Time is of the Essence v Liquidated Damages: Supreme Court clears the Air

Introduction

Before we plunge into the case, it is important to address the nuances of the judgement delivered in the Welspun Specialty Solutions Limited v Oil and Natural Gas Limited[1] case. To begin with, the Welspun case is a landmark judgement in the sense that it encourages the courts to look deeper into the conduct of contracting parties instead of simply construing what is written in the agreement in its literal sense. One common clause which is found in most standard forms of contract is a clause stipulating ‘time-bound performance.’ The then Chief Justice of India, N.V. Ramana, has given a short and straightforward judgement whereby he placed the ‘intent’ of the contracting parties at a superior position than merely the text contained in the agreement while dealing with time-bound performance clauses. The judgement also discusses the issue of waiver of liquidated damages; and whether such damages can be imposed in successive extensions of time for contract fulfillment when the same has already been waived in prior extensions.

At this juncture, it is relevant to understand the legal provision around which the whole dispute is centered. Section 55 of the Indian Contracts Act, of 1872[2] states as follows:

“ When a party to a contract promises to do a certain thing at or before a specified time, or certain things at or before specified times, and fails to do any such thing at or before the specified time, the contract, or so much of it as has not been performed, becomes voidable at the option of the promisee if the intention of the parties was that time should be of the essence of the contract.”                                                                      

Further, if the intention of the parties was not to make time of the essence in the contract, the provision in this regard states as follows:

“…the contract does not become voidable by the failure to do such thing at or before the specified time, but the promisee is entitled to compensation from the promisor for any loss occasioned to him by such failure.”

Upon reading the said provision, it becomes abundantly clear that if the contract contains a clause mandating time-bound performance, the same must be adhered to by the other party (promisor) and upon its failure to adhere to the time-bound performance, the contract becomes voidable at the hands of the promisee. Furthermore, the provision specifically states that the contract will only become voidable if the intention of the parties was that time should be of the essence of the contract. Such intention must be derived through the conduct and commitment of parties toward fulfilling contractual mandates.

Factual Background

ONGC had issued a global tender for the supply of seamless steel casing pipes. The winning bidder being Remi Metals Gujarat Ltd., (presently operating as “Welspun Specialty Solution Ltd.”) claimed that it had bid to supply pipes on behalf of Volski Tube Mills, a company based out of Russia. Four purchase orders were issued by ONGC as part of the tender, each stating that the delivery period would be between week 16 and week 40 from the date of signing of the contract. The purchase orders included a few standard requirements. One such requirement stipulated that the delivery time and date were crucial and of essence to the supply order and that they had to be met within the date provided in the purchase orders. According to the general terms and conditions attached to the purchase orders, ONGC, the buyer, was entitled to damages for breach of contract if the delivery deadlines were not met. However, even if the contract called for liquidated damages to be imposed for a delay in the supply of the pipes, the employer had the option of forgoing them if a clear intention to do so was demonstrated.

There were certain delays in fulfilling the requirements during the contract execution, and the ONGC granted as many as seven extensions to Remi Metals to complete their obligations. In the first two extensions, no damages were imposed however, ONGC imposed damages based on the final 5 extensions sought by Remi Metals. Further, Remi Metals complied with the terms of the contract by accepting the extensions. Thereafter, upon fulfillment of the contractual obligations, Remi Metals submitted several bills against which ONGC deducted a total of USD 8,07,804.03 and INR 1,05,367 as liquidated damages for the delay induced by Remi Metals. This led to a dispute between the contracting parties whereby Remi Metals invoked arbitration proceedings against ONGC on the grounds of wrongful deduction of the liquidated damages.

Before the Arbitration Panel

The Panel interpreted the terms of the contract and gave an award in favour of Remi Metals. According to the Arbitrators, it was not safe to assume that the fulfillment of contractual obligations is strictly time-conditioned in light of Section 55 of the Indian Contract Act merely from a simple language in the contract that states “time is of the essence.” It was decided that the contract as a whole must be examined in order to ascertain the general character of the agreement and to definitively determine whether time is of the essence.

The reasoning behind the award was majorly two-fold:

(a) As the contract contained clauses for extension of time, the penalty for delay, and imposition of liquidated damages, etc., the clause containing “time is of the essence” was held as irrelevant and redundant. The idea behind this was that on one side, the contract states that time is essential and on the other side, it provides for an extension period and payment for delay clauses. Further, through the conduct of ONGC by granting extensions, it was established that time was not of the essence in this contract.

(b) After establishing that time was not of the essence, it was held that there was no breach of contract due to delay in supply, and consequently, the liquidated damages clause could not be invoked by ONGC.

However, the Arbitrators added that based on Section 55, damages would only be payable on unliquidated damages i.e., actual damages incurred by ONGC due to delay in the supply of pipes by Remi Metals which required strict proof and evidence. Now, to substantiate its claim for actual losses, ONGC was forced to estimate its actual losses, which fell into four categories and totaled USD 3,80,64,830 overall. The Panel accepted this estimate but was of the opinion that because ONGC had specifically waived the imposition of liquidated damages for that time period, it was not permitted to sue for any losses it suffered during the period when the deadline for delivery completion was extended. In the end, the Panel rendered a decision in ONGC’s favour, allowing them to withhold USD 4,40,610.42 of the money that had already been deducted as liquidated damages from the numerous bills provided by Remi Metals.

Appeal before the District Court and the High Court

Aggrieved, ONGC moved the District Court under Section 34 of the Arbitration and Conciliation Act, 1996, contending that the Arbitrator Panel’s decision was unlawful because it did not follow the terms of the contract, which is a ‘reasonable justification’ for the Court’s interference. The District Court held that the Arbitral Panel was correct in concluding that time was not of the essence of the contract and that only actual losses may be awarded. 

