem, in the present case - HELD THAT:- It is a rule of interpretation that contracts are to be interpreted based on their plain meaning, as a whole and in accordance with the language used. It is also a settled principle that in case of any ambiguity, a contract will have to be interpreted taking into consideration the surrounding facts and circumstances. The true construction of a commercial contract must depend upon the import of the words used and not upon what the parties choose to say afterwards. Nor does subsequent conduct of the parties in the performance of the contract affect the true effect of the clear and unambiguous words used in the contract. The intention of the parties must be ascertained from the language they have used, considered in the light of the surrounding circumstances and the object of the contract. The nature and purpose of the contract is an important guide in ascertaining the intention of the parties - It is also a well-recognised principle of construction of a contract that it must be read as a whole in order to ascertain the true meaning of its several clauses and the words of each clause should be interpreted so as to bring them into harmony with the other provisions if that interpretation does no violence to the meaning of which they are naturally susceptible. Application of Section 74 of the Contract vis-a-vis Section 31(7)(a) of the Arbitration Act, 1996 - HELD THAT:- Any question as to the unconscionableness of a stipulation contained in an agreement would probably arise for consideration only if it is shown that the relationship between the contracting parties was such that one of them was in a position to dominate the will of the other and that he had made use of such position to obtain an unfair advantage over the other. It is only in cases where both the conditions mentioned above are clearly established by the person who seeks to avoid the transaction and the court further finds that the bargain is in itself unconscionable that the impugned provision will be held to be unenforceable on the ground of unconscionableness. There are no hesitation in going to the extent of saying that where in a contract under which interest is payable it is agreed between the parties that if such interest be not paid punctually the defaulter shall be liable to pay interest at an enhanced rate, whether from the time of default or from the time when interest first became payable under the contract such agreement does not come within Section 74 of the Indian Contract Act, and is to be construed according to the intentions of the parties as expressed therein and not as a stipulation for a penalty. Such agreement is to be enforced according to its terms, unless it be found to have been when made unconscionable or fraudulent. Appeal dismissed. 1. ISSUES PRESENTED AND CONSIDERED 1.1 Whether the bill discounting arrangements constituted 'loans' or 'debts' so as to attract the Usurious Loans Act, 1918 (as amended by the Punjab Relief of Indebtedness Act, 1934) and Section 80 of the Negotiable Instruments Act, 1881. 1.2 Whether the contractual stipulation of interest at 36% per annum with monthly rests, on withdrawal of the concessional rate of 22.5%, is unconscionable, penal, or opposed to public policy, including under Section 74 of the Indian Contract Act, 1872. 1.3 The scope and effect of Section 31(7)(a) of the Arbitration and Conciliation Act, 1996 on the arbitral tribunal's power to award pre-award interest where the contract stipulates a specific rate of interest. 1.4 Whether 'penal interest on penal interest' or compounding of interest at 36% per annum in this commercial bill discounting facility can be treated as a penalty or as contrary to the 'public policy of India' for purposes of Sections 34 and 37 of the Arbitration and Conciliation Act, 1996. 1.5 Whether the maxim 'verba chartarum fortius accipiuntur contra proferentem' and the contra proferentem rule of construction are applicable to interpret clause 4 of the sanction letters in this commercial contract. 1.6 Whether the withdrawal of the concessional rate of interest in the absence of a separate 'notice' to that effect vitiated the arbitral award or infringed any right of the borrower. 2. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Character of the transaction; applicability of Usurious Loans Act and Section 80 NI Act Interpretation and reasoning 2.1 The Court endorsed the concurrent findings of the arbitral tribunal and the High Court that the relationship was founded on bill discounting facilities extended under sanction letters dated 27.12.2002 and 11.06.2003, not on a conventional loan or debt. 2.2 The facilities were short-term, unsecured, commercial bill discounting arrangements whereby the financier purchased bills/hundis drawn by the supplier on the buyer; the drawer and drawee were jointly and severally liable under the sanction letters. 