Before finalizing the contract price for any given project, a contractor has to factor in a number of elements ranging from cost of materials to the cost of complying with the legal and regulatory framework. Yet, involvement in a long-term works contract inadvertently means that the contractor has to face unpredictability with regards to fluctuation in prices of goods/materials or the introduction of a new law or change in legal scenario, compliance with which can significantly increase costs. Higher pre-estimation of such costs while placing bids might place the contractor at a risk of losing the tender, and if he quotes his price without factoring in these economic dynamics, he might incur losses. To account for such contingencies, works contract often contain a Price Variation Clause and a Change in Law Clause to allow alteration of contract price. These clauses safeguard the interest of the contractor against the element of speculation.
Apart from the usual unanticipated rise in market price of materials/goods/components in any given economy by way of inflation or changes in market conditions such as high demand, labour shortages, profit margins, etc., such fluctuations may also be brought about by the government's effecting a change in legislation which may directly/indirectly mandate an increase/ decrease in price of a certain good. There have been many instances where under powers granted to it, the government has increased the price of materials crucial to operations by enacting laws to that effect. This has often left contractors fraught with the issue of whether to raise claim for the differential price escalation under the Price Variation Clause or Change in Law clause, with many leaning towards the latter.
In the case of SEAMEC Ltd. v. Oil India Ltd.1 , although the Supreme Court agreed that increase in the price of High-Speed Diesel had been by way of a government circular attracting the 'Change in Law' clause, yet the Arbitral Tribunal had erred by foregoing interpreting the contract as a whole - that the contract was granted on a 'fixed price basis' and variations to the contract price could not be permitted. Keeping aside the controversial discussion surrounding the interference of the Court with the Arbitral Tribunal's interpretation of the contract (under the ambit of S. 34 of the Arbitration and Conciliation Act, 1996), the mere inclusion of a Price Variation clause or a Change in Law clause in a works contract should imply that the parties had agreed to allocate risk of price escalation to the employer despite it being a fixed-sum contract. This article aims to draw the difference between Price Variation and Change in Law, while providing the best recourse against a situation similar to SEAMEC.
FUNDAMENTALS OF A PRICE VARIATION CLAUSE AND CHANGE IN LAW CLAUSE
A typical Price Variation clause may read like:
"The Contract Price shall be adjusted for increase or decrease in rates and price of labour, cement, steel, plant, machinery and spares, fuel and lubricants and other material inputs in accordance with the principles, procedures and formulae specified."
On the other hand, a Change in Law clause may read as:
"If, after the deadline set for Bid submission in the country where the Site is located, any law, regulation, ordinance, order or by-law having the force of law is enacted, promulgated, abrogated or changed (which shall be deemed to include any change in interpretation or application by the competent authorities) that subsequently affects the costs and expenses of the Contractor and/ or the Time for Completion, the Contract Price shall be correspondingly increased or decreased, and/ or the Time for Completion shall be reasonably adjusted to the extent that the Contractor has thereby been affected in the performance of any of its obligations under the Contract."
It is obvious that while the Price Variation clause is given to account for fluctuations in market prices of commodities determined by employing formulae such
as the Wholesale Price Index (WPI), the origin of Change in Law clause was to account for change in tax liabilities2 e.g., introduction of GST, implementation of safeguard/ anti-dumping duties, etc. However, the scope of the latter has been widened to include all laws in force3 and not be just industry or sector specific.
Yet, it has been seen that despite courts recognizing a change in law which can artificially inflate the prices of materials essential to operations, they have been wont to disentitle the aggrieved party, i.e. the contractor of the reimbursement it sought under this clause citing some other contractual detriment.
SEAMEC LTD. V. OIL INDIA LTD.: BACKGROUND
SEAMEC Ltd. (Appellant) was awarded a contract by Oil India Limited (Respondent) in 1995, for drilling wells and other ancillary operations in Assam. While the operations were underway, the price of High-Speed Diesel (HSD) was increased through a Government of India circular (Govt. Circular). As HSD was crucial for drilling purpose, the Appellant raised a claim for the increased price, by invoking the Change in Law clause under the Contract.
The Arbitral Tribunal interpreted the clause liberally. It held that "while an increase in HSD price through a circular issued under the authority of State or Union is not a "law" in the literal sense, but has the "force of law" and thus falls within the ambit of Change in Law clause" and passed the award in favour of the Appellant. The Respondent's application under Section 34 of the Act for setting aside the award was dismissed by the District Court stating that the award was not baseless, not against the public policy of India, nor patently illegal, and therefore, did not warrant interference. The decision of the District Court was further challenged before the Guwahati High Court in an appeal under Section 37 of the Act.
