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Big win for PSBs: SC upholds arbitral award awarding damages for breach of substitution agreement, asks state agency to compensate lenders in full

The Hon’ble Supreme Court vide an order dated December 01, 2023, dismissed Special Leave Petition (Civil) No. 19675 of 2023 (“SLP”), filed by Haryana State Industrial and Infrastructure Development Corporation (“HSIIDC”), a state government agency, against concurrent judgments of the Hon’ble Delhi High Court, upholding an arbitral award rendered in favour of a consortium of public sector banks, led by IDBI Bank Limited (“Senior Lenders”). The Ld. arbitral tribunal, comprising Hon’ble Justice (Retd.) R M Lodha, former Chief Justice of India, Hon’ble Justice (Retd.) K S P Radhakrishnan and Hon’ble Justice (Retd.) J Chelameswar (“Ld. Arbitral Tribunal”), finding favour with the case, pleaded on behalf of the Senior Lenders, awarded INR 1737.11 crore (plus additional interest and costs) as damages for HSIIDC’s breach of substitution agreement entered into between the Senior Lenders, HSIIDC and M/s KMP Expressways Limited, i.e. the concessionaire (“KMP”/ “Concessionaire”) (“Arbitral Award”).

The Senior Lenders had claimed before the Ld. Arbitral Tribunal that the quantum of damages for breach of the substitution agreement, by HSIIDC, was equivalent to the amount of debt due from the Concessionaire under the financing agreements, in relation to a road infrastructure project – Kundli-Manesar-Palwal expressway. The rationale being that if HSIIDC had not frustrated the Senior Lenders right to substitute a new concessionaire in place of KMP/ Concessionaire, the said new concessionaire would be required to take over the dues owed by the Concessionaire/KMP to the Senior Lenders.

With a claim of such nature having no precedence in Indian law, the Ld. Arbitral Tribunal, placing reliance on foreign jurisprudence, evolved a novel method for the quantification of damages and awarded the entire amount of INR 1737.11 crore, i.e. the debt due to the Senior Lenders, along with interest, to the Senior Lenders. To balance equities, the Arbitral Award also directed reimbursement of sums which the Senior Lenders may recover from the Concessionaire under proceedings before the Ld. Debt Recovery Tribunal, to HSIIDC.

The Hon’ble Supreme Court, in upholding the Arbitral Award, has not only recognised, in no uncertain terms, the importance of the Senior Lenders’ right of substitution and the need to ensure sanctity of contracts in infrastructure projects (which are undertaken on a public-private partnership basis), it has also affirmed the unique manner in which Senior Lenders have been compensated.

Brief background

HSIIDC and KMP (as the Concessionaire) entered into a concession agreement in 2009 to develop, operate and maintain the 135-km Kundli-Manesar-Palwal Expressway in Haryana on a Build, Operate and Transfer basis (“Project”). The Project was funded by the Senior Lenders, with toll revenues and receivables from the Project being the primary security. Further, to recognise and strengthen the Senior Lenders’ security interest, a tripartite Substitution Agreement was executed between HSIIDC, the Concessionaire and IDBI Bank Limited, as the Lenders’ Agent on January 8, 2007 (“Substitution Agreement”), which inter alia gave the Senior Lenders the right to substitute the Concessionaire, with an obligation on HSIIDC to impose a condition on the new concessionaire to take over the Senior Lenders’ dues.

In view of the excessive delays and large public interest involved in the Project, in January 2015, the Hon’ble Supreme Court directed the Haryana Government to take appropriate steps to award the same contract to a new concessionaire within two months. However, HSIIDC replaced the Concessionaire without stipulating that the new concessionaire must take over the debt due to the Senior Lenders, in blatant breach of HSIIDC’s obligations under the Substitution Agreement. This was done despite the Senior Lenders putting HSIIDC to notice of its obligations towards the Senior Lenders under the Substitution Agreement, as well as of the Senior Lenders’ vital right to substitute the Concessionaire.

