Section 31(7) of the Arbitration and Conciliation Act 1996 (the 1996 Act) gives an arbitrator the discretion to include, in a sum for which an award is made, interest, unless otherwise agreed by the parties.

Krafters Engineering and Leasing (P) Limited (the respondent) was awarded a contract by the Union of India (the appellant) to work on signalling arrangements at certain railway stations. The contract contained (among other things) an arbitration clause and a clause which prohibited the award of interest on amounts due under the contract.

Upon completion of the contract, the respondent raised certain claims and the Bombay High Court (High Court) referred the dispute to arbitration under the provisions of the Arbitration Act 1940 (the 1940 Act).

The tribunal rendered an arbitral award which included an award of interest. The appellant challenged the award in the High Court. The Single Judge, and subsequently the Division Bench of the High Court each dismissed the challenge.

The appellant applied to the Supreme Court of India (Supreme Court) by a special leave petition, raising the question of whether the tribunal had jurisdiction to grant interest despite the agreement prohibiting the granting of such interest.

The Supreme Court, allowing the appeal, held that "...where the parties had contractually agreed that no interest shall be payable, the arbitrator cannot award interest for the amounts payable to the contractor under the contract." The court observed that the 1940 Act did not contain any specific provision relating to the power of an arbitrator to award interest. However, the specific provision in section 31(7) of the 1996 Act, and the Supreme Court's own decisions in previous cases where the same point of law was considered, suggested that the power to grant interest could be excluded by agreement. The court, therefore, set aside the award of the tribunal granting interest, as well as the orders of the Single Judge and the Division Bench of the High Court.

With this decision, the Supreme Court has made it amply clear that if the parties to the arbitration agreement so desire, they can contractually agree to bar any interest being awarded. This judgment is also consistent with earlier judgments of the Supreme Court in referring to sections specifically inserted in the 1996 Act (which were absent in the now repealed 1940 Act), even when an arbitration has taken place under the 1940 Act.

Union of India (UOI) v. Krafters Engineering and Leasing (P) Limited, Civil Appeal No. 2005 of 2007 (12 July 2011).