The High Court set aside the award on the ground that it overlooked the terms of the contract -the Change in Law clause was akin to a Force Majeure clause. Aggrieved by the decision of the High Court, the Appellant filed an appeal before the Supreme Court.
The Supreme Court noted that the Tribunal had considered the Govt. Circular as a change in law, not only due to the principles of interpretation, but also based on the testimony of the Respondent's witness. This testimony cleared that the Respondent had been aware - even during the time of entering the Contract - that a change in fuel price was never brought about by a statutory enactment, but always through a Government Order, etc. Therefore, the change in law was broadly construed to include the Govt. circular.
However, according to the Court, the Tribunal should have taken into consideration all the clauses of the Contract. After perusing all the materials on record, the Court came to the conclusion that the parties had not agreed to a broad interpretation of the Change in Law clause, and therefore the Tribunal should have harmoniously constructed the contract as a whole. The Court also observed that the contract had been awarded on the basis of SEAMEC's bid and that the rates, terms and conditions of the Contract were to be in force until the completion of the last well. To this end, the Court concluded that he Contract was awarded on a fixed price basis with no scope for price variation - that to mitigate the risk of the employer footing price fluctuations, the contractor had agreed to factor in the contingency into the contract price while submitting its final bid.
ANALYSIS OF THE SUPREME COURT'S DECISION
The entire purpose of the clause was to specifically entitle the contractor to an increased price claim, in case the event in question caused the overall cost of undertaking the works to inflate for the contractor. The adjudication should have been limited to whether the event causing the increase in cost was indeed a 'change in law' - something that the Tribunal constrained itself to. Even if the parties had intended for the contract to be a fixed price contract, the inclusion of Change in Law clause, which has become an industry standard at this point, should imply that parties do anticipate price escalation on a limited aspect. The Supreme Court's decision effectively not only rendered the clause superfluous, but also potentially added to the woes of a contractor who often has to suffer from unequal bargaining power with the government while negotiating contractual terms.
RECOURSE TO PRICE VARIATION CLAUSE
The case of SEAMEC is a not a unique one where contractors have faced reluctance on part of the judiciary to acknowledge and implement change in law to the former's benefit. In Energy Watchdog v. Central Electricity Regulatory Commission, even though the price of imported Indonesian coal was raised astronomically by the Indonesian Government, the Supreme Court refused to grant relief by way of compensatory tariff citing the Change in Law clause, stating that change in foreign law could not invoke said clause.
The presence and invocation of a Price Variation clause could have been beneficial in these cases. The Supreme Court has duly observed and held in the matter of Food Corporation of India v. AM Ahmed & Co.4 that even if there is no clause pertaining to price escalation, the contractor shall be entitled to same if the delay was attributable to employer. In this case, the Arbitral Tribunal found that there was escalation by way of statutory wage revision and therefore, came to the conclusion that it was reasonable to allow escalation under the same. Similar precedent was set by the Supreme Court in JG Engineers Pvt. Ltd. v. Union of India5 wherein it upheld an award entitling the contractor to price escalation despite it being conditional in term of the contract for the extended period of contract, wherein delay was attributable to the employer.
Even if the courts seem more inclined toward granting relief under an Price Escalation clause, it has to be borne in mind that an arbitrator must apply terms of contract for determining valuation of claim if it is a result of price variation of materials. In Bedi Construction Co. v. Delhi Development Authority6 , it was held that if increase in prices of material purchased by contractor or labour rate is more than 10% of value of contract, then the contractor can only make a claim in respect of increase in prices that also for the amount which goes beyond 10% of the contract value. Thus, to a contractor it may seem more feasible to invoke a Price Variation clause to compensate for statutory increase of prices of materials given that the drafting of this clause is usually more forthcoming than a Change in Law clause, even though there is always a threshold to the relief that can be granted under a Price Variation clause as opposed to a Change in Law clause.
1. Civil Appeal No. 673 of 2012 (decided on 11 May 2020).
2. M/s Sumitomo Heavy Industries Ltd v. Oil & Natural Gas Company (AIR 2010 SC 3400).
3. Energy Watchdog v. Central Electricity Regulatory Commission ((2017) 14 SCC 80)
4. (AIR 2007 SC 829)
5. (AIR 2011 SC 2477)
6. ((2009) ILR Supp. 8 Del 52)
Originally published by INDIAN LEGAL IMPETUS® on JULY 2020. Vol. XIII, Issue VII
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.