The Project was re-tendered for the balance work by way of a tender notice, dated February 20, 2015 (“Tender Notice”), and the Senior Lenders’ right to substitute the Concessionaire and consequently their right to recover the debt due from the new concessionaire stood frustrated, which was the genesis of the dispute between the Senior Lenders and HSIIDC.

The Senior Lenders initiated arbitration proceedings against HSIIDC and the Concessionaire, claiming damages for the loss suffered by the Senior Lenders due to breach of the Substitution Agreement by HSIIDC. In a first of its kind claim, the Senior Lenders claimed damages to the extent of the entire debt due to them, considering that the same would have been recoverable from the new concessionaire had the Tender Notice not been issued in breach of the Substitution Agreement.

The Ld. Arbitral Tribunal in a novel adjudication of the claims sought for, relied on foreign jurisprudence to award the entire principal outstanding along with interest, amounting to INR 1737.11 crore, as damages to the Senior Lenders. The Arbitral Award is a first of its kind in India, wherein the debt due from the Concessionaire has been awarded as damages for breach of contract by a government authority. Additionally, to balance equities and ensure that the Senior Lenders do not recover their debt twice, the Ld. Arbitral Tribunal directed the Senior Lenders to reimburse HSIIDC for the full amount that they may recover from the Concessionaire, in the proceedings initiated before the Ld. Debt Recovery Tribunal.

Proceedings before the High Court challenging the Arbitral Award

The Arbitral Award was challenged by HSIIDC by initiating proceedings under Section 34 of the Arbitration and Conciliation Act, 1996 (the “Act”), before the Hon’ble Delhi High Court. However, the Hon’ble Delhi High Court, by way of an order dated March 29, 2022 upheld the Arbitral Award and dismissed the petition. Thereafter, HSIIDC preferred an appeal under Section 37 of the Act. During the pendency of the said appeal, by way of an order dated May 30, 2022, the Hon’ble Delhi High Court directed HSIIDC to deposit a portion of the outstanding amount – INR 600 crore – into the escrow account of the Senior Lenders within six weeks. HSIIDC challenged the said order before the Hon’ble Supreme Court, however, the appeal was dismissed as the Hon’ble Supreme Court refused to interfere and upheld the order directing deposit. Subsequently, the appeal under Section 37 of the Act also came to be dismissed by way of an order dated July 11, 2023, in favour of the Senior Lenders.

Proceedings before the Hon’ble Supreme Court

The order dated July 11, 2023 passed in the appeal under Section 37 of the Act was then challenged by HSIIDC by way of the SLP. Vide order dated December 01, 2023, the Hon’ble Supreme Court has dismissed the said petition and upheld the Arbitral Award, while recording that HSIIDC shall pay the entire outstanding amount under the Arbitral Award to the Senior Lenders within two months from the date of the said order. Further, to balance the interest of parties, the Hon’ble Supreme Court has exercised its powers under Article 142 of the Constitution of India and directed that HSIIDC be impleaded as a co-applicant in the ongoing proceedings before the Ld. Debt Recovery Tribunal initiated by the Senior Lenders against the Concessionaire.

The arbitral proceedings which were initiated in 2016, have culminated into a final order, with the Hon’ble Supreme Court in effect enforcing the Arbitral Award, which is path breaking for public sector banks in other similar proceedings, especially those involving infrastructure projects. As a result of the aforesaid order, the Senior Lenders will now be able to recover 100% of the principal amount due to them, along with interest.

The Senior Lenders are set to recover approximately INR 2100 crore in total, out of which HSIIDC has paid approximately INR 1800 crore, subsequent to the passing of the order dated December 01, 2023. The proceedings have reinstated the belief that lending banks/ agencies are not remediless when they fund infrastructure projects, executed by special purpose vehicles incorporated with negligible assets or state agencies that are known to be voracious litigants.