Bombay HC: Compensation Prohibited Under Contract Cannot Be Granted Through Arbitration

Aadrikaa Legal Services (ALS)- Law I Litigation I Arbitration

Date: 09.10.2026

Bombay HC: Compensation Prohibited Under Contract Cannot Be Granted Through Arbitration

The Bombay High Court, in Union of India v. M/s KR. Traders & Another, delivered an important judgment concerning the enforceability of contractual restrictions, the jurisdiction of arbitrators to award damages and the evidentiary requirements for claims arising from construction delays.

Justice R. D. Dhanuka held that an arbitrator is bound by the terms of the agreement governing the parties and cannot award compensation expressly prohibited by those terms. The Court further held that damages for loss of overheads and anticipated profits cannot be sustained when they are awarded without supporting evidence.

The judgment arose from a construction contract executed between the Union of India and M/s KR. Traders for specialised accommodation at Air Force Station, Pune. Following delays in execution and disputes over payments, the contractor obtained an arbitral award granting various monetary claims.

The Union of India challenged the award, principally contending that compensation had been granted in violation of Clause 11(C) of the General Conditions of Contract.

The High Court partly allowed the appeal, setting aside compensation for loss of overheads and anticipated profits while upholding the remaining contractual entitlements, including reimbursement of bank guarantee charges.

The ruling provides significant guidance on contractual autonomy, arbitral jurisdiction, proof of damages and the limits of judicial interference under the Arbitration and Conciliation Act, 1996.

Background of the Dispute

• In 1992, the Union of India invited tenders for providing specialised technology accommodation at Air Force Station, Pune.
• M/s KR. Traders submitted its tender, which was accepted for a contractual consideration of ₹4,75,27,093.05.
• The parties entered into a formal agreement on 28 September 1992, and a work order was issued on 10 October 1992.
• The contractual commencement date was 13 October 1992, while the stipulated completion date was 12 October 1994.
• However, the project could not be completed within the original period.
• The Union of India granted several extensions of time, ultimately extending the completion date to 20 April 1997.
• The contractor completed the work on that date, and completion was certified by the Government through its communication dated 27 April 1997.
• Subsequently, disputes arose concerning outstanding payments, deviation orders, escalation charges, prolonged execution and reimbursement of expenses.
• The contractor demanded payment of outstanding dues on 23 March 2001 and invoked arbitration on 25 July 2001.
• As the Union of India did not appoint an arbitrator, the contractor approached the Bombay High Court under Section 11 of the Arbitration and Conciliation Act, 1996.
• By an order dated 24 June 2003, Shri S. G. Mahajan was appointed as sole arbitrator with the consent of both parties.

Arbitral Award and Subsequent Proceedings

• The sole arbitrator delivered an award on 19 June 2005.
• The award partly allowed the contractor’s monetary claims, granted interest and rejected the counterclaims raised by the Union of India.
• The Government challenged the award before the District Court, Pune, under Section 34 of the Arbitration and Conciliation Act, 1996.
• By its judgment dated 23 October 2008, the District Court dismissed the challenge.
• Aggrieved by that decision, the Union of India preferred Arbitration Appeal No. 8 of 2009 before the Bombay High Court under Section 37.
• The High Court examined the contractual provisions, the arbitrator’s findings, the objections raised by the Government and the extent to which the award could be interfered with in appellate proceedings.

Principal Legal Issues

The proceedings involved several significant questions:

1. Whether an arbitrator could grant compensation for prolonged execution despite the restrictions imposed by Clause 11(C) of the General Conditions of Contract.
2. Whether claims for overhead losses and anticipated profits could be awarded without oral or documentary evidence.
3. Whether the arbitrator exceeded his jurisdiction by considering claims not specifically identified in the Section 11 application.
4. Whether submission of a bill amounted to final settlement and waiver of subsequent claims.
5. Whether claims relating to deviation orders were barred by limitation.
6. Whether the contractor was entitled to escalation payments and reimbursement of bank guarantee charges.
7. Whether the arbitrator’s previous professional engagement against the Union of India established bias.
8. Whether the Court could interfere with the arbitrator’s factual findings under Sections 34 and 37.

