The Shifting Sands of Contractual Autonomy: The Supreme Court's Landmark Reference on Excepted Claims in Arbitration

Introduction: The Paramountcy of Party Autonomy in Arbitration

The law of arbitration in India, governed by the Arbitration and Conciliation Act, 1996 (the "Act"), has long celebrated the principle of party autonomy as its "brooding and guiding spirit." This foundational doctrine empowers contracting parties to design their own dispute resolution universe, defining its scope, procedure, and the very boundaries of what can be adjudicated. Central to this autonomy is the parties' freedom to agree on terms that may exclude or prohibit certain categories of claims from being raised in any subsequent arbitration. Such clauses, commonly known as "excepted matters," "prohibited claims," or "exclusionary clauses," are the bedrock of contractual risk allocation, particularly in complex government and construction contracts.

However, a critical question has simmered in Indian arbitration jurisprudence: Does a contractual prohibition on a specific claim apply only to the employer/opposing party, or does it also bind the Arbitral Tribunal, thereby ousting its very jurisdiction to entertain such a claim?

The recent judgment of the Supreme Court of India in The State of Jharkhand v. The Indian Builders, Jamshedpur (Civil Appeal Nos. 8261-8262 of 2012, decided on December 05, 2025), authored by Justice Pamidighantam Sri Narasimha, has thrown this question into sharp relief. In a momentous decision, the Court has chosen not to decide the immediate dispute but has instead referred the seminal case of Bharat Drilling & Foundation Treatment Pvt. Ltd. v. State of Jharkhand (2009) to a larger bench for reconsideration. This reference signals a potential tectonic shift in how Indian courts view the sanctity of contractual prohibitions vis-à-vis an arbitrator's jurisdictional mandate.

This blog post dissects this pivotal judgment, analyzing its context, the legal principles it engages with, and its profound implications for arbitrators, lawyers, contracting parties, and students of arbitration law.

Part I: The Factual Crucible – Prohibited Claims and Judicial Discord

The dispute arose from a standard construction contract between the State of Jharkhand (Appellant) and The Indian Builders (Respondent). The contract contained two critical clauses under the "Claims" section:

a.   Clause 4.20.2: "No claim for idle labour, idle machinery, etc. on any account will be entertained..."

b.   Clause 4.20.4: "No claim shall be entertained for business loss or any such loss. 

Disputes arose, and arbitration was invoked. The Arbitral Tribunal, in its award dated 19.04.2007, allowed several claims, including:

a.   Claim No. 3: For underutilised overheads.

b.   Claim No. 4: For loss due to underutilised tools, plants, and machinery.

c.   Claim No. 6: For loss of profit.

The State challenged the award under Section 34 of the Act before the Civil Court. The Civil Court, applying a textual reading of the contract, set aside Claims 3, 4, and 6. It held that Claims 3 & 4 were squarely barred by Clause 4.20.2 (idle machinery etc.), and Claim 6 (loss of profit) was expressly prohibited by Clause 4.20.4 (business loss). The Civil Court thus upheld the sanctity of the contractual prohibition.

The Contractor appealed to the High Court under Section 37 of the Act. The High Court, in a terse order, reversed the Civil Court and restored the Arbitral Tribunal's award. Its sole reasoning was that the issue was "conclusively covered" by the Supreme Court's 2009 decision in Bharat Drilling & Foundation Treatment Pvt. Ltd. v. State of Jharkhand.

 Aggrieved, the State approached the Supreme Court. Its core grievance was not merely the outcome in its specific case but a systemic concern: the Bharat Drilling precedent was being "regularly and wrongly" applied to interpret prohibitory clauses in government contracts, effectively neutralizing them.

Part II: The Legal Fault Line – Bharat Drilling and the Principle Under Challenge

The Supreme Court's decision to refer Bharat Drilling hinges on a critical examination of what that case actually held. In Bharat Drilling, a similar argument was advanced that a contractual bar against certain claims applied only to the employer department and not to the Arbitral Tribunal. The Supreme Court in 2009, without extensive analysis, cited its earlier judgment in Board of Trustees for the Port of Calcutta v. Engineers-De-Space-Age (1996) and restored the arbitral award.

