Introduction

1. In arbitrations, quite often parties employ all their strength and resources in proving the breach of contract. However, they may not always succeed in making a case for the quantification of damages claimed. This happens more often in cases where there is a clause for liquidated damages, wherein the parties believe that once the breach is proven, the liquidated damages follow. Years of jurisprudence has shown that this is not the case. In vast number of cases, the exact nature of the damages (such as loss of profit or non-exact assessment of losses) cannot (or are difficult to) be proved by the parties due to availability of limited documents to lend support on quantification of claims. With the benefit of only limited documents, how should the arbitral tribunal then decide the quantum of damages that may be awarded once the breach is established?

2. In light of the foregoing, this piece discusses the principle called 'honest guesswork' in light of certain cases which have recognized the power of the arbitral tribunal to perform an estimation and what could form part of such assessment for the arbitral tribunal. This piece will also highlight certain good practices that may be employed to persuade a reluctant arbitral tribunal to make such an assessment.

3. In addition to the above, this piece shall also show how commonly used formulas for quantifying loss of profit and loss of overhead claims can come to the aid of the arbitral tribunal in its guesswork. Specific reference, however, will also be made to a recent case of the Delhi High Court in SMS Ltd. v. Konkan Railway Corporation1 ("SMS Ltd.") wherein the Court set aside the award of the arbitral tribunal which quantified damages using a formula. Hence, an analysis of this judgment will also be done to understand, what the strategy may be to avoid such a conclusion if an award is challenged.

Honest Guesswork - The genesis

4. In two decisions of the Supreme Court of India ("SCI"), the genesis for the honest guesswork principle has been laid. In Mohd. Salamatullah v. Andhra Pradesh2 ("Mohd. Salamatullah") it was held that that guess of a trial court is the best guess on facts and evidence and the appellate court's guess is not supposed to substitute the guess of the trial court. In A.T. Brij Paul Singh v. State of Gujarat ("A.T. Brij Paul"),3 the SCI held that every contract for civil works will be made with expectation of profit and the claim for loss of profit is a legitimate claim for breach of contract. The SCI in A.T. Brij Paul also held that while estimating the loss of profit, it is unnecessary to go into the minutest of details.

5. In A.K. Sinha v. MTNL,4 ("AK Sinha") the High Court of Delhi ("DHC") was hearing an application under Section 34 of the Arbitration and Conciliation Act, 1996 ("Act") for challenge of an award. In this case, the arbitral tribunal had not awarded loss of profits for the breach of the contract. The petitioner argued that it is not necessary to prove loss of profit for grant of damages and that once the breach is proved, an honest guesswork may be undertaken by the arbitral tribunal. In support, the petitioner relied on the cases of Mohd. Salamatullah and A.T. Brij Paul. While the DHC agreed that an honest guesswork can be made to assess the damages for loss of profit, however, it also referred to the cases cited by the counsel for the petitioner and held that such an assessment cannot be made when no evidence is led by the parties.

6. Accordingly, in A.K. Sinha, the DHC approved the possibility of undertaking an honest guesswork for assessing damages but stated that the parties must lead appropriate evidence supporting their contention in order to make such an estimation or guess.

Actual loss caused - Section 73 of the Indian Contract Act, 1872 ("Contract Act")

7. The DHC in A.K. Sinha v. MTNL also referred to evidence led before the arbitral tribunal, by MTNL, which was relevant for establishing the absence of loss caused to the petitioner. The contract under which the claims were brought for arbitration was for laying of telephone cables using the trench method. MTNL reduced the scope of the contract substantially by way of reduction in the number of kilometres for which the cables were to be laid by this method. Hence, the petitioner instituted arbitration inter alia for loss of profit due to reduction of the scope of its work. However, in the alternative, the petitioner was given a contract to lay the cables using the advanced trenchless method which was more than sufficient to cover the losses caused under the original contract. Relevant paragraphs of the judgment are quoted hereunder:

4...

