INTRODUCTION

Parties enter a commercial contract for financial benefit and both parties have obligations to perform the contract. The origin of  law relating to contract damages is the endeavor of lawmakers to compensate an injured party for a breach committed by the other party to the contract. The breach of contract can be due  to non-fulfillment of the obligations, delay in fulfilling the obligations or abandonment or termination etc.1

An aggrieved party can claim damages as a matter  of  right, but the court has the discretion in determining the 'quantum' of damages. Common law principles  governing the grant of damages are codified in Section 73 and Section 74 of the Indian Contract Act, 1872. Liquidated damages  stipulating reasonable compensation would ordinarily be awarded against the party causing a breach of contract. Therefore, the risk of a party causing a breach of contract is comparatively less. Some key principles for determining damages are as follows:

DETERMINING DAMAGES: UNDERSTANDING KEY PRINCIPLES

PRINCIPLE 1: A RIGOROUS ONUS OF PROOF OF DAMAGE FOR A CLAIM OF LIQUIDATED DAMAGES

  1. To begin with, regardless of the extent of the damages, there must be a breach of contract before damages  can be claimed. To seek damages, the person making the claim must show that he or she has suffered a loss.
  2. The hon'ble Supreme Court of India in Maula  Bux  v. Union of India2 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.
  3. The Supreme Court in Oil & Natural Gas Corporation v. Saw Pipes Ltd.3 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.

PRINCIPLE 2: A BREACH OF CONTRACT DOESN'T ALWAYS RESULT IN DAMAGES

  1. The Bombay High Court in Raheja Universal case4 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 there was no evidence to prove any loss or damages.
  2. In the case of M/s. Herbicides (India) Ltd. v. M/s. Shashank Pesticides P. Ltd5, 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".

PRINCIPLE 3: DEMARCATING A DISTINCT DIFFERENTIATION BETWEEN LIQUIDATED DAMAGES AND PENALTIES

  1. 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 the exercise of contractual obligations.
  2. In Fateh Chand6, the Supreme Court considered section 74 as it stands and contrasted it with the position  under English common law. It found that under English common law, a mutually agreed genuine pre-estimate of damages is considered by courts as liquidated damages and claims thereon are sustained. According to the Supreme Court, section 74 is a conscious attempt by the legislature to move away from complex rules and presumptions under English common law,  to distinguish between stipulations providing for liquidated damages and those in the nature of penalty.

PRINCIPLE 4: TRAVELLING BEYOND PRE-DETERMINED AMOUNTS IN THE EVENT OF ANY BREACH UNDER THE CONTRACT

  1. The Supreme Court in SAIL v. Gupta Brother Steel Tubes Limited7 recognized  the ambiguity in liquidated damages wherein the contract  doesn:t  specifically provide for all  breaches of contract. The court observed, "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."
  2. Parties committed to reducing litigation and providing commercial certainty opt for a liquidated damages clause in commercial contracts, particularly when the sector is subject to regulatory regimes such as telecommunications. The Supreme Court in BSNL v Reliance Communication Limited,8 held that the loss was measured based on costing and pricing, and because the amount represents a pre-estimate of reasonable compensation, so section 74 was not violated.

PRINCIPLE 5: REMOTENESS OF DAMAGE

  1. Section 73 of the Act incorporates two rules laid down in Hadley & Anor v Baxendale & Ors, (1854)9. 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 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.10.
  2. The Kerala High Court observed in State of Kerala v. K.  Bhaskaran, "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."11

PRINCIPLE 6: COMPUTATION OF DAMAGES

  1. It is 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.12 And also it is not necessary to dive deep into minute details of the project for adjudicating claims of loss of profit, rather a broad evaluation would be sufficient.
  2. The apex court  recognized the following formulae which can be relied upon by the parties for the purpose of calculation of damages in construction disputes globally. These are (i) Hudson Formula; (ii) Emden Formula; and (iii) Eichleay Formula.13

PRINCIPLE 7: CESSATION OF PAYMENT FOR LIQUIDATED DAMAGES

  1. 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 case14, 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 the escalation of costs to the contractor and hence, the owner seemed to have waived his right to claim liquidated damages.
  2. Liquidated damages  cannot  be claimed if  it is proved that no actual loss was suffered by the breach and mere delay in construction of the project did not  entitle to get Liquidated Damages as no actual loss was suffered by the corporation.15

