Bpl Limited vs. Morgan Securities And Credits Private Limited

2025 INSC 1380
REPORTABLE

IN THE SUPREME COURT OF INDIA
CIVIL APPELLATE JURISDICTION
CIVIL APPEAL NO. 14565 - 14566 OF 2025
(@ SLP(C) 32849-32850 of 2025 @ Diary No.56596 of 2024)


BPL LIMITED ….Appellant(s)

VERSUS

MORGAN SECURITIES AND CREDITS ….Respondent(s)
PRIVATE LIMITED




J U D G M E N T


Signature Not Verified
Digitally signed by
VISHAL ANAND
Date: 2025.12.04
18:11:36 IST
Reason:

J.B. PARDIWALA, J.
For the convenience of exposition, this judgment is divided in the
following parts:-
Index

A. FACTUAL MATRIX ............................................................... 2
B. ARBITRAL PROCEEDINGS ................................................... 6
C. FIRST APPEAL UNDER SECTION 34 OF THE ACT, 1996 ..... 11
D. ORDER PASSED BY A LEARNED SINGLE JUDGE IN SECTION
34 PETITION DATED 18.12.2018 ....................................... 11
E. SUBMISSIONS ON BEHALF OF THE APPELLANT ................ 20
F. SUBMISSIONS ON BEHALF OF THE RESPONDENT ............. 23
G. ANALYSIS .......................................................................... 27
H. NATURE OF THE COMMERCIAL CONTRACT BETWEEN THE
PARTIES ........................................................................... 35
I. SECTION 31(7)(a) AND (b) RESPECTIVELY OF THE
ACT, 1996 ......................................................................... 37
J. IS PENAL INTEREST ON PENAL INTEREST OPPOSED TO
PUBLIC POLICY? ............................................................... 50
i. Cavendish embraced in foreign jurisdictions ................... 89
a. Australia .......................................................................... 90
b. New Zealand .................................................................... 92
c. Malaysia .......................................................................... 93
d. Germany .......................................................................... 94
K. APPLICABILITY OF THE MAXIM ‘VERBA CHARTARUM
FORTIUS ACCIPIUNTUR CONTRA PROFERENTEM’ IN THE
PRESENT CASE ............................................................... 104
L. APPLICATION OF SECTION 74 OF THE CONTRACT ACT VIS-A-
VIS SECTION 31(7)(a) of the ARBITRATION ACT, 1996 ..... 109
M. CASE LAW RELIED UPON BY THE APPELLANT: ................ 115
N. CONCLUSION .................................................................. 116



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1. Leave granted.
2. Since the issues involved in both the captioned appeals are the same,
the parties are also the same and the subject matter of challenge in
one of the connected appeals is to the order of review passed by the
High Court in the main matter those were taken up for hearing
analogously and are being disposed of by this common judgment and
order.
3. These appeals arise from the judgment and order passed by the High
Court of Delhi dated 18.11.2024 in FAO(OS) (COM) No. 46 of 2019 by
which the appeal filed by the appellant herein under Section 37(1)(b)
of the Arbitration and Conciliation Act, 1996 (for short, the “Act,
1996”) read with Section 13 of the Commercial Courts Act, 2015 (for
short, the “Act, 2015”) seeking to assail the order dated 18.12.2018
passed by a learned Single Judge of the High Court in OMP (COMM)
No. 176/2017 upholding the arbitral award came to be dismissed.

4. The appellant also seeks to challenge the order passed by the High
Court, rejecting the review application preferred against the judgment
and order dismissing the Section 34 appeal.
A. FACTUAL MATRIX
5. One M/s BPL Display Device Ltd./BDDL had sold certain goods to
the appellant herein/BPL over a period of time. As there arose some
issues of timely payments, the buyer and seller companies viz. , BPL

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and BDDL, together approached the respondent for extending a Bill
Discounting facility to BDDL, to which the respondent agreed.
Accordingly, the Bill Discounting facility was sanctioned by the
respondent vide letters dated 27.12.2002 (to the extent of Rs. 6 crores)
and 11.06.2003 (to the extent of Rs. 6.5 crores).
6. It would be apposite to bring to the fore, some relevant terms of the
Sanction Letters, as mutually agreed between the parties:
• The said Sanction Letters referred to BDDL as the ‘Drawer’
and the appellant/BPL as the ‘Drawee’.
• It was provided that the “Bill of Exchange /Hundi shall be
with recourse to Drawer.”
• The repayment of the amount was mutually agreed to be
both the responsibility of the Drawer/BDDL and
drawee/appellant jointly and severally.
• The facility was approved at a concessional rate of interest
i.e., 22.5% per annum payable upfront as against the normal
agreed rate of interest, i.e., 36% per annum but in case of
default in making payment on its due dates, the
concessional rates would stand withdrawn and the normal
rate of interest i.e., @ 36% per annum would become
payable.
• The bill discounting period was up to 150 days. §

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• As per the Sanction Letter dated 11.06.2003, one M/s
Electronic Research Pvt. Ltd./ERPL stood surety for the
repayment of Rs. 6,43,32,301/- in the event the Drawer and
Drawee failed to repay the amount due in term of sanction
letter dated 11.06.2003. In pursuance of the same, ERPL
furnished a ‘Comfort letter’ along with PDCs guaranteeing
repayment of the amounts due and payable to the
respondent/claimant.
7. However, dispute between the parties arose when a sum of
Rs.25,79,91,096/- against particular Bills of Exchange became due
and payable to the respondent/claimant by BPL and BDDL in 2004,
which amount they defaulted in repaying despite several reminders
on behalf of the respondent/claimant. It is stated that during the
subsistence of the contract, BDDL along with ERPL had issued
postdated cheques (PDCs) to discharge their respective partial
contractual liabilities towards the respondent/claimant. However,
BPL allegedly requested the claimant to not encash the said cheques
and assured the respondent/claimant that given some more time,
they would make arrangements for the payments. The
respondent/claimant, in good faith, considered the requests and upon
assurances of BDDL, did not present the cheques for encashment.
8.
After an extension of time to make the payments was sought,
admittedly, the appellant/BPL made two payments to the respondent

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herein vide Demand Drafts dated 08.08.2005 and 29.08.2005 both
drawn on Bank of India for a sum of Rs. 50,00,000/- each, and it is
stated that such amounts were adjusted by the respondent/claimant
towards seven Bills of Exchange drawn pursuant to the Sanction
Letter dated 11.06.2003, the details of which are reproduced
hereinbelow:

9. However, despite the assurances extended by the appellant/BPL and
BDDL as well as the indulgence accorded by the respondent, the
appellant/BPL and BDDL failed to repay the amounts due with
interest and relying upon the letter of acknowledgement of debt dated
02.02.2007 issued by the appellant/BPL, the respondent invoked
arbitration by way of issuance of a Notice dated 28.06.2007, against

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the appellant/BPL as well as BDDL. Accordingly, a sole Arbitrator was
appointed to preside over the matter.
B. ARBITRAL PROCEEDINGS:
10. In a nutshell, the respondent/claimant raised a total of four claims;
three claims under the sanction letter dated 11.06.2003, and one
claim under the sanction letter dated 27.12.2002, amounting to an
aggregate of Rs.25,79,91,096/- which had become due and payable
by the appellant/BPL and BDDL to the respondent herein. It is
pertinent to note that during the course of the arbitration proceedings,
ERPL was impleaded as respondent No.3 and the claim against BDDL
was dropped by the respondent/claimant, since BDDL was
undergoing liquidation proceedings.
11. On the basis of the pleadings, the following issues were framed by
the learned sole Arbitrator:
“1. Whether the claimant is entitled to a sum of
Rs.7,27,05,579/- as on 10.08.2007 against Bill
Discounting Facility Agreement/ sanction vide letters
dated 27.12.2002 and Rs,20,62,28,681/- as on
10.08.2007 on account of the Bill Discounting Facility
Agreement/ Sanction letter dated 11.06.2003?

2. Whether the claimant is entitled to any damages. If so,
to what amount?

3. Whether the claimant is entitled to interest. If so, at what
rate and from which date?

4. Whether the claimant is entitled to cost?

5. Whether the claims have been validly instituted? OPR2

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6. Whether, assuming the Respondent No.2 is liable for
payment under the Bill Discounting Facility Agreement
dated 27.12.2002 and 11.06.2003, the claim is barred by
time? OPR2

7. Whether the Claimant can claim any amount from
Respondent No.2 under the Bill Discounting Facility
Agreement dated 27.12.2002 and 11.06.2002 in view of
the Respondent No.2 having tendered post-dated cheques
towards payment of liability on the hundies discounted by
the Claimant? OPR2

8. Whether the Respondent N.o.2 made any verbal
representation to the Claimant not to present the post-
dated cheques issued by the Respondent No.2 as alleged
by the Claimant? OPR2

9. If not, did the Claimant waive its right to the payment of
the amounts of each cheque issued by Respondent No.2
and under the Bill Discounting Agreement? OPR2

10. Reliefs.”

12. As regards Issue No.1, the learned Arbitrator outright rejected the
contention of the appellant that the transaction between the parties
is governed by the Usurious Loans Act, 1918, as amended by the
Punjab Relief of Indebtedness Act, 1934, by observing that the
transaction between the parties was neither a loan nor a debt, rather
it was simply in the nature of a commercial transaction wherein BPL
and BDDL being ‘traders’, had transacted a deal in the course of their
business. Since BPL was not in a financial position to pay BDDL,
and therefore, they together approached the respondent/claimant to
pay to the seller the amounts of the transactions, with a stipulation
that the same would be repaid to the respondent/claimant along

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with interest as per the terms agreed upon. Secondly, the learned
Arbitrator held that it cannot be said that the sanction letters are
distinct from the Bills of Exchange/hundis or that the Bill
Discounting Agreements/sanction letters are not binding upon BPL
and BDDL; nor can it be said that the claim of the non-payment of
the bills of exchange is not governed by the terms of the said Bill
Discounting Agreements/sanction letters. Accordingly, the learned
Arbitrator decided Issue No.1 in favour of the claimant/respondent
herein.
13. As regards Issue No. 2, it was held by the learned Arbitrator that the
claimant has failed to prove that damages had been suffered, and
thus, the said issue was decided against the claimant/respondent
herein.
14. As regards Issue No.3, relying upon Class Motors Ltd v. Maruti
Udyog Ltd . reported in 1996 SCC OnLine Del 872, Modi Rubber Ltd
v. Morgan Security and Credits reported in 2002 SCC OnLine Del
546 and West Bengal Cement Ltd v. Syndicate Bank reported in
2009 SCC OnLine Del 3318, the learned Arbitrator held that the
terms of payment of interest as mutually agreed upon by the parties
vide sanction letters dated 27.12.2002 and 11.06.2003 respectively
cannot be held to be unconscionable, arbitrary, or excessive in case
of non-payment after the stipulated due date. It was held that BPL
and BDDL were under no obligation to enter into a contract with the

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respondent/claimant in the first place, and thus, having taken the
advantage of the contract, the appellant herein, could not be allowed
to turn around and raise a plea that the rate of interest was excessive
or unconscionable. Moreover, the learned Arbitrator by relying upon
Central Bank of India v. Ravindra and Others reported in 2001
SCC OnLine SC 1266, rejected the contention of the appellant that
the interest cannot be added to the principal amount and held that
since the compounding of interest on monthly rest was provided in
the mutually agreed upon terms of the contract entered into between
the parties, therefore, the respondent/claimant was entitled to claim
interest as per the terms of the contract i.e., @ 36% per annum with
monthly rests. Accordingly, Issue No. 3 was decided in favour of the
claimant/respondent herein.
15. Issue No. 5 was decided by the learned Arbitrator in favour of the
claimant/respondent herein by observing that Section 64 of
Negotiable Instruments Act, 1881 is not applicable to the facts of the
present case and the surety ERPL (Respondent No.3 therein) having
admitted the existence of the arbitration agreement/sanction letter
dated 11.06.2003, has rightly been impleaded to the arbitration
proceedings. It was further held that BPL has also been rightly
impleaded in view of the joint liability clause contained in the
sanction letters dated 27.12.2002 and 11.06.2003.

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16. As regards Issue No.6 qua the issue of limitation, the learned
Arbitrator while observing that the part payments amounted to
acknowledgement and would extend the period of limitation, held
that since, admittedly, there was a part payment made by BPL within
the period of limitation i.e., in August 2005, and the debt was
acknowledged vide letter dated 02.02.2007, by no stretch of
imagination can the claims of the claimant/respondent herein be
said to be barred by time in view of the fact that the claimant invoked
arbitration within six months from 02.02.2007. Thus, Issue No. 6
was decided in favour of the claimant/respondent herein.
17. In respect of Issues No. 7, 8 and 9, relying upon the decision in
Harish Chander v. Ganga Singh and Sons reported in 1973 SCC
OnLine P&H 40, it was held that despite the fact that the
claimant/respondent herein did not present the postdated cheques
issued by BDDL, it would not absolve the appellant herein from its
liability. However, with regard to ERPL, it was held that its liability
stood discharged on account of the failure of the
claimant/respondent herein to present the post-dated cheques
issued by ERPL for payment coupled with the fact that ERPL never
issued any letter of acknowledgement of debt either, and thus, the
claim of the respondent herein against ERPL was dismissed as
barred by limitation.

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18. Resultantly, the learned Arbitrator, by way of the impugned award
dated 14.12.2016, directed the appellant to pay a sum of Rs.
7,27,05,579/- as well as Rs. 20,62,28,681/- with interest as
applicable in the terms of the sanction letters i.e., @ 36% per annum
from the date these amounts were due till the date of the Award, and
@10% per annum from the date of the Award till realization.

C. FIRST APPEAL UNDER SECTION 34 OF THE ACT, 1996
19. Aggrieved by the Award dated 14.12.2016, each of the rival parties
instituted an application under Section 34 of the Act, 1996 before
the Delhi High Court. On one hand, the appellant herein challenged
the directions of the learned sole Arbitrator to make the payment of
the claim to the respondent herein, while on the other hand, the
respondent herein challenged the dismissal of its claims against
ERPL.
D. ORDER PASSED BY A LEARNED SINGLE JUDGE IN
SECTION 34 PETITION DATED 18.12.2018
20. The gist of the findings recorded by the learned Single judge while
dismissing Section 34 petition filed by the appellants herein, is as
under:
“(i)The claim of the respondent/claimant was not on the
basis of the Bills of Exchange but on the basis of two
Sanction Letters to which the appellant herein was
admittedly a party. Section 80 of the NI Act, which
prescribes a fixed rate of interest to be charged, has no
application to the present case.

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(ii) As per Section 31(7) of the NI Act, the transaction in
question does not fall within the ambit of the Usurious
Loans Act, 1918 as amended by the Punjab Relief of
Indebtedness Act, 1934 since the transaction in question
was not in the nature of a loan or a debt, rather it
pertained to discounting of Bills of Exchange which was
simply a commercial transaction.

(iii) The interest awarded by the learned sole Arbitrator,
having been granted in accordance with the terms of the
contract between the parties, cannot be set aside by
invoking the general principles of fairness or equity.

(iv) Since the respondent/claimant had stated on
affidavit that it had adjusted the part payments made
by the appellant against seven particular Bills of
Exchange, the respondent cannot claim the benefit of
extension of limitation for those Bills of Exchange for
which it did not receive any payment. Therefore, the
claim of the respondent for Bill of Exchange bearing OMR
No.35 has to be held as being barred by limitation.

(v) As per Section 37 of NI Act as well as the terms of the
Sanction Letters, the Drawer/BDDL and the
Drawee/BPL of the Bills of Exchange are jointly and
severally liable for repayment of the amounts
discounted. Merely because the terms of the Sanction
Letters state for reference to the Drawer/BDDL, it cannot
absolve the Drawee/BPL of such liability.

(vi) Non-application of Section 64, NI Act to the facts and
circumstances of the present case is a finding on fact
made by the learned Sole Arbitrator, hence it cannot be
interfered into in Section 34, Arbitration Act proceedings.

(vii) There was no acknowledgment of liability by ERPL
that could have extended the period of limitation against
it. Further, no reason for non-presentation of the Post-
Dated Cheques issued by ERPL was presented by the
respondent/claimant before the Arbitrator or before this
Court. Thus, the ERPL has been rightly discharged from
the liability by the ld. Sole arbitrator.


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(viii) Post-award interest awarded by the learned Sole
arbitrator is a matter of discretion of the arbitrator, hence
the same cannot be faulted merely because the Court
could have exercised its discretion in another manner.”

21. Thus, the learned Single Judge vide common order dated
18.12.2018 partly allowed the petition filed under Section 34 of the
Act, 1996 preferred by the appellant herein and dismissed the
petition filed by the respondent herein.
22. The final directions issued by the learned Single Judge read thus:
“63. In view of the above, the Award on the principal sum of
Bill of Exchange bearing No.OMR-35 of an amount of
Rs.75,39,304/- is set aside. The Award inasmuch as it
directs the petitioner to make payments to the respondent
except for the above Bill of Exchange and proportionate
interest thereon, is upheld.”

23. The appellant herein being dissatisfied with the judgment and order
passed by the learned Single Judge referred to above, preferred an
appeal under Section 37(1)(b) of the Act, 1996.
24. The Division Bench of the High Court dismissed the appeal filed by
the appellant herein holding as under:
“42. We find that there is not an iota of patent illegality in the
aforesaid reasoning spelled out by learned Single Judge
except for a typographical error that the learned judge was
referring to Section 31(7) of the A& C Act. The Usurious Loan
Act, 1918 as followed by the Punjab Relief of Indebtedness
Act, 1934, were promulgated in a different era and the power
of the Court to adjudicate if the interest on a loan amount is
excessive has to give way in view of the plenary powers of
the Courts provided under the later enactment i.e., the
Arbitration & Conciliation Act. Unhesitatingly, the
transactions between the parties whereby payments were
made for supply of goods to the appellant by the
respondent/claimant were not in the nature of a loan or an

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advance. In essence, the respondent/claimant had been
making payment to the appellant for the supply of goods to
BDDL and such payments were purely in the nature of
commercial transactions as amongst the parties. Both
parties, the appellant herein/BPL and the respondent
No.2/BDDL evidently approached the respondent/ claimant
for providing bill discounting facilities and agreed to their
joint and several liabilities towards the discounting of the
Bills of Exchanges.”
25. The final order passed by the Division Bench dismissing the Section
37 appeal reads as under:

“43. In view of the foregoing discussion, this Court finds that
neither the learned Arbitrator nor the learned Single Judge,
while adjudicating the issues raised by the rival parties, has
committed any patent illegality or perversity that go to the root
of the matter. The arbitral award, although has granted
interest at a rate which is on the higher side, cannot be held
to be so unfair and unreasonable so as to shock the conscience
of this Court. There is nothing to suggest that the Award is
opposed to public policy, and therefore, inexecutable.

42. In view of the above, the instant appeal is dismissed,
thereby holding that there is no illegality, infirmity or incorrect
approach adopted by the learned Single Judge in passing the
impugned order dated 18.12.2018, thereby awarding a sum
of Rs. 7,27,05,579/- and Rs. 20,62,28,681/- with interest as
applicable in accordance with the terms of the
agreements/Sanction Letters from the date these amounts
became due till the date of the award as well as interest @
10% per annum from the date of the award till realization.

43. The parties are left to bear their own costs.”

26. It appears that after the dismissal of Section 37 appeal by the High
Court, a Review Petition No. 309 of 2024 was filed. The Review
Petition also came to be rejected vide the order dated 18.11.2024.
27. The High Court while rejecting the review application made the
following observations:

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“18. Adverting to the issues raised in the instant review,
the plea that as per the tabular chart submitted by the
respondent before the Arbitral Tribunal, most of the bills of
exchange/hundis stood paid within a period of nine
months, is belied from the record of the Arbitral Tribunal
inasmuch as while deciding Issue No.1 as to what amount
is payable against the bill discounting facility/sanction
letters dated 27.12.2002 up to 10.08.2007, it was
categorically found that not a single bill of exchange/hundi
was paid by the applicant/appellant on the respective due
dates. The said statements which were marked Ex.CW-
1/294 with respect to sanction letter dated 27.12.2002
and Ex.CW-1/295 with respect to sanction letter dated
11.06.2003 were not assailed in any manner before the
learned Arbitral Tribunal.

19. In fact, a bare perusal of the tabular details of the bills
of exchange/hundis in the instant application so as to
invoke the review jurisdiction, is rather in the nature of
almost placing a whole new interpretation with regard to
the chart that was filed by the applicant/appellant vide
annexure “B” as well annexure “A” relied upon by the
respondent/claimant, referred to in our judgment vide
paragraph (29). By all means, it amount to espousing a
new assertion to the whole story that most of the bills of
exchanges/hundis were discharged within nine months. It
is borne out from the record that no plea was advanced to
the effect that substantial payments had been made
within a period of nine months. It is also a matter of record
that neither the witness for the respondent/claimant was
prodded about the payments done within nine months nor
the Managing Director of the applicant/appellant stepped
into the witness box to prove such aspect. The evidence led
by the claimant proven in accordance with statement of
claim forming Annexure “A” was not shaken or
controverted in any manner.

20. Likewise, the plea that only seven payments were
attributable to the applicant/appellant under the sanction
letter dated 11.06.2003 and none under the first sanction
letter dated 27.12.2002 is also misconceived since the
liability of both the drawer and the drawee i.e., BDDL as

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drawer, and the applicant/appellant as the drawee, was
joint and several, and the desperate attempt by the
applicant/appellant to wriggle out of its liability towards
the bills of exchange/hundis deserves to be nipped in the
bud, in the face of acknowledgment of its liability vide
letter dated 02.02.2007 issued by the
applicant/appellant, the contents of which letter are
referred by us in paragraph (30) of the impugned judgment
dated 19.07.2024.

21. In the same vein, the plea that each bill of exchange
was an independent negotiable instrument and could not
have been clubbed or lumped together for the purposes of
Section 19 of the Limitation Act, 1963, was also decided
by taking a substantive view of the matter inter alia
upholding the observations of the Arbitral Tribunal as well
as the learned Single Judge who passed the order dated
18.12.2018 under Section 34 of the A&C Act.

22. As regards the plea raking up the issue of the
unreasonableness of the rate of interest claimed on the
bills discounted in terms of the two sanction letters, the
same was ardently urged before the Arbitral Tribunal, and
later before the learned Single Judge in the application
under section 34 of the A& C Act, and lastly before us in
proceedings under section 37 of the A & C Act, only to be
met with rejection from all the three forums. Further, the
plea advanced to the effect that the stipulation of high
interest @ 36% is contrary to the usage, practices or
ordinary disposition in the financial world cannot be re-
agitated in review proceedings once it is found that a
substantive view has been taken on that aspect.

