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All you need to know about assessing damages for breach of contract

August 5, 2021

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This article is written by Aakriti Bansal who is pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from Lawsikho.

Table of Contents

Introduction

With the rapid increase in corporate and commercial transactions in our growing economy and other allied areas, contracts have assumed increased importance. It is nonetheless inevitable that with contracts governing almost all forms of transactions and other relations between parties, the disputes arising out of them have also increased.

In situations wherein the Parties fail to honour the obligations set forth in the contract governing their relation, it is essential to evaluate the resources and remedies available in such situations. One such recourse provided under law is that of Damages in lieu of breach of a contract.

Damages have to be determined keeping in mind a lot of factors, thus this article will aim to systematically list down all the key factors to be kept in mind while assessing damages and will critically examine the same through the help of statutory provisions, case laws and illustrations.

Breach of contract and statutory provisions

Taking the aspect of breach of contract under consideration, the very foremost essential for breach of contract to happen is the existence of a valid contract.

A contract is an agreement that binds parties and obligates them to perform certain specified tasks as envisaged in the agreement between them. The term contract is defined in the Indian Contract Act, 1872 under Section 2(h) as “An agreement which is enforceable by law”.

From the definition it is clear when the agreement becomes enforceable by law, it transforms into a contract, creating legal obligations for the parties. There are certain essential defined under the Indian Contract, 1872 which need to be met in order for a contract to qualify as a valid contract. Some of these conditions are offer and acceptance, the intention of parties to create a legal obligation, consideration, and consensus among other essentials.

Section 39 of the Indian Contract Act, 1872 gives out the concept of “breach of contract”. Although this Section doesn’t use the term breach of contract, yet the conditions set out form the basis of a breach of contract.

According to this Section, breach of contract happens when the party to a contract refuses or has failed or omits or disables himself, to perform his part of the promise as set out in the contract between the parties.

This may put an end to the contract unless the breaching party signifies on words or conducts his acquiescence in continuing to perform his obligations. It is basically a violation of the contract terms when one party fails to fulfil its promises.

Example:

A enters into an agreement with B to deliver certain goods to B within a period of 20 days, starting from the date of execution of the agreement. A fails to deliver these goods to B. There is a breach of contract on part of A.

A breach can be of various types, from material breach of contract wherein the breach is so grave in nature that it dishonours the entire purpose of the contract; to an actual breach of contract wherein, the party fully refuses to perform its part of the promise or an anticipatory breach of contract, wherein from the conduct of one party, its intention of non-performance can be clearly made out. Section 73 of the Indian Contract, 1872, further lays the provision for governing breach of contract; this is discussed in the next part of this article.

Remedies available in case of breach of contract

“Ubi jus, ibi remedium”, meaning that where there is a right there is a remedy. Thus, since a contract creates some rights in favour of the parties, in case of a breach there is always a remedy available.

There can be numerous remedies available in case of a breach of contract, depending upon the nature of the contract, the surrounding circumstances and the intention and position of parties. Some of these remedies are an award for damages, specific performance, restitution, and rescission, injunctions.

The Indian Contract Act, 1872, along with the Specific Relief Act, 1963, provides for various remedies in case of breach of contract:

Damages

This implies that compensation in monetary terms is provided by the breaching party to the party who has suffered loss or injury on account of the breach. Section 73 and Section 74 of the Indian Contract Act, 1872 lays down the provisions relating to the same.

Restitution

Restitution is a remedy that is used to restore the status quo of the injured party to the contract in a position before the contract or as if the contract never happened. For example, the breaching party can be directed to return the property of the injured party on account of the breach.

Rescission

Rescission happens when a contract is terminated on the order of the court. This remedy comes into the picture when the consent to contract is obtained via fraud or undue influence and the contract terms are detrimental to one party in such a case and it would only be justified to rescind the contract.

