DIGITAL CONTRACT

M/S Goa Telecommunications & Systems Ltd. vs Union Of India on 17/7/2001

ORDER

J.D. Kapoor, J.

1. This is an application under Order 39 Rules 1 & 2 for interlocutory injunction by way of restraining the
defendants, their servants, agents, officers, representatives from and in any manner encashing or
attempting to encash or acting further to demands dated 18.1.2000 issued fro encashment of bank
guarantees issued by Syndicate Bank, Panaji, Goa, defendant No. 4 and also for restraining defendant No. 4
from acting on the demand of defendants 1-3 and from disbursing or paying any money to the said
defendants.

2. The facts relevant for the aforesaid application are in brief as under:

The plaintiff was one of the successful bidders to a tender floated by the defendant No. 1 and 2 for supply of
optical fibre line terminating equipment in the year 1995 and the defendants placed an Advance Purchase
Order (APO) on the plaintiff for supply of two items as referred in para 3 of the plaint for a total contract
value of Rs. 9,17,56,000/-.

3. In terms of Clause 1 of the said Advance Purchase Order, the plaintiff furnished a Bank Guarantee (No.
24/95) of the Syndicate Bank, Panaji, Goad in the sum of Rs. 30,36,000/-. A detailed and final Purchase
Order was placed by the plaintiff on 31.1.96 which was a consolidated purchase order for supply of both the
aforesaid items. In respect of one item the defendants rejected the plaintiff's sample. In the meanwhile the
Bank guarantee which was furnished by the plaintiff in response to the Advance Purchase Order expired on
30.4.99.

4. In order to maintain cordial relations with the defendants, the plaintiff, by letter dated 13.7.99, agreed to
replace the said expired guarantee by a fresh guarantee subject to the condition that replaced guarantee
shall be for a value calculated as a percentage of the value of the purchase order dated 30.1.96 in
accordance with Clause 4.1 of the General (Commercial) Condition of the contract. The plaintiff furnished
the fresh guarantee for Rs. 22,62,103/- as against the sum of Rs. 30,36,000/-.

5. There was no response to the plaintiff's proposal and in fact by letter dated 20.10.99 the defendants 1 to 3
made a demand on the plaintiff for payment of Rs. 30,36,000/- the amount covered by the said bank
guarantee, interalia, on the ground that the plaintiff has not performed its contractual duties/obligations
under the purchase order dated 31.1.96 and has, therefore, purportedly committed breach of the contract.

6. However, the plaintiff while making its position clear sent a letter dated 2.12.99 to the defendants
informing that even if the said bank guarantee had been alive, it was not encashable for the full amount as it
was far in excess of the amount contractually required to be secured and also that in any event since one of
the two items have already been supplied in full, the defendants were not entitled to recover the entire
secured amount. Inspite of this defendant No. 2 threatened to encash both the bank guarantees furnished
by the plaintiff as security in two other contracts to recover the said amount of Rs. 30,36,000/- and
revealed its entitlement to do so for the first time under the "Set-off" clause in conditions governing the
purchase order dated 31.1.96. At the same time defendants 1-3 also issued two demands claiming a total
sum of Rs. 27,36,160/- being the balance after adjusting the payment of Rs. 2,99,840/- issued by the
defendants addressed to the Syndicate Bank, Panaji, Goa for encashment furnished by the plaintiff in two
other purchase orders/contracts which were not related to the purchase order dated 31.196.

7. It is averred that the aforesaid Purchase Orders against which the two impugned bank guarantees were
furnished by the plaintiff were fully executed and supplies there under concluded and the defendants 1 and
2 have also issued the Final Inspection Certificate tot he plaintiff in respect thereto, the entire action of the
defendants in firstly demanding from the plaintiff the full secured amount of Rs. 30,36,000/- is completely
illegal and without any basis and the said defendants have no authority whatsoever under any provision of
the contract governing the said Purchase Order, much less the purported "Set-Off" Clause, to recover the
amounts purportedly and allegedly due in one contract from bank grantees furnished by the plaintiff in
other contracts.

8. It is further averred that even if it is assumed that the defendant shave the authority to do so, the demand
made by the defendants for encashment of the said two bank grantees is invalid as it is not in accordance
with the said bank guarantees which can, in accordance with their terms, be encashed only to recover
damages in the event of breach of only those Purchase Orders in relation to which they were furnished.

9. The "Set-Off" Clause in the purchase order dated 31.1.96 under which the said bank guarantee is sought
to be encashed by the defendants is incorporated as Clause 21 of Section III of the General conditions
Contract and reads as under:

"21.0 Set-Off - Any sum of money due and payable to the contractor (including security deposit refundable
to him under this Contract may be appropriated by the Purchaser or the Government or any other person or
persons contracting through the Government of India and set off the same against any claim of the
purchaser or Government or such other person or persons for payment of a sum of money arising out of
this contract or under any other contract made by the contractor with the purchaser of the Government or
such other person or persons contracting through Government of India".

10. The relevant term requiring demand to be made in a specific manner contained in the bank guarantee
reads as under:

"We, Syndicate Bank, Panaji Branch do hereby undertake to pay the amounts due and payable under this
Guarantee without any demur, merely on a demand from the Government stating that the amount claimed
is due by way of loss or damage caused to or would be caused to or suffered by the government by reason of
breach by the said Contractor(s) of any of the terms or conditions contained in the said Agreement or by
reason of the Contractor(s) failure to perform the said Agreement....."

11. According to the plaintiff the purported "Set-Off" Clause and the terms of the Bank Guarantee shows
that the action of defendants 1 to 3 in attempting to encash the bank guarantees is not only completely
invalid, illegal and without any contractual or equitable basis, but is also a completely mala fide action
tantamounting to a fraud being payed on the plaintiff.

12. Defendants, on the contrary accused the plaintiff for having failed to complete the contractual obligation
and the purchase order was short closed and thereafter the plaintiff was requested to send a performance
bank guarantee amount to the defendant but the request was not complied with and only a partial amount
of Rs. 2,99,840/- was sent against the total amount Rs. 30,36,000/- and therefore to realise the balance
amount the defendants are within their right to invoke the Set-Off Clause.

13. As is apparent the whole controversy revolves around that fact whether the invocation is in terms of the
bank guarantee or not s there is a distinction between the guarantee for due performance of the work
contract and the guarantee given towards security deposit to that contract. It is settled law that the
invocation of bank guarantee should be in terms of the bank guarantee alone unless elements of fraud and
irretrievable damages are involved.

14. In view of this settled position of law with regard to the relationship between banker and customer, the
legal position governing the grant or refusal of injunction with regard to the bank guarantee is also beyond
the pale of controversy.

15. The court should always be reluctant in the case of a confirm bank guarantee to interfere with the same.
In other words it should refrain from injuncting against its encashment as doctrine of due performance of
contract is not applicable to encashment of bank guarantees. The above view receives support and
confirmation from the following decisions of the Supreme Court:

1. Hindustan Steel Workers Construction Ltd. vs. G.S. Atwal & Co. (Engineers) Pvt. Ltd. .

2. Hindustan Steelworks Construction Ltd. Vs. Tarapore & Co. and Another .

3. Dwarikesh Sugar Industries Ltd. Vs. Prem Heavy Engineering Work (P) Ltd. & Another .

16. Observations of the Supreme Court in Hindustan Steelworks vs. Tarapor & Co. case need to be
reproduced. These are as under:

"Whether the bank guarantee is towards security deposit or mobilisation advance or contract if the same is
unconditional and if there is a stipulation in the bank guarantee that the bank should pay on demand
without a demur and that the beneficiary shall be the sole judge not only on the question of breach of
contract but also with respect to the amount of loss or damages, the obligation of the bank would remain
the same and that obligation of the bank would remain the same and that obligation has to be discharged in
the manner provided in the bank guarantee.

17. The main objection of the plaintiff is with regard to the authority to invoke the bank guarantee in
question by switching in the Set-Off Clause i.e. Clause 21 of the Contract which states that any claim of the
purchaser or the government or any other person or persons contacting through the Government of India
and Set Off the same against any claim of the purchaser or government or such other person or persons for
payment of a sum of money arising out of this contract or under any other contract made by such other
person or persons contracting through Government of India.

18. The contention of learned counsel for the plaintiff in brief is that the invocation is not in terms of the
bank guarantee in as much as bank guarantee was in respect of contract NO. SE/APO/18/98-99 while the
invocation is being sought in respect of purchase order CPO/105/95-96 dated 31.1.96.

19. There is no dispute with regard to the legal preposition that the invocation of the bank guarantee has
always to be in terms of the bank guarantee. In Hindustan construction Co. Ltd. vs. State of Bihar & Ors.
1999(6) SCALE 486, it was held that a bank guarantee is the common mode of securing payment of money
in commercial dealings as the beneficiary, under the guarantee, is entitled to the whole of the amount under
that guarantee in terms thereof irrespective of any pending dispute between the person on whose behalf the
guarantee was given and the beneficiary of the bank guarantee constitute a separate distinct and
independent contract.

20. In the aforesaid case bank guarantee was furnished to the Chief Engineer and chief Engineer was
nowhere defined in the bank guarantee nor was it provided therein that the Chief Engineer was inclusive of
Executive Engineer. It was held that the bank guarantee was invokable by none except by the Chief
Engineer. Since the Bank guarantee in that case was invoked by Executive Engineer, it was held to be
wholly wrong as the bank was under no obligation to pay the amount covered by the Performing Guarantee
to the Executive Engineer.

21. If the applicant/plaintiff succeeds in showing that the invocation of the guarantee is not in terms of the
bank guarantee it will be entitled for interlocutory injunction, otherwise no. Admittedly the bank guarantee
was given in respect of contracts SE/APO/18/98-99 and SE/APO/28/98-99 dated 1.9.98. The invocation is
being sought in respect of purchase order CPO/105/95-96 dated 31.1.96.

22. Let us see what does the controversial Clause of the guarantee contemplates. Said Clause reads as
under:

We, Syndicate Bank, Panaji Branch do hereby undertake to pay the amounts due and payable under this
guarantee without any demur, merely on a demand from the Government stating that the amount claimed
is due by way of loss or damage caused to or would be caused to or suffered by the Government by reason of
breach by the said Contractor(s) of any of the terms or conditions contained in the said Agreement or by
reason of the Contractor(s) failure to perform the said Agreement. Any such demand made on the Bank
shall be conclusive as regards the amount due and payable by the Bank under this guarantee where the
decision of the Government these counts shall be final and binding on the bank.

23. Clause 21 of the Agreement is a Set-Off Clause that has already been set out above.

24. As is apparent from the aforesaid clause of the bank guarantee, mere statement in the letter of
invocation that the amount is due by way of loss and damages was sufficient as the bank was not concerned
as to how the loss has been caused or suffered by the Government. Letter invoking the bank guarantee
reads as under:

"1. This has reference to your letter No. Italtel/99-Y2K/453 dated 2.12.99 forwarding cheque No. 863268
dated 28.7.99 for Rs. 2,99,840/- against encashment of the above mentioned bank guarantee.

2. In this connection your kind attention is drawn to this office letters of even no. dated 21.10.99 and
30.11.99 wherein your company were requested to pay Rs. 30,36,000/- i.e. equivalent to the bank
guarantee amount on account of failure of contractual obligation against DOT Purchase Order No.
CT/PO/105/95-96 dated 31.1.96 for the supply of OLTE and digital Mux.

3. In our letter dated 30.11.99, it was clearly mentioned that in case full payment is not received within 15
days, we shall be constrained to recover the amount from other bank guarantee available with this office.

4. While accepting the payment of Rs. 2,99,840/- as partial payment, the balance amount is being
recovered from other bank guarantees available with this office by invoking set off clause of purchase order
under reference."

25. By virtue of Clause 21 any sum or money due and payable under the contract can be appropriated by the
purchaser or the Government or any other person or persons contracting through the Government of India
and set Off the same against any claim of the purchaser or Government or such other person or persons for
payment of a sum of money arising out of this contract or under any other contract made by the contractor
with the purchaser of the Government or such other person or persons contracting through Government of
India.

26. Thus the defendants were well within their right to invoke the bank guarantee though given in respect
of a different contract after setting off the same against any claim of the purchaser under any other contract
made by the contractor with the defendants.

27. Reliance by learned counsel for the applicant upon the decision made in Driplex Water Engineering
Limited vs. Indian Oil Corporation FAO(OS)185/1999 is misplaced as in this case the invocation of the bank
guarantee by the defendant-corporation was found to be not in terms of the bank guarantee. Similarly the
ratio in Driplex Water Engineering Limited Vs. Indian Oil Corporation & Another FAO(OS) 185/1999 relied
by the learned counsel does not come to its rescue. In Driplex Water the bank guarantee said that it was
unconditional and irrevocable guarantee but at the same time it required serving of a notice of demand by
the defendant on the bank and such a notice also required the defendant to state the amount of claim as
retention cum performance. The bank guarantee provided that the amount so stated by the defendant in
any demand claimed or notice of retention-cum-performance as between bank and the defendant for the
purpose of the bank guarantee shall be conclusive.

28. Since it was observed that the invokation was not in consonance with the terms of the guarantee in as
much as notice did not mention that there was a claim against the plaintiff and that it merely stated that the
bank guarantee was being invoked as per the terms of the bank guarantee, that the invokation was held to
be not in terms of the guarantee.

29. The difference of facts of the instant cases and the case referred above is of earth and sky.
30. In the instant case the defendants have made a claim in respect of past contract which was permissible
under Clause 21 of the Agreement and the bank guarantee specifically mentioned that the bank shall pay
the amount due and payable under the guarantee without any demur or merely on a demand from the
Government stating that the amount claimed was due by way of loss or damage caused or would be caused
to or suffered by the Government by reason of any breach by the said Contractor of any of the terms or
conditions contained in the said Agreement or by reason of the contractor's failure to perform the said
Agreement.

31. Since Clause 21 of the Agreement provided that if some of money due and payable by the contractor
under this contract may be appropriated by the purchaser or Government or any other person or persons
contracting through the Government of india and Set Off the same against any claim of the purchaser or
Government or such other person or persons for payment of a sum of money arising out of this contract or
under any other contract made by the contractor with the purchaser of the Government or such other
person or persons contracting through Government of India, the objection of the plaintiff that the
defendant was not empowered to invoke the bank guarantee in respect of a past contract is wholly
groundless and without any substance whatsoever.

32. I deem it needless to discuss in detail the authorities cited by the learned counsel for the plaintiff in
support of his contention that the bank guarantee has been invoked in respect of past contract and not in
respect of the contract to which it pertained and therefore is not in terms of the bank guarantee as the facts
are pronounced distinguishable.

33. The authorities cited by the learned counsel are to the effect that unless the bank guarantee invoked is
as per terms of the guarantee its invocation is bad in law. The authorities relied upon are:

(i) Ansal Properties & Industries Ltd. vs. Union of India & Ors.

(ii) Puri International (P) Ltd. vs. National Building Construction Co. Ltd. & Another .

34. The Supreme Court has cautioned the courts to be slow in granting the injunction to restrain the
realisation of such a bank guarantee and in a decision in U.P. State Sugar Corporation has made the
following observations with regard to the bank guarantees:

"The very purpose of giving such a bank guarantee would otherwise be defeated. The Courts should
therefore, be slow in granting an injunction to restrain the realisation of such a bank guarantee. The
existence of any dispute between the parties to the contract is not a ground for issuing an injunction to
restrain enforcement of bank guarantees. The Courts have carved out only two exceptions. A fraud in
connection with such a bank guarantee would vitiate the very foundation of such a bank guarantee. The
second exception relates to cases where allowing the encashment of an unconditional bank guarantee would
result in irretrievable harm or injustice to one of the parties concerned."

35. In view of the undisputed legal position that the contract of bank guarantee is independent of the
primary contract and encashment of an unconditional bank guarantee is not dependent upon the
adjudication of dispute between the parties to the primary contract and since there is a stipulation that the
bank shall pay the amount covered by the guarantee of payment without any demur and there is no plea of
fraud or irretrievable injury neither has the applicant good prima facie case nor does the balance of
convenience lie in its favor not is the applicant going to suffer irreparable loss and injury.

36. The aforesaid reasons persuade me to decline the interlocutory injunction against the defendants. The
application has no merit and is hereby dismissed.

OUTSOURCING CONTRACT:
Godavari Polymers Pvt. Ltd. vs Agricultural Products Commissioner And Principal Secretary, Agriculture
And Co-Operation (Horti) Department, Govt. Of A.P. And Anr. on 4/12/2003

ORDER

V.V.S. Rao, J.

Prologue

1. The Government of Andhra Pradesh (GoAP), so as to increase irrigation efficiency with available water
has mooted A.P. Micro Irrigation Project (APMIP). The project envisages to bring a huge extent of
agricultural land under micro irrigation. So as to encourage the farmers to shift from surface method of
irrigation to micro irrigation, GoAP took a policy decision to give fifty per cent subsidy to farmers who
invest in micro irrigation equipment by taking a bank loan arranged by the Department of Horticulture.
Identification of the land to be brought under particular technology of micro irrigation and modus operandi
were worked out. As a first step, the Government identified seven manufacturers and suppliers willing to
supply micro irrigation system (MIS) with performance guarantee and agronomic extension service to the
farmers. The petitioners also expressed interest to participate in APMIP. The petitioners were not included
in the panel of shortlisted manufacturers. Inclusion of seven companies/concerns is not challenged, but
non-inclusion in the list of participants is made the issue in these proceedings. As the background facts and
submissions to assail the decision of GoAP are same, it is expedient to dispose of the writ petitions by a
common order.

Introduction

Task Force on Micro Irrigation System

2. After instituting green revolution by Integrated Seed Water Irrigation Fertilizer Technology, irrigation
percentage in India increased from less than 20% in 1950-51 to about 40% in 2002 bringing 82 million
hectares under irrigation. The irrigated area, however, deteriorated due to exhaustion of irrigable area and
depletion of water sources. It is estimated that by 2025, due to increased demand of water by different
sectors, the share of water for agriculture is expected to get reduced from 84% to 69% though demand for
water for agricultural purposes is likely to increase by two-fold.

3. At present, canal irrigation and tube-well irrigation are predominant irrigation systems. This has led to
indiscriminate use of water and lack of appropriate technology and technology transfer mechanism
resulting in agro-ecological and sustainability problems. The receding water table along with underground
water pollution posed problems in tube-well irrigation areas. The water use efficiency in India is lowest in
the world. It appears that water use efficiency in Indian agriculture is about 30% to 40% whereas it is 55%
in China. Development of water resources and the management of developed water sources are constant
problems in managing agriculture.

4. In comparison to canal/tube-well irrigation system, micro-irrigation allows the application of water to

the root zone of the crops through specially designed equipment known as emitters. This technology is said
to be more efficient method of irrigation and was introduced in India on a commercial scale during Eighth
Five Year Plan. During the last ten years, 0.5 million hectares was brought under micro-irrigation. Surveys
revealed that an extent of 69 million hectares would be covered through improved technology of micro
irrigation system (MIS) so that inefficient water use in agriculture would be curbed and water is reserved
substantially to meet the future needs and aspirations of the people. There is a paradigm shift in the policy.
In February 2003, Government of India (GOI) decided to go into various aspects of water management in
irrigation by constituting a task force headed by Chief Minister of Andhra Pradesh to recommend measures
needed to expand the coverage by micro irrigation. This task force on micro irrigation (TFM) visited various
States in India as well as Israil which made progress in micro irrigation. The TFM felt that micro irrigation
system should be addressed to poverty alleviation by increase in income, to bring vast rain-fed areas in
irrigated areas to greater productivity and stability and by creation of additional employment opportunities
through involvement of private sector. It also felt that MIS is also addressed to horticulture-led
diversification of agriculture, (enhanced productivity through increase in the yield resulting in greater
competitiveness in the world market by adopting the motto 'more crop per drop'. Environmental protection
and ecological security and promotion of equity be considered while reviewing MIS in a holistic manner.

5. The TFM also noticed that lack of credit, human resources, availability of appropriate material and
technical know how and financial incapacity of farmers to invest in MIS are some of the constraints in
pushing MIS ahead. Therefore, TFM while suggesting important considerations for successful adoption of
MIS made recommendation regarding fiscal incentives, tax incentives and credit support. It also
recommend that flow of benefits either by financial assistance or subsidy would be routed through National
Bank for Agriculture and Rural Development (NABARD). It was further suggested that Rural Infrastructure
Development Fund (RIDF) can also be availed in the form of loan from NABARD. The TFM also suggested
to use appropriate technology of MIS in either drip irrigation or lift irrigation depending on area and crop
pattern.

Salient features of MIS Technology

6. Agricultural and Horticultural experts and scientists perceive MIS Technology as consisting of Drip
Irrigation which again has two systems known as Online Drip System and Inline Drip System. They also
perceive MIS Technology as consistent of Sprinkler Irrigation System and Rain Guns. The use of particular
technology depends on the crop pattern, soil chemistry and crop spacing. For instance, Sprinkler system is
employed where the crops like groundnut, sugarcane, millets, pulses and vegetables are raised using
irrigation source of a pumpset of moderate capacity. Sprinkler system can be employed covering about
double the area than the area covered by conventional method of open rain farming. The technology used is
simple and user friendly. The rain gun technology would replace the Sprinkler Irrigation System if a large
area of the farm is to be covered. This requires better high capacity pumping for maintaining sufficient
pressure to enable the rain gun to carry the water to desired distance.

7. Drip Irrigation System is altogether different from Sprinkler Irrigation System. Online drip system
consists of HDPE semi-hard pipe which is made of emitters and plain lateral. That is to say, that the fanner
can make water allotting facility online as per need by pumping plain lateral. Inline drip irrigation system
consists of emitting pipe with fixed holes and the system laid in such a manner that water is released either
through pumping or gravitation so as to enable plants to absolve water at the route level without wastage.
Either under online or inline systems, water is directly carried to the root without large surface evaporation
losses. Inline drip system is relatively new technology with self cleaning, low clogging problem and stronger
seamless lateral tubes. Both drip systems have their own advantages and disadvantages. Inline Drip
Irrigation System is predominantly used in close growing crops like Sugarcane, Malbari, Cotton and Spices.
Online Drip Irrigation system is used in wider row orchard and plantation crops, Cashewnut and Coconut.
All the systems can be used simultaneously in the same form and there is no hard and fast rule that a
farmer should use only one technology even if he is raising different crops.

8. There is a difference of opinion as to which Drip system is cost effective. The amount of money for laying
drip system in one hectare of land is treated as a 'unit cost'. Unit cost may not be an important factor when
one decides upon appropriate drip system for a particular agricultural land. Be that as it is, Andhra Pradesh
Micro Irrigation Project, as we see presently, envisages adoption of Sprinkler Irrigation System and Drip
Irrigation System (both Online and Inline)

A.P. Micro Irrigation Project (APMIP)

9. A.P. Micro Irrigation Project was taken up with plan for installation of MIS in 2.5 lakhs hectares covering
fruits, vegetables, flowers, Rice and Sugarcane, Malbari, Cotton, Tobacco, Groundnut, Pulses etc. The
project seeks to implement the scheme in 18 to 24 months in a phased manner in 901 Mandals giving
priority to drought prone areas of Rayalaseema and Telangana regions as well as water-scarce Mandals of
Coastal Districts of Andhra Pradesh. All the owners in specified mandals cultivating the crops which are
amenable for installation of MIS are eligible to get financial assistance under the scheme. The particulars of
the scheme are given in G.O. Ms. No. 62, Agriculture and Co-operation (Hort.) Department, dated 5-3-
2002. As per the scheme, the Government would provide 50% subsidy for MIS with a ceiling of Rs.
50,000/- for each individual farmer. Each farmer has to participate with 50% contribution either directly or
through the bank duly paying 5% margin money to the bank. The scheme envisages the funding of subsidy
under RIDF by NABARD to the tune of Rs. 560 crores. At the State level, District level and Mandal level,
institutional machinery was constituted. The Director of Horticulture (one of the respondents in these writ
petitions) was designated as Project Director of APMIP at the State level and the scheme has to be
implemented under the overall control and supervision of the District Collector.

10. As per the orders in G.O. Ms. No. 62, the Director of Horticulture was asked to get a panel of
vendors/suppliers prepared by advertising in the newspapers. The vendors/suppliers who qualified to be
included in the panel will have to meet all the requirements and standards of BIS certification to ensure
quality of material. Such suppliers should also be willing to participate, if necessary in deferred subsidy
scheme covered under the APMIP besides offering performance guarantee. The project envisaged
modalities of working as under:

(i) Each vendor would be allotted a compact area for convenience of operation.

(ii) The manufacturers and suppliers will be required to do maintenance contract and the guarantee period
upto a period of five years as part of supply.

(iii) The manufacturers and suppliers would also extend extension facility for a period of five years to
farmers in the designated area by appointing qualified Agricultural/Horticultural Officers at their own cost.

Background of Writ Petitions

11. The APMIP Cell in Department of Horticulture issued an advertisement in the newspaper dated
19.4.2003 inviting reputed Drip/Sprinkler Irrigation System manufacturers with comprehensive facilities, a
good track record and who are willing to provide performance guarantee and high-class agronomic
extension services to farmers to register their names with the Department of Horticulture for being
considered to be empanelled for the project. The manufacturers were advised to procure Expression of
Interest (EOI) documents from the department and submit them before 3 p.m. on 12.5.2003.

12. The document of request for EOI for APMIP (EOI document for brevity) is a comprehensive document
giving background of MIP, its objectives, its rationale, modus-operandi and scope of the work of suppliers.
It also contains instructions for preparation of EOI and criteria for short-listing. Every manufacturer/
supplier requesting for EOI is required to give the particulars of technical and agronomic support,
company's experience, major works during the last five years and qualifications and curriculum-vitae of
personnel in-charge of manufacturing and maintenance services. It is necessary to read instructions for
preparation of EOI and also criteria for short-listing.

13. Paragraph 7 of EOI document gives some criteria as instructions for preparation of EOI thus:

Instructions for preparation of expression on interest

1. The Supplier should have manufacturing facility and proven experience in producing online emitters,
drip laterals and inline/integral emitting pipe as per the BIS in India; supplying, surveying, designing,
installation and management of Micro Irrigation Schemes in farmers fields during past five years in any
three states of India as one of the essential qualification criteria.

2. The Supplier should have a sound knowledge and clear perception of Indian agriculture as well as
competence regarding field applicability, technical feasibility and economic viability of drip/ sprinkler
technology in fruits, vegetables commercial crops like sugarcane, cotton, mulberry etc., medicinal and
aromatic plants, spices and condiments, silviculture plantations etc.

3. The Expression of Interest should contain the following :

(a) Introduction of company with details as per Annexure-II.

(b) Experience of the firm in similar schemes/projects, size of the project, the level of responsibility and the
extent of experience are to be furnished in the format (Annexure-III). One sheet for each scheme/project
undertaken in last three years to be enclosed.

(c) Manufacturing facilities - Present Production and utilization level of the factory.

(d) Financial status of the firm. The audited balance sheets of the firm for past three years are to be
furnished.

(e) Key personnel - The C.V. of key personnel of the company are to be furnished in the format given in
Annexure-IV.

(f) Dealer and Field Extension Service Team network.

14. The other criteria for short-listing has been given in Paragraph 10 of the EOI documents.

Criteria for Shortlisting:

The Expression of Interest received by C & DOH will be evaluated and eligible and capable firms will be
short-listed. The shortlisting of the firms will be based on the following considerations;

1. Company experience.

2. Extensive experience in similar schemes/ projects, size of the project, services (technical and agronomic)
provided particularly in the most demanding features of the project.

3. Exposure at national and international level.

4. Manufacturing facilities - Present Production and utilization level. This will be verified by physical
inspection of the factory site.

5. Capacity to deliver viz. Dealer and Field Extension Service Team network.

Request for negotiations will be sent to only short-listed firms.

15. In response to advertisement, thirty seven companies submitted EOI to participate in APMIP. The GoAP
issued G.O. Rt. No. 444 dated 17.5.2003 constituting Technical Evaluation Expert Team (hereinafter called
as 'Technical Committee') for evaluation and scrutiny of EOI documents. By subsequent revised orders
dated 26.5.2003, the Technical Committee was also authorized to inspect the companies who gave EOI
documents. The Technical Committee consisted of Secretary to Government, Professors from Indian
Institute of Technology and Agriculture University, General Manager of NABARD and Additional Directors
of Agriculture and Horticulture Departments. The said committee scrutinized the EOI documents as per the
criteria for preparation of EOI and criteria for short-listing of various parameters. The following criteria for
short-listing was statedly followed by the Technical Committee.

Criteria for Shortlisting :

1. Manufacturing facility and proven experience in producing online emitters, drip laterals and
inline/integral emitting pipe as per the BIS in India as an essential qualification criteria.

2. Company experience in supplying, surveying, designing, installation and management of micro irrigation
schemes in farmers fields during past five years in any three states of India as an essential qualification
criteria.

3. Financial capability of the company.

4. Extensive experience in similar schemes/ projects, size of the protest, services (Technical and
Agronomic) provided particularly in the most demanding features of the project.

5. Exposure at national and international level.

6. Capacity to deliver viz., Dealer and Field Extension Service Team network.

7. Professional expertise.

16. The Technical Committee evolved a standard format to scrutinize and tabulate the data presented by
thirty seven (37) Micro Irrigation Companies who gave EOI for participation in APMIP. This format
included the details like year of establishment, area of operation, financial capability, production capability
(online, inline sprinkler systems), projects executed, dealer network, professional experts in the company,
Bureau of Indian Standards (BIS) licence/ certification, and the remarks of the Technical Committee which
included final conclusion of the committee. The Technical Committee also evolved guidelines for reaching
various parameters like manufacturing facilities for inline emitters and plain laterals (online irrigation
system) and emitting pipe (inline drip system), BIS licence for online and inline, national and international
exposure, financial capability, project experience in terms of network, dealer net work in Andhra Pradesh
and Profession experts in the company.

17. The Technical Committee scrutinized thirty seven (37) EOI applications between 17.5.2003 and
30.5.2003. Seven companies satisfied the criteria for shortlisting and the Technical Committee undertook
physical inspection of factories of these companies. The infrastructure facilities and technical data
pertaining to different micro irrigation companies was also tabulated in various tables and the summary of
observation of the Technical Committee during inspection was consolidated in a tabular form. The standard
formats in respect of thirty seven (37) companies who submitted EOI documents, the particulars of
infrastructure facilities and technical data obtained after inspection of seven short listed companies and the
summary of observations of the committee were included and submitted as a "Report of the Technical
Committee to the Chairman of State High Level Committee (SHLC). Be it noted, that the said SHLC was
constituted vide orders of the Government in G.O. Ms. No. 80 dated 31.1.2003 for overseeing APMIP.

18. The SHLC met on 12th and 13th of June, 2003 and made recommendations to the GoAP. The
Government considered the EOI documents, recommendations of Technical Committee and initially
approved five companies namely ; Jain Irrigation System Ltd., Jalgoan, Maharashtra, Netafim Irrigation
India (P) Ltd., Baroda, Gujarat, Parixit Industries Ltd., Ahmedabad, Gujarat, Plastro Plasson Industries
(India) Ltd., Pune, Maharashtra, Premier Irrigation Equipment Ltd., Nagpur, Maharashtra for short-listing
under APMIP. By another order in G.O. Rt. No. 627 dated 18.7.2003, Government also approved EPC
Industries Limited, Maharashtra and Nagarjuna Palma India Limited, Hyderabad for short-listing under
APMIP. These companies were advised to sign the Memorandum of Understanding (MOU) with authorized
agencies of the Government for implementation of the project. Petitioners in these three writ petitions, as
noticed hereinabove, were not approved for short-listing for participation in APMIP.

Case of the Petitioners

(i) WP No. 23777 of 2003

19. Godavari Polymers Private Limited is the petitioner. It is a company registered under the Companies
Act. They manufacture Poly Ethylene (PE) Pipes, Sprinkler Irrigation Systems and other analogous
products at its factory at Hyderabad. According to the Petitioner, these PE pipes are widely used by
consumers all over the State of A.P. and elsewhere for irrigation purpose, supply of potable water for
human consumption. It is also alleged that the petitioner's products are approved by the Governments of
Gujarat, Karnataka, Maharashtra and Tamilnadu. Pursuant to the advertisement dated 19.4.2003 in
Economic Times soliciting EOI, petitioner submitted its EOI documents allegedly complying with all
formalities and requirements, but they did not hear any response from the respondents for three months
inspite of the petitioner addressing letters on 7.7.2003, 10.9.2003 and 25.9.2003 seeking the status of
petitioner's EOI documents. On 20.6.2003, the Principal Secretary to GoAP in Agriculture and Co-
operation Department sent a communication to the effect that out of thirty seven applicants, seven have
been short-listed after inspecting them. The petitioner alleges that the respondents adopted pick and
choose method for conducting inspection of seven units elsewhere in other States, but failed to inspect the
factory of the petitioner which is 20 kms. away from Hyderabad. It is also the case of the petitioner that on
2.7.2003, the Commissioner of Industries recommended to the Director of Horticulture for giving
preference to Small Scale Industries (SSI) units, but there was no proper response from the respondents. It
is also alleged that inviting EOI, conducting inspection and short-listing of seven units is only an empty
formality as the names of short-listed companies appeared on 23.4.2003 in Economic Times newspaper.

20. It is their further case that the petitioner is a very popular manufacturer and supplier of Sprinkler
Irrigation System in the State since 1995 through the Department of Agriculture and other Departments.
The Government also gave subsidy facilities for the irrigation systems purchased from the petitioner. The
petitioner has market share of 40% in sprinkler systems. During 2002-2003 and 2003-04, Government
also placed orders. Three out of seven short-listed manufacturers of Irrigation Systems do not have
manufacturing facilities for Sprinkler Irrigation Systems. The selection of seven manufacturers is arbitrary
and mala fide being violative of letter and spirit of Constitution of India.

21. The petitioner challenges G.O. Rt. No. 529 dated 20.6.2003 and G.O. Rt.627 dated 18.7.2003 wherein
the GoAP shortlisted seven companies for participation in APMIP as violative of Articles 14, 19 and 21 of the
Constitution of India. A consequential direction is also sought directing the Respondents to consider the
application of the petitioner by inspecting its factory premises and evaluating the facilities for supply of
Sprinkler Irrigation Systems.

(ii) WP No. 23940 of 2003

22. The first petitioner is a company incorporated under the Companies Act, 1956. The second petitioner is
a Partnership firm. They filed the writ petition seeking a declaration that the action of GoAP in not
registering EOI by the petitioners to participate in APMIP as arbitrary, unjust, unfair and violative of
Article 14 of Constitution of India and for a consequential direction to GoAP to register EOI of the
petitioners and on that basis to identify compact area where sprinklers/rain guns/ online drip irrigation
systems are to be supplied by petitioners. The case of these petitioners in brief is as follows.

23. The State Government with a view to improve the quality of utilization of water resources with the
assistance of GOI implemented pilot projects switching over from conventional irrigation system by
replacing them with advanced technologies. Sprinkler Irrigation System was adopted for various crops viz.
groundnut, sugarcane etc., whereas rain guns have been adopted when farming area is large with better
pumping facilities. Yet another technology innovation is Drip Irrigation System in which water is carried
through water pipes intended to deliver required quantity of water at the required root point especially in
selected Horticulture farms. The Government also mooted APMIP and invited EOI by publishing
advertisement in Economic Times.

24. The petitioners have comprehensive manufacturing facilities for making Sprinkler Irrigation
System/Online Drip Irrigation System. They sent their EOI documents. The EOI documents of the
petitioners and other 35 manufacturers were evaluated by a committee constituted as per the orders of
GoAP in G.O. Rt. No. 444 dated 25.6.2003. This committee short-listed seven micro irrigation companies
for the purpose of inspection. The other thirty companies were not identified for inspection without any
reason. Even before short-listing of seven companies, these companies advertised that they have already
been short-listed for participation in APMIP. The appointment of a committee for inspection, the procedure
adopted for short-listing is only make believe, and arbitrary exercise.
25. The Government issued G.O. Rt. No. 529 dated 20.6.2003 initially approving short-listing five
companies and subsequently GoAP added two more companies by issuing another Government order. The
Government issued orders in G.O. Rt No. 931 dated 28.10.2003 according administrative sanction to
APMIP, by reason of which the period of two years time Government is pumping Rs. 560 crores as subsidy
component which also have loan component in equal amount by nationalised banks. Thus, the Government
has created a monopoly situation in favour of seven preferred suppliers with an assured market of Rs. 1000
crores. Though it is open to the State to choose any agency to execute its projects. State has to consider all
applicants fairly and equally on a level playing field. When all the parameters are equal, the respondents
ought not to have rejected the EOI of the petitioners though in the year 2003 the Commissionerate of
Agriculture engaged the petitioners for their pilot projects of Micro Irrigation System in five Mandals of
Ranga Reddy District. The petitioners also contend that the online drip irrigation system is the best suited
technology for the State of A. P. where water is not totally free from salts and minerals and therefore the
petitioners ought to have been preferred to Inline drip irrigation system manufacturers. The seven short-
listed companies do not manufacture all three types of Micro Irrigation Systems. The action of the State in
not registering the petitioners EOI for participation in APMIP is arbitrary and the same cannot be
sustained.

iii. WP No. 23944 of 2003

26. Two petitioners in this writ petition are companies registered under the Companies Act. The prayer
sought in this writ petition is also similar to the prayer made in W.P. No. 23940 of 2003. The first
petitioner is manufacturer of Sprinkler Irrigation Systems, whereas the second petitioner is the
manufacturer of Sprinkler Irrigation System and Online Drip Irrigation Systems. They also submitted EOI
in response to the advertisement issued by the Director of Horticulture and their EOI was not registered for
participation in APMIP. Therefore they filed the present writ petition raising contentions which are similar
to those raised in W.P. No. 23940 of 2003.

Case of the Respondents

27. The Commissioner and Director of Horticulture filed a common counter-affidavit in all the three writ
petitions denying all material averments made by the petitioners. While tracing the various stages taken by
the respondents for short-listing seven micro irrigation manufacturers, it is stated that all the thirty seven
EOI documents were scrutinized by a Technical Committee as well as SHLC. The Government accepted
recommendation of the Technical Committee and SHLC and approved short-listing of seven manufacturers
who fulfilled all the criteria. An applicant company should have in-house manufacturing facility for three
drip components, namely, lateral, online emitter and emitting pipe as per BIS specifications and five years
experience in micro irrigation schemes in any three States in India. All the seven short-listed companies
have in-house manufacturing facility for online and inline drip systems which is an essential criteria for
short-listing. Out of seven companies, two companies i.e. M/s Premier Irrigation Equipment Ltd., Nagpur,
Maharashtra and EPC Industries Limited, Maharashtra have also got in-house facility for manufacturing of
sprinklers and other five companies have outsourcing arrangement for sprinklers like the petitioner
companies. Petitioners have not fulfilled the essential criteria of manufacturing online and inline drip
irrigation systems.