23. To sum up, we are not persuaded to take a different
view on the instant review application. In upholding the
findings of both the Arbitral Tribunal and the learned
Single Judge, we have taken a substantive view of the
matter by reaching to the conclusion that the payment of
interest on the basis of the terms of the two sanction letters
cannot be called unconscionable or excessive. At first
blush, the interest rate and quantum worked out so far
seem to be quite humungous, however, objections in the

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nature of arbitrariness, unconscionability and violation of
public policy, cannot be invoked in cases where a business
entity has entered into a commercial contract, and has
acquiesced and acted upon the terms and conditions of the
said contract, without ever having raised any objections of
such nature, either before or immediately after entering
into the contract.

24. Evidently, the applicant /appellant never took any
steps to avoid the contract within the stipulated time and
having reaped the benefits arising out the contract, now,
at this belated stage, it does not lie in its mouth to avoid
the said stipulation in the contract by alleging unfairness
and unconscionability. It is on record that the
applicant/appellant directly benefited from the two
sanction letters. As noted in paragraph (34) of the
judgment under review, the applicant/appellant
acknowledged its liability via letter dated 02.02.2007,
specifically referencing outstanding dues pertaining to the
BDDL account and seeking additional time for payment.

25. Notably, the author of this letter did not testify before
the Arbitrator, and consequently, no objection was raised
regarding the interest clause in the sanction letters. It is
axiomatic that the sanctity of a contract is a fundamental
principle underlying the stability and predictability of legal
and commercial relationships. This legal position is
precisely what we have upheld.

26. There is no gainsaying that the question as to whether
the charging of a high rate of interest in the case of a purely
commercial transaction is morally wrong entails a complex
web of issues that would be contingent upon a variety of
factors and perspectives. Although at first glance, the
charging of interest @36% could be considered as
exploitative, unfair and morally blameworthy, high interest
rates reflect the lenders risk of default due to highly
competitive and uncertain market conditions, besides the
fact that high interest rates might discourage borrowers
from taking unnecessary risks. In the commercial world,
justifiability or reasonability of high interest rates would
depend on the transparency of the terms and conditions of

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the contract entered into between the lender and the
borrower, as well as the informed consent of the borrower.
Ultimately, morality is inherently dependent on context,
shaped by a complex interplay of cultural norms, as well
as individual values. The moral implications of high
interest rates are not absolute, rather they must be
assessed through a nuanced lens that considers the inter-
relationship between economic, social, and regulatory
factors.

27. Further, the plea that interest has been granted in
contravention of the Section 80 of the Negotiable
Instruments Act, 1881 and the award is liable to be set
aside for being against the public policy of India, since the
claim is not entirely based on the bills of exchange but the
two sanction letters, cannot be countenanced again in the
review sought since such pleas already stand rejected in
view of the categorical finding that the bills of exchange
were an integral part of the two sanction letters. It is a
matter of record that the claim of the respondent was not
based merely on the basis of bills of exchange, rather on
the basis of the two sanction letters to which the
applicant/appellant was admittedly a party.

28. Likewise, the plea in the same vein that the interest
claimed is hit by the Usurious Loans Act, 1918, as
amended by Punjab Relief Indebtedness Act, 1934, was
too rejected by us for the substantive finding that the
aforesaid Act was not applicable in view of Section
31(7)(a)10 (b)11 as it stood prior to the amendment. The
said view was supported with case law by the learned
Single Judge as also by us in the impugned judgment
under review.”


28. On the issue whether interest rate is against public policy, the High
Court observed thus:
“32. In the light of the aforesaid discussion, reverting back
to the instant matter, on a plain and grammatical
construction of clauses (ii) and (iii) of Explanation 1 to
Section 34(2) of the A&C Act, it is doubtful if the imposition

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of an exorbitant interest in the background of
contemporary commercial practices, would be against the
fundamental policy of Indian Law, or against the basic
notions of morality or justice. It is noteworthy that the
applicant/appellant has consistently and brazenly denied
its liability to honour the hundis, despite being confronted
with overwhelming evidence. Furthermore, it has shown
no willingness to settle accounts with the
respondent/claimant. Consequently, the
applicant/appellant cannot now dispute its substantial
financial liability. Notably, the applicant/ appellant is a
sophisticated entity, unaffected by illiteracy, ignorance, or
economic disadvantage.

33. While exorbitant interest rates may be deemed unjust
or immoral in certain circumstances, particularly where
beneficiaries lack equal bargaining power or suffer from
illiteracy, poverty, or ignorance, the present case does not
warrant such consideration.

34. Considering the foregoing discussions, we are
unconvinced that any error apparent on the face of the
record warrants a review of our judgment dated
19.07.2024. The review sought essentially constitutes an
appeal to recall our judgment, which is inherently not
maintainable. To reiterate, the pleas raised in this
application have already been addressed through a
substantive examination of the matter, in accordance with
the law.”


29. Being dissatisfied with the judgment and order passed by the High
Court dismissing the Section 37 appeal, and also the order rejecting
the review application, the appellant is here before this Court with
the present appeals.


SLP (C) Nos. 32849 – 32850 of 2025 Page 19 of 120


E. SUBMISSIONS ON BEHALF OF THE APPELLANT
30. Mr. Gopal Subramanium, the learned Senior counsel appearing for
the appellant strenuously submitted that clause 4 of the sanction
letters which prescribes the rate of interest carries in it an
unambiguous element in so far as the applicable rate of 36% is
concerned. It was submitted that read as a whole, the clause is
capable of a construction that parties intended that if there was any
default, they would revert to the normal rate being 36% which would
be through an active notification.

31. As a second proposition, the learned Senior counsel submitted that
the rate of interest at 36% with monthly rest as provided in clause 4
is in the nature of penal interest and could not have been awarded
having regard to illustration ‘D’ read with Section 74 of the Indian
Contract Act, 1872. Section 74 of the Indian Contract Act, prescribed
that even if there is a penal stipulation, only damages as occurred or
suffered can be adjudicated.
32. As a third proposition, the learned Senior counsel submitted that
the words “unless otherwise agreed as occurring in Section 31(7)(a)”
are susceptible of three interpretations. The first is that the words
unless otherwise agreed between the parties referred to an
agreement containing a prohibition against the arbitral tribunal to
award interest.

SLP (C) Nos. 32849 – 32850 of 2025 Page 20 of 120



33. The learned Senior counsel argued that the second interpretation is
that if there is no bar which precludes the arbitrator from granting
interest then, the Arbitrator acts under Section 31(7)(a) having
regard to the factors outlined therein to make a judicious and judicial
determination of reasonable amount of interest which would be
payable. In such a case too, the Arbitrator can consider the terms of
the contract including any term which may prescribe interest as a
relevant factor in consideration under Section 31(7)(a).
34. The third interpretation according to the learned Senior counsel is
that “unless otherwise agreed between the parties” can control whole
aspect of the matter covered under Section 31(7)(a).
35. In the last, the learned Senior counsel submitted that the
observations contained in the DMRC v. Delhi Airport Metro
Express Private Limited reported in (2024) 6 SCC 357 to the
aforesaid extent were not apposite for the issue which fell for
consideration. It was submitted that having regard to the nature of
the arbitral functions to award interest both under Sections 31(7)(a)
and 31(7)(b) being of an adjudicatory character which is a
performative function of the arbitral tribunal, there can only be an
exclusion of that function but not the ancillary execution of that
function through an Agreement.
36. The gist of the broad submissions canvassed by Mr. Gopal
Subramanium is as under:

SLP (C) Nos. 32849 – 32850 of 2025 Page 21 of 120


“a. Grant of interest under the Award and Impugned Orders
is opposed to public policy in terms of Section 34(2)(b)(ii) of the
Arbitration Act read with Section 80 of the Negotiable
Instruments Act, 1881;

b. Award and Impugned Orders are passed in contravention
of Section 31(7)(a) of the Arbitration Act which concerns itself
with ‘reasonable pendente-lite interest’ and not contractual
rate of interest;

c. In the absence of either a statement of account or a demand
for payment by the Respondent, clause 4 of the Sanction Letter
dated 27.12.002 was not effectively exercised;

d. Interpretation of clauses 4 and 5 respectively of the
Sanction Letter dated 27.12.2002 in light of the admitted
adjustment of payments against the principal amount of the
Bills of Exchange (34 Bills of Exchange in toto);

e. Clause 4 of the sanction letter 27.12.2002 is subject to the
principle of ‘ verba chartarum fortius accipiuntur contra
proferentem ’ and the effect of a unilateral and one-sided
arbitration clauses under the sanction letters;

f. Interest awarded at 36% per annum is ‘penal interest on
penal interest’ and as such, is opposed to public policy;

g. The Award and Impugned Orders fail to consider the fact
that the Respondent’s claims were ex-facie barred by
Limitation.

37. To fortify the submissions noted above, the learned Senior counsel
placed strong reliance on the following decisions:
(1) Central Bank of India v. Ravindra and Others
reported in (2002) 1 SCC 367. Paras 36, 37, 38, 39, 40,
44 and 55 respectively.
(2) Unitech Limited and Others v. Telangana State
Industrial Infrastructure Corporation (TSHC) and

SLP (C) Nos. 32849 – 32850 of 2025 Page 22 of 120


Others reported in (2021) 16 SCC 35. Paras 47, 48 and
49 respectively.
(3) Morgan Securities and Credits Private Limited v.
Videocon Industries Limited reported in (2023) 1 SCC
602. Para 24.
(4) Jaiprakash Associates Limited (JAL) v. Tehari
Hydro Development Corporation (THDC) reported in
(2019) 17 SCC 786. Paras 15, 16 & 17 respectively.
(5) Delhi Airport Metro Express Private Limited v.
Delhi Metro Railway Corporation reported in (2022) 9
SCC 286.
38. In such circumstances referred to above, the learned Senior counsel
prayed that there being merit in his appeal, the same may be allowed
and the impugned judgment and order passed by the High Court be
set aside.

39. In the last, the learned Senior counsel prayed that in so far as the
rate of interest is concerned this Court may modify the same
accordingly with a view to balance the equities between the parties.

F. SUBMISSIONS ON BEHALF OF THE RESPONDENT
40. Mr. Shyam Divan the learned Senior Counsel appearing for the
respondent broadly submitted the following:

SLP (C) Nos. 32849 – 32850 of 2025 Page 23 of 120


a. No error not to speak of any error of law could be said to have
been committed by the High Court in passing the impugned
judgment and order.
b. The four sets of concurrent findings encompass various
issues such as the enforceability of the contractual rate of
interest, limitation, inapplicability of Section 80 of the
Negotiable Instruments Act, 1881(“ NI Act ”), Joint and Several
Liability of Drawer and Drawee, inapplicability of Section 64 of
the NI Act to the facts of the present case, inapplicability of the
Usurious Loans Act, 1918 etc.
c. It is a settled law that when an arbitral award has been
affirmed by the Court under Section 34, and thereafter, by the
Court in an appeal under Section 37 then this Court in exercise
of its jurisdiction under Article 136 of the Constitution should
be slow and loath in disturbing such concurrent findings. In
this regard reliance has been placed on the decision of this
Court in the case of MMTC Limited v. Vedanta Limited
reported in (2019) 4 SCC 163 para 14.
d. It is for the first time that the appellant canvassed an entirely
new plea i.e., that no specific notice was issued to it by the
respondent for withdrawal of the concessional rate of 22.50%
p.a.

SLP (C) Nos. 32849 – 32850 of 2025 Page 24 of 120


e. No such plea had been taken either before the arbitrator or
in the proceedings or arguments before the Court under Section
34 and Section 37 of the Act, 1996 respectively.
f. The aforesaid did not find mention in any response to the
notice of arbitration dated 28.06.2007 issued by the respondent
or in the statement of defence before the arbitrator or in the
pleadings under Section 34 and Section 37 of the Act, 1996
respectively wherein, the rate of interest 36% p.a. with monthly
rests stood firmly embedded in the claim amount/award
amount. At no point of time the appellant redressed the
grievance that the same had caused prejudiced citing alleged
lack of such notice.
h. Withdrawal of a concessional rate of interest or for that
matter any other concession for failure to apply with the terms
thereof cannot be said to be a penalty.
i. The appellant made no attempt to pay any part of the claimed
amount at any stage of the arbitral proceedings or even after
the award. No attempt to pay any part of the claimed sum was
made even after the orders under Section 34 and Section 37 of
the Act, 1996 respectively. It is only for the first time before this
Court that some amount came to be deposited under the orders
passed by this Court.

SLP (C) Nos. 32849 – 32850 of 2025 Page 25 of 120


l. The pendente lite period was utilized by the appellant in
diverting various assets and monies to third parties with the
intention to take the said assets beyond the pale of a potential
enforcement process and because of such conduct the
appellant company and its contractors were held guilty of
contempt of court on account of wilful violation of the interim
restraint order dated 23.08.2013 passed by the Delhi High
Court.
m. In terms of Section 31(7)(a) of the Act, 1996, the contractual
rate of interest held the field for the pre-award period and in a
commercial contract between two large corporates no cavil
could have been raised with the agreed rate of interest.
n. The arbitrator’s jurisdiction to grant pendente lite/ pre award
interest is governed strictly by the contract between the parties.
In this regard, reliance was placed on the decisions of this Court
in the case of State of Haryana v. S.L. Arora reported in
(2010) 3 SC 690 and in the case of Delhi Airport Metro
Express (supra) para 20 respectively.
o. The principle of unconscionability is inapplicable to
voluntary commercial agreements between the parties of equal
bargaining strength.
p. Clauses providing for compounding of interest in commercial
contracts voluntarily entered into between the parties are not

SLP (C) Nos. 32849 – 32850 of 2025 Page 26 of 120


violative of Public policy. In this regard, reliance was placed on
the decision of this Court in the case of Renusagar Power
Company Limited v. General Electric Company reported in
1994 Supp (1) SCC 644 at 693 para 93.
41. In such circumstances referred to above, it was prayed by the
learned Senior counsel appearing for the respondent that there
being no merit in this appeal, the same may be dismissed.

G. ANALYSIS

42. Before adverting to the rival submissions canvassed on either side,
we must look into few pieces of documentary evidence on record.
43. The letter dated 27.12.2022 addressed by the respondent herein to
the appellant as regards the Bill Discounting facility to the extent
of Rs. 6, 00, 00, 000/- reads thus:

“MORGAN SECURTIES AND CREDITS PRIVATE LIMITED
CORPORATE OFFICE: 53, Friends Colony (East), New Delhi-
110065.
Dated: 27.12.2022
BPL Display Devices Limited
A-41, 42 & 42/1 Site IV
Industrial Area Sahibabad
Ghaziabad-201010
Uttar Pradesh.

Dear Sir,

Re: Bill Discounting Facility to the extent of Rs. 6,00,00,000/-


SLP (C) Nos. 32849 – 32850 of 2025 Page 27 of 120


Please refer your request and the discussions your
representatives had with us in connection with extension of the
Bills Discounting facility to you. We have considered your
proposal and on the basis of the documents, explanations,
representations (hereinafter collectively called as the proposal).
Furnished and made by you, we are agreeable to sanction you a
facility of Bills Discounting limit to the extent of Rs. 6,00,00,000/-
(Rupees Six Crores Only), on the following terms and conditions
(hereinafter call as “the Facility”).

1. We hereby confirm the allocation of funds on the following
terms and conditions:

i) Amount Upto Rs. 6,00,00,000/-
ii) Period Upto 150 days
iii) Drawer BPL Display Devices Ltd
iv) Drawee BPL Limited

2. The above facility be utilized in a way that the total amount
outstanding at any point of time should not exceed the maximum
limit of Rs. 6,00,000/- granted herein.

3. Bill of Exchange/Hundi shall be with recourse to Drawer.
Therefore, the liability to repay amount to Morgan Securities &
Credits Private Limited (hereinafter referred to as “the
Discounting Company”) on the due date shall be of Drawer and
Drawee jointly and severally. In case the Drawee does not make
payment on due date of any bill of exchange /hundi, the Drawer
shall make the payment of all the amount due thereon to without
any notice or demand or presentment from the payee or the
holder in this behalf.

4. The Drawee/Drawer agrees that normal agreed rate for
providing Bill Discounting facility is 36% p.a., however as a
special case the Discounting Company is providing the Bill
Discounting Facility at concessional rate of 22.5% p.a. payable
upfront. In case of delay or default in making payment of amount
of the Bill of Exchange or overdue bill discounting
charges/interest or any part thereof on its due date, the
concessional rate will be withdrawn and the normal rate of bill
discounting charges of 36% p.a. monthly rests, shall be payable
by the Drawee/Drawer from its due date. Margin @3% p.m. for 3
days shall be deducted at the time of discounting, to be adjusted
against delays in repayment, if any.


SLP (C) Nos. 32849 – 32850 of 2025 Page 28 of 120


5. The repayment on the due date will be made to us by way of
crossed cheque/Demand Draft payable at New Delhi of high
value, clearing. Any amount paid under any Bill of Exchange by
the Drawer and/ or Drawee shall be first adjusted towards
overdue charges/interest, costs and expenses and other
facilities, if any, and then towards the amount of Bill of
Exchange.

6. In the event of any amount remaining overdue or any
hundi/bill of exchange under this facility, neither of the Drawer
and Drawee shall without the prior written permission of the
Discounting Company pass any resolution for its winding up for
its amalgamation/merger or otherwise or for
amalgamation/merger of any other Company into the Drawer or
Drawee: enter directly or indirectly into any new area/field of
business/operation or dispose off or sell or encumber any of its
undertaking or business or any of its investments in shares etc.;
register/recognize any transfer of its shares by any of its present
promoters’ group; change its paid up share capital or redeem any
security; appoint or reappoint, or modify any term and condition
of appointment of, any whole time or managing; director; pay any
remuneration to any of its managing directors, whole time
directors or the Chairman; or pay any dividend on any shares.

7. This sanction is made at New Delhi and the disbursement
shall be made from New Delhi. The Courts at New Delhi only
shall have the exclusive jurisdiction to entertain any dispute
relating to this facility. However, in case of dishonour of any
cheque relating to this facility. However, in case of dishonour of
any cheque issued by the Drawer/Drawee under this facility, the
Courts having the territorial jurisdiction over the area where the
collecting banker of the dishonoured cheque is situated, shall
have the exclusive jurisdiction to try the offence under the
Negotiable Instruments Act, 1881.

8. The amount shall be disbursed to you on the submitting by
you the following:

i) Post dated cheque for the payment of Amount of Bills of
Exchange from the Drawer and Drawee.

ii) Signature Attestation of the signatories from the bank of
signatories of Hundi as well as resolution (of Drawer as well as
drawee).


SLP (C) Nos. 32849 – 32850 of 2025 Page 29 of 120


iii) Bill of Exchange (as per our format) duty stamped and
accepted for payment on due date by Drawer & Drawee company
(with recourse to Drawer)

iv) Original copies of Invoices/Bills duly accepted by Drawee
stating that the goods received are in perfect order and condition
and certified/original copies of relevant Challans L/R and G/R

v) Certified true copy of the Board Resolution authorising to draw
documents/acceptance of Bill Discounting facility and
authorization of persons to sign for and on behalf of Drawer &
Drawee Company.

vi) Mode of Operation of Bank Account of Drawer & Drawee
Company (wherein cheque signing authorities are given)

vii) Names and Residential addresses of Directors of Drawer &
Drawee Company.

Any dispute or difference whatsoever between the parties arising
out of or in connection with the present facility and for any other
transaction/s between the parties shall be settled by Arbitration
of a Sole Arbitrator appointed by Chairman of Morgan Securities
and Credits Private Limited, who would also have right to appoint
alternate Arbitrator in place of the aforesaid Arbitrator, in case of
his death or being incapable or refusal to act or in the event of
termination of his mandate for any reason. The arbitration
proceedings shall be held at New Delhi. The power of the
Chairman to appoint a sole Arbitrator shall not be challenged by
any party. Further, the parties agree that the Arbitrator be
appointed may be an employee and/or professional retainer
and/or a person who has a relation or interest in the company.
The parties agree not to ask for any adjournment except under
extra-ordinary reasons.

We reserve the right to modify, add or delete any of the terms
and conditions mentioned in this letter at any time for which due
notice will be given to you.

Kindly furnish the above documents/papers at an early date
with a letter of acceptance to the terms and conditions of this
sanction letter by you and the drawee.

We look forward to a continuous business relationship and
assure you of our prompt services at all times.

SLP (C) Nos. 32849 – 32850 of 2025 Page 30 of 120



Thanking you,

Yours faithfully,
For Morgan Securities and Credits Private Limited

Sd/
Authorised Signatory.”
(Emphasis supplied)
44. The letter dated 11.06.2023 addressed by the respondent to the
appellant as regards the Bill Discounting facility to the extent of Rs.
6,50,00,000/- reads thus:
“ MORGAN SECURITIES AND CREDITS PRIVATE LIMITED
CORPORATE OFFICE: 53, Friends Colony (East), New Delhi-
110065.

Dated: 11.06.2023
BPL Display Devices Limited
A-41, 42 & 42/1 Site IV
Industrial Area Sahibabad
Ghaziabad-201010
Uttar Pradesh.

Dear Sir,

Re: Bill Discounting Facility to the extent of Rs. 6,50,00,000/-

With reference to our discussions, we are pleased to sanction Bill
Discounting Limit to your Company to the extent of Rs.
6,50,00,000/- (Rupees Six Crores Fifty Lakhs only), for your
Sales to BPL Limited. We hereby confirm the allocation of funds
on the following terms and conditions:

i) Amount Upto Rs. 6,50,00,000/-
ii) Period Upto 150 days
iii) Drawee BPL Limited
iv) Drawer BPL Display Devices Ltd
v) Guarantor Electronic Research Private Limited.

