INTRODUCTION
The most commonly encountered claims, raised by Contractors against employers in a construction dispute are claims for ‘loss of profit' (on account of unexecuted work) and ‘loss of profitability' (on account of prolongation of the period of contract). Although a plethora of judgements of the Supreme Court and various High Courts deal with the requirement of proof and computation under these distinct heads of claims, they are oft-conflated by the Indian courts, despite there being fundamental differences between the two.
It's a trite position of law that where it is possible to prove actual damage or loss, such proof is not dispensed with and the contractor must establish actual loss in order to sustain the claim for loss of profit.1
However, a conundrum persists over the proof of loss that should be tendered by the contractor in order to sustain a claim for loss of profits or loss of profitability. This article attempts to draw a clear distinction between these heads of claims and the nature and extent of proof required to claim damages thereunder.
Loss of Profit v. Loss of Profitability: Concept
It is first essential to highlight the distinction between the two heads of claim:
- Loss of Profit: Claims for loss of expected profit due to unexecuted work resulting from premature/illegal termination of the contract.
- Loss of Profitability: Claim for the reduction in the estimated profit margin due to prolongation of the contract, or a claim for loss of opportunity to take up other projects during the extended period where the contractor could have earned a profit,.
REQUIREMENT TO PROVE ACTUAL LOSS
There has been considerable confusion regarding the requirement of proof of actual loss in establishing a claim under these two heads of losses. This confusion primarily stems from the synonymous use of the terms ‘loss of profit' and ‘loss of profitability'. Despite the conflation of the two terms, Contractors often raise separate heads of Claim for loss of profits and loss of profitability. There exists a distinction albeit not a well-defined as to extent to which actual loss must be proved by party, while claiming damages under these distinct heads.
Loss of Profitability
It is a trite position of law that compensation claimed for loss of profitability will not be allowed in the absence of evidence to prove such loss i.e., in addition to establishing that such delay was solely attributable to the Employer, the actual loss suffered by the Contractor has to be pleaded and proved through documents and evidence. 2
In NHAI vs. HCC3, the Delhi HC while observing that the claim of the claimant for loss of earning capacity and profit is actually in the nature of ‘opportunity cost', i.e., what the contractor would have earned if he had not pursued the activity in question and had deployed his resources in another venture, held that such a claim for loss of profitability must satisfy the twin criteria of proximity and measure. The claimant must establish that he had the opportunity to deploy his resources in another venture and that the venture would have yielded profits.
Furthermore, in Bharat Coking Coal Ltd. v. L.K. Ahuja4, the Supreme Court upheld the award of the Arbitrator rejecting the claim for loss of profit arising out of diminution in turnover on account of delay in the matter of completion of the work, as the same could not be established by the material placed on record. The court reiterated the principle that the claimant in such cases must necessarily establish that had he received the amount due under the contract, he could have utilised the same for some other business in which he could have earned profit. Unless such a plea is raised and established, a claim for loss of profits could not have been granted. It is pertinent to note here that even though the Apex court used the expression ‘loss of profits' in essence the claim was that of ‘loss of profitability' and thus the requirement to prove actual loss was mandated only for losses arising out of delay and should not be misunderstood to be applicable to loss of profits for unexecuted works.
For the computation of a claim for loss of profitability, three widely accepted formulae namely: Hudson, Emden and Eichleay formula; are relied upon by the Contractors. The Supreme Court in McDermott International Ltd v. Burn Standard Co. Ltd.5, while elaborating upon the three formulas and their usage reiterated the settled position of law that different formulas can be applied in different circumstances and the question as to whether damages should be computed by taking recourse to one or the other formula, having regard to the facts and circumstances of a particular case, would eminently fall within the domain of the Arbitrator. However, as explained above, loss allegedly suffered by the Claimant has to be pleaded and proved through documents and evidence.
