Contractual Bars On Interest In Infrastructure Contracts: Scope And Equitable Limits

Delayed projects are a commercial reality in infrastructure contracts, often caused by factors solely attributable to the employer, such as late site handover, delayed approvals, and design changes. These delays increase the contractor's costs and frequently postpone payments due under Running Account (RA) bills, which themselves depend on certifications and approvals controlled by the employer. Despite this, most standard-form construction contracts provide that no interest is payable on delayed payments, leaving contractors to bear the monetary burden, creating an obvious financial imbalance between the contractor and the employer. Since interest is essentially compensation for being kept out of money, this note argues that such interest-barring contractual clauses cannot operate absolutely.

The law on payment of interest in cases of delayed payments lies at the intersection of the Court’s discretionary powers and the parties’ autonomy to enter into an agreement that bars its payment. As per the present statutory framework, the following provisions govern claims for interest:

• Section 3 of the Interest Act, 1978, which allows Courts to award interest for the period before legal proceedings begin (pre-suit interest). However, Section 3(3) restricts this power where the parties have entered into an agreement expressly stipulating that no interest shall be payable on delayed payments.
• Section 34 of the Code of Civil Procedure, 1908 (CPC) allows Courts to award interest from the date a suit is filed until the decree (pendente lite interest), and thereafter until payment (post-suit interest).
• Section 31(7) of the Arbitration and Conciliation Act, 1996 (Arbitration Act) gives arbitral tribunals a similar power to award pre-award and post-award interest. While pre-award interest is subject to an agreement to the contrary between the parties, post-award interest is mandatory.

Although the above provisions indicate that pre-suit interest cannot be claimed where the contract prohibits it, an important question that remains is whether this rule is absolute, particularly where a contractor has been wrongfully deprived of its money. Recently, the Supreme Court of India affirmed the contractual restriction on pre-suit interest in Kerala Water Authority v. TI Raju.¹ While the decision is correct on the facts before the Court, the scope of the bar under Section 3(3) of the Interest Act may require a more nuanced examination based on the stages of claiming interest in different factual circumstances.

A claim for interest typically arises across 4 distinct stages of a dispute:

• The period of delay during the subsistence of the agreement (pre-suit interest).
• The period from the expiry of the original contractual term to the institution of the suit/arbitration (pre-suit interest).
• The period commencing from the date of institution of the suit/arbitration till the date of passing of the decree/award (pendente lite interest).
• The period from the date of decree/award until actual realisation of the decretal/awarded amount (post-suit/award interest).

While the first 2 stages form part of the larger umbrella of ‘pre-suit interest’, a possible commercial distinction warranting different treatment of interest-barring clauses may be drawn:

• During the subsistence of the contractual term where payments are delayed while the contract is still being performed. During project execution, RA bills require certification, measurements, verification, and adjustments, and payment delays may legitimately arise as part of the contractual administration of the project. A clause excluding interest during this stage reflects a commercial bargain that temporary delays in the payment process will not attract interest.
• After the contractual period, the situation is fundamentally different. Here, the original contractual period has expired, yet payments continue to remain outstanding. This may happen because:
• The project continued beyond the stipulated completion period due to delays attributable to the employer, such as late approvals, design changes, or delayed site handover.
• The work was eventually completed, but the corresponding payments continued to be withheld.

In either situation, the contractor continues to perform work, or has already completed it, beyond the original contractual timeline while remaining deprived of payments that have fallen due.

Treating both these stages identically merely because they fall within ‘pre-suit interest’ overlooks this important commercial distinction. Section 3(3) recognises party autonomy; however, contractual clauses must be interpreted according to their purpose. An interest-bar clause serves a legitimate commercial purpose while the contractual relationship remains subsisting. That commercial justification weakens considerably once the original contractual period has expired, as such a bar effectively permits an employer to withhold payments for a prolonged period while shifting the entire financial consequence of the delay onto the contractor.

Such an interpretation is difficult to reconcile with Section 4 of the Interest Act, which provides that the statute is in addition to, and not in derogation of, other laws under which interest may be awarded. The effect of this provision is that even where Section 3(3) is attracted, the Court is not stripped of its authority to award interest if such power can be sourced to other substantive principles, including principles of equity,² which may be applied where the conduct of the defaulting party renders strict enforcement of the contractual bar unjust, such as the wrongful withholding of legitimate dues. This is in alignment with the long-established principle that interest is compensation for the wrongful deprivation of money, not merely a contractual benefit. To hold otherwise would allow a party to benefit from its own wrong, a result which the law consistently seeks to avoid.

The arbitration perspective

Most infrastructure contracts are resolved through arbitration rather than Courts. While a purposive interpretation of Section 3(3) may be warranted in proceedings before Courts, the position under the Arbitration Act is less straightforward. Section 31(7) expressly makes the award of pre-award interest subject to an agreement to the contrary, and since the Arbitration Act is a self-contained code, arbitral tribunals have consistently accorded primacy to the statutory provisions as well as the agreed contractual terms.

However, the Arbitration Act does not preclude distinguishing between the period during the subsistence of the contract and the period after the expiry of the contractual term (but before commencement of arbitration). Such a distinction may enable an arbitral tribunal to invoke equitable principles while considering the award of interest. Further, the application of an interest-bar clause may warrant closer scrutiny where it operates in an unfair or lop-sided manner, particularly in standard-form infrastructure contracts involving Government employers, where contractors are often required to accept contractual terms with little or no opportunity for negotiation. Such clauses have similarly been struck down in the case of lop-sided arbitrator appointment procedures.

Since an arbitral tribunal is empowered to apply the doctrine of severability to preserve the valid portions of a contract while ‘severing’ those that are unenforceable, an interest-bar clause may be read as operating only during the subsistence of the contract, with its application to the post-contract period being severed where it would be inequitable or legally unsustainable.

The law governing interest balances party autonomy with fairness. While parties may validly agree to exclude interest on delayed payments, such clauses should not be viewed in isolation from the commercial context in which they operate. Distinguishing between delays during the contractual period and those extending beyond it, particularly where attributable to the employer, better reflects the compensatory nature of interest and the purpose of such clauses.

Seen in this light, the contractual bar under Section 3(3) cannot be treated as absolute. It remains a relevant and often decisive factor, particularly during the subsistence of the contract; however, it cannot be applied mechanically in a manner that defeats justice. Where the withholding of money is unjustified, prolonged, or demonstrably inequitable, the Court may not be powerless merely because the parties entered into an agreement prohibiting payment of interest in cases of delayed payments.

This issue is especially significant in infrastructure projects where projects frequently continue well beyond their original completion dates for reasons entirely attributable to the employer – late site handover, delayed approvals, design changes or funding issues. Contractors finance labour, machinery, materials and overheads long before they receive payment, and delayed payments increase borrowing costs, disrupt cash flow, and often delay project execution. Contractors should proactively document employer-caused delays, maintain contemporaneous records of payment defaults, approvals and correspondence, and preserve evidence linking project prolongation to the employer, as these records may prove critical in overcoming contractual bars on interest.

Footnotes

^{1 SLP (C) No.24631/2023}

^{2 (2007) 13 SCC 43; 2017 SCC OnLine Del 9154}

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.