The Indian Contract Act, 1872 ("Act") governs the law of contracts in India and is predominantly based on English common law. The Act defines the term "contract" as an agreement enforceable by law2. In other words, it is a legally enforceable and binding agreement, which is voluntarily entered into between two or more competent parties, for consideration and with mutual obligations. In today's dynamic business environment, majority of the commercial transactions are successfully and effectively undertaken through contracts. The list of such transactions include manufacturing arrangements, supply arrangement, sub-contracting, infra projects, EPCs, advisory, etc. Moreover, due to the aggressive growth in the field of technology, the parties entering into such commercial transactions, are more cautious than ever, thus making the parties deliberate even on the minutest of details / specifications so as they can best secure their interest. Therefore, contents of a contract have become highly detailed and elaborate. Particularly, as a measure of safeguarding, securing and protecting their respective interests in an event of breach of the terms of the contract, parties generally negotiate and agree upon the various remedies that the injured party can invoke to mitigate and compensate for the losses it may suffer on account of such breach. In other words, any breach of the terms and conditions of the contract by either party ("Defaulting Party"), entitles the other party ("Non-Defaulting Party") to claim for damages and / or other remedies from the Defaulting Party. The term "damages" is not defined under the Act. However, it can be said to mean an award of money to be paid by the Defaulting Party to the Non-Defaulting Party as compensation for loss or injury caused on account of the Defaulting Party's breach of the terms and conditions of the contract. Damages can be broadly divided into two categories, (i) direct damages; and (ii) indirect / consequential damages. This article aims to highlight and discuss the legitimacy of claiming indirect / consequential damages arising out of the breach of the terms of the contract.
Section 73 of the Act provides that "When a contract has been broken, the party who suffers by such breach is entitled to receive, from the party who has broken the contract, compensation for any loss or damage caused to him thereby, which naturally arose in the usual course of things from such breach, or which the parties knew, when they made the contract, to be likely to result from the breach of it. Such compensation is not to be given for any remote and indirect loss of damage sustained by reason of the breach"It further states that "When an obligation resembling those created by contract has been incurred and has not been discharged, any person injured by the failure to discharge it is entitled to receive the same compensation from the party in default, as if such person had contracted to discharge it and had broken his contract." The explanation to Section 73 states that "In estimating the loss or damage arising from a breach of contract, the means which existed of remedying the inconvenience caused by non-performance of the contract must be taken into account."
It appears from Section 73 of the Act that the general principle for assessment of damages is compensatory, i.e. the innocent party is to be placed, so far as money can do, in the same position as if the contract had been performed. However, the question which arises for deliberation is that whether the Defaulting Party can be held liable for the indirect damages / consequential damages suffered by the Non-Defaulting Party?
Consequential damage or loss usually refers to pecuniary loss consequent on physical damage, such as loss of profit sustained due to fire damage in a factory3. It arises due to the existence of certain special circumstances. The basic rule for determining scope and extent of consequential damages, which Defaulting Party would be liable to pay to Non-Defaulting Party, was first elaborated in the judgment of Alderson B., in the English Court of Exchequer, in the case of Hadley v. Baxendale4. In the said case, the plaintiff, were millers and used to run the City Steam-Mills in Gloucester. A crankshaft of a steam engine at the mill had broken and the plaintiff arranged to have a new one made by W. Joyce & Co. in Greenwich, and for the said purpose W. Joyce & Co. required that the broken crankshaft be sent to them in order to ensure that the new crankshaft would fit together properly with the other parts of the steam engine. The plaintiffs contracted with the defendants, who were common carriers, to deliver the crankshaft to engineers for repair by a certain date at a cost of £2 sterling and 4 shillings. The defendants failed to deliver on the date in question, causing the plaintiff to lose business. The plaintiff sued for the profits lost due to the defendant's late delivery, and the jury awarded the plaintiff damages of £25. The defendants appealed, contending that they did not know that the plaintiff would suffer any particular damage by reason of the late delivery. The issue raised by the defendants in the appeal was whether the defendant in breach of contract could also be held liable for the damages that the defendant was not aware and which were suffered by the plaintiff from a breach of the contract.
The Court observed that "Where two parties have made a contract which one of them has broken, the damages which the other party ought to receive in respect of such breach of contract should be such as may fairly and reasonably be considered either arising naturally, i.e., according to the usual course of things, from such breach of contract itself, or such as may reasonably be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of the breach of it. Now, if the special circumstances under which the contract was actually made where communicated by the plaintiffs to the defendants, and thus known to both parties, the damages resulting from the breach of such a contract, which they would reasonably contemplate, would be the amount of injury which would ordinarily follow from a breach of contract under these special circumstances so known and communicated. But, on the other hand, if these special circumstances were wholly unknown to the party breaking the contract, he, at the most, could only be supposed to have had in his contemplation the amount of injury which would arise generally, and in the great multitude of cases not affected by any special circumstances, from such a breach of contract."