Allegations of Arbitrator Bias Rejected

• The Union of India contended that the sole arbitrator lacked independence and impartiality because he had previously represented another construction company in arbitration proceedings against the Government.
• It argued that the arbitrator had advanced similar compensation claims in that professional capacity and should therefore have declined his appointment.
• The contractor opposed the allegation, emphasising that the arbitrator had been appointed by consent and had no professional relationship with the contractor in the present dispute.
• The High Court examined Sections 12 and 13 of the Arbitration and Conciliation Act, 1996.
• It held that previous professional representation against a party in an unrelated proceeding does not automatically establish a conflict of interest.
• The Court distinguished a genuine circumstance creating justifiable doubts about impartiality from a party’s mere suspicion.
• Since the Union of India had not established a relevant conflict, the challenge based on alleged bias was rejected.

Additional Claims Not Mentioned in Section 11 Application

• The Government argued that certain subclaims under Claim No. 1 had not been mentioned in the contractor’s application for appointment of the arbitrator.
• It therefore contended that those claims fell outside the arbitrator’s jurisdiction.
• The High Court rejected this submission.
• Relying upon the Supreme Court’s decision in State of Goa v. Praveen Enterprises, the Court explained that Section 11 proceedings primarily concern appointment of an arbitrator.
• Unless the arbitration agreement prescribes a specific procedure restricting the reference, the arbitrator’s jurisdiction is not necessarily confined to the claims identified in the appointment application.
• The Court found no contractual requirement obliging the contractor to quantify or notify every claim before invoking arbitration.
• Accordingly, the arbitrator had jurisdiction to entertain the additional claims.

Final Bill and Waiver Under Clause 65

• The Union of India relied upon Clause 65 of the General Conditions of Contract, which restricted further claims after submission of the final bill.
• The Government argued that the contractor had submitted its final bill and had consequently waived additional claims.
• However, the High Court examined the contractual requirements governing preparation of the final bill.
• The contractor had submitted a bill on 17 July 2002, but the Government had not finalised the valuation of relevant deviation orders at that stage.
• Those valuations were completed only on 31 December 2002.
• The Court also considered the absence of necessary pricing abstracts and recovery statements.
• It held that the contractor could not reasonably have prepared a proper final bill before completion of the essential contractual valuation process.
• Consequently, the bill submitted on 17 July 2002 could not be treated as a final bill attracting the waiver provision under Clause 65.
• The arbitrator’s decision permitting the additional claims was therefore upheld.

Limitation and Deviation Orders

• The Union of India further argued that the contractor’s claims relating to deviation orders were barred by limitation.
• The Government relied upon the fact that the physical work had been completed in April 1997.
• However, the Court noted that the relevant deviation orders were valued only on 31 December 2002.
• The contractor raised the corresponding claims before the arbitrator on 19 September 2003.
• The High Court upheld the rejection of the limitation objection, considering the date on which the relevant contractual valuation had been completed.
• It also noted that the Government had not raised the limitation objection in its written statement before the arbitrator.
• The ruling illustrates the importance of identifying the relevant cause of action for each contractual claim rather than treating physical completion of the project as the starting point for every dispute.

Escalation Claims Upheld

• The contractor claimed escalation on account of increases in material, labour and fuel costs during execution.
• The arbitrator awarded ₹60.40 lakh towards escalation.
• The Union of India challenged this amount, arguing that extensions had been granted subject to restrictions on compensation.
• The High Court examined the arbitrator’s assessment of the contractual provisions and the relevant records.
• The contractor had undertaken not to claim material escalation for a specified period, and the arbitrator had excluded the corresponding amount.
• The remaining escalation claims were assessed with reference to the contract, relevant indices and documentary material.
• The Court found no sufficient basis to interfere with the award.
• Importantly, it distinguished escalation payable under the contract from compensation for delay that might be prohibited by Clause 11(C).

Clause 11(C): Contractual Prohibition on Compensation

• The central controversy concerned Clause 11(C) of the General Conditions of Contract.
• The clause prohibited claims for compensation or otherwise arising from extensions granted under Clauses 11(A) and 11(B).
• The Union of India contended that the contractor had obtained extensions under those provisions and could not subsequently claim compensation for the corresponding delays.
• The contractor argued that the Government was responsible for several causes of delay and that compensation was therefore justified.
• The arbitrator awarded ₹50,50,243.40 towards loss of overheads by applying a percentage-based calculation.
• The High Court examined whether the award complied with the contractual restriction.

