Tarapore & Company v Cochin Shipyard Ltd (1984)

Read the judgment before you classify it. This is not a decision under s. 56 of the Indian Contract Act, and the Court nowhere holds that the contract was frustrated or that performance became impossible. It is an arbitration judgment, and its two working propositions are these.

First, where the parties specifically refer a question of law to the arbitrator, including a question touching his own jurisdiction, his decision binds them and the award will not be set aside merely because the Court would have taken a different view of the law.

Second — and this is why the case sits beside the frustration line rather than inside it — where a contract is built upon an agreed fact situation and that fact situation ceases to exist, the terms resting on it cease to govern. Desai J's sentence is the one to carry away: "When an agreement is predicated upon an agreed fact situation, if the latter ceases to exist the agreement to that extent becomes irrelevant or otiose."

That proposition is about construction, not discharge. It gave the contractor a claim to compensation within the contract; it did not dissolve the contract. Contrast it deliberately with Davis Contractors, where a contractor's increased costs left him bound to his price, and with Alopi Parshad, cited in the judgment, where altered circumstances did not rewrite the bargain. The difference lies in what the parties had themselves agreed the foundation to be.

The respondent shipyard invited tenders for the construction of a Building Dock and a Repair Dock at Cochin. Response was poor. The Tender Committee accepted the appellant contractor's tender for reasons it recorded: that works of such complexity and magnitude had not been undertaken before by any Indian contractor; that the plant and equipment required were not available indigenously; that if the contractor procured the specialised equipment "there is hardly any assurance that after these works are over, he would find any substantial use for the same"; that excavation and subsequent construction involved de-watering, with considerable uncertainty; and that RCC piling required highly skilled and complex technical operations and involved "a large element of risk and uncertainty in the work."

Both parties knew when contracting that equipment and technical know-how would have to be imported, involving a huge outlay of foreign exchange. The contractor therefore quoted on two alternative bases: one on the footing that it would itself import the equipment and know-how at a cost of about Rs. 2 crores in foreign exchange, and the other on the footing that the shipyard would import them and the contractor would pay specified hire charges, recoverable from the running bills.

The contractor was given to understand, by a note in the invitation to tender, that foreign exchange in yen credit to the tune of Rs. 38 lakhs was earmarked for purchase of construction equipment from Japan. By the work order of 24 January 1973 the shipyard adopted the alternative under which the contractor was to procure the equipment and know-how at a cost of about Rs. 2 crores in foreign exchange, and additional condition No. 31 recorded that the requisite foreign exchange "amounting to about Rs. 2.00 crores in all will be made available to the contractor from the 11th Yen Credit subject to his getting indigenous clearance and providing detailed justification." The formal contract was signed on 29 January 1973.

The pile-driving equipment and know-how were not available against the 11th Japanese Yen credit. The shipyard's own inquiries failed. Ultimately a firm in Holland agreed to supply equipment conforming more or less to the specification already cleared. The shipyard certified the conformity and itself requested the Government of India to clear the import; approval came on 1 September 1973 and foreign exchange of Rs. 211.80 lakhs was released. The equipment arrived in four consignments between March and July 1974.

In the intervening period the rates of exchange varied and prices rose. The contractor's outlay went well past the figure on which the rates had been built: the judgment records an investment of Rs. 275.40 lakhs on imported pile-driving equipment and spares, a further sum on technical services and know-how fees, and higher customs duty.

Desai J summarised the position: "From the commencement i.e, from the stage of inviting tenders and through the negotiations and the finalisation of the contract, at every stage, the respondent assured that foreign exchange would be made available from 11th Yen Credit. As the equipment was not available from Japan, the availability of Yen Credit become otiose from the contractor's point of view."

The contractor claimed compensation. The shipyard's first answers, of 2 July and 29 August 1975, asserted that the foreign exchange expenditure was less than Rs. 2 crores, so that any argument based on exchange fluctuation was not tenable. The Court noted the significance of that stance: "the refusal to entertain the claim for compensation was predicated upon the estimates having not exceeded the basic minimum of Rs 2 crores by the contractor on which rates were worked out and agreed, and not that such claim cannot be entertained under the contract."

When the expenditure did exceed Rs. 2 crores, the shipyard changed ground, denying it had ever taken that position. The Court was unimpressed: the respondent "has gone back upon its original position and having found that the expenditure under this head has gone up beyond the estimated expenditure made a volte face, the two positions so adopted being entirely inconsistent with each other".

