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Introduction
In the fiercely competitive landscape of modern finance, commercial entities often enter into loan agreements bearing a demanding 24% annual interest rate terms that reflect the high-risk, high-reward nature of lending to businesses. When a borrower defaults, and an arbitral tribunal later upholds an award calculated based on this rate, a critical legal question arises: Can the judiciary intervene and strike down the interest, deeming it an oppressive term that violates fundamental Indian public policy?
This very question lay at the heart of a recent landmark ruling by the Supreme Court of India. In a decisive move, the bench of Justices JB Pardiwala and KV Viswanathan in Sri Lakshmi Hotel Pvt. Limited & Anr.Versus Sriram City Union Finance Ltd. & Anr1.,upheld the validity of charging a 24% interest rate stipulated in a commercial loan agreement, affirming that the rate itself did not violate the fundamental policy of Indian law.
The issue stemmed from a dispute involving a Non-Banking Financial Company (NBFC) and borrowers who had defaulted on two loan agreements from 2006, which expressly provided for the 24% per annum interest rate. The subsequent arbitral award in favor of the NBFC was challenged, essentially questioning whether such an exorbitant interest rate could stand scrutiny under the grounds of public policy as defined in the Arbitration and Conciliation Act, 1996.
This judgment powerfully underscores the primacy of contractual agreement in commercial dealings, even when the terms seem onerous. The ruling provides critical clarity on the limits of judicial intervention in arbitral awards based on public policy and “basic notions of morality or justice.” This article will delve into the underlying legal principles, particularly concerning the interpretation of Section 31(7)(a) and Section 34(2)(b) of the Arbitration Act, that formed the robust basis of the Supreme Court’s definitive pronouncement.
When a dispute is resolved through arbitration, the resulting award is intended to be the final word, yet it is not beyond the reach of the courts. What extent of judicial conscience can actually override the contractual terms and the arbitrator’s mandate, particularly when it comes to the charged rate of interest? The very architecture of the Arbitration and Conciliation Act, 1996 (the “Act”), attempts to strike a delicate balance between party autonomy and the basic principles of justice, and this balance is vividly tested in the context of awarding interest. The legal framework for awarding interest is meticulously laid out in Section 31(7) of the Act, which governs the form and contents of an arbitral award, dividing the power into two distinct regimes: pre-award and post-award interest.
Does the contract or the statute dictate the interest awarded before the final decision is reached?
Section 31(7)(a) deals with pre-award interest—the interest payable from the date the cause of action arose until the date the award is made. The language is clear: “Unless otherwise agreed by the parties,” the Arbitrator may award interest at such rate as deemed reasonable. This establishes the principle of Party Autonomy as Paramount, meaning the arbitrator’s discretion on the rate, the sum, and the period of interest is subject to the agreement between the parties. If parties have specifically agreed on a rate of interest or a bar on interest in their contract, the arbitrator must respect that agreement. As held in HlV Limited V. Pbsamp Projects Pvt. Ltd2., the discretion to grant interest is only available to the Arbitral Tribunal when there is no agreement to the contrary. The primary intent of pre-award interest is to compensate the claimant for the pecuniary loss suffered over time and to incentivize the speedy conclusion of the arbitration, a purpose reiterated in North Delhi Municipal Corpn. v. S.A. Builders Ltd3.
But does that same contractual freedom apply once the award is pronounced? In stark contrast, Section 31(7)(b) governs post-award interest, the interest payable from the date of the award until the date of payment. This clause is not subject to the contract, introducing a mandatory statutory rate of 18% per annum unless the award directs otherwise. This establishes a Statutory Mandate over Contractual Wishes. The Supreme Court, in R.P. Garg v. The General Manager, Telecom Department & Ors4. (relying on Morgan Securities & Credits Pvt Ltd. v. Videocon Industries Ltd5.), clearly stated that the clause does not give parties the right to “contract out” of post-award interest, clarifying that the phrase “unless the award otherwise directs” applies only to the rate of interest, not the entitlement.
