ONGC v Saw Pipes

This case arose out of a challenge to an arbitral award rendered with regard to a dispute relating
to supply of equipment for off shore oil exploration by the respondent. The case was heard by
M.B Shah and Arun Kumar JJ. The judgment was written by Shah J.
FACTS
Oil and Natural Gas Commission had placed an order on Saw Pipes for supply of equipment for
off shore exploration, to be procured from approved European manufacturers. The delivery was
delayed due to general strike of steel mill workers in Europe. Timely delivery was the essence of
the contract. ONGC granted extension of time, but it invoked the clause for recovery of
Liquidated Damages by withholding the amount from the payment to the supplier. ONGC
deducted from the payment $3,04,970.20 and Rs 15,75,557 towards customs duty, sales tax and
freight charges. Saw pipes disputed the deduction and matter was referred to arbitration. While
the arbitral tribunal rejected Saw Pipes defence of force majure, it required ONGC to lead
evidence to establish the loss suffered by breach and proceed to hold, in absence of evidence of
financial losses, that the deduction of Liquidated damages was wrongful. The award was
challenged by ONGC; inter alia as being opposed to public policy ONGCs case was that the
arbitral tribunal failed to decide the dispute by not applying the prevailing substantive law,
ignoring the terms of the contract and customary practices of usage of trade in such transactions.
ONGC challenged the award as being patently illegal. The single judge and division bench of
Bombay High Court dismissed the challenge. The Supreme Court set aside an arbitration award
directing ONGC to refund $3,04,970.20 and Rs 15.76 Lakhs towards liquidated damages
retained by it while making payment to the company.
Issues Raised
1) Whether ONGC had the right to Liquidated Damages.
2) Whether Patent illegality could be used as a ground to assail the award under section 34.

Decision Of The Supreme Court

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The Honble Court first extensively discussed the courts jurisdiction to set aside an award under
Section 34 of the Arbitration and Concilliation Act 1996 and the various grounds on which
interference was permissible. The Honble Court first extensively discussed the courts
jurisdiction to set aside an award under Section 34 of the Arbitration and Concilliation Act 1996
and the various grounds on which interference was permissible.
Passing over to the question of damages, the Honble Court opined that when the words of the
contracts are clear, there is nothing that the court can do about it. If the parties had agreed upon a
sum as being pre- estimated genuine liquidated damages there was no reason for the tribunal to
ask the purchaser to prove his loss.
It further opined that when the court concludes that stipulation for damages is by way of penalty,
it can grant reasonable compensation upon proof of damage. However, where an agreement has
been executed by experts in the field, the court should be slow to construe a clause providing for
liquidated damages as penalty. At paragraph 49, citing Maula Bux v Union of India1 (the court
concludes that this is especially true where the court is unable o assess compensation or such
assessment is fraught with difficulties. In such cases the burden of proof would be on party who
contends that the stipulation amount is not reasonable. There was no such contention raised in
the instant case.
As regards forfeiture, after considering its decision in Union of India v Rampur Distellery2 the
court states the forfeiture clause can be construed either as liquidated damages or as a penalty,
depending on the reasonableness of the amount to be forfeited.
Therefore, as regards Liquidated Damages and penalties, the primary conclusion of the court
appears to be that Liquidated Damages should be regarded as reasonable compensation, while
penalties should not. Further, it also appears to have concluded in case of penalty damages will
1 AIR 1970, SC 1955
2 AIR 1973, SC 1098
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have to be proved. The Honble Court reaffirms that no compensation at all be awarded if the
court concludes that no loss is likely to occur because of the breach.
The court took the view that the appellant had rightfully deducted the amount of liquidated
damages from the amount claimed by the respondent, and it was not necessary for the appellant
to prove the loss suffered by it in view of the provisions in the contract for the payment of
liquidated damages, and the impugned award thus suffered from patent illegality and was,
therefore liable to be set aside on the ground that the patent error of law was included in the
ground of public policy.
Patent Illegality used as a ground to assail the award under section 34
Patent Illegality
The court held that the jurisdiction or the power of the arbitral tribunal is prescribed under the
Act and if the award is de hors the said provisions, it would be, on the face of it, illegal. The
legislative intent could not be that if that the award is in contravention of the provision of the
Act, however, the court could still not set it aside. The decision of the tribunal must be within
bounds of its jurisdiction conferred under the Act or the contract. In exercising jurisdiction, the
tribunal can not act in breach of some provisions of substantive law or the provisions of the Act.
If the tribunal has not followed the mandatory provisions of the Act it would mean that it has
acted beyond its jurisdiction and thereby the award would be patently illegal which could be set
aside under section 34.
The Honble Court interpreted patent illegality as meaning any violation of the substantive law in
force in India, or as an award opposing the terms of the contract. It also laid down guidelines to
determine reasonable compensation with reference to Section 74 of the Indian Contract Act.
The article also highlights the shift in the interpretation of public policy from the Renusagar to
the Saw Pipes case. In the former, the narrow view of public policy was adopted, requiring
something more than the violation of the law. The wider connotation adopted in the latter, might,
however, flood the courts with challenges to awards suffering from negligible legal defects. The
in definability of the public policy concept makes it all the more likely to be misused.
The court further clarified that an award is patently illegal if the illegality goes to the root of the
matter. The Court restricted its holding to circumstances where the contractual agreement runs
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contrary to an explicit and well defined public policy, as demonstrated by the positive statutory
law of India, rather than on general consideration of public interest.