In any case, I find that this issue would not have much bearing on the facts of this case as I am more concerned with the two aspects which have been raised by the respondent before the Arbitrator and one of which shows that no loss of profits was caused to the petitioner. The first aspect is that the respondent has stated before the arbitrator by filing its affidavit by way of evidence that the same petitioner instead of doing the work in question was awarded work of cable laying by trenchless technology and if the value of both the works is taken i.e. the work performed in the contract in question and the new work of cable laying by trenchless technology, then the value of the work so done by the petitioner for which it would have earned profit is much more, than the value of the balance of the work not performed. I may note that the total value of the work under the subject contract is Rs.2,40,00,000/-. The evidence has been filed on behalf of the respondent before the Arbitrator that the present petitioner has in fact done work of the value of Rs.8,28,85,648/-. The relevant paragraph 10 of the affidavit by way of evidence dated 6.11.2007 of one Sh. S.K. Kapadia reads as under:

"10. I say that in the tender for open trench method he was awarded cable laying work for 600 kms cables length for a total value of Rs.24000000/-. I say that out of this, the claimant executed cable laying and other allied works work for a value of Rs.56,75,128/-. I further say that in the tender for trench less method the claimant was awarded cable laying work for 57.25 kms cable length for a total value of Rs.25565560/-. I say that the claimant was given additional wok and thus executed cable laying work by trenchless method for 178.689 kms cable length for a value of Rs.7,72,10,520/-. I say that in terms of value combined in both methods of work, the claimant was entitled to work of value of Rs.49565560/- only whereas work of value of Rs.8,28,85,648/- was given to the claimant, which is much more than the entitlement of the claimant under both the tenders."

...

6. The explanation to Section 73 is relevant and as per which merely because there is a breach of contract the aggrieved party is not entitled to damages unless it actually suffers loss. In the present case, it is clear that the petitioner was awarded work of much more value than the balance work which was not performed under the original contracts dated 1.3.2002. That being the position, the petitioner would have earned profit for the portion of the work done under the contracts dated 1.3.2002 and also for the new cable laying by trenchless technology. If that be so profits would have been in fact earned by the petitioner disentitling it to claim any compensation as loss of profits.

8. Hence, we see that the tribunal and the DHC took note of the legal position under Section 73 of the Contract Act which states that damages can only be granted if actual losses have been suffered by the non-defaulting party due to the breach of the contract. If alternate contract has been provided to the Claimant which reduces or extinguishes any losses caused to the Claimant, then the claim for damages under Section 73 of the Contract Act will not be available. The authors believe that this observation by the DHC in A.K. Sinha v. MTNL becomes relevant, while claiming loss of profit.

9. In relation to establishing claim of loss of profit, the test appears to be: (a) the non-defaulting party must prove that it had invested time and money towards performance of the contract in anticipation of receiving certain profits; (b) such profits could not be realised due to the breach by the defaulting party; and (c) the breach and the related losses could not be mitigated by the non-defaulting party.

Affirmation in subsequent decisions

10. In NHAI v. ITD Cementation5 ("NHAI") also, the DHC referred to the SCI's judgments in Mohd. Salamatullah and A.T. Brij Paul to state that the arbitral tribunal may undertake honest guesswork based on reasonable material available before the tribunal. In the NHAI matter, the arbitral tribunal had awarded damages for use of materials and labour during the extended period of time for completion of the contract, required due to the delay by NHAI. The award of damages was on the basis of percentages. The High Court affirmed the assessment done by the arbitral tribunal (consisting of 2 engineers and a retired judge) including the percentage arrived at for calculating damages and held that any other assessment or percentage was not warranted in the challenge stage by the DHC. The High Court however did not highlight the percentages that were used by the arbitral tribunal to award the damages for loss of profit. In this regard, the DHC highlighted that because the arbitral tribunal is not bound by the strict principles of Code of Civil Procedure, 1908 and the Indian Evidence Act, 1872, the use of honest guesswork by arbitral tribunals was justified. The court referred to the power of the arbitral tribunal under Section 19(4) of the Act to determine the admissibility, relevance, materiality and weight of any evidence.