The Port of Calcutta case, however, dealt with a fundamentally different issue: the arbitrator's power to award interest. It established that unless a contract contains an express, specific prohibition on the arbitrator's jurisdiction to award interest, the arbitrator retains that power. This principle stems from the unique statutory scheme for interest under Section 31(7) of the Act.

The Core Contention: The State of Jharkhand argued that Bharat Drilling erroneously transposed the "interest jurisprudence" from Port of Calcutta to the realm of substantive claim prohibitions. The question of interest is largely procedural and statutory. In contrast, clauses like 4.20.2 and 4.20.4 define the substantive rights and liabilities of the parties—they delineate what can and cannot be claimed as a matter of contractual entitlement. By relying on Bharat Drilling, arbitrators and courts were effectively rewriting substantive contractual risk allocation, holding that a clause stating "no claim shall be entertained" only bound the employer, not the tribunal.

The Supreme Court in the present case found this contention compelling. It highlighted that the High Court had failed to even examine the contractual clauses, blindly applying Bharat Drilling. This prompted the Court to undertake a deeper examination of the underlying principles.

Part III: The Supreme Court's Reasoning: Reaffirming Contract as the Foundation

Justice Narasimha’s judgment powerfully reiterates the primacy of the contract in arbitration. The Court draws upon a trilogy of recent landmark judgments to underscore this point:

1.  Central Organisation for Railway Electrification (CORE) v. M.P. Karmachari Sabha (2024): This judgment was quoted extensively to reaffirm that "party autonomy" is the "brooding and guiding spirit" and "backbone" of arbitration. The Act repeatedly uses phrases like "unless otherwise agreed by the parties" and "the parties are free to agree," making it clear that the arbitrator is bound by the procedures and agreements between the parties.

2.  Pam Developments Private Limited v. State of West Bengal (2024): This case was directly on point. The Supreme Court there upheld the High Court's setting aside of an award that granted claims for idle machinery, which were prohibited under the contract's "Special Terms and Conditions." The Court held: "This is not even a matter of interpretation. It is the duty of every Arbitral Tribunal and court alike and without exception, for contract is the foundation of the legal relationship." This statement is a direct rebuke to the approach that sidelines clear contractual prohibitions.

3.  Cox and Kings Ltd. v. SAP India Private Ltd. (2024) & In Re: Interplay Between Arbitration Agreements... and Stamp Act (2023): These decisions were cited to emphasize the contemporary judicial trend of strictly upholding contractual terms and the institutional integrity of arbitration agreements.

The Court’s Key Distinction: The judgment makes a crucial analytical distinction:

a.   Interest under Section 31(7): This is a statutory power conferred on the arbitrator. A contractual clause must specifically oust this statutory jurisdiction to be effective. The Port of Calcutta line of cases governs this.

b.   Substantive Claim Prohibitions (e.g., "no claim for idle machinery"): These are creatures of the contract itself. They define the substantive scope of what is payable. An arbitrator derives jurisdiction from the arbitration agreement, which is itself part of the contract. If the contract declares that a certain head of damage is not claimable, there is arguably no substantive right to be arbitrated upon. The arbitrator, whose mandate is to decide disputes "in accordance with" the contract, cannot create a liability that the contract expressly extinguishes.

The Supreme Court concluded that the reasoning in Bharat Drilling, which borrowed from the interest-related Port of Calcutta doctrine to handle substantive claim bars, was "not appropriate" and was "not in tune" with the principles reaffirmed in CORE, Pam Developments, and Cox and Kings.

 Part IV: Implications of the Reference: A Legal Crossroads

The reference of Bharat Drilling to a larger bench places Indian arbitration law at a significant crossroads. The eventual decision will have far-reaching consequences:

 For Arbitrators & Arbitration Practice:

a.   Clarity on Mandate: A potential overruling or refinement of Bharat Drilling would provide much-needed clarity. Arbitrators will be on firmer ground in dismissing prohibited claims at the threshold, upholding the principle of kompetenz-kompetenz to determine that they lack jurisdiction over a substantively barred claim.

b.   Shift in Approach: It would necessitate a more rigorous contractual analysis at the award-writing stage. Arbitrators would be expected to directly engage with and give effect to exclusionary clauses, rather than sidelining them based on a precedent that may be overturned.

c.   Reduced Award Challenges: Awards that respect clear contractual prohibitions may face fewer challenges under Section 34(2)(b)(ii) (award in conflict with the public policy of India) for being patently illegal or contrary to the terms of the contract.