Concept of Public Policy Expanded

Public Policy

The Arbitration and Conciliation Act 1996, was conceived by the compulsions of globalization
leading to adoption of the United Nation Commissions on International Trade Law (UNCTRAL)
model law. This Act is by and large an integrated version of the 1940 Act which governed
domestic arbitration, The Arbitration (protocol and convention) Act, 1937 and the foreign award
(recognition and enforcement) Act, 1961 which governed into arbitral awards. Apparently
chapter I VIII of the UNCTRAL are replicas of Chapter I VII of the Part I of the 1996 Act,
with the difference that in UNCTRAL the provisions are called Article whereas under the act
they are called section. The main objectives set out in the statement of objects and reasons of
1996 Act are- to minimize the supervisory role of courts in arbitral process and to provide that
every final arbitral award is enforced in the same manner as if it were a decree of the court
Public Policy is that principle of law which holds that no subject can do, which has a tendency to
be injurious to the public or against the public good, which may be termed as it sometimes has
been policy of the law or public policy in relation to administration of the law. Public Policy
connotes some matter which concerns public good and public interest. The concept of Public
Policy varies from time to time.
The judgment expanded the concept of Public Policy to add that the award would be contrary to
public policy if it is patently illegal. An earlier Supreme Court decision of a three judge (larger
bench) bench, in the case of Renu Sagar Power Co v General Electrical Corporation had
construed the ground of public policy narrowly as confined to the fundamental policy of Indian
Law or the interest of India or justice or morality.

While analyzing the ratio of Renusagar case3, the court held that it was to be understood in the
context of foreign award. The ratio of Renusagar could not be applied while interpreting section
34(2)(b)(ii) of the 1996 Act, though applicable in case of challenge to foreign awards. It was
observed that section 48(2)(b) was liable to be construed differently having regard to the concept
of double exquator recognized in the context of a challenge to foreign awards.
The Supreme Court specifically stated the phrase public policy of India used in section 34
context is required to be given wider meaning. It can be stated that a concept of public policy
connotes some matter which concerns public good and the public interest. What is for public
good or in public interest or what would be injurious or harmful to the public good or public
interest, and that has varied from time to time. However, the award which is, on the face of it,
patently in violation of statutory provisions cannot to be said to be in public interest. Such
award/judgement/ decision is likely to adversely affect the administration of justice. Hence, in
addition to narrower interpretation given to the term public policy in Renusagars case (supra),
which was in context of a foreign award, it is required to be held that the award could be set
aside if its patently illegal. The award could now be set aside, if it is contrary to:(i)
(ii)
(iii)
(iv)

Fundamental policy of Indian law; or

The interest of India; or
Justice or morality; or
In addition, if it is patently illegal.

