Performance guarantee proceeds cannot be retained without proof and quantification of corresponding loss.

Prakash Industries Limited (“PIL”) placed a purchase order dated 18 November 2017 on ISGEC Heavy Engineering Limited (“ISGEC”) for the supply, erection supervision and commissioning of two Waste Heat Recovery Boilers, including Induced Draft (“ID”) Fans. The purchase order was subsequently amended, and the equipment for one kiln was withdrawn pursuant to settlement. ISGEC furnished a Performance Bank Guarantee (“PBG”) of ₹1,47,10,000, equivalent to 10% of the basic order value.

After commissioning of the remaining boiler, both ID Fans stopped functioning in September 2019, causing shutdown of the relevant kiln. PIL purchased replacement fans at a cost of ₹65,92,000 and invoked the PBG. PIL commenced arbitration and raised several claims, including the replacement cost of the ID Fans. ISGEC raised counter-claims, including a claim for refund of the amount received under the allegedly wrongful invocation of the PBG.

The Arbitral Tribunal awarded PIL ₹65,92,000 towards replacement of the ID Fans, rejected PIL’s other claims, awarded interest and costs of ₹20,00,000, and rejected all of ISGEC’s counter-claims. Before the High Court under Section 34 of the Arbitration and Conciliation Act, 1996, ISGEC challenged only the rejection of its counter-claim concerning the PBG and the award of costs; the award of ₹65,92,000 was not challenged.

Whether the Arbitral Tribunal erred in rejecting ISGEC’s counter-claim for refund of the PBG proceeds when PIL had not established loss or damage corresponding to the amount retained, particularly in light of Clause 17 of the amended purchase order?

Whether the award of ₹20,00,000 towards arbitration costs was excessive or otherwise liable to be interfered with under Section 34 of the Act?

The Court applied Section 34 of the Arbitration and Conciliation Act, 1996, under which interference with an arbitral award is limited, but is permissible where the award suffers from patent illegality, including failure to act in accordance with the contract. Under Section 31A(3), the arbitral tribunal has discretion to award costs having regard to the conduct and circumstances of the proceedings.

The Court relied on Ssangyong Engineering & Construction Co. Ltd. v. NHAI, (2019) 15 SCC 131, PSA SICAL Terminals (P) Ltd. v. Board of Trustees of V.O. Chidambaranar Port Trust, 2021 SCC OnLine SC 508, and Indian Oil Corporation Ltd. v. Shree Ganesh Petroleum Rajgurunagar, (2022) 4 SCC 463, for the principle that an arbitral tribunal is a creature of contract and cannot disregard or act beyond the contractual terms.

The Court further applied Clause 17 of the amended purchase order, which excluded liability for loss of production, loss of profit, loss of use and other indirect or consequential damages, and relied on Gayatri Balasamy v. ISG Novasoft Technologies Ltd., (2025) 7 SCC 1, which recognises that a severable invalid portion of an arbitral award may be set aside without disturbing the valid remainder.

The Tribunal had found that the ID Fans failed because of defects in their hub design and had awarded PIL the direct cost of replacing them. However, the PBG secured indemnification for “damage or loss” suffered due to non-fulfilment of ISGEC’s guaranteed-performance and defect-liability obligations; its invocation did not automatically entitle PIL to retain the entire guaranteed amount.

PIL was required to establish and quantify the loss or damage corresponding to the retained PBG proceeds. Since PIL’s other loss claims were rejected, and the only established loss was the replacement cost of the ID Fans, the Tribunal had no basis to permit appropriation of the full PBG amount.

The Tribunal also failed to consider the interaction between the PBG and Clause 17, which excluded specified indirect and consequential losses. By permitting retention of the PBG towards unproved losses, the Tribunal acted contrary to the contract, rendering that part of the award perverse and patently illegal.

In contrast, the challenge to costs failed because the award of costs was within the Tribunal’s statutory discretion under Section 31A(3), and costs are not determined solely by comparing the amount claimed with the amount awarded; the conduct of the parties and the circumstances of the proceedings are also relevant.

The portion of the award rejecting counter-claim no. 1 was therefore set aside. The challenge to the award of ₹20,00,000 in costs was rejected, and that part of the award was upheld. The petition was consequently allowed only to this limited extent, with the remaining parts of the award left undisturbed.