Further aggrieved, both parties moved the Uttarakhand High Court under Section 37 of the Arbitration and Conciliation Act. By its contested order, the High Court ruled that the District Judge’s order and the Arbitral award both misconstrued the contract in terms of whether time was of the essence. Furthermore, the High Court ruled that the District Court and the Arbitral Tribunal made grave mistakes in determining that ONGC had to establish its loss in order to be entitled to damages. 

This led Remi Metals, the appellants herein, to file an appeal in the Supreme Court.

Before the Supreme Court

Aggrieved by the Uttarakhand High Court’s decision, Remi Metals approached the Supreme Court under a Special Leave Petition and contended that the position of the Arbitrators was reasonable, tenable, and maintainable. Remi Metals argued that because the contract allowed for extensions of time and liquidated damages, time was not of the essence of the agreement. Additionally, ONGC was unable to pursue additional delivery date extensions after waiving the liquidated damages for the first two extensions. They further argued that the Hon’ble Supreme Court should not ideally strike down the arbitral award unless an issue of public policy is violated by citing the ruling in Associate Builders v. Delhi Development Authority[3]. Instead, the Apex Court should conclude unequivocally that the arbitral verdict was flagrantly unconstitutional while vacating it.

In response, ONGC argued that the arbitral award was invalid because the Arbitral Tribunal had violated the terms of the contract by reaching several erroneous conclusions. It was argued that because the contract called for the imposition of liquidated damages, the Tribunal committed a grave error by imposing unliquidated or actual damages in accordance with Section 55 read with Section 73 of the Indian Contract Act. To further substantiate its argument, ONGC relied upon ONGC v Saw Pipes Ltd.[4] case, whereby the Supreme Court had upheld the imposition of liquidated damages under similar circumstances.

Supreme Court Verdict

To begin with, the Supreme Court analyzed the scope and ambit of Section 34 of the Arbitration and Conciliation Act prior to its 2015 revision. The court noted that the object of Section 34 is to find a balance between the courts’ ability to appeal decisions and the fairness of the arbitral procedure. The Supreme Court cited the ruling in Renusagar Power Co. Ltd. v. General Electric Co.[5] that said a foreign verdict cannot be enforced under the Arbitration Act if it is against Indian public policy. The court then cited the judgement in ONGC Ltd. v. Saw Pipes Ltd[6], which extended the purview of Section 34. Additionally, the ruling in ONGC Ltd. v. Western Geco International Limited[7] was cited, which said that insignificant violations of the law could not be used to support a finding that an arbitral judgement was against the law.

The Supreme Court held that ‘time not being the essence of the contract’ as determined by the Arbitral Panel, was beyond reproach and must be upheld. The court emphasized that the Arbitral Tribunal’s reliance on the terms of the contract and the actions and conduct of the parties in coming to the judgement that the presence of an extension clause weakens the contract’s time limit was compatible with the contractual interpretation of the rule.

The court rejected ONGC’s reliance on the Saw Pipes case by stating that the imposition of liquidated damages, in that case, was not made under similar circumstances as in that case, there were no extensions granted. 

To consider the relevancy of time-bound obligations, the Apex body observed certain basic principles in this regard:

• Referring to the case Greater London Council v. Percy Bilton Ltd.[8], the court stated that the promisor is required to complete the obligation by the date specified in the contract, subject to the ‘nature of the deal as a whole.’
• Taking reference from Holme v. Guppy[9], the court added that except in cases where the promisee’s act or omission impeded the promisor from finishing the task by the completion date, in which case the promisee is not entitled to liquidated damages.
• These general principles are not absolute and can be amended by the express terms of the contract.

The court outlined the Arbitral Tribunal’s interpretation of the second part of Section 55 of the Contract Act and stated that the Arbitral Panel read the aforementioned language to mean the actual tangible loss that could be proven by evidence rather than pre-estimated loss. Given the facts and circumstances of the case, the court found that this was a reasonable interpretation, and neither side was able to refute it by presenting any papers or evidence to the contrary. The court pointed out that ONGC on two occasions waived the liquidated damages before granting an extension with pre-estimated damages, therefore the same cannot be enforced unless it was expressly agreed to by the parties and flowed from the contract with evident intention. The court accepted the appeal, overturned the High Court’s ruling and the District Court’s interference, and decided to uphold the Arbitral Tribunal’s verdict.

Concluding Statements

It is agreed that when a contract contains clauses relating to the extension of time, the penalty for delay and imposition of liquidated damages, etc., the ‘time is of the essence” clause becomes redundant and unnecessary. However, the Arbitration Panel’s reasoning that since it was established that time is not of the essence, there cannot be a breach of contract is highly misconceived. In our opinion, even when the contract stipulates that time is important, failure to complete the work by the stipulated deadline could nonetheless constitute a breach of the agreement.

The Supreme Court correctly held that whether time was of the genuine essence of the contract would not be determined by simply adding an express language declaring that time is of the essence of the contract. A reading of the full contract, circumstances and the conduct of parties that are strong enough to suggest the same will reveal the parties’ purpose and intent to make time the basis of the agreement. In this case, it would be assumed that the parties did not intend for time to be of importance in their transactions because ONGC initially agreed to a time extension and did so by surrendering its authority to collect liquidated damages, on the first two occassions.

Furthermore, this judgement will have wide implications in the sense that all standard forms of contracts that contain the ‘time is of the essence clause,’ along with ‘extension of time’ and ‘penalty for delay’ clauses will have to revise their agreements. After this judgement, even if a contract explicitly states that time will be of the essence, it will still be moot if this provision will hold true once the arbitral tribunals or courts have reviewed the entire agreement based on the intent and conduct of the parties.