Critical Appraisal

This decision has provoked considerable adverse comments. A common criticism of the Saw
pipe judgment is that it has erroneously expanded the meaning of public policy in India, which
was given a narrow interpretation in the Renusagar case4, although in a case of foreign award
under the repealed foreign awards (Recognition and Enforcement Act) Act of 1961. The decision
of the two judges Bench in ONGC has bypassed the ruling of the three judges Bench of Supreme
3 AIR 1994 SC 860
4 (1994) Supp 1 SCC 644 at p. 671, para 33.
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Court in the Renusagar case. It has been criticized for both judicial indiscipline and violation of
the binding precedent of a larger Bench. While the Bench in Renusagar case held that the term
public policy of India was to be interpreted in a narrow sense, the Division Bench went ahead
unmindful of the prior precedent and expanded the same to such an extent that arbitral awards
could now be reviewed on their merits. This is a huge step backwards in laws relating to alternate
dispute resolution in the era of globalization.
The gravamen of all the comments is that this case has set the clock back to the pre 1996 era,
when parties could challenge arbitral awards on the grounds of error of law apparent on the face
of the award.5 The purport of UNICITRAL Model Law a priori of the 1996 Act, was to leave that
era behind. The decision of Supreme Court in Renusagar case gave a narrow meaning to the
expression Public Policy of India by confining judicial intervention with an arbitral award only
to the three reasons set forth in it. These reasons hitherto have been treated as exhaustive and
incapable of expansion.
Mr Fali. S. Nariman, one of the greatest lawyers of our generation, remarks6 on the judgments as
having virtually set at naught the entire Arbitration and Concillation Act of 1996.To have
introduced by judicial innovation a fresh ground of challenge and placed it under the head of
public policy was first contrary to the established doctrine of precedent. The division of 3 judge
bench binding on a bench of 2 judges. It was also contrary to the plain intent of the 1996 the new
need of finality in alternative method of dispute resolution without court interference.
The most common criticism of the ONGC case is that it has widened the scope of judicial
intervention which is contrary to Section 5 which provides that no judicial authority shall
intervene, except where so provided in Part-1.7
5 O.P.Malhotra. the Law & Practice if Arbitration; Third Edition, 2014. Pp. 1359.
6 From transcript of speech delivered by Mr. F. S. Nariman at the inaugural session
of Legal Reforms in Infrastructure, New Delhi, 2 May, 2003 quoted in Kachwaha,
Sumeet, The Indian Arbitration Law : Towards a New Jurisprudence, Int. A.L.R.
2007, 10(1), 13-17
7 O.P.Malhotra. the Law & Practice if Arbitration; Third Edition, 2014. Pp. 1360..
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The contra view in favour of ONGC is that there is no rational justification to fault ONGC
merely because it had added one more head to thos who set forth in accordance with the
substantive law in force in India, as is explicitly provided in the section 28 (1) (i) of the act.it is
relevant to note here that the three heads set ou in Renusagar were stated by the court for the
first time.8
Before this, the parameters of public policy were not demarcated, by the same logic, there is no
justification to fault ONGC because another bench has added one more head to the three already
existing as required by the situation.