28. It is also stated that petitioners in W.P. No. 23940 of 2003 and the second petitioner in W.P. No. 23944
of 2003 have not satisfied the essential criteria of having in-house manufacturing facility of emitting pipe
(inline drip system) and are only online drip system manufacturers operating in one State. Though the
petitioners in W.P. No. 23940 of 2003 have mentioned that they have supplied sprinklers and rain guns in
various schemes of concerned departments of State Government, the same is not correct. The petitioners in
W.P. No. 23944 of 2003 have sold sprinklers as per EOI documents and both the petitioners are only online
drip system manufacturers and they do not have manufacturing facility for emitting pipe which is an
essential criteria as indicated in the EOI documents. It is also stated that as per the data available with the
Agriculture Department, petitioner in W.P. No. 23777 of 2003 supplied 469 sets of sprinklers during 2000
to 2003 and the first petitioner in W.P. No. 23944 of 2003 supplied 195 sets during 2000 to 2003.

29. The allegation made by the petitioners in W.P. Nos. 23940 of 2003 and 23944 of 2003 that short-listed
companies failed to accomplish the task of covering more than 700 acres to be covered under the drip
system in five Mandals of Ranga Reddy District is denied. It is stated that two micro irrigation projects
namely Integrated Agricultural Development Project (IADP) and Integrated Vegetable Development Project
(IVDP) are in operation in Ranga Reddy District. An extent of 1000 acres in Kandukur and Maheshwaram
Mandals is proposed to be covered under IADP and 600 acres in six Mandals (100 acres each) is proposed
to be covered under IVDP. In IADP, none of the seven short-listed companies are participating. But six
companies including Netafim Irrigation India (P) Ltd., Baroda, Gujarat, Nagarjuna Palma India Limited,
Hyderabad, Plastro Plasson Industries (India) Ltd., Pune, Maharashtra, Premier Irrigation Equipment Ltd.,
Nagpur, Maharashtra and Jain Irrigation System Ltd., Jalgoan, Maharashtra participated in 249.95 acres of
IVDP. The funds were provided by DPAP towards subsidy. Due to paucity of funds, DPAP could mobilize
only Rs. 28.01 lakhs against Rs. 74.98 lakhs. As the balance amount was not released by DPAP, further
installations could not be continued under IVDP.

30. The allegation that 50% of the identified 2.48 lakhs hectares of land to be covered under APMIP under
Sprinkler system is denied. It is stated that is per the project report, an extent of 1,08,221 hectares (43.65%)
is to be covered under online drip system and 1,02,587 hectares (41.37%) is to be covered under inline drip
system. The area to be covered under sprinkler system of irrigation is 37,139 hectares which is 1.4.98% of
the total area. The counter-affidavit also adverts to the advantages of inline drip system stating that the
manufacturing cost is lower in inline system, that there will be no loss of emitters in the field and that inline
system has many inherent user friendly features such as self-cleaning, low clogging and low discharge
variation across the field. Practically it is not feasible for any farmer to clean thousands of emitters
manually in the field since all water for irrigation is not free from salts. Further in online drip system,
relocation of emitters by punching the lateral repeatedly reduces the life of the system and also causes
variation in water distribution uniformity across the field. In inline system due to turbulent mechanism,
inline emitters are less susceptible to clogging problem. The cost of inline drip system for a given length of
lateral and number of emitters is relatively cheap as compared to online drip system. The inline drip system
facilitates continuous wet moisture band along the lateral and hence it is more flexible for planning the crop
at desired spacing.

31. The Director of Horticulture further states that micro irrigation project involves both supply of micro
irrigation equipment, provision of services for maintenance, guidance and training to the beneficiary
farmer for a period of five years as well as Agri extension services. This is specifically mentioned as criteria
for shortlisting micro-irrigation companies irrespective of their location in the country. The shortlisted
seven companies are doing business in the State of A.P. for the past five to ten years.

Gist of submissions by the Petitioners

32. Learned Senior Counsel for the petitioner in W.P. No. 23777 of 2003, Sri K. Pratap Reddy, made
submissions to the following effect. Transparency in the decision making process is part of principle of
fairness. Decision making by the respondents lacks transparency as hidden criteria was followed. The
aspirant companies were not informed of the correct criteria to be satisfied at the stage of going in for EOI
by publishing advertisement in newspapers or in the EOI document supplied to the petitioner. When the
Government prescribed five criteria in EOI document, the technical committee, which evaluated EOI
submitted by participating companies, added its own criterion in addition to five criterion. For instance,
there was no specific condition that a company expressing EOI should have BIS specifications for its
products or there was no condition regarding financial position of the company. The petitioner's claim was
rejected on the ground that it has no BIS specifications for its sprinklers. Secondly, he would urge that the
criterion for short-listing a participating company was evaluated after rejecting the claim of the petitioner
and without inspecting petitioner's factory. The petitioner's claim has not been evaluated with reference to
the criterion laid down in the EOI document. The petitioner's EOI was rejected on the ground that it has no
BIS specification for sprinklers and on the ground that it has inadequate dealer net work in Andhra
Pradesh. He also submits that the criteria laid down for assessing the financial capability is arbitrary. The
rejection on these two grounds amounts to misdirection in law as respondents have not applied their mind
properly to EOI document submitted by the petitioner and the criterion evolved by the Government. The
decision of the technical committee to inspect only short-listed companies is deviation from EOI document
itself. This amounts to applying criteria which is not specified in the EOI document. He further submits
that as per the APMIP, 15% of the targeted agricultural land is to be brought under sprinkler system of
irrigation. None of the short-listed companies have manufacturing facilities for sprinklers. They were
permitted to resort to outsourcing for sprinklers. When the petitioner is manufacturer of sprinklers, the
respondents ought to have preferred a manufacturer to a company which outsources for sprinklers. The
decision making process is vitiated by irrationality and arbitrariness. The criteria applicable for drip
irrigation system has no application for sprinkler irrigation system. The Government took a decision to
approve the short-listed seven companies based on the report of the technical committee. As the petitioner
is entitled to know the reasons for rejecting its claim to meet the case of rejection, it is incumbent on the
part of the respondents to supply the report of the technical committee. Non-supply of the report which is
the basis for rejection vitiates the decision making process. The action of the respondents in short-listing
seven companies is arbitrary and illegal. Learned Senior Counsel placed reliance on the decisions of the
Supreme Court in Maneka Gandhi v. Union of India, , R.L Sharma v. Managing Committee, Dr. Hari Ram
(Co-edn.) H.S. School, ,Managing Director, ECIL v. B. Karunakar, and

33. Learned Counsel for the petitioners in W.P. Nos. 23940 and 23944 of 2003, Sri N. Rama Mohan Rao,
while adopting the submissions made by the learned Senior Counsel, made additional submissions as
follows. The petitioners' are manufacturers of either sprinklers or online drip system. The TFM as well as
EOI documents envisage use of sprinkler system as well as online drip system in APMIP depending on the
crop pattern, soil nature and inter-spacing of the crops. Hence, the exclusion of sprinkler manufacturers or
manufacturers of sprinklers and online drip systems is against the project objectives. The unit cost of online
drip system is less than inline drip system and it has more advantages on the filed than inline drip system.
Therefore, while interpreting the conditions for short-listing, one needs to give a broad meaning in such a
manner that sprinkler manufacturers and manufacturers of online drip system are not excluded. If these
two manufacturers, which are direct source of supply, are excluded, cost restriction imposed by APMIP
cannot be adhered to. The entire micro irrigation project is intended to achieve maximum utility of
available irrigable water with least expenditure. The project is of colossal cost in which the State funding by
way of subsidy is 50%. By excluding the petitioners', the Government, in effect, created a monopoly in
favour of seven chosen micro irrigation companies though they do not have the manufacturing facility for
all systems.

34. The learned Counsel further submits that the decision making process suffers from the vice of
unfairness. The State is required to adhere to principle of equality in distributing largesse and conferring
privileges. After the area is allocated to a manufacturer and supplier, farmers in the locality are necessarily
required to buy micro irrigation system only from the short-listed companies. The action result is depriving
the petitioners' of their fundamental right to carry on business under Article 19(1)(g) of the Constitution,
though some of the petitioners' were asked to implement pilot projects in Ranga Reddy District.

35. Learned Counsel also pointed out the lacunae in EOI documents as analysed by the technical committee
in the standard format in support of the contention that respondents applied different standards and
treated equals as unequal violating the principle of equality in Article 14 of the Constitution. These lacunae
are: (i) The BIS specifications annexed by Jain Irrigation Systems ('Jains' for brevity) do not relate to any
micro irrigation equipment. BIS specifications produced by Jains have long expired and as on the relevant
date i.e., 12-5-2003, which is the last date for submission of EOI, Jains have no BIS specifications. As per
the advertisement and EOI document, participants is APMIP should have manufacturing facilities for
sprinklers as well. Though Jains do not have manufacturing facility for sprinklers and rain-guns, they were
permitted to outsource, which is illegal; (ii) Though the vision and preparedness of Nagarjuna Palma and
Parixit Industries was assessed by the technical committee as poor, they were short-listed. All the short-
listed companies do not have manufacturing facilities of all systems of micro irrigation; (iii) Some of the
shortlisted companies do not have five years experience. Therefore, the action of the respondents in
excluding the petitioners' and shortlisting the companies which failed to comply with the conditions is
illegal and arbitrary. Learned Counsel, however, does not deny that it is open to the State to choose agencies
through which they can execute its project and that petitioners' have no right much less enforceable right to
seek a mandamus for inclusion in the list of participating micro irrigation companies. The petitioners', it is
urged, have a limited right that their EOI shall be considered in the background of criterion laid down by
the Government. It is also submitted that the petitioners being small scale units, the respondents ought to
have given preference to the petitioners. It is also submitted that the petitioners being small scale units, the
respondents ought to have given preference to the petitioners.

Gist of submissions by the Respondents

36. Learned Additional Advocate General, Sri D. Prakash Reddy, has placed before the Court the report of
the technical committee and the EOI documents submitted by the seven short-listed companies. The EOI
document of the petitioner in W.P. No. 23777 of 2003 was also placed before this Court. Learned Additional
Advocate General submits that the criteria evolved by the technical committee is strictly in accordance with
the criteria prescribed in EOI document in Paragraphs 7 and 10 thereof. The criteria for shortlisting and
instructions for preparation of EOI (in 'Paragraphs 10 and 7 of EOI respectively) have to be read together.
The petitioners' reliance only on Paragraph 10 is misconceived. The criterion of having manufacturing
facility for emitters and plain lateral (online drip system) and manufacturing facility for emitting pipe
(inline drip system) was also treated as essential criterion. Likewise, BIS licence for online and inline drip
system was treated as essential criterion. Insofar as other criteria, the technical committee did not treat
them as essential. He would urge that manufacturing facilities for online and inline drip systems with BIS
specifications is the criterion which requires strict compliance whereas others need substantial compliance.

37. Micro irrigation companies manufacturing online and inline drip irrigation systems with or without
manufacturing facilities for sprinklers form a different class. The companies which manufacture only
sprinklers or sprinklers and online drip system cannot be equated with the first category. As per the EOI
document, that class of companies who manufacture online and inline drip system are alone eligible to be
shortlisted for participation in APMIP. Equality clause in Article 14 of the Constitution of India does not
prohibit classification and that the classification of these companies is valid and rationale having nexus
with the object sought to be achieved. He would submit that the intention and object of APMIP is to provide
one stop marketing facility for the farmers opting for micro irrigation in their farm land. If a farmer is
required to shop for sprinklers with one manufacturer, for online drip system with another and for inline
drip system with yet another manufacturer, the whole scheme under APMIP would get impeded.

38. It is nextly contended by the learned Additional Advocate-General that the requirement of
manufacturing facilities with sprinklers is not an essential criterion. Even a company which substantially
complies with this by outsourcing supply of sprinklers, it is treated as substantial compliance with the
conditions. The same is strictly in accordance with the criteria and the Technical Committee has not
deviated from the path. The said Committee, according to the learned Additional Advocate-General, has
proceeded with the evaluation of EOI documents strictly in accordance with Paragraphs 7 and 10 of the said
document.

39. Learned Additional Advocate-General seriously refutes all the allegations made by Sri N. Rama Mohana
Rao regarding alleged disqualifications and lacunae in seven recipient short-listed companies. He would
urge that when there is no challenge to the two Government Orders and when the seven shortlisted micro
irrigation companies are not arrayed as respondents, he would urge, it would be improper to decide the
alleged disqualification, if any, incurred by these selected companies. When the State has excluded the
petitioner companies/concerns applying valid classification, the non-inclusion of petitioners cannot be
rectified by issuing a mandamus. Learned Additional Advocate General also submits that the petitioners
cannot be accorded any preferential treatment merely because they are small scale industrial units. The
petitioners have not challenged the conditions/criteria and, therefore, they cannot be heard to say anything
regarding rationality in the criteria laid down.

Points and Questions for Consideration

The following points need to be considered in these writ petitions.

(1) What are the principles of judicial review to be followed with special reference to judicial review of
exercise of contractual powers of the Government?

(2) What is the criteria to be followed for shortlisting micro irrigation companies for participation in A.P.
Micro Irrigation System? Whether the conditions require strict compliance or substantial compliance?

(3) Whether the inclusion of seven shortlisted companies is not proper and whether such inclusion is not
legal?

(4) Whether non-inclusion of petitioners is arbitrary, illegal and violative of Articles 14 and 19(1)(g) of the
Constitution of India?

Question No. 1

What are the principles of judicial review to be followed with special reference to judicial review of exercise
of contractual powers of the Government?

40. The extraordinary power of judicial review vested in this Court is intended to review an administrative
decision at the instance of an aggrieved person to see whether such person has been treated fairly by the
public authority. The power of judicial review in India is also available to test the administrative, quasi-
judicial as well as legislation of Parliament or of State Legislature. However, the power of judicial review
conferred on this Court does not empower the Court to act as an appellate Court. The power is concerned
with the process of making a decision and not the merit of decision. If the decision made by public authority
is in accordance with law and even if such decision is not correct as perceived by the Court, still such case
does not warrant interference in exercise of power of judicial review. "Illegality" "irrationality" and
"impropriety" of the decision are only some of the grounds on which a decision of a public authority can be
invalidated if the same has resulted in arbitrary exercise of power and unfairness. If any authority is
required, a reference may be made to the decision of the Supreme Court in H.B. Gandhi v. Gopi Nath and
Sons, 1992 Supp (2) SCC 312, wherein the Supreme Court explained the extent and scope of judicial review
as under.

............. Judicial review, it is trite, is not directed against the decision but is confined to the decision making
process. Judicial review cannot extend to the examination of the correctness or reasonableness of a decision
as a matter of fact. The purpose of judicial review is to ensure that the individual receives fair treatment and
not to ensure that the authority after according fair treatment reaches, on a matter which it is authorised by
law to decide, a conclusion which is correct in the eyes of the Court. Judicial review is not an appeal from a
decision but a review of the manner in which the decision made. It will be erroneous to think that the Court
sits in judgment not only on the correctness of the decision making process but also on the correctness of
the decision itself.

41. In Indian Railway Construction Co., Ltd. v. Ajay Kumar, , the Supreme Court referred to the relevant
case law and observed that in exercise of power of judicial review, the Court will be slow to interfere in
matters relating to administrative function unless the decision is tainted by any vulnerability. Whether a
decision is tainted with illegality, irrationality or impropriety has to be established and mere assertion in
that regard would not be sufficient. Dealing with judicial review of administrative decision, the Apex Court
observed as under:

................. Administrative action is stated to be referable to the broad area of Governmental activities in
which the repositories of power may exercise every class of statutory function of executive, quasi-legislative
and quasi- judicial nature. It is trite law that exercise of power, whether legislative or administrative, will be
set aside if there is manifest error in the exercise of such power or the exercise of the power is manifestly
arbitrary (See State of U.P. v. Renusagar Power Co., . At one

time, the traditional view in England was that the executive was not answerable where its action was
attributable to the exercise of prerogative power. Professor De Smith in his classical work Judicial Review
of Administrative Action, 4th Edn., at pp.285-87 states the legal position in his own terse language that the
relevant principles formulated by the Courts may be broadly summarised as follows. The authority in which
a discretion is vested can be compelled to exercise that discretion, but not to exercise it in any particular
manner. In general, a discretion must be exercised only by the authority to which it is committed. That
authority must genuinely address itself to the matter before it; it must not act under the dictates of another
body or disable itself from exercising a discretion in each individual case................

42. Judicial review of contractual power of the Government is also subject to same legal principles. The
various contentions raised by the learned Counsel for the petitioners would necessitate recapitulation of
settled principles of judicial review vis-a-vis contractual power of the State. In matters of State contracts,
distribution of largesse, conferment of privileges, engagement of services for material and consultation, the
State has absolute discretion. In exercising this, larger public interest cannot be ignored and deriving
utmost benefit to the State and adhering to principles of equality and fairness are sine que non for exercise
of such administrative power.

43. In Rasbihari Panda v. State of Orissa, , Siemens Engg, and Mfg. Co. v. Union of India, , Radha Krishna
Agarwal v. State of Bihar, AIR 1977 SC 1496, R.D. Shetty v. International Airport Authority, , Kasturi Lal v.
State of J&K, , Fertiliser Corporation Kamagar Union v: Union of India, AIR 1981 SC 344, Gujarat State
Financial Corporation v. Lotus Hotels Pvt. Ltd., , Ram and Shyam Co. v. State of Haryana, , C. Rami Reddy
v. Government of Andhra Pradesh, , Life Insurance Corporation of India v. Escorts, , Harminder Singh v.
Union of India, , Sri Sachidanand Pande v. State of West Bengal, AIR 1987 SC 1109, Haji T.M. Hassan v.
Kerala Financial Corporation, , Ram Gajadhar Nishad v. State of Uttar Pradesh, , G.J. Fernandez v. State of
Karnataka, , Poddar Steel Corporation v. Ganesh Engg. Works, , Srilekha Vidyarthi v. State of Uttar
Pradesh,

, Food Corporation of India v. Kamadhenu Cattle Feed Industries, , Sterling Computers Ltd. v. M&N
Publications Ltd., , Union of India v. Hindusthan Development Corporation, , Tata Cellular v. Union of
India, , New Horizons Ltd. v. Union of India, , State of Himachal Pradesh v. Ganesh Wood Products, , Delhi
Science Forum v. Union of India, , Raunaq International Ltd. v. I.V.R. Constructions, , AIR India Ltd. v.
Cochin International Airport Ltd., , Monarch Infrastructure Pvt. Ltd, v. Commr., Ulhasnagar Municipal
Corporation, , Duncan Industries v. State of Uttar Pradesh, , Centre for Public Interest Litigation v. Union
of India, , West Bengal Electricity Board v. Patel Engg. Corporation, , and Balco Employees Union v. Union
of India, , the Hon'ble Supreme Court laid down various principles in this branch of administrative law. It is
not necessary to extract passages from the precedents. Suffice to summarise principles of law that flow from
these precedents. A brief reference may, however, be made to the decisions of the Supreme Court in Tata
Cellular v. Union of India (supra) and Centre for Public Interest Litigation v. Union of India (supra).

44. In Tata Cellular v. Union of India (supra), Department of Telecommunications invited tenders from
Indian companies for giving licence for operation of cellular mobile telephone services in four metropolitan
cities namely, Bombay, Calcutta, Delhi and Madras. Thirty bidders participated at the first stage. The first
tender evaluation committee shortlisted twelve companies and also recommended four other companies on
condonation of certain defects. The Telecom Commission accepted the recommendations of the technical
committee and financial bids were directed to be submitted to the selection/high-power committee. On the
recommendations of the said committee, the Minister issued approval for issue of financial bids with
modification to short-listed companies and financial tenders were issued containing seven criteria.
Fourteen companies have submitted their bids. These bids were evaluated by another tender evaluation
committee by dividing some parameters and making system which was not done by the selection
committee. After the committee submitted its report, Telecom Department recommended only four
operators based on the evaluation and financial bids. The first choice for Delhi and Bombay was in favour of
BPL Ltd. and Tata Cellular as second choice for Calcutta and Madras. Other six short-listed companies were
rejected. Companies whose tenders were rejected, filed writ petitions before Delhi High Court on the
ground that the decision is vitiated with bias, that including certain hidden criteria is illegal, that the
decision is based on irrelevant considerations etc. It was also alleged that criteria was evolved to knock out
the petitioners. The Delhi High Court allowed the writ petitions filed by India Telecom and another
company by issuing a mandamus to consider their case for grant of licence and dismissed the writ petitions
filed by other companies. Against the judgment of Delhi High Court, civil appeals and special leave
petitions were filed before the Supreme Court. It was contended that the decision of the technical
evaluation committee is biased and that the decision is illegal and irrational.

45. The Supreme Court exhaustively discussed the scope of judicial review in matters of granting licence for
providing services. After referring to American and English decisions as well as its earlier judgments, the
Apex Court laid down as under:

It cannot be denied that the principles of judicial review would apply to the exercise of contractual powers
by Government bodies in order to prevent arbitrariness or favouritism. However, it must be clearly stated
that there are inherent limitations in exercise of that power of judicial review. Government is the guardian
of the finances of the State. It is expected to protect the financial interest of the State. The right to refuse the
lowest or any other tender is always available to the Government. But, the principles laid down in Article 14
of the Constitution have to be kept in view while accepting or refusing a tender. There can be no question of
infringement of Article 14 if the Government tries to get the best person or the best quotation. The right to
choose cannot be considered to be an arbitrary power. Of course, if the said power is exercised for any
collateral purpose the exercise of that power will be struck down........ Judicial quest in administrative
matters has been to find the right balance between the administrative discretion to decide matters whether
contractual or political in nature or issues of social policy; thus they are not essentially justiciable and the
need to remedy any unfairness. Such an unfairness is set right by judicial review.

46. In Centre for Public Interest Litigation v. Union of India (supra), the Court after referring toTata
Cellular v. Union of India (supra) and Kasturi Lal v. State of J&K (supra) explained the approach of the
Court of judicial review in matters involving commercial or technical aspects. It was laid down as under:

It is clear from the above observations of this Court that it will be very difficult for the Courts to visualize
the various factors like commercial/ technical aspects of the contract, prevailing market conditions, both
national and international and immediate needs of the country etc., which will have to be taken note of
while accepting the bid offer. In such a case, unless the Court is satisfied that the allegations leveled are
unassailable and there could be no doubt as to the unreasonableness, mala fide, collateral considerations
alleged, it will not be possible for the Courts to come to the conclusion that such a contract can be prima
facie or otherwise held to be vitiated so as to call for an independent investigation, as prayed for by the
appellants....................

47. The principles that emerge from above referred decisions are as under:

(i) There is no mandatory principle of law, convention, custom, or administrative precedent requiring the
Government or public authority to call for tenders while undertaking various governmental activities.

(ii) The Government is free to enter into contract with citizens either for the sale of immovable property like
land/ buildings or movable property, sell industrial units or its shares and stocks in public limited
companies or in the companies of Government participation.

(iii) The Government's exercise of contractual powers must adhere to principles of equality before law and
equal protection of laws keeping in view Articles 14, 15(1), 298 and 299.

(iv) All the eligible, qualified and suitable persons are entitled to claim right to be treated equally in the
matter of awarding contract by the Government and public authorities.

(v) No citizen however can have an enforceable right to compel the State to enter into contract with him or
her. The Court of judicial review cannot either declare or enforce such a nebulous right.

(vi) The Court of Judicial review cannot interfere with the Government's absolute right to enter into
contract with citizens unless such action is contrary to public interest, arbitrary and/or discriminatory.

(vii) When the award of contract by a public authority or State is challenged before the Court, ordinarily the
decision cannot be interfered with, unless the Court is satisfied that there is some element of public interest
involved in entertaining such writ petition. By award of the contract, if the best price or best service is
procured the same generally would subserve public interest and mere price difference between two
tenderers may or may not be decisive in deciding whether any public interest is involved.

(viii) State owned/public owned property cannot be dealt with at absolute discretion of the executive.
Public interest is a paramount consideration and one of the methods of securing public interest when it is
considered necessary to dispose of the property is to sell property by public auction or by inviting tenders.
This rule of disposing of property by public auction or by inviting tenders can only be relaxed in a situation
intended to achieve goals set out in Part-IV of-the Constitution.

(ix) When the property is disposed of by public auction or by public tender the standards and guidelines set
out in the invitation to tender or tender document must be scrupulously adhered to and the method private
negotiations is not ordinarily permissible unless there is sufficient indication in notice inviting tenders for
such negotiations.

(x) Tender conditions are in the nature of administrative guidelines or instruction, Thus, the principle in
Vitarelli v. Seaton, 359 US 535 = 3 L Ed. 2nd 1012 (1959), that an executive agency must be rigorously held
to the standards by which it professes its actions to be judged and if the tender conditions require strict
compliance there can be no relaxation of tender conditions. This, however, is not the case if the tender
document or tender conditions require only substantial compliance with the tender conditions. This point
is further discussed infra.

(xi) When the offers/proposals by bidding parties are evaluated by committee of experts with special
knowledge, the decision plays an important role and price offered is only one of the criteria. The past record
of the tenderers, quality of goods or services which are offered, its market reputation etc., play important
role in deciding to whom the contract should be awarded.
(xii) The decision of public authority or the State especially when it is founded on the decision of experts
committee cannot be subjected to appeal before the Court and ordinarily the decision of experts committee
should receive approval of the Court unless it is grossly arbitrary and discriminatory.

(xiii) So as to get the best price, best goods or best services, even if the Government enters into negotiations
with all the eligible tenderers, there should be equality in the process, in that all the tenderers should be
given an opportunity to participate in the negotiations. If the process is fair and not arbitrary, the absence
of power to negotiate would not vitiate the decision-making by the public authority.

(xiv) Each and every lapse, breach or contravention, unless contrary to public interest, would not give rise
to a ground for interference in a petition for judicial review. Administrative Law recognizes that fair play in
the joints is a necessary concomitant for an administrative body functioning in an administrative sphere
while making decisions in the tender process.

48. The questions of fact and law raised in these petitions need to be resolved keeping in view the above
principles and scope of judicial review as laid down above by the Supreme Court.

Question No. 2

What is the criteria to be followed for shortlisting micro irrigation companies for participation in A.P. Micro
Irrigation System? Whether the conditions require strict compliance or substantial compliance?

49. It is strenuously argued that the respondents applied hidden criteria in rejecting the claim of the
petitioners for participation in APMIP. It is pointed out that BIS licence/specification is not one of the
criteria, but still it was applied to the petitioners white evaluating EOI. This is refuted by the learned
Additional Advocate General. He would urge the Court to read Paragraphs 7 and 10 together to arrive at a
criteria to be applied. He would also urge that the criteria evolved by the technical committee is strictly in
accordance with Paragraphs 7 and 10 of the EOI document.

50. Paragraphs 7 and 10 as well as the criteria evolved by the technical committee are already extracted
supra. The submission that the criteria for short-listing as envisaged in Paragraph 10 should be adopted is
wholly misconceived. The EOI document consists of 10 paragraphs and four annexures. All the Micro
Irrigation Companies desirous of participating in the project are required to keep in view the instructions
while preparing EOT document. Sub-para (1) of Paragraph 7 gives essential qualification/criteria. The
supplier should have manufacturing facility and proven experience in producing online and inline drip
system as per BIS specifications. As per sub-para (2), a supplier should have sound knowledge of
drip/sprinkler technology in horticulture, vegetable growing, medicinal herbs. Sub-para (3) gives details
which should be given in EOI document. Coming to paragraph 10, it stipulates that the EOI document
received by the Director of Horticulture will be evaluated so as to find out the eligible and capable firms.
This eligibility and capability necessarily must be with reference to Paragraph 7 which contains the
essential qualifications and other qualification. If Paragraph 10 is given too much importance ignoring
instructions in Paragraph 7, that would render evaluation to find out eligible and capable firms an empty
formality.

51. The whole endeavour is to make available to the farmer the best quality online and inline drip systems
with BIS specifications. Therefore when a technical committee evolved seven criteria for shortlisting, it is in
tune with Paragraphs 7 and 10 together. This Court is really surprised to hear that the petitioners were not
aware that they should satisfy the requirements of having BIS specifications. In a colossal project involving
billions of rupees, every intending participant is expected to know the criteria minutely. If anybody had any
doubt, nothing prevented to seek clarifications. I therefore hold that the criteria evolved by the technical
committee does not in any manner deviate from criteria laid down by the Government. It is also not
possible to accept the submission that the respondents applied some hidden criteria which was not
informed to the petitioners.
52. The submission made by the learned Counsel for petitioners is also belied by two representations dated
1.5.2003 and 2.5.2003 made by the Irrigation Association of India, Pune to the Hon'ble Chief Minister of
Andhra Pradesh (See Paragraphs 41 and 44 of paper book filed in W.P. No. 23777 of 2003). Though the
Association expressed difficulty in so far as fixation of Rs. 1.00 lakh as registration fees and compulsory
condition of manufacturing facility for inline drip system, no objection was raised regarding BIS
licence/specifications. The representation made by the Association would clearly indicate mat nobody was
in any doubt. Indeed in the representation made to the Hon'ble Chief Minister on 2.5.2003, the Association
itself requested to prescribe BIS specifications-IS 14151 Part-I & II for sprinkler irrigation companies.

53. Having held that manufacturing facility with experience in producing online and inline drip systems
with BIS specifications is an essential qualification criteria and also other conditions required to be fulfilled,
it is to be seen whether these conditions require strict compliance. When strict compliance of conditions or
qualifications is required, essential conditions of eligibility are required to be enforced strictly. It is not
open to the tenderer or requisitioning authority to relax these conditions. The second category of conditions
or criteria is substantial compliance. Under this category, the ancillary or subsidiary conditions are required
to be followed for achieving the main object of the conditions. Conditions of technical nature regarding the
procedure may be condoned or relaxed and rigid compliance is not required. If strict compliance test is
applied in accordance with tender/EOI document, the law treats all the conditions as mandatory and if
substantial compliance test is applied, all other conditions are to be treated as valid leaving it to the
decision maker to decide whether the contesting participants have substantially complied with the non-
essential conditions. Some of the decided cases in this regard would lend support to this.

54. In R.D. Shetty v. International Airport Authority (supra), it was observed that rules of interpretation
applicable to statutes are equally applicable to documents, save for compelling necessity. The Court should
not be prompt to ascribe superfluity to the language of a document and should be rather at the outset
inclined to suppose every word intended to have some effect or be of some use. To reject words as
insensible should be the last resort of judicial interpretation, for it is an elementary rule based on common
sense that no author of a formal document intended to be acted upon by others should be presumed to use
words without a meaning. The Court must avoid construction which render words used by the author of the
conditions applicable, meaningless and futile or reduce to silence any part of the document and make it
altogether inapplicable.

55. In Ram Gajadhar Nishad v. State of Uttar Pradesh (supra), the tender conditions required the tenderer
to submit solvency certificate to the Collector. The Supreme Court interpreted the condition as requiring
strict compliance and that non-compliance with the condition would lead to non-acceptance of the
tender. In G.J. Fernandez v. State of Karnataka (supra), the Supreme Court considered a case where the
notification inviting tenders by Karnataka Power Corporation Ltd., was in XII paragraphs, and the question
was whether the conditions in Parts-I and V are mandatory. Paragraph I laid down preconditions of
eligibility for submitting a tender. Para-V requires the tenderers to supply the details called for. The
Supreme Court held that the pre-conditions of eligibility for submitting tender must be considered as
mandatory, and that omission to supply every small detail referred to in Paragraph-V will not affect the
eligibility under Paragraph I and disqualify the tenderer. It was also indicated that the various conditions
should be considered in a harmonious and practical manner. Be it noted that Paragraph-I laid down the
preconditions of eligibility and Paragraph-V required supplying of details for assessing the fulfilment of
conditions in Paragraph-I. The following observations are apt.

............. It is true that the relaxation of the time schedule in the case of one party does affect even such a
person in the sense that he would otherwise have had one competitor less. But, we are inclined to agree
with the respondent's contention that while the rule in Ramana case will be readily applied by Courts to a
case where a person complains that a departure from the qualifications has kept him out of the race,
injustice is less apparent where the attempt of the applicant before Court is only to gain immunity from
competition. Assuming for purposes of argument that there has been a slight deviation from the terms of
the NIT, it has not deprived the applicant of its right to be considered for the contract; on the other hand,
its tender has received due and full consideration. If, save for the delay in filing one of the relevant
documents, MCC is also found to be qualified to tender for the contract, no injustice can be said to have
been done to the appellant by the consideration of its tender side by side with that of the MCC and in the
KPC going in for a choice of the better on the merits.

56. G.J. Fernandez v. State of Karnataka (supra) is an authority for the proposition that pre-conditions of
eligibility cannot be deviated from and strict compliance test should be applied, whereas the conditions
requiring formalities in relation to the pre-conditions can be deviated from without causing prejudice to the
rival competitors as they require a substantial compliance only. GJ. Fernandez v. State of Karnataka (supra)
was followed in Poddar Steel Corporation v. Ganesh Engg. Works (supra), and it was held thus:

... As a matter of general proposition it cannot be held that an authority inviting tenders is bound to give
effect to every term mentioned in the notice in meticulous detail, and is not entitled to waive even a
technical irregularity of little or no significance. The requirements in a tender notice can be classified into
two categories - those which lay down the essential conditions of eligibility and the others which are merely
ancillary or subsidiary with the main object to be achieved by the condition. In the first case, the authority
issuing the tender may be required to enforce them rigidly. In the other cases, it must be open to the
authority to deviate from and not to insist upon the strict literal compliance of the condition in appropriate
cases...

57. In West Bengal Electricity Board v. Patel Engg. Corporation (supra), the respondent requested
permission to correct a 'repetitive systematic computer typographical transmission error' in their tender
submitted by it pursuant to the tender notification issued by the West Bengal Electricity Board. The
appellant evaluated the bid and pointed out a number of arithmetical errors. Challenging the same, a writ
petition was filed in the High Court at Calcutta. A learned single Judge of the High Court directed the West
Bengal Electricity Board to reconsider the representation and pass reasoned order, A Division Bench of the
High Court in writ appeal agreed with the learned Single Judge and further directed the West Bengal
Electricity Board to correct the errors in the tender documents. In appeal by the West Bengal Electricity
Board, the Supreme Court reversed the judgment of the High Court at Calcutta holding that the instructions
to bidders have to be strictly complied with, and there can be no departure therefrom. It is apposite to
quote the following:

... The degree of the care required in such a bidding is greater than in ordinary local bids for small works. It
is essential to maintain the sanctity and integrity of process of tender/ bid and also award of a contract. The
appellant-respondent Nos. 1 to 4 and respondent Nos. 10 and 11 are all bound by the ITB which should be
complied with scrupulously. In a work of this nature and magnitude where bidders who fulfill
prequalification alone are invited to bid, adherence to the instructions cannot be given a go-bye by branding
it as a pedantic approach otherwise it will encourage and provide scope for discrimination, arbitrariness
and favouritism which are totally opposed to the Rule of law and our constitutional values. The very
purpose of issuing rules/instructions is to ensure their enforcement lest the Rule of law should be a
casually. Relaxation or waiver of a rule or condition, unless so provided under ITB, by the State or its
agencies (the appellant) in favour of one bidder would create justifiable doubt in the minds of other
bidders, would impair the rule of transparency and fairness and provide room for manipulation to suit the
whims of the Slate agencies in picking and choosing a bidder for awarding contracts as in the case of
distributing bounty or charity. In our view such approach should always be avoided. Where power to relax
or waive a rule or a condition exists under the Rules, it has to be done strictly in compliance with the Rules.
We have, therefore, no hesitation in concluding that adherence to ITB or Rules is the best principle to be
followed, which is also in the best public interest.
58. The Micro Irrigation Companies are required to strictly comply with the essential conditions, but
insofar as other conditions are concerned, discretion is left to the respondents. As presently seen, Technical
Committee adopted the method by treating availability of manufacturing facility with BIS experience and
proven experience as essential criteria requiring strict compliance and all other conditions requires
substantial compliance. To the mind of the Court, the method adopted cannot be called incorrect. Having
regard to the project objectives and purposes as indicated hereinabove, a reference to Paragraph 7 and 8 of
the report submitted by the Technical Committee would show that manufacturing facility for online drip
systems and inline drip systems as well as BIS licence for fees is treated as essential criteria. All the
companies, as stated in the counter-affidavit which do not comply these two conditions strictly were not
short-listed. The Technical Committee examined all the EOI documents not only with reference to these
essential criteria, but also other parameters by duly awarding rating for the purpose of short-listing
Therefore, it is must be held that the Technical Committee, SHLC and the GoAP have followed a rationale
and reasonable method having regard to the EOI documents and there is no deviation of the same.

Question Nos. 3 and 4

(3) Whether the inclusion of seven short-listed companies is not proper and whether such inclusion is not
legal?

(4) Whether non-inclusion of petitioners is arbitrary, illegal and violative of Articles 14 and 19(1)(g) of the
Constitution of India?

59. It is better to deal with both these questions together. Learned Counsel for petitioners in W.P. Nos.
23940 and 23944 of 2003 Sri N. Ram Mohan Rao, has raised number of grounds challenging the inclusion
of seven short-listed companies. If this Court is sitting in appeal over the decision of the respondents, it
would have been proper to deal with these questions in detail. It is axiomatic that this Court while
exercising power under Article 226 of the Constitution does not sit in appeal over the decision of the public
authorities. The whole exercise of power is aimed at examining the question whether the petitioners were
given fair deal by the decision making authority.

60. Secondly, the challenge to the inclusion of seven companies as well as the challenge to G.O.Ms.No. 529
dated 20.6.2003 and G.O.Rt.No. 627 dated 8.7.2003 (challenge in W.P.No. 23777 of 2003) must fail for yet
another ground. It is too well settled that the power under Article 226 should not be exercised if the
decision of the Court is likely to affect the rights and interests of those persons who are not arrayed as
respondents in a petition for judicial review. A reference may be made to the decisions of the Supreme
Court in Prabodh Verma v. State of U.P., , Ishwar Singh v. Kuldip Singh, 1995 Supp (1) SCC 179, J.Jose
Dhanapaul v. S. Thomas, , Arun Tewari v. Zila Mansavi Shikshah Sangh, AIR 1998 SC 331, and All India SC
& ST Employees' Association and another v. A. Arthur Jeen and Ors., .

61. In Arun Tewari v. Zila Mansavi Shikshah Sangh (supra), Madhya Pradesh Class III Education Service
Rules, 1973 were challenged before M.P. Administrative Tribunal, Jabalpur. The applicants were those
candidates who were not selected in the recruitment pursuant to a notification. The Administrative
Tribunal struck down the amendment to the rules and the circulars issued by the Government of M.P.
Before the Tribunal, selected/appointed candidates who were directly appointed by the outcome of original
applications, were not made as party respondents. When the matter was brought before the Supreme Court
by way of Special Leave Petitions, the Apex Court observed that the entire exercise by the Tribunal is
seriously distorted because of the omission. After referring to the cases of Prabodh Verma v. State of U.P.
(supra), Ishwar Singh v. Kuldip Singh(supra), J.Jose Dhanapaul v. S. Thomas (supra), it was observed that:

The employees who were directly concerned were not made parties - not even by joining some of them in a
representative capacity, considering that their number was too large for all of them to be joined individually
as respondents. This Court observed that High Court ought not have decided a writ petition under Article
226 of the Constitution without the persons who would be vitally affected by its judgment being before it as
respondents or at least some of them before it as respondents in a representative capacity. These
observations apply with equal force here. The same view has been reiterated by this Court in Ishwar Singh
v. Kuldip Singh, 1995 Supp (1) SCC 179, where the Court said that a writ petition challenging selection and
appointments without impleading the selected candidates was not maintainable (Vide also J.Jose
Dhanapaul v. S. Thomas,. On this ground alone the decision of the Tribunal is vitiated.

