In the situation described in your question, it should be simple interest.
Let me point out that Section 3 of the Interest Act, 1978, deals with the power of the courts and tribunals to allow interest to the person entitled to the debt or damages. Sub-section (3) of this Section lays down that “Nothing in this section … shall empower the court to award interest upon interest”. This means that compound interest is not permissible. [Note: It is noteworthy that Section 5 of this Act says that “Nothing in this Act shall affect the provisions of Section 34 of the Code of Civil Procedure, 1908 (5 of 1908)”. Remember, Section 34 of the CPC deals with interest.]
In this regard, let me point out that in the case of State of Haryana v. S.L. Arora & Co., (2010) 3 SCC 690 : AIR 2010 SC 1511, the Supreme Court held that:
“Section 3 of the Interest Act, 1978 enables the courts and Arbitral Tribunals to award interest from the date of cause of action to the date of institution of legal proceedings or initiation of arbitration proceedings. Sub-section (3)(c) of Section 3 of the Interest Act, 1978 makes it clear that nothing in the said section shall empower the court or arbitrator to award interest upon interest. It should be noted that Section 3 of the Interest Act does not deal with either pendente lite or future interest.”
In the case of Renusagar Power Co. Ltd. v. General Electric Co., 1994 Supp (1) SCC 644, the Supreme Court held that award of interest on interest was not opposed to the public policy of India, but could be awarded only if authorised by the contract or statute. It was observed:
“… Merely because in Section 3(3)(c) of the Interest Act, 1978, the court is precluded from awarding interest on interest does not mean that it is not permissible to award such interest under a contract or usage or under the statute. It is common knowledge that provision is made for the payment of compound interest in contracts for loans advanced by banks and financial institutions and the said contracts are enforced by courts. Hence, it cannot be said that award of interest on interest i.e. compound interest, is against the public policy of India. We are, therefore, unable to accept the contention that award of interest on interest i.e. compound interest is contrary to public policy of India….”
Likewise, in the case of SBI v. Ganjam District Tractor Owners’ Assn., (1994) 5 SCC 238, Supreme Court observed that in the absence of a provision for compound interest or interest with periodical rests in the agreement between a bank and the borrower, the bank cannot claim such interest.
Dr. Ashok Dhamija is a New Delhi based Supreme Court Advocate and author of law books. Read more about him by clicking here. List of his Forum Replies. List of his other articles. List of his Quora Answers. List of his YouTube Videos.
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