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Union Of India v. Colonel L.S.N Murthy And Another
Factual and Procedural Background
In August 1999 the appellant (Union of India) invited tenders for supplying fresh fruits to its troops for the period 1-10-1999 to 30-9-2000. The tender of Respondent 2 was accepted. Supplies commenced on 1-10-1999 but were stopped on 6-6-2000. After issuing a show-cause notice and receiving a reply citing steep price escalation, the appellant rescinded the contract on 29-6-2000, forfeited the security deposit and intimated its intention to recover extra expenditure incurred for procuring fruits.
The contract contained an arbitration clause. Respondent 2 claimed ₹12,23,732; the appellant counter-claimed ₹5,89,130.72. By award dated 6-6-2001 the sole arbitrator (Respondent 1) granted Respondent 2 ₹38,173 with 18% interest and directed return of the security deposit.
The appellant challenged the award under Section 34 of the Arbitration and Conciliation Act, 1996. The Third Additional Chief Judge, City Civil Court, Hyderabad dismissed the challenge on 5-11-2004. A further appeal under Section 37 (CMA 322/2005) was dismissed by the Division Bench of the Andhra Pradesh High Court on 27-4-2006. The present civil appeal was filed in the Supreme Court by special leave under Article 136 of the Constitution.
Legal Issues Presented
- Whether the arbitrator erred in law in holding that the contract was void ab initio and therefore unenforceable.
- If the contract is void ab initio, whether the arbitration clause embodied in that contract could be invoked.
- Whether the arbitral award, being allegedly contrary to statutory provisions and public policy, was liable to be set aside under Section 34 of the Arbitration and Conciliation Act, 1996.
Arguments of the Parties
Appellant's Arguments
- The arbitrator’s finding on Issue 4 (that the contract was void ab initio) is contrary to law and unsupported by the material on record.
- Assuming the contract was void, the arbitration clause—being part of that contract—could not survive; reliance was placed on National Insurance Co. Ltd. v. Boghara Polyfab (2009) 1 SCC 267.
- On either ground, the award ought to have been set aside under Section 34 of the 1996 Act.
Respondent 2's Arguments
- The arbitrator correctly applied Section 70 of the Contract Act, 1872 and awarded compensation for fruits actually supplied and ordered return of the security deposit with 18% interest.
- The award was within the arbitrator’s jurisdiction and disclosed no patent illegality warranting interference.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| National Insurance Co. Ltd. v. Boghara Polyfab Pvt. Ltd., (2009) 1 SCC 267 | An arbitration clause does not survive if the underlying contract is void ab initio. | Cited by the appellant to contend that, on the arbitrator’s own reasoning, arbitration could not be invoked; the Court noted the argument but proceeded to test the validity of the finding that the contract was void. |
| Shri Lachoo Mal v. Shri Radhey Shyam, (1971) 1 SCC 619 | Performance of an agreement is illegal only if it necessarily entails an unlawful act; otherwise the agreement is not void under Section 23. | Relied upon to explain that an otherwise lawful contract is not rendered void unless its performance is necessarily unlawful. |
| Vita Food Products Inc. v. Unus Shipping Co. Ltd., 1939 AC 277 (PC) | The doctrine that contracts may be nullified for statutory disobedience is itself a rule of public policy and should be sparingly applied. | Quoted to reinforce that contracts should not be invalidated unless serious and sufficient grounds exist. |
| ONGC Ltd. v. Saw Pipes Ltd., (2003) 5 SCC 705 | An arbitral award that is patently illegal is contrary to public policy and liable to be set aside under Section 34. | Invoked to justify setting aside the award once patent illegality was found. |
| Renusagar Power Co. Ltd. v. General Electric Co., 1994 Supp (1) SCC 644 | Laid down a narrower test of public policy for enforcement of foreign awards; referred to in Saw Pipes. | Mentioned indirectly through Saw Pipes to contrast broader and narrower meanings of “public policy.” |
Court's Reasoning and Analysis
The Supreme Court scrutinised the arbitrator’s conclusion that the contract was void because the tendered rates were more than 20% below “reasonable rates,” allegedly violating a Ministry of Defence letter dated 31-8-1990. The Court reasoned as follows:
- The letter is merely an administrative instruction to Defence officers; it is neither legislation nor a statutory rule.
- Article 13(3)(a) of the Constitution extends the term “law” to include notifications only for the limited purpose of testing their conformity with fundamental rights. It has no bearing on whether a private contract is void.
- Under Section 23 of the Contract Act an agreement is void only if its object or consideration is unlawful or would defeat the provisions of an enacted law. “Law” in Section 23 refers to legislation, not departmental instructions.
