Arbitrator ignored contract terms. Supreme Court says: that's 'patent illegality'.

The contract said 'supervision charges are payable.' The arbitrator said 'refund them.' The Supreme Court just called that—patent illegality. On a November morning in 2021, a two-judge bench pulled the plug on an arbitral award that had ordered the State of Chhattisgarh to return supervision charges it had collected from a private company, even though the written agreement between them explicitly allowed those charges.

Could a private company walk away with a refund that the contract itself said the State was entitled to keep? That was the question the Supreme Court had to answer. And in doing so, the top court drew a hard line that every arbitrator, every litigant, and every company doing business with the government now has to reckon with.

When the contract said one thing, the arbitrator another

In 1992, the State of Madhya Pradesh (now Chhattisgarh) and Sal Udyog Private Limited signed a long-term agreement for the supply of Sal seeds—the small, oily seeds used in everything from soap to traditional medicine. The contract included a clause: the company would pay supervision charges as part of the cost. A government circular dated 27 July 1987 had fixed those charges at 10 percent.

Then the law changed. The Madhya Pradesh government enacted a new statute—the M.P. Van Upaj Ke Kararon Ka Punarikshan Adhiniyam No. 32 of 1987—and terminated the agreement in 1998. The company, now free from the contract, went back and looked at the numbers. It believed it had paid more than it should have. It demanded a refund of the excess amounts, including the supervision charges.

The State refused. The company went to arbitration.

The arbitrator's award that ignored the fine print

A sole arbitrator heard the dispute and, in February 2005, ruled in favour of Sal Udyog. The award directed the State to refund the supervision charges it had collected from the company as part of the price calculation. The arbitrator's reasoning? The State had terminated the agreement early. So, the company should not have to bear those charges for the full term.

The State saw a problem. The contract—Clause 6(b)—expressly allowed supervision charges. The government circular fixed the rate. The arbitrator had simply ignored both. The State challenged the award under Section 34 of the Arbitration and Conciliation Act, 1996 (the provision that allows a court to set aside an arbitral award on limited grounds).

The District Judge in Raipur partially modified the award in March 2006 but did not address the supervision charges issue. Both sides appealed to the Chhattisgarh High Court under Section 37 of the Act (the provision for appeals against orders under Section 34). In October 2009, the High Court partially allowed the State's appeal but again left the supervision charges untouched. The State went to the Supreme Court.

What the Supreme Court saw that everyone else missed

The bench—Chief Justice N.V. Ramana, Justice Surya Kant, and Justice Hima Kohli—looked at the contract. They looked at the circular. They looked at the award. And they saw something the lower courts had missed: the arbitrator had committed what the law calls "patent illegality" (an error so obvious and fundamental that it goes to the root of the matter).

The court applied Section 34(2-A) of the 1996 Act, which allows a court to set aside an award if it finds patent illegality on the face of the award. The court held that the arbitrator had violated Section 28(3) of the Act (the provision that requires an arbitrator to decide the dispute in accordance with the terms of the contract).

"An arbitrator's failure to decide in accordance with express terms of the contract governing the parties constitutes patent illegality," the court said. The contract said supervision charges were payable. The circular fixed them at 10 percent. The arbitrator had no business ordering a refund. That error went to the root of the matter.

Why the lower courts failed to catch it

The Supreme Court noted that the District Judge under Section 34 and the High Court under Section 37 had both failed to address the State's argument about supervision charges. The court made a significant procedural point: the ground of patent illegality under Section 34(2-A) is equally available in an appeal under Section 37. A party is not barred from raising it simply because it was not specifically pleaded in the Section 34 petition. The expression "the Court finds that" in Section 34(2-A) empowers the court to act on its own.

In other words, even if the State had not framed its argument perfectly in the trial court, the High Court could—and should—have spotted the error on its own. The error was that obvious.

The precedents that sealed the case

The Supreme Court relied on its own earlier rulings. In Associate Builders v. Delhi Development Authority (2015), the court had held that an arbitrator who ignores the terms of the contract commits a patent illegality. In Ssangyong Engineering and Construction Company Limited v. National Highways Authority of India (2019), the court clarified that the patent illegality standard under Section 34(2-A) is distinct from the broader "public policy" ground—it is narrower and focuses on errors that are apparent on the face of the award. In Delhi Airport Metro Express Pvt. Ltd. v. Delhi Metro Rail Corporation Ltd. (2021), the court reinforced that an award that contravenes the fundamental policy of Indian law or the terms of the contract cannot stand.

These cases together built a clear message: an arbitrator is not a free agent. The contract is the law between the parties. If the arbitrator decides against the plain language of that contract, the award is dead on arrival.

What this means for every commercial contract

For companies that do business with the government, this judgment is a warning. If your contract says you must pay a charge, and you later claim a refund through arbitration, the arbitrator cannot rewrite the deal. The contract governs. For the government, the judgment is a shield. If an arbitrator ignores the terms of a written agreement, the State can—and should—challenge the award on the ground of patent illegality.

For arbitrators, the message is even sharper. The Supreme Court has made it clear: Section 28(3) of the Arbitration Act is not a suggestion. It is a command. An arbitrator who disregards the express terms of a contract does so at the risk of having the award set aside.

THE PLAY: When challenging an arbitral award that ignores contract terms, plead patent illegality under Section 34(2-A) even if you did not raise it in the trial court—the appellate court can act on its own.

The contract said supervision charges were payable. The arbitrator said refund them. The Supreme Court said the contract wins.