Image source - https://bit.ly/3fqJfJ5

This article is written by Nikhil Sharma who is pursuing a Certificate Course in Commercial Contract Law, Drafting and Negotiation from LawSikho.

Introduction

The primary purpose of any contract is to contrive rights and liabilities between the parties who wish to enter into an indenture. Now, these rights and liabilities are two sides of the same coin. In an ideal world, every term of the contract will run smoothly as planned. However, in reality, the breach of terms of the agreement is a common occurrence and it is quite ubiquitous that the terms of contract getting derailed and the party suffering loss due to certain events or due to the actions of the other party. To compensate for the loss to the party, damages are to be given by the defaulting party to the injured party. 

Under the Indian Contract Act, the word ‘damages’ is understood as compensation under a contract paid by the defaulting party to the non-defaulting party, which are awarded to the non-defaulting party to compensate for actionable wrongs of the former.

The provision related to damages is provided under Section 73 and Section 74 of the Indian Contract Act, 1872. Through the interpretation of these provisions by the judiciary, various types of damages have been classified such as general damages, nominal damages, aggravated damages, liquidated or unliquidated damages. Under these classifications lies consequential damages, this article will emphasize the propounded tests and principles related to consequential damages and to what extent the consequential damages are considered while awarding the damages.

Consequential Damage: Meaning

As the name suggests consequential damages are the compensation awarded for the injury/loss suffered by one party due to the consequence of the breach of the terms of the agreement. Consequential damages are mainly associated with (although not limited to it) with the pecuniary loss suffered by the party such as the delay in prospective profits if the breach would not have occurred or the expenses incurred by the injured party in order to rectify the injury or harm caused due to the breach of agreement (associates, 2017). One of the fundamental conditions necessary to claim Consequential damages is that it should not be remotely related to the breach but it should be manifest and certain in the eyes of any prudent man that such pecuniary loss or expenditure in incurred due to the breach of the agreement by the defaulting party. Some important aspects which are needed to be ascertained while determining the scope of consequential damages are:

  • Proximity/natural consequence: The first thing which is needed to be ascertained by the courts and established by the plaintiff is that the loss for which the plaintiff is claiming damages arose due to the consequence of the breach of contract. It is evident from the perusal of Section 73 of the Indian Contract Act, 1872 that the aggrieved party cannot seek damages for any remote or indirect loss. To ascertain the proximity the principle of the remoteness of damages is applied. As described under the Indian Contract Act, 1872 the scope of damages, it is imperative for an award of damages is that the loss or damage “arose in the usual course of things from such breach; or parties knew that such a loss or damage could subsequently arise at the end of the time of entering into the contract.” Thus, the defendant would not be liable for damages that are remote to the breach of contract. In the landmark case of Hadley v. Baxendale, the principle governing remoteness of damages was elaborated. The rules enunciated in this case were that a party injured by a breach of contract can recover only those damages that either should “reasonably be considered…as arising naturally, i.e., according to the usual course of things” from the breach or might “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.” (1854, p. Hadley vs Baxendale).

In Forward Foundation, Bangalore & Ors. Vs State of Karnataka & Ors., the same notion to determine the proximity was reiterated and court held that losses are of two types; one which is general damage arising out of breach of terms of agreement and the other one is the apparent profit loss and expenditure incurred as the consequence of breach, can be claimed by the aggrieved party given that it should not be remote (Forward Foundation& Ors. Vs. State of Karnataka & Ors., 2014).

In Reliance General Insurance Co. Ltd. vs. Anish Sebastian it was a special case because in this case, the court in a good manner elaborated on the concept of the difference between direct damages and consequential damages as loss/expense incurred outside of the contract. Furthermore, it enunciated the ambit of consequential damages as loss of profits, loss of value of the product (Depreciation), the loss of time or damage to reputations. While considering the time factor in this case the court held that the denial of claim and repudiation of insurance claim resulted in the laying of the vehicle in the workshop in the damaged condition has deteriorated the entire value of the vehicle.  Hence the complainant is entitled to the entire value of the vehicle (Reliance General Insurance Co. Ltd. vs. Anish Sebastian, 2015).

