‘Notional Proportional Loss’ Formula: Del HC’s Analysis of the Erroneous Novel Formula for Damages



Vikash Kumar & Saksham Shrivastav[1]

Introduction

Perhaps of all the protocols under an Infrastructure Arbitral Proceeding, computation of damages is the most vital for both, the parties as well as the arbitrators. It is a reflection of how judiciously the arbitrator has acted. Infrastructure arbitral proceedings are mostly built around big and complex transactions, wherein the computation of damages is usually done through the use of mathematical formulas which are primarily – Hudson, Emden and Eichleay. These are the most frequently used and widely applicable formulas as they are recognised and accepted by various International Arbitration Institutions and FIDIC (International Federation of Consulting Engineers). Despite of such formulas for calculating damages there are limited options when it comes to formulas to calculate compensation, as the arbitrators are independent of their application, varying from the facts and circumstances of the cases. It is an accepted position that different formulas can be applied in different circumstances and the question as to whether damages should be computed by taking recourse to one or the other formula, depending on the facts and circumstances of a particular case, would eminently fall within the domain of the Arbitrator. If the learned Arbitrator, therefore, applied the Emden Formula in assessing the amount of damages, he cannot be said to have committed an error warranting interference by this Court. This, however, gives rise to a lacuna. On one hand, there is no binding law that specifies the usage of any particular formula and on the other hand, the arbitrator cannot act whimsically as he is expected to act judiciously. So what happens if the arbitrator applies a new formula, not recognised by any arbitration institution, in order to balance the interest of both the parties? Recently Hon’ble Delhi High Court while determining the validity of an award in the case of MS SMS Ltd. v. Konkan Railways Corporation Ltd. dealt with similar circumstances.

Background of the Case

In the aforesaid case, the North Eastern Railway was implementing the Construction of the Udhampur-Srinagar Baramula Rail Link (“USBRL”) project in the State of Jammu and Kashmir. The construction of this project was to be done by the Konkan Railway Corporation Limited (“Respondent”) on behalf of the Northern Eastern Railway. The construction of the project ‘Kotli Tunnel’ was awarded by Respondent to M/s SMS Infrastructure Ltd. (“Petitioner”) vide contract agreement dated 23.01.2004 at the cost of Rs. 133.07 Cr. The completion period as given under the contract was supposed to be of 36.5 (thirty-six and a half) months i.e. it was expected to be completed till 26.12.2006. However, upon reaching the said deadline, only 10% of the work was completed. An extension was granted up to 31.12.2008 without levying any penalty, despite the Petitioner contending that it would require a minimum of 4 years to complete the project i.e. by December 2012. Petitioner suspended the work in May 2007 due to financial crisis, and unsafe conditions. Later Respondent foreclosed the contract vide letter dated 05.10.2007 citing technical impossibility.

Disputes were raised by both the parties and thereafter an Arbitral Tribunal was constituted to adjudicate the disputes. In the arbitration proceedings, Claimant-Petitioner prayed for compensation for idling of Machinery and Manpower, loss of overheads, loss of profits for the balanced work, loss due to the damage and non-capitalization of material due to delay, claim on interest and cost of Arbitration Proceeding. The Petitioner claimed Rs. 75.66 Cr. vide letter dated 31.12.2008. This was followed by Respondent submitting a counterclaim for Rs 21.65 Cr. against the claimant during the Arbitral proceeding.

Award by Learned Arbitrator

The Learned Tribunal held that no joint/agreed records were available to prove the idling, and therefore it worked out a “notional proportionate loss” that would have resulted due to underutilization. The Learned Arbitral Tribunal applied this formula after taking the following factors into account.

Firstly, The Claimant was expected to work off 85% of its machinery cost of approximately Rs. 16 crores over a period of 96 months. If the contract had not been foreclosed, it was expected to complete the work by December 2011, as per the letter dated 16.4.2007.

Secondly, since both parties contributed to the delays at various stages, the Tribunal deemed it to be fair if the loss on account of under-utilization of machinery was shared by both parties.

Thirdly, as per the Tribunal, the Respondent could only be held liable for a delay of 10 months, in arriving at the decision to foreclose the contract.

Finally, after considering the cost of machinery as Rs.16 Crores (as per joint note), 50% of the “notional idling cost” for 10 months was worked out to Rs.70.83 lacs (i.e. 16 crores x 85/100 x (10/96) x 5) and was awarded by the Learned Tribunal for idling machinery.

Similarly, Arbitral Tribunal also awarded Rs.6 lakh to the Claimant for the idling of manpower following the above method.