- Because the Ministry’s letter is not “law” within Section 23, supplying fruits at rates 20% below the benchmark does not involve an unlawful act, nor does it defeat any statutory provision.
- Authorities such as Lachoo Mal and scholarly commentary (Pollock & Mulla) underscore that courts should preserve bargains unless their performance necessarily involves illegality.
- The arbitrator’s finding that the contract was void therefore constitutes a patent error of law. Under the principle in ONGC v. Saw Pipes, such patent illegality offends public policy and justifies setting aside the award.
Having invalidated the arbitrator’s determination on Issue 4, the Court found it unnecessary to rule on the appellant’s alternative argument regarding the survival of the arbitration clause, because the foundational error itself vitiated the award.
Holding and Implications
Holding: The Supreme Court set aside the arbitral award dated 6-6-2001, as well as the orders of the City Civil Court, Hyderabad and the Andhra Pradesh High Court, and remitted the matter to the arbitrator for fresh determination consistent with its judgment (maintaining the findings on Issues 1, 2 and 3). The appeal was allowed with no order as to costs.
Implications: The decision nullifies the award and revives arbitration on the merits. It underscores that departmental instructions do not constitute “law” for purposes of Section 23 of the Contract Act and that misapplication of statutory provisions constitutes patent illegality justifying judicial intervention under Section 34. No new legal precedent was expressly created beyond this clarification.
A.K Patnaik, J.— This is an appeal by way of special leave under Article 136 of the Constitution against the judgment dated 27-4-2006 of the Division Bench of the Andhra Pradesh High Court in Union of India v. Col. L.S.N Murthy CMA No. 322 of 2005, (for short “the impugned judgment”).
2. The facts in brief are that in August 1999, the appellant invited tenders for supply of fresh fruits for its troops for the period from 1-10-1999 to 30-9-2000 and Respondent 2 amongst others submitted tenders and the tender of Respondent 2 was accepted. Respondent 2 started supply of fresh fruits on 1-10-1999 and stopped the supply on 6-6-2000.
3. On 13-6-2000, the appellant issued a notice to Respondent 2 to show cause why action should not be initiated for such non-supply of fresh fruits. Respondent 2 submitted its reply dated 20-6-2000 saying that the prices of all variety of fruits had increased and that it was impossible on its part to perform the contract and that the appeals made by Respondent 2 were not considered by the authorities. The appellant then rescinded the contract with Respondent 2 by Letter dated 29-6-2000 and informed Respondent 2 that its security deposit has been forfeited and that the appellant will recover the expenditures made by the appellant for purchase of fruits during the contract period.
4. As the contract provided for an arbitration clause, the dispute between the parties was referred to the arbitrator. Respondent 2 made a claim of Rs 12,23,732 before the arbitrator and the appellant made a claim of Rs 5,89,130.72 for purchase of fruits during the period from 7-6-2000 to 30-9-2000 before the arbitrator. The arbitrator (Respondent 1) framed four issues and answered the four issues in his award dated 6-6-2001 and awarded a sum of Rs 38,173 towards prices of fresh fruits supplied by Respondent 2 to the appellant with interest at the rate of 18% per annum till payment and also directed the appellant to hand over the fixed deposit certificates retained as security deposit to Respondent 2.
5. The appellant filed OP No. 1457 of 2001 under Section 34 of the Arbitration and Conciliation Act, 1996 (for short “the Act”) for setting aside the award dated 6-6-2001 in the City Civil Court, Hyderabad. The Third Additional Chief Judge, City Civil Court, Hyderabad, by his order dated 5-11-2004 did not find any patent illegality in the award and dismissed the application of the appellant under Section 34 of the Act. Aggrieved, the appellant filed Civil Miscellaneous Appeal No. 322 of 2005 under Section 37 of the Act against the order dated 5-11-2004 of the Third Additional Chief Judge, City Civil Court, Hyderabad, but by the impugned judgment, the Division Bench of the High Court has dismissed the appeal.
6. The learned counsel for the appellant challenged the findings of the arbitrator on Issue 4. He submitted that Issue 4 framed by the arbitrator was whether the contract between the appellant and Respondent 2 was legally enforceable and the arbitrator has held in the award that the contract was void ab initio and was not enforceable. He referred to the reasons given by the arbitrator in the award to show that this finding of the arbitrator on Issue 4 was contrary to law.
