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Contractual breach and calculation of damages

October 23, 2021
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This article is written by Aparna Jayakumar, an Advocate at The Bar Council of Delhi. This article exhaustively discusses the contractual breach and the ways of calculating damages arising out of the breach.

Introduction

The Indian Contract Act, 1872, which is primarily based on English common law, regulates the law of contracts in India. The word “contract” is described in the Act as a legally binding arrangement. In other terms, it is a voluntary, legally enforceable, and binding arrangement between two or more competent parties for consideration and reciprocal obligations. The majority of commercial transactions are successfully and efficiently completed by contracts in today’s competitive market climate.

The parties of a contract face a risk of “breach of contract” when they enter into the contract. Such risk arises when any of the parties fail or refuse to perform the obligations as promised under the contract. A breach of contract is a failure, without any legal excuse, to perform any or a part of a promise that forms all or a part of the contract. Any party who has broken or failed to comply with the promises under the contract is liable to compensate or fulfil the damages and loss caused to the suffered party. Such remedial provisions are provided under Part VI of the Indian Contract Act, 1872.

However, Part VI of the Act does not deal with the method of computation and calculation of the damages arising out due to the breach of the contract. In M.N. Gangappa v. Atmakur Nagabhushanam Setty & Co. and Anr, 1972 the Apex Court held that the damages shall be computed taking the facts and circumstances in mind and for such computation, strict legal obligation, not the expectation must be considered. In this article, we will discuss the methods for calculating the damages arising out of a contractual breach. Compensation for failure to fulfil contractual obligations similar to those set out in the contract. Every person who fails to discharge a duty equivalent to what was established in the contract is entitled to the same reimbursement from the party in default as if that person had contracted to discharge it and had breached his contract.

Contractual Breach

The contract exists in the form of a legally binding agreement supported with some consideration, for the violation or non-binding of which damages as a remedy is available. The term “breach of contract” arises when a party or parties in the contract contravene the terms of the contract, break the promise, or don’t follow the terms and conditions in a manner as provided in the contract.

Section 39 of the Indian Contract Act defines the breach of contract as ‘when a party has refused to do or disable himself from performing his promise, this promise may put an end to the contract unless he has signified by words or conducted his acquiescence in its continuance. It means that if a party to the contract has promised to perform his obligation, and he fails to do the same, it is said that he has made a breach of contract.

For example- C is a builder who enters into a contract with his client B to construct a rectangular house of 1200 sq. feet having 4 windows and 2 doors. C builds a house of 1180 sq. feet with 3 windows and 1 door, violating the terms of the contract. Here, B is entitled to the damages for the losses incurred in conformity with the contract. 

The contractual agreement is based on the Latin maxim ‘Ubi jus, ibi remedium’ which means ‘where there is a right, there is a remedy’. So, the contract has a set of correlative rights and obligations for the respective parties to perform. In case there is a breach of contract, the remedies arise for the enforcement of such rights. In absence of remedies for the non-performance or violation of the contractual terms, the rights and obligations for the parties shall be of no value.

The party who commits a breach of contract is known as the “guilty party” whereas the party who suffers the loss is known as the “aggrieved party or injured party.”

Damages

Parties usually discuss and compromise on the various remedies that the injured party may invoke to mitigate and compensate for the damages it might suffer as a result of any violation as a measure of safeguarding, securing, and protecting their respective interests in the event of a breach of the contract’s terms. In other words, any infringement of the contract’s terms and conditions by any party (“Defaulting Party”) entitles the other party (“Non-Defaulting Party”) to sue the defaulting party for damages and/or other remedies. The Indian Contract Act does not describe the word “damages.”

The term ‘damages’ refers to the monetary compensation to the aggrieved party in a contract for the losses, injury, or damages caused by the guilty party. The quantum of the damages caused is determined by the magnitude of the damages caused to the injured party due to the breach of contract. As the injured party suffers loss or inconvenience so, if the matter for damages reaches the court it would want the victim party to accept his mistake and pay adequate compensation to the affected party for the damages. 

The principle behind the damages is explained by Fuller and Prude, the expectation interest, also known as performance interest, refers to putting the suffering party in a position where he would have been if the promise would have been fulfilled.  The reliance interest is also known as the status quo interest seeks to restore the position of the injured party where he was before the promise was made and in the course of which the promise altered his position by putting reliance over the promise. The restitution interest tends to prevent the defaulter promiser from gaining due to the loss caused to the promisee. Section 73 and Section 74 of the Indian Contract Act envisage the provisions of the contractual damages. Section 73 deals with the “general or unliquidated damages” whereas Section 74 deals with the “liquidated damages”. Since the contractual breach is civil, the purpose behind the damages is to compensate the injured party for the loss and not to punish the victim party.

Determining damages for different kinds of breaches 

To determine the amount of damages, the injured party must show that the breach of contract caused him or her financial losses. Before the court, the injured party (plaintiff) must determine the type of damages he or she is seeking. The court considers whether the violation is major or minor. In certain cases, the courts can grant damages that go beyond the traditional definition of compensation. Nominal damages, aggrieved damages, and restitution damages are forms of non-compensatory damages. The principles of remoteness, causation and mitigation apply to damages for breach of contract. We will now examine the Indian courts’ approach to assessing damages.