2.3 The Court distinguished business loans from bill discounting: bill discounting is a short-term liquidity product, with a higher risk profile and typically higher pricing, in consideration of immediate cash and assumption of commercial credit risk by the discounter. 2.4 In this setting, high rates of interest are commercially justified by the risk of default, absence of security, and repeated redeployment of funds; such billing is inherent to the product and not akin to 'usurious loans' targeted by the 1918 statute. 2.5 As the claim was founded on the sanction letters and not on the negotiable instruments simpliciter, Section 80 of the Negotiable Instruments Act, 1881 (prescribing a fixed statutory rate of interest for certain instruments) had no application. Conclusions 2.6 The transaction was a commercial bill discounting facility, not a 'loan' or 'debt' within the Usurious Loans Act, 1918 as amended; that statute did not apply. 2.7 Section 80 of the Negotiable Instruments Act, 1881 was inapplicable as the liability flowed from the contractual sanction letters, of which the bills/hundis formed an integral part. Issue 2 - Validity of 36% p.a. compound interest; penalty, unconscionability and public policy (including Section 74 Contract Act) Legal framework discussed 2.8 The Court examined Section 74 of the Contract Act and Indian and foreign jurisprudence on penalties and liquidated damages, including Fateh Chand, Maula Bux, Kailash Nath, and English decisions culminating in Cavendish Square Holding BV v. Makdessi, along with references to comparative law (Australia, New Zealand, Malaysia, Germany). 2.9 The Court also referred to decisions holding that high or compound interest in commercial contracts voluntarily entered into between parties of equal bargaining strength is not per se unconscionable or opposed to public policy, absent dominance, fraud or unfair advantage. Interpretation and reasoning 2.10 Clause 4 expressly provided that the 'normal agreed rate' for bill discounting was 36% p.a., but that, as a special concession, the facility would be extended at 22.5% p.a. payable upfront; in case of delay or default in payment of principal or interest, the concession would stand withdrawn and 36% p.a. with monthly rests would apply from the due date. 2.11 The Court characterised this structure as: (a) a primary obligation to pay 36% p.a. with monthly rests; (b) coupled with a conditional concession reducing the rate to 22.5% p.a. on punctual performance. Withdrawal of such concession on default is not a penalty, but loss of a benefit linked to punctual performance. 2.12 Relying on long-standing Indian and Privy Council authority (including Lala Balla Mal, Sheth Burjorji Shapurji, Kulada Prosad Chowdhury, Banke Behari (FB), and K.P. Subbarama Sastri), the Court reaffirmed that:   (i) Stipulations providing that failure to pay interest punctually will entail payment of enhanced interest (from default or from inception) are generally not 'penal' within Section 74 where they reflect an alternative contractual arrangement consciously accepted by the borrower.   (ii) Concessions in the form of lower rates conditional on punctual repayment do not convert the higher 'normal' rate into a penalty. 2.13 The Court embraced, in substance, the Cavendish approach, focusing on whether the clause protects a 'legitimate business interest' and whether the detriment is exorbitant or unconscionable relative to that interest, especially in complex commercial contracts. 2.14 The financier's business model hinged on short-duration, unsecured redeployment of funds. Prolonged default (here, spanning years) disrupted this cycle, causing loss beyond simple time value of money. Compounding at 36% p.a. with monthly rests, as the agreed normal rate, was therefore a commercially justified risk-pricing mechanism and not a punitive exaction. 2.15 The Court stressed party autonomy and freedom of contract in commercial dealings, particularly where both parties are sophisticated entities, legally advised and not subject to inequality of bargaining power or undue influence. The borrower had repeatedly availed similar facilities over years without objection. 2.16 The plea of unconscionability/public policy was raised belatedly, after enjoying the facility and defaulting for a long period, and without any prior attempt to avoid or renegotiate the contract; this conduct undermined any equitable claim to relief. 