11. The DHC reiterated the principle of non-interference in arbitral awards and stated that "before this Court interferes with an Award, it is necessary that the Award is illegal or violative of the contractual provisions or perverse. I do not find any perversity or illegality whatsoever in the approach of the Arbitrators who have after examining in detail the entire record made an honest guesstimate, which the Arbitrators were entitled to do."6 Hence, it is clear, that guesswork and estimation by the arbitral tribunal falls within the purview of appreciation of evidence and can only be set aside under Section 34(2A) of the Act which allows domestic awards to be set aside if the same is patently illegal.

12. Similar principles were affirmed by the Calcutta High Court ("CHC") in Bata India Limited v. Sagar Roy.7 In this case, the arbitrator was hearing the claims of the Claimant, Sagar Roy regarding unpaid dues from Bata India Limited regarding the renovation work done in Bata's office. While hearing the claims, the arbitral tribunal accepted the evidence and arguments of Bata India that Sagar Roy used material which was cheaper and inferior to the quality mentioned in the contract. Accordingly, the arbitrator employed honest guesswork and reduced the claimed amount by 15% since the exact quantity and price of the cheaper material used was not available. Such guesswork was not interfered with by the CHC as it could not sit in appeal over the honest guesswork made by the tribunal. It is pertinent to note that the CHC affirmed such estimation even though the underlying claims did not pertain to loss of profits or other non-exact claims. This also opens up the possibility of using honest guesswork in areas other than for loss of profits and overheads claim, as long as the breach has been established and appropriate evidence has been put forth to help in quantification of the loss caused.

Use of Formulas for granting damages

13. In civil construction matters while such guesswork becomes necessary there have also been several formulas devised over the years, to adequately estimate the loss caused or the damages that the courts or tribunals can award. For instance, the Hudson Formula, the Emden Formula and the Eichleay Formula. The use of such formulae was affirmed by the SCI in McDermott International Inc. v. Burn Standard & Co.8 The SCI held in this case, that once the breach is established, the manner of computation of damages can be done by use of internationally accepted formulae and the same is within the domain of the arbitral tribunal. The SCI referred to the aforesaid formulae and held that one or the other technique may be used based on the facts and circumstances of the case.

Use of a vague formula and awarding damages contrary to evidence

14. The conspectus of decisions cited above would give sufficient cushion to the arbitral tribunal to make assessment of damages. However, in SMS Ltd.,9 the DHC concluded that the manner of quantification of damages by the arbitral tribunal was perverse and contrary to the evidence before the arbitral tribunal.

15. In SMS Ltd.,10 the arbitral tribunal had created a formula called 'notional proportional loss' and used it for the grant of damages. Under this formula, it shared the costs of the machinery equally between the parties and hence granted only 50% of the loss of idling to SMS Ltd., when the contract between the parties clearly showed that the responsibility and costs of the machinery was entirely on the contractor/SMS Ltd. Further, the arbitral tribunal had also made certain assumptions as to the period for which the loss had been caused, which in the opinion of the DHC, was unreasonable as Konkan Railway Corporation had stalled the removal of the machinery and the labour of the Claimant from the site. The DHC found the award patently illegal and set it aside under Section 34(2A) of the Act.

16. In February 2021, in the case of BSF Commandant and Anr. v. Applied Communication and Controls,11 ("BSF Commandant") the DHC heard a challenge against an arbitral award inter alia for the claim for loss of profits allowed by the arbitral tribunal for the illegal termination of a contract for supply of fogging machines to the Indian Army. In this case, evidence was led to show the fair market cost price of the product supplied and the percentage profit margin of 10% and overheads at 20% that was usually charged by the supplier. However, the selling price calculated, based on the aforesaid information was not the price at which the goods were supplied. The supplier had rather given a discount on the selling price. The arbitral tribunal, however, had awarded loss of profits of 10% based on the regular selling price and not the selling price after discount. The DHC held that such a calculation of loss of profits was not correct. It then went on to state that the overheads component was enough to accommodate the discount and it would not reduce the profit margin. Finally, the court quantified the profit based on the profit percentage on the discounted selling price and not the original selling price and set aside the award of loss of profits to the extent that it exceeded such calculation by the DHC. This judgment gives further guidance as to the path to be taken to quantify a claim for loss of profit. Oral evidence can be led to show the margins generally kept for profits and for overheads. Another fact that became relevant was regarding the discount that was given and how the same would affect the profit margin of the supplier of goods and its subsequent claim for loss of profits in case of a breach by the opposite party.

