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Compensation for loss or damage caused by a breach of contract : can parties limit their liability

November 10, 2021
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This article is written by Warisha Solanki, pursuing Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution from LawSikho. The article has been edited by Prashant Baviskar (Associate, LawSikho) and Smriti Katiyar (Associate, LawSikho).

Introduction

A contract is a legal promise to perform certain obligations According to Section 2(h) of the Indian Contract Act, 1872 “An agreement enforceable by law is a contract.” An agreement by two private parties that create mutual legal obligations. A contract can be either oral or written, when one party breaks such a promise the other party can claim for losses caused by the breach of contract.

The following remedies are available to each party

Damages

Remedy by the way of damages is the most common way available to the injured party. This entitles the injured party to recover compensation for the loss suffered by him due to breach of contract from the party who caused the breach. Section 73 to 75 incorporates the provisions in this regard. Every breach of contract entitles the injured party to claim damages for the loss he has suffered. The aggrieved party can recover damage by way of compensation for loss suffered by his due to breach of contract. 

Quantum meruit

Literally translated to “as much is earned”. Where a party has in the performance of his contractual obligation done some work or rendered some service and further performance has been prevented by the other party as a breach on his part then in such case the aggrieved party plaintiff is entitled to reasonable remuneration under it.

Specific performance

A party in breach actually has to carry out his duties according to the contract. In certain cases, the court may insist that the party carry out the agreement. If any of the parties fails to perform the court may order them to do so. In this case, a specific decree of performance is granted instead of damages.

Injunction

It is basically a decree for specific performance but for a negative contract. An injunction is a court order restraining a person from doing a particular act. Therefore, a court may grant an injunction to stop a party to a contract from doing something he promised to do.

The first remedy (damages) will be discussed in some detail below.

Damages

Damages in simple terms refer to a form of compensation due to breach, loss or injury. Damages are popularly granted in cases of tort or breach of contract. Section 73 of the Indian Contract Act deals with damages arising upon the breach of contractual obligation, resulting in losses to the aggrieved party. Damages refer to money paid by one side to the other; it is a legal remedy. A party who breaches the contract is liable to compensate the injured party for loss or damages caused by the way of breach of contract

Damages under section 73 are compensatory and not penal in nature. 

Types of damages

Ordinary damages

On the breach of contract, the suffering party may incur some damages arising naturally in the usual course of events. If the contract was breached he can claim compensation for such losses.

Special damages

A party to a contract might receive a notice of special circumstances affecting the contract. In such cases, if the contract is breached then he is liable for ordinary damages plus special damages.

Exemplary damages

There are two scenarios for such damages:

• Breach of promise to marry because it causes injury to his/her feelings.

• Wrongful dishonour of cheque by banker because it causes loss of reputation and credibility.

Nominal damages

If a party to a contract files a suit for losses but proves that while there has been a breach of contract he has not suffered any real losses the compensation for nominal damages is awarded for such damages.

Damages by delay

In case where the goods are being carried by transport and he delays the delivery of goods causing them to deteriorate the affected party can file a suit for such damages caused by delay.

Pre-fixed damages

During the formation of a contract, the parties might stipulate payment of a certain amount as compensation upon breach of contract. This amount can be a reasonable estimate of the likely loss in case of breach of contract.

Remoteness of damages

The rules on the remoteness of damage in the contract have been discussed in the judgement of  Hadley v. Baxendale. It  is considered to be the basis of law to determine whether the damages are a proximate or remote consequence of the breach of contract:

  1. When the nature of the damage is as may fairly and reasonably be considered to arise naturally from the breach of contract. In other words, the loss or damage must be proximate damage arising naturally in the usual course from breach of contract.
  2. Such damage or loss is reasonable in the contemplation of both the parties at the time they made the contract if a breach happens. The parties to the contract must know that if a breach takes place such damages can arise.

Under this branch of rule, compensation can be claimed for any loss damage that arose in the usual course of things from any breach of contract.