 For Drafting Lawyers & Contracting Parties:

a.   Sanctity of Drafting: The reference reinforces that carefully drafted "excepted matter" clauses are meaningful. Parties, especially government entities, can have greater confidence that their risk-allocation mechanisms will be enforced.

b.   Precision is Key: The distinction highlighted by the Court underscores the need for precision. A clause stating "the Employer shall not be liable for..." may be argued differently from "No claim shall be maintainable/entertainable before any forum including arbitration for..." The latter is a stronger ouster of jurisdiction.

c.   Strategic Considerations: Contractors will need to be more vigilant during contract formation and project execution. Claims falling under prohibited categories may need to be framed as variations, breaches of fundamental terms, or under separate legal heads not covered by the prohibition.

 For the Judiciary (Courts under S. 34 & S. 37):

a.   Scope of Intervention: It may reaffirm the courts' role in examining whether the arbitrator has acted contrary to the express terms of the contract—a core ground for challenge. The "patent illegality" standard of review may see a resurgence in the context of ignoring clear contractual bars.

b.   End of Mechanical Application: It should prevent the mechanical application of Bharat Drilling as a blanket excuse to bypass clear contractual language, as happened in the High Court in this case.

For Law Students & Academics:

a.   Case Study in Evolution: This is a prime example of the dynamic evolution of arbitration law. It highlights the tension between finality of awards, party autonomy, and judicial review.

b.   Doctrinal Analysis: It offers rich material for studying the difference between substantive and procedural limitations on arbitral power, and the interpretive principles governing exclusion clauses.

 Part V: The Road Ahead and Concluding Reflections

The Supreme Court's decision to refer the matter is an act of profound judicial responsibility. It acknowledges that a precedent, perhaps decided without full consideration of its sweeping implications, has created uncertainty in a critical area of commercial law. By seeking an "authoritative decision" from a larger bench, the Court aims to provide stability and align Indian law with the fundamental tenet that arbitration is a consensual process bounded by the contract.

Until the larger bench decides, a state of cautious ambiguity prevails. Practitioners may find lower courts and tribunals less inclined to apply Bharat Drilling rigidly, given the Supreme Court's strong skepticism expressed in this reference order.

In conclusion, State of Jharkhand v. Indian Builders is more than a case about idle machinery and loss of profit. It is a pivotal moment that asks a foundational question: In the temple of party autonomy, who is the higher deity—the unrestricted jurisdictional power of the arbitrator, or the clear, prohibitory words upon which the parties shook hands? The answer from the larger bench will redefine the boundaries of arbitral authority and reaffirm the immutable principle that in arbitration, as in all contract law, the agreement of the parties is the supreme law inter se.

Details of the Case:

1.   Case Title: The State of Jharkhand vs The Indian Builders Jamshedpur

2.   Citation: 2025 INSC 1388

3.   Court: Supreme Court of India

4.   Civil Appeal Nos.: 8261-8262 of 2012

5.   Date of Judgment: December 05, 2025

6.   Bench: Justice Pamidighantam Sri Narasimha, Justice Atul S. Chandurkar

7.   Key Precedent Referred to Larger Bench: Bharat Drilling & Foundation Treatment Pvt. Ltd. v. State of Jharkhand & Ors., (2009) 16 SCC 705.

8.   Core Legal Issue: Whether a contractual clause prohibiting certain claims (e.g., for idle machinery, business loss) binds only the employer or also ousts the jurisdiction of the Arbitral Tribunal from entertaining such claims.

9.   Outcome: The Supreme Court expressed doubts on the correctness of the law laid down in Bharat Drilling, held it was being misapplied, and referred it to a larger bench for reconsideration. The interim implication is a significant challenge to the prevailing practice of bypassing clear contractual claim prohibitions in arbitration.