17. Hence, a combined reading of the judgment in SMS Ltd. and BSF Commandant makes it clear that the arbitral tribunal must be mindful that the award of damages should not be contrary to the evidence led before it (in particular the underlying contract between the parties). While it is prudent and safe to use an internationally recognized formula to assess damages for loss of profits, such a practice must not discourage the arbitral tribunal to employ new / modified methods for calculating damages as long as such method remains inherently consistent with the evidence and the underlying contract. The SMS Ltd ruling should not be construed as a ruling by the court against use of self-made formulas but rather a critique of awarding damages contrary to the evidence before it.

Indicative/suggested strategy for making claims

18. In light of the above discussions, we have set out below certain indicative best practices that may be implemented towards establishing the claim of loss of profit:

  1. Show evidence to support the profit percentage in the bid made for the contract. The fact that the contractor generally keeps and makes a profit margin of 'X' percent in its contracts and is able to successfully achieve the same would be relevant.
  2. Show the alternate opportunities that were available to the contractor which it left to take up this contract.
  3. Highlight the fact that the Code of Civil Procedure and Evidence Act, 1872 are not applicable to arbitration governed by the Act and that the arbitral tribunal has the power to determine the admissibility, relevance, materiality and weight of any evidence under Section 19(4) of the Act.
  4. Cite the judgments quoted in this piece to give the tribunal the support to quantify and award damages as per its own assessment if exact amount of damages are not quantifiable.

Footnotes

1. SMS Ltd. v. Konkan Railway Corporation MANU/DE/1029/2020; O.M.P. (COMM) 279/2017, High Court of Delhi, decided on 11.05.2020 available at http://164.100.69.66/jupload/dhc/YKH/judgement/11-05-2020/YKH11052020OMPCOMM2792017_143426.pdf

2. Mohd. Salamatullah v. Andhra Pradesh (1977) 3 SCC 590

3. In A.T. Brij Paul Singh v. State of Gujarat (1984) 4 SCC 59

4. A.K. Sinha v. MTNL, OMP No.457/2008 Delhi High Court Decided on 30th October 2009 available at http://164.100.69.66/jupload/dhc/VJM/judgement/06-11-2009/VJM30062009OMP4572008.pdf

5. NHAI v. ITD Cementation O.M.P. No. 27/2010, Delhi High Court, decided on 22.01.2010 available at http://164.100.69.66/jupload/dhc/VJM/judgement/01-02-2010/VJM22012010OMP272010.pdf

6. NHAI v. ITD Cementation O.M.P. No. 27/2010, Delhi High Court, decided on 22.01.2010 available at

7. Bata India Limited v, Sagar Roy, A.P. No. 5 of 2013, Calcutta High Court decided on 29.10.2014 available at https://www.calcuttahighcourt.gov.in/Order-Judgment-PDF/O/AP_5_2013_29102014_J_217.pdf

8. McDermott International Inc. v. Burn Standard & Co. (2006) 11 SCC 181

9. SMS Ltd. v. Konkan Railway Corporation Limited O.M.P. (COMM) 279/2017 Delhi High Court decided on 11.05.2020

10. SMS Ltd. v. Konkan Railway Corporation Limited O.M.P. (COMM) 279/2017 Delhi High Court decided on 11.05.2020

11. BSF Commandant and Anr. v. Applied Communication and Controls, O.M.P. (COMM) 21/2021 Delhi High Court decided on 24.02.2021

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.