India: Caution To The Courts: Read Contract As It Reads!

Last Updated: 8 March 2018
Article by Sudha Sampath

1. Introduction

On October 5, 2017 the division bench of Supreme Court ("SC") delivered an important judgment in Nabha Power Ltd. ("NPL") vs. Punjab State Power Corporation Ltd ("PSPCL") and Ors1 wherein the SC held that while interpreting provisions of an agreement, courts should not endeavor to imply terms into the language of the contract; rather, read the contract as per its express terms. The SC analyzed domestic and international jurisprudence on implied terms in contracts and held that unless the court is satisfied that the implication would necessarily have been in the minds of both the parties, a court cannot imply a term which was not explicitly expressed by the parties.

This bulletin summarizes the aforesaid judgment of the SC.

2. The Facts

The Punjab State Electricity Board ("PSEB"), the predecessor of PSPCL, conducted an international competitive bidding process for selection of a developer for power procurement of a power station to be set up at Rajpura, Punjab. The power station was envisaged as Case 2 (a fuel specific procurement for project having a pre-identified site) and scenario 4 which meant an all-inclusive fixed energy charge was not a bidding parameter; hence, the energy charges varied in accordance with the actual cost and quality of coal. As the procurer, PSPCL arranged the fuel linkage from South Eastern Coalfields Ltd ("SECL"), Chhattisgarh. The bidder's responsibility included, amongst others, procurement, testing, operation, etc of the power station. To implement the project, PSEB incorporated NPL. The successful bidder, L&T Power Development Ltd. ("L&T") acquired NPL's 100 % shareholding and executed a 25-year power-purchase agreement ("PPA") with PSEB. NPL was required to supply coal to PSPCL who, in turn, had to pay the monthly tariff payment.2 When the first invoice was raised, issues arose about the amount payable to NPL when PSPCL made certain deductions. NPL filed a petition against the alleged wrong deductions with the state regulator which was dismissed, and then appealed to the appellate tribunal3 but both were dismissed.

3. Issues and Parties Contentions

The case primarily revolved around interpretation of clause 1.2.3 Energy Charges Formula ("ECF") in the PPA which provided certain definitions of FCOAL4 and PCV5 to determine whether the amount payable to NPL towards "actual cost of coal" meant only its purchase price or additional charges, not specifically expressed in the formula. According to NPL, cost of coal had several components including purchase price paid to SECL, additional amounts incurred towards washing, transportation to the project site, transit and handling loss etc. Further, although the Gross Calorific Value ("GCV") of the coal was required to be measured at the project site, it was not done so. In the case, PSPCL paid only the purchase price and considered the theoretical/equilibrated GCV of unwashed coal at the mine-end, rather than GCV of washed coal at the project-end as part of ECF. The location where GCV should be measured is relevant as it drops over a period of time during storage and transportation, thereby significantly impacting the energy charges.

3.1 Washed Coal Cost: The first dispute related to cost incurred by NPL for washing coal. Pursuant to Ministry of Environment and Forest Notification of 19976 as well as PSPCLs' pre-bid clarifications, NPL was bound to use washed coal. Since PSPCL mandated NPL arrange for washing of coal, reference to coal and fuel could only mean washed coal. Therefore, the actual cost of purchasing, transporting and unloading coal referred in the ECF must refer to actual cost of washed coal. NPL argued that the ECF expressly provided for reimbursement of actual cost of specified quality for use in the plant. NPL also claimed costs towards certain ancillary charges like crushing, sizing of coal etc. They invoked the principles of "business efficacy" and the one embodied in the Latin maxim Reddendo Singula Singulis, according to which if a complex sentence has more than one subject and more than one object, the words are to be read distributively by applying each object to its appropriate subject.

PSPCL contended that ECF contained only three distinct identifiable components recognized for tariff i.e. (i) purchase, (ii) transportation, and (iii) unloading. Any other claim for handling from procurement to generation of electricity would be excluded. Further, since "washing" was not an express part of the ECF, the obligation to wash and other essential activities such as sizing, crushing, removal of ash was on NPL. Clause 2.7.1 of the PPA provided for the quoted tariff to be "all-inclusive" with no exclusions. PSPCL argued that had the parties intended to include such costs, they would have expressly stipulated payment for the actual cost of coal used for generation of power.

3.2 GCV: The second dispute related to the coal's GCV. NPL argued that measurement of equilibrated GCV violated the existing regulations7 and industry practice. According to NPL, since coal contained moisture the GCV changed significantly during rail transport over 4 to 5 days and, hence, the critical stage to measure GCV was at the project site and not at delivery point. They argued that mere transfer of title of unwashed coal, which could not be used for electricity generation, did not imply delivery to the project.

On the other hand, PSPCL contended that the contractual delivery point was the loading end of the colliery. PSPCL further argued that the expressions "to and at the project" used in determining cost of the coal, and "to the project" used in relation to GCV of the coal in the formula had different meanings. Therefore, the formula did not contemplate measurement of GCV at the project site.

3.3 Transportation cost: The third dispute related to transportation cost of unwashed coal from the mine to the washery and cost for carriage of washed coal from the nearest railway station to the project site. In the case, the Punjab Government could only acquire part of the land required for railway siding. As a result, NPL could not acquire the railway siding for the transport of coal till the project; rather it was forced to transport it by rail and road although the agreement only envisaged transport by rail. NPL argued that transportation was required to be reimbursed irrespective of its mode. Therefore, FCOALn was stated to refer to the actual cost of coal transported to and unloaded at the project.