2. Bill of Exchange/Hundi shall be with recourse to Drawer.
Therefore, the liability to repay amount to lender on the due date

SLP (C) Nos. 32849 – 32850 of 2025 Page 31 of 120


shall be of Drawer & Drawee jointly and severally, which
hereafter shall be collectively referred to as the “Borrower”.
Kindly arrange to furnish the following documents/papers of the
Company:-

i) Memorandum & Articles of Association of the Drawer & Drawee
Companies.

ii)Copies of the Audited Annual Reports for the last two years of
the Drawer & Drawee Companies.

iii)Post Dated Cheque for the payment of Principal Amount from
the Drawer and Drawee. Drawer’s cheque to be used in case
Drawee is unable to pay on due date.

iv)Signature Attestation of the signatories from the bank of
signatories of Hundi as well as resolution (of Drawer as well as
Drawee).

v) Bill of Exchange (as per format) duly accepted for payment on
due date by Drawer and Drawee Company (with recourse to
Drawer).

vi) Original Copies of Invoices/Bills duly accepted by Drawee
stating that the goods received are in perfect order and condition
and copies of Challans L/R and G/R.

vii) Certified true copy of the Board Resolution authorizing to
draw documents/acceptance of Bill Discounting facility and
authorization of persons to sign for and on behalf of Drawer &
Drawee Company.

viii)Certified true copy of the Resolution passed u/S. 293(1)(d) of
the Companies Act, 1956 of the drawee company and an
undertaking that the total borrowing has not exceeded.

ix) Mode of Operation of Bank Account of Drawer & Drawee
Company.

x) Names and Residential addresses of Director of Drawer &
Drawee Company.

xi) Comfort letter along with PDC of Electronic Research Limited
guaranteeing repayment of amount due.


SLP (C) Nos. 32849 – 32850 of 2025 Page 32 of 120


Kindly furnish the above documents/papers at an early date
with a letter of your acceptance. The Drawee/Drawer agrees
with the lender that normal rate for providing Bill Discounting
facility is 36% p.a. however, as a special case the lender is
providing this Bill Discounting facility at concessional rate of
22.5% p.a. payable upfront. In case of delay or default in making
payment of principal or overdue bill discounting charges/interest
or any party thereof on its due date, the concessional rate will be
withdrawn and the normal rate of bill discounting
charges/interest of 36% p.a. monthly rests, shall be payable by
the Drawee/Drawer from its due date.

As per our understanding, the repayment on the due date will be
made to us by way of crossed cheque/Demand Draft payable at
New Delhi of high value clearing failing which interest on the
delayed period would be payable to us as per above.

Any dispute of difference whatsoever arising between the parties
out of or in relation to the construction, meaning, scope, operation
or effect of any transaction/s or the validity or the breach thereof
arising out of or in connection with the present agreement and for
any other transaction/s between the parties shall be settled by
Arbitration of a Sole Arbitrator appointed by Chairman of Morgan
Securities & Credits Private Limited, who would also have right
to appoint alternate Arbitrator in place of the aforesaid Arbitrator,
in case of his death or being incapable or refusal to act or in the
event of termination of his mandate for any reason. The
arbitration proceedings shall be held at New Delhi. The power of
the Chairman to appoint a Sole Arbitrator shall not be challenged
by either party. Further, the parties agree that the Arbitrator so
appointed may be an employee and/or professional retainer
and/or a person who has a relation or interest in the company.
Both parties are not to ask for any adjournment except under
extraordinary reasons. The award given by the arbitrator shall
be final and binding upon the parties.

We look forward to a continuous business relationship and
assure you of our prompt services at all times.
Thanking you,
Yours faithfully,
For Morgan Securities & Credits Private Limited.
Sd/-

SLP (C) Nos. 32849 – 32850 of 2025 Page 33 of 120


Authorized Signatory”
(Emphasis supplied)

45. Thus, what is important for us to look into and try to understand is
clause 4 of the sanction letters dated 27.12.2022 and 11.06.2023
respectively referred to above. We reproduce the same as under:
“ 4. The Drawee/Drawer agrees that normal agreed rate for
providing Bill Discounting facility is 36% p.a., however as a
special case the Discounting Company is providing the Bill
Discounting Facility at concessional rate of 22.5% p.a. payable
upfront. In case of delay or default in making payment of
amount of the Bill of Exchange or overdue bill discounting
charges/interest or any part thereof on its due date, the
concessional rate will be withdrawn and the normal rate of bill
discounting charges of 36% p.a. monthly rests, shall be
payable by the Drawee/Drawer from its due date. Margin
@3% p.m. for 3 days shall be deducted at the time of
discounting, to be adjusted against delays in repayment, if
any. ”
(Emphasis supplied)
46. Clause 4 can be divided into three parts. First, the Drawer and
Drawee agreed that the normal rate for providing Bill Discounting
facility would be 36% p.a. The second part provides that as a special
case the discounting company, i.e., the respondent herein would
provide the Bill Discounting facility at the concessional rate of
22.5% p.a. payable upfront and the third part provides that in the
event of delay or default, in making payment of amount of the Bill
of Exchange or overdue bill discounting charges/interest or any
part thereof on its due date, the concessional rate would be
withdrawn and the normal rate of bill discounting charges of 36%

SLP (C) Nos. 32849 – 32850 of 2025 Page 34 of 120


p.a., monthly rest would be payable by the Drawer/Drawee from its
due date. The margin at the rate of 3% per month for three days
would be deducted at the time of discounting to be adjusted against
delays in the repayment if any.
H. NATURE OF THE COMMERCIAL CONTRACT BETWEEN THE
PARTIES

47. As the entire debate revolves around clause 4 of the agreement
providing for bill discounting facility, and more particularly, the rate
of interest specified therein, we should try to understand the basic
difference between a business loan and bill discounting. It is
necessary to understand this difference to meet with the case put up
by the appellant that interest at the rate of 36% with monthly rest is
opposed to public policy and could be said to be unconscionable.

48. The crucial difference is that a bill discounting facility is a short-
term financing option where a business sells its unpaid invoices to a
financial institution for immediate cash, while a business loan is a
traditional debt obligation where the business receives a lump sum
and is responsible for repaying it with interest. High interest rates
are prescribed in a contract, relating to a bill discounting facility
primarily due to the higher risk profile of the financing, its nature as
a short-term unsecured funding source and the need for the financial

SLP (C) Nos. 32849 – 32850 of 2025 Page 35 of 120


institution to compensate for the associated costs and potential for
non-payment.

49. The higher rate is a trade-off for the business, which gains
immediate liquidity and operational flexibility by paying a premium
to offload the waiting period and associated payment risks to a
financial institution. In other words, contracts relating to a bill
discounting facility typically contain high rates of interest primarily
due to the higher risk profile for the lender, the unsecured and short-
term nature of the financing, and the quick and hassle-free access
to cash it provides.
50. Keeping the fine distinction between a loan and a bill discounting
facility in mind, the High Court did well to take the view that the
provisions of the Usurious Loans Act, 1918 would not be applicable
in the present case. The High Court said so because in the present
litigation the commercial transaction was one relating to the bill
discounting facility and not a loan. The Usurious Loans Act, 1918
would apply to a loan and not to transaction relating to bill
discounting facility.


SLP (C) Nos. 32849 – 32850 of 2025 Page 36 of 120


I. SECTION 31(7)(a) AND (b) RESPECTIVELY OF THE ACT,
1996
51. The scope of Section 31(7)(a) and (b) and the interplay between the
sub clauses (a) and (b) respectively have been very succinctly
explained by this Court in a very recent pronouncement in the case
of HLV Limited v. PBSAMP Projects Pvt. Limited : 2025 INSC
1148 . We may clarify that in HLV Limited (supra) the court was
concerned with pre-amended Section 31(7)(b) of the Act, 1996.
However, in the case on hand, we are not concerned with Section
31(7)(b) but rather with sub clause (a) of the Act, 1996.

52. We must look into Section 31(7) of the Act, 1996 which reads thus:

“31. Form and contents of arbitral award. (7)(a) Unless
otherwise agreed by the parties, where and insofar as an
arbitral award is for the payment of money, the Arbitral
Tribunal may include in the sum for which the award is
made interest, at such rate as it deems reasonable, on
the whole or any part of the money, for the whole or any
part of the period between the date on which the cause
of action arose and the date on which the award is made.

(b) A sum directed to be paid by an arbitral award shall,
unless the award otherwise directs, carry interest at the
rate of two per cent. higher than the current rate of
interest prevalent on the date of award, from the date of
award to the date of payment.”

53. A bare perusal of the aforesaid provision would indicate that Section
31(7) has got two clauses: clause (a) and clause (b) respectively.
Clause (a) starts with the expression ‘unless otherwise agreed by

SLP (C) Nos. 32849 – 32850 of 2025 Page 37 of 120


the parties’. Thereafter, it says that where an award is for payment
of money, the arbitral tribunal may include in the sum for which
the award is made interest at such rate as it deems reasonable on
the whole or any part of the money and for the whole or any part of
the period from the date when the cause of action arose to the date
when the award is made. In other words, clause (a) empowers the
tribunal to include interest in the ‘sum’ for which the award is
made. The arbitral tribunal is further conferred the discretion to
award interest on the principal sum awarded at such rate as it
deems reasonable. However, this discretion of the arbitral tribunal
is subject to any decision which is agreed upon by the parties.

54. Clause (a) of Section 31(7) of the Act, 1996 was examined by this
Court in North Delhi Municipal Corporation v. S.A. Builders
Limited reported in (2025) 7 SCC 132 whereafter it was held as
under:
“36.1. From a minute reading of sub-section (7), it is seen
that it has got two parts: the first part i.e. clause (a) deals
with passing of award which would include interest up
to the date on which the award is made. The second part
i.e. clause (b) deals with grant of interest on the “sum”
awarded by the Arbitral Tribunal.

36.2. Let us now discuss in detail the contours of the two
clauses. As per clause (a), when an award is made by
the Arbitral Tribunal for payment of money, the “sum”
which is awarded may include interest at such rate as
the Arbitral Tribunal deems appropriate, on the whole or
any part of the money and for the whole or any part of

SLP (C) Nos. 32849 – 32850 of 2025 Page 38 of 120


the period. The period for which the interest may be
granted would be between the date on which the cause
of action arose and the date on which the award is made.
The expression which needs to be noticed in this part is
the following: the Arbitral Tribunal may include in the
sum for which the award is made interest at such rate as
it deems reasonable.

36.3. The word “may” appearing in the above expression
is quite significant. It implies that the Arbitral Tribunal
has the discretion to grant interest at a reasonable rate.
In other words, it may grant interest or it may not grant
interest; but if it grants interest, it would be included in
the “sum” which is awarded by the Arbitral Tribunal.”

55. Insofar clause (b), as it stood at the relevant time is concerned, i.e.,
pre-amended it provides for award of interest by the arbitral
tribunal on the ‘sum’ adjudged under clause (a). It says that ‘unless
the award otherwise directs’, a sum directed to be paid by an award
shall carry interest at the rate of 18% per annum from the date of
the award to the date of payment. In other words, clause (b) is
subject to the interest that may be awarded by the arbitral tribunal.
This provision was explained in S.A. Builders (supra) in the
following manner:
“36.4. This brings us to the second part i.e. clause (b)
which deals with post-award interest. The “sum”
directed to be paid by the Arbitral Tribunal shall, unless
the award otherwise directs, carry interest @ 18% p.a.
from the date of the award to the date of payment. Thus,
what clause (b) provides for is that the Arbitral Tribunal
may award interest on the “sum” adjudged under clause
(a). But if no such interest is awarded, then there shall be
interest @ 18% on the “sum” awarded by the Arbitral
Tribunal from the date of the award to the date of

SLP (C) Nos. 32849 – 32850 of 2025 Page 39 of 120


payment. The two crucial words in this part are sum and
shall. As seen from clause (a), the “sum” awarded by the
Arbitral Tribunal would include interest if it is granted by
the Arbitral Tribunal. Therefore, the “sum” as awarded
by the Arbitral Tribunal may or may not include interest.
Whether the “sum” so awarded includes or does not
include interest, it would carry further interest @ 18%
from the date of the award to the date of payment unless
another rate of interest is granted by the Arbitral
Tribunal. While granting of interest under clauses (a) and
(b) by the Arbitral Tribunal is discretionary, the interest
contemplated under clause (b) in the event of failure of
the Arbitral Tribunal to award interest is mandatory.
Therefore, the legislature has consciously used the word
shall.”

56. Thus, from a conjoint analysis of Section 31(7)(a) and Section
31(7)(b) of the Act, 1996 respectively what is discernible is that
insofar award of interest from the date on which the cause of action
arose till the date of the award is concerned, the legislative intent is
that the parties possess the autonomy to determine the interest and
the rate of interest for the aforesaid period. Clause (a) i.e. discretion
of the arbitral tribunal to award interest is subject to agreement by
and between the parties. Therefore, party autonomy takes
precedence over the discretion of the arbitral tribunal. However,
clause (b) is subject to award of interest by the arbitral tribunal. In
other words, as per clause (b), the ‘sum’ directed to be paid under
an arbitral award shall carry interest at the rate of 18% p.a. from
the date of the award to the date of payment ‘unless the award
otherwise directs’. Therefore, this provision is subject to award of

SLP (C) Nos. 32849 – 32850 of 2025 Page 40 of 120


interest by the arbitral tribunal. If it awards interest, then the same
shall be applicable from the date of the award till the date of
payment; if not, then the ‘sum’ as adjudged under clause (a) shall
carry interest at the rate of 18%. After the amendment in 2015
interest at the rate of 2% higher than the current rate of interest
prevalent on the date of award, from the date of award to the date
of payment.
57. A two-Judge Bench of this Court in S.L. Arora (supra) considered
the question as to whether Section 31(7) of the Act, 1996 authorises
and enables arbitral tribunals to award interest on interest from the
date of the award? In the facts of that case, the consequential
question formulated was as to whether the arbitral award granted
future interest from the date of award, only on the principal amount
found due to the respondent or on the aggregate of the principal
and interest up to the date of the award? After an analysis of the
aforesaid provision, the Bench observed that Section 31(7) makes
no reference to payment of compound interest or payment of
interest upon interest. It was held that in the absence of any
provision for interest upon interest in the contract, arbitral
tribunals do not have the power to award interest upon interest or
compound interest either for the pre-award period or for the post-
award period. It was held thus:


SLP (C) Nos. 32849 – 32850 of 2025 Page 41 of 120


“18. Section 31(7) makes no reference to payment of
compound interest or payment of interest upon interest.
Nor does it require the interest which accrues till the date
of the award, to be treated as part of the principal from
the date of award for calculating the post-award interest.
The use of the words “where and insofar as an arbitral
award is for the payment of money” and use of the words
“the Arbitral Tribunal may include in the sum for which
the award is made, interest … on the whole or any part
of the money” in clause (a) and use of the words “a sum
directed to be paid by an arbitral award shall … carry
interest” in clause (b) of sub-section (7) of Section 31
clearly indicate that the section contemplates award of
only simple interest and not compound interest or interest
upon interest. “A sum directed to be paid by an arbitral
award” refers to the award of sums on the substantive
claims and does not refer to interest awarded on the
“sum directed to be paid by the award”. In the absence
of any provision for interest upon interest in the contract,
the Arbitral Tribunals do not have the power to award
interest upon interest, or compound interest, either for the
pre-award period or for the post-award period .”

58. Thereafter the Bench upon a threadbare analysis concluded that
Section 31(7) merely authorizes the arbitral tribunal to award
interest in accordance with the contract and in the absence of any
prohibition in the contract and in the absence of specific provision
relating to interest in the contract, to award simple interest at such
rates as it deems fit from the date on which the cause of action
arose till the date of payment. The Bench further clarified that if the
award is silent about interest from the date of award till the date of
payment, the person in whose favour the award is made will be
entitled to interest at 18% per annum on the principal amount

SLP (C) Nos. 32849 – 32850 of 2025 Page 42 of 120


awarded from the date of award till the date of payment. In the facts
of that case, the Bench declared that the calculation that was made
in the execution petition as originally filed was correct and that the
modification sought for by the respondent increasing the amount
due under the award was contrary to the award. It was concluded
as under:

“34. Thus it is clear that Section 31(7) merely authorises
the Arbitral Tribunal to award interest in accordance with
the contract and in the absence of any prohibition in the
contract and in the absence of specific provision relating
to interest in the contract, to award simple interest at
such rates as it deems fit from the date on which the
cause of action arose till the date of payment. It also
provides that if the award is silent about interest from the
date of award till the date of payment, the person in
whose favour the award is made will be entitled to
interest at 18% per annum on the principal amount
awarded, from the date of award till the date of payment.
The calculation that was made in the execution petition
as originally filed was correct and the modification by the
respondent increasing the amount due under the award
was contrary to the award.”

59. The correctness of the view taken in S.L. Arora (supra) came up for
consideration before a three-Judge Bench of this Court in Hyder
Consulting (UK) Limited v. Governor, State of Orrisa reported in
(2015) 2 SCC 189. The majority held that the conclusion reached in
S.L. Arora (supra) was not in consonance with the clear language
of Section 31(7) of the Act, 1996. After extracting Section 31(7) of

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the Act, 1996 the Bench explained clause (a) of sub-section (7) of
Section 31 in the following manner:
“4. Clause (a) of sub-section (7) provides that where an
award is made for the payment of money, the Arbitral
Tribunal may include interest in the sum for which the
award is made. In plain terms, this provision confers a
power upon the Arbitral Tribunal while making an award
for payment of money, to include interest in the sum for
which the award is made on either the whole or any part
of the money and for the whole or any part of the period
for the entire pre-award period between the date on
which the cause of action arose and the date on which
the award is made. To put it differently, subsection (7)(a)
contemplates that an award, inclusive of interest for the
pre-award period on the entire amount directed to be paid
or part thereof, may be passed. The “sum” awarded may
be the principal amount and such interest as the Arbitral
Tribunal deems fit. If no interest is awarded, the “sum”
comprises only the principal. The significant words
occurring in clause (a) of sub-section (7) of Section 31 of
the Act are “the sum for which the award is made”. On a
plain reading, this expression refers to the total amount
or sum for the payment for which the award is made.
Parliament has not added a qualification like “principal”
to the word “sum”, and therefore, the word “sum” here
simply means “a particular amount of money”. In Section
31(7), this particular amount of money may include
interest from the date of cause of action to the date of the
award.”

60. On the above analysis, the Bench explained clause (b) of sub-section
(7) of Section 31 of the Act, 1996 to mean that the ‘sum’ which is
directed to be paid by the award, whether inclusive or exclusive of
interest, shall carry interest at the rate of 18% per annum for the
post-award period unless otherwise ordered. The above provision
was explained as under:

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“7. Thus, when used as a noun, as it seems to have been
used in this provision, the word “sum” simply means “an
amount of money”; whatever it may include — “principal”
and “interest” or one of the two. Once the meaning of the
word “sum” is clear, the same meaning must be ascribed
to the word in clause (b) of sub-section (7) of Section 31 of
the Act, where it provides that a sum directed to be paid
by an arbitral award “shall … carry interest …” from the
date of the award to the date of the payment i.e. post-
award. In other words, what clause (b) of sub-section (7)
of Section 31 of the Act directs is that the “sum”, which is
directed to be paid by the award, whether inclusive or
exclusive of interest, shall carry interest at the rate of
eighteen per cent per annum for the post-award period,
unless otherwise ordered.”


61. Finally, Hyder Consulting (supra) arrived at the following
conclusion:

“13. Thus, it is apparent that vide clause (a) of subsection
(7) of Section 31 of the Act, Parliament intended that an
award for payment of money may be inclusive of interest,
and the “sum” of the principal amount plus interest may
be directed to be paid by the Arbitral Tribunal for the pre-
award period. Thereupon, the Arbitral Tribunal may
direct interest to be paid on such “sum” for the post-
award period vide clause (b) of subsection (7) of Section
31 of the Act, at which stage the amount would be the
sum arrived at after the merging of interest with the
principal; the two components having lost their separate
identities.”

62. The question as to whether the ‘sum’ awarded under clause (a) of
sub-section (7) of Section 31 of the Act, 1996 would include interest
pendente lite or not again came up for consideration before a two-
Judge Bench of this Court in Delhi Airport Metro Express Private

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Limited (supra). The Bench analysed Hyder Consulting (supra) in
the following manner:
“15. It could thus be seen that the majority view of this
Court in Hyder Consulting (UK) is that the sum awarded
may include the principal amount and such interest as
the Arbitral Tribunal deems fit. It is further held that, if
no interest is awarded, the “sum” comprises only the
principal amount. The majority judgment held that clause
(a) of sub-section (7) of Section 31 of the 1996 Act refers
to the total amount or sum for the payment for which the
award is made. As such, the amount awarded under
clause (a) of sub-section (7) of Section 31 of the 1996 Act
would include the principal amount plus the interest
amount pendente lite. It was held that the interest to be
calculated as per clause (b) of sub-section (7) of Section
31 of the 1996 Act would be on the total sum arrived as
aforesaid under clause (a) of sub-section (7) of Section 31
of the 1996 Act. S.A. Bobde, J. in his judgment, has
referred to various authorities of this Court as well as
Maxwell on the Interpretation of Statutes. He emphasised
that the Court must give effect to the plain, clear and
unambiguous words of the legislature and it is not for the
courts to add or subtract the words, even though the
construction may lead to strange or surprising,
unreasonable or unjust or oppressive results.”

63. Thereafter, the Bench made an analysis of clause (a) of sub-section
(7) of Section 31 of the Act, 1996 and noted that it begins with the
expression ‘ unless otherwise agreed by the parties’ . This expression
was explained by the Bench by holding as under:
“17. It could thus be seen that the part which deals with
the power of the Arbitral Tribunal to award interest,
would operate if it is not otherwise agreed by the parties.
If there is an agreement between the parties to the
contrary, the Arbitral Tribunal would lose its discretion
to award interest and will have to be guided by the
agreement between the parties. The provision is clear

SLP (C) Nos. 32849 – 32850 of 2025 Page 46 of 120


that the Arbitral Tribunal is not bound to award interest.
It has a discretion to award the interest or not to award.
It further has a discretion to award interest at such rate
as it deems reasonable. It further has a discretion to
award interest on the whole or any part of the money. It
is also not necessary for the Arbitral Tribunal to award
interest for the entire period between the date on which
the cause of action arose and the date on which the
award is made. It can grant interest for the entire period
or any part thereof or no interest at all.”
(Emphasis supplied)
64. Thus, this Court was of the view that power of the tribunal to award
interest would operate if it is not otherwise agreed by the parties. If
there is an agreement between the parties to the contrary, the
arbitral tribunal would lose its discretion to award interest and will
have to be guided by the agreement between the parties. Thus, the
expression ‘unless otherwise agreed by the parties’ assumes
significance and concluded as under:
“20. If clause (a) of sub-section (7) of Section 31 of the
1996 Act is given a plain and literal meaning, the
legislative intent would be clear that the discretion with
regard to grant of interest would be available to the
Arbitral Tribunal only when there is no agreement to the
contrary between the parties. The phrase “unless
otherwise agreed by the parties” clearly emphasises that
when the parties have agreed with regard to any of the
aspects covered under clause (a) of sub-section (7) of
Section 31 of the 1996 Act, the Arbitral Tribunal would
cease to have any discretion with regard to the aspects
mentioned in the said provision. Only in the absence of
such an agreement, the Arbitral Tribunal would have a
discretion to exercise its powers under clause (a) of
subsection (7) of Section 31 of the 1996 Act. The
discretion is wide enough. It may grant or may not grant
interest. It may grant interest for the entire period or any

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part thereof. It may also grant interest on the whole or
any part of the money.”
(Emphasis supplied)


65. From the above, the view of the court is clearly discernible in that
the discretion to grant interest would be available to the arbitral
tribunal under clause (a) of sub- section (7) of Section 31 only when
there is no agreement to the contrary between the parties. When
the parties agree with regard to any of the aspects covered under
clause (a) of subsection (7) of Section 31, the arbitral tribunal would
cease to have any discretion with regard to the aspects mentioned
in the said provision. Only in the absence of such an agreement,
the arbitral tribunal would have the discretion to exercise its powers
under clause (a) of sub-section (7) of Section 31 of the Act, 1996.

