Arbitral Tribunal Cannot Rewrite Contracts: Supreme Court Sets Aside Award Worth INR 995 Crores in SEPCO v. GMR Kamalanga Energy

1. Background and Contractual Framework

SEPCO Electric Power Construction Corporation (SEPCO) was an EPC (Engineering, Procurement, and Construction) contractor that entered into multiple agreements with GMR Kamalanga Energy Limited (GMRKE) Limited for the construction of three 350 MW coal-fired thermal power plants at Kamalanga village in Dhenkanal District, Odisha. The contractual framework included the Original Civil Works and Engineering, Erection, Testing and Commissioning Agreement (CWEETC Agreement) dated August 28, 2008 (as subsequently amended, with the final amendment dated April 4, 2013).

The project encountered significant delays, leading SEPCO to demobilize from construction sites around January 2015 and subsequently invoke arbitration. The disputes centered on various claims including delay-related damages, prolongation costs, equipment payments, and performance guarantee test completion. What followed was a protracted arbitration process that ultimately resulted in a substantial award in favor of SEPCO, which the Supreme Court found to be fundamentally flawed.

2. The Arbitral Award and Initial Challenges

A key contention by SEPCO was that there was no condition precedent for contractual notices under the Amended CWEETC Agreement. Despite acknowledging SEPCO’s failure to adduce evidence of notice compliance, the Arbitral Tribunal focused on waiver or estoppel entitlement, referencing an email dated  March 18, 2012, from GMRKE Limited that invited cooperation for waiver of notice conditions. The Arbitral Tribunal ultimately awarded SEPCO substantial sums including USD 480,000, CNY 730,527,024, INR 29,477,436, and USD 94,361,218.24, totalling approximately INR 995 Crores.

GMRKE Limited challenged the Arbitral Award before the Single Judge under Section 34 of the Arbitration and Conciliation Act, 1996, contending that unfair treatment and adjudication beyond pleadings demonstrated procedural and legal errors. However, the Single Judge upheld the Arbitral Award, determining that there was no violation of Section 18 or Section 34(2)(b)(ii) of the Act. Undeterred, GMRKE Limited pursued the matter further.

3. The Division Bench’s Intervention

GMRKE Limited then moved the Division Bench via appeal under Section 37 of the 1996 Act, raising the issue of whether the tribunal correctly interpreted contractual provisions regarding the issuance of contractual notices as a condition precedent, and whether such conditions could be waived. The Division Bench allowed GMRKE Limited’s appeal and set aside both the Section 34 Judgment and the Arbitral Award, finding multiple fundamental errors in the Arbitral Tribunal’s approach.

The Hon’ble Supreme Court, through Chief Justice B.R. Gavai and Justice Augustine George Masih, examined several critical issues that went to the heart of arbitral jurisdiction and contractual interpretation. The Court’s analysis provides valuable guidance on the limits of arbitral power and the sanctity of contractual terms.

4. Waiver and “No Oral Modification” Clauses: A Critical Analysis

One of the central issues before the Court was whether contractual notice conditions could be waived through informal communications or conduct. The Division Bench analyzed whether such conditions could be waived by reference to Section 62 of the Indian Contract Act, 1872 (requiring consensus ad idem for substitution or alteration of contracts) and Section 63 (allowing a promisee to unilaterally waive performance without consideration).

The Court established that waivers require deliberate and explicit intention to relinquish a known right with mutual comprehension and cannot result from miscommunication or involuntary behavior. This principle is particularly important in commercial contracts where parties have negotiated specific terms and conditions to govern their relationship.

The Division Bench concluded that estoppel was barred by the parties’ adherence to “No Waiver” and “No Oral Modification” clauses, making the Arbitral Tribunal’s contrary view untenable. The Court held that re-wording “No Oral Modification” and “No Waiver” clauses contravenes the fundamental ideas of justice. This finding underscores the importance of respecting the parties’ express agreement on how their contract may be modified or waived.

5. Factual Errors and Their Cascading Impact

The Division Bench identified several critical factual errors made by the Arbitral Tribunal that had significant implications for the award. Most notably, the Arbitral Tribunal erroneously recorded the amended coal moisture range as 9 to 12 percent rather than the correct contractual range of 7 to 15 percent. Furthermore, the Tribunal failed to acknowledge that actual moisture levels were actually between 13.7 and 14.6 percent, thereby distorting the assessment of liability and computation of liquidated damages whilst wrongly attributing delays to GMRKE Limited.

Such factual errors are not merely technical mistakes; they fundamentally alter the basis upon which liability and damages are assessed. When an arbitral tribunal misconstrues basic factual parameters, the entire award becomes suspect.

6. Delay-Related Damages and Evidentiary Standards

The Court examined whether SEPCO was entitled to delay-related damages for prolongation and disruption costs. SEPCO claimed CNY 248,833,587 for undelivered equipment for suspended Unit 4. Despite GMRKE Limited’s objections regarding the lack of supporting evidence, the Arbitral Tribunal awarded over INR 200 Crores. This award was made despite the absence of evidence of actual payments to subcontractors and the fact that settlement agreements relied upon were merely hearsay evidence.