62. In All India SC & ST Employees' Association and Anr. v. A. Arthur Jeen and Ors. (supra), the Supreme
Court laid down as under:

Although the candidates included in the panel showing their provisional selection do not get vested right to
appointment, they will be surely interested in protecting and defending the select list. It is an admitted
position that before the Tribunal the successful candidates whose names were included in the panel of
selection were not made parties. The argument of the learned Counsel that since the names and particulars
of the successful candidates included in the panel were not given, they could not be made parties, has no
force. The applicants before the Tribunal could have made efforts to get the particulars at least they ought
to have impleaded some of the successful candidates, may be, in a representative capacity; if the large
number of candidates were there and if there was any difficulty in service of notices on them, they could
have taken appropriate steps to serve them by any one of the modes permissible in law with the leave of the
Tribunal. This Court in Prabodh Verma v. State of U.P. has held

that in writ petitions filed against the State questioning the validity of recruitment of a large number of
persons in service could not be proceeded with to hear and take decision adverse to those affected persons
without getting them or their representatives impleaded as parties. In Para 50 of the said judgment,
summarizing the conclusions this Court in regard to impleaded of the respondents has stated that : (SCC
pp.288-299)

'A High Court ought not to hear and dispose of a writ petition under Article 226 of the Constitution without
the persons who would be vitally affected by its judgment being before it as respondents or at least some of
them being before it as respondents in a representative capacity if their number is too large to join them as
respondents individually, and, if the petitioners refuse to so join them, the High Court ought to dismiss the
petition for non-joinder of necessary parties'.

63. The petitioner in W.P. No. 23777 of 2003 indeed challenges two Government orders whereby seven
Micro Irrigation Companies were short-listed. The effect of declaring these two Government Orders would
be denying the accrued benefit of predication in APMIP to the seven Micro Irrigation Companies without
hearing them. That would be distortion of justice. Therefore the challenge cannot be accepted. Further, as
rightly pointed out by the learned Additional Advocate General, instructions for preparation of EOI and/or
the criteria for short-listing as notified to all concerned in EOI document have not been specifically
challenged. The learned Senior Counsel for the petitioner in W.P. No. 23777 of 2003, no doubt made
submissions challenging the criteria laid down to assess financial net-worth as arbitrary. He also challenged
the criteria requiring all participants to manufacture all three Micro Irrigation systems as arbitrary. In the
absence of proper pleading and substantiation thereof, an argument of arbitrariness cannot be entertained
as held by the Supreme Court in various judgments. A person seeking invalidation of an administrative
decision on the ground of irrationality and arbitrariness has to properly raise grounds and substantiate
them with proper supporting material. Both these are conspicuous by their absence in the pleadings.
Therefore these submissions cannot be countenanced.

64. As held by the Supreme Court in Prabodh Verma v. State of U.P. (supra), the High Court ought not to
hear and dispose of the writ petition under Article 226 of the Constitution without the person who would be
vitally affected by the judgment being before it as a respondent. This Court also examined the merit of the
various contentions expressed by the learned Counsel for petitioners Sri N. Rammohan Rao, who spent
considerable time for pointing out the so-called lacunae in the EOI submitted by the short-listed
companies.

Transparency in governance

65. As noticed supra, an elaborate exercise was undertaken before short-listing all the companies. The
project/scheme of APMIP was made known in a transparent manner to one and all. Field level surveys were
conducted on the land under different suitable systems of Micro Irrigation were identified district wise. The
Director of Horticulture was asked to get Micro Irrigation Companies empanelled for participation in the
project. A Technical Committee was appointed to evaluate all the EOI documents and submitted its
recommendations and a State High Level Committee was also appointed to finally look into the
recommendations of the Technical Committee. Thereafter the Government after verifying all EOI
documents, recommendations of the Technical Committee as well as SHLC, issued two Government
Orders. The entire exercise was taken up in a transparent manner and no hidden criteria was applied in
choosing the seven companies as alleged. Here this Court may refer to the principle of transparency vis-a-
vis governance by rule of law.

66. Principle of Transparency is an adjutant to Doctrine of fairness. Fairness requires proper treatment of
the individual by public authority by known principles of law. Every person who approaches public
authorities must know by what rules, regulations, provisions of law or instructions, he would be governed.
In a way transparency in the governance and fairness in Government dealings are essential to democracy to
curb nepotism, corruption and parochialism. It does not however mean that the Government at all times
and in all situations must go on advertising what they are going to do. In the very nature of State
Administration, it is conceded by all thinkers, the political, executive and bureaucracy should have
sufficient discretion in dealing with men and material to subserve public interest. In matters relating to
economic issues, Government has a right to 'trial and error' as long as both are bonafide and within the
authority.

67. In Balco Employees Union v. Union of India (supra), decision of the Government of India to disinvest
and transfer 51% shares of M/s Bharat Aluminium Company Limited (BALCO) was challenged inter alia on
the ground that the decision lacked transparency. The Supreme Court rejected the submission observing
thus:

It was contended by the learned Advocate-General that the whole process lacked transparency. We are not
able to appreciate this contention. The disinvestments of BALCO commenced with the recommendation by
the Disinvestment Committee in its second report suggesting that the Government may disinvest BALCO. It
is by global advertisement that the Global Advisor and the strategic partner were chosen. At every stage, the
matter was looked into by the IMG and ultimately by the Cabinet Committee on Disinvestment. The system
which was evolved was completely transparent. It was made known. Transparency does not mean the
conducting of the Government business while silting on the crossroads in public. Transparency would
require that the manner in which decision is taken is made known. Persons who are to decide are not
arbitrarily selected or appointed. Here we have the selection of the Global Advisor and the strategic partner
through the process of issuance of global advertisement. It is the Global Advisor who selected the valuer
who was already on the list of valuers maintained by the Government. Whatever material was received was
examined by high power Committee known as the IMG and the ultimate decision was taken by the Cabinet
Committee on Disinvestment. To say that there has been lack of transparency, under these circumstances,
is uncharitable and without any basis.

After going through all the EOI documents of the short-listed Micro Irrigation Companies as well as those
of petitioners and examining them in the light of executive summary of TFM, the project profile of APMIP
and the EOI documents, I must hold that the argument of lack of transparency is wholly misconceived and
cannot be countenanced.
68. Reverting back to the qualifications of the selected companies and disqualification of the petitioners,
the following Table encapsulates actual status and position of each of the petitioners and seven short-listed
MIS companies.

Statement showing the availability/non-availability of manufacturing facilities for Online drip system,
Inline drip system and sprinklers
__________________________________________________________________

Sl. No. Name of the Company/ Concern Mfg. faciti. for Online Drip System Mfg. facilities for Inline Drip
System Mfg. facilities for Sprinklers Rainguns BIS specification for OnlineInlinelSprinklers Remarks of the
TechnicalCommittee

__________________________________________________________________

1. Godavari Polymers (petitioner in W.P. No.23777 of 2003) Not available Not available Available Has no
BIS licence Not fulfilled essential Criterion. Hence, not Recommended for shortlisting.

2. i) Haritha Irrigation Products Ltd. (Ptr. No.1 in WP.23940 of 2003) Available Not Available Not
Available BIS licence for Online drip System -do-

ii) Kumar Enterprises IPtr. No.2 in WP.23940 of 2003 Available Not available Not available Has no BIS
licence -do-

3. i) Satyasai Polymers (Ptr. fvo.l in W.P. 23944of 2003) Not available Not available Available. (Mfd. By
Tools Engg. with Brand neme of petitioner) Has no BIS licence -do-

ii) Kushal Polymers IPtr. No,2 in WP No.23944 of 20031 Available Not Available Available BIS licence for
Online dripsystem only. -do-

4. EPC Industries Ltd. Available Available Available BIS licence forall. Fulfilled many of the essential
criterion. Hence, recommended for shortlisting.

5. Jain Irrigation Systems Available Available Available, Mfd. By Tools Inline Engg. With Jain Brand. BIS
licence for Online end the essential Drip system. Not fulfilled many of the criterion. Hence, not
recommended for shortlisting.

6. Nagarjuna Raima Available Available Not available. Has BIS licencefor Online and Inline. Fulfilled many
of the essential criterion. Hence, recommended for shortlisting.

7. Netafim ACS & India Ltd. Available Available. Available. Sprinklers headsavailable from Netafirm, Israel.
BIS for Online and Inline drip systems. -do-

8. Parixit Industries Ltd. Available Available Available BIS licence for Online & Inline drip systems only.
-do-

9. Palstro Plasson Ind. Available Available Not available Has BIS lie. forOnline & Inline drip systems only.
-do-

10. Premier Irrigation Available Available. Available. BIS licence for all. -do-

__________________________________________________________________

69. The above table reflects the actual position as obtaining in the report of the Technical Committee and as
verified from EOI document submitted by the petitioners and seven short-listed companies. The above
table would show that none of the petitioners complied with essential criterion of having online and inline
drip manufacturing, facilities. As held by me, as per Paragraph 7(1) of the EOI document, the availability of
manufacturing facilities with online and inline drip system with BIS licence is essential criterion. The
petitioners have not fulfilled this criteria. Therefore, the respondents are justified in not including the
petitioners in the panel of shortlisted micro irrigation companies for participation in the APMIP. As the
petitioners do not have manufacturing facilities for online and inline drip system, whether or not the
petitioners have BIS licence for sprinklers, is not of much relevance.

70. Of the seven shortlisted micro irrigation companies, Epic Industries Ltd., Netafim India Ltd., Parixit
Industries Ltd., and Premier Irrigation Equipment Ltd., have manufacturing facilities for all the three
systems of micro irrigation systems namely, online, inline and sprinklers. Out of these, EPC Industries and
Premier Irrigation Equipment Ltd., have BIS licence for all the three systems whereas Jain Irrigation
Systems, Netafim India Ltd., and Parixit Industries Ltd., have BIS licence for online and inline drip system,
Jain Irrigation Systems, Nagarjuna Palma and Parixit Industries have manufacturing facilities for online
and inline drip system with BIS licence. The Technical Committee rightly treated the availability of
manufacturing facilities of sprinklers as a non-essential criteria and, therefore, these three concerns were
permitted to procure sprinklers by outsourcing. The same does not in any way fall outside the scope of the
EOI document. After evaluating the documents, the Technical Committee came to a conclusion that the
companies either fulfilled many of the essential criterion or not fulfilled many of the essential criterion,
probably to indicate that a short-listed company has facilities for manufacturing online and inline drip
system with BIS licence. The method adopted in the background of the criteria does not suffer from any
arbitrariness or illegality.

71. Basing on the remarks made in the standard format in relation to Jain Irrigation Systems, learned
Counsel for the petitioners Sri N.Rama Mohana Rao contends that the decision of the Technical Committee
suffers from non-application of mind. After verifying the EOI document of Jain Irrigation Systems, the
Technical Committee, at the end of the remarks column in the standard format observed that, "Jain
Irrigation Systems has not fulfilled the essential criterions for selection and hence the same is not
recommended for shortlisting." This is obviously a mistake as rightly contended by the learned Additional
Advocate General. At page 9 of the report of the Technical Committee, it is mentioned that after scrutiny of
the thirty seven applications, the committee satisfied that seven companies including Jain Irrigation
Systems fulfilled the criteria for shortlisting. Further, a perusal of the standard format in relation to Jain
Irrigation Systems would show that it has satisfied all the criterion and obviously the technical committee
by inadvertence observed that Jain Irrigation Systems has not fulfilled the essential criterion. Having
regard to the EOI document and the entire report of the technical committee, I am convinced that the
mistake that occurred does not in any way dilute the ultimate decision of Government in shortlisting Jain
Irrigation Systems.

72. After shortlisting the seven companies which fulfilled the essential criterion of having manufacturing
facilities with BIS licence, the Technical Committee conducted stock inspection of the shortlisted
companies between 31-5-2003 to 6-7-2003 and verified various parameters. As noticed hereinabove,
separate inspection reports in a tabular form were prepared and then only, a report was sent to the
Government. A contention is raised by both the learned Counsel for the petitioners that before taking a
decision against the petitioners, the respondents ought to have inspected the manufacturing facilities at
their respective factories. Not doing this, it is urged, is illegal and contrary to the binding instructions.
Reliance is placed on Paragraph 10(4) of the EOI document which stipulates that the present production
and utilization level would be decided after physically inspecting manufacturing facilities at the
manufacturing site. The Technical Committee first evaluated all the EOI documents with reference to
essential criterion which fulfilled all the essential qualifications. Physical Inspection was undertaken only
with regard to those seven companies as other thirty companies did not fulfil the essential criterion. When
admittedly the petitioners do not have manufacturing facilities for both online and inline drip systems and
have such facilities only for online or sprinklers, there was no necessity for the Technical Committee to
inspect the factory premises for assessing production and utilization level. The decision making process by
the Government does not in any manner affect by the non-inspection of the petitioners' factories by the
technical committee, especially when the petitioners did not fulfil the essential criterion. Physical
inspection would be necessary only to verify the manufacturing facilities at the premises only when such
facilities are available. Therefore, the submission made by the learned Counsel for the petitioners is devoid
of any merit.

73. Yet another submission is made by the learned Senior Counsel Sri K. Pratap Reddy to the effect that the
Government issued orders approving short-listing of seven companies based on the report of the Technical
Committee; as report of the Technical Committee formed the basis, any adverse decision against the
petitioners without supplying a copy of the technical report, is violative of principles of fairness and natural
justice. Strong reliance is placed on the decision of Supreme Court in M.D., E.C.I.L. v. Kanmakar (supra).
This submission is wholly misconceived and cannot be countenanced. It must be reiterated that no person
has right to compel the State to deal with him in the matter of providing services and goods. The claim of a
person to be considered along with others for such a privilege is not even an inchoate right. Amorphous
expectation if any is only to the extent that the State must treat all the persons equally before giving
contracts, licences, largesseess and privileges.

74. In Kanmakar's case, a Constitution Bench of the Supreme Court considered the question whether the
report of the Enquiry Officer in departmental enquiry against public servant is required to be furnished to
the employee to enable him to make proper representation to the disciplinary authority before such
authority arrives its own finding with regard to guilt or otherwise of the employee and punishment if any to
be awarded to him. The question arose in the background of Article 311(2) of the Constitution. The right to
an opportunity before a Public Servant removed/ dismissed or reduced to lower rank is itself a
Constitutional right. The decision if any by the disciplinary authority imposing any of the punishments
without any opportunity therefore would be impermissible. In the same tone, if the report which is the basis
for the disciplinary authority to arrive at a decision is not supplied, it would amount to denying the right to
opportunity of meeting the case. Therefore the Supreme Court having regard to the case law under Article
311 of the Constitution held that the Enquiry report must be furnished to the delinquent employee and
disciplinary authority should pass necessary orders after considering explanation of the employee. This
Court is not able to comprehend the applicability of ratio in Kanmakar's case to the facts of the present
case. In this case the petitioners have no right muchless enforceable right to compel the State to include the
petitioners in the list of companies to participate in APMIP. Further, the Technical Committee examined
the EOI documents and prepared Standard Format having regard to essential criteria. When the report was
submitted to SHLC, the said committee made recommendations. The Government not only relied on the
report of the Technical Committee and the recommendations of SHLC, but also considered all the EOI
documents and passed orders approving short-listing of seven companies. The dynamics of decision
making at different committee levels was only resorted to make a decision broad-based. It does not mean
that the Government has not taken a decision independently though the matter was examined at two lower
levels before a final decision was taken. In the opinion of this Court, non-furnishing of the report of the
Technical Committee or SHLC to the petitioners does not vitiate the decision making process and Doctrine
of fairness has not been breached.

75. One more submission strenuously pressed into service by the learned Counsel for petitioners is that the
decision of the Government is arbitrary and violative of Articles 14 and 19 of the Constitution of India. It is
not necessary to refer to the decisions cited by Sri K. Pratap Reddy in this regard as they have no
application to this case. This Court may however, refer to the decision of the Supreme Court in Krishnan
Kakkanth v. Government of Kerala, , (not cited either by the learned Counsel for petitioners or the learned
Additional Advocate General) in which facts are somewhat similar.

76. In Krishnan Kakkanth v. Government of Kerala, (supra), Government of Kerala issued a circular that
under Comprehensive Coconut Development Programme under which pumpsets and other agro-machines
under the financial scheme have to be purchased from Kerala Agro Industries Corporation (KAICO) and
Regional Agro Industries Development Corporation (RAIDCO). The said circular was challenged and
upheld by the Kerala High Court. It was contended before the Supreme Court, on behalf of the private
dealers, that the Government circular amounts to unreasonable restriction on the fundamental right under
Article 19(1)(g) of the Constitution to trade in the agro machinery as the farmers were compelled to buy
pumpsets from KAICO and RAIDCO only. The Apex Court found that in the past, under the same
programme, notices had been issued by the dealers, who without effecting actual sales had drawn loans,
subsidies and other financial benefits from the Government and that there were widespread manipulation
and irregularities in the activities of various dealers in the pumpsets. This prompted to issue the circular
compelling the fanners to buy agro machines with the financial assistance from KAICO and RAIDCO only.
The Supreme Court held that the impugned circular did not impose any restriction on the trading activity of
the dealers of pumpsets in the State of Kerala and no trader can claim that the Government should also
accept him as an approved dealer of the Government. The following observations are relevant.

................... No restriction has been imposed on the trading activity of dealers in pumpsets in the State of
Kerala including northern region comprising eight districts. Even in such an area, a dealer is free to carry
on his business. Such dealer, even in the absence of the said circular, cannot claim as a matter of
fundamental right guaranteed under Article 19(1)(g) that a farmer or agriculturist must enter into a
business deal with such trader in the matter of purchase of pumpsets. Similarly, such trader also cannot
claim that the Government should also accept him as an approved dealer of the Government. The trading
activity in dealership of pumpsets has not been stopped or even controlled or regulated generally. The
dealer can deal with purchasers of pumpsets without any control imposed on him to carry on such business.
The obligation to purchase from approved dealer has been fastened only to such farmer or agriculturist who
has volunteered to accept financial assistance under the scheme on various terms and conditions.

77. It was further held that the impugned circular does not offend Article 14 of the Constitution and that the
directions contained in the circular cannot be held to be vitiated being arbitrary, capricious and
unreasonable. The Supreme Court opined that if the State Government on consideration of the facts and
circumstances and to ensure genuine sale of pumpsets at proper price with effective after-sales service has
felt that farmers covered by financial assistance scheme should purchase pumpsets only from approved
dealers, it cannot be said that such action of the State Government lies in its ipse dixit without being
informed by any reason. The Supreme Court further observed:

To ascertain unreasonableness and arbitrariness in the context of Article 14 of the Constitution, it is not
necessary to enter upon any exercise for finding out the wisdom in the policy decision of the State
Government. It is immaterial whether a better or more comprehensive policy decision could have been
taken, It Is equally immaterial if it can be demonstrated that the policy decision is unwise and is likely to
defeat the purpose for which such decision has been taken. Unless the policy decision is demonstrably
capricious or arbitrary and not informed by any reason whatsoever or it suffers from the vice of
discrimination or infringes any statute or provisions of the Constitution, the policy decision cannot be
struck down. It should be borne in mind that except for the limited purpose of testing a public policy in the
context of illegality and unconstitutionality. Courts should avoid "embarking on uncharted ocean of public
policy",

78. The submission of the learned Counsel for petitioners Sri N. Rammohan Rao that petitioners being
small scale units, ought to have been preferred is baseless. I have perused the relevant Government Order
which stipulates guidelines to be followed by all the Government Departments while procuring stationery
items and other items for public procurement. The Government Order also contains annexure of items
manufactured by the small scale units which are to be purchased by the Government Departments. Micro
Irrigation systems Sprinklers do not find place in the list. Therefore the decision of the Government on this
score cannot be faulted.
79. The half-hearted submission that the criteria is arbitrary, cannot be countenanced. Para 5 of the EOI
document gives modus-operandi of execution of APMIP. The relevant rules are as under:

Modus Operandi

The agencies to be involved in this project are :

1. Government of Andhra Pradesh.

2. Drip system manufacturer/supplier.

3. Banker who advances loan to the beneficiary farmer.

4. Beneficiary farmer.

The Project is funded by the Government of Andhra Pradesh and the Department of Horticulture is the
principal project coordinating and implementing agency. The appointment of the Drip system Supplier will
be done by the State Level Committee, APMIP and a tri-partite agreement will be made between GoAP,
supplier and banker. The Drip Supplier and Local Bank Representatives will select the beneficiary farmers
jointly with the assistance of the GoAP representative in the allotted project area considering all relevant
revenue, technical, capital and management factors. After selection, the Drip Supplier will install the
irrigation system in the beneficiary fanner's field. The technical and agronomic support to the beneficiary
farmer will be the responsibility of the Drip Supplier at his own cost for a period of five years. While the
project monitoring and quality control will be the responsibility of the District Collector and he will
organize, supervise and co-ordinate the completion of the project on or before the specified project period
or such other period/date as may be fixed under the conditions, subject to the release of funds by GoAP and
Bankers; the supplier and the Beneficiary Farmer and their obligations in terms of tripartite agreement.

80. The endeavour is to involve GoAP, the supplier and the banker in a co-ordinated effort in which
revenue, technical, capital and management factors are the essential inputs. The supplier has to install the
drip system and is held responsible at its own cost for a period of five years. The District Collector is
empowered to monitor and ensure quality. The selection of drip system/ micro irrigation system,
installation, maintenance, providing finance etc., are sought to be made available at single window. The
APMIP seeks to ensure "one stop facility" to the farmer. If a farmer requires online drip system, inline drip
system and also sprinkler system (assuming he has different crops requiring different MIS) the farmer
cannot be asked to buy one system from one manufacturer and other system from another manufacturer. It
would be difficult to monitor for the District Collector as well. If all these three systems are made available
with one manufacturer and after installation, maintenance services, the same would ensure success of
APMIP. Viewed in this background, the submission that the criteria evolved is arbitrary is to be stated for
the purpose of rejection.

Conclusion

81. In view of the findings and conclusion on the above questions framed, it must be held that inclusion of
seven micro irrigation manufacturing companies does not suffer from any vice. It must also held that non-
inclusion of petitioners in the panel of short-listed companies for participation in A.P. Micro Irrigation
Project also does not suffer from any arbitrariness and unreasonableness. The decision of GoAP is justified
as the petitioners did not fulfill and complied with the essential criteria laid down in EOI document.

82. The writ petitions are devoid of merit and are accordingly dismissed with costs.

EMPLOYMENT CONTRACT

Karnataka Bank vs T. Gopalakrishna Rao on 14/12/1993

ORDER

Shivashankar Bhat, J.
1. Rejection of an application to reject the plaint under Order VVI Rule 11 of the Code of Civil Procedure is
challenged by the defendant in CRP No. 1053/93. The defendant is as Bank kin the private sector. Plaintiff
(respondent) is a General Manager in the said Bank. Plaint alleges that the plaintiff received a Memo dated
3.3.1994 informing him that the Board of Directors by its Resolution No. 63 dated 2.3.1995 had resolved to
suspended him on the ground of insubordination and therefore pending disposal of the domestic enquiry
into the charge-sheet dated 8.1.1993, he was to be kept under suspension. This Resolution is attacked as
vitiated by mala fides, arbitrariness and lack of competence. The reliefs sought for in the suit read as follows
:-

" (a) For a declaration that the resolution No. 63 passed by the Board of defendant Bank suspending the
plaintiff with mala fide intention and motivated and hence it is null and void and illegal and consequently
for a permanent injunction restraining the Bank from acting upon the said resolution.

(b) For a declaration that the discipline enquiry now pending against the plaintiff on charge of bigamy or
refusal to acknowledge to sign the delivery register on 6.1.1993 and consequential alleged insubordination
is vitiated, null and void and consequently for a permanent injunction restraining the defendant from
processing with the said enquiry."

The basic question is whether such a suit is maintainable ?

2. The learned Munsiff held that there is no particular legal bar against the maintainability of the suit as
stated in Order VII Rule 11 of the Code of Civil Procedure and that the question of the maintainability of the
suit on other grounds "is a matter to be decided at the time of disposal of the main suit." According the
learned Munsiff legal bar contemplated by Order VII Rules 11 (d) CPC is a bar referred to in such legal
provisions like Section 80 CPC or the Law of Limitation.

3. The above view assumes that Order VII Rule 11 CPC is exhaustive of the circumstances in which a plaint
has to be rejected. But, Order VII Rule 11 CPC is held to be not exhaustive of the grounds to reject a plaint
(vide : Rada Kishen v. Wali Mohammed AIR 1956 Hyderabad 133).

4. If the Court's jurisdiction is not available to grant the relief's sought for in the plaint on the basis of the
entire plaint averments considered as a whole, it will be technically, a case of non-availability of cause of
action for the civil suit. Even otherwise, an inherent lack of jurisdiction to entertain the suit, necessarily
includes a jurisdiction in the Court to reject the plaint, at the threshold of the proceedings.

5. When the plaint is represented Court has to assume all the allegations made in the plaint as correct and if
on that basis, it is realised that the Court cannot grant the relief sought for in plaint, it will be futile exercise
to keep the suit pending so as to undergo the formalities of a trial, before facing a dismissal. It is well known
that the allegations made in the plaint decide the forum and jurisdiction does not depend upon the defence
taken by the defendant in a written statement - (vide : Abdulla Bin Ali & Ors. v. Galappa & Ors. .

6. Whether the Court should postpone its decision regarding maintainability of the suit, depends on the
facts of the case. If the entire plaint averments are accepted and with reference to them the relief prayed for
in plaint cannot be granted by the Civil Court, it will not be in the interest of public to keep such a suit.
Further, keeping such a suit pending will lead to unnecessary harassment of the defendant; it will be
permitting the abuse of the process of the Court at the behest of a plaintiff who is not entitled to any relief,
ultimately. In such a situation, as this, the approach to be adopted is to consider the maintainability of the
suit at the earliest. In T. Arivandandam v. T. V. Satyapal & Anr. AIR 1977 SC 2421 the Supreme Court
observed :

"We have not the slightest hesitation in condemning the petitioner for the gross abuse of the process of the
Court repeatedly and unrepentently resorted to. From the statement of the fact found in the judgment of
the High Court, it is perfectly plain that the suit now pending before the First Munsiff's Court, Bangalore, is
a flagrant misuse of the mercies of the law in receiving plaints. The learned Munsiff must remember that if
on a meaningful - not formal - reading of the plaint it is manifestly vexatious, and meritless, in the sense of
not disclosing a clear right to sue, he should exercise his power under Order VII Rule 11, C. P. C. taking care
to see that the ground mentioned therein is fulfilled. And, if clear drafting has created the illusion of a cause
of action, nip it in the bud at the first hearing by examining the party searchingly under Order X C. P. C. An
activist Judge is the answer to irresponsible law suits. The trial Courts would insist imperatively on
examining the party at the first hearing so that bogus litigation can be shot down at the earliest stage.

If on the facts alleged, the suit is manifestly meritless if has to be thrown out at the earliest.

7. Here is a case, where, a private employer has resolved to initiate disciplinary proceedings against its
employee; the employer has also resolved to keep the employee under suspension. These decisions are
challenged by seeking declaratory reliefs against their validity and the enforcement of the decisions are
sought to be restrained by a decree of permanent injunction. Plaint nowhere relies on any statutory
provision governing the rights of the plaintiff nor of any provision controlling or regulating the exercise of
its power by the employer. Therefore, the question is whether the suit is maintainable in the Civil Court and
whether the Civil Court is competent to grant the reliefs sought for on the facts alleged in the plaint.

8. It is a managerial function vested in an employer to take disciplinary action against the employee; it is for
the employer to decide to initiate disciplinary action or not. Similarly, an employer can always keep his
employee under suspension, provided, the emoluments payable to the employee under the terms of
employment are paid (subject to any other conditions of service as to the reduced emoluments, like
payment of subsistence allowances). The validity or invalidity of the action of the employer, so long as the
employer's action an the relationship between the parties are not governed by statutory provisions, cannot
be examined by the Court, except, in a case where compensation or damages is awardable. In the case of
wrongful dismissal, a private employee (not governed by any statutory provisions) can seek a declaration of
the invalidity of the dismissal not for the purpose of reinstatement, but only for compensation.

9. As a corollary to the above principle, it should follow that, an employer cannot be restrained from
initiating an action for the purpose of deciding whether the employee should be dismissed or punished in
any manner. If the ultimate order of dismissal cannot be challenged so as to get a decree for reinstatement,
can it be that, the said object can be realised in advance by restraining the employer from proceeding to
dismiss an employee. In fact, at the initial stage, when employer resolves to hold an enquiry, if cannot be
held that the employee is bound to be dismissed. Intention of the employer at this initial stage, is relevant,
unless, this intention continues to pervade the entire proceedings leading to a mala fide order of dismissal
(or of any punishment). On proof of such an intention, vitiating the proceedings, the employee can always
seek damages. The basic principle is that, Civil Court is preclude from enforcing a contract of service.

10. In Sirsi Municipality by its President Sirsi v. Cecelia Kom Francis Tellis an employee of a Municipality
sued for a declaration that her dismissal was illegal and void. Since service conditions were statutory, such a
suit was held as maintainable and the remedy of an employee of a statutory body is not confined to
damages. In this connection, the scope of the relevant principle was stated by the Supreme Court. At page
857, the Court held :

"The cases of dismissal of a servant fall under three broad heads. The first head relates to the relationship of
master and servant governed purely contract of employment. Any breach of contract in such a case is
enforced by a suit for wrongful dismissal and damages. Just as a contract of employment is not capable of
specific performance similarly breach of contract of employment is not capable of finding a declaratory
judgment of subsistence of employment. A declaration of unlawful termination and restoration to service in
such a case of contract of employment would be indirectly an instance of specific performance of contract
for personal services. Such a declaration is not permissible under the law of Specific Relief Act.

The second type of cases of master and servant arises under Industrial Law. Under that branch of law a
servant who is wrongly dismissed may be reinstated. This is a special provisions under industrial law. This
relief is a departure from the reliefs available under the India Contract Act and the Specific Relief Act which
do not provide for reinstatement of a servant. The third category of cases of master and servant arises in
regard to the servant in the employment of the State or of other public or local authorities or Bodies created
under Statute.

Termination or dismissal of what is described as a pure contract of master and servant is not declared to be
a nullity however wrongfully or illegal it may be. The reason is that dismissal in breach of contract is
remedied by damages. In the cases of servant of the State or of local authorities or statutory bodies, Courts
have declared kin appropriate cases the dismissal to be invalid, if the dismissal is contrary to Rules of
natural justice or if the dismissal is in violation of the provisions of the Statutes. Apart from the
intervention of statute there would not be declaration of nullity in the case of termination or dismissal of a
servant of the State or of other local authorities or statutory bodies."

The Supreme Court clearly laid down that breach of contract of employment is not capable of founding a
declaratory judgment of subsistence of employment. I am of the view that if the entire terror of the plaint is
to protect the subsistence of a private employment and nothing more, no purpose will be served by
entertaining such a suit.

11. Again the Supreme Court in Executive Committee of Vaish Degree College, Shamli & Ors. v. Lakshmi
Narain & Ors. AIR 1976 SC 888 after referring to Sirsi Municipality's case held at page 897 :

"On a consideration of the authorities mentioned above, it is, therefore, clear that a contract of personal
service cannot ordinarily be specifically enforced and a Court normally would not give a declaration that the
contract subsists and the employee, even after having been removed from service can be deemed to be in
service against the will and consent of the employer. This rule, however, is subject to three well recognised
exceptions - (i) where a public servant is sought to be removed from service in contravention of the
provisions of Article 311 of the Constitutions of India; (ii) where a worker is sought to be reinstated on being
dismissed under the industrial law; and (iii) where a statutory body acts in breach or violation of the
mandatory provisions of the statute.

In view of our finding that the Executive Committee of the College in the instant case was not a statutory
body, the present case does not fall within any of the excepted categories mentioned above, and hence
prima facie, the plaintiff/respondent is not entitled to any declaration or injunction".

12. However, Mr. K. Subba Rao, the learned counsel for the plaintiff relied on the observations of Bhagwati,
J. (as he then was) in the above case. The learned Judge suggested a change from the traditional approach
to such cases, where, in reality, the contract is not a contract of personal service, as the in the case of a large
scale industry or enterprise. At page 902, the learned Judge observed :

"This rationale obviously can have application only where the contract of employment is a contract of
personal service involving personal relations. It can have little relevance to conditions of employment in
modern large-scale industry and enterprise or statutory bodies or public authorities where there is
professional management of impersonal nature. It is difficult to regard the contract of employment in such
case as a contract of personal service save in exceptional cases. There is no reason why specific performance
should be refused in cases of this kind where the contract of employment does not involve relationship of
personal character. It must be noted that all these doctrines of contract of service as personal non-
assignable, unenforceable, and so on, grew up in an age when the contract of service was still frequently a
personal relation between the owner of a small workshop or trade or business and his servant. The
conditions have now vastly changed and these doctrines have to be adjusted and reformulated in order to
suit needs of a changing society. We cannot doggedly hold fast to these doctrines which correspond to the
social realities of an earlier generation far removed from ours. We must rid the law of these anachronistic
doctrines and bring it in accord with the felt necessities of the times."
But this observations was confined to the case of employment under a statutory body or public authority as
could be seen from the observations at page 903 :

"It is, therefore, necessary and I venture to suggest, quite possibly, within the limits of the doctrine that a
contract of personal service cannot be specifically enforced, to take the view that in case of employment
under a statutory body or public authority, where there is ordinarily no element of personal relationship,
the employee may refuse to accept the repudiation of the contract of employment by the statutory body or
public authority and seek reinstatement on the basis that the repudiation is ineffective and the contract is
continuing."

13. Again in Smt. J. Towari v. Smt. Jawala Devi Vidya Mandir & Ors. it was reiterated that in the case of a
private

employment remedy of the employee in the case of a wrongful dismissal, is to seek damages. The fact that
the employer was an educational institution, governed by the Regulation of the University was held, as
insufficient, to permit the relief of a declaration that the termination was illegal and therefore employee is
entitled to continue in service.

14. It was held in Jitendra Nath Biswas v. M/s. Empire of India & Ceylon Tea Co. & Anr. that the Civil Court
had no jurisdiction to grant the relief of reinstatement and back wages, since the case was covered by the
provisions of the Industrial Disputes Act. The principle is reiterated at page 257 :

"It could not be disputed that a contract of employment for personal service could not be specifically
enforced and it is also clear that except the industrial law, under the law of contract and the civil law, and
employee whose services are terminated could not seek the relief of reinstatement or backwages. At best he
could seek the relief of damages for breach of contract. The manner in which the relief has been framed by
the appellant plaintiff in this case, although he seeks a declaration and injunction but in substance it is
nothing but the relief of reinstatement and backwages."

15. Therefore, in the cases not covered by the Industrial Disputes Act, or by another statute and the
employment is a private employment, remedy of the employee will be to sue for damages in the case of an
illegal termination of services; he cannot insist before the Civil Court that he should be continued in service;
he cannot achieve the same result of subsisting in service unhindered, by recourse to an action to restrain
the employer from proceeding in a manner that may lead to the termination of service. Civil Court's
jurisdiction to grant such a relief is barred by necessary implication.

16. Mr. Subba Rao contended that, it is open to the plaintiff to amend the plaint to bring it within the
jurisdiction of the Civil Court and therefore, at this stage, plaintiff should not be non-suited. I fall to
understand this submission. This is not a case of defective plaint. The very subject matter of the litigation is
outside the purview of the Civil Court. A suit cannot be kept pending in the pious hope that an future date,
plaintiff may seek amendment of the plaint.

17. Mr. Subba Rao referred to a Decision of this Court in K. S. R. T. C. & Anr. v. Aron, T. I. 1983 (1) KLJ 555,
Driver of K. S. R. T. C. (a statutory corporation) sought a declaration that the order dismissing him from
service was void and as such he continued in service. Suit was held as maintainable, in spite of the
availability of the provisions of the Industrial Dispute Act. This decision is clearly distinguishable, because,
employee was seeking enforcement of his service conditions under a statutory corporation. It is
unnecessary to express any opinion as to the effect of the Decision of Supreme Court in Jitendranath's case
(supra).

18. Mr. Subba Rao relied on United Theological College v. Sunny Kulathakkal . In this case of United
Theological College, an employee of the College filed a suit for declaration that the Resolution passed by the
Executive Committee granting him eight months leave and that his services would not be continued beyond
30.4.1977, was not void, illegal, etc. and for a declaration that the plaintiff continued in services. Plaintiff
also sought recovery of arrears of salary and damages. It was not a simple suti for declaration to enforce the
contract of service at all. In such a situation where, salary and damage are sought due to the invalidity of the
termination of service, civil suit is maintainable. Therefore, whatever may be the ratio of the Decision
rendered in the said United Theological case, the ultimate conclusion is based on the principle, which I
have derived from the several decisions of the Supreme Court. In fact, the ultimate decree in the said case
did not reinstate the plaintiff, but awarded him a sum of Rs. 4,000/- maintainability of the suit, as such was
not raised as an issue and relied of reinstatement not sought for (see at page 2328).

19. Subsequently I hold that the suit as filed, is not maintainable and the plaint is liable to be rejected. It is
so ordered.

C. R. P. No. 2910 of 1983 is against the order made by the Court of the Civil Judge, refusing to vacate an
interim order dated 21-4-1993, whereby the 'disciplinary charges' against the plaintiff was stayed. As per I.
A. No. III in the suit before the Trial Court, the plaintiff has sought stay of the discipline proceedings; Trial
Court rejected this I. A. against which the plaintiff filed M. A. No. 29 of 1993. Plaintiff has also filed IA No.
II in the Trial Court seeking an order of temporary injunction against enforcing the order of suspension;
this was rejected. Both I. A. Nos. II and III were rejected by the Trial Court by a common order. M. A. 21 of
1993 is against the said order. It seems, plaintiff filed a Memo in the lower Appellate Court confining M. A.
No. 21 of 1993 to the order on I. A. No. II and subsequently filed M. A. No. 29 of 1993, against the order on
I. A. No. III in C. R. P. No. 1053 of 1993 this Court had stayed all further proceedings in the suit in the Trial
Court and M. A. No. 21/1993 in the Lower Appellate Court. This was on 15.4.1993; this interim order
continued from time to time. It seems on 12.4.1993 itself, the plaintiff had filed a Memo in the lower
Appellate Court confining the appeal M. A. No. 21 of 1993 to the order of the Trial Court made on I. A. No.
II. Therefore, the learned Civil Judge held that interim order of this Court staying further proceedings in M.
A. No. 21 of 1993 did not preclude him from making an order in M. A. No. 29 of 1993.

21. Technically he may be correct. But, the learned Civil Judge should have pondered over the matter for a
while, which would have made him to realise that this Court clearly indicated that when the suit and M. A.
No. 21 of 1993 were stayed, indications are that, the Court should not have ventured to consider the prayer
to stay the disciplinary proceedings. Anyhow, discussion on this aspect has become academic, in view of my
order rejecting the plaint. The order made by the Court of the Civil Judge in M. A. No. 29 of 1993 is
accordingly set aside.

