"I realise that some of my criticisms may be mistaken; but to refuse to criticize judgements for fear of being mistaken is to abandon criticism altogether... If any of my criticisms are found to be correct, the cause is served; and if any are found to be incorrect the very process of finding out my mistakes must lead to the discovery of the right reasons, or better reasons than I have been able to give, and the cause is served just as well."

-Mr. HM Seervai, Preface to the 1st ed., Constitutional Law of India.

Monday, August 9, 2010

Sumitomo Heavy Industries v ONGC

ONGC Platform at Mumbai High (formerly Bombay High)* 

Case No.: Civil Appeal No. 3185/ 2002
Date: 28.07.2010
Bench: RV Raveendran & HL Gokhale, JJ.

Preliminary Comments:

On the third of this month, we had a post giving the link to the ONGC v. Sumitomo judgement and had promised we would be having a post on this issue, considering the importance of the case. ONGC v Sumitomo is worth noting for two aspects. One, the case is an example of how in the Indian arbitral system the "award-debtor" could simply delay the execution of the arbitral award by challenging the arbitral award. Dhananjay Mahapatra from the Times of India has adequately commented on this aspect in this article. So we do no more but give the link to Mahapatra's article.

The second reason why this judgement is significant is because it discusses an oft-contested issue of the contractual consequences of imposition of tax due to change of law and the liability to reimburse costs due to change of such law. Despite the fact that contracts generally address this aspect, parties to the contract violently contest with each other the ultimate liability to bear the costs of such change of law. This case is an example of such a dispute.

(Some facts are taken from the decisions by the lower courts)

ONGC invited tenders for installation and commissioning of a well-cum-Production platform deck and connected system on a turnkey basis at Bombay High (the relevant location of the project was 100 miles away from the coastline. The bid closing date was 11.10.1982.

Bid was submitted by SHI and the bid was accepted.

31.03.1983: Notification by Department of Revenue, Ministry of Finance extending the Income Tax Act, 1961 to the continental shelf and exclusive economic zone of India. with effect from 01.04.1983. Thus, income accruing to MHI and MII under the Contract were subject to income tax. 
(almost one year after bid submission) ONGC and MHI executed the contract. The contract provided that the price was firm without escalation but subject to the provisions of the contract.

Relevant provisions of the General Conditions of the Contract were

"13.2.7 The Company shall not be responsible/obliged for making any payments or any other related obligations under this Contract to the Contractor's Sub-contractor/Vendors. The Contractor shall be fully liable and responsible for meeting all such obligations and all payments to be made to its Sub-contractors/ Vendors and any other third party engaged by the Contractor in any way connected with the discharge of the Contractor's obligation under the Contract and in any manner whatsoever."

"13.3.4 Neither the Company nor the Contractor shall be liable to the other for any matter or thing arising out of or in connection with the contract or the doing of the works unless the party asserting the liability has given the other party written notice of its claim before the issue of the last Discharge Certificate under this Clause."

"17.0. Laws/Arbitration
17.1. Applicable Laws
All questions, disputes or differences arising under, out of or in connection with this Contract shall be subject to the laws of India.
17.2. Arbitration
If any dispute, difference or question shall at any time hereafter arise between the parties hereto or their respective representatives or assigns in respect of the construction of these presents or concerning anything herein contained or arising out of these presents or as to the rights, liabilities or duties of the said parties hereunder which cannot be mutually resolved by the parties, the same shall be referred to arbitration, the proceedings of which shall be held at London, U.K. Within 30 days of the receipt of the notice of intention of appointing arbitrators each party shall appoint an arbitrator of its own choice and inform the other party. Before entering upon the arbitration, the two arbitrators shall appoint an umpire. In case the parties fail to appoint its arbitrator within 30 days from the receipt of a notice from the other party in this behalf or if any dispute in selection of umpire, the president of International Chamber of Commerce, Paris, shall appoint the arbitrator and/or the umpire as the case may be.
The decision of the arbitrators and failing to an agreed decision by them, the decision of the umpire shall be final and binding on the parties.
The arbitration proceedings shall be held in accordance with the provision of International Chamber of Commerce and the rules made thereunder as amended from time to time. The arbitration proceedings shall be conducted in English language.
17.3 Change of Law
Should there be, after the date of bid closing a change in any legal provision of the Republic of India or of any political subdivision thereof or should there be a change in the interpretation of the said legal provision by the Supreme Court of India and/or enforcement of any such legal provision by the Republic of India or  any political subdivision; thereof which affects economically the position of the Contractor; than the Company shall compensate contractor for all necessary and reasonable extra cost caused by such a change."

"23.0 Duties and Taxes
Indian Customs Duties, if any, levied upon fabricated structures, sub-assemblies and equipment and all components which are to be incorporated in the works under the contract shall be borne by the company. The company shall bear all Indian income taxes levied or imposed on the Contractor under the Contract, onaccount of its or their offshore personnel while working at offshore or on account of payments received by Contractor from the company for work done under the contract. Notwithstanding the foregoing, the company shall have no obligation whatsoever in respect of the Contractor's onshore employees whether they may be expatriate or nationals."

