Failure to adjudicate an inseverable counterclaim renders the entire arbitral award patently illegal.

The appellant was awarded a contract by the Ministry of Defence for supplying 35,897 blankets to various locations at ₹598 per blanket. Of these, 7,660 blankets supplied to Pune were rejected as allegedly substandard and were taken back by the appellant; the appellant did not replace them. The remaining consignments, totalling 28,237 blankets, were supplied to ten other locations and were claimed to have been accepted by the respective consignees.

The respondent withheld the appellant’s outstanding payment, including 95% of the price and the balance 5%, on the allegation that the blankets were not in conformity with the contractual specifications. The appellant claimed ₹48,14,747 towards the unpaid price, interest and other reliefs. The respondent raised counterclaims for liquidated damages and approximately ₹66.01 lakh towards losses allegedly caused by the supply of inferior blankets.

The sole arbitrator awarded ₹45,38,820 towards the unpaid price, ₹2,75,927 towards the balance 5% payment, and interest, while rejecting the appellant’s compensation claim and the respondent’s counterclaims. However, the arbitrator considered the alleged defects primarily in relation to consignments other than Pune and did not separately adjudicate the respondent’s claim for damages arising from the appellant’s failure to replace the rejected Pune consignment.

The respondent’s petition under Section 34 of the Arbitration and Conciliation Act, 1996 was allowed by the District Judge, who set aside the award on the ground that the arbitrator had failed to decide the counterclaim relating to the Pune consignment. The appellant challenged that decision under Section 37 of the Arbitration and Conciliation Act, 1996 read with Section 13(1A) of the Commercial Courts Act, 2015.

Whether the arbitrator’s failure to adjudicate the respondent’s counterclaim for damages/liquidated damages arising from the appellant’s failure to replace the rejected Pune consignment rendered the arbitral award legally unsustainable?

Whether the High Court could sever or modify the award by preserving the amounts awarded to the appellant in respect of the other consignments and independently determining or adjusting the damages relating to the Pune consignment?

The Court applied Sections 34 and 37 of the Arbitration and Conciliation Act, 1996, which permit judicial interference with an arbitral award only within the limited statutory parameters, including where the award suffers from patent illegality. Under clauses (c) and (d) of the Supply Order, the supplier was required to replace stores found defective or non-conforming to specifications, generally within one month of notification; clause (e)(i) provided for liquidated damages of 0.5% of the contract price for each week of delay, subject to a maximum of 5%.

The Court further relied on Gayatri Balasamy v. M/s. ISG Novasoft Technologies Ltd., (2025) 7 SCC 1, which recognises a limited power to modify an arbitral award, including severing a legally invalid portion where the award is severable, correcting clerical or computational errors, modifying post-award interest in appropriate cases, and exercising constitutional power under Article 142 with caution.

The Court held that the arbitrator had adjudicated the dispute concerning the consignments supplied at locations other than Pune but had failed to decide whether the rejection of the Pune consignment was justified and whether the appellant was liable for failing to replace it within the contractual period.

Taking back the rejected blankets did not by itself answer the respondent’s claim for damages, particularly because the contractual clauses imposed an independent obligation to replace defective stores. The arbitrator was therefore required to determine the validity of the rejection, the obligation to replace, and the resulting liquidated damages or compensation. The failure to address this material counterclaim constituted a patent illegality in the award.

The Court declined to decide the Pune-related damages itself because that would require it to determine factual and contractual issues that had not been adjudicated by the arbitrator.

It also held that the Pune issue could not be severed from the remainder of the award: all consignments arose from one contract, and any damages found payable could potentially require adjustment against the amounts awarded to the appellant. Preserving only the appellant’s award would therefore amount to impermissible modification rather than severance of a distinct invalid portion.

It answered the second issue in the negative: the Court could neither determine the Pune damages itself nor sever that issue from the remaining award.

Consequently, the District Judge was correct in setting aside the entire arbitral award, and the appellant’s Section 37 appeal was dismissed.