Arbitrator Cannot Disregard Express Contractual Terms

• The High Court relied upon the Supreme Court’s decision in Ramnath International Construction (P) Ltd. v. Union of India, (2007) 2 SCC 453.
• The Supreme Court had interpreted Clause 11(C) and recognised that compensation for delays falling within the contractual exclusion could not be granted merely because the employer was responsible for the delay.
• Applying that principle, the Bombay High Court held that the arbitrator was bound to decide the dispute in accordance with the contract.
• The Court rejected the proposition that Clause 11(C) merely prevented Government officers from admitting compensation while leaving the arbitrator free to award it.
• The restriction concerned the contractor’s entitlement itself and therefore bound the arbitrator.
• An arbitrator cannot create an entitlement that the governing contract expressly excludes.

Failure to Apportion Compensable and Excluded Delays

• The Court observed that some causes of delay relied upon by the contractor fell within Clauses 11(A) and 11(B).
• Other causes might have fallen outside those provisions.
• The arbitrator, however, had not apportioned the delays between the two categories.
• Instead, compensation had been awarded for the prolonged period without adequately distinguishing the causes covered by the contractual exclusion.
• The High Court held that, if certain delays fell outside Clauses 11(A) and 11(B), the arbitrator should have separately examined and apportioned those delays before considering compensation.
• The failure to undertake that exercise rendered the award of overhead compensation unsustainable.

Loss of Overheads Cannot Be Awarded Without Evidence

• The Court identified a separate and substantial defect in the award.
• The contractor had not produced oral or documentary evidence proving the alleged overhead losses.
• Nevertheless, the arbitrator had awarded compensation by applying a rate of 10%.
• The High Court held that the award lacked the necessary evidentiary foundation.
• It found that the compensation was contrary to the contractual restriction and had been awarded without proof of the claimed loss.
• Accordingly, the award of ₹50,50,243.40 towards loss of overheads was set aside.
• The judgment reinforces the principle that an arbitrator must assess damages on the basis of the governing agreement and evidence rather than unsupported assumptions.

Anticipated Profit Award Also Set Aside

• The contractor had also claimed compensation for anticipated profits allegedly lost because certain profitable items of work had been deleted from the contractual scope.
• The arbitrator awarded ₹8,33,385.15 under Claim No. 2-B by applying a 10% assessment.
• The High Court noted that the Government had exercised its contractual rights concerning deletion of work under Clause 7 of the General Conditions of Contract.
• More importantly, the contractor had not produced evidence establishing the anticipated profit loss.
• The Court held that the award was based on no evidence.
• Since this component could be separated from the remaining award, the High Court set it aside without disturbing the other claims.

Reimbursement of Bank Guarantee Charges Upheld

• The contractor also claimed reimbursement of additional expenditure incurred in maintaining bank guarantees after completion of the work.
• The arbitrator awarded ₹6 lakh towards bank guarantee charges for the period from 1998 to 2003.
• The Union of India argued that the contractor was contractually obliged to keep the guarantees operative until final settlement.
• However, the High Court noted that the Government had delayed finalisation of the deviation orders and the final bill.
• The Court observed that the work had been completed in April 1997 and that the Government ought to have finalised the bill within a reasonable period.
• The arbitrator had not awarded bank guarantee charges for the original execution period or the period up to December 1997.
• The reimbursement related to the subsequent period during which the guarantees remained operative because of delayed settlement.
• Finding no perversity in the arbitrator’s assessment, the High Court upheld the ₹6 lakh award under Claim No. 2-C.

Interest Under Section 31(7) of the Arbitration Act

• The Union of India also challenged the interest awarded to the contractor.
• The High Court examined Section 31(7)(a) of the Arbitration and Conciliation Act, 1996, which governs an arbitral tribunal’s authority to award interest, subject to the applicable statutory and contractual framework.
• The Court found no reason to interfere with the interest awarded on the surviving claims.
• However, because Claim Nos. 2-A and 2-B were set aside, the corresponding interest was also set aside.
• The Court preserved interest on Claim Nos. 1 and 2-C in accordance with its final directions.

