The Delhi High Court has clarified a critical principle in arbitration law: when a performance bank guarantee is encashed conditionally pending arbitration, and the arbitrator later finds the encashment unlawful, the interest accrued on the encashed amount must be released alongside the principal. This decision reinforces the inseparability of principal and interest in such contexts, preventing unjust enrichment by the opposing party.
Background & Facts
The Dispute
The Delhi Development Authority (DDA) invited bids for the construction of a hotel on commercial plot No. 3B1, Twin District Towers, Rohini, to accommodate guests for the Commonwealth Games 2010. The petitioner, Jackson Developers (P) Ltd., was the successful bidder. A Demand-cum-Allotment Letter was issued on 04.01.2008, requiring the hotel to be operational within 24 months of allotment. The petitioner was obligated to furnish a Performance Bank Guarantee (PBG) equivalent to 5% of the bid amount, valid for four years.
Key Facts
- The bid amount was Rs. 186,00,00,000 (Rs. 186 crores), making the PBG amount Rs. 9,30,00,000 (Rs. 9.3 crores)
- The petitioner submitted building plans in March 2008, but approvals were delayed: Chief Fire Officer approved on 28.11.2008 and Delhi Urban Arts Commission on 12.12.2008
- The petitioner deposited "Prior to Sanction Charges" in May 2009 as a condition for plan approval
- Formal possession of the plot was granted on 08.09.2008
- The hotel was made operational in September 2010, prior to the commencement of CWG 2010
- The petitioner applied for a completion certificate on 15.09.2010, which was rejected on 21.09.2010
- The petitioner rectified deficiencies and obtained Limited Term Permission on 29.09.2010, which was extended periodically
- The hotel operated continuously during and after CWG 2010
- The DDA intended to invoke the PBG in May 2010 for alleged delay in completion
Procedural History
- 09.06.2010: Petitioner filed petition under Section 9 of the Arbitration and Conciliation Act, 1996; Delhi High Court granted ex parte ad interim injunction restraining DDA from encashing PBG
- 12.05.2011: Sole arbitrator appointed by the Court
- 22.10.2013: Arbitrator, under Section 17, vacated the Section 9 injunction but directed DDA to deposit the encashed PBG amount in a Fixed Deposit Receipt (FDR) with a nationalized bank, with interest to "abide the outcome of the matter"
- 25.04.2023: Arbitral award passed holding DDA was not entitled to invoke or encash the PBG; claim for non-encashment allowed
- 21.05.2023: Addendum issued clarifying that while the principal amount of Rs. 9,30,00,000 was to be released to petitioner, interest accrued on the FDR was not to be released
- 30.04.2026: Judgment reserved
- 05.05.2026: Judgment pronounced
Relief Sought
The petitioner sought setting aside of the addendum dated 21.05.2023 to the arbitral award, specifically challenging the denial of interest accrued on the FDR. The petitioner contended that the interest formed an inseparable part of the PBG amount and must be released along with the principal.
The Legal Issue
The central question was whether, after an arbitral award holds that a Performance Bank Guarantee could not lawfully have been encashed, the interest accrued on the encashed amount held in a Fixed Deposit Receipt must be released to the party entitled to the principal, or whether the arbitrator may independently deny interest under Section 31(7) of the Arbitration and Conciliation Act, 1996.
Arguments Presented
For the Petitioner
The petitioner argued that the interest accrued on the FDR was not a separate claim under Section 31(7) but an inseparable component of the PBG amount, as explicitly stated in the interim order under Section 17. The arbitrator’s own direction that the amount "along with interest accrued thereon shall abide the outcome of the matter" bound the final award. Denying interest while releasing principal violated the principle of equity and rendered the interim order nugatory. The petitioner relied on Central Bank of India v. Ravindra & Ors. to establish that interest becomes part of the principal when held in a deposit account.
For the Respondent
The DDA contended that Section 31(7) grants the arbitrator discretion to award interest on monetary claims, and since the petitioner’s claim for interest on the delayed completion was rejected, the arbitrator was entitled to deny interest on the FDR. It argued that the interest was not part of the original dispute and was a separate financial benefit, not a component of the PBG itself. The DDA further claimed that delay in completion was attributable to both parties, justifying retention of interest.
The Court's Analysis
The Court examined the nature of the interim order under Section 17 and its relationship with the final award. It emphasized that the condition imposed by the arbitrator on 22.10.2013 - that the encashed amount and interest "shall abide the outcome of the matter" - was not a mere procedural formality but a substantive safeguard to preserve the status quo pending final determination.
"The realised amount along with interest accrued on FDR was subject to outcome of the arbitration proceedings."
The Court held that the interest accrued on the FDR was not a claim for interest under Section 31(7), which applies to monetary awards made by the arbitrator. Rather, it was a natural consequence of the encashment of the PBG, which itself was held to be unlawful. The FDR, including its interest, was a single, inseparable fund created to ensure that the party ultimately entitled to the PBG received the full benefit.
"The FDR as a whole will have to go as per the decision of the arbitrator with regard to invocation of the PBG."
The Court rejected the DDA’s argument that the arbitrator had discretion to deny interest under Section 31(7), noting that no monetary award was made - only a declaration that the encashment was unlawful. The interest was not a claim for damages or compensation; it was a financial consequence of the interim arrangement. To permit the DDA to retain the interest while returning the principal would amount to unjust enrichment and defeat the very purpose of the interim order.
The Court further noted the contradiction in the award: while rejecting DDA’s counterclaim for interest on delay, it indirectly awarded DDA interest on the FDR. This was held to be perverse and patently illegal.
The Court invoked Gayatri Balasamy v. ISG Novasoft Technologies Ltd. to hold that the award’s direction denying interest on the FDR was severable from the rest of the award, as it was a distinct, non-dependent part. The principal release and interest denial were not interwoven.
The Verdict
The petition was allowed. The Court set aside the addendum dated 21.05.2023 to the extent it denied the release of interest accrued on the Fixed Deposit Receipt. The DDA was directed to release to the petitioner the entire amount of Rs. 9,30,00,000 along with all interest accrued thereon from the date of encashment until the date of actual payment. The DDA was ordered to comply within four weeks from the date of judgment.
What This Means For Similar Cases
Interest on Encashed Security Is Inseparable from Principal
- Practitioners must now treat interest accrued on encashed performance guarantees or bank securities as part of the principal sum, not as a separate claim under Section 31(7)
- Any interim order directing funds to be held in an FDR with interest "to abide the outcome" creates a binding obligation to release the entire corpus upon final determination
- Arbitrators cannot sever interest from principal when the interim order explicitly links them
Arbitrators Cannot Use Section 31(7) to Justify Retaining Interest on Encashed Security
- Section 31(7) applies only to interest on monetary awards, not to interest generated on funds held in trust pending final award
- If the arbitrator finds the encashment unlawful, the entire fund - principal and interest - must be returned to the party entitled to the security
- Retaining interest under the guise of denying a claim for interest under Section 31(7) constitutes patent illegality
Interim Orders Under Section 17 Are Binding on Final Awards
- Interim directions under Section 17 are not mere procedural safeguards; they form part of the procedural framework governing the final award
- Courts will enforce the spirit of interim orders even if the final award does not explicitly reiterate them
- Failure to comply with the condition of an interim order (e.g., holding funds in FDR with interest) renders the final award partially invalid