2.17 The Court held that objections of 'arbitrariness, unconscionability and violation of public policy' in the context of a purely commercial transaction between equal parties cannot be used ex post to escape an agreed interest clause voluntarily acted upon and acknowledged. Conclusions 2.18 The 36% p.a. rate with monthly rests, triggered on default by withdrawal of a concessional rate, is not a 'penalty' under Section 74, nor unconscionable, nor opposed to public policy. 2.19 The stipulation represents a commercially justified allocation of risk and a legitimate business interest in punctual payment in a high-risk, unsecured, short-term commercial financing product. 2.20 The challenge to the rate of interest as 'penal interest on penal interest' or as expropriatory was rejected; the contractual clause is valid and enforceable. Issue 3 - Scope of Section 31(7)(a) Arbitration Act; party autonomy and arbitral discretion in awarding interest Legal framework discussed 2.21 The Court analysed Section 31(7)(a)-(b) of the Arbitration and Conciliation Act, 1996, and the jurisprudence in North Delhi Municipal Corporation v. S.A. Builders, S.L. Arora, Hyder Consulting, Delhi Airport Metro Express, HLV Ltd., Morgan Securities v. Videocon, PAM Developments, and others. Interpretation and reasoning 2.22 Section 31(7)(a) begins with 'unless otherwise agreed by the parties'. The Court held these words qualify the entire clause: party agreement on interest displaces arbitral discretion for the pre-award period. 2.23 Thus, the arbitral tribunal's power to award interest 'at such rate as it deems reasonable' and for such period exists only in the absence of a contrary contractual stipulation. Where the contract prescribes the rate, period or mode (e.g. compounding), the tribunal is bound to follow that agreement. 2.24 The Court rejected the appellant's argument that 'unless otherwise agreed' should be read narrowly as referring only to a prohibition on grant of interest, or that it leaves a residuary discretion to substitute a 'reasonable' rate even where the contract stipulates a rate. 2.25 Applying Delhi Airport Metro Express, the Court reiterated that in the presence of a specific contractual regime on interest, the tribunal 'ceases to have any discretion' on aspects covered by the agreement; party autonomy 'takes precedence over the discretion of the arbitral tribunal.' 2.26 In the present case, clause 4 of the sanction letters clearly fixed the 'normal agreed rate' at 36% p.a. with monthly rests, with a concessional rate subject to punctuality. There was no contractual bar on interest; rather, there was a detailed interest regime. Hence, the tribunal rightly applied 36% p.a. with monthly rests for the pre-award period. Conclusions 2.27 Under Section 31(7)(a), where parties agree on interest (rate, basis, period), the arbitral tribunal has no residual discretion to substitute a 'reasonable' rate; it must apply the agreed terms. 2.28 The award of pre-award interest at 36% p.a. with monthly rests was strictly in accordance with the contractual stipulations and within Section 31(7)(a). Issue 4 - Whether compound/high interest in this case is contrary to 'public policy of India' for purposes of Sections 34 and 37 Legal framework discussed 2.29 The Court considered Explanation 1 to Section 34(2) of the Arbitration Act (public policy ground), the evolution of the concept of 'public policy' and its limited, precedent-governed contours, with reference to Renusagar, ONGC v. Saw Pipes, and scholarly commentary. Interpretation and reasoning 2.30 The High Court, whose reasoning the Court endorsed, had held that even 'exorbitant' interest in a purely commercial transaction between sophisticated parties does not ordinarily offend the 'fundamental policy of Indian law' or the 'basic notions of morality or justice,' especially where there is full transparency and informed consent. 2.31 The Court emphasised that public policy is a narrow, dynamic, but precedent-constrained doctrine; it is not a free-ranging equity to rewrite commercial bargains merely because the outcome appears harsh or the interest quantum is 'humungous.' 2.32 In commercial contracts with equal bargaining power, freedom of contract and 'pacta sunt servanda' prevail; courts must be 'circumspect' in invoking public policy and only in clear, incontestable cases of harm to public interest. 