The Court further pointed out that "But how do these circumstances show reasonably that the profits of the mill must be stopped by an unreasonable delay in the delivery of the broken shaft by the carrier to the third person? Suppose the plaintiffs had another shaft in their possession put up or putting up at the time, and that they only wished to send back the broken shaft to the engineer who made it; it is clear that this would be quite consistent with the above circumstances, and yet the unreasonable delay in the delivery would have no effect upon the intermediate profits of the mill. Or, again, suppose that, at the time of the delivery to the carrier, the machinery of the mill had been in other respects defective, then, also, the same results would follow. Here it is true that the shaft was actually sent back to serve as a model for the new one, and that the want of a new one was the only cause of the stoppage of the mill, and that the loss of profits really arose from not sending down the new shaft in proper time, and that this arose from the delay in delivering the broken one to serve as a model. But it is obvious that, in the great multitude of cases of millers sending off broken shafts to third persons by a carrier under ordinary circumstances, such consequences would not, in all probability, have occurred; and these special circumstances were here never communicated by the plaintiffs to the defendants" Therefore, applying the aforesaid rule and considering the fact that the special circumstance was not communicated by the plaintiff to the defendants, it was held that the plaintiffs could not recover the loss of profits from the defendants.
A similar question arose in the case of Victoria Laundry (Windsor Ltd.) v. Newman Industries Ltd.5 In the said case, the defendants were to deliver a boiler for the plaintiff and the delivery was delayed by five months. As a result of not having enough laundry capacity, the plaintiff lost a high value cleaning contract from the Ministry of Supply. The plaintiff sued the defendants for the loss of profits on account of (i) the large number of customers which could have been served if the said boiler was delivered on time; and (ii) the amount the plaintiff could have earned if it had received the contract from the Ministry of Supply. In the instant case the defendants were aware that the plaintiff required the boiler for immediate use and therefore, it was held that the defendant as a reasonable man could have foreseen some loss of profit though not the loss of profit resulting from the special circumstance with respect to the Ministry of Supply's contract.
Therefore, the defendant was held liable to compensate for the ordinary loss of profits and not for the extraordinary loss of profits which were on account of the special circumstances.
Analyzing the principles laid down in the aforesaid cases, it is evident that there are two categories of damages which the can be claimed by the Non-Defaulting Party i.e. (1) which can be fairly and reasonably considered arising naturally, i.e., in the usual course of things, from such breach of contract itself; and (ii) which may reasonably be supposed to have been in the contemplation of both the parties, at the time they made the contract, as the probable result of the breach of it. The first category refers to the direct damages and the second category refers towards consequential damages. Consequential damages can only be claimed by the Non-Defaulting Party in case the special circumstances resulting into the consequential damage were already brought into the Defaulting Party's knowledge at the time of executing the contract.
It is also relevant to highlight herein that Section 73 of the Act very clearly provides that compensation is not to be given for any remote and indirect loss of damage sustained by reason of the breach on the contract. However, it also states that the Non-Defaulting Party is entitled to receive from the Defaulting Party the compensation for any loss or damage caused thereby, which the parties knew, when they made the contract, to be likely to result from the breach of it.
It is also evident from the above discussion that the principles laid down in aforesaid case of Hadley v. Baxendale have been adopted by the draftsmen within the language of Section 73 of the Act and the same has also been applied in various Indian cases.
It may be concluded that the general principle with respect to claiming the consequential damages by Non-Defaulting Party is that the Non-Defaulting Party is only entitled to recover / claim such part of the damages or losses resulting from the breach by the Defaulting Party, as was at the time of execution of the contract reasonably foreseeable as liable to result from the breach. Further, the damage or loss "reasonably foreseeable" would inter-alia depend on the knowledge possessed / shared between the parties. It is expected out of a reasonable person to understand and foresee the damage which may be suffered by the Non-Defaulting Party and resulting from the breach by the Defaulting Party in the "ordinary course". However, in case of existence of "special circumstances", which are outside the purview of the "ordinary course" what is of utmost importance, so as to be able to claim the consequential damages, is that the Defaulting Party should be aware of the said "special circumstances" which would result into consequential losses for the Non-Defaulting Party, at the time of executing the contract.
1.Author is working as a Senior Associate with Vaish Associates Advocates, New Delhi. The author's views expressed in the article are personal and author is solely responsible for any errors that may remain in this article.
2.Section 2(h) of the Act.
3.Pollock & Mulla, Indian Contract & Specific Relief Acts, 11th edition, pg. 802.
4.Pollock & Mulla, Indian Contract & Specific Relief Acts, 13th edition, pg. 1523.
5. (1854) 9 Exch. 341.
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