Loss of Profits
This principle of establishing through evidence actual loss holds good for loss of profitability however, the same could not be said in respect of claims for loss of profit due to illegal termination of the contract. The Supreme Court in M/s A.T Brij Paul Singh and others v. State of Gujarat,6 while adjudicating a claim for loss of profits held that once it is held that the respondent was guilty of breach of contract, part of which was already performed by the contractor, certainly he would be entitled to damages under the head of ‘loss of expected profit in the works'. This decision was later followed by the Supreme Court in Dwarka Das v. State of M.P. & Anr.7
Subsequently, in MSK Projects India (JV) Limited v. State of Rajasthan & Another8, the apex court clearly stated that a claim of expected profits is legally admissible on proof of the breach of contract by the erring party, as a reasonable expectation of profit is implicit in a works contract and its loss has to be compensated by way of damages once the breach on part of the other party is established and no other proof of loss shall be required.
However, on account of the conflation between the concepts of Loss of Profits and Loss of Profitability, divergent views have emerged in the judiciary regarding the requirement of proof of loss. In Ajay Singh v. Suneel Darshan9, a Division Bench of the Bombay High Court relying on Maharashtra State Electricity Board v. Sterlite Industries (India) Ltd.10, held that if a party has not suffered any loss, even if the defaulting party commits a breach, in the absence of proof of loss, the opposite party cannot be awarded the claim of loss of profit. The court further observed that if damage or loss is not suffered, the law does not provide for a windfall. Similarly, the Bombay High Court in Essar Procurement Service Ltd. v. Paramount Constructions11, held that Sections 73 & 74 of the Contract Act require actual damage or loss and proof cannot be dispensed with.
Such an approach in respect of loss of profit is against the fundamental tenets of Contract Law. It is a general principle of Contract law that in case of breach of contracts, the injured must be put back in the same position that he would have been if he had not sustained the wrong. 12 Once the contractor has established an unjustified breach of contract on the part of the employer, it cannot be further obligated to establish a loss suffered on account of such breach, because a reasonable expectation of profit is implicit in a works contract.13 Therefore, any loss occasioned due to illegal termination of works contract, has to be compensated by way of damages once the breach on part of the erring party is established. This is obviously subject to the caveat that the compensation must be reasonable and the parties should not be allowed to make a windfall profit14, by a mere allegation of breach of contract. However, it is a settled position of law that for estimating damages, courts are not required to go into the minute details; a broad evaluation of the same would suffice.15
CONCLUSION
As a general rule a party claiming damages on account of loss suffered must establish the same through contemporaneous documents and other evidence. However, the burden is heavier in the case of a claim for loss of profitability than that of a claim for loss of profit.
In case of Loss of profits, as long as the breach has been clearly established by the Contactor, no further evidence as to proof of actual loss ought to be required. Moreover, for estimating the amount of damages, the court should only make a broad evaluation instead of going into minute details. The rationale behind the same is that in a works contract, a reasonable expectation of profit is implicit. Thus, the court only needs to determine the percentage of profit implicit in the Contract to compute the loss of profit on unexecuted works.
On the other hand, in the case of a claim for loss of profitability, not only will the Contractor have to evince the causation for the loss but will also have to prove the extent of loss so incurred through contemporaneous documents. This, for instance, can be a list of projects/works, where the Claimant was eligible, but could not undertake work, on account of the extended duration of the Contract.
For the sake of clarity, it is essential for the courts to finally put this controversy to rest by drawing a distinction between these two heads of claim in relation to the requirement of proof of actual loss.
Footnotes
1 Kailash Nath Associates v. DDA and Anr., (2015) 4 SCC 136.
2 NTPC Limited v. Sri Avantika Contractors (I) Limited, Delhi HC, O.M.P. (COMM) 370/2017, Pronounced on: 08.06.2020.
3 2016 SCC OnLine Delhi 6112.
4 (2004) 5 SCC 109.
5 (2006) 11 SCC 181.
6 (1984) 4 SCC 59.
7 (1999) 3 SCC 500.
8 (2011) 10 SCC 573.
9 2015 SCC Online Bom 1412.
10 2000 SCC Online Bom 89.
11 2016 SCC Online Bom 9697.
12 State of West Bengal v. Pam Developments Pvt. Ltd, MANU/WB/1044/2016.
13 Supra note 8.
14 Id.
15 Id.
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.