2.33 The Court also noted that the borrower had (a) acknowledged liability in writing; (b) never challenged the interest clause contemporaneously; and (c) benefited from the facility while resisting payment for years and diverting assets, even attracting contempt findings. This conduct further militated against relief on public policy grounds. Conclusions 2.34 The agreed interest regime, including compounding at 36% p.a., did not violate the 'fundamental policy of Indian law' or 'basic notions of morality or justice' and was not opposed to public policy. 2.35 The award could not be set aside or modified on the ground that the interest was excessive or shocking to the conscience in the context of this voluntary commercial transaction. Issue 5 - Applicability of contra proferentem / maxim 'verba chartarum fortius accipiuntur contra proferentem' Legal framework discussed 2.36 The Court examined the contra proferentem rule, its origin in the maxim 'verba chartarum fortius accipiuntur contra proferentem,' and its typical application in standard form insurance contracts, with reference to Halsbury's Laws, Haris Marine Products, Sushilaben Indravadan Gandhi, and Export Credit Guarantee Corporation v. Garg Sons International. Interpretation and reasoning 2.37 Contra proferentem is a rule of last resort to resolve genuine ambiguity, primarily in adhesion contracts where one party drafts and the other has little bargaining power. It cannot be used to create ambiguities or rewrite clear terms. 2.38 The Court stressed that in commercial contracts between sophisticated entities, clauses are bilaterally negotiated; the presumption of imbalance that undergirds contra proferentem is generally absent. 2.39 Clause 4 was clear and unambiguous when read as a whole: it set a normal rate of 36% p.a., granted a concessional 22.5% p.a. rate upfront, and provided that on any default the concession would be withdrawn and 36% p.a. with monthly rests would apply. No genuine ambiguity was demonstrated. 2.40 The Court reiterated that contracts must be construed as a whole, according to the plain meaning of their words, without recourse to subsequent conduct or post-facto constructions, unless ambiguity truly exists. Conclusions 2.41 The maxim 'verba chartarum fortius accipiuntur contra proferentem' and the contra proferentem rule do not apply to this commercial contract. 2.42 Clause 4 was clear, bilateral, and must be enforced according to its plain terms; no adverse construction against the financier was warranted. Issue 6 - Alleged absence of notice withdrawing concessional rate Interpretation and reasoning 2.43 The appellant argued, for the first time before the Court, that clause 4 required an 'active notification' or specific notice to withdraw the concessional 22.5% p.a. rate and revert to 36% p.a. 2.44 The Court noted that this plea was never raised (a) in response to the arbitration notice, (b) before the arbitral tribunal, or (c) in the Section 34 or Section 37 proceedings. Throughout, the claim and award proceeded on the basis that 36% p.a. with monthly rests applied on default. 2.45 On the language of clause 4, withdrawal of the concession operated automatically upon 'delay or default' in payment of principal or interest on due dates; no separate notice was envisaged or required. The contractual trigger was objective default, not an additional unilateral act by the financier. 2.46 Even assuming arguendo that some notice could be read in, the Court held that the appellant suffered no demonstrable prejudice: it was continuously in default and had never offered to pay either principal or concessional interest within contractual timelines. Conclusions 2.47 The contention that the concessional rate could not be withdrawn absent a specific notice had no foundation in the contract and was an afterthought; it was rejected. 2.48 The higher contractual rate of 36% p.a. with monthly rests validly applied automatically upon default, without need of separate notice. Issue 7 - Overall result 2.49 Upholding the concurrent findings of the arbitral tribunal and the High Court, the Court held that:   (i) The transaction was a commercial bill discounting facility outside the Usurious Loans Act;   (ii) The agreed interest regime, including 36% p.a. with monthly rests upon default, was valid, non-penal and not against public policy;   (iii) Under Section 31(7)(a), party autonomy bound the arbitral tribunal to the contractual rate of interest;   (iv) Contra proferentem and public policy doctrines could not be used to rewrite the bargain of sophisticated commercial parties. 2.50 The appeals were dismissed; the arbitral award (as modified by the High Court only to the limited extent already indicated by it) was sustained, including the award of interest at the contractual rate and post-award interest at 10% p.a. until realization.