Specific performance

When monetary damages are not adequate to compensate the injured party, the court could direct specific performance of the contract under dispute. It basically means that the court could direct the breaching party to specifically perform his promise or some part of it. The provisions for the same are laid down in the Specific Relief Act, 1963.

Injunction

Injunction basically implies a restraint from breaching the contract by the other party. It is basically in the form of a court direction.

What are damages and their kinds

The term damages is not defined per se defined under the Indian Contract Act, 1872. However, in a common general sense, damages mean an award in terms of money to be paid by the breaching party to the injured party as compensation for the loss that it suffered on account of the breaching party’s default of the terms and conditions of the contract.

In the case of Common Cause v. Union of India, the Supreme Court of India, emphasized on the definition of Damages as, “Damages are the pecuniary compensation, obtainable by success in an action, for a wrong which is either a tort or a breach of contract, the compensation being in the form of a lump sum which is awarded unconditionally”.

There are three basic essential of damages that were pointed out by the Supreme Court in the case of Organo Chemical Industries v. Union of India;

The detriment caused to one party by the wrongdoing or not doing of another;
Reparation to be awarded to the injured party through the legal remedies; and
Determination of quantum on the basis of pecuniary compensation for the loss suffered and punitive addition as a deterrent.

Consequences of breach of contract

Section 73 to 75 of the India Contract Act, 1872, layout the provisions for consequences of breach of contract and for an award of Damages.

Compensation for damage due to breach of contract (Section 73)

When one party breaches the contract and another party suffers the consequences of such a breach, then the injured party is entitled to compensation. The compensation will not be given for any remote or indirect damage.

Example: A contracts with B, to buy an exclusive car for 5 crores rupees from B, on delivery of the car, B fails to make the payment, B is entitled to compensation.

Compensation for breach of contract where penalty stipulated (Section 74)

It might be possible that in some cases, the amount of compensation is envisaged under a clause in the contract itself, in case of a breach of contract. In such cases, the compensation should be paid which is not exceeding the amount already stipulated in the contract.

Example: X contracts with Y to supply lentils to Y on an agreed amount, in the contract it is stipulated that on the failure of any party to perform their obligations, the injured party will be liable to compensation of 5 Lacs. Thus, the compensation amount cannot exceed 5 Lacs.

Party rightfully rescinding contract entitled to compensation (Section 75)

A person who rightfully rescinds a contract under the Indian Contract Act, 1872 is thereby entitled to compensation for any damage that he might have suffered due to the rescission of the contract.

Kinds of damages

Unliquidated damages

Damages in the monetary form are awarded by the court after due assessment of the situation of the breach. This is provided for under Section 73 of the Indian Contract Act, 1872.

Liquidated damages

Damages that are stated and stipulated specifically in the contract are called liquidated damages; the amount is specified in the contract itself. This is provided for under Section 74 of the Indian Contract Act, 1872.

Ordinary or general damages

Section 73 of the Indian Contract Act, 1872 identifies general damages to mean the damages which naturally occurred in the usual course events or things from the breach that has been caused, or which the parties were sure would arise in the event of a breach.

Example: Anish decides to sell and transport 10 bags of potatoes to Ram for Rs 5,000 subsequently after two months. On the date of transfer, the rate of potatoes increased and Anish denies to complete his promise. Ram buys 10 bags of potatoes for Rs 5,500. He can receive Rs 500 from Anish as ordinary damages arising directly from the breach.

Special damages or consequential damages

Special damages can arise on account of unusual or differing circumstances affecting the injured party, which couldn’t have been foreseen and eventually result into consequential damages.

These damages are usually not recoverable unless the special varying circumstances are brought to the due knowledge of the breaching party, so the possibility of loss can be evaded by them.

Consequential Damages are losses above the general losses incurred due to the breach of contract and don’t directly flow from the act of the party but as a consequence of a wrongful act. They focus on the cost outside the contract as was held in the case of Reliance General Insurance v. Anish Sebastian.

