Arbitrator ignored contract terms, Supreme Court slashes Rs 1.49 crore refund

The contract said the company had to pay supervision charges. The arbitrator said: refund them anyway.

For twelve years, a private company bought Sal seeds from the Madhya Pradesh government. Both sides signed a deal that explicitly required the company to pay "supervision charges" as part of the seed cost. When the government terminated the agreement in 1998 under a new state law, the company went to arbitration demanding a Rs 1.49 crore refund of charges it had willingly paid for over a decade.

The arbitrator agreed. The district judge agreed. The High Court agreed. But the Supreme Court stopped at one question: can an arbitrator ignore what the contract actually says?

The contract that never said "refund"

In 1979, the State of Madhya Pradesh signed a 12-year agreement with a private company called Sal Udyog. The deal was simple: the state would supply 10,000 tonnes of Sal seeds annually, and the company would pay a price that included "handling and supervision charges." In 1992, both sides renewed the agreement for another 12 years on similar terms. Clause 6(b) of both agreements expressly stated that supervision charges formed part of the seed cost. A government circular dated July 27, 1987, further mandated that 10% supervision charges be collected. The physical contract document, its pages yellowed by time and smelling faintly of old paper, carried the clause in plain language — the ink had faded but the words remained unmistakable.

Then came the M.P. Van Upaj Ke Kararon Ka Punarikshan Adhiniyam No. 32 of 1987 — a state law that allowed the government to review and terminate certain agreements. In 1998, the state terminated the renewed agreement under this law. The company invoked arbitration, claiming it had overpaid Rs 1.72 crores over the life of the contract. It wanted a refund — including the supervision charges it had paid under Clause 6(b).

The arbitrator's award that rewrote the contract

The Sole Arbitrator, appointed by the Chhattisgarh High Court, awarded the company Rs 7.43 crores. This included a refund of approximately Rs 1.49 crores in supervision charges. The arbitrator rejected the state's argument that these charges were contractually payable. The written award, a thick sheaf of papers that rustled as the state's counsel flipped through its pages in court, contained no mention of Clause 6(b)'s express language. The weight of the document felt disproportionate to the legal error it contained.

The state appealed under Section 34 of the Arbitration and Conciliation Act, 1996 (the provision that allows a party to challenge an arbitral award before a court). The District Judge in Raipur partially modified the award in 2006. Both sides appealed under Section 37 of the Act (the provision for appeals against a court's decision on an arbitration challenge). The Chhattisgarh High Court partially modified the award again in 2009 and dismissed the state's cross-appeal. The state then approached the Supreme Court.

Patent illegality: when an arbitrator goes off the rails

The state's core argument was simple: the arbitrator had committed "patent illegality" (a legal error so obvious it jumps off the page) by ignoring the express terms of the contract. Section 28(3) of the Arbitration Act requires an arbitral tribunal to decide disputes "in accordance with the terms of the contract." The state argued that Clause 6(b) and the 1987 circular made supervision charges a contractual obligation — not something the company could later demand back. The state's counsel, standing before the bench, gestured toward the contract's text as if to say: the answer is written here.

The company countered that the state had waived its right to challenge this part of the award because it had not raised the specific ground of patent illegality in its Section 34 petition before the District Judge. The company also argued that the supervision charges were not genuinely incurred by the state and therefore should be refunded. The courtroom air grew tense as the two positions clashed — one side pointing to the written word, the other to the absence of a prior objection.

The Supreme Court's question: what did the contract say?

The Supreme Court bench — comprising Chief Justice N.V. Ramana, Justice Surya Kant, and Justice Hima Kohli — delivered its judgment on November 8, 2021. The courtroom fell silent as the operative order was read aloud, the only sound being the rustle of robes and the quiet scratch of a pen on paper.

The court found that the arbitrator had indeed committed patent illegality by ignoring the contract's express terms. The court held that the arbitrator's failure to decide in accordance with Clause 6(b) constituted a gross contravention of Section 28(3) of the 1996 Act. This was not a minor error — it went "to the root of the matter." The bench's tone, as captured in the judgment, was firm and unambiguous: a contract's words cannot be set aside by an arbitrator's preference for what seems fair.

