High Court Quashes Coal India’s Termination of Fuel Supply Agreement as Arbitrary
The Coal India Limited & Ors. v. Kunj Iron Products L.P.A. No. 328 of 2015
Facts
The case is a Letters Patent Appeal arising out of a commercial and contractual dispute between Coal India Limited and its subsidiary Eastern Coalfields Limited (“ECL”) and Kunj Iron Products Limited (“KIPL”), a sponge iron manufacturing company situated in Jharkhand. KIPL was a valid coal consumer under the New Coal Distribution Policy, 2007, framed pursuant to directions of the Supreme Court. In terms of the 2007 policy, KIPL furnished the requisite bank guarantees and entered into a Fuel Supply Agreement (“FSA”) dated 30 April 2008 with ECL for supply of coal over a period of five years.
Under the FSA, only 75% of the normative coal requirement was to be supplied by ECL, while the remaining 25% was to be sourced through e-auction or other means. The agreement contained detailed clauses relating to minimum lifting obligations, compensation for short lifting, suspension of supply, and termination. During the period between May 2009 and October 2009, KIPL lifted coal but could not consume it fully as its plant was undergoing heavy repairs and renovation, including compliance with directions of the Jharkhand State Pollution Control Board. A survey of coal stock conducted by a government-approved agency confirmed that the lifted coal was lying within the plant premises and had not been diverted.
Despite being aware of these circumstances, ECL suspended further coal allocation to KIPL with effect from 21 July 2010. Shortly thereafter, ECL raised compensation demands for alleged short lifting and threatened invocation of bank guarantees. Ultimately, by letter dated 25 July 2011, ECL terminated the FSA alleging breach of Clauses 3.4, 3.5 and 15.1.4 of the agreement and forfeited bank guarantees amounting to over Rs. 43 lakhs. Additional compensation demands were also raised for subsequent periods.
Aggrieved by the above, KIPL approached the High Court under Article 226 by filing W.P.(C) No. 6545 of 2011, challenging the suspension, termination of the FSA, forfeiture of bank guarantees, and levy of compensation. The learned Single Judge allowed the writ petition, holding the termination and forfeiture to be illegal and arbitrary. The Coal India authorities challenged this judgment before the Division Bench by way of the present Letters Patent Appeal.
Legal Issues
The principal issues before the Division Bench were:
(i) Whether suspension and termination of the Fuel Supply Agreement by ECL were valid and in accordance with the terms of the FSA?
(ii) Whether ECL was justified in levying compensation and forfeiting bank guarantees after suspension of coal supply?
Legal Reasoning
The Division Bench examined the relevant clauses of the FSA, particularly Clauses 3.4, 4.5, 13 and 15.1.4. It noted that Clause 3.4 permitted suspension of coal supply only upon failure to furnish enhanced security deposit after due notice, which had not been properly complied with. Similarly, Clause 15.1.4 permitted termination where lifting fell below 30%, but the Court found that once ECL itself had suspended coal supply from 21 July 2010, it could not thereafter rely on low lifting levels to justify termination.
The Court further observed that the agreement itself contemplated compensation as the contractual remedy for short lifting under Clause 4.5. Termination was not intended to be an automatic or default consequence. The factual record demonstrated that KIPL had neither diverted coal nor acted mala fide but rather the non-lifting was attributable to bona fide renovation and statutory compliance. The survey reports and correspondence supported the petitioner’s explanation.
The Division Bench agreed with the learned Single Judge that ECL’s actions were arbitrary, disproportionate, and contrary to the scheme of the FSA. It emphasised that public sector undertakings, even in contractual matters, are bound by standards of fairness and reasonableness under Article 14 of the Constitution. The forfeiture of bank guarantees and continued levy of compensation after suspension of supply were held to be unsustainable.
Holding
The Division Bench dismissed the Letters Patent Appeal and affirmed the judgment of the learned Single Judge. It held that the termination of the Fuel Supply Agreement dated 30 April 2008 and the forfeiture of bank guarantees by ECL were illegal and arbitrary. The Court further held that once coal supply had been suspended, ECL could not demand compensation for non-lifting thereafter. All consequential demands raised against Kunj Iron Products Limited were quashed.
