Construction companies use different types of contracts depending upon project cost, scope of work, right of way, scheduled completion date, etc. Construction of any project in modern time is riddled with complexities and risks; so to shift the risk or burden of project management, employers prefer the EPC (Engineering, Procurement, and Construction) mode of contract over other forms of contracts. EPC contract is a preferable form of contract executed between the employer and contractor yet in the process of execution of these contracts, various types of disputes may arise. Since these contracts generally comprise huge sums, any delay or breach of contract by one party can cause a huge loss to the other party. Thus, in case of any non-performance or breach or termination of the contract as the situation may be, the affected party seeks damages suffered by them as genuine pre-estimates of loss are recoverable under law.
Damages are a form of compensation that are awarded to the affected party to enable restoration of the position prior to the occurrence of any breach. Damages are claimed in construction contracts interalia on account of the loss of profit, loss of opportunity, overheads, etc.1 Damages are of two types namely liquidated & unliquidated. Unliquidated damages are awarded by the court the amount of which is not preestimated.
The term 'Liquidated Damage' is not per se defined anywhere in the Indian Contract Act, 1872, but section 74 sets out the elements which constitute the meaning of liquidated damage. So, when a sum is mentioned in a contract that it will be granted in case of a breach, then upon the occurrence of the actual event the innocent party will be entitled to receive damages equal to that or less than that depending upon the facts and circumstances of the case subject to the maximum amount mentioned in the contract.
According to Black's Law Dictionary, liquidated damage is an amount contractually stipulated as a reasonable estimation of actual damages to be recovered by one party if the other party breaches; also, it is a sum fixed as a measure of damages for a breach of contract, but the actual amount of damage can be more or less than the amount of damage mentioned.
Under the Indian Law, the damages are awarded to recompense the aggrieved party and by way of this, it puts the aggrieved party in the same position in which it would have been if no breach had occurred. But no one is allowed to make an unjust enrichment by taking benefit of the clause to claim damage for breach.
The parties in construction contracts can easily envision certain breaches that may occur throughout the execution of the contract, and can gauge without much of a stretch the comparative misfortunes or expenses. The parties may fix a sum as liquidated damage for a breach and add it into the contract. When the actual breach happens, the actual damage may either be lesser or more than the aggregate sum fixed by the parties. The purpose of inserting such a clause into the contract is to leave the requirement to prove the same.
DETERMINING FACTORS FOR CONFIRMATION OR REJECTION OF A CLAIM
To confirm or reject a claim for liquidated damage by a party in a legal proceeding, certain factors are taken into account by the arbitrators and the courts in India i.e. the sum of liquidated damages are those liberated from an indefinite quality and controlled by agreement, or it could be by the court, to show an exact measure of obligation or damages or exact information from which the real value was determined; it is recollected that the contracts should be interpreted overall and not in parts. Accordingly, the total sum must be reasonable and adequate and not excessive.
LIQUIDATED DAMAGE SHOULD NOT BE TREATED AS A PENALTY
Liquidated damages should never be considered as a penalty2 As it is a pre-assessed loss agreed between the parties at the time of making a contract as likely to arise from the breach of a contractual provisions or obligations, while a penalty is a stipulation in the contract like 'terroram', which can be defined as a stipulation to award and impose an amount due to breach which is so disproportionate that no knowledgeable person would consider the same as a reasonable pre-estimate of loss.
CASE LAWS RELATED TO LIQUIDATED DAMAGES
In landmark judgments of Maula Bux Vs Union of India3 and Fateh Chand V. Balkishan Das,4 the Supreme Court expressed similar views with regard to liquidated damages. The apex court stated that in the event of a breach of a contract, the aggrieved party will be entitled to receive reasonable compensation even if the aggrieved party is not able to prove actual loss or damages suffered. As in some cases, the court finds it difficult to assess the amount of compensation to be paid, so a genuine pre-estimate of loss is taken into consideration but in case of a penalty, a party needs to prove the loss suffered.