The court cited its own precedent in Associate Builders v. Delhi Development Authority (2015) 3 SCC 49, where it had held that an award that ignores the terms of a contract is perverse and liable to be set aside. It also relied on Ssangyong Engineering and Construction Company Limited v. National Highways Authority of India (NHAI) (2019) 15 SCC 131, which clarified the scope of patent illegality under Section 34(2A). The court further referenced Delhi Airport Metro Express Pvt. Ltd. v. Delhi Metro Rail Corporation Ltd. (2021 SCC Online SC 695), State of Maharashtra v. Hindustan Construction Company Limited (2010) 4 SCC 518, and Lion Engineering Consultants v. State of Madhya Pradesh and Others (2018) 16 SCC 758. Each precedent, as the court noted, reinforced the same principle: an arbitrator's hands are tied by the contract the parties signed.

On the waiver argument, the court rejected the company's plea. It held that the power under Section 34(2A) of the Act (the specific provision allowing courts to set aside awards for patent illegality) is equally available to a court hearing an appeal under Section 37. A party cannot claim waiver simply because the specific ground was not raised in the Section 34 petition but was raised in the Section 37 appeal. The court reasoned that patent illegality goes to the root of the award and cannot be shielded by procedural technicalities.

The court also examined the arbitrator's reasoning in light of Section 31(3) of the Act (the requirement that an award must state reasons). The arbitrator had failed to provide any justification for ignoring Clause 6(b) and the 1987 circular. This omission, the court held, compounded the illegality — an unreasoned departure from the contract's terms is precisely the kind of error Section 34(2A) was designed to correct. The court further noted that Section 28(1)(a) of the Act requires the tribunal to decide disputes in accordance with the substantive law of India, which includes respect for contractual obligations freely entered into by parties.

The line an arbitrator cannot cross

The Supreme Court partly allowed the state's appeal. It quashed the portion of the arbitral award that directed a refund of supervision charges. The operative order stated: "the impugned Award, insofar as it has permitted deduction of 'supervision charges' recovered from the respondent-Company by the appellant-State as a part of the expenditure incurred by it while calculating the price of the Sal seeds, is quashed and set aside, being in direct conflict with the terms of the contract governing the parties and the relevant Circular." The rest of the award — the part that did not conflict with the contract — remained untouched. The court modified the High Court's judgment to that extent and ordered both sides to bear their own costs. As the order was pronounced, the state's counsel exhaled quietly — a decade-long legal battle had finally found its resolution on this single point.

The procedural journey itself tells a story of persistence. The arbitration began in 2005, with the Sole Arbitrator issuing an award in the company's favour on February 17, 2005. The state then filed a Section 34 petition before the District Judge in Raipur, who partially modified the award on March 14, 2006. Both sides appealed under Section 37 to the Chhattisgarh High Court, which delivered its judgment on October 21, 2009, partially modifying the award again and dismissing the state's cross-appeal. The state finally reached the Supreme Court in Civil Appeal No. 4353 of 2010, where the matter was heard by a bench that included Chief Justice N.V. Ramana, Justice Surya Kant, and Justice Hima Kohli. The judgment, delivered on November 8, 2021, brought the dispute to a close — 16 years after the arbitration began, and 23 years after the contract was terminated.

The message was clear: an arbitrator is not a contract-rewriter. When the parties have agreed to specific terms, the arbitrator must enforce them — not substitute their own view of what is fair. The court's central reasoning was that ignoring express contractual terms amounts to patent illegality that goes to the root of the award, making it liable to be set aside under Section 34(2A). The arbitration regime under the 1996 Act gives parties autonomy to design their dispute resolution, but that autonomy ends where the contract's plain language begins.

THE PLAY: If your contract says a charge is payable, do not expect an arbitrator to order a refund — the Supreme Court will strike down that part of the award as patently illegal.

The contract said the company had to pay supervision charges. The Supreme Court said: that is exactly what the contract means.