Beyond the 1% Cap: Bombay High Court Upholds Arbitrator's Power to Ignore Liability Limits in Cases of Abject Government Default and Explains the "Take Into Account" Standard Under Section 28(3).

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Case: PUBLIC WORKS DEPARTMENT GOT OF MAHARASHTRA NATIONAL HIGHWAYS v. KHARE AND TARKUNDE INFRASTRUCTURE PVT LTD
Court: Bombay High Court
Date: 12-06-2026
Law: Arbitration and Conciliation Act, Indian Contract Act.

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In the complex world of infrastructure projects, the "Right of Way" (ROW) is the lifeblood of progress. Without it, contractors are left with idle machinery, mounting bank interest, and a project that exists only on paper. But what happens when a government department fails to provide this land for years, yet points to a tiny clause in the contract to limit its liability? A recent judgment by the Bombay High Court in Public Works Department v. Khare And Tarkunde Infrastructure Pvt. Ltd. offers a masterclass in how modern arbitration law balances the "sanctity of contract" with "commercial common sense".

The case involved a road infrastructure project where the PWD was supposed to provide 90% of the ROW within 15 days. Instead, the delay stretched to 45 months. When the contractor sought damages, the PWD pointed to Clause 4.1.5, which capped aggregate damages at a mere 1% of the contract price. The Arbitral Tribunal ignored this cap, and the High Court was asked to decide if an arbitrator has the power to "rewrite" a contract in the face of such an absurdity.

1. The "Take Into Account" Revolution

Perhaps the most significant legal takeaway is the court’s analysis of the 2015 amendment to Section 28(3) of the Arbitration and Conciliation Act. Previously, the law mandated that tribunals decide "in accordance with" the terms of the contract. The amendment changed this to "take into account" the terms of the contract.

The court noted that this was a conscious departure by Parliament to give arbitrators "greater elbow room" to adjudicate facts. While an arbitrator cannot simply ignore a contract, they are no longer "hidebound" by clauses that, when applied to extraordinary facts, produce irrational results. This shift allows the tribunal to act as a judge of equity and business reality rather than a mere grammarian of the contract text.

2. When a Liability Cap Becomes "Unconscionable"

The PWD argued that even if they were ten years late, the 1% cap should remain. The court found this proposition "absurd". It held that the 1% cap was premised on the PWD fulfilling its foundational obligation—providing the land. When that foundation is missing, the cap cannot be blindly applied.

"To my mind the serious deep limit placed under Clause 4.1.5 would be applicable only if there had been a reasonable delay in handing over the ROW... the contention that even if the Agreement had been terminated only another decade later... the cap on damages would still be 1%, would lead to an absurd outcome and make a mockery of contract law."

This reinforces the principle that a party cannot benefit from its own wrong by using a limitation clause as a shield against a total breach of its primary obligations.

3. The Business Efficacy Test as a Tool of Justice

The judgment highlights the "Business Efficacy Test"—a legal doctrine used to imply terms into a contract to make it work as the parties must have intended. The court used this to reconcile conflicting clauses. If one clause (the 1% cap) "inflicts violence" upon the rest of the contract (the 18-month completion timeline), the arbitrator must reconcile them to give the project commercial sense.

The court agreed that keeping a contractor mobilized for 45 months on a project meant to last 18 months, while refusing to pay more than 1% in damages, fails the test of commercial wisdom. It transforms a contract into an "unconscionable" bargain that no reasonable businessman would have struck if they knew the land would never be provided.

4. The Boundary of Perversity: The Interest Rate Trap

While the court supported the arbitrator on damages, it drew a sharp line at the award of interest. The Tribunal had awarded 18% interest compounded quarterly, justifying it by looking at the contractor’s actual borrowing costs from banks. The High Court set this aside as "patently illegal".

The reasoning is a vital warning for arbitrators: while you have leeway to interpret the "substance" of a dispute, you cannot ignore specific "calibrated bargains" regarding interest rates. If the contract specifies a rate for defaults, the tribunal cannot "turn the bargain on its head" by substituting it with the contractor's personal financial burdens. Interest is a matter of contract and statute, not a secondary vehicle for awarding extra damages.

A Forward-Looking Summary

This judgment is a victory for substantive justice over formalistic contract reading. It signals that in the post-2015 arbitration era, Indian courts will protect the "commercial soul" of an agreement. However, it also serves as a reminder that this "elbow room" is not a license for total freedom; the specific bargains made by parties—especially regarding interest—remain protected from judicial or arbitral overreach.