Ramification of the Case:The Supreme Court in Saw Pipes confined the expansion of public policy to domestic awards as
an earlier larger bench decision of the court in case of Renusagar Power Co vs General
Electricals9 had construed narrowly this ground as limited to fundamental policy of Indian Law.
The Saw pipes judgment has come in for sharp criticisms from several quarters . Read literally,
the judgment sets the clock back to the old position where an award could be challenged on merit
and indeed renders the court as a court of appeal.
the judgement was followed by two judge bench of the Supreme Court in Centrotrade Minerals
& Metals Inc. vs. Hindustan Copper ltd.10 It was held that the doctrine of Public Policy must be
held to be ground for setting aside as arbitration agreement and consequently an award.
The judgement of ONGC v. Saw Pipes has now been affirmed by a three judge bench in the case
of Shri Lal Mahal Ltd. Vs. Progetto Grano Spa.11 In para 26 of this judgement, the court held that
8 The three heads stated in Renusagar were taken from Cheshire and North, Privste
International Law, 12th Edition, pp. 131-133.
9 (1994) Supp 1 SCC 644 at p. 671, para 33 :AIR 1994 SC 860: 1994 (2) Arb LR 405
(SC)
10 2006 (3) Arb LR 201 SC: (2006) 11 SCC 245: [2006] Supp. (2) SCR 146.
11 2013 (3) Arb LR 1: 2013 (8) SCALE 489
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insofar as proceedings for setting aside an award under section 34 is concerned, the principles
laid down in Saw pipes would govern the scope of proceedings foe setting aside an award under
section 34 is concerned, the principles laid down in the Saw Pipes would govern the scope of
proceedings.
It also finds support in comments of two eminent commentators Michael Hwang and Amy Lai in
the following language12:
Public policy is a ground for challenge has been historically viewed with much skepticism,
often for good reason. While we do not advocate that it be used as catch-all provision to be
applied whenever convenient, it should be available for attacking awards that are fundamentally
flawed. To allow such awards to stand, uncorrected would undermine confidence in the integrity
of the arbitral process. A supervisory or enforcing court should not second- guess a tribunal, and
the risk f arbitral error is inherent in the acceptance of the process. However, parties do not
bargain for a perverse and manifest error that calls out for correction. To ignore suc errors would
be to accept that the arbitral process can condone miscarriage of justice.

Some judicial decisions have tried to reign in this effect of Saw Pipes. One instance of this is the
Supreme Court decision in case of McDermott International vs. Burn Standard Co Ltd.13 Where
the court somewhat read down Saw Pipes. It held that1996 Act makes provision for supervisory roles of courts, for the review of the arbitral award
only to ensure fairness. Intervention of the court is envisaged. In few circumstances only, like in
case of fraud or bias by the arbitrators, violation of natural justices etc. The court can not correct
the errors of the arbitrators. It can only quash the award leaving the parties to begin the
arbitration again if it is desired. So, the scheme of this provision aims at keeping the supervisory
role of the court at minimum level and this can be justified as parties to the agreement make a
consciousness decision to exclude the courts jurisdiction by opting for arbitration as they prefer
12 Michael Hwang and Amy Lai, Do Egrigious Errors Amount to a breach of Public
Policy? The Journal of the Chartered Institute of Arbitrators, Vol. 71, (February 2005),
pp. 1-24
13 (2006) 11 SCC 181
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the expediency and finality offered by it.

Commenting on Saw Pipes it held We are not unmindful that the decision of this court in
ONGC had invited considerable adverse comments but the correctness or otherwise of the said
decision is not in question before us. It is only for a larger bench to consider the correctness or
otherwise of the said decision the said decision is binding on us and has been followed in many
cases.
Parliamentary

Arbitration

and

Concilliation

(Amendment)

Bill,

2003

In light of the criticisms (as mentioned above) the Legislature has introduced in the parliament
Arbitration and Conciliation (amendment) Bill, 2003 in order to clarify that public policy does
not have extended meaning as given by the Supreme Court in ONGC v Saw Pipes. To remove
doubts, the bill provides an explanation to the words contrary to public policy in section 34 to
mean

contrary

i)

Fundamental

ii)

Interests

to
Policy
of

:of

India

India

or,

iii) Justice and morality, thus retaining the meaning given by Supreme Court in Renusagar Power
Co

Ltd

General

Electrical

Co.

This can be seen as a positive step in Arbitration law of India for future cases. This Bill was
withdrawn later but again in 2007 it was brought up and its implementation is yet to be done.