Contractual Exclusion of Interest in Arbitration: The Supreme Court’s Evolving Approach to Party Autonomy and Section 31(7) of the Arbitration and Conciliation Act, 1996

Introduction

The law relating to interest in Indian arbitration has evolved significantly over the last two decades, particularly in relation to the powers of arbitral tribunals to award pre-award, pendente lite, and post-award interest. One recurring issue before Indian courts has been whether arbitral tribunals can award interest despite an express contractual prohibition.

In a significant judgment in Union of India & Ors. v. Larsen & Toubro Limited^[1], the Supreme Court once again reaffirmed that arbitral tribunals derive their authority from the contract between the parties and therefore cannot ignore explicit contractual clauses prohibiting pre-award or pendente lite interest. The ruling strengthens the principle of party autonomy under Section 31(7) of the Arbitration and Conciliation Act, 1996 (“Arbitration Act”), while also clarifying the distinction between pre-award and post-award interest.

The judgment is particularly important for infrastructure contracts, EPC agreements, railway contracts, government procurement arrangements, and construction arbitration disputes where standard form contracts frequently contain “no interest” clauses. It also has wider implications for drafting arbitration clauses in commercial contracts and for enforcement of arbitral awards in India.

Legal Framework Governing Interest in Indian Arbitration

The power of an arbitral tribunal to award interest flows primarily from Section 31(7) of the Arbitration and Conciliation Act, 1996. Section 31(7)(a) provides that unless otherwise agreed by the parties, an arbitral tribunal may award interest for the period between the date on which the cause of action arose and the date of the arbitral award. This covers:

• Pre-reference interest;
• Pendente lite interest; and
• Pre-award interest generally.

The phrase “unless otherwise agreed by the parties” is crucial because it places party autonomy above the tribunal’s discretionary powers.

Section 31(7)(b), on the other hand, deals with post-award interest. It provides that a sum directed to be paid by an arbitral award shall carry interest from the date of the award until payment unless the award otherwise directs.

Indian courts have repeatedly held that:

1. Parties are free to contractually exclude pre-award interest;
2. Arbitrators cannot rewrite contractual terms;
3. Post-award interest stands on a different footing unless specifically excluded.

The jurisprudence reflects a balance between contractual freedom and statutory compensation for delayed payment.

Evolution of Judicial Position on Contractual Bar Against Interest

Earlier decisions under the Arbitration Act and the Arbitration Act, 1940 often adopted a liberal approach in favour of awarding interest, particularly where money had been wrongfully withheld. However, over time, the Supreme Court shifted toward a stricter contractual interpretation approach.

In Sayeed Ahmed & Co. v. State of Uttar Pradesh, the Court held that where the agreement expressly bars interest, the arbitrator cannot award pendente lite interest merely on equitable considerations.

Similarly, in Sri Chittaranjan Maity v. Union of India, the Court ruled that a clear contractual prohibition deprives the tribunal of jurisdiction to award interest for the prohibited period.

The principle emerging from these decisions is that arbitral tribunals are creatures of contract and cannot exercise powers contrary to the agreement itself.

Distinction Between Pre-Award and Post-Award Interest

One of the most important aspects of Indian arbitration law is the distinction between:

Courts have consistently treated post-award interest differently because it serves an enforcement-oriented function. It prevents award debtors from delaying compliance with arbitral awards.

Therefore, unless the contract expressly excludes post-award interest as well, tribunals and courts may still award it even where pre-award interest is barred.

The Supreme Court’s Decision in Union of India v. Larsen & Toubro Limited

Background of the Dispute

The dispute arose out of a contract awarded by the North Central Railway to Larsen & Toubro Limited in 2011 for modernization work at the Jhansi Workshop valued at approximately ₹93 crore. The project suffered substantial delays, following which L&T invoked arbitration seeking various monetary claims including:

• Outstanding payments;
• Price variation claims;
• Compensation for delay; and
• Financing charges.

The General Conditions of Contract (GCC) contained clauses expressly prohibiting interest up to the date of the arbitral award. The arbitral tribunal nevertheless awarded substantial amounts resembling pre-award interest and financing charges, along with post-award interest at 12% per annum.

The Union of India challenged the award under Section 34 of the Arbitration Act.

Key Legal Issue Before the Supreme Court

The central issue was: Whether an arbitral tribunal can award pendente lite or pre-award interest despite an express contractual prohibition. A secondary issue concerned the validity and quantum of post-award interest.

Supreme Court’s Findings

1. Contractual Bar on Pre-Award Interest is Binding

The Supreme Court held that the arbitral tribunal lacked jurisdiction to award pre-award interest because the contract expressly prohibited it. The Court emphasized that the opening words of Section 31(7)(a) “unless otherwise agreed by the parties” give overriding effect to contractual terms. The relevant clauses in the GCC prohibited interest on security deposits, earnest money, amounts payable under the contract, and compensation claims until the date of the award.