66. In the facts of that case, it was held that in view of the specific
agreement between the parties, the interest quotient prior to the
date of the award so also after the date of the award will be governed
by article 29.8 of the concession agreement which was also directed
by the arbitral tribunal. This view was accordingly affirmed by this
Court.

67. In Morgan Securities and Credits Private Limited (supra), a two-
Judge Bench of this Court again examined the decision in Hyder
Consulting (supra). After an extensive analysis, the Bench was of

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the view that the decision in Hyder Consulting (supra) was on the
limited issue of whether post-award interest could be granted on
the aggregate of the principal and the pre-award interest. The
opinion authored by Bobde, J. was limited to this aspect of post-
award interest. Thereafter, the Bench noted that the issue before it
was whether the phrase ‘unless the award otherwise directs’ in
Section 31(7)(b) of the Act, 1996 only provides the arbitrator the
discretion to determine the rate of interest or both the rate of
interest and the ‘sum’ it must be paid against. Thereafter it was
noted that both clauses (a) and (b) of sub-section (7) of Section 31
are qualified. While clause (a) is qualified by the arbitration
agreement between the parties, clause (b) is qualified by the
arbitration award. The words ‘unless otherwise agreed by the
parties’ occurring at the beginning of clause (a) qualifies the entire
provision. However, the words ‘unless the award otherwise directs’
occurring in clause (b) only qualifies the rate of post-award interest.
68. In line with the Delhi Airport Metro Express Private Limited
(supra) we have to our advantage one recent pronouncement of this
Court in the case of PAM Developments Private Limited v. State
of West Bengal and Another reported in (2024) 10 SCC 715
wherein this Court observed thus:
“ 23.3. Under the 1996 Act, the power of the arbitrator to
grant interest is governed by the statutory provision in
Section 31(7). This provision has two parts. Under clause

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(a), the arbitrator can award interest for the period between
the date of cause of action to the date of the award, unless
otherwise agreed by the parties. Clause (b) provides that
unless the award directs otherwise, the sum directed to be
paid by an arbitral award shall carry interest @ 2% higher
than the current rate of interest, from the date of the award
to the date of payment.

23.4. The wording of Section 31(7)(a) marks a departure
from the Arbitration Act, 1940 in two ways : first, it does not
make an explicit distinction between pre-reference and
pendente lite interest as both of them are provided for under
this sub-section; second, it sanctifies party autonomy and
restricts the power to grant pre-reference and pendente lite
interest the moment the agreement bars payment of
interest, even if it is not a specific bar against the arbitrator.
[Sayeed Ahmed & Co. v. State of U.P., (2009) 12 SCC 26,
paras 14, 23, 24 : (2009) 4 SCC (Civ) 629; Union of
India v. Saraswat Trading Agency, (2009) 16 SCC 504 :
(2011) 3 SCC (Civ) 499; Sree Kamatchi Amman
Constructions v. Railways, (2010) 8 SCC 767, para 19 :
(2010) 3 SCC (Civ) 575; Union of India v. Bright Power
Projects (India) (P) Ltd., (2015) 9 SCC 695, para 13 : (2015)
4 SCC (Civ) 702; Reliance Cellulose Products Ltd. v. ONGC
Ltd., (2018) 9 SCC 266, para 24 : (2018) 4 SCC (Civ)
351; Jaiprakash Associates Ltd. v. Tehri Hydro
Development Corpn. (India) Ltd., (2019) 17 SCC 786, paras
13-15 : (2020) 3 SCC (Civ) 605; Delhi Airport Metro Express
(P) Ltd. v. DMRC, (2022) 9 SCC 286, paras 16-20, 24 :
(2022) 4 SCC (Civ) 623]”
(Emphasis supplied)

J. IS PENAL INTEREST ON PENAL INTEREST OPPOSED TO
PUBLIC POLICY?

69. The leaned Senior counsel appearing for the appellant made a
gallant effort to convince us to take the view that although there
may be an agreement between the parties prescribing a particular
rate of interest yet the words “unless otherwise agreed between the

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parties” would control the whole aspect of the matter covered under
Section 31(7)(a) of the Act, 1996. In other words, the argument is
that once the parties enter Section 31(7)(a) of the Act, 1996 it would
be within the discretion of the arbitral tribunal to include in the
sum for which the award is made, interest at such rate as it deems
reasonable.
70. We are afraid it is not legally permissible for us to subscribe to such
a view as sought to be canvassed by the learned Senior counsel
referred to above. The language of Section 31(7)(a) of the Act, 1996
is plain and simple. We place emphasis on the words “ unless
otherwise agreed by the parties ”. The words “ unless otherwise
” at the beginning of clause (a) qualify the
agreed by the parties
entire provision. Once the parties by mutual consent agreed to a
particular rate of interest to be charged and the same is included in
the terms of the contract there is no escape thereafter. The party
concerned would be bound by the rate of interest as prescribed in
the agreement. The rate of interest once agreed and forms part of a
written contract between the parties the borrower after availing the
finance cannot turn around and question the rate on the ground of
being unconscionable or opposed to Public policy.
71. The words of Justice Burrough aptly justify the unpredictability of
the interpretation of the term ‘public policy’. He says, “Public Policy

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is an unruly horse where once you stride on it you do not know
where it’s going to take you.”
72. When Justice Burrough said in Richardson v. Mellish , a famous
1824 English case: “Public is an unruly horse,” he gave us a
definition both original and witty, but one which does not help us
much to clearly understand the meaning of the term. “Public policy
is in its nature so uncertain and fluctuating, varying with the habits
and fashions of the day, with the growth of commerce and the
usages of trade, that it is difficult to determine its limits with any
degree of exactness. It has never been defined by the courts, but
has been let loose and free from definition in the same manner as
fraud.
73. Public policy is dictated by the law-making power the legislature,
and is found in the general tenor of statutes, and in direct
enactments. When the legislature, within the powers conferred by
the constitution, has declared the public policy, and fixed the rights
of the people by statute, the courts cannot declare a different policy
or fix different rights.
74. In the aforesaid context, we must look into the decision rendered
by the United Kingdom Supreme Court in the case of Cavendish
Square Holding BV v. Talal El Makdessi decided on 01.12.2015.
75. The facts of the said case were that by an agreement, Mr Makdessi
agreed to sell to Cavendish a controlling stake in the holding

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company of the largest advertising and marketing communications
group in the Middle East. The contract provided that if he was in
breach of certain restrictive covenants against competing activities,
Mr Makdessi would not be entitled to receive the final two
instalments of the price paid by Cavendish (clause 5.1) and could
be required to sell his remaining shares to Cavendish, at a price
excluding the value of the goodwill of the business (clause 5.6). Mr
Makdessi subsequently breached these covenants. Mr Makdessi
argued that clauses 5.1 and 5.6 were unenforceable penalty
clauses. The Court of Appeal, overturning Burton, J., at first
instance, held that the clauses were unenforceable penalties under
the penalty rule as traditionally understood.
76. The Supreme Court allowed the appeal in Cavendish v. El
Makdessi (supra), upholding the validity of the disputed clauses.
77. In the joint leading judgment by Lords Neuberger and Sumption
(with which Lord Clarke and Lord Carnwath agreed), both the
learned judges held that the true test of whether a clause is penal,
and therefore unenforceable, is whether the offending clause is a
secondary obligation which imposes a detriment on the party in
breach, out of all proportion to any legitimate interest of the
innocent party in the enforcement of the primary obligation.
78. They went on to explain that the validity of a clause providing for
the consequences of a breach of contract depends on whether the

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innocent party could be said to have a legitimate interest in the
enforcement of the clause. There is a legitimate interest in the
recovery of a sum constituting a reasonable pre-estimate of
damages, but the innocent party may have a legitimate interest in
performance which extends beyond the recovery of pecuniary
compensation. The law will not generally uphold a contractual
remedy where the adverse impact of that remedy significantly
exceeds the innocent party’s legitimate interest.
79. Lords Neuberger and Sumption also described the penalty rule as
“an ancient, haphazardly constructed edifice which has not
weathered well” but maintained that the penalty rule should not be
abolished in light of its endorsement by and application across all
major systems of law in the western world.
80. The court went on to conclude that neither clause 5.1 nor clause 5.6
respectively were unenforceable penalty clauses.

81. The court construed clause 5.1 as a price adjustment clause. It went
on to explain that the relevant clause was not a secondary provision
but a primary obligation. The sellers earn consideration for their
shares by (amongst other things) observing the restrictive
covenants. Whilst clause 5.1 had no relationship with the measure
of loss attributable to the breach, Cavendish also had a legitimate
interest in the observance of the restrictive covenants, in order to
protect the goodwill of the Group generally. The goodwill of the

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business was critical to Cavendish and the loyalty of Mr Makdessi
was critical to the goodwill. The Supreme Court observed that the
Court should not assess the precise value of that obligation or
determine how much less Cavendish would have paid for the
business without the benefit of the restrictive covenants. The
parties were the best judges of how it should be reflected in their
agreement. To that end, in finding that neither of the disputed
provisions was avoided by the penalty rule, the court also
considered that the agreement had been extensively negotiated
between informed and legally advised parties dealing on equal
terms, and a large proportion of the price for the shares represented
goodwill.
82. A very similar analysis was applied to clause 5.6. The clause was
also justified by the same legitimate interest as the first provision,
being an interest in matching the price of the retained shares to the
value that the seller was contributing to the target’s business. In
this regard, the court considered that the price formula in the
disputed clause had a legitimate function, i.e. it reflected the
reduced consideration which Cavendish would have been prepared
to pay for the acquisition of the business on the hypothesis that
they could not count on the loyalty of Mr Makdessi.
83. We may refer to few observations made in the judgment:

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“ The law in relation to penalties
3. The penalty rule in England is an ancient, haphazardly
constructed edifice which has not weathered well, and which
in the opinion of some should simply be demolished, and in
the opinion of others should be reconstructed and extended.
For many years, the courts have struggled to apply standard
tests formulated more than a century ago for relatively simple
transactions to altogether more complex situations. The
application of the rule is often adventitious. The test for
distinguishing penal from other principles is unclear. As early
as 1801, in Astley v Weldon (1801) 2 Bos & Pul 346, 350
Lord Eldon confessed himself, not for the first time, “much
embarrassed in ascertaining the principle on which [the rule
was] founded”. Eighty years later, in Wallis v Smith (1882)
21 Ch D 243, 256, Sir George Jessel MR, not a judge noted
for confessing ignorance, observed that “The ground of that
doctrine I do not know”. In 1966 Diplock LJ, not a judge given
to recognising defeat, declared that he could “make no
attempt, where so many others have failed, to rationalise this
common law rule”: Robophone Facilities Ltd v Blank [1966] 1
WLR 1428, 1446. The task is no easier today. But unless the
rule is to be abolished or substantially extended, its
application to any but the clearest cases requires some
underlying principle to be identified.
Equitable origins
4. The penalty rule originated in the equitable jurisdiction to
relieve from defeasible bonds. These were promises under
seal to pay a specified sum of money, subject to a proviso
that they should cease to have effect on the satisfaction of a
condition, usually performance of some other (“primary”)
obligation. By the beginning of the 16th century, the practice
had grown up of taking defeasible bonds to secure the
performance obligations sounding in damages. This enabled
the holder of the bond to bring his action in debt, which made
it unnecessary for him to prove his loss and made it possible
to stipulate for substantially more than his loss. The common
law enforced the bonds according to their letter. But equity
regarded the real intention of the parties as being that the
bond should stand as security only, and restrained its
enforcement at common law on terms that the debtor paid
damages, interest and costs. The classic statement of this

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approach is that of Lord Thurlow LC in Sloman v Walter
(1783) 1 Bro CC 418, 419:
“… where a penalty is inserted merely to secure the
enjoyment of a collateral object, the enjoyment of the object
is considered as the principal intent of the deed, and the
penalty only as accessional, and, therefore, only to secure
the damage really incurred ...”
5. The essential conditions for the exercise of the jurisdiction
were (i) that the penal provision was intended as a security
for the recovery of the true amount of a debt or damages, and
(ii) that that objective could be achieved by restraining
proceedings on the bond in the courts of common law, on
terms that the defendant paid damages. As Lord
Macclesfield observed in Peachy v Duke of Somerset (1720)
1 Strange 447, 453:
“The true ground of relief against penalties is from the
original intent of the case, where the penalty is designed
only to secure money, and the court gives him all that he
expected or desired: but it is quite otherwise in the present
case. These penalties or forfeitures were never intended by
way of compensation, for there can be none.”
This last reservation remained an important feature of the
equitable jurisdiction to relieve. As Baggallay LJ put it in
Protector Endowment Loan and Annuity Company v Grice
(1880) 5 QBD 592, 595, “where the intent is not simply to
secure a sum of money, or the enjoyment of a collateral
object, equity does not relieve”.
The common law rule
6. The process by which the equitable rule was adopted by
the common law is traced by Professor Simpson in his article
The penal bond with conditional defeasance (1966) 82 LQR
392, 418-419. Towards the end of the 17th century, the
courts of common law tentatively began to stay proceedings
on a penal bond to secure a debt, unless the plaintiff was
willing to accept a tender of the money, together with interest
and costs. The rule was regularised and extended by two
statutes of 1696 and 1705. Section 8 of the Administration of
Justice Act 1696 (8 & 9 Will 3 c 11) is a prolix provision whose
effect was that the plaintiff suing in the common law courts
on a defeasible bond to secure the performance of covenants
(not just debts) was permitted to plead the breaches and
have his actual damages assessed. Judgment was entered

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on the bond, but execution was stayed upon payment of the
assessed damages. The Administration of Justice Act 1705
(4 & 5 Anne c 16) allowed the defendant in an action on the
bond to pay the amount of the actual loss, together with
interest and costs, into court, and rely on the payment as a
defence. These statutes were originally framed as facilities
for plaintiffs suing on bonds. But by the end of the 18th
century the common law courts had begun to treat the
statutory procedures as mandatory, requiring damages to be
pleaded and proved and staying all further proceedings on
the bond: see Roles v Rosewell (1794) 5 TR 538, Hardy v
Bern (1794) 5 TR 636. The effect of this legislation was thus
to make it unnecessary to proceed separately in chancery for
relief from the penalty and in the courts of common law for
the true loss. As a result, the equitable jurisdiction was rarely
invoked, and the further development of the penalty rule was
entirely the work of the courts of common law.
7. It developed, however, on wholly different lines. The
equitable jurisdiction to relieve from penalties had been
closely associated with the jurisdiction to relieve from
forfeitures which developed at the same time. Both were
directed to contractual provisions which on their face created
primary obligations, but which during the 17th and 18th
centuries the courts of equity treated as secondary
obligations on the ground that the real intention was that
they should stand as a mere security for performance. The
court then intervened to grant relief from the rigours of the
secondary obligation in order to secure performance in
another, less penal or (in modern language) more
proportionate, way. In contrast, the penalty rule as it was
developed by the common law courts in the course of the 19th
and 20th centuries proceeded on the basis that although
penalties were secondary obligations, the parties meant
what they said. They intended the provision to be applied
according to the letter with a view to penalising breach. The
law relieved the contract-breaker of the consequences not
because the objective could be secured in another way but
because the objective was contrary to public policy and
should not therefore be given effect at all. The difference in
approach to penalties of the courts of equity and the common
law courts is in many ways a classic example of the contrast
between the flexible if sometimes unpredictable approach of
equity and the clear if relatively strict approach of the
common law.

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8. With the gradual decline of the use of penal defeasible
bonds, the common law on penalties was developed almost
entirely in the context of damages clauses – ie clauses which
provided for payment of a specified sum in place of common
law damages. Because they were a contractual substitute for
common law damages, they could not in any meaningful
sense be regarded as a mere security for their payment. If
the agreed sum was a penalty, it was treated as
unenforceable. Starting with the decisions in Astley in 1801
and Kemble v Farren (1829) 6 Bing 141, the common law
courts introduced the now familiar distinction between a
provision for the payment of a sum representing a genuine
pre-estimate of damages and a penalty clause in which the
sum was out of all proportion to any damages liable to be
suffered. By the middle of the 19th century, this rule was
well established. In Betts v Burch (1859) 4 H & N 506, 509,
Martin B regretted that he was “bound by the cases” and
prevented from holding that “parties are at liberty to enter
into any bargain they please” so that “if they have made an
improvident bargain they must take the consequences”. But
Bramwell B (at p 511) appeared to have no such
reservations.
9. The distinction between a clause providing for a genuine
pre-estimate of damages and a penalty clause has remained
fundamental to the modern law, as it is currently understood.
The question whether a damages clause is a penalty falls to
be decided as a matter of construction, therefore as at the
time that it is agreed: Public Works Comr v Hills [1906] AC
368, 376; Webster v Bosanquet [1912] AC 394; Dunlop
Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd
[1915] AC 79, at pp 86-87 (Lord Dunedin); and Cooden
Engineering Co Ltd v Stanford [1953] 1 QB 86, 94 (Somervell
LJ). This is because it depends on the character of the
provision, not on the circumstances in which it falls to be
enforced. It is a species of agreement which the common law
considers to be by its nature contrary to the policy of the law.
One consequence of this is that relief from the effects of a
penalty is, as Hoffmann LJ put it in Else (1982) Ltd v
Parkland Holdings Ltd [1994] 1 BCLC 130, 144, “mechanical
in effect and involves no exercise of discretion at all.” Another
is that the penalty clause is wholly unenforceable:
Clydebank Engineering & Shipbuilding Co Ltd v Don Jose
Ramos Yzquierdo y Castaneda [1905] AC 6, 9, 10 (Lord
Halsbury LC); Gilbert-Ash (Northern) Ltd v Modern

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Engineering (Bristol) Ltd [1974] AC 689, 698 (Lord Reid), 703
(Lord Morris of Borth-y-Gest) and 723- 724 (Lord Salmon);
Scandinavian Trading Tanker Co AB v Flota Petrolera
Ecuatoriana (The “Scaptrade”) [1983] 2 AC 694, 702 (Lord
Diplock); AMEV-UDC Finance Ltd v Austin (1986) 162 CLR
170, 191-193 (Mason and Wilson JJ). Deprived of the benefit
of the provision, the innocent party is left to his remedy in
damages under the general law. As Lord Diplock put it in The
“Scaptrade” at p 702:
“The classic form of penalty clause is one which provides
that upon breach of a primary obligation under the
contract a secondary obligation shall arise on the part of
the party in breach to pay to the other party a sum of
money which does not represent a genuine pre-estimate
of any loss likely to be sustained by him as the result of
the breach of primary obligation but is substantially in
excess of that sum. The classic form of relief against
such a penalty clause has been to refuse to give effect to
it, but to award the common law measure of damages
for the breach of primary obligation instead.”
10. Equity, on the other hand, relieves against forfeitures
“where the primary object of the bargain is to secure a stated
result which can effectively be attained when the matter
comes before the court, and where the forfeiture provision is
added by way of security for the production of that result”:
Shiloh Spinners Ltd v Harding [1973] AC 691, 723 (Lord
Wilberforce). As Lord Wilberforce said at p 722, the paradigm
cases are the jurisdiction to relieve from a right of re-entry in
a lease of land and the mortgagor’s equity of redemption (and
the associated equitable right to redeem) in relation to
mortgages. Save in relation to non-payment of rent, the power
to grant relief from forfeiture to lessees is now contained in
section 146 of the Law of Property Act 1925, and probably
exclusively so (see Official Custodian for Charities v Parway
Estates Departments Ltd [1985] Ch 151). Relief for
mortgagors through the equitable right to redeem is (save in
relation to most residential properties) largely still based on
judge-made law. However, neither by statute nor on general
principles of equity is a lessor’s right of re-entry or a
mortgagee’s right of sale or foreclosure treated as being by
its nature contrary to the policy of the law. What equity (and,
where it applies, statute) typically considers to be contrary to
the policy of the law is the enforcement of such rights in
circumstances where their purpose, namely the performance

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of the obligations in the lease or the mortgage, can be
achieved in other ways – normally by late substantive
compliance and payment of appropriate compensation. The
forfeiture or foreclosure/power of sale is therefore
enforceable, equity intervening only to impose terms. These
will generally require the lessee or mortgagor to rectify the
breach and make good any loss suffered by the lessor or
mortgagee. If the lessee or mortgagee cannot or will not do
so, the forfeiture will be unconditionally enforced – although
perhaps not invariably (see per Lord Templeman in
Associated British Ports v CH Bailey plc [1990] 2 AC 703,
707-708 in the context of section 146, and, more generally,
the judgments in Cukurova Finance International Ltd v Alfa
Telecom Turkey Ltd (No 3) [2013] UKPC 20, [2015] 2 WLR
875).
11. The penalty rule as it has been developed by the judges
gives rise to two questions, both of which have a considerable
bearing on the questions which arise on these appeals. In
what circumstances is the rule engaged at all? And what
makes a contractual provision penal?

In what circumstances is the penalty rule engaged?