The apex court, in another leading judgment of ONGC Vs SAW Pipes5 in view of Sections 73 and 74 of Contract Act, 1872, while dealing with liquidated damages held that6 before concluding that a party is entitled to claim damages or not, terms of the contracts should be taken into account and it should be clear, stating unambiguously that liquidated damages will be given in the case of breach unless the damages claimed is unreasonable or is in the form of a penalty. As per section 73, a party who commits breach of the contract is required to pay damages to the other party who suffered due to that breach. Both sections 73 & 74 should be read harmoniously as the aggrieved person before claiming for the decree is not required to prove the actual loss suffered. The court has the authority to award reasonable compensation to the aggrieved party even if the actual loss suffered is not proved. In case of breach of several contracts, the court can't determine damages suffered but where there is a genuine pre-estimated loss & the damages/ compensation contemplated is not in the manner of penalty or is reasonable then the court can award the same. Therefore, even when the amount of liquidated damages is mentioned in the contracts, the court or arbitrator should award the damage which is reasonable and it should not exceed the amount stipulated in the contract.
CESSATION OF PAYMENT FOR LIQUIDATED DAMAGE
- Liquidated damages even though specifically mentioned in the contract will not be payable where the owner has waived his right to claim the same. In J.G. Engineers case 7 , at the time of extending the project completion date to execute the contract, the owner did not impose liquidated damages even though there was a provision in the contract and further allowed escalation of costs to the contractor and hence, the owner seems to have waived his right to claim liquidated damages.
- Liquidated damages cannot be claimed if it is proved that no actual loss was suffered by the breach as held by the Delhi High Court in Indian Oil Corporation Vs. Messrs Lloyds Steel Industries Limited [2007 (144) DLT 659] that mere delay in construction and commissioning of the terminal at Jodhpur by the contractor did not entitle Indian Oil Corporation to get Liquidated Damages as no actual loss was suffered by the corporation. The court stated that on 31.08.1996 pipeline reached the Jodhpur terminal that is much after the scheduled completion date (31.3.1996). The terminal could not be put to commercial use without pipeline reaching it but since no actual loss was suffered by the IOC, court didn't allow the claim.
A RIGOROUS ONUS OF PROOF
Courts have been incredulous in authorizing the enforcement of the liquidated damage clause, except if the claimant builds up probably some similarity to misfortune. But in most of the cases, courts have requested a severe limit of evidence to build up the specific nature and level of damages that have been caused because of the disavowal of the contract. This interest of the court to prove the amount of loss suffered invalidates the very point for which this provision of damages is embedded in any contracts.
FORMULAE FOR CALCULATION OF DAMAGES
In the event of a breach of construction contracts, it is difficult to establish the amount of loss suffered due to the fault of the other party based on documentary evidence so, in such cases reliance is placed on well-established concepts and formulae which are available for calculation of losses.
The Supreme Court, in the case of AT Brij, held that while adjudicating upon the claim for loss of profit due to breach of a contract, broad evaluation is sufficient instead of the need to check minute details of loss suffered.
For calculation of damage, the aggrieved party depends upon the following formulae8 :
- Hudson Formula
- Emden Formula
- Eichleay Formula
The inquiry encompassing the idea of liquidated damages in an agreement should be dispassionately evaluated to set up whether it is a terroram/penalty or genuinely deals with the pre-estimated loss arrived due to breach of contract. As long as liquidated damage serves a compensatory work & there is a genuine loss, the court should grant damages to the aggrieved party based on equitable doctrines, without the need to measure or prove the definite/actual loss.
But the process of awarding damages based on equitable doctrine essentially requires a legal methodology that is more flexible in delivering verification of misfortune. In construction matters due to the default on part of the authorities, contractors suffer huge losses related to the idling of manpower, machinery, opportunities, profit, etc. So, to provide relief to the contractor it is advisable to grant the liquidated damages as compensation to the contractor or the aggrieved party, although the facts and circumstances of each case should always be taken into consideration.
1. In Xstrata Coal Marketing Ag vs Dalmia Bharat (Cement) Ltd, Delhi High court observed that a party is entitled to claim loss of profits resulting from a breach of contract on the part of the other party.
2. Ultratech Cement Ltd. vs. Sunfield Resources Pty. Ltd. (21.12.2016 - BOMHC): MANU/MH/2733/2016
3. Maula Bux Vs Union of India (1969)2 SCC 554
5. Oil and Natural Gas Corporation Ltd., Vs SAW pipes Ltd (2003) 5 SCC 705
6. Liquidation of Damages in Breach of Contract: All you must know (ipleaders.in)
7. J.G.Engineers (P) Ltd., Vs Union of India (2011) 5 SCC 758
8. McDermott International Inc. v. Burn Standard Co. Ltd
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.