Therefore, the grant of post-award interest is mandatory, and the arbitrator’s discretion is unfettered in deciding the rate, subject only to judicious exercise , while the purpose remains a disincentive to the award-debtor against delaying payment. The established legal principle, stemming from Constitution Bench decisions cited in State of Rajasthan and Another v. Ferro Concrete Construction Private Limited6, holds that unless there is an express bar in the agreement, the arbitrator has the jurisdiction to award interest for all three periods, which are pre-reference, pendente lite, and post-award. The judgment in the Union of India and Anr. v. Sudhir Tyagi7 applied this framework to uphold the contracted rate.
Given this comprehensive statutory framework, how expansive is the court’s power to set aside an award under Section 34? The appellants challenged the 24% interest rate as being against the Public Policy of India. However, the Supreme Court provided a definitive answer, solidifying the restrictive nature of judicial intervention. The Court’s refusal to interfere was primarily based on the Proviso to Section 34(2A), which explicitly prohibits the Court from setting aside an award by re-appreciating evidence, a bar consistently upheld in cases like Swan Gold Mining Ltd. v. Hindustan Copper Ltd8., Ssangyong Engg. & Construction Co. Ltd. v. NHAI9, and PSA Social Terminals (P) Ltd. v. V.O. Chidambranar Port Trust Tuticorin10. Since the Arbitrator and the lower courts had already affirmed the genuineness of the 24% agreement, the Supreme Court correctly refrained from re-entering this factual arena.
Finally, at what point does a contractually agreed interest rate actually violate the fundamental public policy? The Court defined the strict test for an interest rate conflicting with public policy by referencing Explanation 1, Clauses (ii) and (iii) of Section 34(2)(b). It ruled that a violation of the Fundamental Policy of Indian Law refers to the core principles of law, not the mere violation of any specific statute, placing a controversy over a rate of interest generally outside this scope.
Furthermore, the imposition of an exorbitant interest in the context of contemporary commercial practices is not per se against the Basic Notions of Morality or Justice, especially since a high rate reflects the high degree of risk associated with commercial loan transactions, such as lending to an already defaulting borrower. “Interference is only warranted if the interest rate awarded is so perverse and so unreasonable so as to shock the conscience of the Court.” Absent this extremely high bar, judicial non-interference prevailed, affirming the principle that in commercial disputes, the sanctity of the contract remains supreme.
Conclusion
The Supreme Court’s definitive ruling on the 24% interest rate is more than just a case-specific verdict; it is a profound affirmation of the foundational principles underpinning India’s arbitration regime. By upholding the contractual rate, the Court has sent a clear message to the commercial world: party autonomy is not a mere preference, but a binding legal force, especially where sophisticated entities have willingly entered into high-risk agreements.
The judgment effectively raises the bar for invoking the “public policy” defense under Section 34 of the Act, confirming that judicial intervention is reserved only for awards that are so fundamentally flawed, or the terms so inherently unconscionable, that they truly “shock the conscience of the Court.” This restrictive approach is critical for maintaining the efficiency and credibility of arbitration, signaling that courts will not be allowed to function as appellate forums merely to re-evaluate the commercial wisdom or factual findings of the Tribunal, thereby respecting the statutory bar against the re-appreciation of evidence.
Looking ahead, this ruling shapes the legal landscape by posing several critical questions for practice and jurisprudence. Will this judgment empower lenders to push the boundaries on interest rates in high-risk commercial contracts, now confident that arbitration awards based on these rates are virtually ironclad against public policy challenges? For arbitrators, the judgment solidifies their broad, almost unfettered discretion in setting the post-award interest rate under Section 31(7)(b), provided that discretion is exercised judiciously and in good faith. More fundamentally, how will future courts interpret the elusive distinction between an interest rate that is merely “exorbitant” and one that is truly “perverse and unreasonable”? This judgment firmly establishes the commercial nature of the transaction as the paramount contextual factor, but the line between aggressive commerce and legal exploitation remains a field for future judicial exploration. Ultimately, this verdict ensures that the sanctity of the written agreement and the finality of the arbitral award remain the guiding stars of India’s commercial justice system.
Citations
Expositor(s): Adv. Anuja Pandit
