Interest on interest is not permissible unless expressly provided by statute or contract – says Supreme Court

This case, adjudicated by the Supreme Court of India, arises from a dispute concerning an arbitration award under the Indian Arbitration Act, 1940, related to a contract from 1984-85 between M/s D. Khosla and Company (petitioner) and the Union of India (respondent). An arbitrator’s award dated 17.09.1997 granted the petitioner a principal sum of Rs.21,56,745 with interest at 12% per annum from the date of completion of work until the award date, and 15% per annum from the award date until payment or court decree, whichever was earlier. The award was made a rule of the court under Sections 14 and 17 of the Act, and a decree was drawn accordingly. The petitioner, dissatisfied with the interest calculation during execution, contended that the 15% post-award interest should apply to the principal sum plus the 12% pre-award interest, effectively seeking compound interest. This led to a Special Leave Petition challenging the decisions of the High Court and the Principal Senior Civil Judge, which rejected the petitioner’s claim.

The key legal issue was whether the arbitrator’s award entitled the petitioner to interest on interest (compound interest) for the post-award period, specifically whether the 15% interest was payable on the principal sum of Rs.21,56,745 plus the 12% pre-award interest. The petitioner, represented by Ms. Jyoti Mendiratta, argued that the pre-award interest formed part of the principal sum, losing its character as separate interest, and thus, the post-award interest should be calculated on this aggregated amount. In contrast, Ms. Aishwarya Bhati, Additional Solicitor General for the respondent, contended that the arbitrator’s award clearly granted interest only on the principal sum for both periods, with no provision for interest on interest unless explicitly stated in the award or authorized by statute or contract. The petitioner’s interpretation was challenged as lacking support in the award’s language or applicable legal provisions.

The Supreme Court, in its judgment authored by Justice Pankaj Mithal, meticulously analyzed the arbitrator’s award and the decree, alongside relevant legal provisions, including Section 29 of the Indian Arbitration Act, 1940, Section 34 of the Code of Civil Procedure (CPC), and Section 3(3) of the Interest Act, 1978. The Court observed that the award explicitly awarded 12% simple interest on the principal sum for the pre-award period and 15% simple interest on the same principal sum post-award, with no indication that the post-award interest included the pre-award interest component. The Court emphasized that Section 34 CPC and Section 3(3) of the Interest Act, 1978, prohibit awarding interest on interest unless specifically provided by statute or contract. Distinguishing cases like Hyder Consulting (UK) Limited v. Governor, State of Orissa, which interpreted “sum” under Section 31(7) of the Arbitration and Conciliation Act, 1996, to include pre-award interest, the Court clarified that the 1940 Act and CPC use “principal sum adjudged,” limiting interest to the principal amount. The Court also referenced Oil and Natural Gas Commission v. M.C. Clelland Engineers S.A. and State of Haryana v. S.L. Arora to affirm that compound interest requires explicit authorization, absent in this case. Finding no provision in the contract or statute supporting compound interest, and concurring with the lower courts’ findings, the Court dismissed the Special Leave Petition under Article 136. This judgment is significant as it reinforces the legal principle that interest on interest is not permissible under the Indian Arbitration Act, 1940, without explicit statutory or contractual provisions, ensuring clarity in the execution of arbitral awards and protecting parties from unintended financial burdens.