ISGEC Heavy Engineering Limited v. Prakash Industries Limited

What happened

On 18 November 2017 Prakash Industries Limited (PIL), which makes sponge iron and steel at Champa, Chhattisgarh, placed a purchase order on ISGEC Heavy Engineering Limited for the supply, supervision of erection and commissioning of two waste heat recovery boilers for kilns 6 and 7, each valued at ₹13,71,00,000 including induced draft fans, amended on 27 December 2017, 6 June 2018 and 30 June 2018, with the boiler for kiln 7 later withdrawn by settlement. ISGEC furnished a performance bank guarantee of 24 April 2019 for ₹1,47,10,000, 10% of the basic order value, against damage or loss suffered by PIL for non-fulfilment of the guaranteed performance and defect liability obligations. The induced draft fans stopped functioning on 16 and 22 September 2019, kiln 6 was shut down from 22 September to 16 November 2019, and PIL bought replacement fans for an additional ₹65.92 lakh, invoked the guarantee on 18 November 2019 and invoked arbitration on 6 December 2019. PIL claimed ₹12,34,40,887 under five heads and ISGEC made five counter-claims totalling ₹5,81,73,614, including one for refund of the guarantee amount as wrongly invoked. By the award of 17 August 2023 the tribunal allowed PIL ₹65,92,000 for replacing the fans, rejected its other claims, awarded interest at 7.5% from 6 December 2019 and 8% after eight weeks, awarded ₹20,00,000 as costs, and rejected all five counter-claims. ISGEC challenged only the rejection of counter-claim no. 1 and the costs.

ISGEC argued that, having held under clause 17 of the amended purchase order that neither party is liable for loss of production, loss of profit, loss of use or indirect or consequential damage, the tribunal could not let PIL retain the guarantee proceeds towards losses it had rejected, that no loss corresponding to the proceeds was proved, relying on Uni Bros. v. All India Radio, Ssangyong Engineering and Associated Engineering v. Government of Andhra Pradesh, and that ₹20,00,000 costs was excessive against the ₹65,92,000 awarded. PIL answered that section 34 is not an appeal, that clause 17 excludes only indirect losses and not the direct loss caused by the defective fans, which the minutes of meetings showed ISGEC and its vendor had admitted, that the guarantee was liable to be invoked on the failure of performance, and that costs lay within the tribunal's discretion.

Questions before the court

• Could the tribunal permit the buyer to keep the proceeds of the performance bank guarantee when no loss corresponding to them was established, and was the award of costs open to challenge?

Why the court ruled this way

The Court noted that the tribunal had found the failure of the fans due to a defective hub design supplied by ISGEC and awarded the cost of replacement, and had rejected PIL's other claims after applying clause 17, and that clause 13(f), which allows liquidated damages up to 5% of the basic price for non-performance, was not invoked (paragraphs 7–8). The tribunal's reliance on the terms of the guarantee did not help PIL, because the guarantee indemnifies against damage or loss suffered for non-fulfilment of the terms, and the appropriation of the proceeds is directly related to a loss that has to be established and quantified, whereas the invocation of a guarantee is a different matter (paragraphs 9–10). The tribunal also did not consider the interplay between the guarantee and clause 17, which opens with a non obstante clause, and a tribunal cannot travel beyond the contract, so allowing appropriation of the proceeds towards unproved losses had no basis and was perverse, amounting to patent illegality under Ssangyong, PSA Sical and Indian Oil v. Shree Ganesh Petroleum (paragraphs 11–12). On costs, section 31A(3) gives the tribunal discretion, costs do not depend solely on the percentage of success but on conduct, partial success, frivolous counter-claims and refused settlement offers, and section 34 is not a regular appeal, so the award of costs stood (paragraphs 13–14). Under Gayatri Balasamy v. ISG Novasoft a court under section 34 cannot modify an award but can set aside a severable part, and the rejection of counter-claim no. 1 is severable and not intricately connected with the other claims (paragraphs 15–16).

Controlling point

Allowing a buyer to retain the proceeds of an invoked performance bank guarantee towards losses that were neither proved nor recoverable under the contract, without considering the exclusion clause, is perverse and patently illegal, and the severable part of the award rejecting the counter-claim for refund can be set aside under section 34.

Order and next steps

The Court set aside the award to the extent that it rejected counter-claim no. 1 and allowed the petition to that extent, and otherwise upheld the award of costs of ₹20,00,000.

Practical implications

A supplier whose guarantee has been encashed should be ready to ask the tribunal for a refund of the proceeds where the buyer has not proved loss, and a buyer that retains guarantee proceeds should prove and quantify the loss for which they are held, bearing in mind any clause that excludes liability for indirect losses or provides for liquidated damages.

Limits of this ruling

• The Court set aside only the rejection of counter-claim no. 1 and did not direct a refund of the guarantee amount or send the counter-claim back to the tribunal, did not disturb the award of ₹65,92,000 for the replacement fans, the rejection of the buyer's other claims or the costs, and its decision rests on the contract terms and the findings recorded in the award.