In Hadley v. Baxendale, the working of the plaintiff mill was stopped by the breakage of the crankshaft and it was necessary to send the crankshaft to the makers. The defendant who was the carrier undertook the delivery of the shaft to the makers. The only information given by the plaintiff mill owner was that the article was to be carried. Due to some neglect of the carriers, the delivery of the shaft to the makers was delayed and the production of the mill remained shut for a longer time than it could have been, had the shaft been delivered without any delay. 

It was held that the circumstances as well as the information to communicate with defendants were not sufficient to show that the mere delay in the delivery of the shaft could be a loss of profits to the mill owner. The plaintiff might have had another shaft in reserve. As such it was beyond the contemplation of the defendant that mere delay would cause loss to the miller.

Accordingly, the plaintiff mill owner could not recover damages for the loss because the special circumstances involved were never communicated by the plaintiff to the defendant.

Measure of damages 

Once it has been recognised that a certain loss arising out of breach of contract is direct and proximate and not remote then the plaintiff is entitled to recover the damages. The object of awarding damages to the aggrieved party is to put him in the same position in which he would have been if the contract had been performed. Damages are therefore assessed on that basis.

Limitation of liability 

A ‘limitation of liability’ or ‘liability’ clause, is defined as a disclaimer for a contract that limits the conditions under which the breaching or the disclaiming party may be held liable for loss or damages. Limitation of liability is of fundamental importance in managing and allocating risks in commercial contracts. They are often the subject of intense negotiations between the contracting parties to exclude certain types of losses or set a financial ceiling for contracting parties total liability. One should consider the following factors when negotiating limitation of liability clause:

  1. The value of the contract,
  2. The role and responsibilities of the parties,
  3. The potential risks and liabilities, and
  4. The relative bargaining powers of the parties.

A well-drafted clause enables both parties to balance their risks with the benefits of the contract. There are several types of legal liabilities to be aware of including:

  1. Breach of contract- One contracted party does not deliver as per contractual obligation.
  2. Negligence- A failure to meet the reasonable duty of care caused harm to somebody else.
  3. Misrepresentation- False claims about goods or services result in the termination of the clause.
  4. Infringement of intellectual property right- One party infringes the copyright design right, patents or trademark of another.

It is important to understand the typical limitation of the liability clauses and pay particular attention to them.

Conclusion

Thus, where a sum is named in a contract as a liquidated amount payable by the way of damages, the party complaining about the breach can receive as reasonable compensation such amount only if a genuine pre-estimate of damages is fixed by both the parties can be found by the court. It is the nature of the damage clause that needs to be considered that is whether it is genuine damage or loss of profit by looking at the circumstances and the remoteness of damages and measure of damages.

References

  1. http://docs.manupatra.in/newsline/articles/Upload/30C28D5D-262B-4A4A-AE17-C4D86F92BCE0.pdf
  2. https://www.complybook.com/blog/quantum-meruit-under-the-contract-act-1872
  3. https://www.findlaw.com/smallbusiness/business-contracts-forms/what-is-specific-performance-as-a-legal-remedy.html
  4. https://www.indiafilings.com/learn/what-is-an-injunction/#:~:text=An%20injunction%20is%20a%20remedy,penalties%20or%20contempt%20of%20court.
  5. https://www.owlgen.in/explain-ordinary-damages-special-damages-exemplary-damages-and-quantum-meruit/#:~:text=Ordinary%20damages%20are%20 damages%20which,be%20described%20as%20ordinary%20damages.
  6. https://www.legalmatch.com/law-library/article/special-damages-in-breach-of-contract.html
  7. https://www.nishithdesai.com/fileadmin/user_upload/pdfs/Research_Papers/Law_of_Damages_in_India.PDF
  8. http://www.delaydamages.com/
  9. https://www.casebriefs.com/blog/law/contracts/contracts-keyed-to-farnsworth/remedies-for-breach/hadley-v-baxendale/

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