7. The learned counsel for the appellant alternatively submitted that if it is held that the contract was void ab initio, then the arbitration clause which is part of the contract cannot be invoked. He cited the decision in National Insurance Co. Ltd. v. Boghara Polyfab (P) Ltd. (2009) 1 SCC 267 in which this Court has held that where a contract is void ab initio and has no legal existence, the arbitration clause also cannot operate, for along with the original contract, it is also void. He submitted that on these two grounds the award of the arbitrator should have been set aside and the application of the appellant under Section 34 of the Act should have been allowed.
8. The learned counsel for Respondent 2, on the other hand, sought to sustain the award of the arbitrator. He submitted that the arbitrator has held that even though the contract was void under Section 70 of the Contract Act, 1872, the appellant is liable to pay compensation to Respondent 2 for the supply of fruits made by Respondent 2 to the appellant and to the security deposit with interest at the rate of 18% per annum to Respondent 2.
9. We have perused the award of the arbitrator and we find that the arbitrator has framed the following four issues:
1. Whether the parties to the contract were discharged?
2. Whether the disputed contract was discharged in the following ways:
(a) By performance of the contract
(b) By breach of the contract
(c) By impossibility of performance
3. Construction of ASE Specification 68;
4. Whether the contract was legally enforceable?
10. On Issue 1, the arbitrator has held that Respondent 2 by not supplying fruits to the appellant had discharged the appellant from its obligations under the contract and the appellant had the right to sue for breach of contract for damages for loss caused to it in accordance with the provisions of the Contract Act. On Issue 2, the arbitrator has held that the contention of Respondent 2 that he was disabled to perform his part of the contract due to impossibility of performance caused by short supply of fruits is not correct. On Issue 3, the arbitrator has held that the contention of Respondent 2 regarding ASE Specification 68 and the note thereto failed because Respondent 2 has accepted and signed the chart and performed his part of the contract up to June 2000. On Issue 4, however, the arbitrator has held that the contract was void ab initio and was not enforceable and therefore no right accrued to any of the parties for breach of contract.
11. We, however, find that the reasons given by the arbitrator in his award for recording this finding on Issue 4 that the contract was void ab initio are not tenable in law. The arbitrator has found that Government of India, Ministry of Defence in its Letter dated 31-8-1990 has issued an instruction that if the rate quoted by a tenderer was lower than 20% of the reasonable rates, the rate should be treated as fictitious and the tender should be rejected by a panel of officers. The arbitrator has held that as the rates quoted by Respondent 2 were below 20% of the reasonable rates the agreement entered into with Respondent 2 for supply of fruits at the tendered rates was hit by the Letter dated 31-8-1990 of Government of India, Ministry of Defence.
12. The arbitrator has further held that under Article 13(3)(a) of the Constitution of India, law includes a notification of the Government and therefore the Letter dated 31-8-1990 of Government of India, Ministry of Defence was law and as the consideration or object of the agreement between the appellant and Respondent 2 defeated a provision of law, the agreement was void under Section 23 of the Contract Act. In our considered opinion, the arbitrator has failed to appreciate not only the provisions of Article 13(3)(a) of the Constitution but also of Section 23 of the Contract Act.
13. Article 13 of the Constitution is quoted hereinbelow:
“13. Laws inconsistent with or in derogation of the fundamental rights.—(1) All laws in force in the territory of India immediately before the commencement of this Constitution, insofar as they are inconsistent with the provisions of this Part, shall, to the extent of such inconsistency, be void.
(2) The State shall not make any law which takes away or abridges the rights conferred by this Part and any law made in contravention of this clause shall, to the extent of the contravention, be void.
(3) In this article, unless the context otherwise requires—
(a) ‘law’ includes any Ordinance, order, bye-law, rule, regulation, notification, custom or usage having in the territory of India the force of law;
(b) ‘laws in force’ includes laws passed or made by a legislature or other competent authority in the territory of India before the commencement of this Constitution and not previously repealed, notwithstanding that any such law or any part thereof may not be then in operation either at all or in particular areas.
(4) Nothing in this article shall apply to any amendment of this Constitution made under Article 368.”
14. A reading of clause (2) of Article 13 of the Constitution quoted above would show that by the said clause the State is prohibited from making any law which takes away or abridges the fundamental rights conferred by Part III of the Constitution. Clause (2) of Article 13 of the Constitution further provides that any law made in contravention of clause (2) shall to the extent of the contravention be void.