LASTLY IN INDIA, THE CLEAR PRINCIPLES THAT EMERGE FROM THE LINE OF PRECEDENTS ON THE SUBJECT CAN BE SUMMARIZED AS:

  1. Legal injury is an absolute essential for award of compensation
  2. Damages merely dispenses with the proof of 'actual loss or damage', it does not justify award of compensation when no legal injury results as a consequence of breach
  3. The party complaining of a breach can receive a named amount as compensation in instances where exact loss or damage is difficult to prove, provided it is a genuine pre-estimate of damage, fixed by both parties and found to be so by court
  4. In other instances, the measure for damages is 'reasonable compensation', subject to the limits set out in the clause on liquidated damages. Such compensation is to be fixed on settled principles found 
  5. The Courts while awarding compensation must give due regard to conditions existing on the date of the breach
  6. Jurisdiction of courts to award compensation is unqualified except as to the limit stipulated 
  7. Section 74 is available to both plaintiff and respondent in a lawsuit
  8. The provision applies with equal force to amounts already paid or those payable in future

CONCLUSION

The moot proposition of this article revolves around how an aggrieved party can decide the quantum of damages in some exceptional circumstances. So many of the issues faced by courts and experts in the assessment of damages are based on the above-laid criteria and factors. Tribunals face an even tougher job when evaluating expert evidence on the damages that in such cases core principles as mentioned above always came to rescue the parties for claiming damages.

Damages are usually awarded for expectation loss (loss of a bargain) or reliance loss (wasted expenditure) but there is no straight-jacket formula for the same. Therefore, it is important to keep these principles of remoteness, causation, and mitigation in mind, not only while assessing damages but also while entering contracts. It is always advisable that the contract or agreement between the parties be crystal clear when it comes to damages.

In conclusion, to ensure that an enforceable claim of liquidated damages arises at the end of hard-fought litigation, it is necessary to spend some time on the clause on such damages when it is being drafted and some due diligence should be done by the parties. The principles outlined above, come from some of the most important decisions on  this point in the jurisdiction and, if followed assiduously, will assist in ensuring  enforcement of a decree/award of amount as liquidated damages before the courts in India.

Footnotes

1. P. Radhakrishna Murthy v. NBCC Ltd (2013) 3 SCC 747.

2. Maula Bux vs. Union of India (UOI) (19.08.1969 - SC) : MANU/SC/0081/1969.

3. Oil and Natural vs. Saw Pipes Ltd. (30.07.2002 - BOMHC) : MANU/MH/1307/2002.

4. B.E. Billimoria and Co. Ltd. vs. Raheja Universal Private Ltd. (27.10.2015 - BOMHC): MANU/MH/2917/2015.

5. Herbicides (India) Ltd. vs. Shashank Pesticides P. Ltd. (13.05.2011 - DELHC) : MANU/DE/1804/.

6. Fateh Chand vs. Balkishan Das (15.01.1963 - SC) : MANU/SC/0258/1963.

7. Steel Authority of India Ltd. v. Gupta Brother Steel Tubes Ltd. MANU/ SC/1624/2009.

8. Bharat Sanchar Nigam Limited v Reliance Communication  Limited (2011) 1 SCC 394.

9. Hadley v Baxendale (1854) 9 Ex 341, Victoria Laundry (Windsor) Ltd. v Newman Industries Ltd [1949] 2 KB 528 ; Koufos v C. Czarnikow Ltd. (The Heron II) [1969] 1 AC 350 ; Sprint Electric Ltd. v Buyer's Dream Ltd. and Anorr (24.07.2020 - UKCH) : MANU/UKCH/0358/2020.

10. The Andhra Pradesh Mineral Development Corporation Ltd. vs. Pottem Brothers (04.02.2016 - HYHC) : MANU/AP/0013/.

11. State of Kerala v. K. Bhaskaran, MANU/KE/0011/1985 : AIR 1985 Ker 49.

12. M.N. Gangappa  v. Atmakur Nagabhushanam Shetty & Co. and Anr. AIR 1972 SC 696.

13. McDermott International Inc. v. Burn Standard Co. Ltd. & Ors.: MANU/SC/8177/2006 : (2006) 11 SCC 181.

14. J.G. Engineers (P) Ltd., Vs Union of India (2011) 5 SCC 758.

15. Indian Oil Corporation Vs.  Messrs  Lloyds Steel Industries Limited 2007 (144) DLT 659.

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.