Delhi High Court Partly Sets Aside Arbitral Award; Holds Performance Bank Guarantee Proceeds Cannot Be Retained Without Proved Loss Despite Valid Invocation for Contractual Breach
Delhi High Court Finds Patent Illegality in Arbitral Award Allowing ₹1.47-Crore PBG Retention Despite Absence of Corresponding Proven Loss
Facts
The Delhi High Court considered a petition under Section 34 of the Arbitration and Conciliation Act, 1996 filed by ISGEC Heavy Engineering Limited challenging an arbitral award dated 17 August 2023 against Prakash Industries Limited (PIL).
On 18 November 2017, PIL placed a Purchase Order upon ISGEC for supply, supervision of erection and commissioning of two Waste Heat Recovery Boilers (WHRBs) for kiln Nos. 6 and 7, each valued at ₹13.71 crore, including associated Induced Draft Fans. ISGEC furnished a Performance Bank Guarantee (PBG) of ₹1,47,10,000, equivalent to 10% of the basic order value.
Disputes arose over delays and performance. The two ID fans stopped functioning in September 2019, resulting in shutdown of kiln No. 6 from 22 September to 16 November 2019. PIL purchased replacement fans at an additional cost of ₹65.92 lakh.
PIL subsequently invoked the PBG and commenced arbitration. It raised five claims aggregating to approximately ₹12.34 crore, including loss of production, power losses, purchase of sponge iron and ₹65.92 lakh towards replacement fans. ISGEC raised five counterclaims totalling approximately ₹5.82 crore.
The Tribunal allowed only PIL’s ₹65.92-lakh claim for replacement of the ID fans, rejected its remaining claims, awarded interest and ₹20 lakh costs, and rejected all of ISGEC’s counterclaims.
Before the High Court, ISGEC confined its Section 34 challenge to:
- rejection of Counterclaim No. 1 seeking refund of the ₹1.47-crore PBG amount; and
- the award of ₹20 lakh towards costs.
The ₹65.92-lakh award for replacement fans was expressly not challenged.
Issues
The principal issues were:
- Whether valid invocation of a Performance Bank Guarantee automatically permits the beneficiary to retain and appropriate the entire proceeds, even where corresponding loss or damage has not been proved.
- Whether the Tribunal committed patent illegality by ignoring the contractual exclusion in Clause 17 for loss of production, loss of profit, loss of use and indirect/consequential damages.
- Whether the rejection of ISGEC’s ₹1.47-crore PBG refund counterclaim was contrary to the contract and therefore vulnerable under Section 34.
- Whether the ₹20-lakh costs award was excessive because PIL succeeded only to the extent of ₹65.92 lakh.
- Whether the offending portion concerning Counterclaim No. 1 could be severed and independently set aside without disturbing the remainder of the award.
Petitioner – ISGEC’s Arguments
ISGEC contended that the Tribunal had adopted an internally inconsistent approach.
On one hand, it accepted Clause 17 of the amended Purchase Order, which expressly excluded liability for:
- loss of production;
- loss of profit;
- loss of use; and
- indirect or consequential damages.
On the other hand, despite rejecting PIL’s claims founded on those losses, the Tribunal permitted PIL to retain the ₹1.47-crore PBG proceeds without any separate corresponding loss being proved.
ISGEC argued that damages cannot be awarded without proof of actual loss and relied upon Uni Bros. v. All India Radio.
It further relied upon Delhi Metro Rail Corporation, Ssangyong Engineering, Santosh Dodrajka and Associated Engineering to contend that an award based on no evidence or contrary to the express contract suffers from patent illegality.
On costs, ISGEC contended that ₹20 lakh was disproportionate when PIL ultimately succeeded only on a ₹65.92-lakh claim.
Respondent – Prakash Industries’ Arguments
PIL emphasised the restricted scope of judicial review under Section 34. It argued that the High Court could not re-appreciate evidence or treat the challenge as a regular appeal.
PIL submitted that Clause 17 excluded only indirect and consequential losses—not direct loss resulting from ISGEC’s defective equipment.
It relied upon the Tribunal’s finding that the ID fan failure resulted from a defective hub design supplied by ISGEC, which had been acknowledged in meetings involving ISGEC and its vendor.
According to PIL, failure of the equipment constituted breach of ISGEC’s guaranteed performance obligations and therefore justified invocation and retention of the PBG.
Regarding costs, PIL argued that the Tribunal had statutory discretion under Section 31A and had awarded only ₹20 lakh against its claimed costs exceeding ₹3.29 crore.
Analysis of the Law
1. Invocation and appropriation of a PBG are distinct
This is the central proposition emerging from the judgment.
The High Court drew a clear distinction between:
(a) invocation of the bank guarantee because of contractual non-performance; and
(b) ultimate retention or appropriation of the money received under that guarantee.
The Court held that invocation was one aspect arising from non-fulfilment of contractual obligations. However, retention of the proceeds depended upon establishing and quantifying the loss actually suffered.
The PBG itself secured PIL against damage or loss suffered due to ISGEC’s failure to fulfil guaranteed performance and defect-liability obligations. PIL therefore had to establish the loss against which it sought to appropriate the PBG proceeds.
That crucial second limb was absent.
2. PBG proceeds cannot be appropriated towards unproved damages
The Tribunal had already awarded PIL ₹65.92 lakh towards the replacement cost of the defective ID fans.
