Recovery of debt under Indian Contracts Act, 1872

Synopsis:

There may exist several scenarios where the client may deny or inordinately delay the performance of contract, i.e., payment of debt within scheduled period if specified in contract and sometimes on account of unspecified schedule of payment in the contract agreement. The payment can be refused or inordinately delayed on several grounds - shortage of funds, defective or delayed supply of goods and services, lack of proper front for execution etc. Here, it is intended to discuss that particular situation when a client refuses payment to a contractor on the pretext of shortage of funds. The client also refuses to pay interest on that debt on account of delay on the pretext that interest on payment was not specified in the contract document. This article discusses the ratio of various judgments held in this matter.

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As per the Indian Contract Act, 1872, when an agreement is made between two parties, both parties are bound to perform their contractual obligations. In the given scenario, if the client has refused to make payment of the invoice after the execution of work within the scheduled period, the other party has the option to file a civil suit for the non-payment of the invoice amount along with interest, if any.

The interest rate may be mentioned in the contract between the parties; in the absence of such a clause, the rate of interest may be calculated under the Interest Act, 1978. The Interest Act, 1978 provides that if there is no agreement regarding interest, simple interest at the rate of 18% per annum can be claimed from the date when the payment was due.

It is pertinent to note that Section 46 of the Indian Contract Act, 1872 provides that if no time for performance of a contract is specified, it has to be performed within a "reasonable time". The Hon'ble Delhi High Court in the case of North Delhi Municipal Corporation & Anr. Vs. Amit Tanwar, 2018, SCC OnLine Del 8035 while dealing with provisions of Section 46, inter alia, held that It is slightly unfathomable as to how the Corporation can postpone the payment to the Contractor, indefinitely. The issuance of the tender and the work order in favour of the Contractor has to be on the pre-condition that funds are available with the Corporation. To ask the Contractor to wait endlessly for his payment is wholly arbitrary. The Corporation which hands over the works contract to the Contractor cannot say "Do the work now will pay when I have the money". Even if such a clause has been signed and accepted by the Contractor, it does not make the clause valid inasmuch as it would render a fundamental condition of contract being hit by provisions of the Indian Contract Act, 1872 (hereinafter, Contract Act"). Every contract, to be valid, has to have consideration and the indefinite postponement of consideration would be wholly unconscionable.

It was further opined that corporations which form a part of the State as envisaged under Article 12 of the Constitution have to conduct their activities in accordance with law and public policy. Instrumentalities of States ought to be saddled with a higher responsibility to behave reasonably and not arbitrarily. It can be no justification for a Corporation to claim that it would float the tender, it would issue the works contract, it would get the work executed, its Engineer would supervise the work, the Engineers would pass the bills, but yet no payment would be made. Such a luxury ought not to be available to anyone, even a private individual/corporation who enters into a contract, let alone a State Corporation. The Corporation being an instrumentality of State, such a contract would also be opposed to public policy under Section 23 of the Contract Act. Section 46 of the Contract Act is also clear that if no time for performance of a contract is specified, it has to be performed within a reasonable time. Reading these provisions together, it is clear that an open ended Clause which in effect says that the payment shall be made at an undetermined time in the future, subject to availability of funds, in a particular head of accounts is wholly unreasonable and such a term would also be unfair.

In case of contract agreement between the parties not containing any provision for grant of interest also means that there is also no provision which prohibits grant of interest. It is settled law that arbitral tribunals and courts can award interest for pre-lite, pendente-lite and post-lite periods. Section 3 of Interest Act, 1978 which contains provisions for payment of interest, takes care of such a situation.

That the Constitution Bench of the Hon'ble Supreme Court in Secretary, Irrigation Department, Government of Orissa and Others vs. G.C. Roy, (1992), 1SCC 508 held that a person deprived of the use of money to which he is legitimately entitled has a right to be compensated for the deprivation, call it by any name. It may be called interest, compensation or damages. This basic consideration is as valid for the period the dispute is pending before the arbitrator as it is for the period prior to the arbitrator entering upon the reference. This is the principle of Section 34, Civil Procedure Code and there is no reason or principle to hold otherwise.

That another Constitution Bench of the Hon'ble Supreme Court held in case of Executive Engineer, Dhenkanal Minor Irrigation Division, Orissa and Others vs. N.C. Budharaj (deceased) by LRS and Others, (2001) 2 SCC721, that the arbitrator appointed with or without the intervention of the court, has jurisdiction to award interest, on the sums found due and payable, for the pre-reference period, in the absence of any specific stipulation or prohibition in the contract to claim or grant any such interest.

Conclusion

Section 73 of the Indian Contract Act, 1872 deals with the recovery of compensation for loss or damage caused by breach of contract. It provides that when a contract has been breached, the party who suffers by such breach is entitled to receive compensation for any loss or damage caused to him which naturally arose in the usual course of things from such breach, or which the parties knew, when they made the contract, to be likely to result from the breach of it.

In addition to the compensation for loss or damage caused, the party who suffers by such breach may also be entitled to receive interest for the delayed payment. However, the rate of interest will depend on the terms of the contract if any, or otherwise as per the provisions of the Interest Act, 1978.

The Interest Act, 1978 applies to the whole of India, and it prescribes the maximum rate of interest that can be charged in the absence of any agreement to the contrary. It also specifies the mode of calculation of interest in various circumstances. Therefore, if there is no specific agreement regarding the rate of interest for delayed payment in the contract, then the Interest Act will apply.

Hence, it is valid in law to demand interest for delay in payment as per the Interest Act, 1978 or as per the terms of the contract. However, the exact rate of interest and other terms will depend on the specific circumstances of the case.