Complex construction arbitrations and duty of care of arbitrators: Satluj v Jaiprakash Hyundai case analysis

Gagan Anand
Legacy Law Offices, New Delhi, Delhi
anand@legacylawoffices.com

In the recent case of Satluj Jal Vidyut Nigam Ltd v Jaiprakash Hyundai Consortium & Ors^[1] (hereinafter referred to as ‘Satluj v Jaiprakash’), the Hon’ble High Court of Delhi, while dealing with a challenge to an award passed in a construction-related dispute, observed that in the context of construction contracts, the amounts involved are usually astronomical. The judgment, passed on 12 July 2023, sought to deal with a case where the arbitrator had allegedly granted the party’s claim in the absence of any supporting evidence or justification. However, the underlying effect of the judgment gave rise to an ever-growing debate on the complexities involved in construction arbitrations and the undeniable need to handle such cases with additional care and precaution.

The case brief

The dispute arose in relation to a contract signed between the parties for the construction of ‘civil works of pressure shafts and powerhouse complex of the Nathpa Jhakri Hydro Electric project’. It was alleged by the Respondent that owing to a substantial increase in minimum wages following a series of changes in law, the expenditure incurred by them was more than the claimed amount as per their lowest bid.

While the contract in question contained a clause dealing with such a situation, it was the case of the Respondent/Claimant that the formula contained therein failed to index for the ‘sudden spurt in the minimum wages’. It was requested by the Respondent/Claimant that the formula should be tweaked in order to provide the appropriate compensation towards the escalation of costs. By requesting such an amendment within the formula, the claim was for the amount of INR 66.03 crores (approx $7.92m) allegedly incurred on account of labour expenses. It was noted, however, that in support of the escalated claim, the Respondent/Claimant had merely produced a set of muster rolls, which accounted for only INR 17.47 crores (approx $2.09m), while the remaining expenses were not supported by any evidence.

The Arbitrator, in line with the provisions of the Arbitration and Conciliation Act, 1996 (hereinafter referred to as ‘Indian Arbitration Law’), as well as various judicial precedents, rejected the request for tweaking the formula, on the ground that it could not be allowed at that stage of arbitration. It is therefore peculiar that after such a dismissal of the ground for changing the formula, the Tribunal went ahead with accepting the claimed amount after holding the same to be the actual expenditure incurred by the Respondent/Claimant.

Aggrieved by the said order, the Petitioner approached the Hon’ble High Court of Delhi under Section 34 of the Indian Arbitration Law, subsequent to which the High Court set the impugned order aside under lack of grounds.

Mathematical calculations and construction arbitrations

Construction arbitrations involve extravagantly complicated mathematical calculations, undertaken to support the astronomical claims involved therein. To simplify such calculations, various courts worldwide have laid down a number of formulae to aid the Parties in calculating their overhead expenses and lost profits.

While it is not feasible to undertake a detailed study of all such formulae here, the most commonly used derivations include the Hudson, Emden and Eichley’s formulae.

• Hudson formula: This is the oldest and the most commonly used derivation for calculation of overhead expenditures. In India, the Hudson formula has been subject to both praise and criticism for its various nuances – the criticism being that the formula seeks to calculate the costs on the basis of the head office overhead percentage from the contract itself.

• Emden formula: Within this derivation, the head office percentage is calculated by dividing the total of the overhead costs and the profit of the contractor’s organisation with the total turnover. The underlying benefit of this formula has led to its wide acceptance in cases before the foreign courts.

• Eichley’s formula: This formula primarily finds its application in cases where it is impossible to prove the loss of opportunity and thus the claim originates from the actual costs incurred.

The application of all such formulae is accepted or denied in line with the circumstances of each case as well as the argument made. However, in the majority of these cases, the Arbitrator is a creature of the contract and must therefore confine his decisions to the provision as such.

In fact, in the recent case of Indian Oil Corporation v Shree Ganesh Petroleum Rajgurunagar,^[2] the Hon’ble Supreme Court of India observed that:

‘An Arbitral Tribunal being a creature of contract, is bound to act in terms of the contract under which it is constituted. An award can be said to be patently illegal where the Arbitral Tribunal has failed to act in terms of the contract or has ignored the specific terms of a contract.’

Furthermore, in the landmark judgment of the Hon’ble Supreme Court of India in the case of Associate Builders v Delhi Development Authority,^[3] it was held that an Award ignoring the terms of the contract cannot be considered to be in the public interest.

Contrary to this, in the case of Satluj v Jaiprakash, by accepting the claim, while dismissing the request to tweak the formula, the Arbitrator went beyond his power under the Indian Arbitration Law and decided the case in absolute contravention of acceptable practice.

Conclusion: A duty of care and the importance of the construction sector

‘In the context of construction contracts, where the amounts involved are usually astronomical, any laxity in evidentiary standards and the absence of adequate diligence on the part of an arbitral tribunal in closely scrutinizing financial claims advanced on the basis of mathematical derivations or adoption of novel formula, would cast serious aspersions on the arbitral process.’^[4]

In its judgment passed on 12 July 2023, the Hon’ble High Court of Delhi, while holding the award to ‘not only be at variance with the pleaded case but also unreasoned and palpably absurd’, held that ‘arbitrators must exercise a duty of care in dealing with financial claims based on mathematical derivations in the context of complex construction contracts’.^[5]

While the said observation has been upheld even by the Hon’ble Supreme Court of India in numerous cases, its vitality in terms of ‘complex construction contracts’ cannot be overemphasized. Moreover, where such construction contracts pertain to the projects undertaken at a national level, the outcome of upholding or rejecting such calculations may even have a substantial impact on the public exchequer.

It is pertinent to note that for developing countries like India, the entire economy of which is dependent on the revenue generated by and through the construction and infrastructure sector, these calculations have a much larger impact than the numbers demonstrate. Thus, the context in which the Arbitrators may be held responsible for upholding such complex mathematical derivations may only be effectively reiterated.