Government Counterclaims Remained Rejected

• The Union of India argued that the arbitrator had wrongly rejected its counterclaims.
• The High Court examined the arbitral findings and found that the Government had not demonstrated perversity warranting judicial interference.
• The Court therefore declined to disturb the rejection of the counterclaims.
• This aspect of the judgment reiterates that proceedings under Sections 34 and 37 are not intended to provide an unrestricted rehearing of factual disputes already determined by the arbitrator.

Final Decision of the Bombay High Court

The High Court partly allowed the Union of India’s appeal.

The final operative directions were:

Claim	Decision
Claim No. 1 — Contractual payment claims	Upheld
Claim No. 2-A — Loss of overheads	Set aside
Claim No. 2-B — Loss of anticipated profits	Set aside
Claim No. 2-C — Bank guarantee charges	Upheld
Interest on Claim No. 1	Upheld at specified rates
Interest on Claim No. 2-C	Upheld
Interest on Claim Nos. 2-A and 2-B	Set aside
Government counterclaims	Rejection undisturbed

• The Court directed payment of interest at 18% per annum on Claim No. 1 from 1 January 1998 to 25 July 2003 and at 12% per annum on the principal amount from 26 July 2003 until payment.
• It also directed payment of interest at 12% per annum on Claim No. 2-C from the date of the arbitral award until payment.
• The appeal was disposed of without an order as to costs.

Legal Principles Emerging from the Judgment

Contractual Restrictions Define Arbitral Authority

• An arbitrator must respect the contractual allocation of rights and liabilities. A claim expressly excluded by the agreement cannot be granted merely because the arbitrator considers compensation equitable.

Delay Compensation Requires Contractual and Factual Examination

• Where contractual clauses exclude compensation for specified extensions, the arbitrator must identify the causes of delay and determine which claims, if any, fall outside the exclusion.

Damages Must Be Supported by Evidence

• Loss of overheads and anticipated profits must be established through an appropriate evidentiary foundation. An assumed percentage cannot automatically replace proof of loss.

Valid Contractual Claims May Be Preserved

• The invalidity of particular compensation awards does not necessarily require setting aside the entire arbitral award. Severable claims supported by the contract and evidence may remain enforceable.

A Final Bill Must Satisfy Contractual Requirements

• A bill submitted before completion of essential valuation and documentation requirements may not constitute a final bill capable of extinguishing further claims.

Judicial Review Does Not Permit Routine Reappreciation of Evidence

• Courts exercising jurisdiction under Sections 34 and 37 must distinguish between permissible factual findings and awards that exceed contractual authority or lack an evidentiary foundation.

Practical Implications for Construction and Government Contracts

• The judgment is particularly relevant to contractors, infrastructure developers, public sector undertakings and Government departments.
• Parties negotiating construction contracts should carefully examine extension-of-time clauses, escalation provisions, compensation exclusions and procedures governing final bills.
• Contractors should maintain detailed records of project delays, idle resources, site expenditure, additional financing costs and anticipated profit losses.
• Employers should document the reasons for extensions, finalise deviation orders promptly and ensure that contractual settlements are completed within reasonable periods.
• Arbitrators must examine the contractual basis of every claim and distinguish between compensation prohibited by the agreement and reimbursement or escalation expressly permitted under it.
• The judgment also demonstrates the importance of reasoned findings supported by documentary evidence.

Conclusion

The Bombay High Court’s decision in Union of India v. M/s KR. Traders & Another reinforces the fundamental principle that an arbitrator derives authority from the contract and must decide disputes within its terms.

By setting aside compensation for loss of overheads and anticipated profits, the Court emphasised that arbitral awards cannot disregard contractual prohibitions or grant damages without adequate evidence.

At the same time, the Court upheld legitimate contractual claims, reimbursement of bank guarantee charges and interest on the surviving award. The judgment remains an important reference for construction arbitration, contractual interpretation and judicial scrutiny of arbitral awards under the Arbitration and Conciliation Act, 1996.

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Source: Bombay High Court

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