  • Reasonable Contemplation: In order to understand the remoteness of damage, the first thing which is needed to be determined is whether such loss on the event of a breach was contemplated or anticipated by the party while entering into a contract. When the terms of the agreement are formulated the parties envisage the possible/potential outcomes arising out of the breach of contract. If such loss for which the consequential damages are claimed, was genuinely contemplated by both the parties, then the defendant party cannot evade liability to pay consequential damages by saying that such loss was remote or indirect. This is the unique thing about consequential damages, that even after the apprehension of the possibility of such loss, it is not explicitly mentioned in the contract but the claim can be raised for such loss because it seems plausible to seek damages for such loss. So ultimately this is where the question of remoteness of damage lies by determining whether such loss can be apprehended by a prudent human (Jha, 2018).
  • But For Test: To establish the connection between default committed and loss is suffered is the necessary concomitant for claiming damages, the breach has to have the real and effective cause for the loss. So basically, the impact of the breach which transcends actual loss and causes other ancillary damages closely related to the subject matter of contract can be recovered in the name of consequential damages. To ascertain the link between breach and injury, the English Courts introduced the “But For” test. In this test, the court discerns on a simple question, whether the loss would have taken place if it weren’t for the wrongful acts/omission by the defendant. The test was first applied in Reg Glass Pty Ltd v. Rivers Locking Systems Ltd, the defendant did not insert the locks on the doors in accordance with the terms of the agreement, later a robbery took place in the house of the plaintiff. The court held that if it weren’t for the defendant’s failure in putting locks in accordance with the agreement the robbery could have been precluded (associates, 2017).

The same test of “but for” test was applied by the Hon’ble Supreme Court of India in a landmark case  “but for” test, the Hon’ble Supreme Court had stated that neglect of duty of the defendant to keep the goods insured resulted in a direct loss of claim from the government (there was an ordinance that the government would compensate for damage to property insured wholly or partially at the time of the explosion against fire under a policy covering fire risk). The Supreme Court concluded that “But for the appellants’ neglect of duty to keep the goods insured according to the agreement, they (the respondents) could have recovered the full value of the goods from the government. So there was a direct causal connection between the appellants’ default and the respondents’ loss.” (Pannalal Jankidas v. Mohanlal and Another AIR 1951 SC 144, 1951).

  • Principle of Mitigation: This principle imputes responsibility on the plaintiff to take all reasonable actions to mitigate the effect of injury/loss caused by the default of the defendant. In M Licha Setty & Sons Ltd. vs. Coffee Board Bangalore, the Supreme Court held that the principle of mitigation is not a defense for the defaulting party to absolve itself from the liabilities but the principle is considered while the courts ponder upon quantifying and assessing the damages.

In this case, it was held that the plaintiff has a duty to prevent any further damage/injury due to the breach of contract and in order to preclude further injury the plaintiff shall take all reasonable steps to mitigate the loss and if the plaintiff itself is negligent or ignorant of mitigating the negative impact of the breach of contract then will not be entitled to receive damages for such injury, which he could have prevented with certain actions. Whether the plaintiff has taken reasonable actions will be decided by the courts because such an issue is not a question of law, but it is a question of facts which will vary in different cases. He must act reasonably not only in his own interest but also in the interest of the defendant and lower the damages by acting reasonably in the matter (M Licha Setty & Sons Ltd. vs. Coffee Board Bangalore, 1981).

Conclusion

Often the misgivings of an executed contract show up at the time of disputes; especially when rights and obligations are contrived by the virtue of contract and subsequently non-performance/default can have an overarching impact than what parties contemplate while negotiating the terms of the agreement. This is more probable when more than two parties are involved, and the terms are convoluted. However, if the parties discern properly, negotiation prior to a contract can play a pivotal role in determining the scope and extent of liabilities in the event of a breach.

References

associates, N. D., 2017. Law of Damages in India. pp. 13-17.

Forward Foundation& Ors. Vs. State of Karnataka & Ors. (2014) AIR. 

headley vs Baxendale (1854). 

Jha, A., 2018. Laws For Recovery Of Damages. Singh&Assosiates.

M Licha Setty & Sons Ltd. vs. Coffee Board Bangalore (1981) Supreme Court Reporter.

Pannalal Jankidas v. Mohanlal and Another AIR 1951 SC 144 (1951) AIR. 

Reliance General Insurance Co. Ltd. vs. Anish Sebastian (2015). 


LawSikho has created a telegram group for exchanging legal knowledge, referrals and various opportunities. You can click on this link and join:

Follow us on Instagram and subscribe to our YouTube channel for more amazing legal content.

Did you find this blog post helpful? Subscribe so that you never miss another post! Just complete this form…

LEAVE A REPLY