Punitive damages

Punitive Damages refer to those damages which are a penalty to the breaching party in the form of punishment to act as a deterrent. Courts rarely award punitive damages in breach of contract cases. They are generally awarded in cases of torts.

Nominal damages

Nominal damages are basic to bare minimum damages awarded to the injured party who might not have suffered a heavy monetary loss due to the breach.

Factors to be considered while assessing damages

Causation

For a claim of damages to succeed and for the purpose of affixing liability on the defaulting party, there needs to exist a causal connection between the breach committed by the party and the loss or injury that has been suffered.

This causal connection is said to be established if it is the act of the defendant that has ultimately amounted to the breach of the contract and it is the only “real and effective” cause with respect to the injury or loss that has been incurred for which damages are being claimed.

For establishing a causal link, the courts follow various tests with consideration to the facts and circumstances of each case, out of which the most prominent test is the “but for” test, wherein the court seeks to determine whether the damage would have accrued but for the acts of the defendant.(Pannalal Jankidas v. Mohanlal, AIR 1951 SC 144)

If it is found out by the court that the breach of contract cannot be asserted to the acts of the defendant, it may decide in favour of not awarding damages in any form to the plaintiff.

Remoteness of damage

One of the vital requirements for an award for damages to succeed is to that the loss or the damage should arise in the normal or usual course of things from such a breach; or that the parties knew that such damage could arise, at the time of entering into the contract. Thereby, absolving the defendant of any liability that may have arisen as a remote consequence of a breach of contract.

This aspect is related to special or consequential damages as enumerated in the above Section. It was in the landmark case of Hadley v. Baxendale, that the principle of the remoteness of damage was laid down.

Damages for direct, consequential and incidental losses and damage

In the event of a breach of contract, besides the compensation that is payable due to the loss or the damage caused, the defendant is also liable to compensate for the damages that arise directly in consequence of such loss or damage.

For example, In a contract of construction by a builder, if the construction is so bad that it falls down and is to be rebuilt and subsequent to that it cannot be let out, the builder would be held liable to compensate for the expenses incurred in rebuilding along with the loss of potential rent. If the losses are reasonably foreseeable, they can be compensated for, be it consequential or indirect loss.

Damages for loss of profit

Usually, the defendant is accountable for the loss of profits that emerge directly from the breach of the contractual obligations. For instance, loss of normal profits due to delay in delivery of relevant material by the defendant can be covered under this head. However, if loss of profits, which are not direct consequences of the breach of contract, wouldn’t attract such damages.

Date of valuation for period of loss

For claiming damages for loss for any kind of profit, the period of loss and the date from which it is calculated become important factors for claiming damages. For instance, it might be possible that a person has incurred a loss of profit during his business, but he might not be functioning under an obligation to the contract, thus the other party is not liable to make good that loss during that period.

Future losses

Generally, future losses are problematic to determine than past losses and courts don’t tend to award compensation in the context of future losses. The more evidence there is of the ability to generate future cash flows and profits, the higher the chance there is that the court may award damages in such a situation. For there to be more evidence, it is important to keep copies of all transactions that take place between the parties and to even incorporate such a situation of future losses in the contract.

Damages for non-pecuniary losses

In normal circumstances, damages are usually as compensation for pecuniary losses incurred due to the breach of contract. There may arise situations wherein the plaintiff claims damages for non-pecuniary losses that might have been incurred to him. Courts are usually not inclined to award compensation for such losses however, damages for such nature can be awarded wherein the essence of the contract itself is relating to a non-pecuniary subject.(Ghazibad development Authority v. Union of India AIR 2000 SC 2003.)

For example, damages for mental anguish or suffering may be awarded in cases where the contract itself is for providing enjoyment, pleasure, like a contract of service to click pictures during a wedding ceremony( Disen v. Sampson (1971) SLT (Sh Ct) 49. ).