PSPCL argued that the PPA envisaged only transportation by rail and thus interpreted FCOALn as the weighted average actual cost to the seller of purchasing unwashed coal, transporting washed and unloading the washed coal most recently supplied to and at the project site.

Since the petitions were dismissed by the commission and the appellate tribunal, NPL approached the SC challenging the order denying reimbursement of expenses as cost of coal.

4. SC Analysis and Decision

The prominent issue considered by the SC was whether an inference could be drawn that the ECF methodology contained an implied term that the additional cost, incurred towards steps essential to bring the coal to the required quality, would be reimbursed despite the express provision of the PPA.

The SC, analyzed the development of the concept of implied terms, through (a) The Moorcock which propounded the principle of "business efficacy to the transaction;" (b) Shirlaw v. Southern Foundries, that lay down the "officious bystander" test8; (c) Reigate v. Union Manufacturing Co, (Ramsbottom) Ltd where it was held that unless the implication must necessarily have been in the minds of both the parties, an unexpressed term cannot be implied; (d) Liverpool City Council vs. Irwin, which categorically stated that courts ought to imply a term only when it is reasonable and necessary; (e) B.P. Refinery (Westernport) Proprietary Limited v. The President Councillors and Ratepayers of the Shire of Hastings which lay down the penta-principle test to be satisfied on implied terms which must:

  • be reasonable and equitable,
  • be necessary to give business efficacy, so that no term will be implied if the contract is effective without it,
  • be so obvious that "it goes withoutsaying",
  • be capable of clear expression, and
  • not contradict any express term of the contract.

Relying upon the above, the SC held that the court could not impose its own view of the presumed understanding of the parties, if the terms are unambiguous. Further, explicit terms are always the final word with regard to the parties' intent. Every contract has to be understood and interpreted so as to ensure that a view on a particular provision should not contradict other provisions.

On the specific three disputes, the SC findings were as follows:

4.1 Washed Coal Cost: Three aspects i.e. purchase, transport and unloading in the formula of the coal determined the amount required to be reimbursed. The court applied the principle of Reddendo and held that delivery "to the project" could only mean "at the site of the project" and not at the mine-site. The SC held that prior activity of washing before delivery at the project site would be part of the cost; hence, the reference to term "coal" in ECF was to, "washed coal" and not "unwashed coal." The court clarified that while NPL had to arrange washing of coal, it did not imply that the cost thereof had to be borne by them. The SC specifically pointed that "business efficacy" required reading the ECF in a manner as would be normally understood.

4.2 GCV: Applying the principles of business efficacy as well as Reddendo, the SC held that GCV of the coal was to be measured at the project site where the title of the required quality of coal used for generating electricity passed to NPL.

4.3 Transportation cost: The SC observed that the transportation cost till the project site had to be compensated to NPL as it was not qualified by the methodology of transfer i.e., rail or road. Since the railway siding had not reached the project site, as a matter of necessity, the transportation cost from point to point was required to be paid.

The SC considered the surrounding circumstances highlighted by NPL, such as representations on the basis of which the bid was submitted bidding documents and guidelines for determination of tariff to show liability of PSPCL to reimburse additional expenses However, since the ECF contained only three elements, the SC held that other costs incurred towards crushing, sizing of coal etc could not be implied.

5. Conclusion

The SC arrived at its conclusions based on the contract, as understood in a business sense while stressing on the importance of surrounding circumstance. The court emphasized that modern day contracts are drafted with technical expertise and with involvement of legal brains with opportunities to clarify doubts so that parties sign with eyes open. A contract should be read per its explicit terms. The court also stated that implied term was a concept, necessitated only when the penta-principle test came into play upon strict necessity. This judgment reinforces the jurisprudence against implying terms into a contract unless strictly necessary, by providing the much-needed caution for the courts to abstain from upsetting a carefully drafted contract. It is a positive indication that courts are returning to the strict literal interpretation by giving due focus on the unambiguous language agreed by the parties. The court is required to be mindful of contemporary technical expertise of legal drafting and, at the same time, should also not ignore the objectivity of the contract. The judgment upholds mutuality of obligations as an unalterable requirement in a contract and ensures that a party's contractual rights are based in equity.

Footnotes

1 Civil Appeal No. 179 of 2017

2 This included capacity and energy charges, incentive payments and penalty, if any

3 Under the Electricity Act, disputes are to be resolved first by the state electricity regulatory commission, followed by an appeal to the state appellate tribunal and from there directly to the SC

4 This was defined as the weighted average actual cost to the Seller of purchasing, transporting and unloading the coal most recently supplied to and at the project

5 This was defined as weighted average gross calorific value of the coal most recently delivered to the project before beginning of the month "m" expressed in Kcal/kg

6 The notification mandated thermal power plants located more than 1000 KMs from the pithead and those in urban, sensitive and critically polluted areas, irrespective of the distance, to use beneficiated coal with ash content below 34% from June 01, 2001

7 These are Electricity Act and Central Electricity Regulatory Commission Tariff Regulation, 2009 which allowed determination of coal's GCV on "as-fired" basis

8 As per the test, if an officious bystander were to suggest expression of a specific term in the agreement, and the parties to the contract would have answered "oh of course!", then the term is assumed to be an implied term

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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