12. In England, it has always been considered that a
provision could not be a penalty unless it provided an
exorbitant alternative to common law damages. This meant
that it had to be a provision operating upon a breach of
contract. In Moss Empires Ltd v Olympia (Liverpool) Ltd
[1939] AC 544, this was taken for granted by Lord Atkin (p
551) and Lord Porter (p 558). As a matter of authority the
question is settled in England by the decision of the House of
Lords in Export Credits Guarantee Department v Universal
Oil Products Co [1983] 1 WLR 399 (“ECGD”). Lord Roskill,
with whom the rest of the committee agreed, said at p 403:
“Perhaps the main purpose, of the law relating to
penalty clauses is to prevent a plaintiff recovering a sum
of money in respect of a breach of contract committed by
a defendant which bears little or no relationship to the
loss actually suffered by the plaintiff as a result of the
breach by the defendant. But it is not and never has
been for the courts to relieve a party from the
consequences of what may in the event prove to be an

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onerous or possibly even a commercially imprudent
bargain.”
As Lord Hodge points out in his judgment, the Scottish
authorities are to the same effect.
13. This principle is worth restating at the outset of any
analysis of the penalty rule, because it explains much about
the way in which it has developed. There is a fundamental
difference between a jurisdiction to review the fairness of a
contractual obligation and a jurisdiction to regulate the
remedy for its breach. Leaving aside challenges going to the
reality of consent, such as those based on fraud, duress or
undue influence, the courts do not review the fairness of
men’s bargains either at law or in equity. The penalty rule
regulates only the remedies available for breach of a party’s
primary obligations, not the primary obligations themselves.
This was not a new concept in 1983, when ECGD was
decided. It had been the foundation of the equitable
jurisdiction, which depended on the treatment of penal
defeasible bonds as secondary obligations or, as Lord
Thurlow LC put it in 1783 in Sloman as “collateral” or
“accessional” to the primary obligation. And it provided the
whole basis of the classic distinction made at law between a
penalty and a genuine pre-estimate of loss, the former being
essentially a way of punishing the contract-breaker rather
than compensating the innocent party for his breach. We
shall return to that distinction below.
14. This means that in some cases the application of the
penalty rule may depend on how the relevant obligation is
framed in the instrument, i.e., whether as a conditional
primary obligation or a secondary obligation providing a
contractual alternative to damages at law. Thus, where a
contract contains an obligation on one party to perform an
act, and also provides that, if he does not perform it, he will
pay the other party a specified sum of money, the obligation
to pay the specified sum is a secondary obligation which is
capable of being a penalty; but if the contract does not impose
(expressly or impliedly) an obligation to perform the act, but
simply provides that, if one party does not perform, he will
pay the other party a specified sum, the obligation to pay the
specified sum is a conditional primary obligation and cannot
be a penalty.
15. However, the capricious consequences of this state of
affairs are mitigated by the fact that, as the equitable

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jurisdiction shows, the classification of terms for the purpose
of the penalty rule depends on the substance of the term and
not on its form or on the label which the parties have chosen
to attach to it. As Lord Radcliffe said in Campbell Discount
Co Ltd v Bridge [1962] AC 600, 622, “the intention of the
parties themselves”, by which he clearly meant the intention
as expressed in the agreement, “is never conclusive and may
be overruled or ignored if the court considers that even its
clear expression does not represent ‘the real nature of the
transaction’ or what ‘in truth’ it is taken to be” (and as per
Lord Templeman in Street v Mountford [1985] AC 809, 819).
This aspect of the equitable jurisdiction was inherited by the
courts of common law, and has been firmly established since
the earliest common law cases.
16. Payment of a sum of money is the classic obligation under
a penalty clause and, in almost every reported case involving
a damages clause, the provision stipulates for the payment
of money. However, it seems to us that there is no reason
why an obligation to transfer assets (either for nothing or at
an undervalue) should not be capable of constituting a
penalty. While the penalty rule may be somewhat artificial,
it would heighten its artificiality to no evident purpose if it
were otherwise. Similarly, the fact that a sum is paid over by
one party to the other party as a deposit, in the sense of some
sort of surety for the first party’s contractual performance,
does not prevent the sum being a penalty, if the second party
in due course forfeits the deposit in accordance with the
contractual terms, following the first party’s breach of
contract – see the Privy Council decisions in Public Works
Comr v Hills [1906] AC 368, 375-376, and Workers Trust &
Merchant Bank Ltd v Dojap Investments Ltd [1993] AC 573.
By contrast, in Else (1982) at p 146, Hoffmann LJ, citing
Stockloser v Johnson [1954] 1 QB 476 in support, said that,
unlike a case where “money has been deposited as security
for due performance of [a] party’s obligation”, “retention of
instalments which have been paid under contract so as to
become the absolute property of the vendor does not fall
within the penalty rule”, although, he added that it was
“subject … to the jurisdiction for relief against forfeiture”.
17. The relationship between penalty clauses and forfeiture
clauses is not entirely easy. Given that they had the same
origin in equity, but that the law on penalties was then
developed through common law while the law on forfeitures
was not, this is unsurprising. Some things appear to be clear.

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Where a proprietary interest or a “proprietary or possessory
right” (such as a patent or a lease) is granted or transferred
subject to revocation or determination on breach, the clause
providing for determination or revocation is a forfeiture and
cannot be a penalty, and, while it is enforceable, relief from
forfeiture may be granted: see BICC plc v Burndy Corpn
[1985] Ch 232, 246-247 and 252 (Dillon LJ) and The
“Scaptrade”, pp 701-703, (Lord Diplock). But this does not
mean that relief from forfeiture is unavailable in cases not
involving land – see Cukurova Finance International Ltd v
Alfa Telecom Turkey Ltd (No 2) [2013] UKPC 2, [2015] 2 WLR
875, especially at paras 92-97, and the cases cited there.
18. What is less clear is whether a provision is capable of
being both a penalty clause and a forfeiture clause. It is
inappropriate to consider that issue in any detail in this
judgment, as we have heard very little argument on
forfeitures – unsurprisingly because in neither appeal has it
been alleged that any provision in issue is a forfeiture from
which relief could be granted. But it is right to mention the
possibility that, in some circumstances, a provision could, at
least potentially, be a penalty clause as well as a forfeiture
clause. We see the force of the arguments to that effect
advanced by Lord Mance and Lord Hodge in their judgments.
What makes a contractual provision penal?
19. As we have already observed, until relatively recently
this question was answered almost entirely by reference to
straightforward liquidated damages clauses. It was in that
context that the House of Lords sought to restate the law in
two seminal decisions at the beginning of the 20th century,
Clydebank in 1904 and Dunlop in 1915.
20. Clydebank was a Scottish appeal about a shipbuilding
contract with a provision (described as a “penalty”) for the
payment of £500 per week for delayed delivery. The
provision was held to be a valid liquidated damages clause,
not a penalty. Lord Halsbury (p 10) said that the distinction
between the two depended on
“whether it is, what I think gave the jurisdiction to the
courts in both countries to interfere at all in an
agreement between the parties, unconscionable and
extravagant, and one which no court ought to allow to
be enforced.”

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Lord Halsbury declined to lay down any “abstract rule” for
determining what was unconscionable or extravagant,
saying only that it must depend on “the nature of the
transaction – the thing to be done, the loss likely to accrue to
the person who is endeavouring to enforce the performance
of the contract, and so forth”. Lord Halsbury’s formulation
has proved influential, and the two other members of the
Appellate Committee both delivered concurring judgments
agreeing with it. It is, however, worth drawing attention to an
observation of Lord Robertson (pp 19-20) which points to the
principle underlying the contrasting expressions “liquidated
damages” and “penalty”:
“Now, all such agreements, whether the thing be called
penalty or be called liquidate damage, are in intention
and effect what Professor Bell calls ‘instruments of
restraint’, and in that sense penal. But the clear
presence of this does not in the least degree invalidate
the stipulation. The question remains, had the
respondents no interest to protect by that clause, or was
that interest palpably incommensurate with the sums
agreed on? It seems to me that to put this question, in
the present instance, is to answer it.”
21. Dunlop arose out of a contract for the supply of tyres,
covers and tubes by a manufacturer to a garage. The contract
contained a number of terms designed to protect the
manufacturer’s brand, including prohibitions on tampering
with the marks, restrictions on the unauthorised export or
exhibition of the goods, and on resales to unapproved
persons. There was also a resale price maintenance clause,
which would now be unlawful but was a legitimate
restriction of competition according to the notions prevailing
in 1914. It was this clause which the purchaser had broken.
The contract provided for the payment of £5 for every tyre,
cover or tube sold in breach of any provision of the
agreement. Once again, the provision was held to be a valid
liquidated damages clause. In his speech, Lord Dunedin
formulated four tests “which, if applicable to the case under
consideration, may prove helpful, or even conclusive” (p 87).
They were (a) that the provision would be penal if “the sum
stipulated for is extravagant and unconscionable in amount
in comparison with the greatest loss that could conceivably
be proved to have followed from the breach”; (b) that the
provision would be penal if the breach consisted only in the
non-payment of money and it provided for the payment of a

SLP (C) Nos. 32849 – 32850 of 2025 Page 65 of 120


larger sum; (c) that there was “a presumption (but no more)”
that it would be penal if it was payable in a number of events
of varying gravity; and (d) that it would not be treated as
penal by reason only of the impossibility of precisely pre-
estimating the true loss.
22. Lord Dunedin’s speech in Dunlop achieved the status of
a quasi-statutory code in the subsequent case-law. Some of
the many decisions on the validity of damages clauses are
little more than a detailed exegesis or application of his four
tests with a view to discovering whether the clause in issue
can be brought within one or more of them. In our view, this
is unfortunate. In the first place, Lord Dunedin proposed his
four tests not as rules but only as considerations which might
prove helpful or even conclusive “if applicable to the case
under consideration”. He did not suggest that they were
applicable to every case in which the law of penalties was
engaged. Second, as Lord Dunedin himself acknowledged,
the essential question was whether the clause impugned
was “unconscionable” or “extravagant”. The four tests are a
useful tool for deciding whether these expressions can
properly be applied to simple damages clauses in standard
contracts. But they are not easily applied to more complex
cases. To deal with those, it is necessary to consider the
rationale of the penalty rule at a more fundamental level.
What is it that makes a provision for the consequences of
breach “unconscionable”? And by comparison with what is a
penalty clause said to be “extravagant”? Third, none of the
other three Law Lords expressly agreed with Lord Dunedin’s
reasoning, and the four tests do not all feature in any of their
speeches. Indeed, it appears that, in his analysis at pp 101-
102, Lord Parmoor may have taken a more restrictive view of
what constituted a penalty than did Lord Dunedin. More
generally, the other members of the Appellate Committee
gave their own reasons for concurring in the result, and they
also repay consideration. For present purposes, the most
instructive is that of Lord Atkinson, who approached the
matter on an altogether broader basis.
23. Lord Atkinson pointed (pp 90-91) to the critical
importance to Dunlop of the protection of their brand,
reputation and goodwill, and their authorised distribution
network. Against this background, he observed (pp 91-92):
“It has been urged that as the sum of £5 becomes
payable on the sale of even one tube at a shilling less

SLP (C) Nos. 32849 – 32850 of 2025 Page 66 of 120


than the listed price, and as it was impossible that the
appellant company should lose that sum on such a
transaction, the sum fixed must be a penalty. In the
sense of direct and immediate loss the appellants lose
nothing by such a sale. It is the agent or dealer who
loses by selling at a price less than that at which he
buys, but the appellants have to look at their trade in
globo, and to prevent the setting up, in reference to all
their goods anywhere and everywhere, a system of
injurious undercutting. The object of the appellants in
making this agreement, if the substance and reality of
the thing and the real nature of the transaction be looked
at, would appear to be a single one, namely, to prevent
the disorganization of their trading system and the
consequent injury to their trade in many directions. The
means of effecting this is by keeping up their price to the
public to the level of their price list, this last being
secured by contracting that a sum of £5 shall be paid for
every one of the three classes of articles named sold or
offered for sale at prices below those named on the list.
The very fact that this sum is to be paid if a tyre cover or
tube be merely offered for sale, though not sold, shows
that it was the consequential injury to their trade due to
undercutting that they had in view. They had an obvious
interest to prevent this undercutting, and on the
evidence it would appear to me impossible to say that
that interest was incommensurate with the sum agreed
to be paid.”
Lord Atkinson went on to draw an analogy, which has
particular resonance in the Cavendish appeal, with a clause
dealing with damages for breach of a restrictive covenant on
the canvassing of business by a former employee. In this
context, he said (pp 92-93):
“It is, I think, quite misleading to concentrate one’s
attention upon the particular act or acts by which, in
such cases as this, the rivalry in trade is set up, and the
repute acquired by the former employee that he works
cheaper and charges less than his old master, and to
lose sight of the risk to the latter that old customers, once
tempted to leave him, may never return to deal with him,
or that business that might otherwise have come to him
may be captured by his rival. The consequential injuries
to the trader’s business arising from each breach by the
employee of his covenant cannot be measured by the

SLP (C) Nos. 32849 – 32850 of 2025 Page 67 of 120


direct loss in a monetary point of view on the particular
transaction constituting the breach.”
Lord Atkinson was making substantially the same point as
Lord Robertson had made in Clydebank. The question was:
what was the nature and extent of the innocent party’s
interest in the performance of the relevant obligation. That
interest was not necessarily limited to the mere recovery of
compensation for the breach. Lord Atkinson considered that
the underlying purpose of the resale price maintenance
clause gave Dunlop a wider interest in enforcing the
damages clause than pecuniary compensation. £5 per item
was not incommensurate with that interest even if it was
incommensurate with the loss occasioned by the wrongful
sale of a single item.
24. Although the other members of the Appellate Committee
did not express themselves in the same terms as Lord
Atkinson, their approach was entirely consistent with his.
Lord Parker at p 97 said that “whether the sum agreed to be
paid on the breach is really a penalty must depend on the
circumstances of each particular case”, and at p 99, echoing
Lord Atkinson’s fuller treatment of the point, as just set out,
he described the damage which would result from any
breach as “consisting in the disturbance or derangement of
the system of distribution by means of which [Dunlop’s]
goods reach the ultimate consumer”. In their speeches, Lord
Dunedin (p 87), Lord Parker (p 98) and Lord Parmoor (p 103)
ultimately were content to rest their decision that the £5 was
not a penalty on the ground that an exact pre-estimate of loss
was impossible, whereas, in the passages quoted above,
Lord Atkinson analysed why that was so. It seems clear that
the actual result of the case was strongly influenced by Lord
Atkinson’s reasoning. The clause was upheld although, on
the face of it, it failed all but the last of Lord Dunedin’s tests.
The £5 per item applied to breaches of very variable
significance and it was impossible to relate the loss
attributable to the sale of that item. It was justifiable only by
reference to the wider interests identified by Lord Atkinson.
25. The great majority of cases decided in England since
Dunlop have concerned more or less standard damages
clauses in consumer contracts, and Lord Dunedin’s four tests
have proved perfectly adequate for dealing with those. More
recently, however, the courts have returned to the possibility
of a broader test in less straightforward cases, in the context

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of the supposed “commercial justification” for clauses which
might otherwise be regarded as penal. An early example is
the decision of the House of Lords in The “Scaptrade”, where
at p 702, Lord Diplock, with whom the rest of the Appellate
Committee agreed, observed that a right to withdraw a time-
chartered vessel for non-payment of advance hire was not a
penalty because its commercial purpose was to create a fund
from which the cost of providing the chartered service could
be funded.
26. In Lordsvale Finance plc v Bank of Zambia [1996] QB
752, Colman J was concerned with a common form provision
in a syndicated loan agreement for interest to be payable at
a higher rate during any period when the borrower was in
default. There was authority that such provisions were
penal: Lady Holles v Wyse (1693) 2 Vern 289; Strode v
Parker (1694) 2 Vern 316, Wallingford v Mutual Society
(1880) 5 App Cas 685, 702 (Lord Hatherley). But Colman J
held that the clause was valid because its predominant
purpose was not to deter default but to reflect the greater
credit risk associated with a borrower in default. At pp 763-
764, he observed that a provision for the payment of money
upon breach could not be categorised as a penalty simply
because it was not a genuine pre-estimate of damages,
saying that there would seem to be:
“no reason in principle why a contractual provision the
effect of which was to increase the consideration
payable under an executory contract upon the
happening of a default should be struck down as a
penalty if the increase could in the circumstances be
explained as commercially justifiable, provided always
that its dominant purpose was not to deter the other
party from breach.”
27. Colman J’s approach was approved by Mance LJ,
delivering the leading judgment in the Court of Appeal in Cine
Bes Filmcilik ve Yapimcilik v United International Pictures
[2004] 1 CLC 401, para 13. A similar view was taken by
Arden LJ in Murray v Leisureplay plc [2005] IRLR 946, para
54, where she posed the question
“Has the party who seeks to establish that the clause is
a penalty shown that the amount payable under the
clause was imposed in terrorem, or that it does not
constitute a genuine pre-estimate of loss for the
purposes of the Dunlop case, and, if he has shown the

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latter, is there some other reason which justifies the
Page 14 discrepancy between [the amount payable
under the clause and the amount payable by way of
damages in common law]?” (emphasis added).
She considered that the clause in question had advantages
for both sides, and pointed out that no evidence had been
adduced to show that the clause lacked commercial
justification: see paras 70-76. But Buxton LJ put the matter
on a wider basis for which Clarke LJ (para 105) expressed a
preference. He referred to the speech of Lord Atkinson in
Dunlop and suggested that the ratio of the actual decision in
that case had been that “an explanation of the clause in
commercial rather than deterrent terms was available”. All
three members of the court endorsed the approach of Colman
J in Lordsvale and Mance LJ in Cine Bes.
28. Colman J in Lordsvale and Arden LJ in Murray were
inclined to rationalise the introduction of commercial
justification as part of the test, by treating it as evidence that
the impugned clause was not intended to deter. Later
decisions in which a commercial rationale has been held
inconsistent with the application of the penalty rule, have
tended to follow that approach: see, for example, Euro
London Appointments Ltd v Claessens International Ltd
[2006] 2 Lloyd’s Rep 436, General Trading Company
(Holdings) Ltd v Richmond Corpn Ltd [2008] 2 Lloyd’s Rep
475. It had the advantage of enabling them to reconcile the
concept of commercial justification with Lord Dunedin’s four
tests. But we have some misgivings about it. The assumption
that a provision cannot have a deterrent purpose if there is a
commercial justification, seems to us to be questionable. By
the same token, we agree with Lord Radcliffe’s observations
in Campbell Discount at p 622, where he said:
“… I do not myself think that it helps to identify a
penalty, to describe it as in the nature of a threat ‘to be
enforced in terrorem’ (to use Lord Halsbury’s phrase in
Elphinstone v Monkland Iron & Coal Co Ltd (1886) 11
App Cas 332, 348). I do not find that that description
adds anything of substance to the idea conveyed by the
word ‘penalty’ itself, and it obscures the fact that
penalties may quite readily be undertaken by parties
who are not in the least terrorised by the prospect of
having to pay them and yet are, as I understand it,

SLP (C) Nos. 32849 – 32850 of 2025 Page 70 of 120


entitled to claim the protection of the court when they are
called upon to make good their promises.”
Moreover, the penal character of a clause depends on its
purpose, which is ordinarily an inference from its effect. As
we have already explained, this is a question of construction,
to which evidence of the commercial background is of course
relevant in the ordinary way. But, for the same reason, the
answer cannot depend on evidence of actual intention: see
Chartbrook Ltd v Persimmon Homes Ltd [2009] AC 1101,
paras 28-47 (Lord Hoffmann). However, while we have
misgivings about some aspects of their reasoning, these
aspects are peripheral to the essential point which Colman J
and Buxton LJ were making, and we consider that their
emphasis on justification provides a valuable insight into the
real basis of the penalty rule. It is the same insight as that of
Lord Robertson in Clydebank and Lord Atkinson in Dunlop.
A damages clause may properly be justified by some other
consideration than the desire to recover compensation for a
breach. This must depend on whether the innocent party has
a legitimate interest in performance extending beyond the
prospect of pecuniary compensation flowing directly from the
breach in question.
29. The availability of remedies for a breach of duty is not
simply a question of providing a financial substitute for
performance. It engages broader social and economic
considerations, one of which is that the law will not generally
make a remedy available to a party, the adverse impact of
which on the defaulter significantly exceeds any legitimate
interest of the innocent party. In the famous case of White &
Carter (Councils) Ltd v McGregor [1962] AC 413, Lord Reid
observed, at p 431:
“It may well be that, if it can be shown that a person has
no legitimate interest, financial or otherwise, in
performing the contract rather than claiming damages,
he ought not to be allowed to saddle the other party with
an additional burden with no benefit to himself. If a
party has no interest to enforce a stipulation, he cannot
in general enforce it: so it might be said that, if a party
has no interest to insist on a particular remedy, he ought
not to be allowed to insist on it. And, just as a party is
not allowed to enforce a penalty, so he ought not to be
allowed to penalise the other party by taking one course
when another is equally advantageous to him. … Here

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the respondent did not set out to prove that the
appellants had no legitimate interest in completing the
contract and claiming the contract price rather than
claiming damages. … Parliament has on many
occasions relieved parties from certain kinds of
improvident or oppressive contracts, but the common
law can only do that in very limited circumstances.”
In White & Carter the innocent party was entitled to ignore
the repudiation of the contract-breaker and proceed to
perform, claiming his remuneration in debt rather than
limiting himself to damages, notwithstanding that this course
might be a great deal more expensive for the contract-
breaker. This, according to Lord Reid (p 431), was because
the contract-breaker “did not set out to prove that the
appellants had no legitimate interest in completing the
contract and claiming the contract price rather than claiming
damages”.
30. More generally, the attitude of the courts, reflecting that
of the Court of Chancery, is that specific performance of
contractual obligations should ordinarily be refused where
damages would be an adequate remedy. This is because the
minimum condition for an order of specific performance is
that the innocent party should have a legitimate interest
extending beyond pecuniary compensation for the breach.
The paradigm case is the purchase of land or certain chattels
such as ships, which the law recognises as unique. Because
of their uniqueness the purchaser’s interest extends beyond
the mere award of damages as a substitute for performance.
As Lord Hoffmann put it in addressing a very similar issue
“the purpose of the law of contract is not to punish
wrongdoing but to satisfy the expectations of the party
entitled to performance”: Co-operative Insurance Society Ltd
v Argyll Stores (Holdings) Ltd [1998] AC 1, 15.
31. In our opinion, the law relating to penalties has become
the prisoner of artificial categorisation, itself the result of
unsatisfactory distinctions: between a penalty and genuine
pre-estimate of loss, and between a genuine pre-estimate of
loss and a deterrent. These distinctions originate in an over-
literal reading of Lord Dunedin’s four tests and a tendency to
treat them as almost immutable rules of general application
which exhaust the field. In Legione v Hateley (1983) 152 CLR
406, 445, Mason and Deane JJ defined a penalty as follows:

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“A penalty, as its name suggests, is in the nature of a
punishment for non-observance of a contractual
stipulation; it consists of the imposition of an additional
or different liability upon breach of the contractual
stipulation ...”
All definition is treacherous as applied to such a protean
concept. This one can fairly be said to be too wide in the
sense that it appears to be apt to cover many provisions
which would not be penalties (for example most, if not all,
forfeiture clauses). However, in so far as it refers to
“punishment” and “an additional or different liability” as
opposed to “in terrorem” and “genuine pre-estimate of loss”,
this definition seems to us to get closer to the concept of a
penalty than any other definition we have seen. The real
question when a contractual provision is challenged as a
penalty is whether it is penal, not whether it is a pre-estimate
of loss. These are not natural opposites or mutually exclusive
categories. A damages clause may be neither or both. The
fact that the clause is not a pre-estimate of loss does not
therefore, at any rate without more, mean that it is penal. To
describe it as a deterrent (or, to use the Latin equivalent, in
terrorem) does not add anything. A deterrent provision in a
contract is simply one species of provision designed to
influence the conduct of the party potentially affected. It is no
different in this respect from a contractual inducement.
Neither is it inherently penal or contrary to the policy of the
law. The question whether it is enforceable should depend
on whether the means by which the contracting party’s
conduct is to be influenced are “unconscionable” or (which
will usually amount to the same thing) “extravagant” by
reference to some norm.
32. The true test is whether the impugned provision is a
secondary obligation which imposes a detriment on the
contract-breaker out of all proportion to any legitimate
interest of the innocent party in the enforcement of the
primary obligation. The innocent party can have no proper
interest in simply punishing the defaulter. His interest is in
performance or in some appropriate alternative to
performance. In the case of a straightforward damages
clause, that interest will rarely extend beyond compensation
for the breach, and we therefore expect that Lord Dunedin’s
four tests would usually be perfectly adequate to determine
its validity. But compensation is not necessarily the only
legitimate interest that the innocent party may have in the

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performance of the defaulter’s primary obligations. This was
recognised in the early days of the penalty rule, when it was
still the creature of equity, and is reflected in Lord
Macclesfield’s observation in Peachy (quoted in para 5 above)
about the application of the penalty rule to provisions which
were “never intended by way of compensation”, for which
equity would not relieve. It was reflected in the result in
Dunlop. And it is recognised in the more recent decisions
about commercial justification. And, as Lord Hodge shows, it
is the principle underlying the Scottish authorities.
33. The penalty rule is an interference with freedom of
contract. It undermines the certainty which parties are
entitled to expect of the law. Diplock LJ was neither the first
nor the last to observe that “The court should not be astute to
descry a ‘penalty clause’”: Robophone at p 1447. As Lord
Woolf said, speaking for the Privy Council in Philips Hong
Kong Ltd v Attorney General of Hong Kong (1993) 61 BLR 41,
59, “the court has to be careful not to set too stringent a
standard and bear in mind that what the parties have agreed
should normally be upheld”, not least because “any other
approach will lead to undesirable uncertainty especially in
commercial contracts”.
34. Although the penalty rule originates in the concern of the
courts to prevent exploitation in an age when credit was
scarce and borrowers were particularly vulnerable, the
modern rule is substantive, not procedural. It does not
normally depend for its operation on a finding that advantage
was taken of one party. As Lord Wright MR observed in
Imperial Tobacco Company (of Great Britain) and Ireland v
Parslay [1936] 2 All ER 515, 523:
“A millionaire may enter into a contract in which he is to
pay liquidated damages, or a poor man may enter into a
similar contract with a millionaire, but in each case the
question is exactly the same, namely, whether the sum
stipulated as damages for the breach was exorbitant or
extravagant ...”
35. But for all that, the circumstances in which the contract
was made are not entirely irrelevant. In a negotiated contract
between properly advised parties of comparable bargaining
power, the strong initial presumption must be that the parties
themselves are the best judges of what is legitimate in a
provision dealing with the consequences of breach. In that
connection, it is worth noting that in Philips Hong Kong at pp

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57-59, Lord Woolf specifically referred to the possibility of
taking into account the fact that “one of the parties to the
contract is able to dominate the other as to the choice of the
terms of a contract” when deciding whether a damages
clause was a penalty. In doing so, he reflected the view
expressed by Mason and Wilson JJ in AMEV-UDC at p 194
that the courts were thereby able to “strike a balance
between the competing interests of freedom of contract and
protection of weak contracting parties” (citing Atiyah, The
Rise and Fall of Freedom of Contract (1979), Chapter 22).
However, Lord Woolf was rightly at pains to point out that
this did not mean that the courts could thereby adopt “some
broader discretionary approach”. The notion that the
bargaining position of the parties may be relevant is also
supported by Lord Browne-Wilkinson giving the judgment of
the Privy Council in Workers Bank. At p 580, he rejected the
notion that “the test of reasonableness [could] depend upon
the practice of one class of vendor, which exercises
considerable financial muscle” as it would allow such people
“to evade the law against penalties by adopting practices of
their own”. In his judgment, he decided that, in contracts for
sale of land, a clause providing for a forfeitable deposit of
10% of the purchase price was valid, although it was an
anomalous exception to the penalty rule. However, he held
that the clause providing for a forfeitable 25% deposit in that
case was invalid because “in Jamaica, the customary
deposit has been 10%” and “[a] vendor who seeks to obtain
a larger amount by way of forfeitable deposit must show
special circumstances which justify such a deposit”, which
the appellant vendor in that case failed to do.
Should the penalty rule be abrogated?
36. The primary case of Miss Smith QC, who appeared for
Cavendish in the first appeal, was that the penalty rule
should now be regarded as antiquated, anomalous and
unnecessary, especially in the light of the growing
importance of statutory regulation in this field. It is the
creation of the judges, and, she argued, the judges should
now take the opportunity to abolish it. There is a case to be
made for taking this course. It was expounded with
considerable forensic skill by Miss Smith, and has some
powerful academic support: see Sarah Worthington, Common
Law Values: the Role of Party Autonomy in Private Law, in
The Common Law of Obligations: Divergence and Unity (ed A
Robertson and M Tilbury (2015)), pp 18-26. We rather doubt

SLP (C) Nos. 32849 – 32850 of 2025 Page 75 of 120


that the courts would have invented the rule today if their
predecessors had not done so three centuries ago. But this is
not the way in which English law develops, and we do not
consider that judicial abolition would be a proper course for
this court to take.
37. The first point to be made is that the penalty rule is not
only a long-standing principle of English law, but is common
to almost all major systems of law, at any rate in the western
world. It has existed in England since the 16th century and
can be traced back to the same period in Scotland: McBryde,
The Law of Contract in Scotland, 3rd ed (2007), paras 22-
148. The researches of counsel have shown that it has been
adopted with some variants in all common law jurisdictions,
including those of the United States. A corresponding rule
was derived from Roman law by Pothier, Traité des
Obligations, No 346, which is to be found in the Civil Codes
of France (article 1152), Germany (for non-commercial
contracts only) (sections 343, 348), Switzerland (article
163.3), Belgium (article 1231) and Italy (article 1384). It is
included in influential attempts to codify the law of contracts
internationally, including the Unidroit Principles of
International Commercial Contracts (2010) (article 7.4.13),
and the UNCITRAL Uniform Rules on Contract Clauses for an
Agreed Sum Due upon Failure of Performance (article 6). In
January 1978 the Committee of Ministers of the Council of
Europe recommended a number of common principles
relating to penal clauses, including (article 7) that a
stipulated sum payable on breach “may be reduced by the
court when it is manifestly excessive”. 38. It is true that
statutory regulation, which hardly existed at the time that the
penalty rule was developed, is now a significant feature of
the law of contract. In England, the landmark legislation was
the Unfair Contract Terms Act 1977. For most purposes, the
Act was superseded by the Unfair Terms in Consumer
Contracts Regulations 1994 (SI 1994/3159), which was in
turn replaced by the 1999 Regulations, both of which give
effect to European Directives. The 1999 Regulations contain
an “indicative and non-exhaustive list of the terms which
may be regarded as unfair”, including terms which have the
object or effect of “requiring any consumer who fails to fulfil
his obligation to pay a disproportionately high sum in
compensation”. Nonetheless, statutory regulation is very far
from covering the whole field. Penalty clauses are controlled
by the 1999 Regulations, but the Regulations apply only to

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consumer contracts and the control of unfair terms under
regulations 3 and 5 is limited to those which have not been
individually negotiated. There are major areas, notably non-
consumer contracts, which are not regulated by statute.
Some of those who enter into such contracts, for example
professionals and small businesses, may share many of the
characteristics of consumers which are thought to make the
latter worthy of legal protection. The English Law
Commission considered penalty clauses in 1975 (Working
Paper No 61, Penalty Clauses and Forfeiture of Monies Paid,
April 1975), at a time when there was no relevant statutory
regulation, and the Scottish Law Commission reported on
them in May 1999 (Report No 171). Neither of these Reports
recommended abolition of the rule. On the contrary, both
recommended legislation which would have expanded its
scope.
39. Further, although there are justified criticisms that can
be made of the penalty rule, it is consistent with other well-
established principles which have been developed by judges
(albeit mostly in the Chancery courts) and which involve the
court in declining to give full force to contractual provisions,
such as relief from forfeiture, the equity of redemption, and
refusal to grant specific performance, as discussed in paras
10-11 and 29-30 above. Finally, the case for abolishing the
rule depends heavily on anomalies in the operation of the law
as it has traditionally been understood. Many, though not all
of these are better addressed (i) by a realistic appraisal of
the substance of contractual provisions operating upon
breach, and (ii) by taking a more principled approach to the
interests that may properly be protected by the terms of the
parties’ agreement.

Should the penalty rule be extended?
40. In the course of his cogent submissions, Mr Bloch QC,
who appeared for Mr Makdessi on the first appeal, suggested
that, as an alternative to confirming or abrogating the penalty
rule, this court could extend it, so that it applied more
generally. As he pointed out, this was the course taken by
the High Court of Australia, and it would have the advantage
of rendering the penalty rule less formalistic in its
application, and, which may be putting the point in a
different way, less capable of avoidance by ingenious
drafting.

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41. This step has recently been taken in Australia. Until
recently, the law in Australia was the same as it is in
England: see IAC Leasing Ltd v Humphrey (1972) 126 CLR
131, 143 (Walsh J); O’Dea v Allstates Leasing System (WA)
Pty Ltd (1983) 152 CLR 359, 390 (Brennan J); AMEV-UDC at
p 184 (Mason and Wilson JJ, citing ECGD among other
authorities), 211 (Dawson J); Ringrow Pty Ltd v BP Australia
Pty Ltd (2005) 224 CLR 656, 662. However, a radical
departure from the previous understanding of the law
occurred with the decision of the High Court of Australia in
Andrews v Australia and New Zealand Banking Group Ltd
(2012) 247 CLR 205. The background to this case was very
similar to that in Office of Fair Trading v Abbey National plc
[2010] 1 AC 696. It concerned the application of the penalty
rule to contractual bank charges payable when the bank
bounced a cheque or allowed the customer to draw in excess
of his available funds or agreed overdraft limit. These might
in a loose sense be regarded as banking irregularities, but
they did not involve any breach of contract on the part of the
customer. On that ground Andrew Smith J had held in the
Abbey National case that the charges were incapable of
being penalties: [2008] 2 All ER (Comm) 625, paras 295-299
(the point was not appealed). In Andrews, the High Court of
Australia disagreed. They engaged in a detailed historical
examination of the equitable origin of the rule and concluded
that there subsisted, independently of the common law rule,
an equitable jurisdiction to relieve against any sufficiently
onerous provision which was conditional upon a failure to
observe some other provision, whether or not that failure was
a breach of contract. At para 10, they defined a penalty as
follows:

“In general terms, a stipulation prima facie imposes a
penalty on a party (the first party) if, as a matter of
substance, it is collateral (or accessory) to a primary
stipulation in favour of a second party and this collateral
stipulation, upon the failure of the primary stipulation,
imposes upon the first party an additional detriment, the
penalty, to the benefit of the second party. In that sense,
the collateral or accessory stipulation is described as
being in the nature of a security for and in terrorem of
the satisfaction of the primary stipulation. If
compensation can be made to the second party for the
prejudice suffered by failure of the primary stipulation,

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the collateral stipulation and the penalty are enforced
only to the extent of that compensation. The first party
is relieved to that degree from liability to satisfy the
collateral stipulation.”

42. Any decision of the High Court of Australia has strong
persuasive force in this court. But we cannot accept that
English law should take the same path, quite apart from its
inconsistency with established and unchallenged House of
Lords authority. In the first place, although the reasoning in
Andrews was entirely historical, it is not in fact consistent
with the equitable rule as it developed historically. The
equitable jurisdiction to relieve from penalties arose wholly
in the context of bonds defeasible in the event of the
performance of a contractual obligation. It necessarily
posited a breach of that obligation. Secondly, if there is a
distinct and still subsisting equitable jurisdiction to relieve
against penalties which is wider than the common law
jurisdiction, with three possible exceptions it appears to have
left no trace in the authorities since the fusion of law and
equity in 1873. The first arguable exception is in In re
Dagenham (Thames) Dock Co; Ex p Hulse (1873) LR 8 Ch App
1022 (followed by the Privy Council in Kilmer v British
Columbia Orchard Lands Ltd [1913] AC 319), where the
Court of Appeal granted a purchaser, who had been in
possession for five years and carried out improvements,
further time to pay the second and final instalment of a
purchase price on the ground that the clause requiring him to
vacate and to forfeit the first instalment for not having paid
the second instalment on time, was a “penalty”. However,
James and Mellish LJJ may have been treating the clause as
a forfeiture (as they both also used that expression in their
brief judgments), and in any event they treated the purchaser
in the same way as a mortgagor in possession asking for
more time to pay. Further, as Romer LJ pointed out in
Stockloser at pp 497-498, the decision could be justified by
the fact that time had already been extended twice by
agreement, and in any event there was no question of the
vendor being required to repay the first instalment. The
second arguable exception is no more than an unsupported
throw-away line in the judgment of Diplock LJ in Robophone
at p 1446, where he said it was “by no means clear” whether
penalty clauses “are simply void”, but, on analysis, he was
dealing with a rather different point (namely that discussed

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by Lord Atkin in the passage that follows). The third
exception is the unsatisfactory decision in Jobson v Johnson
[1989] 1 WLR 1026, to which we shall return in paras 84-87
below. It is relevant to add in this connection that the law of
penalties has been held to be the same in England and
Scotland: Stair Memorial Encyclopaedia of the Laws of
Scotland, vol 15, paras 783-801, and see Clydebank. Yet
equity, although influential, has never been a distinct branch
of Scots law. In the modern law of both countries, the penalty
rule is an aspect of the law of contract. Thirdly, the High
Court’s redefinition of a penalty is, with respect, difficult to
apply to the case to which it is supposedly directed, namely
where there is no breach of contract. It treats as a potential
penalty any clause which is “in the nature of a security for
and in terrorem of the satisfaction of the primary stipulation.”
By a “security” it means a provision to secure “compensation
… for the prejudice suffered by the failure of the primary
stipulation”. This analysis assumes that the “primary
stipulation” is some kind of promise, in which case its failure
is necessarily a breach of that promise. If, for example, there
is no duty not to draw cheques against insufficient funds, it
is difficult to see where compensation comes into it, or how
bank charges for bouncing a cheque or allowing the customer
to overdraw can be regarded as securing a right of
compensation. Finally, the High Court’s decision does not
address the major legal and commercial implications of
transforming a rule for controlling remedies for breach of
contract into a jurisdiction to review the content of the
substantive obligations which the parties have agreed.
Modern contracts contain a very great variety of contingent
obligations. Many of them are contingent on the way that the
parties choose to perform the contract. There are provisions
for termination upon insolvency, contractual payments due
on the exercise of an option to terminate, break-fees
chargeable on the early repayment of a loan or the closing
out of futures contracts in the financial or commodity
markets, provisions for variable payments dependent on the
standard or speed of performance and “take or pay”
provisions in long-term oil and gas purchase contracts, to
take only some of the more familiar types of clause. The
potential assimilation of all of these to clauses imposing
penal remedies for breach of contract would represent the
expansion of the courts’ supervisory jurisdiction into a new
territory of uncertain boundaries, which has hitherto been
treated as wholly governed by mutual agreement.

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43. We would accept that the application of the penalty rule
can still turn on questions of drafting, even where a realistic
approach is taken to the substance of the transaction and not
just its form. But we agree with what Hoffmann LJ said in
Else (1982) at p 145, namely that, while it is true that the
question whether the penalty rule applies may sometimes
turn on “somewhat formal distinction[s]”, this can be justified
by the fact that the rule “being an inroad upon freedom of
contract which is inflexible … ought not to be extended”, at
least by judicial, as opposed to legislative, decision-making.”
(Emphasis supplied)

84. Section 74 of the Indian Contract Act explicitly bars any liquidated
damages to be paid which is in the nature of penalty.
However, the Act does not define “penalty”. A clause is considered
to be in the nature of penalty if it provides for “a payment of money
stipulated as in terrorem of the offending party” ( Dunlop
Pneumatic Tyre Co. Ltd. v. New Garage & Motor Co. Ltd. (1915)
AC 79) or, if the clause's contractual nature is “deterrent rather
than compensatory”. On the other hand, a clause is said to be one
of liquidated damages if it is a genuine endeavour by the parties to
stipulate the loss arising out of the breach in advance. The nature
of the clause would also depend on its construction
and the encompassing circumstances during the time of entering
into the contract or at the time of doing the material variation in the
contract.


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85. In the UK, the principles enunciated by Lord Dunedin in Dunlop
(supra) were the guiding test for deciding whether a clause
is in the nature of the penalty or not. It focused on the question of
“whether the clause represents the genuine pre-estimate of loss or
not”. Over a period of time, the contracts have evolved and have
become more complex, which questions the relevancy of the test.
Cavendish Square (supra) emphasised that where a clause does
not represent the genuine pre-estimate of loss, it cannot be
regarded as penalty if there is “commercial justification” for it. The
words “commercial justification” are of prime importance.


86. The courts in India are still reluctant to apply the test propounded
in Cavendish (supra), which respects the party's autonomy. In
arbitration, the freedom of the parties to define their relationship is
the most fundamental principle. Since the relationship between the
Arbitral Tribunals and courts oscillate between forced cohabitation
and true partnership, we are inclined to adopt Cavendish (supra),
which according to us would be a pro-arbitration approach.

87. The most venerated test for determining penalty clause was
propounded by Lord Dunedin in Dunlop Pneumatic Tyre Co.
(supra) where the learned Judge formulated the following four

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rules for the construction of liquidated damages. “A clause is said
to be in nature of a penalty if:
a) The sum pre-estimated is unconscionable and extravagant
compared to the greatest loss that could conceivably be proven
to arise from the breach.
b) The breach consisting only of not paying a certain amount, and
the sum stipulated is a sum greater than the sum which ought
to have been paid.
c) A single lump sum is made payable on the occurrence of one
or more or all of several events, some of which may occasion
serious and other but trifling damage.

d) The sum stipulated is not a genuine pre-estimate of
damage in cases where it is impossible to make a precise pre-
estimation.”


88. The test as aforesaid may be relevant while looking into clauses of
simple damages in standard contracts, however, it is difficult to
apply this test when it comes to complex contracts. In complex
cases where technical expertise is needed to understand the
different aspects of a contract, it is very subjective and difficult to
determine what amounts to “genuine pre-estimate of loss”.
89. Later, Lord Woolf in Philips Hong Kong Ltd. v. Attorney General
of Hong Kong Co. reported in (1993) 61 BLR 41 (Privy Council)
said, “The Court has to be careful not to set too stringent a standard
and bear in mind that what the parties have agreed should
normally be upheld because any other approach may lead to

SLP (C) Nos. 32849 – 32850 of 2025 Page 83 of 120


undesirable uncertainty, especially in commercial contracts.” Lord
Colman in Lordsvale Finance Plc. v. Bank of Zambia reported in
(1996) Q.B. 752 was to examine a simple form of provision in a
syndicate loan agreement which provided for interest to be paid at
a greater rate during any period in which the borrower
was in default. The learned Judge observed that simply
because the provision for the payment of a sum in case of breach
was not a “genuine pre-estimate of damages”, it cannot be said to
be a penalty clause. He further observed, … no reason in principle
why a contractual provision the effect of which was to increase the
consideration payable under an executory contract upon the
happening of a default should be struck down as a penalty if the
increase could in the circumstances be explained as commercially
justifiable, provided its dominant purpose was not to deter the other
party from breach.
90. The UKSC in Cavendish (supra) unanimously felt the need for
further refinement in the pre-Cavendish position. While rejecting
the suggestion of total abolition of the pre-Cavendish position, it
provided a reformed test applicable to the clauses which amount to
the secondary obligation imposed on the contract breacher. It
provided the test in two limbs:

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(a) Whether any “legitimate business interest” is protected
by the clause (first limb)?
(b) If so, is the provision made in the clause “exorbitant,
extravagant or unconscionable” or is there some wider “commercial
or socio-economic justification” for the clause (second limb)?

91. Contrary to the strict bar against all covenants of a deterrent nature
in Dunlop (supra) the test in Cavendish (supra) advocates that
deterrence might not compulsorily be considered as penal in the
cases in which the party establishes the presence of “legitimate
interest” in securing the performance of the contract which goes
beyond the mere right of recovering damages. This test in
Cavendish (supra) renders additional protection to the covenants
that might otherwise be considered as a penalty under the old
Dunlop test but are considered “commercially justifiable” if viewed
in the light of the brisk development of present time business and
commerce. [Raphael Lok Hin Leung, “In Defence of the Halfway
House-The Cavendish Penalty Rule since 2015” (2019) 13 Hong
Kong Journal of Legal Studies.]
92. The test in Dunlop (supra) is susceptible to three main criticism:
1. That there is the absence of consideration appropriated to
commercial realities.

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2. After Lordsvale (supra), this test is inapplicable in
complicated matters pertaining to apparently valid
commercial justification with impugned clauses. This led to
judicial inconsistency and vagueness.
3. That the rigid dichotomy created i.e. “genuine” and “non-
genuine” pre-estimate of loss, is misleading, artificial and
arbitrary. Lucinda Miller, “Penalty Clauses in England and
France: A Comparative Study”, (2008) 53 International and
Comparative Law Quarterly 79, 82.