The dispute went to a sole arbitrator under clause 40. Two points were referred: whether the claim fell within the first paragraph of clause 40, and if so the quantum. The arbitrator held the claim within the clause and awarded Rs. 99 lakhs with interest at 9½ per cent.

The Subordinate Judge rejected the objections of insufficient stamp and excess of jurisdiction, reduced the interest to 6 per cent and made the award a rule of the Court. The High Court agreed on the stamp point but held that arbitrability went to jurisdiction, that an arbitrator "cannot by an erroneous interpretation or construction of the clause confer jurisdiction on himself" and that the claim was outside clause 40 because under clause 26 the contractor was to provide all plant and equipment, so that escalation in their price could not found a claim against the shipyard. The award was ordered to be returned.

The Supreme Court began from the distinction that a question of law may reach an arbitrator in two ways: it may arise incidentally while he decides the main dispute, or the parties may refer a specific question of law to him for decision.

Where they do the latter, the Court held, the award is not open to attack for error of law. "Arbitration has been considered a civilised way of resolving disputes avoiding court proceedings." There is no reason why parties should not refer a specific question of law and agree to be bound; such a reference "manifests faith of parties in the capacity of the tribunal of their choice to decide even a pure question of law." If they do so "with eyes wide open," then "there is no reason why the court should try to impose its view of law superseding the view of the Tribunal whose decision the parties agreed to abide by."

The same holds of a question touching the arbitrator's own jurisdiction. Where such a question is specifically referred, his decision binds, "and it would not be open to any of the two parties to wriggle out of it by contending that the arbitrator cannot clutch at or confer jurisdiction upon himself by mis-construing the arbitration agreement."

On the facts, the shipyard's reservation of its position by the words "without prejudice" did not prevent a specific reference. The Court held that the expression "carries a technical meaning depending upon the context in which it is used" and that "An action taken without prejudice to one's right cannot necessarily mean that the entire action can be ignored by the party taking the same." Here it meant only that the shipyard reserved the right to argue before the arbitrator that the claim was outside the clause.

The High Court's reliance on clauses 16, 26 and 31 was rejected. "In our opinion, this over-simplification of the clauses of the contract involving works of such magnitude is impermissible. The whole gamut of discussions, negotiations and correspondence must be taken into consideration to arrive at a true meaning of what was agreed to between the parties."

The Court added a general direction on the use of pre-contractual material in contracts of this kind: if the final written contract says something contrary to the basic understanding of the formative stage, the written contract prevails; but if it does not say the contrary and the assumptions appear to be the foundation of the contract, "that aspect cannot be overlooked while determining what were the obligations undertaken"

Applied here, there was no room for doubt that the parties agreed the contractor's investment under this head would be Rs. 2 crores and that the tendered rates "were predicated upon and co-related to this understanding." Hence the central proposition, and its consequence: "The rates payable to the contractor were related to the investment of Rs 2 crores under this head by the contractor. Once the rates became irrelevant on account of circumstances beyond the control of the contractor, it was open to the contractor to make a claim for compensation."

Clause 40 was of the widest amplitude, covering "any other questions claim, right, matter or thing whatsoever in any way arising out of or relating to the contract". The Court laid down the working test: if, in settling a dispute, "a reference to the contract is necessary, such a dispute would be covered by the arbitration clause." Here both parties had recourse to the contract in support of their rival contentions, so the claim was plainly within it.

The Court also approved the proposition that where the parties agree they made a binding contract but differ over whether there has been a breach "or whether circumstances have arisen which have discharged one or both parties from further performance," such differences are differences arising in respect of, with regard to, or under the contract, and a widely worded arbitration clause is to be construed accordingly. That is the sentence which links this case to the frustration syllabus: a plea of discharge is itself arbitrable, and does not oust the clause.

The appeal was allowed with costs throughout. A specific question of law touching the arbitrator's jurisdiction had been specifically referred to him, so his decision bound the parties and the award could not be set aside for error of law apparent on its face; the claim for compensation was in any event covered by the arbitration clause; and the quantum was never disputed. The High Court was "clearly in error reversing the decision of the trial court." The judgment of the Subordinate Judge, Ernakulam, restoring the award as a rule of the Court, was restored.

A submission that the claim might be supported on quantum meruit was raised but the Court held it unnecessary to examine, and it decided nothing on that footing.