"27.2 The Company shall in no event be responsible for or liable to the contractor or its Sub-contractors for consequential damages suffered by the Contractor or its Sub-contractors including without limitation, business interruption or loss of profits. Whether such liability is based or claimed to be based upon (i) any breach by the Company of its obligations under the Contract or (ii) any negligent act or omission on the part of the Company or any of its employees, agents or appointed representative in connection with the performance of the work."

28.12.1983: For sub-contracting a major part of its work under the Contract, MHI entered into a (sub)contract with McDermott International Inc (McDII). This fact was within the knowledge of ONGC.

11.04.1984: Issue of Certificate of Completion and Acceptance by ONGC certifying that the work under the contract was completed successfully.

18.05.1984: Certificate of discharge issued. 

1987: Section 44 BB was introduced into the statute book with restrospective effect from 01.04.1983. The Foreign Tax Division of the Department of Revenue issued a circular on turnkey projects and calculation of liability of foreign contractors for income tax.

1988: The income tax authorities asked McDII to re-open its assessments for the Previous Years during which it earned income from the project. Following this, income tax was imposed on McDII.

October 1989: McDII asked MHI to reimburse the amount of income tax it had to bear. After exchange of correspondences, MHI paid approx $ 1.12 to McDII. MHI asked ONGC to reimburse the amounts paid to, and to be paid to, McDII, which ONGC refused. MHI invoked arbitration.
06.03.1991: Invocation of arbitration by MHI.

11.03.1991-11.05.1991: Appointment by both parties of their arbitrators. Subsequently, both parties appointed Sir Michael Kerr as the umpire. Under the Arbitration Act, 1940, the umpire system was followed. In case the two arbitrators, each appointed by the parties, the umpire "entered upon reference" and his decision was to be final.

22.06.1995: Arbitral award by Sir. Michael Kerr in favour of MHI.In sum, the umpire held that reimbursement of income tax by MHI to MII was a consequence of change in law which caused necessary and reasonable increase in costs to MHI and in view of Article 17.3 of the Contract, ONGC was liable to reimburse MHI to that extent.

(Since we are more concerned about what the decision on the issue pertaining to liability for new tax imposed during the currency of the contract, we will and skip summarising the argument of the parties and the decision by the lower courts, and focus on the decision. But to complete the chronology, we'll list the dates of the decision of the lower courts.)

29.11.1999: Decision by Single Judge of the Bombay High Court setting aside the award in favour of ONGC.

19.12.2001: Decision by Division Bench of the Bombay High Court dismissing the appeal filed by SHI.
The court had to decide whether the decision of the umpire was such that intervention by the court was necessary due to any finding of the umpire exceeding his jurisdiction or empire committing an error that was apparent on the face of the record..

The court held that if two views as to the interpretation of provision were possible, the court would not get into the question of whether the arbitrator was right in choosing a particular interpretation. Thus, all the court needed to decide was whether the interpretation afforded by the Umpire was possible.

The court concluded that the lower courts erred in striking the award down on the matter of a plausible interpretation of a provision by the Umpire.

The court held that the term employed in Article 17.3 was "cost" and since there was an increase in costs due to imposition of income tax, the interpretation placed by the umpire was a plausible one. Further, it held that McDII had to pay income tax due to retrospective change of law made effective subsequent to submission of bid.

The evidence placed showed, according to the court, that McDII was to be the principal subcontractor; consequently, "[t]he respondent had taken up the responsibility for the income tax liabilities of the appellant. So had the appellant taken up the responsibility for the tax liabilities of MII and the respondent cannot be said to be ignorant there of."

Hence, the court concluded that the Umpire did not exceed his jurisdiction nor was there any error apparent on the face of the record. 

Further, citing Triveni Rubber & Plastics v. Commsr. of Central Excise (AIR 1994 SC 1341), the court held that a perverse finding was one which no reasonable person could have arrived at. The court concluded that since the arbitrator's finding was after due consideration of the material available, it was not perverse but well-reasoned.


Though the SC's decision seems to be reasonable, it is sad that the court did not consider the law on the liability of a contractual party to bear increase in costs due to change of law during the currency of the contract. This is the problem with arbitration. The courts are forced to rule on whether the award was perverse or not rather than consider what should actually be the law on the issue. The main issue is taken outside the realm of the court. Essentially what the court has stated here is that Article 17.3 could either be narrowly construed like the Division Bench wanted it to be or broadly constructed as was done by the arbitrator. But what is the true law?
This decision must not be taken to mean that all increases in costs due to change of law will be borne by the service receiver/ principal. This judgement only states that if the service receiver/ principal his agreed to bear such risks, it would be to his account. 

But if the service provider/ contractor has agreed to bear such risks, the increase in costs would be to his account. It ultimately depends on the contract. But what would happen if the contract is silent on this aspect?

* Image taken from here.

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