93. This rigid dichotomy has created a dilemma for the judiciary.
“Miller” points out that Lord Dunedin's postulation presumes that
stipulated damages can either be a penalty or liquidated damages.
However, there may be cases where one function may be more
dominant than another, and it is not every time the situation
that the other function is totally absent. Therefore, both functions
are not necessarily mutually exclusive. It is very well possible that
a clause may have an element of deterrence, and at the same time
it may be a “genuine pre-estimate of loss”. [Lucinda Miller, “Penalty
Clauses in England and France: A Comparative Study”, (2008) 53
International and Comparative Law Quarterly 79, 82]. This
situation may arise due to the under compensatory character
of contract damages. A number of damages remain unpaid, such as
loss of productivity, lost opportunity, internal cost and non-
monetary losses like emotional distress [Larry A. DiMatteo, Civil-

SLP (C) Nos. 32849 – 32850 of 2025 Page 86 of 120

penal or not further bolsters this line of reasoning [Aristides N.
Hatzis, “Having the Cake and Eating it Too: Efficient Penalty
Clauses in Common and Civil Contract Law”, 22(4) International
Review of Law and Economics 381].

95. Decades after Dunlop (supra), this Court in Fateh
Chand v. Balkishan Dass reported in 1963 SCC Online SC 49,
examined a deed of sale which provided that if the purchaser could
not register the deed by the stipulated date, the earnest money and
the sale price INR 1000 and 24,000 respectively, paid by the
purchaser would be forfeited. The Court applied the Dunlop test
and observed that the INR 24,000 stipulation was not a “genuine
pre-estimate of loss” and was manifestly a stipulation in nature of
penalty.
96. Again, in Maula Bux v. Union of India reported in (1969) 2 SCC
554, it was held by this Court that in cases where the parties are
unable to determine the reasonable compensation, if the amount
decided by the party is a “genuine pre-estimate of damages” it
should be considered a reasonable compensation.
Further, in Kailash Nath Associates v. DDA reported in (2015) 4
SCC 136, this Court held that only those liquidated damages
clauses which are “a genuine pre-estimate of damages” can be
enforced as “reasonable compensation”.

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97. Although several Indian decisions have referred to Cavendish
(supra), yet none of them have completely relied
on the test propounded therein. In Union of India v. Dishnet Ltd.
reported in 2017 SCC OnLine Tri 90, the High Court of Tripura,
referring to Cavendish (supra), said, “though it establishes true
principles with respect to such clause, the dominant test in India is
still a genuine pre-estimate of damages test” and decided
on the basis of that only. Again, in Electronics Corpn. of Tamil
Nadu Ltd. v. ICMC Corpn. Ltd. reported in 2020 OnLine Mad
244, the High Court of Madras was asked to decide
upon the invocation of the liquidated damages clause due
to the suppliers' failure to follow a delivery schedule. In this case
also, the Court again referred to Cavendish (supra) but ultimately
relied on “the genuine pre-estimate of loss test” for deciding the
nature of the clause. Lastly, in LIC Housing Finance Ltd. v. CST
reported in 2019 SCC Online CESTAT 8290, the Customs Excise
and Service Tax Appellate Tribunal again referred to Cavendish
(supra) however did not discuss its implication on the case.
Therefore, though the Indian courts have cited Cavendish (supra)
but abstained from relying on the test.
i. Cavendish embraced in foreign jurisdictions


SLP (C) Nos. 32849 – 32850 of 2025 Page 89 of 120


a. Australia
98. In Paciocco v. Australia and New Zealand Banking Group Ltd.
reported in 2016 HCA 28, the High Court was asked to decide
whether a bank's credit card late fees qualified as penalties under
the applicable Act. The Court determined that the motive for the
imposition of late payment fees was to make up for any potential
loss that could arise from the failure to pay. Despite the fact that
the fee did not accurately estimate the potential loss resulting from
a specific violation due to the relatively small amount of late
payment, the court determined that the charge did not qualify as a
penalty. The court did not entirely distance itself from the
punishment rule, though.
99. The dictum as laid by the High Court of Australia applying the
principles as laid down in Cavendish (supra) could be said to have
been followed by this Court in the case of Hongkong and
Shanghai Banking Corporation Limited v. Awaz and Others
reported in (2025) 3 SCC 52. In the said case, three questions fell
for the consideration of this Court:
“(i) Whether Reserve Bank of India (hereinafter referred to as
“RBI”) is required to issue any circular or guidelines
prohibiting the banks/non-banking financial
institutions/moneylenders from charging interest above a
specific rate?

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(ii) (a) Whether banks can charge the credit card users interest
at rates from 36% to 49% p.a. if there is any delay or default
in payment within the time specified?
(b) Whether interest at the abovestated rates amounts to
charging usurious rates of interest? ”

100. While answering the aforesaid three questions this Court observed
as under:
“ 67. The credit card holders in the present case are well
informed and educated and had agreed to be bound by the
express stipulation by the terms issued by the respective
Banks. The Banks in the most important terms and conditions,
as provided by the Banks have provided all necessary
information with regard to fees, and charges applicable to
credit cards, credit and cash withdrawal limits. We are of the
considered opinion that once the terms of the credit card
operations were known to the complainants and disclosed by
the banking institutions before the issuance of the credit
cards, the National Commission could not have scrutinised the
terms or conditions, including the rate of interest. More so, the
respondent has not approached the statutory authority,
Reserve Bank of India, for any objection against the rate of
interest, or the high Benchmark prime lending rate.
68. The National Commission, whilst making observations,
has made stipulations to the terms of contract agreed between
the parties, so much so it has supplanted itself as the
custodian of the terms and conditions between the parties. We
are of the considered opinion that to re-agitate the terms and
conditions of credit card facilities provided by the banks, and
rewrite the terms thereof, including the rates of interest
charged by the banks, is exorbitant, however reasonable, is
an attempt by the National Commission to constitute a new
contract, which is impermissible in law. It is a settled canon of
law, that a
“contract, being a creature of an agreement between two
or more parties, has to be interpreted giving literal
meanings unless, there is some ambiguity therein. The
contract is to be interpreted giving the actual meaning to

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the words contained in the contract and it is not
permissible for the Court to make a new contract,
however reasonable, if the parties have not made it
themselves.” [Rajasthan Sidic v. Diamond & Gem
Development Corpn. Ltd., (2013) 5 SCC 470 : (2013) 3
SCC (Civ) 153] (Diamond & Gem Development Corpn.
case [Rajasthan Sidic v. Diamond & Gem Development
Corpn. Ltd., (2013) 5 SCC 470 : (2013) 3 SCC (Civ) 153],
SCC p. 483, para 23)
73. In the present context, the preconditions of “deceptive
practice” and “unfair method” are manifestly absent. The
Banks have in no manner made any misrepresentation, to
deceive the credit card holders. Upon availing the facility of
the credit cards, the customers, are made aware of “the most
important terms and conditions”, including the rate of interest,
that shall be charged by the Banks. Even on merits, Reserve
Bank of India, has made it clear that there exists no material
on record, to establish that any Bank has acted contrary to
the policy directives issued by RBI. Even otherwise, there is
not even a single averment so as to establish how the charging
of rates of interest upon the default by credit card holders,
without a standardised rate, is usurious and constitutes an
unfair trade practice. The mere inflation in the rates of interest
cannot be construed as a practice, intended to cause loss or
injury.
xxx xxx xxx
75. Thus, we agree with the submissions made by Reserve
Bank of India, that the question of directing RBI to act against
any bank does not arise, in the facts and circumstances of the
present case and that there is no question of RBI being
directed to impose any cap on the rate of interest, either on the
banking sector as a whole, or in respect of any one particular
bank, contrary to the provisions contained in the Banking
Regulation Act, and the circulars/directions issued
thereunder.”
(Emphasis supplied)

b. New Zealand


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101. The structure established by Cavendish (supra) was adhered to
by the Supreme Court of New Zealand in 127 Hobson Street
Ltd. v. Honey Bees Preschool Ltd. reported in 2020 NZSC
53. The Court created a new proportionality standard that
weighs the stipulated amount against the non-breaching party's
“reasonable interest”. It acknowledged that damages recoverable
under common law might not include broader economic or
commercial interest protected. The “legitimate interest” of a non-
breaching party is the main focus of this new approach, which
rejects the Dunlop test.

c. Malaysia


102. In Cubic Electronic Sdn Bhd v. Mars Telecommunication-Sdn
Bhd reported in (2019) 6 Mad LJ 15 FC, the Federal Court, following
Cavendish (supra), recognised the concept of “legitimate interest”
and “proportionality” while judging what should be a reasonable
compensation. It held that the court must first determine whether
a damages clause serves to protect any “legitimate business or
commercial interest” in performance that extends beyond the
possibility of monetary compensation which may result from the

SLP (C) Nos. 32849 – 32850 of 2025 Page 93 of 120


breach, and if so, whether the provision created to safeguard that
interest is in proportion to the identified interest.

d. Germany

103. Liquidated Damages and contractual penalties are distinguished
by the German legislation, known as the German Civil Code
( BGB ). In situations where the prescribed amount is
“disproportionate and excessively high”, Article 343 of the BGB
requires a judicial reduction; nevertheless, it also states
that the evaluation must take “every legitimate interest
of the obligee, not merely his financial interest” into account. This
evaluation follows the logic presented in Cavendish (supra).

104. The Cavendish rule gives greater autonomy to parties to define
their relationship in comparison to Dunlop (supra) & party
autonomy is one of the cardinal principles behind the evolution of
the law of arbitration. In cases where the parties are of equal or
comparable bargaining power, the interference by the arbitrator or
Judges by declaring any clause of penalty merely on the basis of a
reasonable pre-estimate of loss goes against the fundamental
principle of party autonomy. The Scottish Law Commission Report
has observed, “the Cavendish test is well-received by

SLP (C) Nos. 32849 – 32850 of 2025 Page 94 of 120


commercial law firms and professional bodies for being highly
flexible and workable in terms of providing clear guidance as to
future contract drafting” [Scottish Law Commission, Report on
Review of Contract Law Formation, Interpretation, Remedies for
Breach, and Penalty clauses (2018) 252]. Various
common law jurisdictions have positively responded
to Cavendish (supra) and have relied on them. [Ref: Embracing
The Cavendish Test for Greater Autonomy in Contract Law by
Ashish Jha, Gujarat National Law University, Gandhinagar ]

th
105. Malhotra in his Commentary on the law of arbitration (4 Edition)
while explaining the ground of ‘public policy’ for setting aside the
Award is concerned states that:
“ The concept of 'public policy', of course, is not immutable. By
its very nature, 'public policy' is not susceptible to a plain
meaning by the courts. Public policy is a dynamic concept
that evolves continually to meet the changing needs including
political, social, cultural, moral and economic dimensions.
The doctrine of public policy is a branch of common law, and
just like any other branch of common law, it is governed by
precedent; the principles have been crystallised under
different heads, and though it is permissible for courts to
apply them to different situations, the doctrine should only
be invoked in clear and incontestable cases of harm to the
public. Public policy connotes some matter which concern
public good and public interest. The duty of the court is to
expound, and not expand the doctrine of public policy. The
courts should use circumspection in holding a contract as
void against public policy, and should do so, only when the
contract is incontestable, and inimical to public interest. The
doctrine should be invoked only in clear cases in which the
harm to the public is substantially incontestable and does not

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depend upon the idiosyncratic inferences of a few judicial
minds. ”
(Emphasis supplied)

106. Mr. Shyam Divan is right in his submission that the agreement
was entered into between the parties who were well versed with the
law and had the advantage of legal assistance before drafting and
entering into the aforesaid agreement. Once there is an agreement
which provides that the interest shall be at a particular rate the
Arbitral Tribunal thereafter is left with no discretion. The Arbitral
Tribunal would be bound by the terms of the agreement. Such be
the position in law on the principles of interpretation of contract,
the clause 4 in the case on hand ought to be interpretated in such
a way so as to save the clause rather than to render it invalid on
the ground of being opposed to Public policy.
107. It is well settled that a contract is a commercial document between
the parties, and it must be interpretated in such a manner so as to
give efficacy to the contract rather than to invalidate it in the name
of public policy, unconscionability etc. It is equally well settled
principle that the terms of the contract executed between two
parties, are not open to judicial scrutiny unless the same is
arbitrary, discriminatory, mala fide or actuated by bias. The courts
should not strike down the terms of a contract because it feels that
some other terms would have been fair, wiser or logical.

SLP (C) Nos. 32849 – 32850 of 2025 Page 96 of 120



108. The argument of the learned senior counsel for the appellant that
the rate of interest or in other words, the clause providing for
penalty on penalty is unconscionable, ex-proprietary and contrary
to law also merits rejection because at no stage the appellant had
questioned the terms on which the bill discounting facility was
extended by the respondent. That apart, having enjoyed those
facilities for a long time the appellant cannot turn around and raise
an argument that penalty on penalty is opposed to public policy. It
must be remembered that the appellant was not in a position of
disadvantage vis-à-vis the respondent. If the appellant wanted, it
could have declined to avail the financial facilities made available
by the respondent without asking for any security. However, the
fact of the matter is that the appellant had signed the agreement
with open eyes and agreed to abide by the terms on which the Bill
discounting facility was offered by the respondent. In such
circumstances, the doctrine of unconscionable contract cannot be
invoked for frustrating the action initiated by the respondent for
recovery of its dues.
109. The Privy Council in the case of Lala Balla Mal v. Ahad Shah
and Anr. reported in Calcutta Weekly Notes Volume XXIII Page 233
exposited the legal position that:
“A borrower who obtains a loan secured by a promissory
note on quite reasonable terms, by neglecting to pay the
note at maturity, further neglecting to pay the accruing

SLP (C) Nos. 32849 – 32850 of 2025 Page 97 of 120


interest for the several years following, and then giving a
renewal note for the original debt plus the capitalised
interest, could produce a result which might at first sight
appear oppressive, and yet there would be nothing harsh
or unconscionable in the creditor’s demand since the added
interest only accumulated while he forbore the payment of
the sums from time to time due to him.

On the other hand, it would be quite possible for a money-
lender, by making loans for short periods on apparently
fair terms, and then insisting on capitalising the interest
immediately on its becoming payable, to pile up compound
interest on the initial debt at such a rate as would make
the result after a few years most oppressive and
unconscionable. But there is nothing inherently wrong or
oppressive in a lender’s securing for himself compound
interest after the borrower has for a considerable time
neglected to pay the debt he owes or the interest accruing
due upon it which he has contracted to pay. The borrower
cannot acquire merit simply by breaking his contract.”
(Emphasis supplied)

110. The Bombay High Court in the case of Sheth Burjorji Shapurji v.
Dr. Madhavlal Jesingbhai reported in ILR Vol. LVIII Page 95
speaking through Chief Justice Sir John Beamont exposited the
legal position in the following words:
“If there is an agreement to pay a sum of money by a
particular date with a condition that if the money is not
paid on that date a larger sum shall be paid, that condition
is in the nature of a penalty against which a Court of equity
can grant relief and award to the party seeking payment
only such damage as he has suffered by the non-
performance of the contract. But if, on the other hand, there
is an agreement to pay a particular sum followed by a
condition allowing to the debtor a concession, for example,
the payment of a lesser sum, or payment by instalments,
by a particular date or dates, then the party seeking to take
advantage of that concession must carry out strictly the
conditions on which it was granted, and there is no power
in the Court to relieve him from the obligation of so doing.”
(Emphasis supplied)

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111. The Calcutta High Court in the case of Kulada Prosad
Chowdhury v. Ramananda Pattanaik reported in AIR 1921 Cal
109 speaking through Justice Mookerjee exposited the legal
position in the following words:
“As regards the merits of the appeal, the contention is that
the agreement for payment of interest is a penalty and
should not have been enforced. The mortgage executed on
th
the 11 February, 1916, provides that interest would run
at the rate of Rs. 2 per cent, per month and would be paid
off every year. It further provides that the amount of
interest which will remain unpaid at the end of the year
would be treated as principal and interest, that is,
compound interest would run at the rate of Rs. 2 per cent,
per month. The agreement consequently was that the loan
would carry interest at the rate of Rs. 2 per cent, per month
with annual rests. There is a further provision to the
following effect: Although the rate of interest per cent, per
month is fixed at Rs. 2 in the bond and the same is agreed
by us, yet at our request and supplication you also agree
that in case we pay off in one lump the” entire sum due as
interest in proper time, that is just at the end of the year
from the date of this document, then we shall pay interest
at the rate of Rs. 1 per cent, per month instead of Rs. 2 per
cent, per month and you and your heirs shall take interest
at the said rate of Rs. 1 per cent, per month without any
objection. But if we or our heirs do not pay the whole
interest in one lump sum at the rate of Rs. 1 per cent, per
month within the year, then we and our heirs shall remain
bound to pay interest and compound interest at the rate of
Rs. 2 per cent, per month as stated in the bond and this
rule will apply all along. We are of opinion that this
covenant to accept interest at a reduced rate, if interest is
paid punctually, does not make the original rate of interest
a penalty within the meaning of section 74 of the Indian
Contract Act. It has not been disputed that this principle
was applied in the cases of Hardy v. Martin [(1783) 1
Brown C.C. 419 note.] , Union Bank of
England v. Ingram [(1880) 16 Ch. D. 53.]
, Wallis v. Smith [(1882) 21 Ch. D. 243.] and Willing
ford v. Mutual Society [(1880) 5 App. Cas. 685.].


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But it has been contended that the rule is not based on
reason and should not be applied to this country. We find,
however, that the rule was applied by this Court in the case
of Kirti Chunder Chatterjee v. J.J. Atkinson [(1906) 10
C.W.N. 640.] by the Allahabad High Court in the case
of Kutubuddin Ahmad v. Bashiruddin [(1910) I.L.R. 32 All.
448.] and by the Madras High Court in the case of Abdul
Rahim Mahammad v. Rangiah Gounden [(1913) 1 Mad.
L.W. 181.] . We are of opinion that the rule is reasonable;
for, as was pointed out by Stanley, C.J.,
in Kutubuddin v. Bashiruddin [(1910) I.L.R. 32 All. 448.]
and by White, C.J., in Abdul v. Rangiah [(1913) 1 Mad.
L.W. 181.], the effect of a clause of this description is to
encourage punctuality on the part of the debtor and there
is no reason why the Courts in such circumstances should
be astute to nullify the contract between the parties. We do
not overlook that in the case of Shampeary
Dassya v. Eastern Mortgage and Agency Co., Ltd. [(1917)
22 C.W.N. 226, 241-245.] the rule, though recognised and
approved, was not applied but the decision in that case
has, upon this point, been reversed by the Judicial
Committee, Mati Lal v. The Eastern Mortgage and Agency
Co.[(1920) 25 C.W.N. 265.]. The position then is that the
rule as enunciated in Willing ford v. Mutual Society [(1880)
5 App. Cas. 685.] has now been adopted by the Judicial
Committee. We hold accordingly that the agreement to
accept interest at a reduced rate, on punctual payment,
does not make the original rate of interest a penalty. We
may add that reference was made to the decision of the
Judicial Committee in the case of Sunder Koer v. Rai Sham
Krishen [(1906) I.L.R. 34 Calc. 150.], but that was clearly a
case where there was no covenant to accept a reduced rate
of interest on punctual payment.”
(Emphasis supplied)

112. This Court in K.P. Subbarama Sastri v. K.S. Raghavan reported
in (1987) 2 SCC 424 observed thus:
“The question whether a particular stipulation in a
contractual agreement is in the nature of a penalty has to
be determined by the court against the background of
various relevant factors, such as the character of the
transaction and its special nature, if any, the relative

SLP (C) Nos. 32849 – 32850 of 2025 Page 100 of 120


situation of the parties, the rights and obligations accruing
from such a transaction under the general law and the
intention of the parties in incorporating in the contract the
particular stipulation which is contended to be penal in
nature. If on such a comprehensive consideration, the court
finds that the real purpose for which the stipulation was
incorporated in the contract was that by reason of its
burdensome or oppressive character it may operate in
terrorem over the promiser so as to drive him to fulfil the
contract,, then the provision will be held to be one by way
of penalty.”
(Emphasis supplied)

113. We also looked into one judgment of the Delhi High Court in the
case of Smt. Shakuntla Educational and Welfare Society and
Ors. v. S.E. Investments Ltd ., reported in 2017:DHC:2946 wherein
the High Court rightly held as under:
“23. The first and foremost question to be addressed is
whether the impugned award is liable to be set aside
inasmuch as the arbitral tribunal had rejected the contention
of the Society/Guarantors that the contractual rate of interest
was expropriatory and unconscionable and thus opposed to
public policy. The arbitral tribunal had considered the
aforesaid contentions and had held that the parties had
agreed to the stipulated rate of interest and had availed the
loans exercising their free will and, therefore, it was not open
for the Society/Guarantors to resile from its agreement and
challenge the loan agreements.
24. The arbitral tribunal had also referred to the decision of
the Supreme Court in the case of Indian Bank v. Blue
Jaggers Estates Limited and Others reported in (2010) 8
SCC 129 and the decision of this Court in Deepak Bhatia v.
Virender Singh reported in 2015 SCC OnLine Del 12187
and concluded that it was not open for a borrower to
challenge the rate of interest after having availed of the loan
facilities.
25. In the case of Blue Jaggers Estates (supra), the Supreme
Court had rejected the arguments raised by the respondents
therein that the rate of interest was unconscionable,

SLP (C) Nos. 32849 – 32850 of 2025 Page 101 of 120


expropriatory and contrary to law since they had, at no
stage, questioned the terms on which the loans/financial
facilities were extended by the appellant bank (Indian Bank).
The respondents therein had enjoyed the facilities for more
than a decade and, therefore, the Court held that it was not
open for them to raise such contentions at that stage.
26. The ratio decidendi of the said decision would, a fortiori,
apply to the facts of the present case. In the present case, the
arbitral tribunal had noted that the
Society/Guarantors/affiliated companies, had entered into
42 loan transactions (other than the subject transactions)
over a period of approximately 12 years and had discharged
the liability in terms of the loan agreements (SEIL claims that
the number is even larger and the
Society/Guarantors/affiliated companies had availed of and
repaid 47 loans between the year 2000 and 2012). The
Society/Guarantors could not be permitted to challenge the
terms of the loan agreements after having enjoyed the benefit
of the funds lent by SEIL.
27. The above also establishes that the Society/Guarantors
were also in no doubt as to the terms of the loan agreements
and had entered upon the same voluntarily at the effective
rate of the interest payable by them.
28. The arbitral tribunal had referred to the decision of a
Coordinate Bench of this Court in Morgan Securities &
Credits Pvt. Ltd. v. Morepen Laboratories Ltd & Anr.: 2006 (3)
ArbLR 159 Delhi and the decision of the Division Bench in
Morepen Laboratories Ltd. & Ors. v. Morgan Securities and
Credits Pvt. Ltd.: 2008 (105) DRJ 408 and rejected the
contention that the loan transactions fell foul of the Usurious
Loans Act, 1918. This Court finds no infirmity with the
aforesaid view.
29. It is also necessary to bear in mind that the transactions
between the parties was a commercial transaction. Although
the rate of interest of 26% p.a. (which would work out to be
much higher as it is a flat rate of interest and not based on
reducing balance method) is ex facie a very high rate of
interest; it cannot be denied that the said transactions were
entered into by the parties voluntarily without undue
influence, in their commercial interest and it is not safe for
courts to pronounce any value based decision on the merits
of commercial terms as the same are determined by market
forces, given the exigencies of trade and commerce. This is

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not a case where the Society/Guarantors are vulnerable
parties who were - or could be - subjected to an exploitative
unconscionable agreement. It is also relevant to mention that
the funds provided by SEIL were unsecured and the loan
transactions were plainly perceived as high risks
transactions (from a lender's point of view). It is also apparent
that the loan or finances sought by the Society was
unavailable from the normal banking system and, therefore,
the Society/Guarantors had to resort to availing loans from
SEIL.
30. It is common knowledge that NBFCs do provide a source
of resources to entrepreneurs and persons of commerce in
cases where such resources are otherwise unavailable to
them. It is also for this reason that it would not be apposite
to curtail or restrict such transactions as they may have an
effect of completely shutting out the only avenue available to
entrepreneurs to avail of such high risk finance.
31. The cost of funds available to NBFCs engaged in lending
high risk finance is also significantly higher and would in
most cases also include significant component of proprietary
funds.”
(Emphasis supplied)

114. As discussed above, the appellant was in need of finance and on
its own will and volition approached the respondent for the same
and knowingly entered into the bill discounting facility agreement.
Had the appellant abided by the terms and conditions of repayment
it could have availed facility of concessional rate as provided in the
agreement, however, the appellant just shut its eyes and declined
to make the payment for years together. In such circumstances the
conditions stipulated in the agreement of compound interest at the
rate of 36% monthly rest cannot be termed as burdensome or
oppressive in any manner.