Claimant-Petitioner challenged the award under Section 34 of the Arbitration and Conciliation Act, 1996 before Delhi High Court for being illegal and alternatively praying for the amount of the compensation to be enhanced.

Issue

Whether the use of “Notional proportionate loss” formula for the computation of damages is valid in the eyes of law?

An Erroneous Formula: Court’s View

The court after taking into account the arguments of both the parties and careful perusal of the award of the learned arbitrator observed that the formula of “Notional proportionate loss” applied by the learned Tribunal suffered from three fundamental flaws in the assumptions that it relied upon:

a) The Tribunal took into consideration a period of only 10 months i.e. time taken by the Respondent to foreclose the contract on 05.10.2007 after the Claimant suspended the project work and applied this period in its formula. This was done despite the specific finding by the learned Tribunal that on encountering the shear zone at Portal 1, from April 2005 to December 2006, both the Claimant and Respondent were grappling with the situation and trying to find methods to control it. Thus, the period to be taken into consideration to compensate the Claimant for the idling on its resources should at the very least run from April 2005 from when, admittedly, the shear zone was encountered and the work under the contract had to cease;

b) The Tribunal held that the Claimant could only utilise 85% of its machinery, cost of which was approximately Rs.16 crores, over a period of 96 months i.e. till December 2011 when the Claimant was expected to complete the Contract work as per letter dated 16.04.2007. This period of 96 months was completely arbitrary and hypothetical as the period of the contract was clearly stipulated in the contract as 36.5 Months.

c) The Tribunal then observed that as both the parties have contributed to the delays at various stages, the loss on account of under-utilization of machinery should be shared by both the parties.

The Court weighed in on the aforesaid parameters and held they were wholly unfounded in law. It further held that for the purpose of computing the damages suffered from idleness, the only inquiry that was relevant was an inquiry as to the extent to which the contract remained idle i.e. un-operated and, the resource deployment that thus remained idle. Admittedly, the works contract could not be operated to the extent of 93% on account of shear zone etc. Resultantly, the Claimant was denied their contracted right to recover the cost through contractual realizations to the extent of 93%.

The Court declared that the Tribunal had applied completely misplaced, ad-hoc and perverse concept of “notional idling cost” to determine the compensation to be paid to the Claimant.

Analysis

Firstly, since the Arbitral Tribunal concluded that the foreclosure of the contract cannot be attributed to the Claimant-Petitioner, it should have awarded the compensation claimed by the Petitioner on the account of idling of machinery and manpower in a reasonable manner.

Secondly, in the opinion of the authors, the approach of the Tribunal is totally flawed as the Respondent had made no investment towards the machinery and therefore multiplying the entire amount of compensation by ½ is completely unsustainable. Therefore, the final conclusion drawn by the arbitral Tribunal is perverse and incorrect. Also, the compensation awarded by the arbitral Tribunal is highly inadequate for Petitioner given the investment made for the project.

Since the circumstance of the idling of manpower and machinery was not disputed by the Respondent during the arbitral proceedings, the learned Arbitrator should have taken a more practical and feasible approach while awarding the quantum claimed on the amount of idling of machinery and manpower. Given the circumstances, ideally, the Arbitral Tribunal should have awarded the amount asked by the claimant in this issue.

The Hon’ble Court also set aside the award on the grounds of ‘Patent Illegality’ as expounded in the landmark judgment of Ssangyong Engineering & Construction Co. Ltd. v. NHAI. Patent Illegality stems from an award that is found to be based on no evidence at all or an award that ignores vital evidence in arriving at its decision. On such grounds, the award is said to be perverse and liable to be set aside. This also suggests that a grave blunder was done by the arbitrator by using imaginary and impermissible parameters, like in the present case, application of the Notional Proportional Loss formula that did not have any known precedent.

Conclusion

After analysing the facts, the line of reasoning of both the Tribunal as well as the Court, and the legal precedents, the authors conclusively put that Arbitrator should not have deviated from the standard formulas for computation of damages. This not only deprived the parties of the proper remedies but also trapped them in pursuit of the justice system. Such irregularities on behalf of the Arbitrators while computing the damages can result in unnecessary litigation and wastage of resources. This can be inferred from the fact that in this case, since the court does not have the power to remand the parties to go back to the arbitral Tribunal, now the Petitioners need to again initiate a fresh arbitration proceeding.

[1] Vikash Kumar is a final year student at National University of Study and Research in Law, Ranchi and can be contacted at vkbairagi23@gmail.com. Saksham Shrivastav is a third year student at National University of Study and Research in Law, Ranchi and can be contacted at saksham.shrivastav@nusrlranchi.ac.in.

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