An interesting question!
The amount deposited as FD with the bank - whose money is that? Your father should have normally executed a bond to repay the money in case the High Court decides the case against him. Scrutiny of the Court order and the documents executed are necessary to determine whether the amount paid by the State Government is his income or liability. As there may not be deduction of tax at source at the time of making the payment by the State Government and further as the income is not taxable, it will be difficult to ascertain the nature of payment by the State Government. Apparently, the State Government did not deposit the compensation amount with the High Court. Hence, based upon the facts as stated by you and subject to the scrutiny of the High Court order and the documents executed by your father, I feel that the amount received was in the nature of income to your father and the future liability is in the nature of a contingent liability.
The income earned on the FD with the bank is taxable in the hands of your father. If your father has to refund the deposit amount along with interest in case he loses his case in the High Court, he can then perhaps seek review of assessment by the Commissioner of Income Tax u/s 264 of the Income Tax Act, if not barred by limitation.