In a commercial contract, a tender is procured upon estimation of prices of material and labor to be incurred in future. However, these prices are susceptible to change due to reasons beyond the control of either party. Such unforeseen change in prices, which may shake the very foundation of the bargain, which parties entered into, may lead to frustration of contract, which in turn leads to termination of contract. To avoid such a situation, an escalation clause is added into the contract, which takes into account any future changes in prices of labor and material.

It is a cardinal principle of arbitration, that the arbitrator derives his authority from the terms of the contract and an award passed in contravention of such terms of contract is without jurisdiction and is liable to be set aside. However, there are several instances where contract does not provide for escalation clause and the contract is extended beyond completion period because of no fault of contractor. Thus, contractor suffers losses because of extension of contract and becomes entitled to damages, which include escalation in cost of material and labor. In such a situation, the question that crops up is whether arbitrator can award escalation in cost of material and labor in absence of any clause for escalation in the contract. In a recent case of Union of India (UOI) vs. Varindera Constructions Ltd. and Ors.,the Supreme Court, in a special leave petition overturned the decision of division bench, Single Judge and arbitral tribunal and held that in presence of a clause expressly prohibiting escalation charges, arbitrator cannot award escalation charges. However, since there are many aspects of interpretation of escalation charges in varying circumstances, the author in this article expounds upon other situations dealing with interpretation of escalation charges in contract.

Where there is absence of escalation clause in contract
In absence of an escalation clause in contract, the arbitrator is within his jurisdiction to award escalation charges if the delay is not attributable to the contractor himself. This was dealt by Supreme Court in case of Food Corporation of India vs. A.M. Ahmed and Co. and Ors.

It was held in this case:

“Escalation, in our view, is normal and routine incident arising out of gap of time in this inflationary age inperforming any contract of any type. In this case, the arbitrator has found that there was escalation by way of statutory wage revision and, therefore, he came to the conclusion that it was reasonable to allow escalation under the claim. Once it was found that the arbitrator had jurisdiction to find that there was delay in execution of the contract due to the conduct of the FCI, the Corporation was liable for the consequences of the delay, namely, increase in statutory wages. Therefore, the arbitrator, in our opinion, had jurisdiction to go into this question.” This has been reiterated by court in case of Assam State Electricity Board and Ors. vs. Buildworth Pvt. Ltd.

In case of Ramachandra Reddy and Co, the court has held that escalation can be granted only either when contract provides for it or when competent authority has agreed to provide for escalation charges by correspondence. In case of Food Corporation of India, the contractor had made several correspondences with regards to escalation charges, however, the authority never replied to them and kept silent as to whether escalation charges will be paid to contractor.

Where there is a cap on amount that can be claimed as escalation charges
The court in case of N.J. Devani Builders P. Ltd. vs. Indian Farmers Fertilizer Cooperative Ltd, held that in case there is a cap on escalation clause, irrespective of the actual amount of loss suffered, arbitrator cannot award escalation charges more than the amount stipulated in the contract. The court stated that: 

“The imposition of limitation on the amount of escalation that the Contractor may claim by a contractual term cannot be said to be a term which offends public policy or to be forbidden by law. In contractual matters, the promisee may desire that the promisor should make a definite promise with regard to the costs to be incurred by the promisee for getting the work done. It is for the promisor to make his own estimation and evaluation on the basis of his experience and to make his offer on that basis, keeping in view the contractual terms”

Where there is cap on total amount of damages that can be claimed in contract
Where there are clauses in contracts which place limit on total amount of damages which can be claimed irrespective of total loss, the question that surfaces is whether escalation can be asked over and above the damages paid by authority under the clause. An illustration of such clause is given in case of Pt. Munshi Ram and Associates (P) Ltd. vs. Delhi Development Authority and Ors.

“Clause 22 is also the relevant clause which reads as under:

“All sums payable by way of compensations under any of these conditions shall be considered as reasonable compensation to be applied to this use of Delhi Development Authority without reference to the actual loss or damage sustained, and whether or not any damage shall have been sustained.”

While giving interpretation of such clause in terms of escalation, the court held that in such cases also if the contractor has suffered actual loss because of no fault of his own then he is liable to be compensated for the same.

Conclusion
Escalation clause takes care of the rise and fall in price but the parties can always agree that the contractor would not be entitled to any escalation whatsoever or that the contractor would be entitled to escalation limited to a certain amount or a certain percentage of  the contract. Such a stipulation is not illegal or inconsistent.

However, in absence of such stipulation, court will always rule in favor of equity and will not allow party to be unjustly enriched at cost of other.