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115. The grant of pendente lite interest depends upon the phraseology
used in the agreement, clauses conferring power relating to
arbitration, the nature of claim and dispute referred to the
arbitrator, and on what items the power to award interest has been
taken away and for which period. Also, the position under Section
31(7) of the 1996 Act, is wholly different, inasmuch as Section 31(7)
of the 1996 Act sanctifies agreements between the parties and
states that the moment the agreement says otherwise, no interest
becomes payable right from the date of the cause of action until the
award is delivered. (See: Jaiprakash Associates Ltd. v. Tehri
Hydro Development Corp. India Ltd.)
K. APPLICABILITY OF THE MAXIM ‘VERBA CHARTARUM
FORTIUS ACCIPIUNTUR CONTRA PROFERENTEM’ IN THE
PRESENT CASE

116. It was sought to be argued by the ld. Senior counsel appearing for
the appellant that clause 4 of the Sanction letter dated 27.12.2002
is subject to the principle of ‘ verba chartarum fortius accipiuntur
contra proferentem ’.
117. It is a rule of interpretation that contracts are to be interpreted
based on their plain meaning, as a whole and in accordance with
the language used. It is also a settled principle that in case of any
ambiguity, a contract will have to be interpreted taking into
consideration the surrounding facts and circumstances.

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118. However, where there are ambiguities, especially in cases of
insurance contracts, the principle of contra proferentem steps in to
aid the interpretation, as reiterated by this Court in its decision
in Haris Marine Products v. Export Credit Guarantee
Corporation Limited reported in (2022) 20 SCC 776.

119. The principle of contra proferentem is etymologically traceable to
the maxim verba chartarum fortius accipiuntur contra
proferentem , which means the words of deeds are to be taken most
strongly against he who uses them.
120. In Sushilaben Indravadan Gandhi v. New India Assurance Co.
Ltd reported in (2021) 7 SCC 151, paras 37-42, this Court charted
the evolution of the rule of contra proferentem , and relied inter alia
on its explanation as provided under Halsbury’s Laws of England :
th
[ 5 Edn., Vol. 60, para 105.]
“Contra proferentem rule.—Where there is ambiguity in the policy
the court will apply the contra proferentem rule. Where a policy
is produced by the insurers, it is their business to see that
precision and clarity are attained and, if they fail to do so, the
ambiguity will be resolved by adopting the construction
favourable to the insured. Similarly, as regards language which
emanates from the insured, such as the language used in answer
to questions in the proposal or in a slip, a construction favourable
to the insurers will prevail if the insured has created any
ambiguity. This rule, however, only becomes operative where the
words are truly ambiguous; it is a rule for resolving ambiguity
and it cannot be invoked with a view to creating a doubt.
Therefore, where the words used are free from ambiguity in the
sense that, fairly and reasonably construed, they admit of only
one meaning, the rule has no application.”
(Emphasis supplied)

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121. The rule of contra proferentem thus protects the insured from the
vagaries of an unfavourable interpretation of an ambiguous term to
which it did not agree. The rule assumes special significance in
standard form insurance policies, called contract d’ adhesion or
boilerplate contracts, in which the insured has little to no
countervailing bargaining power.
122. As to what amounts to “ambiguity” is clarified in P Ramanatha
Aiyar’s Advanced Law Lexicon, which defines the term “ ambiguous ”
as doubtful or uncertain, particularly in respect of signification;
equivocal; indeterminate; indefinite; unsettled; indistinct.
123. Haris Marine (supra) arose out of an appeal against an order
passed by the National Consumer Disputes Redressal Commission
(NCDRC) dismissing a complaint filed by the insured against Export
Credit Guarantee Corporation Limited (ECGC) for rejecting the
insured’s claim. The issue was whether the NCDRC was correct in
placing reliance on guidelines issued by the Directorate General of
Foreign Trade (DGFT) to interpret the date
of ‘despatch/shipment’ in the Single Buyer Exposure Policy
resulting in the consequent denial of the claim. The insured argued
for the application of the principle of contra proferentem , as the
Policy was silent on what amounted to the date of ‘despatch’ or
‘shipment’. While adopting the DGFT Guidelines, the NCDRC

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rejected the insured’s contention that in absence of a clearly
specified provision in the Policy, it was entitled to the benefit of the
rule of contra proferentem .
124. This Court applied the principle of contra proferentem and held
that the rule assumes special significance in standard form
insurance policies, called contract d’ adhesion or boilerplate
contracts, in which the insured has little to no countervailing
bargaining power.
125. It further clarified that the contra proferentem rule protected the
insured from the vagaries of an unfavourable interpretation of an
ambiguous term to which it did not agree. This Court was propelled
to allow the insured’s claim along with interest by reading into the
objectives of the ECGC – a government company offering the niche
service of export credit insurance – and held that denial of the
insured’s claim would be contrary to the duties of the ECGC.

126. Contra proferentem is not a principle of universal application.
Where the terms of the contract are clear, there will be no occasion
to apply the contra proferentem rule. It is useful to refer to the
decision rendered in Export Credit Guarantee Corporation of
India Ltd. v. Garg Sons International reported in 2014 1 SCC
686 wherein it was held that it is not permissible for the court to
substitute the terms of the contract itself, under the garb of
construing terms incorporated in the agreement of insurance. It

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was also held that no exceptions can be made on the ground of
equity. Further, the principle must certainly not be extended to the
extent of substituting words that were never intended to form a part
of the agreement.
127. The contra proferentem principle does not merit applicability in
case of commercial contracts, for the reason that a clause in a
commercial contract is bilateral and has mutually been agreed
upon as held in a number of judgments, including in Rashtriya
Ispat Nigam Ltd. v. Dewan Chand Ram Saran reported in (2012)
5 SCC 306.
128. The true construction of a commercial contract must depend upon
the import of the words used and not upon what the parties choose
to say afterwards. Nor does subsequent conduct of the parties in
the performance of the contract affect the true effect of the clear and
unambiguous words used in the contract. The intention of the
parties must be ascertained from the language they have used,
considered in the light of the surrounding circumstances and the
object of the contract. The nature and purpose of the contract is an
important guide in ascertaining the intention of the parties.
129. In Ottoman Bank of Nicosia v. Ohanes Chakarian reported
in AIR 1938 PC 26. Lord Wright made these weighty observations:
(AIR p. 29)

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“… that if the contract is clear and unambiguous, its true
effect cannot be changed merely by the course of conduct
adopted by the parties in acting under it.”
(Emphasis supplied)

130. In Ganga Saran v. Ram Charan Ram Gopal (Firm) reported in
1951 SCC 1053 a four-Judge Bench of this Court stated:
“12. …Since the true construction of an agreement must
depend upon the import of the words used and not upon
what the parties choose to say afterwards, it is unnecessary
to refer to what the parties have said about it.”

131. It is also a well-recognised principle of construction of a contract
that it must be read as a whole in order to ascertain the true
meaning of its several clauses and the words of each clause should
be interpreted so as to bring them into harmony with the other
provisions if that interpretation does no violence to the meaning of
which they are naturally susceptible. ( North Eastern Railway
Co. v. Lord Hastings reported in (1900-03) All ER Rep 199 (HL.)

L. APPLICATION OF SECTION 74 OF THE CONTRACT ACT VIS-
A- VIS SECTION 31(7)(a) of the ARBITRATION ACT, 1996
132. Any question as to the unconscionableness of a stipulation
contained in an agreement would probably arise for consideration
only if it is shown that the relationship between the contracting
parties was such that one of them was in a position to dominate the

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will of the other and that he had made use of such position to obtain
an unfair advantage over the other. It is only in cases where both
the conditions mentioned above are clearly established by the
person who seeks to avoid the transaction and the court further
finds that the bargain is in itself unconscionable that the impugned
provision will be held to be unenforceable on the ground of
unconscionableness. See Poosathurai v. Kannappa Chettiar ,
ILR 43 Mad 546 : (AIR 1920 PC 65), Ladli Parshad Jaiswal v. The
Kernal Distillery Co., Ltd. Karnal , AIR 1963 SC 1279,
and Subhas Chandra Das Mushib v . Ganga Presad Das Mushib ,
AIR 1967 SC 878. If people with their eyes open choose wilfully and
knowingly to enter into a contractual transaction the court will not
step in to relieve them of their obligations under such contract on
the ground that the terms thereof are unconscionable. [See: P.K.
Achuthan and another v. State Bank of Travancore, Calicut :
AIR 1975 Ker 47 (F.B. ) ]

133. In John Wallingford v . The Directors and Co. of the Mutual
Society, and the Official Liquidator thereof , reported in (1880)
5 AC 685, which is one of the leading English cases on the subject
the House of Lords had to consider the question whether a provision
contained in a mortgage bond executed to secure the due payment,

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by instalments, of a sum due, making the whole amount
recoverable in the event of default in payment of any instalment was
a stipulation by way of penalty. Rejecting the contention of the
appellant that the provision was penal in nature Lord Selborne, L.C.
observed thus at page 696:
“ The real matter seems to stand thus. These mortgage
bonds were given to secure the £ 6000, which sum was
treated as advanced, although money did not pass, and
also the premiums, which would become due by
instalments according to the rules of the society; and the
payment of which under those rules was liable to be
accelerated, if any of the instalments were not punctually
paid. I cannot think that such an acceleration of payments
has anything in common with a penalty. It was a contract
for certain payments which were debits in praesenti
although solvenda in future; and, being such, it is
consistent both with principle and with authority to hold,
that if the party who ought to have paid them, or any of
them, at the proper time failed to do so, the default was
his own, and the time might lawfully be accelerated for
the other payments which were originally deferred. I
think, therefore, that it would not be right for your
Lordships in your order to give effect to that contention on
the part of the Appellant……… ”

134. Based on the above dictum laid down by the House of Lords and
also subsequent pronouncements by the English courts reiterating
the same principle the law on the point has been succinctly
summarised in Halsbury's Laws of England (third edition), Volume
3, paragraph 655 in the following terms:—
“Where a bond is conditioned for the payment of a sum of
money by stated instalments and it is provided that in

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default of payment of any one instalment the whole sum
remaining unpaid shall become payable, the acceleration
of the payment of the remaining instalments is not a
penalty, and on default in respect of any instalment the
entire sum may be claimed.”

135. The same principle has been embodied in illustration (f) to Section
74 of the Indian Contract Act which reads:
“A undertakes to repay B a loan of Rs. 1,000 by five equal
monthly instalments, with a stipulation that in default of
payment of any instalment, the whole shall become due.
This stipulation is not by way of penalty and the contract
may be enforced according to its terms”.
136. We have no hesitation in going to the extent of saying that where
in a contract under which interest is payable it is agreed between
the parties that if such interest be not paid punctually the defaulter
shall be liable to pay interest at an enhanced rate, whether from the
time of default or from the time when interest first became payable
under the contract such agreement does not come within Section
74 of the Indian Contract Act, and is to be construed according to
the intentions of the parties as expressed therein and not as a
stipulation for a penalty. Such agreement is to be enforced
according to its terms, unless it be found to have been when made
unconscionable or fraudulent.
137. We had the advantage of looking into one very erudite judgment
rendered by the Full bench of the Allahabad High Court in the case
of Banke Behari and Ors v. Sundar Lal and Ors. reported in ILR

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(1893) 15 All 232 (FB) wherein, seven learned Judges observed as
under:
“It has been held in India, in cases to which we shall
subsequently refer, that a contract to pay a higher rate of
interest from the date of the contract, on default being
made in payment of a lower rate of interest, is to be
regarded as a stipulation for a penalty, to which s. 74 of
the Indian Contract Act, 1872, is to be applied. It has also
been held in India, and so far as we are aware, has been
seldom doubted, that an agreement to pay a higher rate of
interest from the date of the default in payment of a lower
rate is a contract to be performed, and not a stipulation for
a penalty to be relieved against, and that s. 74 of the
Indian Contract Act, 1872, does not apply to such an
agreement.
The two propositions are clearly and concisely put in the
judgment in Nanjappa v. Nanjappa reported in [12 M.
161 at pp. 166 and 167.]. Although the cases there put,
like many of those in which this question has arisen, were
cases in which a borrower had agreed to pay the principal
money with certain interest on a given day, with a
stipulation that a higher rate of interest should be paid if
default were made, there cannot, as it appears to us, be
any difference in principle between such cases and that
which we are putting by way of illustration. In each case
it is the stipulation as to a higher rate of interest, if it could
be enforced, which would impose on the borrower the
obligation of paying a larger sum than he would have to
pay if no default were made. At pp. 166 and 167 of I.L.R.,
12 Mad., the two propositions are thus stated:—
“By the cases in this country it is well established that
an agreement to pay a sum of money on a given day
with interest at a certain rate with a stipulation that in
default the debtor shall thenceforward pay a higher
rate of interest is strictly enforceable. In such an
agreement no question of penalty arises, because it
imposes an obligation on the debtor to pay a larger sum
than what was originally due. In the words of s. 74 of
the Contract Act no sum is named as the amount to be
paid in case of such breach. At the moment of the
breach no larger sum can be exacted by the creditor,
but from that date the terms on which the debtor holds

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the money became less favourable. By the default he
accepts the alternative arrangement of paying a higher
rate of interest for the future. On the other land, where
the stipulation is that on default the higher rate shall
be payable from the date of the original obligation, the
debtor does on default become immediately liable for a
larger sum, viz., the difference between the enhanced
and the original rate of interest already due.”
We should have thought that in each of those cases the
debtor by the default accepted the alternative
arrangement of paying a higher rate of interest.
xxx xxx xxx
If a contract, the object of which is to ensure by a
provision as to alternative rates of interest, the due and
prompt payment of the principal and a lower rate of
interest, is to be regarded as a penalty and relieved
against, we may ask why do not the Courts in this
country apply the same principle to money bonds or
mortgages, in which it is agreed that the principle shall
be repaid by periodic instalments, and that should
default be made in paying an instalment, the balance
of the principal shall at once become due and
repayable? Is not time as much the essence of the
contract in one case as in the other? Is not the provision
to ensure prompt payment as much a stipulation in
terrorem in one case as in the other? Is the hardship, if
it be one, of a borrower being compelled to perform his
contract any less a hardship in the one case than in the
other? The hardship which may result by the non-
payment of principal or interest on the agreed and
specified date to a man who lends his capital or part of
it, was apparently overlooked by those who were
responsible for the evolution of this doctrine of a
penalty. The borrower might not have had notice when
the contract was made of the loss or damage which
might result to the lender by reason of the non-
performance of the contract to pay at the due date, and
consequently the damages for the breach of contract
which could in such a case be legally awarded might
prove to be an utterly inadequate compensation. A
money-lender cannot now-a-days be regarded in the
eye of the law, as formerly he may have been, as hostis
humani generis, and as long as his contract is not
unconscionable or tainted with fraud, we fail to see

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why the other contracting party should not be bound by
it.”
(Emphasis supplied)


138. The dictum as laid in Banke Behari (supra) should be understood
and applied, keeping in mind the nature of the transaction of bill
discounting facility provided by the respondents to the appellant.

M. CASE LAW RELIED UPON BY THE APPELLANT:


139. We looked into the decision of this Court in the case of Central
Bank of India (supra) on which strong reliance has been placed on
behalf of the appellant . Having looked into the ratio or rather the
dictum as laid in Central Bank of India (supra) on the issue of
penal interest, we are of the view that the same has no application
to the facts of the present case. The observations in para 55
placetum a-e of Central Bank of India (supra) would apply only to
non-corporate borrowers as made clear at page 402 of the report
placetum b-c. In fact, para 55(3) of Central Bank of India (supra)
militates against the case set up by the appellant as it upholds the
capitalization of interest on periodical rest if incorporated in
contract voluntarily entered into between the parties. This aspect
has been looked into by this Court in Punjab Financial

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Corporation v. Surya Auto Industries reported in (2010) 1 SCC
297 at 310 para 26. Over and above, in Hyder Consulting (supra)
this Court had held that the application of Central Bank of India
(supra) should be confined only to those cases under Section 34 of
the CPC and the same cannot be treated as an authority for award
of interest under Section 31(7) of the Act, 1996.
N. CONCLUSION

140. Our final conclusion may be summarised as under:

i. The arbitral tribunal rightly rejected the contention
canvassed on behalf of the appellant as affirmed by the High
Court in Section 34 and Section 37 proceedings respectively
that the transaction between the parties is governed by the
Usurious Loans Act, 1918 as amended by the Punjab Relief
of Indebtedness Act, 1934. The Arbitral Tribunal and the
High Court rightly returned a finding that the transaction
between the parties was neither a loan nor a debt, rather it
was simply in the nature of a commercial transaction. In
other words, the parties had voluntarily/consciously entered
into the bill discounting facility agreement.
ii. The arbitral tribunal including the High Court rightly held
that the terms of payment of interest as mutually agreed

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upon by the parties vide sanction letters dated 27.12.2002
and 11.06.2003 respectively cannot be said to be
unconscionable, arbitrary or excessive in case of non-
payment after the stipulated due date. The arbitral tribunal
and the High Court rightly rejected the contention of the
appellant that interest could not have been added to the
principal amount. It was rightly held that since the
compounding of interest on monthly rest was provided in the
mutually agreed terms of the contract entered into between
the parties, the respondent herein was entitled to claim
interest as per the terms of the contract, i.e., at the rate of
36% p.a. with monthly rest.
iii. There is no merit worth the name in the contention raised on
behalf of the appellant that no specific notice was issued to
it by the respondent for withdrawal of the concessional rate
of 22.50% p.a. No such plea had been taken either before the
arbitrator or in the proceedings before the High Court under
Section 34 and Section 37 of the Act, 1996 respectively. This
aspect does not find mention even in any of the responses to
the notice of arbitration dated 28.06.2007, issued by the
respondent herein or even in the statement of defence before
the arbitrator or in the pleadings under Section 34 and
Section 37 of the Act, 1996 respectively wherein, the rate of

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interest at the rate of 36% p.a. with monthly rest stood firmly
embedded in the claim amount/award amount. Even if, we
have to accept the contention, the same deserves to be
rejected as no prejudice could be said to have been caused
to the appellant due to lack of such notice.
iv. The discretion to grant interest would be available to the
Arbitral Tribunal under clause (a) of sub section (7) of the
Section 31 of the Act, 1996 only when there is no agreement
to the contrary between the parties. When the parties agree
with regard to any of the aspects covered in clause (a) of sub
section (7) of the Section 31 of the Act, 1996, the arbitral
tribunal would cease to have any discretion with regard to
the aspects mentioned in the said provision. Once there is
an agreement between the parties which provides that
interest shall be at a particular rate, the arbitral tribunal
thereafter is left with no discretion. In such circumstances,
the arbitral tribunal would be bound by the terms of the
agreement.
v. The maxim “ verba chartarum fortius accipiuntur contra
proferentem’ has no application at all to the case in hand.
This principle would not apply in case of commercial
contracts for the simple reason that a clause in a commercial
contract is bilateral and has mutually been agreed upon.

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vi. The business model of the Respondent was posited on the
grant of such unsecured facilities for very short periods of
time, thereby enabling the Respondent to repeatedly redeploy
the principal plus interest in its business. In the event of
default, this cycle would stand disrupted for decades, as in
the present case, thereby resulting in loss to the Respondent.
Hence the compensatory contractual requirement of
compounding, in the case of defaulters cannot be faulted or
termed as penal.
vii. The express use of “ Unless otherwise agreed by the
Parties ……” as the opening words of Section 31(7) (a) of the
Act, 1996 is a clear instance of “Party Autonomy” which
forms the bedrock of the arbitral process and will prevail in
all cases, except where the legal provision is strictly non-
derogable in nature e.g. the bar of limitation. The principle
of unconscionability is inapplicable to voluntary commercial
agreements between parties of equal bargaining strength.
viii. Significantly, the contractual clause for interest, in the
present case provides for the levy of a concessional rate of
interest, as an incentive for punctual repayment. The
withdrawal of such concession for failure to abide by the
terms thereof and the consequential levy of a higher rate,
with compounding, cannot be faulted as being penal.

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141. For all the foregoing reasons, the appeals fail and are hereby
dismissed.

142. Pending application(s), if any shall stand disposed of.


......................................... J.
(J.B. PARDIWALA)




......................................... J.
(SANDEEP MEHTA)


New Delhi,
th
4 December, 2025.

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