This finding highlights a crucial principle in arbitration: claims must be supported by credible evidence. An arbitral tribunal cannot award substantial damages based on hearsay or unsubstantiated assertions, regardless of any sympathy the tribunal may have for a party’s position.

7. Performance Guarantee Test: Contradictory Findings

Perhaps one of the most glaring inconsistencies in the Arbitral Award concerned the Performance Guarantee Test. The Division Bench found that under the Amended CWEETC Agreement, the Performance Guarantee Test required both the Reliability Run Test and the Unit Characteristics Test. However, the Arbitral Tribunal awarded INR 255 Crores whilst recognizing the test as “successfully completed,” despite simultaneously declaring that the Unit Characteristics Test for Unit 1 had failed due to excessive attemperator flow, inadequate Induced Draft fans, and excessive noise levels.

This internal contradiction demonstrates how the Arbitral Tribunal departed from basic logic and the contractual framework. A test cannot simultaneously be “successfully completed” and “failed” – such contradictory findings fundamentally undermine the award’s credibility and legal foundation.

8. The Fundamental Principle: Arbitrators Cannot Deviate from Contract Terms

The Supreme Court’s judgment rests on a bedrock principle of arbitration law: arbitral tribunals derive their authority solely from the parties’ agreement and cannot deviate from or reinterpret the contractual terms when making an award. The Court emphasized through numerous precedents that awards must remain within the parameters of the agreement entered into between the parties.

Referring to the landmark decision in Saw Pipes, the Court reiterated that any deviation from the mandate of Section 28(3) of the 1996 Act constitutes a valid ground for challenging an arbitral award. The Court observed that it is the primary duty of arbitrators to enforce the promises made by parties and uphold the sanctity of the contract.

In Union of India v. Bharat Enterprise, a three-Judge Bench underlined that the existence and powers of an arbitrator are creatures of the agreement between the parties. The terms of the contract serve as the fundamental basis for the procedure to be adopted by the arbitral tribunal, and the arbitrator is restricted to those terms and cannot go outside their scope.

In Associated Engineering, the Court observed that an arbitrator cannot act arbitrarily, irrationally, capriciously, or independently of the contract. The arbitrator’s sole function is to arbitrate in terms of the contract, and he has no power beyond what the parties have conferred upon him under the agreement.

9. Discriminatory Treatment and Violation of Natural Justice

Beyond the substantive errors, the Division Bench identified serious procedural irregularities that violated fundamental principles of natural justice. The Division Bench held that the Arbitral Tribunal shocked the conscience by exceeding its jurisdiction and effectively rewriting contract terms through total disregard of specific contractual provisions. The Court found that whilst the Arbitral Tribunal dismissed GMRKE Limited’s counterclaims for alleged lack of notice, it simultaneously held that the parties had waived contractual notification requirements in favour of SEPCO. This unequal treatment by the Arbitral Tribunal constituted a violation of natural justice under Section 18 of the 1996 Act.

The Division Bench determined that the Arbitral Tribunal’s interpretation regarding SEPCO’s right to delay-related damages and conclusion that agreements did not exclude common law termination rights constituted a flagrant breach of the contract between parties.

This discriminatory treatment – applying one standard to SEPCO’s claims whilst applying a different and stricter standard to GMRKE Limited’s counterclaims – violated the fundamental principle of equal treatment enshrined in Section 18 of the Arbitration and Conciliation Act, 1996.

Conclusion: Upholding Contractual Certainty

The Supreme Court affirmed that even under the current arbitration regime, judicial intervention is narrowly confined to specific, enumerated grounds, and arbitral decisions must adhere to natural justice and cannot rest solely on personal beliefs or perceived moral duties. The Court found that the Arbitral Tribunal had incorrectly rewritten the terms of the Amended CWEETC Agreement to falsely empower SEPCO for their claims, despite non-compliance of the contractual provisions.

The Supreme Court’s judgment represents a significant victory for contractual certainty and the rule of law in arbitration. It reaffirms that arbitral tribunals derive their authority exclusively from the contract between parties and cannot exceed that mandate. The decision also clarifies that “No Oral Modification” and “No Waiver” clauses must be respected, and estoppel cannot be invoked to circumvent express contractual provisions without clear and deliberate intention by the parties.

This judgment serves as a crucial reminder to arbitral tribunals that their role is to interpret and apply the contract as written, not to rewrite it based on perceived fairness or sympathy for one party. For commercial parties, the decision reinforces the importance of carefully drafted contracts with clear notice requirements, modification procedures, and waiver provisions. When parties have negotiated and agreed upon specific contractual terms, those terms must be honored – both by the parties themselves and by any arbitral tribunal called upon to resolve disputes arising from the contract.