22. In the result, both the Civil Revision Petitions are allowed and the impugned orders are set aside.
Consequently, the plaint in O. S. No. 293 on the file of the Additional Munsiff, Mangalore, is rejected. No
costs.

BANKING CONTRACT

Union Bank Of India vs M/S. J.B. Khanna & Co. And Others on 9/7/1996

JUDGMENT

1. This is a suit for recovery of money on the basis of contract of guarantee. Defendant No. 2 has contended
the suit by filing written Statement. The other Defendants have not filed any Written Statement and have
not taken part during trial. Second Defendant has also taken a third party notice to all the Defendants, But
the notice was served only on Defendants Nos. ] & 3. The other Defendants have not been served. Both the
Plainiff and the second Defendant have not adduced any oral evidence. Both parties have filed some
documents, which have been marked by consent. The Plaintiff's documents are marked as Exhibit A to
Exhibit Z and Exhibit A1 to Exhibit AA. Second Defendant's documents are marked as Exhibits 1 to 21. In
fact some of the exhibits are common. I have heard the learned Counsel for the Plaintiff and the learned
Counsel for the second Defendant.

2. The Plaintiff's case is as follows:--

The Plaintiff is Union Bank of India, which is a nationalised bank. The Defendant No. 1 is a partnership
firm of which Defendants Nos. 3 to 6 are partners. The First Defendant-firm had entered into an agreement
with the Government of Maharashtra for construction of bridge. In connection with that contract, the first
Defendant was required by the Government to give cash security deposit or a bank guarantee in a sum of
Rs. 34,280/-, Hence, the first Defendant approached the Plaintiff/Bank for a bank guarantee. The Plaintiff
agreed and issued a bank guarantee in favour of the Government of Maharashtra, dated 7th August, 1969.
The guarantee has been renewed form time to time. On the request of first Defendant, Vulcan Insurance Co.
Ltd. entered into guarantee policy with the first Defendant undertaking to pay whatever amount the
Plaintiff/Bank incurs in honouring bank guarantee in favour of the Government of Maharashtra. The said
policy is being extended from time to time. It is stated that the present second Defendant namely United
India Fire & General Insurance Co. Ltd. is the successor in interest of Vulcan Co. Ltd. The Executive
Engineer of Ratnagiri District, State of Maharashtra by a letter dated 5th Dec. 1975 invoked the bank
guarantee and called upon the Plaintiff to make payment of Rs. 34,280/-. Then there was correspondence
between the Plaintiff and Defendants Nos. 1 and 3 to 6. The first Defendant was called upon to make
payment. The first Defendant took time to get the matter settled with the Government. After some
correspondence, the Plaintiff was obliged to make payment to the Government of Maharashtra as per the
conditions of Bank guarantee. The Plaintiff/Bank called upon the second Defendant to make payment of
sum of Rs. 34,280/- which it had paid to the Government of Maharashtra. But the second Defendant did
not comply with the Plaintiff/ Bank's demand. Since, the defendants have filed to reimburse the money to
the Plaintiff, the Plaintiff/Bank has filed this suit for recovery of Rs. 34,280/- with costs.

3. The second Defendant who is the only contesting defendant in this suit has filed Written Statement. It is
stated that the suit is bad for misjoinder of parties and causes of action. The contract between the first
defendant and the Government of Maharashtra and the contract between the Plaintiff and first Defendant
are admitted. The correspondence between the parties is admitted. However, it is stated that on getting
Plaintiff/ Bank's letter, the first Defendant wrote to the Plaintiffs asking him not to make any payment to
the Government, since the Government itself is due (sic) money to the first defendant. In spite of protest by
the first Defendant, the Plaintiff/Bank paid money to the Government of Maharashtra. This payment is
unjustified. Hence, Plaintiff called upon the second Defendant to reimburse the said amount. In the letter
of the Executive Engineer, invoking the bank guarantee, there is no allegation of any default on the part of
the first Defendant regarding the contract work. Hence, there is no default on the part of the first
Defendant, who was doing the contract work and therefore the Plaintiff was not obliged to honour the bank
guarantee. It is stated that the suit is not maintainable. That the second Defendant is not liable to make any
payment. Alternatively it is pleaded that if the second defendant is made liable for the suit claim, then the
second Defendant is entitled to be indemnified by Defendants Nos. 1 and 3 to 6. The second Defendant has
also taken third party notice to the defendants praying that it should be reimbursed by Defendants Nos. 1
and 3 to 6.

However, the third party notice has been served only on the Defendants Nos. 1 and 3.

4. Following issues have been framed in this suit:--

ISSUES

1) Whether Plaintiff Bank was liable to honour its commitment under the Guarantee Dated 7th August,
1969 (Exh. 'A' to Plaint) issued in favour of State of Maharashtra.

2) Whether Defendant No. 2 under Guarantee Policy dated 21st August, 1969 (Exh.'B' to the Plaint) and
extended upto 30th June, 1976, liable to pay to the Plaintiff sum of Rs. 34,280/- along with interest thereon
at the rate of 14% p.a. from the date of Suit till Judgment and thereafter at the rate of 6% p.a. till payment.

3) Whether Defendants Nos. 3 to 6 as partners of Defendant No. 1 firm and/or as the legal heirs of J.S.
Khanna and/or under their indemnity dated 7th August, 1969 (Exh. 'C' to the Plaint) are jointly and
severally liable to pay to the Plaintiffs Rs. 34,280/- along with interest thereon at the rate of 14% p.a. from
the date of the suit till judgment and thereafter at the rate of 6% p.a. till Judgment.

4) What was the correct nature and what were the terms and conditions of the Guarantee Bond executed by
the Plaintiffs in favour of the Government and was Plaintiffs legally bound to make good the Demand made
by the Government?

5) If Defendant No. 2 is to make payment then can they claim indemnity and contribution from Defendant
No. 1 and Defendants Nos. 3 to 6 pursuant to the Counter Guarantee dated 10th January, 1969, executed by
them?

5. Issues Nos. 1 and 4: -- The Plaintiff's contention is that in terms of bank guarantee it was liable to make
payment when there was a demand by the Executive Engineer. Its defence is that in the absence of default
or breach of condition on the part of the first Defendant, the Government had no right to demand the
money on the basis of bank guarantee and that the plaintiff was not liable to pay the money on the basis of
the bank guarantee. Before considering the question of law on this point, let me refer to the available
evidence on this point.

6. Exhibit 'D' dated 7-8-1969 is the bank guarantee executed by the Plaintiff. It is mentioned in the first
para that for the performance of the contract between the Government of Maharashtra and the first
Defendant in respect of constructing bridge across Moohemad Creek at Vengurla-Reddy Road in Ratnagiri
District, the Plaintiff/Bank had executed a bank guarantee. The relevant undertaking on part of the
Plaintiff/ Bank is follows:--

"We, Union Bank of India, Ratnagiri (herein after called "the Bank") do hereby agree to pay on demand to
the employer a sum of Rs. 34,280/- (Rupees Thirty four Thousand and two hundred eighty only) under this
bond."

It is therefore seen that here is an unconditional contract by the bank to pay the agreed amount to the
Government of Maharashtra on demand.

Exhibit 'E' is a letter of indemnity executed by the first Defendant and its partners in favour of the Plaintiff-
Bank on the same day as a security for the bank guarantee given by the Plaintiff on that day namely 7-8-
1969. The letter acknowledges the bank guarantee given by the Plaintiff/ Bank and the first Defendant
agrees to indemnify the bank for any loss incurred by it for honouring the bank guarantee. Then comes an
important clause as to under what terms and conditions the bank was liable to pay the money to the
Government. The relevant clause reads as follows:--

"And I/We further agree that any request made upon you by the Executive Engineer B and C Division,
Ratnagiri for payment of any sum or sums of money in pursuance of the said Guarantee shall be a sufficient
authority to you for making any such payment and that notwithstanding anything contained in the said
Guarantee executed by you it shall not be incumbent upon you to enquire whether any such amount or
amounts is/are in fact due. I/We also agree that payment by you under this guarantee is to be conclusive
that the claim has arisen and of the amount of such claim."

It is therefore, seen that in this letter, the first defendant has categorically and unequivocally admitted that
the plaintiff should make the payment of demand by the Executive Engineer and it is no part of the duty of
the Plaintiff to enquire whether any amount is due to the Government or not. It further records that any
payment under the guarantee is conclusive that the claim has arisen and also about the amount of such
claim. That means the bank is under no obligation to find out whether any amount is due to the Executive
Engieer or not. If there is a demand by the Executive Engineer, without doing any inquiry about the
correctness of the amount or correctness of the demand, the Plaintiff was obliged to make payment.
7. In order to give security to the Plaintiff, the first Defendant entered into an agreement with the Vulcan
Insurance Co, Ltd., and executed an indemnity bond in favour of the Plaintiff, as per Exhibit F dated 21st
August, 1969. It clearly shows that if the Plainitff/ Bank makes any payment on demand by the beneficiary,
it is sufficient authority to the bank for making payment. Then, there is a specific clause in Exhibit 'F',
which reads as follows:--

"..... it shall not be incumbent upon the Bank to enquire whether any such amount or amounts is/are in fact
due and that any payment by the Bank under said Bank Guarantee shall be a conclusive proof that a claim
has arisen and of the amount of such claim."

It is admitted fact that second Defendant is the successor in interest of the Vulcan Insurance Co. Ltd., and
hence, is bound by Exhibit 'F'. Exh. 'F' also clearly shows that bank is under no obligation to find out
whether any amount is at all due to the Government and if so, how much amount is due. Even according to
this document, the plaintiff is under a legal obligation to make payment on demand by the beneficiary.

8. Exhibit 'R' is the letter dated 5-12-1975, under which Executive Engineer, invoked the bank guarantee
and called upon the Plaintiff to make payment. The Executive Engineer has invited the attention of the
Plaintiff-Bank to its bank guarantee dated 7-8-1969 and demands the payment of the amount of Rs.
34,280/-.

It is not as if the Plaintiff-Bank honoured this letter immediately. It is seen from the record that the Plaintiff
wrote letter and reminding letters to the first defendant to make payment and settle the claim. Then the
first Defendant wrote letter to the bank saying that there is no breach on its part and that the breach is on
part of the Government and that he is negotiating with the Government for settlement and that the first
Defendant is itself entitled to large sums of money from the Government and therefore, the Plaintiff should
not make payment under bank guarantee, (vide Exh. S, Y, W, A-3 and A-4). The Plaintiff has brought to the
notice of the first Defendant about the demand made by the Executive Engineer. Whether really breach is
committed by the Government or by the first Defendant is no concern of the plaintiff-bank. It is also no
concern of the plaintiff-bank to find out whether the Government was due any amount to the first
Defendant as alleged by the first Defendant. Since, the first Defendant did not make the payment and did
not settle the matter with the Government and in view of reminding letters received from the Executive
Engineer (Vide Exhibits (sic) the plaintiff was compelled to make the payment to the Government to
honour it bank guarantee in June, 1976 as per its letter Exh. A-6 dated 7-6-1996.

9. The learned Counsel for the second Defendant contended that the bank guarantee was not enforceable
since, it does not mention any default clause on the part of the first Defendant and further in the letter of
Executive Engineer, there is no allegation of default by the first Defendant. He placed reliance on Section
126 of the Contract Act, which provides for a contract of guarantee only when there is default on the person
at whose instance the contract of guarantee was given. The reliance was placed on two authorities.

In (1990) 2 Com LJ 265 (Delhi), Nangia Construction (India) (P) Ltd. v. National. Buildings Construction
Corporation Ltd., the Court was concerned about interpretation of Section 126 of the Indian Contract Act
and also about the bank guarantee produced in that case. The facts of that case are distinguishable.
However, the learned Counsel for the second Defendant placed reliance that a guarantee becomes
enforceable only upon the default as observed at page 279 para 95 of the reported judgment. With great
respect to the learned single Judge of the Delhi High Court, who decided that case, I am unable to subscribe
to the said view. I will presently point out number of decisions of the apex courts, where the consistent view
is taken that bank's liability is to be determined on the basis of the contents of the bank guarantee and not
on the basis of the liability of principal debtor. If the bank guarantee creates a liability on demand then
bank is obliged to honour its commitment and pay the amount irrespective of the question whether there
was a default on the part of the principal debtor or not.
Even assuming for a moment that the view of Delhi High Court in the above case is acceptable, I may point
out that from the facts of this case such a contract can be spelt out from the conduct of the parties. As soon
as the Plaintiff received the demand notice from the Executive Engineer, the Plaintiff did not pay the
amount immediately, but wrote a letter to the first defendant and wrote two/three reminding letters. It is
only about 6 months later the bank paid the amount, when the first Defendant did not settle the matter. It
is already seen that the conditions in the letter of guarantee executed by the first Defendant and also in the
guarantee policy executed by the second Defendant, there is a specific clause that Plaintiff need not go
outside the bank guarantee and Plaintiff need not find out whether there was actually any default by the
first Defendant (Vide Exhibits 'E' and 'F').

The learned Counsel for the Second Defendant also relied on M/s. Banerjce & Banerjce v. Hindusthan Steel
Works

Construction Ltd. In particular the learned Counsel for the second Defendant invited my attention to page
381, where it is observed that the letter invoking the bank guarantee must mention that the contractor has
committed breach of contract etc. In my view in that case the bank guarantee itself provided a clause that
the bank is standing guarantee against any loss or damages etc. committed by the principal debtor by
violating the agreement with the creditor. When the bank guarantee itself mentions such a condition, then
the demand letter must mention that there was such a breach and the bank must pay the money.

In the present case, we find that the hank guarantee Exh. D is unconditional and does not provide any such
contingency about payment on breach by the first defendant. The only condition for payment is there must
be a demand by the Government of Maharashtra. When once there is a demand, there is an unconditional
undertaking in the bank guarantee that bank should pay the amount. Hence, mentioning of any breach
committed by the first defendant in the letter of demand does not arise in view of the special contract
between the parties as mentioned in Exhibit 'D'. I will presently point out that in number of decisions where
consistent view taken is that the bank is bound by the terms of bank guarantee and it is not concerned with
the contract between the debtor and the creditor.

10. The latest decision on the point which I have come across is one , State of Maharashtra v. M/s. National
Construction Company, Bombay. The facts of that case are not relevant for our present purpose. But the
legal position about bank guarantee is stated in para 13 of the reported judgment in the following words:--

"The rule is well established that a bank issuing a guarantee is not concerned with the underlying contract
between the parties to the contract. The duty of the bank under a performance guarantee is created by the
document itself. Once the documents are in order, the bank giving the guarantee must honour the same and
make payment."

Therefore, the position is clear that the bank is not concerned with the performance or otherwise of the
contract between the debtor and the creditor. The bank is bound by only the terms of bank guarantee and
must pay the amount as agreed in the bank guarantee.

In Pollock and Mulla's commentary on Indian Contract Act, (Vol. II) Eleventh Edition, at page 942 it is
stated as follows:--

"In face of an unequivocal understanding by the Bank to pay the amount of guarantee as and when called
upon to do so, the Bank is not entitled to raise a contention that no breach of contract was committed by
the principal debtor."

In my view this statement of law is squarely applicable to the facts of the case. As per the bank guarantee
there is an unconditional offer by the Plaintiff to pay the money on demand by the Government of
Maharashtra and when such a demand is made by the Executive Engineer, the Plaintiff cannot raise any
contention that there is no breach of contract etc. It has to pay money. This position is further explained at
page 946 as follows:--
"The duties of a bank in such guarantee are created by the document itself which in other words is
"independent" and autonomous and is not concerned with the underlying contract unless the guarantee
itself says that it will be enforceable on the proof of breach of the primary underlying contract."

It may be there is exception to this rule if there is allegation of fraud. But in the present case, there is no
allegation of fraud or special equities in favour of the first defendant.

11. We may make useful reference to another decision of the apex Court National Thermal Power
Corporation Ltd.

v. Flowmore Pvt. Ltd. Though the facts are different, the principle of law has laid down regarding
enforcement of a bank guarantee. The apex court has observed at para 10, page 519 (or SCC) : (at p 4308 of
AIR SCW) as follows:--

"..... Nevertheless, this express term merely reiterates the nature of a bank guarantee which is payable on
demand being made by the beneficiary of the bank guarantee. A bank guarantee which is payable on
demand implies that the bank is liable to pay as_and when a demand is made upon the bank by the
beneficiary. The bank is not concerned with any inter se disputes between the beneficiary and the person at
whose instance the bank had issued the bank guarantee." (Underlining is mine)

Hence also the apex Court has made it clear that the bank need not go beyond the bank guarantee and if
there is an unconditional contract for payment on demand, the bank is bound to make the payment and has
no option.

12. In Centax (India) Ltd. v. Vinmar Impex Inc, the question arose about enforcement of bank guarantee.
We are not concerned with the facts of that case, however, the position of law is explained in para 4 of the
reported judgment in the following words: --

"The learned Judges ..... held that the obligation of the Allahabad Bank under the letters of indemnity
countersigned by the appellant was absolute and upon a demand being made by the Shipping Company i.e.
the beneficiary, the Bank was liable to honour the same regardless of any controversy between the
parties ..... as to whether the contract of sale had been performed. We agree with the reasoning and
conclusion of the learned Judges."

We therefore see that the apex Court approved the reasoning of the Division Bench of the Aliahabad High
Court, which had held that in a case of unconditional and absolute bank guarantee the bank is bound to
honour the same irrespective of any dispute between the contracting parties. It is further observed in the
said judgment that the bank must bo allowed to honour their guarantees free from interference by Courts.
Otherwise, it is pointed out, trust in international commerce would be irreparably damaged.

13. In Syndicate Bank v. Vijay Kumar, a question arose about enforcement of bank guarantee. In para 10 of
the reported judgment, it is stated as follows:--

"..... It is well settled that the Bank guarantee is an autonomous contract and imposes an absolute
obligation on the Bank to fulfil the terms and the payment in the Bank guarantee becomes due on the
happen ing of a contingency on the occurrence of which the guarantee becomes enforceable."

Again in para 14 of the reported judgment the Apex Court made it clear that the bank must honour the
terms of the bank guarantee and the court will not interfere except in exceptional cases.

14. In U.P. Cooperative Federation Ltd. v. Singh Consultants and Engineers (P) Ltd., the same principle has
been reiterated namely that the Bank must be allowed to perform their duties as per the terms of bank
guarantee and the Court should not interfere with the same.

15. In view of the above discussion, what follows is that the bank guarantee is a special contract and it has to
be enforced according to its terms. If the bank guarantee is unconditional and payment should be made on
demand, then the bank is under no obligation to find out whether any default is committed or whether any
amount is due by the person at whose instance, the guarantee was issued and once the beneficiary invokes
the bank guarantee and makes a demand, the bank is obliged to make the payment. We must bear in mind
that the bank guarantee is an accepted mode of indemnity in trade and commerce. We must also bear in
mind that the bank must also keep its reputation by complying with the bank guarantee, where it has made
an unconditional offer to make payment on demand. Hence in my view the defence contention that the
bank guarantee was not enforceable of the Plaintiff-bank was not obliged to make payment till there was a
default by the first defendant etc., has no merit and has to be rejected. Hence, issues Nos. 1 and 4 are
answered accordingly.

16. Issue No. 2:-- There is no dispute about this issue at all. When once it is held that the Plaintiff has acted
as per the terms of the bank guarantee, then by virtue of letter of guarantee, the second defendant has to
make good the loss to the Plaintiff, in view of the terms of Exh. F. Hence, issue No. 2 is answered in the
affirmative.

17. Issue No. 3:-- Even on this issue there is no dispute. When once it is held that the Plaintiff has acted as
per the terms of the bank guarantee, these the first defendant and its partners are liable to reimburse the
Plaintiff-bank as per their letter of guarantee or letter of indemnity, which is Exh. E. Hence, issue No. 3 is
answered in the affirmative.

18. Issue No. 5:-- Second defendant has alternatively pleaded that on making payment to the Plaintiff, it is
entitled to be reimbursed by first defendant and its partners. That is why the second defendant has taken
third party notice to the Defendant No. 1 and Defendants Nos. 3 to 6. In fact the first defendant firm has
executed a guarantee deed as per Exh. 'A' in favour of Vuleon Insurance Co. Ltd. undertaking to reimburse
the Insurance Co. for whatever loss they incurred by making payment to the Plaintiff. We have already seen
that the second defendant is a successor in interest of Vuleon Insurance Co. Hence, by virtue of Exh. A, the
second defendant is entitled to get reimbursed from first defendant and its partners. But it is seen that the
third party notice has not been served on all the defendants. It has been served only on defendants Nos. 1
and 3. In fact the learned Counsel for the second defendant has made a statement before the Court that he
will proceed only against Defendants Nos. 1 and 3. (Vide Minutes of Order dated 19-2-1996). In fact the
learned Judge, who was dealing with the suit on 19-2-1996 has mentioned in the said order that the third
party notice is discharged against defendants. Nos. 4 to 6.

19. As per amendment of Order 8 of C.P.C. in State of Maharashtra, Rules XI to XIII have been added to
Order 8 of C.P.C. Order 8, Rule XXIII provides for third party notice. Then Order 8, Rule XXV provides for
making a decree on the basis of third party notice. The Court can pass a decree against the third party as per
the notice.

In the present case, defendants Nos. 1 and 3 have not chosen to file any reply to the party notice. Further,
by virtue of Exh. A, the first defendant has undertaken to reimburse the Insurance Co. for any payment
made to the plaintiff. Hence, we can safely held that the second defendant is entitled to be reimbursed by
defendants Nos. 1 & 3. Hence, issue No. 5 is answered accordingly.

20. In the result, the suit is decreed as follows: --

(a) The defendants, jointly and severally are directed to pay Rs. 34,280 to the Plaintiff together with
interest at 6% p.a. from the date of suit till the date of judgment and again 6% p.a. from the date of
judgment till the dale of payment;

(b) On making payment of the suit amount to the plaintiff, the second defendant is granted a decree against
defendants Nos. 1 and 3 for recovery of Rs. 34,280/-, current interest and costs;

(c) The plaintiff is entilled to get Court costs from the defendants jointly and severally;
(d) Decree in favour of second defendant against defendants Nos. 1 and 3 can be executed only after the
second defendant makes full payment of the decree amount, interest and costs to the plaintiff.

21. Order accordingly.

TRANSPORT CONTRACT

Rolls Royce India Ltd. vs Income-Tax Officer on 13/10/1987

ORDER

U.S. Dhusia, Judicial Member

1. The one issue referred to in grounds of appeal numbered 1 to 5 in this appeal filed by the appellant
company (hereinafter referred to as the 'Indian Company') for assessment year 1982-83 is in respect of
trading receipt of the appellant in the year in question. According to the appellant it was Rs. 2,13,237
representing his remuneration @ 5 per cent of the actual operating cost of Rs. 31,76,373 subject to
adjustment incurred by the assessee for its principal Rolls Royce Limited, U.K. (hereinafter referred to as
the 'English Company') in taxable territory. According to the IAC (Assessment) it was the sum of Rs. 31
76.373 remitted by the English Company towards the actual operating cost plus 5 per cent remuneration.
According to the IAC (Asstt.) this sum. constituted the taxable receipt of the appellant company. The
appellant/Indian Company had returned an income of Rs. 2,13,237 as the income of the assessment year
1982-83. But the IAC (Asstt.) proceeding on the basis of taxable receipt of Rs. 31,76,373 raised it to Rs.
25,33,718.

2. The main controversy in this appeal is what was the trading or taxable receipt of the appellant company.
The Indian Company claimed that it was only 5 per cent of the gross or total expenditure incurred by it on
behalf of the English Company. The appellant company contended that it was doing liaison work for the
English Company for which it got remunerated by the payment of additional 5 per cent of the actual
operating cost incurred in connection with the liaison work. The IAC (Asstt.) ignoring the finding of the
earlier years, held that his trading or taxable receipt was the full amount of remittance consisting of actual
operating cost plus additional 5 per cent for remuneration due to the appellant company for services
rendered by it to the English Company. According to the IAC (Asstt.) the agreement defined 'service fee' as
'shall mean the annual fee payable by Rolls Royce Ltd., the English Company to the Rolls Royce India Ltd.,
the Indian Company, calculated and payable in accordance with Clause (5) hereof. Clause (5) of the
agreement executed on the 1st day of July, 1979 between the Indian Company and the English Company ran
as under :

Service Fee

Rolls-Royce shall pay annually to RR India the Service Pee as hereinafter provided :

(a) The Service Fee shall be calculated for each year of Account at a fixed rate of 105 per cent of the actual
operating costs incurred during the year of account to which the service fee relates.

3. On a consideration of this clause the IAC (Asstt.) held that the trading receipt; of the appellant company
was 105 per cent of the actual operating cost incurred during the year of account to which the service
relates. The appellant had objected to the IAC (Asstt.) in respect of this approach by pointing out, inter alia,
in its letter dated 31st October, 1984 as under :

1. Disallowance under various sections of the Act can be made only out of expanses claimed to be allowable
as business expenditure. It follows that no disallowance can be made in our case as no expenditure has been
claimed to be allowable as business expenditure.
2. As will be seen from the Agreement dated 1 July, 1979 between ourselves and Rolls-Royce Limited, U.K.,
as clarified by the Memorandum dated 20 May, 1980, we receive monies by way of advances and are
accountable to Rolls-Royce Limited, U.K., in respect of such monies. At the point of time when we receive
the said monies we are in the position of a trustee or a bailee and are under contractual obligation to spend
the advances for the purpose for which the advances are received. In the case of Morley (Inspector of Taxes)
v. Tattersall [1939] 7 ITR 316 (CA) even subsequent appropriation of monies belonging to others were held
not to be a trading receipt. On the strength of that case, even if we were to appropriate any part of the
advances received from Rolls-Royce Limited, U.K. without spending the same for the intended purposes,
such appropriation would still not be 'income'. It could not be 'income' even under such circumstances, the
advances received and actually spent cannot obviously be regarded as income or trading receipts. Since the
advances cannot be regarded as income or trading receipts, the question of claiming expenses there-against
cannot arise. Therefore, the further question which follows as a corollary, namely, what part of the
expenses, if any, are disallowable under the provisions of the Act cannot also arise. The legal principle laid
down in Tattersall's case (supra) has been followed in many Indian cases, a list of which is given below :

(i) Addl. CIT v. Netar Krishana Sahgals (P.) Ltd. [1983] 141 ITR 681 (Delhi).

(ii) Bengal & Assam Investors Ltd. v. CIT [1983] 142 ITR 156 (Cal.).

(iii) Lal Chand Gopal Das v. CIT [1963] 48 ITR 324 (All.). (iv) CIT v. A.V.M. Ltd. [1984] 146 ITR 355
(Mad.).

3. Even if there were some instances where expenditure was first incurred by us and thereafter reimbursed
by Rolls-Royce Limited, U.K., such reimbursement of expenses cannot also be regarded as income against
which claim for expenses might arise. This principle is well settled by the decision of the House of Lords in
Owen v. Pook (Inspector of Taxes) [1969] 74 ITR 147. The Calcutta High Court has also held likewise in CIT
v. Dunlop Rubber Co. Ltd. [1983] 142 ITR 493. The point made in this regard in the earlier note is,
however, not relevant as. in fact, there has not indeed been any reimbursement of revenue expenses during
the relevant previous year. All revenue expenses incurred by us during the year ending 31 December 1981
were, in fact, met by us out of advances received from Rolls-Royce Limited, U.K.

The IAC (Asstt.), however, ruled out the objection as in his view subsequent memorandum cannot take
away the true nature of the agreement made on 1-7-1979. He, therefore, proceeded on the basis of gross
remittance including the actual operating cost plus 5 per cent of the same as trading receipt of the appellant
company for making the assessment. He scrutinized the expenses incurred on behalf of English Company
and by making several disallowances raised the total income to Rs. 25,33,718 as against the sum of Rs.
2,13,237 returned by the appellant company.

4. The Commissioner (A) to whom the issue went in appeal preferred by the assessee-company, also relying
on the definition of 'service fees' in the agreement dated 1-7-1979, dittoed the finding of the IAC (Asstt.). He
was also of the view that the memorandum could not affect a change in the nature of receipt as provided, in
Clause (5) of the agreement dated 1-7-1979. The appellant company having felt aggrieved has brought the
issue in appeal before the Appellate Tribunal.

5. The learned counsel for the assessee-company, Mr. R. Ganesan, elaborately argued the issue as to the
basis of assessment made by the IAC (Asstt,) by taking the actual operating cost, besides the remuneration
of 5 per cent as the trading receipt of the assessee. According to him the English Company entered into an
agreement with the Indian Company so that the latter did liaison work for it. He referred to the object in
the preamble of the agreement dated 1-7-1979 which ran as under :

WHEREAS Rolls-Royce sells Engine products to airlines and other markets throxighout the world using
commercial information and marketing support derived from various sources ;
AND WHEREAS Rolls-Royce has accepted and will accept service support obligations to customers and
licensees of Engine products who are located within the Territory and to others of its customers whose
aircraft regularly operate into the Territory ;

AND WHEREAS RR India has been formed for the purpose of providing marketing support and a
commercial information service relating to the Territory and for the purpose of co-ordinating the service
support obligations on behalf of Rolls-Royce throughout the Territory.

6. The learned counsel for the assessee-company referred to the sole purpose of bringing into existence the
appellant company as brought out in the preamble above. It was emphasised by him that the main object in
bringing into existence the RR India, the appellant company, was only to sub-serve and fulfil the need of
the English Company for ensuring market support and availing commercial information. The agreement
defined the obligation of RR India in Clause (2), reproduced below :

Duties of RR India

RR India will carry out the following duties to such extent as Rolls-Royce may require from time to time :

(i) To obtain and report to Rolls-Royce on a regular basis such marketing information as is considered to be
relevant to Rolls-Royce's interests.

(ii) To disseminate such marketing and commercial information relating to Rolls-Royce's products as Rolls-
Royce may require.

(iii) To provide administrative and secretarial assistance locally for the Service Representatives deployed in
the Territory.

(iv) To provide a liaison service between Rolls-Royce and relevant departments of the Government of India
and other customers of Rolls-Royce in the Territory in all matters of supply of products and services.

(v) To monitor the effectiveness of Rolls-Royce's commercial advisers and to report regularly thereon.

(vi) To look after Rolls-Royce visitors in India and arrangements for stay and itinerary.

7. The remuneration for services to be rendered was described as 'service fee' which was to mean annual fee
payable by Rolls-Royce to RR India, calculated and payable in accordance with Clause (5). Clause (5) read
as under :

(a) The Service Fee shall be calculated for each year of Account at a fixed rate of 105 per cent of the actual
operating costs incurred during the year of account to which the Service Fee relates.

(b) Payment of the Service Fee shall be made by way of advance payments by Rolls-Royce to RR India each
AP with quarterly adjustments in manner following :

(i) Each of such advance payments shall be calculated at a fixed rate of 105 per cent of the Budgeted
operating costs for the AP (period normally 4 weeks) to which the particular advance payment relates and
shall be payable by Rolls-Royce to RR India at the beiginning of each AP (or part thereof) commencing with
effect from 1st June, 1979.

(ii) Within ten weeks of the close of the last business day of AP3, AP6, AP9 and AP13 in each year of account
RR India will submit to Rolls-Royce a statement showing the actual operating costs incurred up to the end
of the said APS, AP6, AP9 or AP13 (as the case may be) together with the total of advance payments made
to date during that year of account.

(iii) Following verification of each such quarterly statement Rolls-Royce will calculate the amount by which
the service fee has been overpaid or underpaid and Rolls- Royce or RR India (as the case may be) will
promptly make an adjusting payment to rectify such overpayment or underpayment.
8. It was to be noted that the settlement was to be made by making advance payments as well as
reimbursement of the expenditure incurred. To clarify and remove any doubt in respect of remuneration of
the appellant company a memorandum agreement was made on 20-5-1980 which provided as under :

AND WHEREAS it is deemed necessary and expedient to reiterate and clarify the position with regard to
the remuneration payable under the Formation Agreement by RR to RRI so as to put the same beyond any
doubt ;

NOW THIS MEMORANDUM WITNESSETH AS FOLLOWS :

It is hereby declared and reiterated that the remuneration payable by RR by way of service fee under and in
accordance with the Formation Agreement in respect of liaison services provided by RRI in the territories of
India, Bangladesh, Nepal, Sri Lanka and Bhutan is 5 per cent of the total expenses of RRI (including
depreciation) incurred on behalf of RR in connection with the provision of the said services, the entire
expenditure incurred on this account by RRI being reimbursed by RR and it has always been so intended
between the parties hereto and always so under- stood.

In light of the aforesaid it was asserted by Mr, R. Ganesan, that there was no possibility of treating the 105
per cent of the expenditure-the actual operating cost plus 5 per cent of the remuneration as the taxable
receipt of the appellant company. The learned counsel referred to a string of judicial pronouncements to
support the aforesaid plea that the receipt of the company should be limited to only 5 per cent of the
expenditure which was its remuneration and not the 105 per cent of the gross expenditure consisting of
both actual operating cost and 5 per cent thereof as the remuneration winch were fully reimbursed by the
English Company.

9. Learned Departmental Representative on the other hand made out, inter alia, two pleas-Firstly, the
judicial pronouncements did not apply to the facts of the case and secondly, the provision of Clause (5) of
the agreement provided for calculation of the service fee at 105 per cent of the actual operating cost during
the year of account to which the service related. He countered the suggestions that the appellant company
could be considered as a mere agent or bailee of the English Company. He had his own reality and
independent existence and did not depend upon the English Company for imparting to it substance and
matter as will undoubtedly arise from a consideration of engagement of its personnel and office premises
under agreements entered by it independent of the English Company. Therefore, the agreement should be
taken as one between two principals and not between the principal and his agent or bailee. According to the
clause there was no doubt that his receipt was 105 per cent and not 5 per cent.

10. Having considered the rival submissions made out by the revenue and the appellant company we are of
the view that on a consideration of facts brought on record and the two agreements dated 1st July, 1979 and
20th May, 1980, it is not possible to uphold the finding of the lower authorities and reject the plea of the
appellant company as misconceived. Although Mr. Ganesan stoutly resisted the suggestion that the
appellant company was an agent of the English Company in view of Clause (4) of the agreement dated 1-7-
1979, a consideration of the facts does not support the submission of Mr. R. Ganesan in this respect that the
Indian Company was not a creature of the design of the English Company and a subsidiary one brought into
existence with the sole object of the subserving to the need of its principal, the English Company. Clause (4)
of the agreement read as under :

RR India is not and shall not represent itself to be the agent of Rolls-Royce nor shall it enter into or purport
to enter into any commitments or negotiations of whatsoever nature on behalf of Rolls-Royce in the
territory or elsewhere or do any act or thing which might result in any persons believing that RR India has
authority to contract on behalf of Rolls-Royce.

In spite of this provision and the prohibition contained therein one cannot rebut the suggestion that the
appellant company was a mere agent or a subsidiary creature, created out of the design of the English
Company to fulfil and subserve the need of the latter. This conclusion is not defeated by a consideration of
the fact that the two agreements-the one made on 1-7-1979 and the other on 20-5-1980, were entered into
by the two companies as principal to principal. Even a consideration of the engagement of the premises,
occupied by the Indian Company and its personnel under contractual agreements between the Indian
Company and the personnel cannot overshadow the paramount truth that the Indian Company as brought
out on the preamble was created only to carry out the task appointed by the English Company. The English
Company had brought the Indian Company into existence to sub-serve its need of a company doing liaison
work in India and surrounding countries for it. The Indian Company had no independent activity, no other
business except and apart from the liaison work for the English Company. This conclusion is not only based
on 'a consideration of the preamble but also the permission of the Reserve Bank of India to allow the
company to take a liaison office in India. The Reserve Bank of India in its letter dated 26-9-1979 agreed to
allow the Indian Company to establish a liaison office subject to the following stipulations :

We advise that we are agreeable to your establishing a liaison office at New Delhi initially for a period of
two years for the purpose of undertaking purely liaison activities as stated in the schedule to your above
application. Please note that this permission has been granted subject to the following conditions:

(i) Except the proposed liaison work, the liaison office in India will not undertake any other activity of a
trading, commercial or industrial nature nor shall it enter into any business contracts in its own name
without our prior permission.

(ii) No commission/fee will be charged or any other remuneration received by the liaison office in India for
the liaison activities/ services rendered in India.

(iii) The entire expenses of the liaison office in India will be met exclusively out of the funds received from
abroad through normal banking channels.

(iv) The liaison office in India shall not borrow or lend any money from/to any person in India without our
prior permission.

(v) The liaison office in India shall not acquire, hold, transfer or dispose of (other than by way of lease for a
period not exceeding five years) any immovable property in India without obtaining prior permission of the
Reserve Bank of India under Section 31 of the Foreign Exchange Regulation Act, 1973.

(vi) The liaison office in India will furnish to us (in duplicate on a yearly basis) the following
particulars/documents :

(a) A certificate from the auditors to the effect that during the year no income was earned by/or accrued to
the liaison office in India.

11. It may be of interest to note that Clause (6) of the Agreement made the English Company liable to bear
the cost of setting up of an office in New Delhi for the use of RR India. The clause read as under:

All costs and expenses incurred by RR India (as authorised by Rolls-Royce prior to commitment either
specifically or generally) in establishing a liaison office in New Delhi or otherwise in setting up operations
shall be reimbursed by Rolls-Royce in full in Sterling in the UK as soon as practicable after such costs and
expenses are incurred but in any event within eight weeks from the date they are incurred and notified to
Rolls-Royce.