It rejected PIL’s remaining loss and damage claims.
Further, the contractual provision providing for liquidated damages due to non-performance had not been invoked by PIL.
Consequently, the High Court held that merely relying upon the wording of the PBG could not justify retention of the entire ₹1.47 crore.
The guarantee secured loss; it did not create an independent entitlement to a windfall irrespective of actual established damage.
Contractual Exclusion Under Clause 17
Clause 17 contained a non-obstante provision stating that neither party would be liable to the other for:
- loss of production;
- loss of profit;
- loss of use; or
- any other indirect or consequential damage.
The High Court found that the Tribunal had failed to properly consider the interplay between this exclusion clause and the PBG.
Since the PBG had been furnished pursuant to the Purchase Order, it could not be interpreted in isolation from the underlying contractual limitations.
By ignoring Clause 17 while permitting appropriation of the PBG proceeds, the Tribunal travelled beyond the parties’ agreed contractual framework.
The Court characterised this as a jurisdictional error.
Precedent Analysis
Ssangyong Engineering & Construction Co. Ltd. v. NHAI
The High Court relied upon Ssangyong for the principle that where an arbitrator wanders outside the contract and decides matters beyond what the parties have contractually entrusted, the arbitrator commits an error of jurisdiction capable of attracting Section 34(2A).
The Tribunal could not disregard the contractual exclusion of particular categories of damages.
PSA SICAL Terminals v. V.O. Chidambaranar Port Trust
This authority reinforced the proposition that an arbitrator’s jurisdiction is confined to the four corners of the agreement.
The arbitral tribunal is a creature of the parties’ contract and cannot award or sustain relief contrary to that contractual framework.
Indian Oil Corporation v. Shree Ganesh Petroleum
The Court relied upon Indian Oil Corporation for the principle that an award becomes patently illegal where the Tribunal fails to act according to, or ignores, specific contractual terms.
Applying these authorities, the High Court held that permitting appropriation of PBG proceeds towards unproved losses and damages was without basis, perverse and patently illegal.
Gayatri Balasamy v. ISG Novasoft Technologies Ltd.
This precedent was critical to the relief granted.
The Supreme Court in Gayatri Balasamy, (2025) 7 SCC 1, held that although a Section 34 court ordinarily cannot modify an arbitral award, it may sever and set aside an invalid portion where that portion is separable from the valid remainder.
The power to set aside an award therefore includes the lesser power to set aside a severable part while preserving unaffected determinations.
The High Court found the rejection of Counterclaim No. 1 entirely severable from the remaining claims and therefore set aside only that portion.
₹20-Lakh Arbitration Costs Upheld
ISGEC did not succeed in its challenge to costs.
The High Court held that under Section 31A(3), an arbitrator enjoys discretion in awarding costs, subject to the statutory considerations.
The amount of costs cannot be mathematically determined merely by comparing the amount originally claimed with the amount ultimately awarded.
Relevant considerations include:
- conduct of the parties;
- partial success;
- frivolous counterclaims causing delay; and
- refusal of reasonable settlement offers.
Accordingly, the Court found no factual or legal error in the Tribunal’s award of ₹20 lakh towards costs and refused to interfere with it.
Court’s Reasoning
The High Court did not hold that PIL’s invocation of the PBG was itself invalid.
Rather, its reasoning was more precise: contractual breach may justify invocation, but the beneficiary’s subsequent entitlement to appropriate and permanently retain the proceeds must correspond to loss or damage actually established under the governing contract.
Here:
- defective ID fans were established;
- PIL was separately awarded ₹65.92 lakh for replacing them;
- the remaining loss claims were rejected;
- Clause 17 excluded specified indirect/consequential losses;
- the contractual liquidated damages clause had not been invoked; and
- no separate loss corresponding to the balance PBG amount was proved.
The Tribunal nevertheless permitted PIL to retain the PBG proceeds.
The High Court held that this conclusion had no contractual or evidentiary basis and was therefore perverse and patently illegal under Section 34.
At the same time, because the offending determination was severable, the Court did not disturb the remainder of the arbitral award.
Conclusion
The Delhi High Court partly allowed ISGEC’s Section 34 petition.
It held that the Tribunal had erred in rejecting Counterclaim No. 1 concerning the ₹1.47-crore Performance Bank Guarantee because appropriation of the PBG proceeds required PIL to establish and quantify the loss for which those proceeds were being retained.
The Tribunal’s failure to consider Clause 17 and its decision to permit retention towards unproved losses amounted to patent illegality.
Applying Gayatri Balasamy, the Court held that the rejection of Counterclaim No. 1 was severable and therefore set aside only that portion of the award.
The Court, however, upheld the ₹20-lakh costs award and did not disturb the unchallenged ₹65.92-lakh award for replacement of the defective ID fans.
Case Details
Case: ISGEC Heavy Engineering Limited v. Prakash Industries Limited
Court: Delhi High Court
Case Number: O.M.P. (COMM) 503/2023
CNR: DLHC010518952023
Judge: Justice Avneesh Jhingan
Reserved On: 31 August 2026
Pronounced On: 8 September 2026
Arbitral Award: 17 August 2023
PBG Amount: ₹1,47,10,000
Result: Petition partly allowed; award set aside insofar as it rejected ISGEC’s Counterclaim No. 1 concerning the PBG; ₹20-lakh costs award upheld; remainder of award undisturbed.
