Karnataka High Court Holds Loss Proof Needed For Deposit Deduction, Rejects Indian Oil's Claim

The Karnataka High Court on 8 July held that a contractee cannot retain a contractor's security deposit indefinitely to recover an alleged VAT-related loss unless it proves a contractual breach, actual loss suffered, and its right under the contract to recover the amount.

A Division Bench comprising Chief Justice Vibhu Bakhru and Justice K.S. Hemalekha allowed the appeal filed by BSR Infratech India, set aside the Commercial Court's judgment upholding Indian Oil Corporation's deduction, and directed refund of the withheld security deposit of Rs. 36.64 lakh with 9% annual interest from 31 October 2018. It observed:

“The respondent's own communication (Ex. P15) states that the dispute pertains to tax invoices relating to the financial years 2012-2013 and 2013-2014 and not to payments relating to the work. This admission completely undermines the contractual justification to retain the security deposit as withholding it is admittedly not on account of deficiency in execution of the work.”

The dispute arose after Indian Oil Corporation withheld Rs. 36,64,474 from BSR Infratech India's security deposit, claiming that it had suffered a VAT-related loss due to the contractor's alleged failure to comply with statutory requirements relating to tax invoices issued during the financial years 2012-13 and 2013-14.

BSR Infratech India contended that it had completed the work, fulfilled all contractual obligations, submitted the required documents, and repeatedly requested release of the security deposit after expiry of the warranty and performance guarantee periods.

Examining the contractual clauses governing the security deposit, the Court held that deductions could be made only if Indian Oil Corporation established a contractual default resulting in a recoverable loss. It found that Indian Oil had failed to establish any of these requirements. It observed that a security deposit is intended to ensure due performance of contractual obligations during execution of the work and the defect liability period. It cannot be treated as a reserve fund to adjust every statutory or fiscal liability that may arise subsequently.

The Bench also noted that Indian Oil Corporation's own communication showed that the dispute related to tax invoices and not any deficiency in execution of the work, which weakened its justification for retaining the security deposit. It further noted that although Indian Oil Corporation claimed to have suffered a quantified VAT loss, it neither initiated independent recovery proceedings nor filed a counterclaim seeking adjudication of the alleged liability. It held that this showed that the alleged liability had never been legally established.

Relying on the principle that a party cannot take advantage of its own wrong, the Court observed that if Indian Oil Corporation had accepted the invoices, processed payments, and failed to claim statutory benefits within the prescribed period, it could not later shift the consequences of its own omission onto the contractor. It found that BSR Infratech India had completed the contractual work and Indian Oil Corporation had failed to establish any contractual breach or actual loss attributable to the contractor, and held that the deduction of Rs. 36.64 lakh from the security deposit was unjustified. It observed:

“....While the respondent has failed to establish the contractual default, actual loss, causal connection and contractual authority necessary to justify withholding the amount, the Commercial Court was not justified in holding that the respondent was entitled to deduct ` 36,64,474 from the security deposit....”

On the issue of interest, the Bench rejected BSR Infratech India's claim for 18% interest, noting that the contract excluded payment of interest during the period when the security deposit was lawfully retained. However, it held that once Indian Oil Corporation's right to retain the amount ended after expiry of the performance guarantee period on 30 October 2018, continued retention became wrongful.

Accordingly, the High Court awarded interest at 9% per annum from 31 October 2018 until realisation, holding that the rate was just, reasonable, and equitable.

For Appellant: Pradeep Nayak, Advocate 

For Respondent: Dhananjay V. Joshi, Senior Advocate along with Kavitha Damodaran, Advocate