In this background of facts can it be reasonably maintained that the position of Indian Company was any
better than that of its agent or representative or a subsidiary. Clause (4) only disentitled the Indian
Company to represent in India as the agent of the English Company and bind and saddle the English
Company with liability under an agreement entered into by the Indian Company acting on its own and not
under the authority and command of the English Company. Clause (4) aimed at limiting the power of the
Indian Company to represent and saddle the English Company with liability. Otherwise it is not possible to
think of it as an independent unit doing its business on its own irrespective of its agreement with the
English Company. Its very existence as has been asserted by Mr. R. Ganesan was rooted in the need of the
English Company to derive benefit from the liaison work in India and surrounding countries performed by
the Indian Company and we may add who would do no other trading or business. It could not under the
inhibition placed by the permission accorded by the Reserve Bank of India undertake any liaison work for
any one else. The English Company had not only undertaken to meet the full cost of expenditure incurred
by the appellant company for carrying out its appointed task of doing the liaison work but also had met the
cost of setting up a liaison office. No doubt, the Indian Company had engaged employees and the office
premises under agreements entered into by it, but could a consideration arising from this aspect affect the
finding that the Indian Company was a mere agent or a mere subordinate of the English Company which
was created for the purpose of carrying out of the liaison work for the English Company. Considered in this
light, could we not safely hold that the Indian Company being not an employee or an agent in name, was an
agent in fact for the purpose of carrying out the appointed task of doing the liaison work of the English
Company. Looked at in this baokground could we justify ourselves that the expenditure incurred by the
Indian Company in doing the liaison work which the English Company met hundred per cent besides
remunerating the Indian Company was the expenditure of the Indian Company and not of the English
Company which had borne the incidence of expenditure as well as that a remuneration paid to the Indian
Company, for doing the liaison work. We may look at the issue from a different angle. Suppose the English
Company was resident in the taxable territory could one hold that the expenditure debited by the English
Company resident in India to its profit & loss account was to be considered the expenditure of the Indian
Company and not that of the former. As the law stands the deduction for the said expenditure could not be
claimed by both the companies. In the case of aratias the turnover is limited only to the commission they
receive and not to the sales althotigh it is they who purchase and sell on behalf of their principals. Exactly
this is the situation in the present case. The appellant company undertakes expenditure on behalf of his
principal although full cost of the operation to the last penny is met by the English Company either by
advance payments or by subsequent payments made promptly or latest within a period of ten weeks.
Therefore on a consideration of these facts it is not possible to hold that the IAC was justified in treating the
remittances for operating cost as taxable receipt of the appellant company. In our consideration the IAC
misdirected himself when he proceeded to arrive at the profit of the Indian Company by taking the
remittances for the actual operating cost as the receipt of the Indian Company from which the expenditure
incurred by it on behalf of the English Company was to be deducted to arrive at the taxable profit and not
by limiting the taxable receipt to 5 per cent remuneration paid by the English Company to the Indian
Company under the agreement. Need we emphasise that settlement prescribed under Clause (5) was not
only to make advance payments but also to clear up the liability for expenditure by reimbursement of the
expenditure. The English Company reimbursed every penny of the expenditure incurred by the appellant
company. No one on these facts could hold that the Indian Company, a mere agent, was liable for the profit
resulting from the transactions entered into by the agents on behalf of the principal which the latter
refrains from repudiating. There is no instance when the English Company repudiated the liability for
undertaking the expenditure by the Indian Company. A consideration of the remuneration payable to the
Indian Company also rules out the possibility of taking the expenditure incurred by the Indian Company on
behalf of the English Company as its own expenditure. If the Indian Company was incurring the
expenditure on its own where was the need for the English Company to remunerate it ? On these facts was
it open to Revenue to hold that the expenditure incurred by the Indian Company related to its own business
for which it could beheld liable against the receipts of 105 per cent of the actual operating coat including the
5 per cent remuneration from the English Company. No doubt the IAC (Asatt.) and the Commissioner (A)
had depended upon Clause (5) which prescribed the calculation of service fee as already indicated. This
would call for a look at the two agreements one made on 1-7-1979 and the other memorandum made on 20-
5-1980. We have already in the foregoing paras reproduced the definition of the service fee and also the
Clause (5). We reproduce the relevant portion of the memorandum :

... to reiterate and clarify the position with regard to the remuneration payable under the Formation
Agreement by RR to RRI so as to put the same beyond any doubt.

We may again reproduce for the facility of appreciating the finding :

NOW THIS MEMORANDUM WITNESSETH AS FOLLOWS :

It is hereby declared and reiterated that the remuneration payable by RR by way of service fee under and in
accordance with the Formation Agreement in respect of liaison services provided by RRI in the territories of
India, Bangladesh, Nepal, Sri Lanka and Bhutan is 5 per cent of the total expenses of RRI (including
depreciation) incurred on behalf of RR in connection with the provision of the said services, the entire
expenditure incurred on this account by RRI being reimbursed by RR and it has always been so intended
between the parties hereto and always so understood.

12. A consideration of Clause (5) and the aforesaid explanation in memorandum made on 20-5-1980 does
not leave any doubt that the remuneration of the Indian Company was 5 per cent of the total expenses and
not the total cost of operation which was reimbursed by the English Company. This was the import of the
two-is evident from the corresponding treatment of the remittances regarding the expenses in the account
books of the Indian Company and we take it on the basis of the certificate of the English Company that
similar treatment had been entered in the account of the English Company, as appears from the letter dated
10-10-1986, which runs as under :

1. All expenditure incurred by Rolls-Royce India Limited, both in India and in the U.K., is borne by Rolls-
Royce plc and is charged to the profit and loss account in Rolls-Royce plc's books of account.

2. All monies advanced by Rolls-Royce plc to Rolls-Royce India Limited are for the purposes of defraying
operational costs. Any unexpended advances held by Rolls-Royce India Limited are refundable to Rolls-
Royce plc and are recorded as recoverable from Rolls-Royce India Limited in the books of account of Rolls-
Royce Ple.

What is the true purport of the agreement is to be found out not only from interpretation of the terms but
also the way in which the two parties to the agreement had understood the purport of the various
stipulations of the agreement. It is the surest way to find out the true intention of the parties underlying the
stipulations and provisions in the two agreements. It is not generally the case but there are occasions when
the draftsman is not able to clothe the intention in suitable and proper language. Therefore, it becomes
necessary to make out the true intention from the conduct and understanding of the parties as to what they
had agreed to mean by from a certain stipulation inserted in the agreement. There is no room for doubt that
taking into account the conduct and understanding of the two parties, only 5 per cent of the total expenses
of RRI was to be adopted as the remuneration of the appellant Indian Company. They have accordingly
treated the remittances in their respective accounts. They had no conflict in this respect-rather they were
unanimous in claiming that the stipulations in the first agreement was to limit the remuneration of the
Indian Company to 5 per cent of the actual operating cost. This fact is manifest by their agreement to
execute a memorandum dated 20-5-1980 to clarify the purport of Clause (5) of the original agreement
made on 1-7-1979. A point has been made by the lower authorities that the language of Clause (5) being
crystal clear there was no scope left for causing rectification by the memorandum. We are unable to
appreciate this finding or the basis of this finding. It was not a statutory provision which the revenue
authorities were called upon to interpret. It was a stipulation inserted in the agreement entered into by the
two private parties. They being signatories to the agreement were the best judge and spokesmen of the true
purport of Clause (5). Such an approach as was relied on by the revenue authorities is possible only in
respect of a statutory provision. There the rule prevails that if the purport of a provision was clear there was
no need for explanation. In respect of a statutory provision it has been held that the provision of an
explanation cannot change or override the express provision of a substantive law. But such a rule of
interpretation does not prevail where there is an agreed consensus in the parties to an agreement about the
true purport of a provision in the original agreement.

13. We also cannot appreciate the proposition that the stipulation of an agreement cannot be altered by a
subsequent agreement. We have not succeeded in finding any support for this proposition in law nor
revenue could enlighten us about any support. Any one familiar with the Indian Contract Act knows that
Section 62 of the Indian Contract Act provides for addition, subtraction, alteration, waiver and rescission.
Dutt in his Indian Contract Act has explained the scope of the section as under :

It is competent to the parties to a contract at any time before breach of it by a new contract to add to,
subtract from or vary the terms of it or altogether to waive and rescind it.

However, it was not a case of novation which we are faced with. It was a case of clarifying the intention of
the parties which they felt was abscure in the language of Clause (5). No offence could be possibly taken to
the memorandum on the ground that it was an afterthought. It was not. Memorandum had been executed
long before the IAC had started making the assessment for the year in issue overruling the finding of his
predecessor incorporated in the assessment for the preceding year 1980-81.

14. Therefore, whatever way we look at the issue, whether from the object for realising which the appellant
Indian Company had been created or from the nature of its duties or obligations imposed under the
agreement or from the limitations placed on its authority to represent the English Company or by the
limitations placed on the activity of the Indian Company by the agreement as well as the permission of the
Reserve Bank of India to enable it to set up a liaison office in New Delhi or from the consideration that the
cost of setting up of liaison office was met by the English Company in full or from the interpretation of the
two agreements or from the understanding of the respective parties about the true purport of the relevant
stipulations or from the conduct of the two parties to the agreement or from the treatment in their
accounts, we cannot but hold that the trading receipts of the appellant Indian Company could not be
treated" as 105 per cent of the operating cost instead of remuneration of 5 per cent of the gross operating
cost as made out by the appellant company. We, therefore, hold the two lower authorities in error when
they disregarded the plea of the assessee to treat the taxable receipts of the appellant as 105 per cent and
not 5 per cent of the gross operating cost. We vacate their orders and direct the IAC (Asstt.) to adopt the
remuneration of 5 per cent of the actual operating cost as the taxable receipt of the appellant company and
proceed to make the assessment accordingly. As we are setting aside the assessment it is not necessary to
record a finding on other grounds relating to disallowances. There is another reason why we are not
adjudicating on other grounds. As we have held the expenditure from which disallowances are made, relate
to the trading of the English Company, if any disallowances are to be made, they are to be made in the case
of the English Company, if they are found liable, but not in the case of Indian Company, as they did not
arise for consideration in its assessment. Besides the learned counsel for the assessee did not address the
Board on these grounds. It was evident that these grounds were not pressed. Therefore, the appeal
preferred on these grounds of appeal is dismissed.

15. In the result appeal preferred by the assessee is partly allowed.

Anand Prakash, Accountant Member

1. As it has not been possible for me to agree with the reasoning and conclusion of my learned brother, I
draw up a separate order putting forth my views on the controversy canvassed before us.

2. The assessee is a non-resident company being 100 per cent subsidiary of another non-resident company
namely, Rolls-Royce (For the sake of convenience I will describe these companies as R.R.I. and R.R.
respectively hereafter). It was incorporated on 20-2-1979 with numerous objects enumerated in the
Memorandum of Association. Sub-clauses A to D of Clause 3 appear to set out objects and sub-clauses E to
X appear to enumerate the powers, which may be exercised in pursuance of the objects mentioned in Sub-
clauses A to D. The said sub-clauses are extracted herebelow for ready reference as follows :

(A) To carry on business as manufacturers, builders, designers, repairers and owners of aero-engines,
motor cars and carriages, cabs, omnibuses, wagons, carts, cycles, ships, boats and other marine vessels,
aeroplanes, airships and all other land, sea, or air carriages and conveyances, in whatsoever manner and by
whatsoever powers the same may be propelled or driven and to buy, sell, let out on hire, or act as factor or
agent for the purchase or sale of, or otherwise deal in aero-engines, motor cars and motor vehicles and
boats of every description, aeroplanes, airships and every kind of aircraft and component parts, fittings and
accessories of all kinds for the same and all articles and things used in the manufacture, maintenance and
working thereof.

(B) To carry on business as engineers, machinists, smiths, fitters, electricians, brassfounders, ironfounders,
tubemakers, metalworkers, wiredrawers, ropemakers, rubber or rubber substitute manufacturers, oil-
refiners, automobile store ; garage and aerodrome keepers, storers and suppliers of and dealers in petrol,
paraffin, oils and other fluids, generators and distributors of electricity and suppliers of motive power of
any description for all kinds of motor vehicles and boats.

(C) To make, construct, buy, hire, sell, repair, alter and deal in component parts and accessories of any of
the manufactures or products of the Company and apparatus, machinery, materials and goods and articles
of all kinds useful or necessary in carrying on the business of the Company, or in connection therewith.

(D) To carry on any other trade or business whatsoever which can, in the opinion of the Board of Directors,
be advantageously carried on by the Company in connection with or as ancillary to any of the above
businesses or the general business of the Company.

3.1 In pursuance, presumably, of Clause 'D', the assessee-company entered into an agreement with RR on 1-
7-1979. The preamble of the agreement recited, inter alia, as follows :

WHEREAS Rolls-Royce sells Engine Products to airlines and other markets throughout the world using
commercial information and marketing support derived from various sources ;

AND WHEREAS Rolls-Royce has accepted and will accept Service Support Obligations to customers and
Licensees of Engine Products who are located within the Territory and to others of its customers whose
aircraft regularly operate into the Territory ;

AND WHEREAS RR India has been formed for the purpose of providing marketing support and a
commercial information service relating to the Territory and for the purpose of co-ordinating the Service
Support Obligations on behalf of Rolls-Royce throughout the Territory;

NOW THEREFORE in consideration of the Service Fee payable hereunder it is HEREBY AGREED as follow
:

3.2 Clause 1 of the agreement denned certain terms some of which may be noted here as below :

(a) Service Support Obligations-shall mean obligations of Rolls- Royce under contract or otherwise to
provide technical and after sales service to customers and licensees of Engine Products.

(b) "Service Fee" shall mean the annual fee payable by Rolls- Royce to RR India calculated and payable in
accordance with Clause 5 hereof.

(c) "Actual Operating Costs" shall mean the total of revenue expenditure incurred by RR India in
performing its obligations pursuant to this Agreement in the UK, India and elsewhere.

(d) "Budgeted Operating Costs" shall mean the RR India budget forecast of Actual Operating Costs.

(e) "AP" shall mean a Rolls-Royce accounting period of normally four weeks.
3.3 Clause 2 spelled out the duties of RRI and reads as below :

2. Duties of RR India

RR India will carry out the following duties to such extent as Rolls-Royce may require from time to time-

(i) To obtain and report to Rolls-Royce on a regular basis such marketing information as is considered to be
relevant to Rolls-Royce's interests.

(ii) To disseminate such marketing and commercial information relating to Rolls-Royce's products as Rolls-
Royce may require.

(iii) To provide administrative and secretarial assistance locally for the Service Representatives deployed in
the Territory.

(iv) To provide a liaison service between Rolls-Royce and relevant departments of the Government of India
and other customers of Rolls-Royco in the Territory in all matters of supply of products and services.

(v) To monitor the effectiveness of Rolls-Royce's commercial advisers and to report regularly thereon.

(vi) To look after Rolls-Royce visitors in India and arrangements for stay and itinerary.

3.4 Clause 3 provided for the establishment of the offices of RRI and is extracted here as follows :

Offices of RR India

(a) RR India shall as soon as practicable establish a liaison office in New Delhi and such other similar
offices within the Territory as may from time to time be required by RR India for the purpose of carrying
out its obligations under this agreement.

(b) RR India shall operate and maintain such offices within the Territory as may be necessary to fulfil its
obligations under this Agreement and shall employ competent engineers and other suitably qualified
personnel properly to carry out its duties under the provisions of this Agreement.

(c) Rolls-Royce and RR India may make appropriate arrangements in the UK for such liaison staff as may
be necessary to co-ordinate the activities of RR India with the activities and requirements of Rolls-Royce
concerning its business interests in the Territory.

3.5 Clause 4 clarified that no agency relationship was sought to be established by this agreement in between
RR and RRI and read as below :

No Agency Relationship

RR India is not and shall not represent itself to be the agent of Rolls-Royce nor shall it enter into or purport
to enter into any commitments or negotiations of whatsoever nature on behalf of Rolls-Royce in the
Territory or elsewhere or do any act or thing which might result in any persons believing that RR India has
authority to contract on behalf of Rolls-Royce.

3.6 Clause 5 spelled out the service fee and, as such, deserves to be extracted in full as below :

Service Fee

Rolls-Royce shall pay annually to RR India the Service Pee as hereinafter provided :

(a) The Service Fee shall be calculated for each year of account at a fixed rate of 105 per cent of the Actual
Operating Costs incurred during the Year of Account to which the Service Fee relates.

(b) Payment of the Service Fee shall be made by way of advance payments by Rolls-Royce to RR India each
AP with quarterly adjustments in manner following :

(i) Each of such advance payments shall be calculated at a fixed rate of 105 per cent of the Budgeted
Operating Costs for the AP to which the particular advance payment relates and shall be payable by Rolls-
Royce to RR India at the beginning of each AP (or part thereof) commencing with effect from 1st June,
1979.

(ii) Within ten weeks of the close of the last business day of AP 3, AP 6, AP 9 and AP 13 in each Year of
Account RR India will submit to Rolls-Royce a statement showing the Actual Operating Costs incurred up
to the end of the said AP 3, AP 6, AP 9, or AP 13 (as the ease may be) together with the total of advance
payments made to date during that Year of Account.

(iii) Following verification of each such quarterly statement Rolls-Royce will calculate the amount by which
the Service Fee has been overpaid or underpaid and Rolls- Royce or RR India (as the case may be) will
promptly make an adjusting payment to rectify such overpayment or underpayment.

3.7 Clause 6 pertained to the reimbursement of initial setting up costs and read as below :

Setting-up Costs

All costs and expenses incurred by RR India (as authorised by Rolls-Royce prior to commitment either
specifically or generally) in establishing a liaison office in New Delhi or otherwise in setting up operations
shall be reimbursed by Rolls-Royce in full in Sterling in the UK as soon as practicable after such costs and
expenses are incurred but in any event within eight weeks from date they are incurred and notified to Rolls-
Royce.

4. On 20-5-1980, a supplemental agreement was entered into between RR and RRI which purported to
"reiterate and clarify the position with regard to the remuneration payable under the Formation Agreement
by RR to RRI so as to put the same beyond any doubt." The relevant part read as below :

NOW THIS MEMORANDUM WITNBSSETH AS FOLLOWS :

It is hereby declared and reiterated that the remuneration payable by RR by way of service fee under and in
accordance with the Formation Agreement in respect of liaison services provided by RRI in the territories of
India, Bangladesh, Nepal, Sri Lanka and Bhutan is 5 per cent of the total expenses of RRI (including
depreciation) incurred on behalf of RR in connection with the provision of the said services, the entire
expenditure incurred on this account by RRI being reimbursed by RR and it has always been so intended
between the parties hereto and always so under- stood.

5. Immediately after the aforesaid agreement had been entered into, the assessee applied to the Reserve
Bank of India on 23-7-1979 seeking permission to open an office here. Copy of the said application has not
been placed on record but the gist thereof appears at page 188 of the paper book. The reply of the Reserve
Bank of India dated 26-9-1979 is on record (being page 187 of the paper book). It reads, inter alia, as
below :

2. We advise that we are agreeable to your establishing a liaison office at New Delhi initially for a period of
two years for the purpose of undertaking purely liaison activities as stated in the schedule to your above
application. Please note that this permission has been granted subject to the following conditions :

(i) Except the proposed liaison work, the liaison office in India will not undertake any other activity of a
trading, commercial or industrial nature nor shall it enter into any business contracts in its own name
without our prior permission.

(ii) No commission/fee will be charged or any other remuneration received by the liaison office in India for
the liaison activities/ services rendered in India.

(iii) The entire expenses of the liaison office in India will be met exclusively out of the funds received from
abroad through normal banking channels.

(iv) The liasion office in India shall not borrow or lend any money from/to any person in India without our
prior permission.
(v) The liaison office in India shall not acquire, hold, transfer or dispose of (other than by way of lease for a
period not exceeding five years) any immovable property in India without obtaining prior permission of the
Reserve Bank of India under Section 31 of the Foreign Exchange Regulation Act, 1973.

(vi) The liaison office in India will furnish to us (in duplicate on a yearly basis) the following
particulars/documents :

(a) A certificate from the auditors to the effect that during the year no income was earned by/or accrued to
the liaison office in India.

(b) Details of remittances received from abroad duly supported by bank certificates.

(c) Certified copy of the audited final accounts of the liaison office in India.

(d) Annual report of the work done by the liaison office in India, stating therein the details of activities
taken up/ services rendered in India and also actual export/import, if any, effected during the period in
respect of which the office had rendered liaison services.

3. We further advise that maintenance of an account in the name of your Head Office in the books of the
liaison office in India will require prior permission of the Reserve Bank.

6.1 In accordance with the above permission the assessee opened a liaison office in India and for that
purpose, it leased out suitable building and also engaged staff. Total expenditure incurred during the
accounting period under consideration on the maintenance of the staff and the office and other related
subjects in India is aggregated to Rs. 29,76,865. In terms of , this came to 1,71,281. The expenditure
incurred by the company in the Head Office was 31,462. Thus, the aggregate expenditure incurred by the
assessee- company during the accounting period under consideration was 202,743. The whole of it was
reimbursed to it by RR.

6.2 Audited copies of the assessee-company have been placed on record. They appear at pages 14 to 22 of
the paper book. The Profit and Loss Account appears at page 17 and so far as it is relevant for our purpose,
it reads as below :

1981

"Turnover l(a) 14,014 _______

Profit before taxation 2 14,014 Taxation charge 4 8,462 _____

Retained profit for the year. 5,552

>

Copy of the account on the basis of which the figure of 14,014 has been worked out has not been placed on
record. Some insight into the fact that there is such an account, whether called as trading account or
otherwise, is had from Note 2 to the accounts which states, inter alia, as below :

The profit before taxation is stated after charging :

1981 1980

Depreciation 7,495 5,000 Audit fees and expenses 1,611 1,410 Directors' emoluments 55,131 32,623 (Note 3)

_______

64,237

From the above figures, it immediately follows that the assessee's income before deducting the above
expenses was 78,251 ( 14,014+ 64,237). Where is that account in which these expenses were debited ?
Apparently it has not been placed on record. One has similar insight into this fact from the computation of
total income filed by the assessee, which reads as below :
Profit as per Profit & Loss Account: 14,014 Deduct: Net surplus included therein arising

from adjustments on currency re-alignments

not representing actual profit : 3,877 Add : Depreciation charged : 7,495 _______

17,632

Converted to Indian currency @

Rs. 100 == 5,782 3,04,946 Less : Depreciation : 91,709

6.3 The working of the net surplus on account of foreign exchange amounting to 3,877 appears at page 28
of the paper book. It is seen therefrom that 3,877 was credited to the P & L A/c of 1981 and as is seen from
the computation above, the said sum is part of 14,014, the other sum being 10,137, being 5 par cent of
2,02,743 (i.e., the aggregate revenue expenditure incurred by the assessee- company). There is apparently
an account where these two figures appear separately, but the same has not been placed on record. The
assessee is claiming depreciation separately and for this purpose is adding back the depreciation debited in
accounts, i.e., 7,495 and then deducting that which is allowable under the Income-tax Act, 1961 separately.
There is, again, apparently an account in which 7,495 has been debited. Copy of it should have, in all
fairness, been filed by the asaessee. In the absence of such copy their true state has but to be guessed and
the obvious guess is as follows :

Dr. Cr.

To Depreciation 7,495 By reimbursement of

expenses incurred by

To audit fees and the assessee in carry- expenses 1,611 ing on, its business 2,02,743 To Directors' By service
fee 10,137 Emoluments 55,131

To other expenses 1,38,506 By surplus arising

from adjustments on

currency re-alignments 3,877

_____

To profit before

taxation 14,014

_________

2,16,757 2,16.757

_________ _________

It is this profit of 14,014, with which the Profit & Loss Account, as given to us, starts. An impression was
sought to be given to us in the course of hearing of the appeal that the assessee' s accounts start with the
Profit & Loss Account itself, appearing at page 17. Obviously this is not tie correct factual position. 1 am
unable to understand and appreciate this action on the part of the assessee and its counsel. As substantial
part of the assessee's argument was based on this factually incorrect assumption, the attempt at presenting
a wrong picture of the accounts is, prima facie, regrettable.

7. Having noted the facts of the case, as above, let me note the submissions of the assessee. They were as
below :
(i) That the expenses in question were incurred by RRI on behalf of RR who reimbursed them to the
assessee in full. The assessee got neither a farthing more nor a farthing less than the expenditure actually
incurred by the assessee on behalf of RR.

(ii) That the assessee's only income was service commission computed at the rate of 5 per cent on the total
expenses incurred and the assessee's accounts were made out on this basis. In support of it, reliance was
placed on the copy of the P & L A/c filed at page 17 of the paper book and on the agreement dated 20-5-
1986, which according to the assessee, clarified the position as above is beyond any shadow of doubt.
Attention was also invited to the assessment orders for assessment years 1980-81 and 1981-82, in which the
above submission of the assessee was accepted. According to the assessee, there was no justification to
depart from these assessment orders, while framing the present assessment.

(2) That the monies, which the RR gave to RRI was in the nature of an 'advance' and the 'advance' did not
bear the character of income. Reference was made to Clause 5(6) of the Agreement dated 1-7-1979 in
support of the above submission and to page 63 of the paper book containing account of RRI with
Grindlays Bank, wherein the remittances from U.K. are deposited first and withdrawals are made
subsequently from such deposits. The initial nature of receipts, thus, being not income, it could not be
assessed as income. Reliance was placed on the following authorities in support of the above proposition :

1. Bengal & Assam Investors Ltd. v. CIT [1983] 142 ITR 156 (Cal,).

2. Morley (Inspector of Taxes) v. Tattersall [1939] 7 ITR 316 (CA).

3. CIT v. Sandersons and Morgans [1970] 75 ITR 433 (Cal.).

(3) (i) That whatever expenditure is incurred by RRI in India or in U.K. is for and on behalf of RR and RR
reimburses it to RRI, therefore, the expenditure is not revenue expenditure in the hands of the assessee, (ii)
that even if it is the assessee's expenditure, only the net expenditure should be taken into account in its
hands and not the gross expenditure and inasmuch as all that the assessee spent was reimbursed to it, the
expenditure in the assessee's hands was nil and so nothing could be disallowed in the hands of the assessee
in terms of Section 40(c)(iii) or 40A(5) or Rule 6D, etc. Reliance was placed on the judgment of the Hon'ble
Calcutta High Court in the case of CIT v. Duncan Bros. & Co. Ltd. [1983] 140 ITR 335.

(4) That the monies received to reimburse the expenses incurred did not become income in the hands of the
assessee. Reference was made to the ratio of CIT v. Dunlop Rubber Co. Ltd. [1983] 142 ITR 493 (Cal.), in
support of the above proposition.

8. The Revenue opposed the above submissions and the learned Departmental Representative submitted
that the two companies were separate and independent entities, that both of them were doing their
independent businesses, that their relations inter se, were business relations on principal to principal basis,
that the RRI was not agent of RR, that Clause 4 of the Agreement dated 1-7-1979 made this position
absolutely clear, that therefore, it will be wrong in law to say that RRI was acting as agent of RR and acting
for and on behalf of it; that RRI was acting on its own to carry out its contractual duties listed in Clause 2 of
the Agreement, that the expenditure of RR was the income of RRI, that both of them were of revenue
nature, that what was received under Clause 5 of the Agreement was the service fee for rendering
contractual services, that this fee was paid in advance, that the advance in question was of the service fees
and not de hors that, therefore its nature was that of service fees and not of loan or advance on account,
that, even though Agreements dated 1-7-1979 and 20-5-1980 should be read together, it has not to be
forgotten that the latter agreement was not in substitution of the original agreement, but only in
explanation and clarification of it, that it, in no way, affected or changed the character of the receipts of RRI
from RR ; they were trading receipts to begin with and they continued to be so even under the Agreement
dated 20-5-1980, that the expenses incurred by RRI were its expenses, the employees were its employees
and the leased premises were its, that the privity of contract existed between RRI and its employees and its
lessor, that that RR had nothing to do with the employees or the lessor or within any other expenditure, for
that matter, that the basic question to be asked in the present case was : Are the receipts in the course of
business and are they trading receipts ? Are the expenses incurred by the assessee in the course of its
business, for carrying out its contractual obligations ? That the answers to the above questions were in the
affirmative, that the amounts were received by the assessee in the normal course of its business and not as a
bailee or as a trustee, that the expenses of the assessee were subject to the provisions of Sections 30 to 43A
and, therefore, the ITO had rightly made the disallowances under Section 40(A)(5)/40(c)(m)/rule 6D, etc.,
that the facts of Duncan Bros. & Co. Ltd.'s case (supra) were altogether different and bore no similarity to
the facts of the present case, that the ratio of Dunlop Rubber Co. Ltd.'s case (supra) had also no application
to the assessee's case, that it was the ratio of V.S.S.V. Meenakshi Achi v. CIT [1986] 60 ITR 253 (SC) that
fully governed the facts of the present case, that there too it was the case of reimbursement of the expenses
of the assessee and the receipts in question were held to be of revenue nature, that therefore, it would be
wrong to hold that the entire receipts of RRI from RR, i.e., 105 per cent of the actual operating costs of RRI
were not of revenue nature and that only part of them, i.e., 5 per cent were such.

9. In rejoinder, the learned counsel reiterated that both the agreements should be read together and that
legal effect must be given to the transactions. Reliance was placed on CIT v. B.M. Kharwar [1969] 72 ITR
603 (SC).

10. I will begin with B.M. Kharwar's case (supra). The ratio of that judgment, as extracted in the head note,
is, inter alia, to the following effect:

... It is now well-settled that the taxing authorities are not entitled, in determining whether a receipt is
liable to be taxed to ignore the legal character of the transaction which is the source of the receipt and to
proceed on what they regard as 'the substance of the matter'.... The taxing authority is entitled and is indeed
bound, to determine the true legal relation resulting from a transaction. If the parties have chosen to
conceal by a device the legal relation, it is open to the taxing authorities to unravel the device and to
determine the true character of the relationship. But the legal effect of a transaction cannot be displaced by
probing into the 'substance of the transaction'. This principle applies alike to cases in which the legal
relation is recorded in a formal document and to cases where it has to be gathered from evidence-oral and
documentary-and conduct of the parties to the transaction.

In view of the above settled law, the true nature of relationship between the assessee and RR has to be
determined after examining the documents and record and their conduct.

11.1 The first thing that strikes one on perusal of the facts of this case is the corporate character of both RR
and RRI. Maybe that RR is the holding company and RRI is its subsidiary but, for that reason, their
separate entities are not lost. RRI is an independent juridical entity, having its own Memorandum, assets
and business machinery. It entered into agreement with RR on 1-7-1979 in pursuance of its own object
clause and to pursue its own business, which, to begin with, consisted of providing marketing support and
commercial information service to RR. The obligations, which it undertook, in terms of the said contract,
are listed in Clause 2 of the agreement, which has been extracted in extenso a,bove. In brief, they included
collecting of commercial intelligence marketing information in India and its neighbouring countries for
Rolls-Royce and to disseminate such marketing information in the market, as RR may like to be consumed
by the Indian and other markets, to provide secretarial and administrative assistance to the : Service
Representatives of RR in India, to provide liaison service between RR and its customers or potential
customers regarding supply of RR's products and servicing and to look after the visitors from RR to India
and neighbouring countries and to provide for their stay and travel facilities. To enable the RRI to discharge
the above functions effectively, RRI was to set up its offices in India and was to employ qualified staff. A
liaison office was also to be kept in the U.K. to co-ordinate the activities of RRI with RR.
11.2 RR did not want RRI to act as its agent and to bind it or commit it in any manner in respect of its
business transactions. It was merely to provide the services stipulated in Clause 2 to RR. Lest somebody
should misunderstand the position of RRI vis-a-vis RR, due to the closeness of their mutual dealings, RR
put in a specific clause in the Agreement, being Clause 4, which clarified, in terms, that RRI was not and
"shall not" represent itself to be the agent of RR, nor shall it "enter into any commitments or negotiations of
whatsoever nature on behalf of RR and will refrain from doing anything" which might result in any person
believing that RRI has authority to contract on behalf of RR. The legal effect of this clause is that RR and
RRI are dealing with each other as principal to principal and that RRI was not the agent of RR and it could
not. bind RR by any of its actions. It was to do its contracted jobs for RR as an independent principal and
not as its agent, or servant. All the jobs that RRI did were, no doubt, for the benefit of RR, but they were not
done by RRI for and on behalf of RR, as its agent, but in the course of carrying out its own obligations
under the contract. The activities carried on by RRI were its own activities and they did not become the
activities of RR, even though their sole object as per the Agreement was to sub-serve and cause benefit to
RR. It is a vital distinction and prima facie the parties, attached importance to it and so it has been written
into the contract itself by the contracting parties and it will be wrong to ignore it, while construing their
true relationship.

11.3 To enable RRI to set up its offices in India and to assemble its operational set up, RR was to reimburse
the expenses incurred by RRI "in full in sterling in the U.K. as soon as practicable after such costs and
expenses are incurred...." (clause 6 of the Agreement). For the services to be rendered by RRI to RR, the
latter was to give to the former "Service Fee". This term has been defined in Clause 1 of the Agreement to
"mean the annual fee payable by RR to RRI calculated and paya,ble in accordance with Clause 5 hereof".
Sub-clause (a) of Clause 5 provided the basis for calculating the service fee. According to it, "The service fee
shall be calculated for each year of account at a fixed rate of 105 per cent of the Actual Operating Costs,
incurred during the year of account to which the service fee relates". It is clear from the aforesaid wordings
that the basis of calculation of service fee is the actual operating costs of RRI. If it is 100, the fee will be 105,
In other words, the service fee was to be the amount which will compensate the RRI for all its actual
operating costs cent per cent and then leave it with a surplus of 5 per cent of the said cost. The agreement
dated 20-5-1980 does not improve upon or alter the aforesaid implication of Sub-clause (a). It also does not
claim to do so. It is at pains to emphasize that it was only reiterating and clarifying the position, as already
existed, vide Sub-clause (a) (supra). In the process, it divides the "service fee" into two parts, one being 100,
i.e., actual operating cost which will be reimbursed in full to RRI and the other being 5 per cent of the actual
operating cost and clarifies that the real and effective fee (i.e., surplus) of RRI will be 5 per cent of the actual
operating cost. The clarificatory agreement is, however, at pains to emphasize that the expenses were of
RRI (e.g., witness the language "5 per cent of the total expenses of RRI") and goes on to say that the said
expenses of RRI were incurred "on behalf of RR". The use of the phraseology "on behalf of" has, therefore,
to be understood in the setting and context of the entire agreement and inasmuch as Clause 4 of the
agreement makes it absolutely clear that RRI was not RR's agent and that both of them were working as
independent principals, the said words will in my opinion mean for the benefit of and not "incurred as the
agent of RR". The RR is paying to RRI a composite sum equal to 105 per cent of the actual operating cost.
One may, therefore, say that imbedded in it is the reimbursement of the 100 per cent actual operating cost,
plus 5 per cent over and above it. The clarification, therefore, does not improve or alter the nature of the
agreement dated 1-7-1979 and, of the payment. It is the sum which as per contract has to be paid for the
services rendered by RRI to RR. It is important to remember in this connection that the Agreement dated
20-5-1980 does not in any way refer to Clause 4 of the agreement, which, therefore, retains its full
operating efficacy. Definition of Service Fee has also not been changed. It continues to be "the annual fee
payable by Rolls-Royce to RR India". Its "calculation" was left to Clause 5 of the agreement. What is paid
annually to RRI by RR is 105 per cent of the actual operating costs. The cost incurred is of RRI. Even the
Agreement da,ted 20-5-1980 say so. The entire operations of RRI in India are, no doubt, for the benefit of
RR. One may, therefore, loosely say that RRI is acting in India on behalf of RR, but there is Clause 4 to
remind one that "on behalf of" can never mean in the above context, "as agent of RR" ; it can only mean for
the benefit of RR.

11.4 It is possible that the contracting parties might have been advised that clarification as above was
necessary to bring the reality into sharper focus, as the commercial profit of the assessee will be only 5 per
cent but, as it did not purport to change the original agreement and meant only "to reiterate and clarify the
position" as it already existed and as in fact also it did so, it will not in my opinion, be correct to say that the
quality of the payment of 105 per cent visualized under the contract underwent any change as a result of the
agreement dated 20-5-1980. Earlier also 105 per cent of the actual operating costs were to be paid ; later
also, the same amount is to be paid. Its bifurcation into two parts is only with a view to emphasize that the
RRI's net surplus will be 5 per cent of actual operating cost, the remaining 100 per cent being just sufficient
to make the both ends of RRI meet. It was so earlier also and the Agreement dated 20-5-1980 did not
improve the situation.

11.5 Sub-clause (b) of Clause 5 spells out the mode of payment of service fee. It is to be paid, not at the end
of the year of accounting, but in advance for a period of four weeks at one time. As the actuals will be known
only at the end of the year of accounting, so a system had to be derived to calculate the advance to be paid.
It was, therefore, stipulated that RRI shall prepare a budget forecast of its actual operating cost and the
advance shall be paid on its basis. The discrepancy between the budget and the actual shall be adjusted at
quarterly rests. The actual operating cost has been defined for this purpose as "total of revenue expenditure
incurred by RRI in performing its obligations" pursuant to this agreement. As will be clear from the
portions intelicised above, actual operating cost meant-

(i) revenue expenditure (ii) incurred by RRI

(iii) in performing its obligations tinder the Agreement dated 1-7-1979.

The expenditure incurred was thus of RRI, on its own behalf, to carry out its own obligations. The purpose
of all this activity was no doubt to benefit RR and in this sense the expenditure, though of RRI, was for the
benefit of RR, but it was not on its behalf. It will in fact, be half truth to even say that the expenditure in
question was only for the benefit of RR, it also benefited RRI. It enabled it to show its flag in the entire
territory, to set up its reputation, goodwill, contacts, etc., in the territory and also to earn the surplus of 5
per cent of its operating cost. So to say that the expenditure was incurred by RRI on behalf of RR will be
totally misleading and to say that it was incurred for the benefit of RR will be only half the truth.

11.6 The mode of payment of Service Fee as above, i.e., in advance, did not change the character of the
payments from that of service fee to an advance or loan. Sub-clause (b) of Clause 5 is quite forthright on
this point. It stipulates-

Payment of the service fee shall be made by way of advance payments....

Advance payments were thus not "on account", but of service fee itself. The basis of payment was obviously
"Pay as you earn". To term the payments as advance will in my opinion be travesty of facts. All the three
cases, referred to in para 7.2 supra and relied upon by the assessee are irrelevant in view of the above
factual situation.

11.7 The accounts of the assessee have also been maintained on the above basis, as noted above. All the
receipts under Clause 5 of the Agreement are credited to the Operating or Trading account and all the
expenses incurred are debited to the said account. On ground also, it is the assessee which engages its
employees, which hires out its accommodation and pays salaries and rents, etc. The respective agreements
for hiring the employees and leasing the accommodation have been admittedly entered into by the assessee
on its own and not on behalf of RR. The offices set up in India are of the assessee and so are the employees.
It is, again, the assessee which approached the Reserve Bank of India for permission to set up its office in
India and the RBI accorded its permission to the assessee "to your establishing a liaison office at New
Delhi". (See page 187 of the paper book.) In the face of these hard facts, it is impossible to accept the
proposition that the expenses incurred by the assessee in India were not its expenses. It paid salary to its
directors and employees, it paid rents to its lessors and it paid audit fee to its auditors. It is because of this,
that the auditors of the company clarified in note 2 to their report that profit before taxation was stated
after charging Depreciation, Audit fee and expenses and Directors' remuneration aggregating to 64,237. If
these were not the assessee's. expenses, where was the question of deducting them from the assessee's gross
receipts or giving an audit note to the above effect ? Even in its return, the assessee claimed depreciation. If
it had been reimbursed to the assessee, being the expenditure of RR, where was the occasion of claiming it
as a deduction from the assessee's income which as per the assessee's present "stand was 10,137. Prima
facie, the assessee has been keeping its accounts in which all the amounts received by it from RR (i.e., 105
per cent of actual operating costs) are being credited and all the expenses incurred by it are being debited.
This is the true state of affairs and the assessee, being a company is obliged under the law to present its
accounts in a manner which will represent its true state of affairs.

The assessee cannot, in my opinion, be allowed to take a stand not in consonance with its true state of
affairs as reflected in the accounts.