15. In clause (3)(a) of Article 13 of the Constitution, the word “law” has been defined for the purpose of Article 13 to include any Ordinance, order, bye-law, rule, regulation, notification, custom or usage having in the territory of India the force of law. Clause (3)(a) of Article 13 of the Constitution therefore makes it clear that not only law made by the legislature but also an order or notification which takes away or abridges the fundamental rights conferred by Part III of the Constitution would be void. Thus, clause (3)(a) of Article 13 of the Constitution is relevant, where an order or notification of the Government attempts to take away or abridge the fundamental rights conferred by Part III of the Constitution and this provision of the Constitution has no relevance in deciding a question whether an agreement is void and is not enforceable in law.
16. For deciding whether an agreement is void and is not enforceable, we have to refer to Section 23 of the Contract Act, which is quoted hereinbelow:
“23. What considerations and objects are lawful, and what not.—The consideration or object of an agreement is lawful, unless—
it is forbidden by law; or
is of such a nature that, if permitted, it would defeat the provisions of any law; or
is fraudulent; or
involves or implies injury to the person or property of another; or the court regards it as immoral, or opposed to public policy.
In each of these cases, the consideration or object of an agreement is said to be unlawful. Every agreement of which the object or consideration is unlawful is void.”
Section 23 of the Contract Act inter alia states that the consideration or object of an agreement is lawful, unless the consideration or object of an agreement is of such a nature that, if permitted, it would defeat the provisions of law and in such a case the consideration or object is unlawful and the agreement is void.
17. In Pollock & Mulla, Indian Contract and Specific Relief Acts, 13th Edn., Vol. I published by LexisNexis Butterworths, it is stated at p. 668:
“The words ‘defeat the provisions of any law’ must be taken as limited to defeating the intention which the legislature has expressed, or which is necessarily implied from the express terms of an Act. It is unlawful to contract to do that which it is unlawful to do; but an agreement will not be void, merely because it tends to defeat some purpose ascribed to the legislature by conjecture, or even appearing, as a matter of history, from extraneous evidence, such as legislative debates or preliminary memoranda, not forming part of the enactment.”
It is thus clear that the word “law” in the expression “defeat the provisions of any law” in Section 23 of the Contract Act is limited to the expressed terms of an Act of the legislature.
18. In Lachoo Mal v. Radhey Shyam (1971) 1 SCC 619 this Court while deciding whether an agreement was void and not enforceable under Section 23 of the Contract Act held:
“7. … What makes an agreement, which is otherwise legal, void is that its performance is impossible except by disobedience of law. Clearly no question of illegality can arise unless the performance of the unlawful act was necessarily the effect of an agreement.”
19. We are, therefore, of the opinion that unless the effect of an agreement results in performance of an unlawful act, an agreement which is otherwise legal cannot be held to be void and if the effect of an agreement did not result in performance of an unlawful act, as a matter of public policy, the court should refuse to declare the contract void with a view to save the bargain entered into by the parties and the solemn promises made thereunder.
20. As has been observed by Lord Wright in Vita Food Products Inc. v. Unus Shipping Co. Ltd. 1939 AC 277, (1939) 1 All ER 513 (PC) (AC at p. 293):
“… Nor must it be forgotten that the rule by which contracts not expressly forbidden by statute or declared to be void are in proper cases nullified for disobedience to a statute is a rule of public policy only, and public policy understood in a wider sense may at times be better served by refusing to nullify a bargain save on serious and sufficient grounds.”
21. The arbitrator was, therefore, not right in law in coming to the conclusion that the agreement between the appellant and Respondent 2 was void and not enforceable as the consideration or object of the agreement was hit by the Letter dated 31-8-1990 of the Government of India, Ministry of Defence. This letter may be an instruction to the officers of the Defence Department to reject a tender where the rate quoted by the tenderer is more than 20% below the reasonable rates but the letter was not an Act of the legislature declaring that any supply made at a rate below 20% of the reasonable rates was unlawful. The finding of the arbitrator on Issue 4 is thus patently illegal and opposed to public policy.
22. In ONGC Ltd. v. Saw Pipes Ltd. (2003) 5 SCC 705 this Court after examining the grounds on which an award of the arbitrator can be set aside under Section 34 of the Act has said:
“31. … However, the award which is, on the face of it, patently in violation of statutory provisions cannot be said to be in public interest. Such award/judgment/decision is likely to adversely affect the administration of justice. Hence, in our view in addition to narrower meaning given to the term ‘public policy’ in Renusagar case 1994 Supp (1) SCC 644 it is required to be held that the award could be set aside if it is patently illegal.”
23. We accordingly set aside the award of the arbitrator and the judgments of the City Civil Court, Hyderabad and the High Court and remit the matter to the arbitrator for deciding the claims of the appellant and Respondent 2 in accordance with the findings in the award on Issues 1, 2 and 3 and in accordance with this judgment. The appeal is allowed with no order as to costs.
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