A contract is said to have been breached when the terms of the contract are violated or when the commitment made is broken. "Breach of contract" constitutes the pre-condition for a claim of damages, be it liquidated, unliquidated or otherwise.1 Thus, regardless of how much benefit the defendant makes from the contractual agreement, there can be no argument for damages until the contract is broken. A violation must be adjudicated and proven, not simply agreed upon by the parties, in order to be established.2
The Law of Damages under Indian Contract Act, 1872:
Section 73 & 74 of the Act contain provisions relating to breach of contractual obligations. Section 73 of the Act deals with damages arising upon breach of a contractual obligation, resulting in losses to the aggrieved party. Under this section the damages that are awarded to the aggrieved party are in the nature of unliquidated damages upon assessment of the loss and injury suffered and doesn't compensate for indirect or remote losses arising out of such breach. Section 74 deals with liquidated damages where the contract stipulates the quantum of damages in case of a breach of the contract.
Liquidated Damages:
The Black's Law Dictionary defines a liquidated damages clause as "a contractual provision that determines in advance the measure of damages if a party breaches the agreement". However, where there is a valid termination of the contract, without any violation of the terms of the contract, the question of claim for damages should not arise since there is no breach per se. There can be no award of any compensation if there is no legal injury to the party.3
The Supreme Court in Kailash Nath Associates v. Delhi Development Authority and Another (2015), observed that, wherein a contract has provisions for liquidated damages, such amount can be received in totality only if the amount of damages suffered by the aggrieved party is similar to such pre-established amount of damages. The court further observed that the quantum of damages awarded by the court should at no point exceed the amount mention in the contract in the form of liquidated damages.4
Wherein the court finds it difficult to ascertain the quantum of damages to be awarded in liquidated damages, the aggrieved party has to prove losses suffered as a result of contractual breach. Once such loss is proved, the court grants reasonable compensation. For instance, in Haryana Telecom Ltd. v. Union of India (2006), when a contractor delayed in supplying cables requiring the Government to purchase the same from other sources, subsequently procuring it at cheaper rates, the award of the arbitrator awarding damages for breach was set aside as no loss was caused.
Even in the presence of pre-determined sum of reward as liquidated damages, the court will take into consideration factors such as mitigation of losses, reasonability of the sum, and other facts and circumstances so as to ensure that the aggrieved party is compensated adequately but not over compensate so as to prevent any occurrence of profit to the aggrieved party as a result of breach of the said contract.5 The primary objective of damages resulting out of breach of contractual obligation is to place the aggrieved party in the same position as he was supposed to be in, had the contractual obligation been honoured and not to put him in a profitable position.
Proof of damage for a claim of liquidated damages:
To begin with, regardless of the extent of the damages, there must be a breach of contract before damages can be claimed. That is, if there is no breach of contract between the parties, there can be no argument for damages. Further, in order to seek damages, the person making the claim must show that he or she has suffered a loss.
The Supreme Court in Fateh Chand v. Balkishan Dass (AIR 1963) demanded the parties to prove the degree of loss or damage suffered as a result of breach of contract.
The Hon'ble Supreme Court of India in Maula Bux v. Union of India held that the court is competent to award reasonable compensation in a case of breach even if no actual damage is proved to have been suffered in consequence of the breach of contract. However, the court also held that in case of breach of some contracts it may be impossible for the court to assess compensation arising from breach. In such a case, the sum named by the parties if it be regarded as a genuine pre-estimate may be taken into consideration as the measure of reasonable compensation, but not if the sum named is in the nature of a penalty. Where loss in terms of money can be determined, the party claiming compensation must prove the loss suffered by him.
The Supreme Court in Oil & Natural Gas Corporation v. Saw Pipes Ltd. held that in the absence of such proof or an honest estimate by the claimant, the court must award damages that are less than the prescribed liquidated damages, based on a reasonable assessment of the consequences of the breach of contract.
In Board of Trustees of Port vs Pioneer Engineer And Anr. (2006), the apex court was of the view that there has been no departure by the court in the ONGC judgement from the Fateh Chand as well as Maula Bux's cases. The conclusions drawn by the Supreme Court in this case can, in no way, be said to be contrary to what the Supreme Court has stated in Fateh Chand's case and Maula Bux's case.
Breach of Contract doesn't result in Damages:
The Bombay High Court in Raheja Universal Pvt. Ltd. v. B.E. Bilimoria & Co. Ltd. (2016) had upheld the finding of a Single Judge who had set aside the arbitral award on the ground that the award for grant of liquidated damages had been made even though no evidence had been led to prove any loss or damages.
The Division Bench cited Kailash Nath's case, wherein the Supreme Court held that (a) the sum mentioned as liquidated damages must be a reasonable compensation and a true pre-estimate of damages determined by both parties and found to be such by the court; and (b) the damages awarded must not exceed the amount so specified or the penalty so mandated. The Division Bench further cited Kailash Nath, in which the Supreme Court interpreted Section 74 of the Contract Act's expression "whether or not actual damage or loss is proved to have been caused thereby" and concluded that, only in cases where actual damage from a breach of contract cannot be proved or calculated, the court will take the liquidated amount as pre-determined. If the damages can be estimated, they must be stated in the pleadings and quantified.
In the case of M/s. Herbicides (India) Ltd. v. M/s. Shashank Pesticides P. Ltd (2011), the court held in case of liquidated damages that "... even if it does not prove the actual loss/damage suffered by it, is entitled to reasonable damages unless it is proved that no loss or damage was caused on account of breach of the contract"
Differentiating between Liquidated damages and Penalties:
In general, while liquidated damages are pre-determined estimates of losses and corresponding compensation that is payable in the event of a contract breach, penalties are usually disproportionate to the losses and are higher than the losses that may result from the contract breach, which are stipulated with the intent to ensure exercise of contractual obligations.