12. The claim of the assessee that it incurred no expenses because all that it incurred was reimbursed to it
by RR would be negating the above reality. It not only incurred the expenses in question, but also debited
them in its accounts. The position in this case is far different from that in Duncan Bros. & Co. Lld.'s case
(supra). There, the assessee was the Managing Agent of certain other companies. It had centralised the
working and had common employees who worked both in the offices of the managed companies as well as
in the office of the assessee. The assessee debited the salaries of the employees, who worked in the managed
companies to its own account, in the first instance, but simultaneously debited the accounts of the managed
company for the amounts which were payable by them for the services rendered by the employees to the
managed companies and the net amount was finally debited to the P & L A/c and was claimed as an
expenditure under Section 37(1). The ITO, however, proceeded on the footing that the gross salary paid to
the employees was to be taken into account for the purpose of Section 40(c)(iii) and the reimbursement of
the salary being of the revenue nature was to be credited separately. On these facts, it was held by their
Lordships that the ITO's stand was wrong and that the gross amount before making adjustments could not
be considered in considering the amount coming within the purview of Section 40(c)(iii). The above facts
have prima facie, no similarity with the facts of the present case. Here, the assessee's employees are not
working on deputation, so to say with RR and RR is not paying anything to those employees for the services
rendered by them to RR. The employees are rendering services to RRI and it is RRI, which is paying them.
The employees have no direct/ indirect relationship with RR or its work. RR is the client of RRI and RRI's
employees discharge their duties to RRI, when they provide contracts-for services to RRI's client. There
can, therefore, be no question of the reimbursement of the salary of the employees of RRI by RR, for the
employees of RRI have not been deputed, to it for rendering services to it. RR pays to RRI for the services
rendered and merely because the computation of such payment is related to the actual operating costs of
RRI, the payment does not become ipso facto the re-imbursement of the costs. That may be the result of it,
that may be the measure of it, but the true nature of the payment unalterably remains the quid pro quo for
the rendering of the contracts-for service by RRI to RR. The ratio of Duncan Bros. does not, therefore, apply
to the facts of the present case. There is in fact no similarity of facts in the two cases.

13. This being so, the expenditure of the assessee has to be subjected to scrutiny by the ITO and if any
expenditure comes within mischief of the restrictive sections like 40(c)(ni), 40A(5) or Rule 6D, the same
will apply to the assessee's case. The Intome-tax Act, 1961 makes no distinction in this regard in a Resident
and a Nonresident. The learned counsel of the assessee also did not put forward any arguments to show as
to why the various restrictive provisions will not apply to the expenditure incurred by the assessee. The
correctness of the computation of the disallowances was also not challenged by the assessee. There is,
therefore, no case to interfere with the orders of the authorities below on this point.

14.1 Whether or not the amounts received by the assessee from RR in terms of Clause 5 of the agreement
(by virtue of which alone 100 + 5 per cent of the actual operating costs of the assessee are paid to it by RR)
constitute trading receipts in the assessee's hands is strictly not germane to deciding the issue as to whether
or not the "actual operating costs" are "of the assessee" and whether to them the various provisions of the
Income-tax Act mentioned by the assessee in ground Nos. (4) and (6) apply. The grounds raised by the
assessee concern themselves only with the restriction of the expenditure by the ITO and not with the nature
of the receipt in the assessee's hands. Yet, as the issue was raised by the assessee's counsel and argued at
length, I will deal with it.

14.2 That one of the components of the receipts, i.e., 5 per cent of the actual operating costs is of income
nature is not disputed by the assessee. May it be noted, at this stage, that the payment is a composite one,
calculated at 105 per cent of the budgeted operating costs, adjusted at the end of each quarter with the
actual operating costs incurred till then and this mode of payment has not been touched by the Agreement
dated 20-5-1980. This entire payment is termed as "Service Fee" by the definition clause. Agreement dated
20-5-1980 clarifies that the above provision in the original agreement in fact meant that (i) the entire
expenditure incurred in connection with the provision of the services stated in Clause 2 of the Agreement
incurred by RRI will be reimbursed to it by RR and (ii) that 5 per cent of the above will be paid in addition.
Even according to the latter Agreement the payment in question is for the services rendered by RRI to RR
in terms of the Agreement dated 1-7-1979 and not de hors it. It is one of the businesses of the assessee to
render such services. It is in the course of carrying on of such business and the rendering of services that
the payment is made by RR to RRI. This basic character of the payment cannot be camouflaged under any
subtility of legal drafting-it is the amount, which has been earned by RRI by dint of rendering of the
services to RR in terms of Clause 2 of the Agreement and the amount so earned would be its trading receipt
coming to it directly as a result of its carrying on its business. It is the endeavour of every businessman to
earn so much as will reimburse it its costs and leave with it some surplus. This is what the assessee is also
doing. The mode of the calculation of the quid pro quo with reference to its "actual operating costs" will not,
in my opinion, change its basic character of it being a trading receipt.

14.3 The assessee had placed reliance on Dunlop Rubber Co. Ltd.'s case (supra) in support of the
proposition that amounts received as reimbursement of expenditure were not revenue receipt. The decision
in that case turned on its own peculiar facts and it cannot be held to be laying down such a wide proposition
as the assessee's learned counsel canvassed. The relevant facts as weighed with their Lordships of Calcutta
High Court may be noted. The assessee, a non-resident English Company, which had a world-wide network
of subsidiaries and associated companies, maintained in the U.K. extensive technical research
establishments, which were known as service departments for its entire organization throughout the world.
The assessee-company communicated the latest information, process and inventions relating to goods
manufactured by them to its subsidiaries and associated companies on certain terms and conditions.
Dunlop Rubber (I) Ltd., an Indian Company availed of the above facilities, and, in lieu of it, paid certain
amounts to the non-resident assessees. The question was whether the amounts so paid by the Indian
Company to the assessee non-resident were revenue receipts in its hands. The assessee pleaded that the
amount received by it from the Indian Company could not constitute income, as the payments were merely
reimbursement of the expenditure, incurred in connection with the research work and so the amounts
could not be assessed in its hands and that the assessee-company incurred large expenditure but only a part
of it was allocated to the various subsidiary companies in the world and what it received from the subsidiary
companies was only a part of the expenses incurred by it and as such, there was no element of profit in
them. The above plea of the assessee was found to be factually correct by the Tribunal and so its appeal was
allowed by it. On a reference to the Hon'ble High Court, the above view was confirmed by their Lordships,
who observed, inter alia, as follows :

It appears to us that the Tribunal was right in arriving at the view that it was the recoupment of expenses.
The result of the research was for the benefit of all concerned including the head office and the subsidiary
concerns. It was for sharing of the expenses of the research which was utilized by the subsidiaries as well as
the Head Office organization that the payments were made... the very fact that the technical data were
jointly obtained and the expenses were shared together indicates that it could not be treated as income.(p.
502)

14.4 The above narration shows-

(i) That the non-resident company was not doing the business of doing research work with a view to sell its
results.

(ii) That it was an inhouse R & D effort and it was doing research jointly for itself and its subsidiaries, which
all owned the fruits of research.

(iii) That subsidiaries shared all expenses of this joint effort and did not purchase the information.

(iv) That the expenses incurred by the non-resident were far more than it realized from its subsidiaries and
there was no profit element in such realizations from the subsidiaries.

In the context of these facts, it was held that the receipts were by way of recoupment of joint expenses
incurred by the assessee on its own and the "Subsidiaries" behalf and were not income.

14.5 It is not possible to record such a finding in the present case. There is no jointness of action on which
joint expenses have been incurred by RR & RRI, which have been reimbursed by RR to RRI. Here, there is
an agreement between RR & RRI in terms of which RRI renders services to RR and the latter pays to RRI
stipulated payments computed with reference to actual operating costs of RRI. The payment in the hands of
RRI is thus clearly a trading receipt. There is nothing done jointly for which the other joint owner of the
result of the joint effort might be reimbursing part of the cost. No assistance can, therefore, be derived by
the assessee from the Dunlop Rubber Co. Ltd.'s case (supra).

15. The assessee's case, in fact, stands neatly covered by the ratio of the judgment of the Hon'ble Supreme
Court in the case of V.S.S.V. Meenakshi Achi (supra) It has been categorically held by their Lordships in the
said case that the receipt on account of the reimbursement of revenue expenditure is revenue receipt. The
contention of Mr. Vishwanath Shastri before their Lordships was : "The payments were made to the
appellants to enable them to recoup the revenue expenditure incurred for running and maintaining the
rubber plantation, and, therefore, the payments were revenue receipts". Their Lordships accepted the above
reasoning relying on Higgs v. Wrightson [1944] 26 Tax Cases 73.

This is what their Lordships said at p. 260 :

Having regard to the aforesaid facts, we must hold that the amounts from the fund earmarked for the
appellants on the basis of the rubber produced by them were paid against expenditure incurred by them for
maintaining the rubber plantation and producing the rubber. If so, it follows that the receipts by the
assessee during the accounting year were revenue receipts.

In the present case also, the expenses in question have been incurred by the assessee for carrying on its
business of rendering stipulated services to RR. Therefore, the reimbursement of such expenses even if this
be the true nature of the payments, for argument sake will be revenue receipt.

16. The facts of Bengal Textiles Association v. VAT [1960] 39 ITR 723 (SC) are also (rather more) apposite.
In that case, the Government of Bengal, in terms of an agreement with the assessee, agreed to pay every
month to the association the administrative expenses, incurred in the previous month including
establishment charges, office advertising, salaries and wages not exceeding Rs. 600,000 per year less the
salary and expenses of the Liaison Officer. The question for determination was whether the reimbursement
of the above expenses was trading receipt of the assessee. It was held by the Hon'ble Supreme Court that
the payments were made by the Government to the assessee to assist it in carrying on its business and for
the services it was rendering to the Government by doing so. They were not of a benevolent nature and
constituted trading receipts. In the present case also, this is precisely what has happened. The payments
have been made in the present case, as per the assessee's submission in the form of reimbursement of
expenses (if this plea of the assessee be accepted for arguments sake) for rendering services in terms of the
contract dated 1-7-1979 read with that dated 20-5-1980, and, therefore, they will even on this concessional
hypothesis, constitute business receipts in terms of the ratio of the above case.

17. In the end, I sum up the above discussion by holding-

(i) That the assessee has a separate and independent entity from that of RR and that the Agreement dated
1-7-1979 was entered into on principal to principal basis and so there is no question of the assessee
incurring its actual operating expenditure on behalf of RR as its agent. The assessee's expenditure is not
RR's expenditure. It is its own expenditure.

(ii) That the above position is reflected from the accounts kept by the assessee showing its true state of
affairs in terms of its obligation under the respective company law.

(iii) That therefore, the various restrictive provisions of the Income-tax Act, 1961 (from Sections 30 to 43A,
including the relevant rules) apply to the assessee and the assessee's counsel has put forward not a single
argument in support of the proposition that the above restrictive provisions will not apply to it,

(iv) That the total receipts of the assessee from RR computed in terms of Clause 5 of the Agreement dated 1-
7-1979 read with that dated 20-5-1980 are business receipts.

18. In view of the above, I reject the assessee's appeal. I need not repeat that ground Nos. 7 to 13 were not
pressed by the assessee and so they deserve to be rejected for non-prosecution thereof.

As Per Bench - As it has not been possible for us to come to an agreed conclusion in the present appeal, we
refer the following question for the valued opinion of the Hon'ble Third Member :

Whether, on the facts and in the circumstances of the case, the GIT (Appeals) was justified in holding that
the entire receipts by RRI from RR (being 105 per cent of the actual operating costs of RRI) minus expenses
admissible under the Income-tax Act, 1961 were liable to income-tax ?

THIRD MEMBER ORDER

G. Krishnamurthy, President

1. On a point of difference of opinion between the learned Members of the Tribunal who heard this appeal
originally, their difference of opinion was formulated in the following words and was referred to the
President for the nomination of the Third Member to express his opinion on the point of difference of
opinion :-

Whether, on the facts and in the circumstances of the case, the CIT (Appeals) was justified in holding that
the entire receipts by RRI from RR (being 105 per cent of the actual operating cost of RRI) minus expenses
admissible under the Income-tax Act, 1981, were liable to income-tax ?

The matter has now come before me in my capacity as a Third Member and I shall proceed to recount the
facts, the narration of arguments addressed to me both for and against the views expressed by the Members
and then express my opinion. I shall take the facts from the order of the learned Accountant Member, not
that there is any difference in the facts narrated by both the Members but it is more convenient to take
them from the order of the learned Accountant Member.
2. The assessee is a non-resident company being 100 per cent subsidiary of another non-resident company,
namely, Rolls-Royce. For short, they will be referred to as RRI for the non-resident Indian Company and
RR for the non-resident holding company. RRI was incorporated on 20th of February, 1979. In Sub-clauses
(A) to (23) of Clause 3 of the Memorandum of Association the objects of the RRI were set out. They are :

(A) To carry on business as manufacturer, builders, designers, repairers and owners of aero-engines, motor
cars and carriages, cabs, omnibuses, wagons, carts, cycles, ships, boats and other marine vessels,
aeroplanes, airships and all other land, sea or air carriages and conveyances, in whatsoever manner and by
whatsoever powers the same may be propelled or driven and to buy, sell, let out on hire, or act as factor or
agent for the purchase or sale of, or otherwise deal in aero-engines, motor cars and motor vehicles and
boats of every description, aeroplanes, airships and every kind of aircraft and component parts, fittings and
accessories of all kinds for the same and all articles and things used in the manufacture, maintenance and
working thereof.

(B) To carry on business as engineers, machinists, smiths, fitters, electricians, brassfounders, ironfounders,
tubemakers, metal- workers, wiredrawers, ropemakers, rubber or rubber substitute manufacturers, oil-
refiners, automobile store and garage and aerodrome keepers, storers and suppliers of and dealers in
petrol, paraffin, oils and other fluids, generators and distributors of electricity and suppliers of motive
power of any description for all kinds of power vehicles and boats.

(C) To make, construct, buy, hire, sell, repair. alter and deal in component parts and accessories of any of
the manufacturers or products of the Company and apparatus, machinery, materials and goods and articles
of all kinds useful or necessary in carrying on the business of the Company, or in connection therewith.

(D) To carry on any other trade or business whatsoever which can, in the opinion of the Board of Directors,
be advantageously carried on by the Company in connection with or as ancillary to any of the above
businesses or the general business of the Company.

3. The RRI entered into an agreement with RR on 1-7-1979 for rendering of certain services by RRI to RR.
The preamble of this agreement is as follows :

WHEREAS Rolls-Royce sells Engine Products to airlines and other markets throughout the world using
commercial information and marketing support derived from various sources,

AND WHEREAS Roll-Royce has accepted and will accept Service Support Obligations to customers and
Licensees of Engine Products who are located within the Territory and to others of its customers whose
aircraft regularly operate into the Territory,

AND WHEREAS RR India has been formed for the purpose of providing marketing support and a
commercial information service relating to the Territory and for the purpose of co-ordinating the Service
Support Obligations on behalf of Rolls-Royce throughout the Territory,

NOW THEREFORE in consideration of the Service Pee payable hereunder it is HEREBY AGREED as
follows :

4. Clause 1 of the agreement defined the terms agreed upon between RRI and RR, They are :

(a) 'Service Support Obligations' shall mean. obligations of Rolls- Royce under contract or otherwise to
provide technical and after sales service to customers and licensees of Engine Products.

(b) 'Service Fee' shall mean the annual fee payable by Rolls- Royce to RR India calculated and payable in
accordance with Clause 5 hereof.

(c) 'Actual Operating Costs' shall mean the total of revenue expenditure incurred by RR India in performing
its obligations pursuant to this Agreement in the UK India and elsewhere.

(d) 'Budgeted Operating Costs' shall mean the RR India budget forecast of Actual Operating Costs.
(e) 'AP' shall mean a Rolls-Royce accounting period of normally four weeks.

5. Clause 2 provided for the duties of the RRI as :

RR India will carry out the following duties to such extent as Rolls-Royce may require from time to time :

(i) To obtain and report to Rolls-Royce on a regular basis such marketing information as is considered to be
relevant to Rolls-Royce's interests.

(ii) To disseminate such marketing and commercial information relating to Rolls-Royce's products as Rolls-
Royce may require.

(iii) To provide administrative and secretarial assistance locally for the Service Representatives deployed in
the Territory.

(iv) To provide a liaison service between Rolls-Royce and relevant departments of the Government of India
and other customers of Rolls-Royce in the Territory in all matters of supply of products and services.

(v) To monitor the effectiveness of Rolls-Royce's commercial advisers and to report regularly thereon.

(vi) To look after Rolls-Royce visitors in India and arrangements for stay and itinerary.

6. Clause 8 provided for the establishment, of the offices of RRD as :

Offices of RR India

(a) RR India shall as soon as practicable establish a liaison office in New Delhi and such other similar
offices within the Territory as may from time to time be required by RR India for the purpose of carrying
out its obligations under this agreement.

(b) RR India shall operate and maintain such offices within the Territory as may be necessary to fulfill its
obligations under this Agreement and shall employ competent engineers and other suitably qualified
personnel properly to carry out its duties under the provisions of this Agreement.

(c) Rolls-Royce and RR India may make appropriate arrangements in the UK for such liaison staff as may
be necessary to coordinate the activities of RR India with the activities and requirements of Rolls-Royce
concerning its business interests in the territory.

7. Then came Clause 4 which clearly stipulated that this agreement should not be construed as having
established a relationship of agency, as under :

No Agency Relationship

RR India is not and shall not represent itself to be the agent of Rolls-Royce nor shall it enter into or purport
to enter into any commitments or negotiations of whatsoever nature on behalf of Rolls-Royce in the
Territory or elsewhere or do any act or thing which might result in any persons believing that RR India has
authority to contract on behalf of Rolls-Royce.

8. Then came the most important Clause 5 for our present purpose, namely, the clause providing for the
remuneration to be paid by RRI to RR.

Service Fee

Rolls-Royce shall pay annually to RR India the Service Pee as hereinafter provided :

(a) The Service Pee shall be calculated for each Year of Account at a fixed rate of 105 per cent of the Actual
Operating Costs incurred during the Year of Account to which the Service Pee relates.

(b) Payment of the Service Pee shall be made by way of advance payments by Rolls-Royce to RR India each
AP with quarterly adjustments in following manner :
(i) Each of such advance payments shall be calculated at a fixed rate of l05 per cent of the Budgeted
Operating Costs for the AP to which the particular advance payment relates and shall be payable by Rolls-
Royce to RR India at the beginning of each AP (or part thereof) commencing with effect from 1st June,
1979.

(ii) Within ten weeks of the close of the last business day of AP 3. AP 6, AP 9 and AP 13 in each Year of
Account RR India will submit to Rolls-Royce a statement showing the Actual Operating Costs incurred up
to the end of the said AP 3, AP 6, AP 9 or AP 13 (as the case may be) together with the total of advance
payments made to date during that Year of Account.

(iii) Following verification of each such quarterly statement Rolls-Royce will calculate the amount by which
the Service Fee has been overpaid or underpaid and Rolls-Royce or RR India (as the case may be) will
promptly make an adjusting payment to rectify such overpayment or underpayment.

9. Then by Clause 6, it is provided that the expenditure incurred by RRI will be reimbursed to it in full by
RR in the following terms :

Setting-up Costs

All costs and expenses incurred by RR India (as authorised by Rolls-Royce prior to commitment either
specifically or generally) in establishing a liaison office in New Delhi or otherwise in settingup operations
shall be reimbursed by Rolls-Royce in full in Sterling in the UK as soon as practicable after such costs and
expenses are incurred but in any event within eight weeks from day they are incurred and notified to Rolls-
Royce.

10. Another point to be noted, in this connection, is that on 20th of May, 1980 a supplementary agreement
was entered into between RR and RRI, the purpose of which was stated to "reiterate and clarify the position
with regard to the remuneration payable under the formation agreement by RR to RRI so as to put the
same beyond any doubt". This agreement provided in categorical terms that all the expenditure incurred by
RRI would be reimbursed by RR. It was also pointed out in this supplementary agreement that
reimbursement of expenditure incurred by RRI by RR was always the intention between the parties. It is,
therefore, necessary to notice what was provided in this supplementary agreement and it is to the following
effect:

NOW THIS MEMORANDUM WITNESSETH AS FOLLOWS :

It is hereby declared and reiterated that the remuneration payable by RR by way of service fee under and in
accordance with the Formation Agreement in respect of liaison services provided by RRI in the territories of
India, Bangladesh, Nepal, Sri Lanka and Bhutan is 5 per cent of the total expenses of RRI (including
depreciation) incurred on behalf of RR in connection with the provision of the said services, the entire
expenditure incurred on this account by RRI being reimbursed by RR : and it has always been so intended
between the parties hereto and always so under- stood.

11. On 23rd of July, 1979, the assessee-compauy, RRI applied to the Reserve Bank of India seeking
permission to open an office in India, in reply to which the Reserve Bank of India by its letter dated 26th of
September, 1979 granted permission laying down certain stipulations, namely, that permission to establish
a liaison office in India for an initial period of two years would be granted if the office undertakes only the
proposed liaison work and would not undertake any other activity of trading commercial or industrial
nature, nor enter into any business contracts in its own name without the prior permission of the Reserve
Bank of India ; that it would charge no commission or fee or any other remuneration for the liaison
activities rendered by RRI in India ; that the entire expenses of the liaison office in India would be met
exclusively out of the funds received from abroad through normal banking channels ; that the liaison office
in India should not borrow or lend any money from or to any person in India without prior permission. It
also stipulated that the liaison office in India should not acquire, hold or dispose of any property in India
without the prior permission of the Reserve Bank of India under Section 31 of the Foreign Exchange
Regulation Act, 1973 ; that the liaison office in India would furnish every year a certificate from the auditors
to the effect that during the year no income was earned by or accruing to the liaison office in India, along
with details of remittances received from abroad duly supported by the bank certificates. A certified copy of
the audited final accounts by the liaison office in India and finally an annual report of the work bone by the
liaison office in India stating therein the details of activities taken up, services rendered in India and also
actual export and import, if any, effected during the period in respect of which the office had rendered
liaison services should also be furnished. It also proposed that maintenance of account in the name of RR
which was described in this letter as Head Office by the assessee, in the books of the liaison office in India
will be shown only after permission of the Reserve Bank of India to do so.

12. After, thus, obtaining permission from the Reserve Bank of India, the assessee-oompany, RRI opened a
liaison office in India by taking a suitable building on lease. It also engaged the staff as per the
requirements provided in Clause 3 of the agreement. The assessee-company, RRI incurred in the
accounting year a total expenditure of Rs. 29,76,865, on the maintenance of the staff and office in India to
render services to RR as provided for in the agreement. In addition. to the expenditure incurred in India,
some other expenditure was also incurred in the head office of the RRI at London. The total amount of
expenditure incurred by RRI expressed in terms of pound sterling came to 2,02,743 ( 1,71,281 in India and
31,462 at the head office outside India). The whole of this expenditure was reimbursed to RRI by RR.

13. The dispute in regard to the computation of the income of the RRI presented a piquant situation. The
assessee-company states that its income was only the remuneration of 5 per cent of the actual operating
cost and that amounted to only 2,37,237 in terms of Indian rupee and that alone constituted its income and
nothing more. Whereas the IAC (Assessment) was of the opinion that the entire amount remitted by RR
towards the actual operating cost increased by the remuneration of 5 per cent thereof constituted assessee's
income and that had worked out to Rs. 31,76,373. After making certain allowances, the final income of the
assessee was computed at Rs. 25,33,718 as against Rs. 2,13,237 returned. The main controversy was as to
whether the reimbursement of expenditure to assessee-company, RRI by RR constituted the income of the
assessee. Put it differently, whether expenditure by RRI in India for and on behalf of RR and got
reimbursement thereof in full could either, in fact, or in law be regarded as the expenditure incurred by the
assessee-company RRI. The revenue's point was that the expenditure incurred by RRI in India though on
behalf of RR and though reimbursed by RR in full yet it constituted the expenditure of the assessee-
company in India for the purpose of earning income and when that was the expenditure of the assessee-
company in India, the allowance of expenditure to compute the income for the purpose of the Income-tax
Act should be as per the provisions of the Income-tax Act and if the Income-tax Act had placed any
prohibitions or restrictions on the allowance of that expenditure, those prohibitions or restrictions should
be given full effect to and only then the expenditure eligible to be allowed as permissible expenditure should
be allowed. Since, the entire expenditure was reimbursed the amount received towards reimbursement was
in the course of business carried on by the assessee-company and, therefore, constituted its trading receipt.
Thus, the entire remittances whatever be its nature must be taken as trading receipts including the
commissions received and from those gross receipts, only the permissible expenditure under the Income-
tax Act should be allowed and the balance should be taken as income. It is in this view of the interpretation
of the Income-tax Act, that the IAC (Asst.) computed the income of the assessee at Rs. 25,33,718, negativing
the assessee's claim that the expenditure incurred by it having been solely, entirely, for and on behalf of and
at the behest of RR did not become the expenditure incurred by the assessee at all and, therefore, the
question of treating remittances received by way of reimbursement of the expenditure so incurred should
not and could not be regarded as trading receipts, muchless, as income. Since, the assessee got only
reimbursement of the expenditure incurred by it on behalf of RR there was an element of income in it.
Since, the aasessee did not claim any portion of that expenditure as allowable in computing its income, the
question of disallowing the expenditure would not arise nor the question of applying the provisions of the
Income-tax Act would arise because the assessee, in so far as that expenditure and remittances received by
way of reimbursement are concerned, was not carrying on any business. Even to meet the expenditure, the
assessee-company RRI was receiving advances from RR, which is clear from the terms of agreement
referred to above in Clause 5. It was the amount received from RR by way of advance to meet the
expenditure in India that the RRI. spent the money in India towards the expenditure for RRI and met the
cost of expenditure out of advance received. Thus, there was not even any investment made by RRI to meet
the expenditure. Therefore, the expenditure incurred by RRI in India and the reimbursements received
from. RRI should both be excluded and only the commission received by RRI, which was measured at a
particular percentage of the actual expenses incurred in India must be regarded as the income of the RRI
minus expenditure incurred by it on its own behalf to earn this commission. The actual cost incurred by
RRI in India was only a measure to arrive at the commission that accrued to RRI in India and that should
not be misunderstood that the reimbursement of the expenditure by RRI in India constituted its trading
receipts.

14. This is the essence of the case of the assessee-company before the authorities below. The IAC (Asst.) for
reasons recorded by him in his assessment order rejected the assessee's contentions and proceeded to
compute the income as stated earlier. It may be noted here that the revenue accepted this position as
explained by the assessee in respect of the earlier two assessment years but this was the only year where a
departure was made to tax the remittances received by the assessee by way of reimbursement. The assessee
having failed in appeal before the GIT (A) preferred a further appeal before the Income-tax Appellate
Tribunal.

15. The learned Judicial Member expressed his assent to the view canvassed on behalf of the assessee by
holding that only the oommission received by the assessee-oompany constituted the income of the assessee
and not the receipts received by way of reimbursement of expenditure. The learned Accountant Member
expressed a dissent with the view expressed on behalf of the assessee and assented with the view of the
revenue stating that the reimbursement of expenditure and the amount received by way of remittances
constituted trading receipts of the assessee.

16. Before I go to the reasons that prevailed with my learned brothers to come to their respective
conclusions, I may have to notice what prevailed with the CIT(A) in declining to accept the claim of the
assessee. In paras 3.6 and 3,7 of his order, CIT(A) has mentioned as under :

3.6 As such it is clear that the amount paid by Rolls-Royce U.K. was in the form of Service fee. This Service
fee was fixed at 105 per cent of the actual operating cost incurred during the year of account to which the
Service fee related. In the circumstances, I am of the view that entire amount received from Rolls-Royce
U.K. by the appellant was in the form of ordinary receipt of service fee received by a,ny businessman or
professional or company, etc., for the services rendered by him/it. Hence, entire receipt minus expenses
admissible under the IT Act, 1961 were liable to income- tax.

3.7 I further agree with the IAC (Asst.) that memorandum dated 29-5-1980 cannot change the nature of
receipt in the hands of the appellant. So far as the actual expenses are concerned, Rolls-Royce U.K. might
be competent to verify the same for the purpose of calculation of Service fee. But that does not mean that
each and every expenditure is exempt from income-tax. As such entire amount received from Rolls-Royce
U.K. by the appellant has to be treated as revenue receipt. As regards the expenses, these have to be
scrutinised under the Income-tax Act and such expenses as are not admissible under the Income-tax Act
have to be disallowed. To this extent I completely agree with the IAC (Asst.)

17. It will be seen from the above that the CIT(A) was under the genuine impression that the service fee
fixed was 105 per cent of the actual operating costs incurred during the year of account and, therefore, the
entire amount received from RR by the assessee- company RRI constituted receipt for service fees and,
therefore, taxable, minus expenses admissible under the Income-tax Act. Whether reference to 105 per cent
as actual operating cost would lend support to the view taken by the assessee is a matter for deep thought.
What is more, the CIT(A) held that the agreement entered into on 29-5-1980 had brought about a change in
the nature of the receipt in the hands of the assessee and that change would not be permitted, and,
therefore, the service fee by the assessee was at 105 per cent of the actual operating cost and, therefore, the
expenses incurred by the assessee had to be scrutinized under the Income-tax Act and such expenses as are
not admissible under the Income-tax Act had to be disallowed. Whether this view is right or wrong, as I
have mentioned earlier, is the bone of contention, in this appeal.

18. The learned Judicial Member held that the view taken by the learned CIT(A) was incorrect. After
referring to the relevant passages of the agreement, objects in memorandum of association and the
arguments of the learned counsel for the assessee and the D.R., the learned Judicial Member held that the
service fee received by the assessee was not 105 per cent of the actual operating cost incurred during the
year of account but it was only 5 per cent. He held that RR had brought RRI into existence to subserve its
needs of performing liaison work in India and surrounding countries to promote the sales of its
manufactured goods ; that the RRI had no independent existence or activity ; that this fact was borne out
not only by the preamble to the agreement but also by the permission granted by the Reserve Bank of India
whereby the Reserve Bank of India had specifically restrained RRI from carrying on any business of
whatever kind other than performing the liaison work as mentioned in the agreement, a copy of which was
filed before it. He held that on a careful consideration of agreement entered into between RR and RRI, RR
had agreed to reimburse the entire expenditure by RRI in carrying out the appointed tasks by RRI. He held
that though Clause 4 of the agreement between RRI and RR had prohibited RRI from acting as the agent of
RR, having regard to the other clauses of the agreement and the purpose for which RRI was brought into
existence, RRI was acting as a de facto agent of RR though not as de jure agent of RR. He, therefore, held
that the expenditure incurred by RRI and reimbursed by RR was not at all the expenditure of RRI. The
reference to 105 per cent of the actual cost incurred in the agreement must be understood in such a way, as
to mean that what was to be paid to the RRI was only actual expenses incurred by it for which it received
advance money from RR plus 5 per cent remuneration. Since, 105 per cent included reimbursement of
expenditure to the full brim, that amount should not be regarded as receipt at all being only reimbursement
of expenses. Placing reliance upon the agreement entered into on 20-5-1980, which was entered into with a
view to reiterate and clarify the position as understood between RR and RRI, when the original agreement
was entered into, the learned Judicial Member held that this matter was put at rest beyond any doubt that
the expenditure incurred by RRI in India was really the expenditure of RR and, therefore, the
reimbursement of it did not constitute receipt in the hands of the assessee- company, RRI as a taxable
receipt. He also placed reliance upon a certificate issued fay RR on 10-10-1986 wherein RRI had certified
that all expenditure incurred by RRI both in India and in the U.K. was borne by RR and was charged with a
profit and loss account in the books of account of RR. It also stated that the moneys advanced to RRI were
for different purposes for defraying operational costs to be incurred by RRT in India. Any unexpended
advance held by RRI was refundable to RR and was shown as such in the books of RRI. According to the
learned Judicial Member, this certificate put beyond any shadow of doubt, the nature of the expenditure
that was all spent by RRI. The learned Judicial Member finally held that it was not possible to agree with
the view expressed by either the IAO (Asst.) or the CIT(A) that the intention of entering into an agreement
on 20-5-1980 was to change a situation which did not exist at the time when the agreement was originally
entered into on 1-7-1979. The purport of agreement of 20-5-1980 was only to clarify the situation and to
clear the doubts not to bring about a change as was supposed by the authorities. In. this context, he made
reference to Section 62 of the Indian Contract Act, which provided for addition, subtraction, alteration,
waiver or a recession of an agreement before a contract was breached. He held that the agreement dated
20-5-1980 could not be taken as an afterthought so as to circumvent a situation created by the proceedings
initiated by the IAC(A) because IAC(A) initiated proceedings for this assessment year long after the
agreement was entered into on 20-5-1980 and the assessments for the earlier years were completed on the
basis of these agreements. He, therefore, vacated the order passed by the IAC (Asst.) and directed him to
take the remuneration of 5 per cent of the actual operating cost as the taxable receipt of the assessee-
company and proceed to make the assessment accordingly. On other grounds no finding was recorded as
assessment was set aside.

19. The learned Accountant Member, however, took a different stand. After exhaustively referring to the
material placed on record, which was considered by the learned Judicial Member also, he held that the
assessee-company was trying to hide something from the department. By reconstructing the profit and loss
account on the basis of figures available on record, he came to the conclusion that the assessee made an
attempt at presenting a wrong picture of the accounts. According to the learned Accountant Member, RRI is
an independent juridical entity having its own identity and the business machinery. It is not the agent of RR
either factually or legally. Though RRI undertook all the jobs, they were not for and on behalf of RR as its
agent but they were for the benefit of RR in the course of carrying out the obligations cast upon by RR on
RRI. The activities carried on did not become the activities of RR even though their sole object was to
subserve the cause of RR. This, according to him, was vital distinction. Closely relying upon Clause 5 of the
agreement, the held that since the service fee was to be calculated at a fixed rate of 105 per cent of the actual
operating cost, it meant that if 100 rupees was spent, the fee that the assessee-company would be entitled to
receive would be 105 per cent. That is to say, the service fee was so fixed as to compensate the assessee-
company, RRI not only for its actual operating costs in their entirety but also leave it with a surplus of 5 per
cent. The agreement of 20-5-1980 did neither improve upon nor alter the aforesaid arrangement by
remunerating the assessee-company. Again, dwelling on the agreement of 20-5-1980, particularly the
phrase "used on behalf of RR", the learned Accountant Member said that that phrase has to be understood
in the setting and the context of the entire agreement and so construed. It should be interpreted as meaning
"for the benefit of RR" and not "incurred as the agent of RR". When the agreement provided for the
payment of full expenditure incurred by RRI plus 5 per cent commission, the expenditure incurred by RRI
became its own expenditure and the amount received by way of reimbursement became its receipt and
while computing the income under the Indian Income-tax Act from the gross receipts of 105 per cent such
expenditure as is allowable under the Income-tax Act only will have to be allowed and in this context, it is of
no consequence to contend that whether the receipts were not 105 per cent nor the expenditure incurred by
the assessee was not of its own. Thus, the agreement of 20-5-1980, according to him, did not bring about
any change in the method, manner and nature of remunerating the assessee-company. Since, the
complexion of the arrangement had not changed, he did not agree with the view expressed by the revenue
that agreement of 20-5-1980 had brought about a change in the complexion of the earlier agreement.
Advance payments towards full reimbursement of expenditure, according to him, was only a convenient
system devised to facilitate accounting and payments and that by itself did not advance the assessee's case.
As the actual should be known only at the end of the year of accounting, this system had to be devised. Even
so, the method and manner of remunerating the assessee-company had not undergone any change. He also
drew support for his view that the expenditure incurred was that of RRI and not that of RR, from the use of
the expression in the agreement "total of revenue expenditure incurred by RRI for performing its
obligations". The "revenue expenditure incurred by RRI" according to the learned Accountant Member,
meant that the expenditure was incurred by RRI as its own and not as that of RR, even though in the
process, RR was amply benefited. It is only by incurring this expenditure that RRI was able to earn
commission by 5 per cent. It would be, therefore, misleading to say that the expenditure was incurred by
RRI on behalf of RR. Though the copy of the profit and loss account as prepared by the assessee-company
was filed before the Bench, the learned Accountant Member constructed a profit and loss account on the
basis of figures furnished and arrived at the profit which was shown in the statement filed by the assesses
and since, to that profit and loss account the entire remittances were credited, he drew support for his view
that the entire receipts constituted the trading receipts of the assessee in the sense that 105 per cent in
entirety became assessee's trading receipts. He also relied upon the fact that it was the assessee-company
RRI which engaged the employees, hired out accommodation, set up office in India and which approached
the Reserve Bank of India for permission to set up office in India. The Reserve Bank of India granted
permission to the assessee-company to set up an office in India and this, according to him, is of paramount
importance to support the view that the assessee-company was incurring the expenditure on its own and
thereby carrying on business in India. On behalf of the assessee, reliance was placed upon the decision of
the Calcutta High Court in Duncan Bros. & Co. Ltd.'s case (supra) a,nd another judgment of the Calcutta
High Court in Dunlop Rubber Co. Ltd.'s case (supra). By distinguishing both these decisions, the learned
Accountant Member held that the principle enunciated in those decisions did not at all apply to the facts of
the case. Once the expenditure was incurred by the assessee, that expenditure has to be subjected to the
scrutiny by the Income-tax Officer and if any expenditure carne within the mischief of Sections 40C(3),
40A(5) or Rule 6D, that has to be applied to this expenditure also irrespective of the fact whether the
assessee-company was a resident or non-resident because the Income-tax Act did not make any distinction
in so far as the application of these restrictive provisions between a resident and a non-resident assessee is
concerned. Finally, the learned Accountant Member, drew ample support for his view from the ratio of the
judgment of the Supreme Court in the case of V.S.S.V. Meenakshi Achi (supra). The Supreme Court,
according to the learned Accountant Member, held in this case that receipt on account of the
reimbursement of revenue expenditure is revenue receipt. He also relied upon another judgment of the
Supreme Court in the case of Bengal Textiles Association (supra).

