No-Interest Clauses Get Supreme Court Backing, Reshaping Government Contract Disputes
In a ruling with wide implications for India’s infrastructure sector, the Supreme Court of India has reinforced the legal validity of no interest clause contracts in public works. The judgment, delivered in February 2026, arose from a dispute between the Kerala Water Authority and a government contractor over delayed payments for a sewage treatment project.
The verdict confirms that when contractors voluntarily accept clauses barring interest on delayed payments, courts cannot override such terms. As a result, the ruling strengthens employer-drafted agreements and shifts financial risk firmly onto contractors.
Background of the Payment Dispute
The dispute originated from a 2013 contract for constructing a sewage treatment plant at Kozhikode Medical College. The contractor completed the work in July 2014. However, the final payment of ₹86.64 lakh was released only in March 2016, following court intervention.
Subsequently, the contractor filed a civil suit seeking interest at 14 per cent per annum for the delayed period. The trial court allowed the claim. Later, the Kerala High Court reduced the interest to 9 per cent. However, the Supreme Court overturned both decisions and denied interest entirely.
Therefore, the case became a test of how far courts can intervene in government contract terms.
The Contract Clause That Changed the Outcome
At the centre of the case was Clause 5 of the preliminary agreement. The clause clearly stated that:
- Payments depended on budget availability.
- Bills would be cleared according to seniority.
- No claim for interest or damages would arise from delays.
The Court held that this clause represented a conscious commercial decision by the contractor. Therefore, it ruled that the contractor had accepted the possibility of delayed payments without compensation.
Moreover, the Court observed that contractors were expected to factor such risks into their bid pricing.
Interest Act and Contractual Supremacy
A major legal issue involved the application of the Interest Act, 1978. The High Court had relied on Section 3(1) of the Act to justify interest. However, it ignored Section 3(3), which prohibits interest when parties agree otherwise.
The Supreme Court corrected this interpretation. It held that statutory provisions cannot override explicit contractual waivers. Consequently, contractual freedom prevailed over judicial discretion.
In addition, the Court rejected reliance on Section 34 of the Code of Civil Procedure. It clarified that procedural powers cannot negate substantive contractual terms.
Public Interest and Fiscal Constraints
The Court also considered the public purpose behind the project. It noted that:
- The project served public health needs.
- Delays were linked to funding limitations.
- Immediate project execution benefited citizens.
Therefore, the Court treated funding-related delays as systemic constraints rather than administrative misconduct.
As a result, it viewed no-interest clauses as necessary tools for sustaining public infrastructure development.
Impact on EPC and Infrastructure Industry
Strengthening Employer-Controlled Contracts
The ruling gives legal certainty to standard government templates. Public agencies can now rely on no-interest clauses with greater confidence.
Consequently, future litigation on delayed payments is likely to reduce.
Transfer of Financial Risk to Contractors
However, the judgment places financing burdens squarely on contractors. They must now absorb:
- Bank interest costs
- Working capital losses
- Cash flow disruptions
This situation particularly affects small and medium EPC firms.
Likely Increase in Project Costs
To compensate for higher risk, contractors may inflate bids. In addition, they may demand higher advances and stricter milestones.
Paradoxically, this could increase public project costs over time.
Judicial Shift from Equity to Contractual Certainty
Traditionally, courts used interest awards to balance unequal bargaining power. Government contracts are often non-negotiable. Therefore, contractors usually accept standard clauses to remain eligible for work.
However, this ruling signals a shift. Courts are now prioritising contractual certainty over equitable relief. As a result, judicial intervention in payment disputes is becoming limited.
Legal Position When the Contract Is Silent on Interest
A crucial clarification emerges when contracts contain no clause on interest.
Under Section 3(1) of the Interest Act, 1978, courts may award interest when money is wrongfully withheld. In addition, Section 34 of the Code of Civil Procedure allows courts to grant pendente lite and future interest.
Importantly, Section 3(3) of the Interest Act applies only when interest is expressly barred.
Therefore, when a contract is silent:
- Courts retain full discretion to award interest.
- Silence is not treated as waiver.
- Funding shortages alone are insufficient defence.
In such cases, contractors remain legally protected.
Hence, the present judgment applies only to contracts with explicit prohibitions. It does not weaken claims arising from silent agreements.
Strategic Lessons for Contractors
The ruling offers important commercial lessons.
First, contractors must treat payment-delay risk as a standard business variable. Second, contract vetting has become critical. Third, financial models must include prolonged credit exposure.
In addition, contractors should explore safeguards such as:
- Escrow mechanisms
- Milestone-linked releases
- Higher mobilisation advances
- Stronger arbitration provisions
These tools can partially offset legal limitations.
A Defining Moment for Public Contract Governance
The Supreme Court’s verdict establishes that no interest clause contracts will be strictly enforced. It reflects a policy preference for fiscal discipline and contractual predictability.
At the same time, it limits judicial relief for private contractors facing systemic delays.
While the ruling may stabilise public finances, it also accelerates risk privatisation within India’s infrastructure sector. Contractors are now expected to absorb financial shocks that were earlier mitigated through judicial intervention.
Going forward, interest clauses will no longer be peripheral provisions. They will determine commercial viability itself.