The meaning of the stipulation provided under the contractual terms is often debated as to whether it is a penalty or liquidated damages. The need to distinguish between liquidated damages and penalty exists primarily because a provision for penalty does not preclude the plaintiff from seeking unliquidated damages; nevertheless, if a provision for liquidated damages is present, no further relief in the form of unliquidated damages may be obtained.
Travelling beyond pre-determined Amounts in the Event of any Breach:
The Supreme Court in Steel Authority of India Limited v. Gupta Brother Steel Tubes Limited (2009) recognised the ambiguity in liquidated damages wherein the contract doesn't specifically provide for all breaches of contract. The court observed that –
"We are not aware of any principle that once the provision of liquidated damages has been made in the contract, in the event of breach by one of the parties, such clause has to be read covering all types of breaches although parties may not have intended and provided for compensation in express terms for all types of breaches."
Remoteness of Damage:
Section 73 of the Act incorporates two rules laid down in Hadley & Anor v Baxendale & Ors, (1854). Firstly, 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; and secondly, 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.6
Under Section 73 of the Act, the damages are unliquidated in nature, therefor the quantum of such damages awarded is the judicial discretion of the court. The section does lay down that damages awarded have to be reasonably foreseeable and should not be remote or indirectly resulting from the breach however, it doesn't lay down procedures for calculation of such damages.7
The Kerala High Court observed in State of Kerala v. K. Bhaskaran AIR 1985 that –
"The defendant is liable only for natural and proximate consequences of a breach or those consequences which were in the parties' contemplation at the time of contract... the party guilty of breach of contract is liable only for reasonably foreseeable losses - those that a normally prudent person, standing in his place possessing his information when contracting, would have had reason to foresee as probable consequences of future breach."
Calculation of Damages:
The Supreme Court in M.N. Gangappa v. Atmakur Nagabhushanam Shetty & Co. and Anr., (AIR 1972 SC 696) has observed that in absence of a strict procedure for calculation of damages arising out of breach of contract, damages would be calculated based on the facts and circumstances of each case.
The Supreme Court in A.T. Brij Paul Singh v. State of Gujarat (1984) has observed in this light that "commercially, works contracts are entered into for the purpose of earning profits and the party committing the breach of the contract would therefore be liable to compensate the affected party for their expected loss of profit." While adjudicating the case, the court for the very first time relied upon Hudson's Building and Engineering Contracts that states, "in major contracts subject to competitive tender on a national basis, the evidence given in litigation on many occasions suggests that the head office overheads and profits is between 3 to 7 per cent of the total price of cost". Further, the court observed that it is not necessary to dive deep into the minute details of the project for adjudicating claims of loss of profit, rather a broad evaluation would be sufficient.
In McDermott International Inc. v. Burn Standard Co. Ltd (2006) the apex court recognised the following formulae which can be relied upon by the parties for the purpose of calculation of damages in construction disputes globally. These are as follows –
- Hudson Formula
- Emden Formula
- Eichleay Formula
The use of these formulae was neither forbidden nor incompatible with Indian law, according to the Court. Damages will be calculated based on the facts and circumstances of each situation. Furthermore, it is the arbitrators' decision to use one formula over another and the calculation of the quantum of damages will be under their purview, and would not warrant court intervention.
The Delhi High Court in National Thermal Power Corporation Limited v. Wig Brothers Builders and Engineers Limited, ILR (2009) IV Delhi 663 relied upon the Supreme Court's decision and held that objects raised purely on ground that the formulae put to use could not be used is devoid of merits.
However, the Supreme Court in Steel Authority of India Ltd. v. J.C. Budharaja, Government and Mining Contractor, observed that the Arbitration Act does not give any power to the arbitrator to act arbitrarily or capriciously and his existence depends upon the agreement and his function is to act within the limits of the said agreement.
Damages in Midst of Force Majeure Event:
The Delhi High Court in M/s Halliburton Offshore Services Inc v. Vedanta Limited (2020) held that, any violation or non-performance could not be justified or excused solely because Covid-19 was invoked as a force majeure scenario; instead, the Court would have to consider whether the party was taking all possible actions to comply with its contractual obligations and was actually unable to perform due to the pandemic.
In the English case of Classic Maritime Inc v. Limbungan Makmur (2019), the Court of Appeal held that it was not enough for parties to demonstrate that they were stopped from performing due to a force majeure event; they also had to show that the non-performance was caused directly by the force majeure event.
The purpose of this article is to give an overview of the laws and judgements relating to the principle of damages under the contract regime in India.
Footnotes
1. Managing Director, Army Welfare Housing Organisation v. Sumangal Services Pvt. Ltd. (2004)
2. P Radhakrishna Murthy v. NBCC Ltd. (2013); J.G. Engineers (P) Ltd., v. Union of India (2011)
3. State of Kerala v. M/s United Shippers and Dredgers Ltd., AIR 1982 Ker
4. . ONGC v. Saw Pipes (2003) 5 SCC 705; Maya Devi v. Lalta Prasad (2015) 5 S.C.C. 588; A.S. Motors (P) Ltd. v. Union of India (2013) 10 SCC 114
5. MSK Projects (I) (JV) Ltd. v. State of Rajasthan (2011) 10 SCC 573; M/s Auto Craft Engineers v. Akshar Automobiles Agencies Private Limited (2016) SCC Online Bom 5185
6. The Andhra Pradesh Mineral Development Corporation Ltd. v. Pottem Brothers (2016)
7. McDermott International Inc. v. Burn Standard Co. Ltd, (2006)
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.
