Supreme Court Clarifies: "No Compound Interest Without Explicit Provision" in Arbitration Awards

The Supreme Court of India, in a significant ruling on August 7, 2024, has upheld the decisions of the lower courts, clarifying that interest on interest is not permissible unless explicitly provided by statute or contract. The judgment, delivered by a bench comprising Justices Pamidighantam Sri Narasimha and Pankaj Mithal, emphasized that courts cannot award compound interest or interest upon interest unless clearly stipulated by the terms of the contract or applicable statutes.

The case arose from a 1984-85 contract between M/s D. Khosla and Company and the Union of India, which led to an arbitration award on September 17, 1997. The award granted simple interest at 12% per annum from the date of work completion until the award date and 15% per annum from the award date until payment or the court decree. However, a dispute emerged when M/s D. Khosla and Company sought to recover 15% interest on both the principal amount and the 12% pre-award interest. The lower courts rejected this claim, leading to the present appeal before the Supreme Court.

The Supreme Court meticulously examined the legal framework governing the awarding of interest. It reiterated that under Section 29 of the Indian Arbitration Act, 1940, and Section 34 of the Code of Civil Procedure, 1908, interest is generally payable only on the principal sum awarded. The court noted that "interest upon interest" or compound interest is not permissible unless specifically provided by statute or contract.

The judgment highlighted that "the decree cannot be read to include compound interest when the language used clearly indicates the award of simple interest on the principal sum alone." The court further emphasized that the terms "simple interest" used by the arbitrator must be interpreted strictly, as awarding compound interest would require a specific provision that was absent in this case.

The Supreme Court referred to multiple precedents, including State of Haryana vs. S.L. Arora & Company and Hyder Consulting (UK) Limited vs. Governor, State of Orissa, to bolster its decision. The court observed that while arbitrators have the power to award interest, they must do so within the confines of the law, which does not generally allow for the awarding of interest on accrued interest.

In rejecting the petitioner's plea, the court stated, "The award and the decree do not contemplate the payment of 15% interest on a sum that includes pre-award interest. Such an interpretation would be contrary to the provisions of the Interest Act, 1978, and the established legal principles governing arbitration awards."

The Supreme Court's decision to dismiss the appeal reaffirms the limitations on the awarding of interest in arbitration cases, particularly the prohibition against compound interest unless explicitly authorized. This judgment serves as a crucial precedent, ensuring that interest awards remain consistent with statutory provisions and contractual terms. The ruling is expected to impact future arbitration cases, reinforcing the principle that interest on interest requires clear statutory or contractual authority.

Date of Decision: August 7, 2024​.

M/S D. Khosla and Company vs. The Union of India