Mitigation

For an award of damage, it is necessary that the party which is claiming damages on account of the breach, itself was willing to perform its part of the promise under the contract or has already performed it. Therefore, the duty to mitigate losses is indispensable, prior to claiming damages. The party claiming damages has a duty to take all reasonable steps necessary to avoid such damages.

A party cannot just let the situation worsen without taking any affirmative steps on its part to avoid such a breach. The duty of implementing reasonable steps to alleviate the loss is supplemented by the duty to hold back from resorting to unnecessary means that would further aggravate such a loss(Burn & Co. Ltd. V. Thakur Sahib Lakhdirjee AIR 1924 Cal 42.). Thus, it is necessary to evaluate whether the party claiming damages undertook such steps or not.

For instance, a builder breaches a contract by failing to repair a leak in the roof of an office building and then when the owner of the property discovers the same, he let all his computer equipment sit there without shifting them, where he could have easily done that.

Later if the owner claims damages for damage to the computer due to the leaking roof, the court would dismiss his claim to that extent because he didn’t take any steps to mitigate the situation.

Contributory Negligence

Contributory negligence refers to a situation wherein the party claiming damages has itself contributed to the negligence that leads to the loss. The basic principle is that no one can benefit from his own fault. If the court finds that the plaintiff has contributed towards the breach, then the finding of contributory negligence can lead to a reduction in the award of damages.

For example, in a contract to repair a computer, if after reparation, the user uses it negligently and drops it and spills water on it, he has contributed towards the damage thus his claim of award for damages will be affected.

Measures and calculation of damages

The aim of an award of damages in case of breach of a contract is to restore the party against whom the breach has been committed in a position that would have persisted if the contract never took place. Therefore, the damages awarded cannot exceed the loss suffered by the party or are likely to be suffered by the party. The Supreme Court in the case of Murlidhar Chiranjilal vs. Harishchandra Dwarkadas had laid down two important principles with respect to the calculation of damages subsequent to breach of contract:

On proof of breach of contract, the claiming party is to be placed so far as money can do it in as good a situation as if the performance of the contract took place;

It is the duty of the plaintiff to take all reasonable steps to mitigate the loss incurred due to the breach, and he cannot claim any damage resultant of his failure to mitigate such a loss.

With respect to the time and place for assessment of damages, generally, the value of goods is calculated on the basis of where and when the goods were originally to be delivered under the contract or where and when such services were to be performed.

Interest on damages

Interest, despite the fact that it is statutory or contractual, depicts the profits the creditor might have made if he was in a position to use that money or the loss he suffered because he couldn’t use it (as held in the case of Dr. Shamlal Narula v. Commissioner of Income Tax, AIR 1964 SC 1878.).

Grant of interest in the case of a contractual breach greatly depends upon the terms and conditions of the agreement, the customs that govern those payments and the relevant provisions of the statutes.

Interests that are granted as damages would be calculated at the rate of interest that the person to whom it ought to have been paid would have got on it, if it had been paid per the terms of the contract. Section 34 of the Civil Procedure Code provides that rates for such interests shall not exceed 6%.

Taxation

If a compensation amount received as damages, qualifies as income under the Income Tax Act, 1961, then it may be liable to tax in certain situations. In a case where the applicable tax rate on profits is equivalent to the rate of tax on a damages award, then the damages claim may be calculated on a pre-tax (or grossed-up) basis. Care should be taken, however, to ensure that any claim for interest on the tax payable for the award is calculated in line with the underlying cash flows. Thus, the tax laws can affect the value of the award.

Conclusion

Many of the issues encountered by courts and experts in the assessment of damages are based on the above-laid criteria and factors, thus it is important to keep these points in not only while assessing damages but also while entering into contracts. It is always preferable, to whatever extent possible it is favourable to specify the number of damages in the contract itself, which saves a lot of litigation costs and effort and other resources of both parties. Thus, it is always suggested to do intense research before entering into contracts and draft the contracts with utmost diligence.

Reference

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All you need to know about assessing damages for breach of contract

Introduction

Breach of contract and statutory provisions