20. Now, it is my task and endeavour to find out whose view is just, correct and according to law on the
facts, if not close to it. I do not have to reproduce here the arguments addressed to me by both the learned
counsel for the assessee and the departmental representative because they emphasised, reiterated their
respective stands taken up before the authorities below as well as before my learned Brothers. My first task
is to resolve the raging controversy as to how RRI rendered services to RR and in what capacity ? To answer
this question, one has necessarily to go to the agreement, which is on pages 42 to 49 of the paper book. I
have already extracted above the relevant clauses from the order of the learned Accountant Member. RR,
whose registered office was at London was selling engine products to Ireland and other markets throughout
the world using commercial information and marketing support derived from various sources. So, for RR in
order to maintain its sales and to push them up further, it is of paramount importance to obtain
commercial information and marketing support without which it would not be able to sell its engine
products, which are of complex nature. Another aspect of paramount importance to RR is that under the
sale agreement it entered into with its customers, it had accepted the service and support obligations to
customers and to licensees of the engine products. RR had been specifically therefore thought of a source
for perennial supply of information as part of its business activity. Thus RRI was incorporated for this
specific purpose of providing marketing support and commercial information service relating to the
territory, to which it is assigned and also for carrying out the service support obligations undertaken by RR
in that territory. Thus, for RR to maintain and promote its sales, it has to have a source from which it could
obtain commercial information and provide marketing support as well as discharge its obligation of
providing service support to customers and licensees. It is to perform these functions that RRI was
conceived of, promoted and was brought into existence. That is why, if we have a look at the memorandum
of association of RRI, it will be seen that of the total share capital of RRI of 50,000 divided into 50,000
shares of 1 each RR subscribed for 9,990 shares of 1 each and Alan Edward West had subscribed for the
balance of 10 shares in his capacity as Chartered Secretary. This shows that RRI is a more or less 99.9 per
cent owned subsidiary of RR. but for the 10 shares held by the Chartered Secretary, there is no distinction
between RR and RRI although for the purposes of Indian Companies Act, RR and RRI are two juridical
entities having perpetual succession. In conducting the business of RRI, it cannot have a say of its own
other than submitting to the dictates of RR. One can even say by piercing the corporate veil of RR and that
of RRI one would discover that RRI was nothing but the agent or benami of RR. That; is not a question
directly before me. Therefore, I would not like to go into this aspect except to take assistance and support
from this fact to the view that I am going to take as to whom the expenditure incurred by RRI eventually
belonged. This fact would lend support to the view that RRI though was given a legal independent existence
was not factually independent. The entire control of it vested with RR. RRI was operating in the territory of
India, Bangla Desh, Sri Lanka and Bhutan, where RR had sold its products and incurred service support
obligations, that is, to provide technical and affcer-sales service to customers. This is essentially highly
technical service to be provided by RR under the agreement it entered into. For this purpose, RRI on which
this responsibility was cast has to engage competent and technical qualified men. But when we look at the
salaries paid to employees, RRI engaged two persons, both of whom were directed to be employed by RR.
This is the information ascertained during the course of hearing before me because of the observation of the
learned Accountant Member that the employees of the assessee-cornpany RRI were paid huge salaries and
they were engaged by RRI. I do not have to refer to the duties that were entrusted to RRI under the
agreement except to state that they include obtaining and reporting to RR on a regular basis the marketing
information as is considered relevant to RR's interest, to provide administrative and secretarial assistance
for the service representatives deployed in the territory assigned to RRI and to provide liaison service
between RR and the relevant departments of the Government of India and other customers and to look
after the visitors of RR in India by making arrangements for their stay and itinerary. Their duties are
basically not for the benefit of RRI but for and on behalf of RR. For this purpose it had to establish an office
in India. Even though RRI was empowered to employ competent engineers and other suitably qualified
personnel to carry out its duties, the immediately next clause provided, which is Clause 3(c) that RR and
RRI should make appropriate arrangements in the U.K. for such liaison staff, as may be necessary to carry
out the activities of RRI with the activities and requirements of RR. Clause 4 comes in, to specifically state,
that no relationship of agency existed but this is more to avoid and circumvent the application of the
provisions of F.E.R.A. and perhaps, the Income-tax Act also but really not to say that RRI should not act as
the agent of RR. What was prohibited under this Clause 4 was entering into or purporting to enter into any
commitment or negotiations of whatsoever nature on behalf of RR. This is to prevent RR from being
dragged into any controversy or getting caught in the web of legal complexities of the countries assigned to
RRI rather than prevent RRI from acting. A close look at the duties assigned to RRI under Clause 2 and the
restriction contained in Clause 4 do suggest that there is some amount of mutual contradiction. It cannot
provide a liaison office or provide service support obligations, if it did not represent RR. Just to collect
information from the customers about the proper functioning and performance of goods sold and about
further needs and transfer that information to RR, I do not see how RRI can obtain, the information, which
is sometimes of complicated and confidential nature without its holding out to be representative of RR.
How can it act as representative unless it implies agency. There is one point which has to be borne in mind
for resolving the issue involved in this case.

21. As I see, since RRI was put-up to perform the obligations that were otherwise to be performed by RR
and at the same time obtain information, which has to be creditable and trustworthy and since both are one
and the same except for difference of 10 shares RR has to meet and own the entire expenditure, to be
incurred by RRI. Since, RRI has no independent existence and since, it has not been permitted by the
Reserve Bank of India to perform any other activities than to purely and simply acting as liaison office of
RR, it has no purpose to incur any expenditure of the nature now incurred by RR. This background has to
be borne in mind to decide this issue. RR having put up RRI as its shadow has to necessarily meet its
expenditure and, therefore, it has to show the entire expenditure in its accounts and also provide resources
to RRI to meet the expenditure by way of periodical advances depending upon the requirements as
projected to it by way of budgets by RRI and RR. The agreements entered into on 1-7-1979 and clariflcatory
agreement entered into on 20-5-1980 have to be read and under- stood and appreciated in this background.
So understood, I am of the view that the expenditure incurred by RRI cannot be said to be the expenditure
incurred by it on its own behalf. The agreement of 20-5-1980 entered into with a view to provide
clarification cannot be interpreted in a manner otherwise than as how the parties to it understood it.
Therefore, in my opinion, it is not very appropriate to substitute the expression "on behalf of" by the
expression as was brought to be done by the learned Accountant Member "for the benefit of". This is to say
the least, would amount to rewriting the agreement between the parties. It is, no doubt, true that both the
parties are two independent legal entities yet for the purposes of business that these entities were carrying
on, they are one and the same within the meaning of the expression 'same business" as enunciated by the
Supreme Court in the case of Produce Exchange Corporation Ltd. v. CAT [1970] 77 ITR 739. Judged from
this angle there can be no doubt that RRI is not free to spend any money by way of expenditure. This is also
brought out more clearly from a close reading of the agreement entered into between RRI and RR. The
furnishing of budget, approval by RR, payment of advance to meet the expenditure by RR to RRI and
clarification of the statements submitted by RRI to RR to ascertain over-payments or under payments and a
provision for adjustment of payment to rectify such over or under-payments, all go to show that RRI is not
free to incur expenditure as it likes. This position is borne out by Sub-clause (b) Sub-clauses (i), (ii), (Hi) of
Clause 5 of the agreement, which provided for the payment of service fee. Now, Sub-clause (b) very clearly
pointed out that all costs and expenses incurred by RRI are to be authorised by RR but prior to
commitment either specifically or generally in establishing a liaison office in New Delhi or otherwise in
setting up operations. This reference to "otherwise in setting up operations" reinforces the inference, I am
drawing, that RRI cannot incur any expenditure other than that authorised by RR either in establishing a
liaison office or in setting up office later. This arrangement, in my opinion, proves the statement made by
RR that the expenditure incurred by it was not its own expenditure incurred by it for the purpose of its own
business. Thus, RRI is only an agent of RR for the specific purpose of incurring expenditure on behalf of
RR.

22. Before I go to the other aspects of the matter, I would like to deal here with the interpretation sought to
be placed upon Sub- Clause (c) of Clause 5 of the agreement whereunder the service fee of 105 per cent of
the actual operating costs incurred, was provided.

When the agreement provided that the service fee shall be 105 per cent of the actual operating costs, it did
not, in my opinion, mean that RRI is receiving 105 per cent as its trading receipts. Of this 100 per cent cost
was towards the reimbursement of expenses and the balance of 5 per cent was only towards service fee. The
expression 105 per cent to the actual operating costs incurred is not like weighted receipt like the weighted
deduction under Section 35 of the Income- tax Act. The same thing could have been expressed in a manner
as to show that 100 per cent was to go towards expenses and the balance of 5 per cent only would be the
service fee. Instead of mentioning that the actual expenditure incurred by RRI would be reimbursed in full,
the agreement said in a manner of expression that the service fee would be 105 per cent of the actual
operating costs. That the actual operating costs were going to be reimbursed to RRI becomes clear from the
reading of Sub-clauses of Clause 5. Sub-clause (ii) of Sub-clause (b) of Clause 5 provided that within 10
weeks of the close of the last business day, RBI will submit to RR a statement showing the actual operating
costs incurred up to that day together with the total advance payments made up to that day. Thus, Sub-
clause (iii) provided that following that verification, the RR will calculate the amount by which service fee
has been over-paid or under-paid and make necessary adjustments. This clearly proves that the actual
operating costs incurred by RRI in India is to be reimbursed. When the actual operating cost was
reimbursed to it, the question would arise whether that constituted the income of the assessee. In my
opinion, it does not constitute income. It is like a businessman 'A' carrying on business in Delhi asking his
Mend, another businessman 'B', let us sa,y in Trivandrum, to buy for him rail-tickets or air-tickets and to
make hotel arrangements and also for transport and agreeing to reimburse the expenses incurred later. The
amount spent by businessman 'B' in Trivandrum was fully reimbursed to him by the businessman 'A' at
Delhi. For the businessman in Trivandram, the receipt by way of reimbursement can neither be a trading
receipt much less its income. Nor the expenditure incurred by him can be said to be expenditure incurred
by him for the purpose of his business. In other words, the reimbursement received for the expenditure
incurred for the purpose of business carried on by an assessee can it be said that reimbursement would be
revenue receipt ? This is what the Supreme Court held in V.S.S. V. Meenakshi Achi's case (supra). In this
case, the assessee owned 5/6 shares in an estate in Malaya. During the Second World War rubber estates in
Malaya were destroyed or denuded. In order to encourage planting or re-planting of rubber trees, the Govt.
of Malaya by an Ordinance constituted a Board to administer the funds accumulated in terms of the said.
Ordinance. The assessee received 5,962 Malayan dollars as re-plantation cess from the said Board. The
assessee claimed that the said amounts were capital receipts. The Income- tax Officer treated them as
revenue receipts on the ground that the said payments were made to cover the re-plantation expenses of the
assessee. The A.AC on appeal held that the ITO's view was right because the assessee had a reasonable
expectation of receiving the amounts from the Government in consideration of running a rubber estate
business. The Tribunal also confirmed the view of the revenue. The High Court also affirmed the view of the
Tribuna] and when the matter came before the Supreme Court, the Supreme Court also confirmed the view
of the revenue. The Supreme Court analysed the provisions of the Ordinance issued, under which the cess
was collected and found that the cess was collected in terms of the rubber exported and the distribution has
to toe made among the planters in a manner as to provide them compensation for the expenditure incurred.
It is not necessary for me to reproduce here all the clauses of the Ordinance there. The Supreme Court
noticed that the finding of the Tribunal in that case was that those expenses were based upon the
production and not the actual expenses shown as having been incurred by the assessee. The Tribunal had
also found that it was not a reimburse- ment of expenditure outlaid. The Supreme Court approved this
finding and held eventually that the amounts made out of the funds earmarked for the assessee on the basis
of rubber produced by them were paid against the expenditure incurred by them for maintaining the rubber
plantation and producing the rubber. It would, thus, be seen that the expenditure incurred there by the
assessee was her own expenditure and the reimbursement made not to the full extent but partly, was, held
to be revenue receipt. Therefore, the primary fact to be established before a reimburse- ment of expenditure
can be held to be a revenue receipt is whether the expenditure incurred was the assessee's own expenditure
and whether it was incurred in the course of its business. If the expenditure incurred was in the course of its
business, then the reimburse- ment would be his income. In the example, I have given above, the
expenditure incurred by the businessman in Trivandrum is neither his expenditure nor incurred in the
course of his business and, therefore, reimbursement of expenditure cannot be said to be a trading receipt. I
am of the opinion that the Supreme Court decision relied upon by the learned Accountant Member may
apply to a case where the expenditure was incurred by the assessee on its own in the course of its business
but not to a case where the expenditure was incurred not on its own but on behalf of someone else. On the
facts of this case, it cannot be said that RRI incurred expenditure on its own. It incurred the expenditure for
and on behalf of and at the behest of RR. Neither RRI has a say in the planning of the expenditure,
employment of personnel nor can it incur any expenditure on its own and then claim reimburse- ment.
Everything is controlled and regulated by RR, by means of advance payments, pre-budgeting and prior
approvals.

23. Another aspect that requires to be considered is whether the provisions of the Income-tax Act would
apply to the expenditure incurred by the assessee in order that the aforesaid expenditure could be
disallowed. Sections 30 to 43A of the Income-tax Act are the concerned provisions. Each of these
provisions, to which I have made a close study, stipulates, that the expenditure must be incurred by the
assessee or depreciation must be on the machinery owned by the assessee and used for the purpose of the
assessee's business. Therefore, I do not wish to quote the provisions of Sections 30 to 43A in extenso,
suffice it to say that those provisions apply to an expenditure incurred by an assessee in carrying on its
business. Therefore, the basic requirement for these sections to apply are that the expenditure must be
incurred by the assessee on its own for the purpose of its business. Section 37, for example, opens with the
words "any expenditure laid out or expended wholly or exclusively for the purpose of business or profession
shall be allowed in computing the income chargeable under the head profits and gains of business or
profession" (words not necessary for our present purpose are omitted). This shows that the expenditure
must be incurred by the assessee first on its own. So, too is the provisions made by Section 40 which puts a
prohibition on the allowance of expenditure in computing the income chargeable under the head "Profits
and gains of business or profession". Again, Section 40A(2)(a) states that "Where the assessee incurs any
expenditure in respect of which"-------which again applies only when the assessee incurred an expenditure
on his own and claimed it as a deduction in computing the income is only then the ITO's power to make a
disallowance out of it will arise and the said basic jurisdictional fact to vest him with the power of
disallowance is the incurring of the expenditure by the assessee and claiming it as a deduction. Here, the
assessee claimed that it never incurred any expenditure on its own and never incurred any part of the
expenditure as a deduction. It is the Income- tax Officer, who is forcing upon the assessee that some
expenditure was incurred by Mm or must be deemed to have claimed some expenditure and, therefore, a
portion of it would be disallowed by applying the restrictive provisions of the Income-tax Act all because the
assessee-eompany received some reimburse - ment of the expenditure incurred. This, in my opinion, is not
the correct appreciation of the situation. The correct appreciation of the situation is as was done by the ITO
in the earlier asst. years 1980-81 and 1981-82. No departure should have been made from that view. So,
when the requirement of the Income-tax Act, namely, incurring of expenditure by the assessee and claiming
the same as deduction was not fulfilled and without these two basic conditions being fulfilled, it is not
permissible in my view to proceed to disallow the expenditure. When the reimbursement was not in respect
of the expenditure incurred by the assessee on its own like in V.S.S.V. Meenakshi Achi's case (supra), the
same cannot be considered as revenue receipt. Unless, the receipt is considered as revenue receipt, the
question of considering the expenditure for the purpose of disallowance can arise. I have already noticed
that even the employees employed by RRI were not those employed by RRI at its own instance but those
employed at the instance of RR. They were qualified people sent over by RR to RRI to render the services
that RRI was obliged to do under the agreement, which again enures for the benefit of RR. It is RR that is
working through RRI in all this arrangement. Perhaps this fact should not be forgotten. The clarification
provided by the agreement dated 20-5-1980 though held to be of no consequence by the learned
Accountant Member with which I agree, does not also bring about any change in the understanding
between RRI and RR in so far as the payment of service fee was concerned. It made explicit what was
implicit in it, earlier. That explicit arrangement between the two entities is a clear pointer that RRI was not
to incur any expenditure in India for its own purpose except for the purpose of RR. If the purpose of
expenditure in India was not for the purpose of RR, RR need not agree to reimburse it. But one thing has to
be noted here, namely, that the subsequent agreement on 20th May, 1S80 clearly stated that what was to be
paid to RRI by way of service fee was only 5 per cent of the total expenses of RRI incurred on behalf of RR.
Thus, the incurring of expenditure is taken only as a measure for the purpose of calculating the 5 per cent of
service fee. This being clear from the agreement of 20th of May, 1980 and having found that this agreement
was not a fictitious one but only clariflcatory of the earlier agreement and did not bring any change, it
should have been held that the fee of the assessee RRI was only 5 per cent and not 105 per cent.
Furthermore, the letter of 20th October, 1986 which was available on the record clearly provides that the
expenditure incurred by RRI in India and in the U.K. is borne by RR and the moneys advanced by RR were
for the purpose of defraying operational costs. What is more important in this letter is the explanation that
the unexpended advance, if any, held by RRI is refundable to RR. This suggests that the advances received
by RRI were held in trust by RRI for and on behalf of RR and in this state of affairs it cannot be said that
the expenditure incurred by RRI was on its own and not on behalf of RR.

24. The learned departmental representative did not advance any particular argument before me during the
course of the hearing except to strongly defend the view taken by the learned Accountant Member. The
learned Accountant Member proceeded on the assumption that expenditure incurred by RRI was its own
and, therefore, the reimbursement of it was trading receipt and, therefore, when the income is to be
computed for the purpose of the Income-tax Act, the entire 105 per cent should be taken as trading receipts
and from that only such expenditure which could be allowed as a deduction under the Income-tax Act, be
allowed. The basic postulate of the learned Accountant Member was that the expenditure incurred by RRI
was its own expenditure. Here, I find it difficult to travel with him. I am inclined to agree with the view
expressed by the learned Judicial Member. Though the revenue refused to treat the agreement of 20th May,
1980 as of any consequence in validity both the learned Members have proceeded on the assumption that
the agreement of 20th May, 1980 was a valid agreement intended only to bring out explicitly what was
implicit in the agreement. I do not have to express a,ny opinion on this agreement even though the learned
D.R. had made a submission that this agreement must be looked as an afterthought.

25. In my opinion, the letter issued by the Reserve Bank of India permitting RRI to open a liaison office in
India imposing several restrictions also lends support to the view that I am taking that the expenditure
incurred by RRI in India could not be said to be its expenditure. The decision of the Calcutta High Court in
Dunlop Rubber Co. Ltd.'s case (supra) lays down the rule that amount received by way of recoupment of
expenditure incurred could not be regarded as income. When the Calcutta High Court laid down the
principle that amounts received for recoupment of expenditure incurred was not income, the Supreme
Court laid down in V.S.S.V. Meenakshi Achi's case (supra), that amount received towards incurring of
expenditure was of revenue receipt. Apparently, it may seem that there is a conflict between these two
decisions and the Supreme Court decision must overrule the Calcutta High Court decision and the Calcutta
High Court decision must yield to the Supreme Court decision. But in my view there is no conflict between
these two decisions. In the case of V.S.S.V. Meenakshi Achi (supra), the assessee incurred some expenditure
for the purpose of its own business and received some reimbursement from the Government by way of a
help or subsidy or subvention, the amounts so received were rightly held to be revenue receipts. But in the
case of Calcutta High Court, it was direct recoupment of expenses incurred under a prior arrangement.
Recoupment of expenditure can be income in very exceptional cases. If expenditure is incurred by an
assessee and that expenditure is fully or partially reimbursed, the net addition to income is nil, for, in that
case the reimbursement received will offset the expenditure leaving the income unaffected either by way of
addition or diminution. But if the expenditure incurred is claimed and allowed as deduction and
reimbursement of such expenditure is excluded, then that will give a distorted picture of income because
the receipts, which are clearly of income nature, are being excluded. The present case to my mind is not the
one where expenditure was incurred by the assessee-RRI claiming it as expenditure but at the same time
claiming the reimbursement to be excluded. The assessee is claiming that expenditure spent by it was not
its own, nor incurred by it for its business purpose. The expenditure was that it was required to spend and
the reimbursement it got should, therefore, be excluded. This, I think is fair and justified. As rightly pointed
out by the learned Judicial Member, the assessee-company RRI did not incur any expenditure in the true
sense of the expression "incur" but it spent the money belonging to RR, for the business purpose of RR, as
its agent. Therefore, it was to hold out as an agent of RR. But the reservation in Clause 4 of the agreement
became necessary for, RR, did not want to entangle itself by the commitment, intended or unintended
made or to be made by RRI. This is not to be construed that RRI is not acting as agent of RR. As I pointed
out earlier, there will be an apparent repugnancy in the agreement if RRI is read as not to act as an agent of
RR. Therefore, in my opinion the ruling of the Supreme Court cannot be applied to the facts of this case but
the ruling of the Calcutta High Court does seem to apply.

26. For these reasons I am in agreement with the view expressed by the learned Judicial Member. The
matter will now be placed before the regular Bench to dispose of the appeal in accordance with the opinion
of the majority.

27. Before I conclude I would like to draw sustenance for my view that that amount would only be called
expenditure which an assessee incurs on a permanent basis and parts with the money irretrievably for this
purpose of his business. If there is a prospect of recovery of money by reimbursement or the money is spent
at the behest of someone else with a promise to reimburse it that would never be the expenditure
contemplated for deduction under the Income-tax Act. This is amply borne out by a series of decisions and I
would like to rely for my present purpose on one decision of the Orissa High Court in Sajowanlal Jaiswal v.
CIT [1976] 103 ITR 706. Though for the purposes of Section 40A(3) of the Income-tax Act, the word
'expenditure' used in Section 40A(3) came up for interpretation in this case their Lordships of the Orissa
High Court relying upon the meaning assigned to the word 'expenditure' in the dictionaries, because the
word 'expenditure' was not denned in the Income-tax Act, held that the expenditure was such where money
was spent irretrievably. This would show that the money spent by the assessee, in this case, was not for its
own purposes.

ENGINEERING CONTRACT

PETITIONER:

GANNON DUNKERLEY & CO. LTD.

Vs.

RESPONDENT:

UNION OF INDIA

DATE OF JUDGMENT:

28/10/1969

BENCH:

SHAH, J.C.

BENCH:

SHAH, J.C.

HEGDE, K.S.

CITATION:

1970 AIR 1433 1970 SCR (3) 47

1969 SCC (3) 667

CITATOR INFO :

R 1992 SC 111 (4)

ACT:

Limitation Act, 1908-Suit for payment at an additional rate over contract rate in view of altered
circumstances and complex nature of work--Claim is not one for price of work done nor for compensation
or breach of contract--Therefore Art. 56 and Art. 115 of First Schedule not applicable--Suit governed by Art.
120--Commencement of period of imitation under Article.

HEADNOTE:

The appellant-company filed a suit against the Union of India demanding payment at an enhanced rate
over the basic rate stipulated in a construction contract with the Union of India. The claim related to
revision of rates due to the complex nature and increase in the quantity of work and in respect of work not
covered by the, contract. The addi- tional work was done at the request of the Engineer-in- charge who
under the terms of the contract was competent to give instructions for work not covered by the terms of the
contract and fix the rate at which remuneration was to be paid in respect of such work. The Union of India
contended that the claim was barred, by the law of limitation. The trial court decreed the suit for the
amount certified by the Superintending Engineer. On appeal the High Court held that the claim was
governed either by Art. 56 or by Art. 115 of the First Schedule, to the Limitation Act, 1908, and a suit, more
than three years of the date on which the work was done and in any event of the, date on which the claim
was rejected, was barred. Allowing the appeal to this Court and restoring the decree for the trial court,
HELD : (i) Article 56 of the First Schedule to the Indian Limitation Act, 1908, prescribes a period of three
years for a suit for the price of the work done by the plaintiff for the defendant at his request, where no time
has been fixed for payment, and the, period of limitation commences to run from the date when the work is
done. A suit is governed by Art. 56 if it arises out of a contract to pay the price of work done at the request
of the defendant., The claim in the present case is for payment at an additional rate over the stipulated 'rate
in view of change in circumstances and not for the, price of work done by the appellant, even though the
additional work was done :at the request of the Engineer-incharge. [51 F]

(ii) Article 115- of the First Schedule to the Limitation Act is a residuary article dealing with the claim for
compensation for the breach of any contract, express orimplied, not in writing registered and, not specially
provided for in the first schedule. The period of limitation in such cases is three years and it commences to
ran when the contract is broken, or where there are successive breaches when the breach in respect of
which the suit is instituted occurs or where the breach is continuing when it ceases. The suit filed by the
appellant company is not a suit for compensation for breach of' contract express or implied; it is: a suit for
enhanced rate because of change of circumstances, and in respect of work not covered by the contract. The
additional work directed by the Engineer-in-charge when carried out May be deemed to be done under the

48

terms of the contract; but the claim for enhanced rates does not aris out of the contract : it is in any case not
a claim for compensation for beach of contract. [51 H] (iii)The claim is, therefore, not covered by any
specific article under the First Schedule and must fall within the terms of Art. 120. Under this Article the
period of six years commences to run when the right to sue accrues. There is no right to sue until there is an
accrual of the right asserted in the suit and its infringement or at least a clear and unequivocal threat to
infringe the right by the defendant against whom the suit is instituted. [52 C] Bolo v. Kokao and Others,
L.R. 87 I.A. 325, referred to.

JUDGMENT:

CIVIL APPELLATE JURISDICTION : Civil Appeals Nos. 258, and 2585 of 1966.

Appeals from the judgment and decrees dated January 19 1965 of the Patna High Court in First Appeals
Nos. 190 and 21 of 1960.

H.R. Gokhale, G. L Sanghi, J. B. Dadachanji and Ravinde, Narain, for the appellant (in both the appeals).
Jagdish Swarup, Solicitor-General, V. A. Seyid Muhammad, B. D. Sharma and S. P. Nayar, for the
respondent (in both the appeals).

The Judgment of the Court was delivered by Shah, J. The Government of India invited tenders for "rein
forced concrete work relating to the foundation and super structure of the Fertilizer Factory building at
Sindri" in the State of Bihar. The tender submitted by the appellant Company was accepted on November
22, 1947 and a formal contract in that behalf was executed on November 26, 1948. By cl. 12 of the contract,
insofar as it is relevant, it was provided :
"The Engineer-in-charge shall have power to make any alterations in, omissions from, additions to, or
substitutions for, the original specifications, drawings, designs and instructions and the contractor shall be
bound to- carry out the work in accordance with any instructions which may be given to him and any
altered, additional or substituted work which the contractor may be directed to do in the manner above
specified as part of the work shall be carried out: by the contractor on the same conditions in all respects on
which he agreed to do the main work, and at the same rates as are specified in that tender for the main
work And if the altered, additional or substituted work includes any class of work, for which no rate is
specified in this contract then such class of work shall

49

be carried out at the rates entered in the current schedule of rates of the Hazaribagh P.W.D. district which
was in force at the time of the acceptance of the contract minus/plus the percentage which the total
tendered amount bears to the estimated cost of the entire work put to tender, and if the altered, additional
or substituted work is not entered in the said schedule of rates, then the contractor shall within seven days
of the date of his receipt of the order to carry out the work inform the Engineer-in-charge of the rate which
it is his intention to charge for such class of work, and if the Engineer-incharge does not agree to this rate
he shall, by notice in writing, be at liberty to cancel his order to carry out such class of work provided that if
the contractor shall commence work or incur any expenditure in regard thereto before the rates shall have
been determined then .... he shall only be entitled to be paid in respect of the work carried out or
expenditure incurred according to such rates as shall be fixed by the Engineer-in-charge. In the event of a
dispute, the decision of the Superintending Engineer of the Circle shall be final." Clause 25 of the
agreement provided, insofar as it is relevant

"Except where otherwise provided in the contract all questions and disputes relating to the meaning of the
specifications, designs, drawings, and instructions, hereinbefore mentioned and as to the qualify of
workman- ship, or materials used on the work, or as to any other question, claim, right, matter or thing
whatsoever, in any way arising out of, or relating to the contract, designs, drawings, specifications,
estimates, instructions, orders or these conditions, or otherwise concerning the works, or the execution, or
failure to execute the same, whether arising during the progress of the work or after the completion or
abandonment thereof shall be referred to a Superintending Engineer to be nominated by the Chief Engineer
for arbitration in the manner provided by law relating to arbitration

The Sindri Factory Buildings were to be constructed under the, , advice and guidance of M/s. Chemic
Construcetion, Corporation of New York. That Firm made delay in supplying the drawings and
specifications which involved work of a complicated nature not included in the original contract. Time for
completion of the work was on that account extended till February 26, 1950.

On September 20, 1950 the appellant Company made a demand for payment at an enhanced rate of 421 %
over the basic 50

rates stipulated under the original contract. This claim was made on -five grounds :

1 . That there was a "substantial deviation" in the nature of work of which the detailed work drawings were
supplied to the appellant Company after the date of the contract. The work involved was of a complex
nature requiring highly skilled labour, and that additional labour and materials not covered by the contract
rates were required;

2. That there was "great increase in the price of materials and labour on account of undue prolongation of
the period of work;"

3. That there was increase in the cost of transportation on account of rise in the price of petrol and increase
in railway freight;
4. That the Government of India entered into other contracts incidental to the construction of the Sindri
Factory at substantially higher rates which directly affected the cost of labour and materials of the appellant
Company who had to compete with the other contractors;

5. That additional work ordered to be done involved in many instances quantity of -work several times the
work set out in the contract.

By his letter dated September 13, 1950, the Additional Chief Engineer rejected the claim. In September 1954
the disputes relating to the claim for rise in cost of material and labour due to delay in supplying detailed
work drawings, the claim arising from rise in price of petrol and for increase in the cost of material and
labour due to other contractors working on the site, were referred to arbitration, but not the claims for
revision of rates due to complex nature of the work and increase in the quantity of work, The arbitrator
rejected the claims of the Company in respect -of the matters which were referred.

Thereafter the appellant Company filed a suit on August 9, 1956, against the Union of India, for a decree for
Rs. 3,62,674/9/6 being the amount claimed at the rate of 421% above the contract rate, in the alternative, a
decree for Rs. 2,44,000/- being the amount claimed at the rate of 28.1% above the contract rate as
recommended by the Executive Engineer, and in the -further 'alternative, a decree for Rs. 1,36,222/-at the
rate of 18 17% above the contract rate as certified by the Superintending Engineer. The Union of India
contended, inter alia, that the claim was barred by the law of limitation.

51

The Trial Court held that the claim was not barred by the law of limitation and decreed the claim for Rs.
1,36,222/- as certified by the Superintending Engineer. Aginst the decree passed by the Trial Court the
appellant Company as well as the Union of India appealed to the High Court. Before the High Court, in
support of the appeal only the plea of limitation was pressed on behalf of the Union of India. In the view of
the High Court the claim was governed either by Art. 56 or by Art. 115 of the First Schedule to the
Limitation Act, 1908, and the suit not having been filed within three years of the date on which the work
was done and in any event of the date on, which the claim was rejected was barred. The appellant Company
has appealed to this Court with certificate.

The appellant Company had undertaken under the terms of the contract to do specific construction work at
"basic rates". The Engineer-in-charge was by the terms of cl. 12 of the agreement competent to give
instructions for work not covered by the terms of the contract, and it was provided that remuneration shall
be paid at the rate fixed by the Engineer-in-charge for such additional work, and in case of dispute the
decision of the Superintending Engineer shall be final. It is common ground that the claim made by the
appellant Company was not covered by the arbitration agreement, and on that account it was not referred
to the arbitrator. The claim in suit related to the revision of rates due to the complex nature of the work and
due to increase in the quantity of work and also grant of contracts to other competing parties at
substantially higher rates and other related matters.

Article 56 of the First Schedule to the Indian Limitation Act. 1908, prescribes a period of three years for a
suit for the price of work done by the plaintiff for the defendant at his request, where no time has been fixed
for payment, and the period of limitation commences to run from the date when the work is done. A suit is
governed by Art. 56 if it arises out of a contract to pay the price of work done at the request of the
defendant. The claim in ,the present case is for payment at an additional rate over the stipulated rate in
view of change in circumstances, and not for price of work done by the appellant Company. It is true that
additional work was done at the request of the Engineer-in-charge, but the claim in suit was not for the
price of work done but. for enhanced rates in view of altered circumstances.
Article 115 of the First Schedule to the Limitation Act is a residuary article dealing with the claim for
compensation for the breach of any contract, express or implied, not in writing registered and not specially
provided for, in the First Schedule. The period of limitation in such cases is three years and it commences

52

to run when the contract is broken, or where there are successive breaches when the breach in respect of
which the suit is instituted occurs, or where the breach is continuing when it ceases. The suit filed by the
appellant Company is not a suit for compensation for breach of contract express or implied : it is a suit for
enhanced rate because of change of circumstances, and in respect of work not covered by the contract. The
additional work directed by the Engineer-in-charge when carried out may be deemed to be done under the
terms of the contract : but the claim for enhanced rates does not arise out of the contract : it is in any case
not a claim for compensation for breach of contract. The claim is therefore not covered by any specific
article under the First Schedule, and must fall within the terms of Art. 120. The Solicitor-General appearing
on behalf of the Union of India contended that even if the claim falls within the terms of Art. 120 of the
Limitation Act, it was barred, for, the appellant Company had in the suit made a claim for work done more
than six years before the institution of the suit. Counsel submitted that under Art. 120 the period of
limitation commences to run from the date on which the defendant obtains the benefit of the work done by
the plaintiff. But under Art. 120 of the Limitation Act the period of six years for suits for which no period of
limitation is provided elsewhere in the Schedule commences to run when the right to sue accrues. In our
judgment, there is no right to sue until there is an accrual of the right asserted in the suit, and its
infringement, or at least clear and unequivocal threat to infringe that right by the defendant against whom
the suit is instituted : Bolo v. Kokan and, Others(1).

The appeals are allowed and the decree passed by the Trial Court is restored with costs in the High Court
and in this Court. One hearing fee. The appellant will be entitled to intereston the amount decreed at the
rate of 6% per annum from the date of the suit till payment. R.K.P.S.

Appeals allowed.

(1) L.R. 57 I.A. 325 at p. 331,

53

The New India Insurance Company Limited vs Ramesh Kumar And Ors. on 21/9/2001

JUDGMENT

Rajesh Balia, J.

1.Heard learned Counsel for the parties on stay application.

2. Prima-facie, I am of the view that the decision rendered by the Supreme Court in New India Assurance
Co., Shimla v. Kamla 2001 AIR SCW-1340 makes out the distinction between the cases of the absolute
liability of the insurer which may arise out of a contract and the right of the claimant party to recover
compensation as a result of accident from Insurance Company. If the Insurance Company succeeds in
establishing that there was breach of the policy condition, the right of the claimant to effect recovery from
the Insurance Company remains unimpaired because it is a statutory liability of the Insurance Company
under Section 147 of the Act of 1988 on the one hand and on the other hand the Insurance Company is
absolved from absolute liability on the ground that relationship between the insurer and the insured arise
from contract and in case breach of any condition by the insurer Insurance Company is absolved from
fulfilling the contract to indemnify the insured from loss. This is recognised and is permissible under
Section

149. The Court said as under:

The insurer and insured are bound by the conditions enumerated in the policy and the insurer is not liable
to the insured if there is violation of any policy condition. But the insurer who is made statutorily liable to
pay compensation to third parties on account of the certificate of insurance issue shall be entitled to recover
from the insured the amount paid to the third parties, if there was any breach of policy conditions on
account of the vehicle being driven without a valid driving licence. Insurance Company must be given an
opportunity to substantiate its contention that document is fabricated one. If the Insurance Company
succeeds in establishing that there was breach of the policy condition, the Claims Tribunal shall direct the
insured vehicle owner to pay that amount to the insurer. In default the insurer shall be allowed to recover
that amount which the insurer is directed to pay to the claimants-third parties from the insured person.

3. I am, therefore, prima-facie of the opinion that the claimants cannot be deprived of their right to
recovery from the Insurance Company and therefore, the interim order passed by this Court is modified to
the extent that the Insurance Company shall deposit the entire amount with the Motor Accident Claims
Tribunal and it shall be paid to the claimants subject to furnishing an adequate security to the satisfaction
of the Motor Accident Claims Tribunal in terms of the award for restitution of that amount in case the
appeal succeeds qua the claimants also. The amount may be deposited within a period of six weeks.
POWER SUPPLY CONTRACT

Smita Conductors Pvt. Ltd., Bombay And Anr. vs Madhya Pradesh State Electricity Board on 12/10/1983

JUDGMENT

C.P. Sen, J.

1. This is a petition under Article 226 of the Constitution of India amongst others praying for striking down
of Clause 4 (b) of the contract entered into by the parties regarding supply of conductors by the petitioner
to respondent Madhya Pradesh Electricity Board, for quashing of the letter of the respondent dated 6-11-
1980 asking the petitioner to defer the supplies and tor directing the respondent to issue despatch
instruction for renewing the supplies as per contract. In pursuance of the notice issued to the respondent to
show cause as to why the petition be not admitted, the respondent has raised written preliminary objection
regarding inability of the petition. It is contended on behalf of the respondent that this Court under its
extraordinary jurisdiction under Article 226 of the Constitution can neither enforce the contract between
the parties nor compel the respondent to purchase particular material from a particular party at a particular
price as there is no such statutory obligation nor can strike down a term of the contract as unreasonable
and arbitrary especially when the petitioner entered into the ron-tract voluntarily with open eyes. The
remedy of the petitioners is to rile a civil suit but it is doubtful whether the reliefs claimed can Gven be
granted in a civil suit. A rejoinder has been filed by the petitioner refuting the objection.

2. Shri S. Rangarajan for the petitioners and Shri Y. S. Dharmadhikari for the respondent were heard at
length on the preliminary objection,

3. The respondent invited tenders for supply of 8,350 Kms. of 6/1/2.59 mm. greased ACSR Weasel
Conductor and 23,050 Kms. of 6/1/2.11 mm. greased ACSR Squirrel Conductor. The tender of the
petitioners at the rate of Rs. 2,700/-per Km. for the Weasel and at the rate of Rs. 1,866/- per Km. for the
Squirrel Conductors was accepted by the respondent by letter dated 22-7-1980. It was made clear that the
acceptance was subject to the conditions mentioned in the letter, which shall be binding on the petitioners
and no condition or stipulation to the contrary or which are inconsistent will be acceptable. Clause 4 is
quoted hereinunder:--
"4. Delivery:-- (a) The supplies shall commence after 2/2 1/2 months from the date of commercial and
technical clear order including Letter of Credit and supply @ 600/700 Mt of Aluminium content per
quarter.

(b) The Board has the option to defer the scheduled supplies, if considered essential."

4. The value of the total supply to be made was 6,66,75,900/-. The respondent issued its Letter of Credit
dated 22-9-1980 for rupees 2.2. crores and the petitioners supplied 4000 Km. of Weasel and 4000 Km. of
Squirrel Conductors i.e. approximately one third of the total supply. However, by letter dated 6-11-1980 the
respondent asked the petitioners to defer further supply as per Clause 4 (b) of the contract due to
'unavoidable circumstances and informed that suitable programme will be intimated later in due course.
The petitioners thereupon sent a series of letters and telegrams to the respondent and the Joint President of
the petitioner company met the Technical Member of the respondent. In the meanwhile, the respondent
invited fresh tenders to be opened on 12-2-1982 for supply of similar types ol Conductors and the petitioner
offered to co-operate by making additional supply of 4350 Kms of Weasel Conductors at Rs. 2,413 per Km
and 19,650 Kms of Squirrel Conductor at Rs. 1602/- per Km i.e. at reduced rates, without prejudice to its
rights under the earlier contract by its letter dated 12-2-1982 followed by other letters and Telex messages
but with no response. So as a final attempt, the representatives of the petitioner company and those of
Cable and Conductor Manufacturers Association of India (CACMAI) met the Chief Minister of M. P. and
other officers including those of the respondent on 2-7-1983 at Bhopal and they were apprised of the
difficulties faced by the petitioner because of sudden deferring of further supply of Conductors, It was
explained that the petitioners, had not only planned its production well ahead of the delivery schedule, but
also arranged for its finance in order to enable it to fulfil and discharge its obligations under the contract.
Due to the arbitrary and uncalled, for stoppage of the supplies, the petitioners had to close its Gaziabad
factory and lay off its workers. Although a month elapsed, there was no further communication and so the
petitioners filed this petition.