The tribunal attempted to characterize certain amounts as “compensation” or “financing charges” rather than interest. The Supreme Court rejected this approach and held that tribunals cannot circumvent contractual prohibitions through creative nomenclature.

The ruling reiterates an important principle in Indian arbitration law: Substance prevails over form in determining whether a claim effectively amounts to interest.

2. Arbitrator Cannot Ignore Express Contractual Terms

The Court reaffirmed that arbitrators are bound by the contract and cannot grant relief contrary to express provisions. This aligns with earlier Supreme Court precedents holding that an arbitral award contrary to contractual provisions may be set aside under Section 34, arbitrators cannot act as courts of equity detached from contractual obligations and that party autonomy remains the foundational principle of arbitration.

The judgment therefore strengthens the enforceability of “no interest” clauses in commercial contracts.

3. Post-Award Interest Stands on a Different Footing

The Court distinguished post-award interest from pre-award interest. It noted that while the contract barred interest “till the date of the award,” it did not prohibit interest after the award. Accordingly, Section 31(7)(b) became applicable.

The Court held that statutory post-award interest continues to operate unless expressly excluded by the agreement or modified in the award itself. This distinction is commercially significant because many standard government contracts prohibit only pendente lite interest while remaining silent on post-award interest.

4. Reduction of Post-Award Interest Rate

The arbitral tribunal had awarded post-award interest at 12% per annum. The Supreme Court found the rate excessive considering prevailing economic conditions and modern banking rates. Relying on Gayatri Balasamy v. ISG Novasoft Technologies Ltd.^[2], the Court reduced the rate to 8% per annum.

The judgment demonstrates that courts may intervene where interest rates appear arbitrary, punitive, or commercially disproportionate.

Why This Judgment Matters for Commercial Arbitration in India

The judgment strongly reinforces the principle that arbitration is fundamentally contract-driven. Commercial parties are free to:

• Permit interest;
• Restrict interest;
• Exclude interest altogether; or
• Prescribe different regimes for different stages.

Courts and tribunals are expected to enforce these bargains strictly.

Importance for Infrastructure and Government Contracts

The ruling has major implications for:

• Railway contracts;
• NHAI disputes;
• Public works contracts;
• EPC contracts;
• Construction arbitration claims;
• Government procurement disputes.

Most government standard form contracts contain broad interest exclusion clauses. Contractors pursuing arbitration claims against government entities may therefore face limitations on recovery of financing costs and delayed payment compensation.

Impact on Drafting Arbitration Clauses

The judgment highlights the need for precision in drafting interest clauses. Parties should clearly specify:

• Whether pre-reference interest is barred;
• Whether pendente lite interest is excluded;
• Whether post-award interest survives;
• Applicable interest rates;
• Whether compound interest is permitted.

Ambiguity in drafting can lead to prolonged litigation and award challenges.

Practical Takeaways for Businesses and Arbitration Practitioners

For Contractors and Claimants: Before initiating arbitration, parties should carefully examine interest exclusion clauses, GCC provisions, payment terms, and delay compensation mechanisms. Claims framed as “financing costs” or “compensation” may still be treated as disguised interest if linked to delayed payment.

For Government Bodies and Employers: The judgment strengthens the enforceability of standard no-interest clauses and may reduce exposure in large-value infrastructure arbitrations. However, excessively broad exclusion clauses may still face scrutiny if they are unconscionable or inconsistently drafted.

For Arbitrators: they must-

• Strictly interpret contractual provisions relating to interest;
• Avoid awarding interest contrary to express contractual terms;
• Provide reasoned justification for interest rates awarded;
• Distinguish carefully between compensation claims and interest claims.

Failure to do so may expose the award to challenge under Section 34.

Conclusion

The Supreme Court’s ruling in Union of India v. Larsen & Toubro Limited is another important milestone in the evolution of Indian arbitration jurisprudence concerning contractual exclusion of interest.

The judgment firmly reiterates that party autonomy remains the cornerstone of arbitration law in India. Where parties expressly prohibit pre-award or pendente lite interest, arbitral tribunals cannot override the contract by invoking equitable principles or by relabelling interest as compensation.

At the same time, the Court clarified that post-award interest operates differently and may continue unless specifically excluded.

For businesses, infrastructure developers, contractors, and arbitration practitioners, the decision underscores the critical importance of careful drafting of arbitration and interest clauses in commercial contracts. In high-value construction and infrastructure disputes, the wording of a single interest clause may significantly affect the ultimate financial outcome of the arbitration.

1. Special Leave Petition (Civil) No. 14989 Of 2023. ↑

2. (2025) 7 SCC 1 ↑