5. The petitioners contend:--

(i) Under Clause 4 (b) of the contract, the respondent has clothed itself with uncanalised, vague and
arbitrary power giving itself option to defer the schedule supplies 'if considered essential', without arty
guideline for what is essential;

(ii) The respondent is debarred by the principle of promissory estoppel by going back on the solemn
obligations undertaken by it in discharge of its statutory functions;

(iii) The respondent cannot capriciously and without justification whatso ever indefinitely defer issue of
despatch instruction to force the petitioners to reduce the contracted price and also to manoeuvre supply of
aluminium at reduced rate from the public sector undertaking BALCO in lieu of the electricity dues, to
other manufacturers and thereby getting supply of ACSR Conductors from them at cheaper prices;

(iv) The respondent under cover of Clause 4 (b) of the contract wants to take advantage of the prices of
aluminium conductors having gone down but overlooking thai if the prices have gone up and the
petitioners failed to supply, penalty would have been imposed on the company;

(v) The above contract was entered into by the respondent for the supply of conductors in discharge of its
statutory-duties relating to production and distribution of electricity under the Electricity (Supply) Act,
1948; and

(vi) The power of the respondent to defer supplies is neither absolute nor uncontrolled, it could be
exercised in a reasonable manner, a party who has committed fundamental breach of contract may not be
able to rely on an exemption clause in his favour contained in the contract.
6. Therefore, what the petitioners want to say is that Clause 4 (b) is liable to be struck down for giving
arbitrary and unguided power to the respondent to defer the supplies if considered essential. Even if the
clause cannot be held to be bad, still the supplies can only be stopped 'if considered essential' and the
respondent has to act fairly and reasonably being a statutory corporation. It cannot indefinitely defer the
supplies without disclosing the reason for deferring the supplies. It is no ground to defer the supplies
because prices of aluminium conductors have come down or because- of financial constraints. There is no
provision in the contract for reduction in the prices, Oa the other hand there is provision for increasing the
prices when the prices go up. The petitioners want to invoke Article 226 in its favour by saying that the
respondent under, the Electricity (Supply) Act has a statutory duty to distribute electricity and for this
purpose has to lay transmission lines. Conductors are essential component for the transmission lines and
since the respondent is not manufacturing conductors, it has to enter into contracts for supply of
conductors. As such the contract for supply of conductors entered into by the respondent was in
performance of its statutory duty. So it has to be seen whether the contract was entered into by the
respondent with the petitioners was in discharge of its statutory duty and then only it would be possible to
invoke Article 226 in aid, of the petitioners. It is not disputed that the respondents, being a statutory
corporation, it is a state within the meaning of Article 12 of the Constitution. The Court can compel the
authority under Article 226 to fulfil its representation within the scope of its authority which raises a
promissory estoppel, where the petitioners have altered its position on the basis of that representation
where the contract is short of a contract under Article 299 of the Constitution.

7. Basu on Shorter Constitution, Eighth Edition, at page 478 has commented as under by relying on the
pronouncements of the Supreme Court in various cases: --

(I) Mandamus will not issue to enforce a privtae contract and the remedy, if any, is private law, e.g. a suit
for damages or specific performance.

The State can enter into a contract with an individual just as any other individual can, and the contract, as
such, does not change its legal character merely because the other party to the con-ract is the State, hence
mandamus will not issue.

(II) But the Court may interfere under Article 226 where, though the cause of action arises out of or
pertains to a contract, there is some other feature which brings the cause within the sphere of public law i.e.
because of the exercise by the State of its sovereign power, apart from the contract, e.g. --

(a) For breach of contract, where the breach itself violates a fundamental right;

(b) Where, in refusing to enter into a contract with the petitioner, the State has violated a statutory
provision and

(c) Where the breach if contract involves the breach of statutory obligations i.e. where the order complained
of was made by a statutory Authority in exercise of its statutory power.

8. Under the Electricity (Supply) Act, the State Electricity Boards are constituted for the coordinated
development of the generation, supply and distribution of electricity within the State. The case of the
petitioners is that under Section 18(e) of the Act, the respondent amongst others is charged with the duty to
prepare and carry out schemes for transmission, distribution and generally for promoting the use of
electricity within the State. So the respondent is obliged under the Act to lay transmission lines for
distribution of electricity. Section 2(15) provides that other expressions not enumerated earlier, have the
meanings respectively assigned to them in the Electricity Act 1910. Section 2(f) of the latter Act defines
'electric supply lines' as meaning a wire, conductor or other means for distribution for conveying,
transmitting or distributing energy; in Section 2(n) 'works' includes electric supply line and any building,
plant, machinery, apparatus and any other thing of whatever description required to supply energy. So the
conductors are essential components for laying of transmission lines. Since the respondent is not
manufacturing its own conductors it has to enter into contracts to buy conductors from others. So it is said
that there is a statutory duty or obligation to make purchases of conductors from others and enter into
contracts. We are unable to accept the contention. The contract with the petitioners was not entered into by
the respondent in pursuance of its statutory duty, no such duty is cast on the impendent to enter into
contracts to purchase conductors. One of its duties is laying of transmission lines. May be conductors are
'essential components for erecting transmission lines and at present the respondent is not manufacturing
any conductors and has to purchase the same from other suppliers. According to us, statutory duty is to lay
transmission lines and discretion has been given to the respondent as to how best to carry out the work.
The conductors required, for laying down of the transmission lines may be manufactured by itself or
purchased from the market by the respondent. There is no such statutory obligation to make a purchase or
for that matter any particular type of conductor from any particular purchaser. In such a case, though the
Court may compel the respondent for laying a transmission line, it cannot compel it to perform it in a
manner directed by the Court. So the transaction between the petitioners and the respondent is purely
contractual and has to be enforced like any other contract by filing a civil suit. It is not for us to consider at
this stage as to whether the respondent had the power or it was justified in deferring the supply indefi
nitply. The matter can well be agitated in a civil suit.

9. The Supreme Court in Harshankar v. Dy. E. & T. Commr.. AIR 1975 SC 1121 has held as under :--

"Contractual obligations-- A writ petition is not an appropriate remedy for impeaching validity of
contractual obligations -- Liquor shops, auction sale of to licensees -- conditions of sale -- van-dees cannot
subsequently apply under Article 226, for writ to avoid enforcement against them, of their obligations
under the terms of auction."

In Shamlal v. State of Punjab AIR 1978 SC 2045 the Supreme Court held that contractual obligations
cannot be avoided by licensee -- recourse to writ petition is not proper. Further inRadhakrishna Agarwal v.
State of Bihar AIR 1977 SC 1496 the Supreme Court has held as follows:--

"Where the State Government leased out some forest land to appellants to collect and exploit sal seeds for
15 years on payment of royalty at a certain rate and when the State, under the terms of leases, revised the
rate of royalty and, thereafter, cancelled the leases for breach of certain conditions the petitioners-
appellants challenged the orders of revision of rate and cancellation of leases as illegal by writ proceedings
under Article 226:

Held that (i) the contracts did not contain any statutory terms or obligations and no statutory power or
obligation which could attract the application of Article 14 was involved.

(ii) It was the contract and not the executive power regulated by the Constitution which governed the
relations of the parties on the facts apparent in the instant cases. They involved questions of pure alleged
breaches of contract. No writ or order could issue under Article 226 in such cases to compel the authorities
to remedy a breach of contract pure and simple."

In State of Haryana v. Jage Ram AIR 1980 SC 2018 the Supreme Court has opined that bidders cannot
wriggle out of their vountarily incurred contractual obligations by invoking writ jurisdiction. The Supreme
Court in D. F. O. v. Bishvanath Tea Co. AIR 1981 SC 1368 has stated that when breach of statutory
provision, not proved, right cannot be enforced in a writ petition. The Supreme Court in State of Punjab v.
Dial Chand Gian Chand & Co. AIR 1983 SC 743 laid down that order of High Court in granting damages in a
writ petition is without jurisdiction.

10. The petitioners contend that a statutory corporation like the respondent cannot act arbitrarily or
unreasonably causing harm and injury to a private party like the petitioners and mainly relies on a recent
decision of the Supreme Court in Gujarat State Financial Corpn. v. Lotus Hotels Pvt. Ltd. AIR 1983 SC 848
wherein it has been laid down as under:--
"Evidence Act-- Section 115 -- Promissory estoppel -- Gujarat State Financial Corporation entered into
agreement in performance of its statutory duty to advance loan to a company -- Acting on undertaking the
company proceeded, to undertake and execute project of setting up a 4-Star Hotel -- Company incurred
huge expenses and suffered liabilities to set up hotel -- Held, principle of promissory estoppel would stop
Corporation from backing out of its obligation --Corporation would be "other authority" within Article 12 --
Writ of mandamus could be issued directing Corporation to perform its statutory duty." In that case the
Gujarat State Financial Corporation took the plea that the loan was conditional upon the Industrial
Development Bank of India undertaking to refinance the loan. This was negatived by the Courts below also
by the Supreme Court that it was not so conditional. However, it has been found that the loan was granted
to M/s. Lotus Hotels Pvt. Ltd. by the Corporation in exercise of its statutory function under Section 25(1)(g)
of the State Financial Corporation Act, 1951. It is one of the duties of the Corporation that they may grant
loans. Therefore, it was held that on the principle of promissory estoppel the Corporation cannot be
permitted to back out from its obligations of providing the loan when the respondent acting on that
promise took up the construction of a 4-Star Hotel and they would not have incurred the expenses if they
knew that the loan would not be forthcoming. Here in the present case the respondent deferred further
supplies in pursuance of Clause 4 (b) of the contract entered into between the parties. So there is no
question of any promissory estoppel. In the absence of Clause 4 (b) the principle of promissory estoppel
could have been invoked in favour of the petitioners. The petitioners had supplied conductors of the 1/3 of
the total value for one quarter and thereafter further supplies were stopped. As per Clause 4 (a) the
petitioners were to commence supplies after 2 1/2 months from the date of commercially and technically
clear order including opening of Letters of credit. May be the petitioners were required to arrange for funds
and gear up their production to keep the time schedule. But further supplies could be stopped under Clause
4 (b). It is not clear why the petitioners agreed to enter into a contract having such a clause giving right to
the respondent to stop supplies at any time if considered essential. Whether the respondent could under
Clause 4 (b) indefinitely defer further supplies of the conductors is a question which need not be gone into
in this petition and can be best agitated in a civil suit. It has also not been explained as to why the
petitioners kept quiet for about 3 years before invoking the extraordinary jurisdiction of this Court under
Art 226 of the Constitution. As has been observed earlier, there was no statutory obligation on the part of
the respondent in entering into contract for supply of conductors and the relations between the parties is
purely contractual. So the aforesaid decision is of no help to the petitioners. The next decision relied upon
is D. F. O. South Kheri v. Ram Sanehi, AIR 1973 SC 205 wherein the Supreme Court held that where the
action of a public authority invested with statutory powers is challenged, the writ petition is maintainable
even if the right to relief arises out of an alleged breach of contract. The Supreme Court in that case found
that right to relief flows from the contract entered into by the respondent but the order of the Divisional
Forest Officer cancelling the contract to cut timber was passed without calling for an explanation from the
respondent and without giving any opportunity of hearing and there was violation of the principles of
natural justice. So the order has been set aside on that count in exercise of writ jurisdiction because every
citizen is protected against exercise of arbitrary authority by the State or its officers. While stopping further
supplies the respondent was not called upon to give an opportunity to the petitioners or opportunity of
hearing under the contract , and the respondent could defer further supplies under Clause 4 (b). The next
case relied upon is Ramana v. I. A. Authority of India, AIR 1979 SC I62S wherein the Supreme Court held as
under :--

"Constitution of India, Articles 12 & 14 International Airport Authority is State -- Tenders called for running
restaurant and snack bars -- Qualifications laid down as requisite -- It cannot accept tender of person who
does not fulfil tha requisite qualifications." In that case tenders were invited from registered IInd Class
Hoteliers having at least 5 years' experience for putting up and running a IInd Class Restaurant and two
Snack Bars at the Airport. The tender of a person who did not have that experience was accepted and so it
was held that there was violation of Article 14 of the Constitution. There is no allegation of any breach of
Article 14 in the present case. Lastly reliance is placed on a passage of Denning L. J. in John Lee & Son v.
Railway Executive, (1949) 2 All ER 581 that above all, there is the vigilance of the common law which, while
allowing freedom of contract, watches to see that it is not abused. It would, therefore, be a very serious
question whether the defendants are free to exempt themselves in the wide terms which are here contended
for. It seems to me preferable that a limited construction -should be put on the clause so that it should be
valid. Whether Clause 4 (b) has been abused by the respondent is a matter which can well be agitated in a
civil suit and need not be considered in this writ petition. Lastly it was contended that in view of Article
300A of the Constitution no person can be deprived of his property without authority of law. By the
impugned action of the respondent, the petitioners have been deprived of their contract which is a property.
Firstly, the petitioners have not been deprived of their contract, part of the contract has been executed
while the remaining has been suspended, as per Clause 4 (b) of the contract. So it cannot be said that there
is deprivation without any authority of law. Whether the action of respondent was justified or not is a
different matter. The Supreme Court in Anwar Khan Mehboob & Co. v. State of M. P., AIR 1966 SC 1637 has
held that a bare contractual right does not constitute property.

11. With the result, we accept the preliminary objection and dismiss the petition.
FOREIGN TRADE CONTRACT

PETITIONER:

VEB DEUTFRACHT SEEREEDEREI ROSTOCK A DEPT. OF THE GERMAN DEM

Vs.

RESPONDENT:

NEW CENTRAL JUTE MILLS CO. LTD AND ANOTHERS

DATE OF JUDGMENT05/11/1993

BENCH:

SINGH N.P. (J)

BENCH:

SINGH N.P. (J)

PUNCHHI, M.M.

CITATION:

1994 AIR 516 1994 SCC (1) 282

JT 1993 (6) 479 1993 SCALE (4)390

ACT:

HEADNOTE:

JUDGMENT:

The Judgment of the Court was delivered by "N.P. SINGH, J.- The defendant is the appellant in this appeal.
The suit in question was filed by the respondent, for a decree for Rs 2,40,000 alleging that the respondent
had purchased diverse spare parts and accessories from the appellant, which were found to be damaged.
The appellant is a company incorporated under the appropriate laws of West Germany and is carrying on
its business in West Germany as also at Calcutta.

2.An objection was taken at the initial stage on behalf of the appellant that it was a department and/or
agent and/or instrumentality of the Government of German Democratic Republic, which is recognised as a
sovereign foreign State and as such the suit in question cannot be entertained against the appellant without
prior consent of the Central Government as required by Section 86 of the Code of Civil Procedure
(hereinafter referred to as "the Code"). The same plea was taken even on behalf of the carrier, which also
belongs to and is owned by the German Democratic Republic. In support of the stand and in order to attract
the bar of Section 86 of the Code, the appellant produced the certificate dated September 18, 1981 granted
by the Consul-General of the German Democratic Republic at Bombay saying:

"VEB Deutfracht Seereederei Rostock, abbreviated as 'D.S.R.' commonly known as D.S.R. Lines constitutes
a department of the Government of the German Democratic Republic exercising the rights of a legal entity."
The Constitution of the German Democratic Republic was also produced.

Reference was made to Article 12 of the said Constitution which says:

"Mineral resources, mines, power stations, barrages and large bodies of water, the natural resources of the
continental shelf, the larger

285

industrial enterprises, banks and insurance companies nationally'-owned farms, traffic routes, the means of
transport of the railways, ocean shipping and civil aviation, post and telecommunication installations, are
nationally-owned property, private ownership thereof is inadmissible."

3. In respect of the carrier also, the Consul-General of the German Democratic Republic at Bombay granted
the certificate saying that the said vessel "is owned by the people of the German Democratic Republic and,
hence, owned by the State".

4. A learned Judge of the Calcutta High Court by order dated February 3, 1982 allowed the objection taken
on behalf of the appellant and rejected the plaint saying that in absence of written consent by the Central
Government, as required by Section 86 of the Code, the suit filed on behalf of the respondent could not: be
entertained. On appeal filed on behalf of the respondent, the Division Bench set aside the order of the trial
Judge and directed that whether the suit cannot be entertained in absence of consent of the Central
Government, should be considered during the trial of the suit.

5. One of the principles of International Law is that every sovereign State respects the independence of
every other foreign State. This absolute independence and the international comity underlines the
relationship between sovereign States. The object of Section 86 of the Code is to give effect to the principles
of International Law. But, in India it is only a qualified privilege because a suit can be brought with the
consent of the Central Government in certain circumstances. Just as an independent sovereign State may
statutorily provide for its own rights and liabilities to sue and be sued so can it provide rights and liabilities
of foreign States to sue and be sued in its Courts. It can be said that effect of Section 86 thus is to modify the
extent of doctrine of immunity recognised by the International Law. If a suit is filed in Indian Courts with
the consent of the Central Government as required by Section 86, it shall not be open to any foreign State to
rely on the doctrine of immunity. Sub-section (1) of Section 86 says in clear and unambiguous terms that no
foreign State may be sued in any court, except with the consent of the Central Government certified in
writing by the Secretary to that Government. Sub-section (2) prescribes that such consent shall not be given
unless it appears to the Central Government that the case falls within any of the clauses (a) to (d) of sub-
section (2) of Section 86. Sub-section (6) enjoins that where a request is made to the Central Government
for the grant of any consent referred to in sub- section (1), the Central Government shall before refusing to
accede to the request in whole or in part, give to the person making the request a reasonable opportunity of
being heard. On a plain reading of different sub-sections of Section 86, it is apparent that no foreign State
may be sued in any court in India, except with the consent of the Central Government which has to be
certified in writing by the Secretary to that Government. In view of the provisions aforesaid, before any
action is launched or a suit is filed against a foreign State, person concerned has to make a request to the
Central Government for grant of the 286

necessary consent as required by sub-section (1) of Section 86 and the Central Government has to accede to
the said request or refuse the same after taking into consideration all the facts and circumstances of the
case. In a sense it amounts to a bar on the power of court itself which is entitled to try all suits of civil
nature in view of Section 9 of the Code. But, Section 9 itself recognises the limitation on such courts to try
any suit the cognizance whereof is either expressly or impliedly barred. As such whenever a relief is sought
against a foreign State, the court before which such claim is lodged has to examine whether the person
concerned has got the consent of the Central Government in terms of Section 86 of the Code.

6. The stand of the respondent is that as the dispute has arisen in connection with a commercial contract,
Section 86 shall not be applicable. According to the respondent, the framers of the Code, while recognising
the sovereignty and the immunity of the foreign States on principles recognised by the International Law,
never purported to give immunity to the breach and contravention of the terms of the contract entered on
behalf of the foreign State, which has nothing to do directly or indirectly with the sovereignty of the one
State or the other but relates to commercial trade between the two States. There cannot be any conceivable
object to keep such contracts within the scope of Section 86. As a first impression, this looks attractive. But,
from bare reference to sub-section (2)(b) of Section 86, it shall appear that it requires such consent of the
Central Government, even in respect of agreements relating to commercial or trading contracts, because it
says that such consent "shall not be given, unless it appears to the Central Government that the foreign
State by itself or another, trades within the local limits of the jurisdiction of the Court". If sub-section (2)(b)
of Section 86 itself prescribes that the consent to sue shall not be given unless it appears to the Central
Government that tile foreign State which is being sued, by itself or by any other authority, trades within the
local limits of the jurisdiction of the court, how it can be held that such consent is not required in
connection with commercial contracts. If for granting consent the Central Government is required to be
satisfied as to whether such foreign State, by itself or by any other authority, trades within the local limits of
the jurisdiction of the court concerned, then can it be urged that commercial contracts relating to trade and
business having been entered on behalf of a foreign State are beyond the purview of Section 86 of the Code?

7. This Court in the case of Mirza Ali Akbar Kashani v. United Arab Republic' pointed out in respect of
Section 86: "Section 86(1) proceeds to prescribe a limited liability against foreign States. The limitation on
the liability of foreign States to be sued is twofold. The first limitation is that such a suit cannot be
instituted except with the consent of the Central Government certified in writing by a Secretary to that
Government. This requirement shows the anxiety of the Legislature to save foreign States from frivolous or
unjustified

1 (1966) 1 SCR 319: AIR 1966 SC 230

287

claims. The second limitation is that the Central Government shall not give consent unless it appears to the
Central Government that the case falls under one or the other of clauses (a) to (d) of Section 86(2)."

8. It is true that Government Corporations have been incorporated to undertake the activities, which at one
time were directly part of the activities of the foreign State. A question may arise whether the immunity
provided by Section 86 of the Code can be extended to even such Government Undertakings which have
their own legal entity. At one time, in view of their corporate and juristic personality, such Government
Corporations were held not to be part of a State having their own independent existence. But, this aspect
was reexamined by the English Court as well as this Court. In the case of Baccus S.R.L. v. Servicio Nacional
Del Trigo.2 it was said:
"Are we then to hold that the State of Spain is deprived of sovereign immunity with respect to this activity
of importing and exporting grain by reason of the fact that the defendants are a corporate body? In my view
that would be plainly wrong. In these days the government of a sovereign state is not as a rule reposed in
one personal sovereign: it is necessarily carried out through a complicated Organisation which ordinarily
consists of many different ministries and departments. Whether a particular ministry or department or
instrument, call it what you will, is to be a corporate body or an unincorporated body seems to me to be
purely a matter of governmental machinery."

Again, in Krajina v. The Tass Agency3 it was pointed out: "The history of the legislation in this country as
regards the departments of State seems to me to show that it is quite possible that a State may for certain
purposes under its own legislation give some department of State the status and the rights of a juridical
entity without depriving the department of its general immunity from suit, and it seems to me that it would
be impossible to say no doubt, our government would not wish to say that the Crown had thereby deprived
itself of the right to rely on that immunity if an attempt were made to sue it in a foreign country. One must
took in every case at the facts to reach a conclusion whether the Crown has intended to give up its immunity
generally or only for limited and defined purposes."

9. In the case of Royal Nepal Airlines Corpn. v. Monorama Meher Singh Legha4 a Division Bench of the
Calcutta High Court held that Nepal Airlines Corporation having its office at Calcutta shall be deemed to be
department of the Government of Nepal on the basis of the documents produced before the court and as
such was entitled to claim immunity from the process of the Indian Court to exercise its jurisdiction in
respect of the claim for damages which had been brought by the plaintiff of the said suit. But, at the same

2 (1957) 1 QB 438: (1956) 3 All ER 715, 732 3 (1949)2 All ER 274,280

4 AIR 1966 Cal 319: 69 CWN 767

288

time, it must be impressed that any plea of immunity raised by a corporate undertaking of a foreign State,
has to be examined on the basis of materials produced on behalf of such undertaking or corporation. The
initial onus of establishing that such corporation or undertaking had right to immunity, must be
discharged. If it satisfies the court that because of any constitutional provision, although such corporation
has its separate legal entity, still it shall be deemed to be a department of the State for purpose of immunity,
then only the onus will shift to the plaintiff to disprove any such claim.

10. In the present case, the appellant had produced the Constitution of the German Democratic Republic,
Article 12 whereof has been reproduced above, which provides that larger industrial enterprises, banks,
insurance companies, nationally-owned farms, means of transport of the railways, ocean shipping and civil
aviation, post and telecommunication installations are nationally-owned property, private ownership
thereof is inadmissible. In view of the aforesaid Article 12 of the Constitution and the certificate granted by
the Counsel General of the German Democratic Republic, the appellant shall be deemed to be a department
of the Government of German Democratic Republic.

11. Sub-section (2) of Section 86 of the Code says that such consent shall not be given unless it appears to
the Central Government that the suit in question has been filed under the conditions mentioned in clauses
(a) to (d) of sub- section (2) of Section 86. Clause (b) of sub-section (2) provides that consent shall be given,
in respect of a suit, which has been filed against a foreign State, if such foreign State 'by itself or another,
trades within the local limits of the jurisdiction of the Court'. When sub-section (2) provides that such
consent shall be given by the Central Government in respect of cases covered by clause (b) of sub- section
(2), then a person who is to sue in any court of competent jurisdiction, against any such foreign State or any
company or corporation, which can be held to be a foreign State in respect of any breach of contract, is
entitled to apply for consent of the Central Government and the Central Government is expected to
consider the said request taking into consideration the facts and circumstances of that particular case.
While considering the question of grant or refusal of such consent, the Central Government is expected to
examine that question objectively. Once the Central Government is satisfied that a cause of action has
accrued to the applicant against any foreign company or corporation, which shall be deemed to be a foreign
State, such consent should be given. The immunity and protection extended to the foreign State on the
basis of International Law should not be stretched to a limit, so that a foreign company and corporation,
trading within the local limits of the jurisdiction of the court concerned, may take a plea of Section 86,
although prima facie it appears that such company or corporation is liable to be sued for any act or
omission on their part or for any breach of the terms of the contract entered on their behalf. It is neither the
purpose nor the scope of Section 86 to protect such foreign traders, who have committed breach of the
terms of the contract, causing loss and injury to the plaintiff. But, if it appears to the

289

Central Government that, any attempt on the part of the plaintiff, to sue a foreign State, including any
company or corporation, is just to harass or to drag them in a frivolous litigation, then certainly the Central
Government shall be justified in rejecting any such application for consent, because such motivated action
on the part of the plaintiff, may strain the relations of this country with the foreign State.

12. In the present case, the appellant having been held to be a foreign State within the meaning of Section
86 and the plaintiff-respondent not having obtained the consent of the Central Government, as required by
Section 86, the suit filed on its behalf was not rightly entertained by the trial court. The question whether a
suit should be entertained, cannot be deferred, till the stage of the final disposal of the suit, because that
will serve neither the interest of the plaintiff nor of the defendant. The object of Section 86 is to save foreign
States from being harassed by defending suits in which there are hardly any merits. If the foreign State is
required to file written statement and to contest the said suit and only at the stage of final disposal, a
verdict is given whether in the facts and circumstances of the particular case, such foreign State is entitled
to the protection of Section 86 of the Code, the very object and purpose of Section 86 shall be frustrated.
The bar of Section 86 can be taken at the earliest opportunity and the court concerned is expected to
examine the same.

13. Accordingly, the appeal is allowed. The order of the Division Bench is set aside and that of the trial court
is restored. In the facts and circumstances of the case, there shall be no order as to costs.

290
GOVERNMENT CONTRACT:

India Trades Corporation vs Union Of India (Uoi) on 3/5/1956

JUDGMENT

Mallick, J.

1. This is a special case stated by the arbitrator under Section 13, Arbitration Act, for the opinion o this
Court on a question of law involved in the proceedings now pending before the arbitrator. The question of
law involved is whether the claim in dispute is barred by limitation.

2. The case originally stated by the arbitrator came for consideration before Bachawat J. Bachawat J. felt
that the case stated did not contain sufficient facts to enable the Court to give its opinion on the point of law
raised and directed the arbitrator to restate the case. Pursuant to such direction the arbitrator has restated
the present case on which this Court is called upon to give its opinion.

3. Mr, Roy appearing for the claimant made a grievance that the arbitrator stated the present case without
giving his client any opportunity to make his submission as to the correctness of the facts stated. It is not
for me in the present proceeding to adjudicate on the correctness of the facts stated by the arbitrator. I am
to give my opinion on the basis of facts stated by the arbitrator. If the facts are not correct or if the
arbitrator is guilty of misconduct in not giving an opportunity to Mr. Roy's ' client to make his submission
on the correctness of facts stated the right of Mr. Roy's client to challenge the award that may be passed
hereafter remains unaffected.

4. The arbitration proceeding relates to a claim for damages for breach of contract. Messrs. India Trades
Corporation (for convenience "referred to as a contractor) entered into three several contracts with the
Government for the manufacture and supply of bricks. As is usual in case of Government contracts there
was in each case what may be characterised as a provisional agreement of an informal character entered
into by one of the officer of the Government which was subsequently embodied in a formal document in
compliance with the formalities provided by Section 175(3), Government of India Act. The first of such
provisional agreement was entered into on 12-11-1942 and the formal document evidencing the contract
was executed on 31-1-1943. The second provisional agreement was enter ed into on 25-2-1943. This was
finally embodied in two formal documents executed on 12-12-1947 in compliance with the formalities
provided by Section 175(3), Government of India Act. It is said that under the second and third contracts
the Government was under an obligation to supply coal in order to enable the contractor to manufacture
and supply bricks. It is stated that the Government supplied coal in terms of the agreement during January,
February and March 1944 but did not supply any coal thereafter.

On 5-7-1944 the contractor submitted a claim to the Superintending Engineer, Eastern Aviation Circle of
compensation for the loss alleged to have been suffered by the contractor. The case does not state on what
basis this claim has been made by the contractor. Learned counsel of both sides stated, however, that the
claim was by way of compensation for breaches of contract alleged to have been committed by Government
mostly for not supplying coal in terms of the contract, though the Government is alleged to have committed
other breaches as well.

5. Be that as it may, all the breaches alleged to have been committed by the Government and on the basis of
which the contractor preferred its claim for damages took place prior to 5-7-1944. Certain payments were
made by the Government on account of the price of bricks sold and delivered but not on account of
damages. Mr. Roy appearing for the contractor stated that his client does not contend'that limitation is
saved by reason of these payments. Nor does Mr. Roy contend that limitation is saved by reason of any
acknowledgment of liability made on behalf of the Government.

6. On 6-8-1949 the contractor asked the Government to refer the dispute arising out of the claim submitted
on 5-7-1944. Pursuant thereto the present arbitration proceedings are pending. Before the arbitrator the
Government in its statement contended inter alia that the claim of the contractor was barred by limitation.
The arbitrator is seeking the opinion of this Court on this point of law raised by the Government.

7. I cannot help expressing my regret that in spite of clear direction given by Bachawat J. the case stated by
the learned arbitrator is not satisfactory. It should have been self-contained containing all the material
facts. Unfortunately it is not so. I had to refer to other papers and statements made by learned counsel to
understand the nature of breach complained of, the obligation of the Government under three several
contracts and the claim of the contractor under each of the three contracts.

8. It would be proper to consider the point of limitation with reference to the first contract separately from
the second and third contracts. With reference to the first contract there is no difficulty at all. The formal
contract was signed on 13-1-1943. Breaches giving rise to the cause of action for damages took place before
5-7-1944. Reference to arbitration was made on 6-8-1949, that is long after three years from the date of
breach. I have no doubt that Article 115 of the Limitation Act will govern the case and there is no difficulty
in applying the said article to the facts of this case. I, therefore, hold that the claim of the contractor for
damages under the first contract dated 13-1-1943 is barred by limitation.
9. Claim under the second and third contract presents some difficulty. It will appear from the facts stated
before that the breaches of tae said contracts are alleged to nave taken place before 5-7-1944 whereas
formal contracts were executed only on 25-12-1947, As I stated before the provisional contract covering
these contracts was, however, entered into on behalf of the Government by the Superintending Engineer
Aviation Circle with the contractor as far back as 25-2-1943. Such provisional contract, not in compliance
with the provisions of Section 175(3), Government of India Act, was formerly considered to be void
contract. In the case of Chaturbhuj Vithaldas v. Moreshwar Pareshram, , it has been held by the Supreme
Court that such a contract is not void but the Government cannot be sued on such contract. The position,
therefore, seems to be that prior to the execution of a formal contract in strict compliance with Section
175(3), Government of India Act, there may be a contract and a breach thereof but no suit for damages can
be maintained against the Government until the contract is embodied in a formal document in terms of
Section 175(3), Government of India Act, In the instant case breaches were committed in any event before
5-7-1944 that is more than three years before the date of the forma] agreement, namely, 25-12-1947. In
other words the breaches were committed more than three years before the contractor acquired the cause of
action to institute a suit against the Government under the contract. It is submitted by Mr, Roy that by
reason of this fact Article 115, Limitation Act, becomes inapplicable and Article 120 is the proper article to
be applied in this case. This is a point of first impression and both the learned counsel appearing before me
confessed that they have not been able to find any case directly on the point.

10. The first point to be decided is which of the two articles of the Limitation Act, namely. Article 115 or
Article 120 would govern the case. Mr. Mitter appearing for the Government suggested that Article 115
would be the proper article whereas Mr. Roy contended that Article 115 is not at all applicable to this case
and there being no other article the residuary Article 120 would apply.

11. The first column of the schedule of the Limitation Act states the class of cases to be governed by each
article. The second column states the period and the third column states the starting point of limitation. For
the purpose of finding out what article will apply in a suit or matter the proper thing to do is to look to the
first column of article. The first column of Article 115 reads as Follows :

"For compensation for the breach of any contract, express or implied, not in writing registered and not
herein specially provided for."

Clearly a suit for breach of contract comes within the language of the first column of Article 115 of the
Limitation Act and the instant case must be governed by Article 115 of the said Act. If Article 115 of the
Limitation Act applies there is no question, that the case would not come under Article 120.

12. The next point to be considered is, what would be the starting point of limitation in a suit for damages in
this case Would starting point of limitation be before 5-7-1944 when the breaches are alleged to have been
committed by the Government? Or would limitation act begin to run till 12-12-1947, when the formal
agreement was executed? It cannot be denied that before 12-12-1947, the contractor had not the full cause
of action to institute a suit for damages against the Government even though the breaches were committed
as far back as before 5-7-1944. The answer to this question will depend on the true and proper construction
ot the third column of Article 115, Limitation Act.

13. The third column of Article 115 reads as follows :

"When the contract is broken, or (where there are successive breaches) when the breach in respect ot which
the suit is instituted occurs, or (where the breach is continuing) when it ceases."

14. If the third column of Article 115, as stated above, is to be construed literally according to language, the
starting point must be before 5-7-1944 because that is the time when breaches of contract are alleged to
have taken place. It is elementary that the cause of action in a suit tor damages for breach of contract arises
at the date of the breach. In ordinary cases, therefore, the date of breach and the date of the cause of action
for damages for breach of contract synchronise. But it may not synchronise as in the instant case when
cause of action to institute a suit becomes complete after the contract is signed in compliance with the
provisions of Section 175(3), Government of India Act, and this date is long after the date of breach. In such
cases could it possibly have been the intention of the Legislature that limitation would begin to run and
complete its full course even before the accrual of the cause of action? To my mind the answer must dearly
be in the negative. The whole object of the Limitation Act is to prevent a suit being filed after a certain time.
It was never intended to prevent a suit being filed at all, i.e., to take away the right of suit. Yet if the third
column of Article 115 is to be construed literally, that would be the result in cases like the one we are
considering now. That in my judgment could not have been the intention of the Legislature. The Court,
therefore, must have to go Behind the language of the third column to get the intention of the Legislature
and to give effect to it. It has been held that the third column of the sche dule of the Limitation Act, has
been loosely worded and the Court is entitled by way of construction to go behind the language to find out
the intention of the Legislature and to give effect to it. This has been done by the Courts in India as well as
by the Judicial Committee. Otherwise it would be not merely an inconvenient state of law but absurd state
when a suit becomes time barred even before the right to sue accrues."

15. In the case of Hari Mohan Dalal v. Parmeshwar Shau , heard by a Special Bench of three Judges of this

Court consisting of Rankin, C. J., C.C. Ghose J. and Buckland J. Rankin J. makes the following observation
at p. 979 (of Cal WN): (at p. 648 of AIR):

"The broad scheme of the Indian Limitation Act is that so far as possible the terminus a quo of the period of
limitation shall be stated specifically with reference to each class of suit, appeal or application. The old.
English statutes of limitation had been content to prescribe the period by putting as the limit so many years
after the cause of action.

The Indian Legislature endeavours in detail by the Indian Limitation Act to state in the third column of the
schedule, the event which is to be taken as completing a cause of action, that is the date from which time
begins to run. The language of the third column of the schedule should in general if not indeed always, be so
interpreted as to carry out the true intention of the legislature, that is to say, to date, the cause of action
from the date on which the remedy is available to the party." (Underline here into single inverted commas
is mine).

16. In the case of Muthu Korakki Chetty v. Md. Madar Animal, ILR 43 Mad 185: (AIB 1920 Mad 1) (C), and
heard by a Full Bench of the Madras High Court, Sheshagiri Ayer, J. after an exhaustive review of the cases
heard by the Judicial Committee and other High Courts recorded the following observation at p. 213 (of ILR
Mad): (at p. 13 of AIR):

"All of them may be said to go to some extent, behind the actual words of the third column and to import
into the decisions consideration based on the intention of the legislature; but none of them introduces a
principle which adds to or subtracts from the statutory exemptions. That is my view of the decisions of the
Judicial Committee. Therefore in my opinion, the true rule deducible from these various decisions of the
Judicial Committee is this : 'that subject to the exemptions, exclusion, mode of computation and the
excusing of delay, etc., which are provided in the Limitation Act, the language of the third column of the
first schedule should be so interpreted as to carry out the true intention of the Legislature, that is to say, by
dating the cause of action from a date when the remedy is available to the party'." (Underline here into
single inverted commas is mine).

17. In the case of Sarat Kamini Dasi v. Nagendra Nag Pal heard by a Division Bench of this Court and
reported in 29 Cal WN 973 : (AIR 1926 Cal 65) (D), M.N. Mukherjee J. makes the following observations :

"In the case of such of the articles of the Limitation Act in which the starting point of time synchronises
with the cause of action I am prepared to hold that the test is to ascertain the time when the plaintiff could
have maintained his action to a successful issue. If in such a case, at the time when the cause of action
arises there is no person capable of suing upon it the statute does not run; similarly it is necessary that
there shall be a person to be sued; and it is also necessary that the cause of action should be complete, that
is, all the facts must have happened which are material to be proved in order to entitle the plaintiff to
succeed. This should of course be borne in mind in interpreting the intention of the Legislature as
expressed in the articles of the Act itself or rather in such of them as admit of a consideration of the
question as to when a cause of action arises and in such a case I am in entire accord with the view expressed
by Seshagiri Ayyar J., at p. 213 (of ILR Mad): (at p. 13 of AIR) of the Madras' Full Bench case to which I
have referred.''

18. With all these above observations made by eminent Judges, I respectfully agree. I, therefore, hold that
in the case of a suit against the Government in respect to a contract which is required to comply with the
formalities provided by Section 175(3), Government of India Act, time does not begin to run till the date the
contract is signed as required , by the Act even though the provisional contract and the breach thereof took
place prior thereto.

19. Mr. Mitter appearing for the Government strongly urged that the Supreme Court has held in the case
of Chaturbhuj Vithaldas v. Moreshwar Parashram (A), cited before that the provisional contract is a good
contract and when the formal contract is executed under Section 175(3), Government of India Act, it
amounts to nothing more than a ratification by the Government of an unauthorised act of one of its
employees. He argues that it is well known that the ratification relates back to the act ratified. Hence the
contract even though signed later on must be ante-dated to the date of the provisional agreement.
Assuming that the analogy of ratification taken recourse to by the Supreme Court in the above case be made
applicable with full force to case of this description, it does not help us in determining what would be the
starting point of limitation, viz., what would be the starting point of limitation against principals who have
ratified unauthorised contract entered into on behalf of the principal long before? No case has been cited to
show that in such a case limitation runs from the date of the breach even against the ratifier.

20. In my judgment the principle of ratification relied on by Mr. Mitter does not help us very much in
determining the question of limitation that has to be decided in this case. In the result, I hold that while the
claim under the first contract dated 31-1-1943 is time barred the claim under 2nd and 3rd contracts dated
12-12-1947 is not time barred.

21. Costs of this special case will be costs in the arbitration proceedings. Certified for two Counsel.