  1. Remoteness of Damages

The provision under Section 73 of the Indian Contract Act provides ‘loss or damages occurred in the usual course of things in a contractual breach’ as one of the important requirements for awarding the damages. So, the victim party (defendant) shall not be liable for the damages that are remote to the breach of contract. In a landmark common law case of Hardley v. Baxendale (1854), the principle of remoteness was described. The rules enumerated in this case was that the injured party can only ask for the recovery of damages where the damages are fairly and reasonably arising out naturally from the usual course of things; or supposed to have been reasonably in contemplation of both the parties at the time of the execution of the contract, as its probable breach. 

Now, in case the contract was executed under special circumstances and such circumstances were communicated to both parties, in such a situation the breach shall reasonably contemplate the injury as the special circumstances were duly communicated to the parties in the contract. But, if the party causing injury is fully unaware of the special circumstances and the damages arise out of the breach, such damages shall put the guilty party at an advantage depriving the other party.

In this case, the special circumstances were never communicated by the plaintiff to the defendant which resulted in losses to the plaintiff.  So, it was held that if the plaintiff proves that the defendant was in the knowledge of the special circumstances arising in the contract, the latter will be liable for the damages for the losses. However, if the defendant assumes the risks evolved under the special circumstances under the contract as a reasonable man would have, such assumption shall not be deemed as the communication of the special circumstances to the defendant and not make him liable for any breach.

The Indian Courts have also adopted this evolving jurisprudence while deciding the case on similar issues. The Kerala High Court in State of Kerala v. K. Bhaskaran (1984) held that the defendant shall be liable only for the natural and proximate consequences of breach or those consequences which were in the contemplation of the parties at the time of contract. The party guilty of breach shall be liable only for reasonably foreseeable losses that a prudent man possessing similar information during contract would have reason to foresee the future breach.

  1. Causation

Causation refers to the causal connection between the breach committed and the injury or losses suffered. The casual connection is said to be established if the defendant’s act amounting to a breach of the contract is a “real and effective” cause of the injury or damages claimed. In cases where multiple causes are present, the “dominant and effective” cause shall be taken into consideration.

Depending upon the facts and circumstances, the courts use several tests to establish a causal link. The “But-for” test is one of the most important tests used by the courts to determine whether the damages have accrued ‘but for’ the acts of the defendants. This test has been adopted in the case of Reg Glass Pty Ltd v. Rivers Locking Systems Ltd. (1968) where the defendant failed in installing the door and security system lock as per contractual norms. The plaintiff’s property was stolen and he claimed the damages from the defendant. The High Court of Australia held the defendant liable as the theft would not have happened if the defendant would have installed the locks and the security system as per contract.

In India, the Supreme Court has adopted the “but for” test in the case of Pannalal Jankidas v. Mohanlal and Another (1950). In this case, the ordinance stated that the government shall fulfil fully or partially the losses incurred due to fire explosion to the party who has got his property insured under the fire risk policy. The Apex Court stated that it was neglect on the part of the defendant to keep his goods insured as it led to his loss of claim from the government. The Court further held that as the appellant’s neglect of duty to get his goods insured was stated in the agreement, so the respondent could have recovered the full loss from the government. Hence, there was an established causal connection between the appellant’s default and the defendant’s loss.

However, in every case, the establishment of a connection shall not make the defendant liable as sometimes the causal connection is broken by the third party action or negligence on the plaintiff’s part. So, in such cases, the damages claim of the plaintiff shall be repudiated.

  1. Mitigation

The term mitigation of damages finds its place in the Halsbury Laws of England (4th edition, volume 12) as-

Plaintiff’s duty to mitigate loss. The plaintiff must take all reasonable steps to mitigate the loss which he has sustained consequent upon the defendant’s wrong, and, if he fails to do so, he cannot claim damages for any such loss which he ought reasonably to have avoided.”

As a result, the party alleging breach of contract or damages must have met the contract’s requirements. Consequently, before seeking damages, the obligation to mitigate losses is required. The mitigation of damages does not give the parties any rights; it is only used by the court to determine damages. The plaintiff’s effective mitigation measures will be determined entirely by the facts and circumstances of the case. However, in such circumstances, the plaintiff must ensure that he not only behaves in his own best interests but also in the best interests of the defendant, reducing the damages fairly, failing which he would not be entitled to the damages that might have been prevented.

The purpose of the duty to mitigate losses is relevant in the assessment of the damages where the plaintiff is not entitled to any damages of losses which (s)he is supposed to have mitigated. The Apex Court in M. Lachia Setty & Sons Ltd. v. Coffee Board, Bangalore (1980) held that the principle of mitigation of loss doesn’t give any right to the party who is in breach of the contract but it is a concept that has been born in the mind of the court while awarding the damages. In the case of Pannalal Jugatmal v. State of Madhya Pradesh (1953), the Court held that the mitigation of damages is incorporated under Section 73 of the Contract Act. The provision provides a burden on the party complaining about the breach of the contract to show that he doesn’t possess the methods for remedying the damages caused to the non-performance of the contract. The law for wise reasons imposes mitigating damages upon the party who has been subjected to the injury due to breach of contract, to make efforts for rendering the injury as low as possible.

  1. Damages for direct, consequential, and incidental losses

On the breach of a contract the defendant is not only liable to compensate the plaintiff for the injury and losses incurred but (s)he is also liable to compensate for the losses and damages “consequent to such loss and damage”. For example- In a contract of construction of a building the builder has assured to build it on time so that it could be let out on rent. Unfortunately, the building fell down and the builder had to reconstruct it. In this case, the builder is liable for the expenses incurred in the reconstruction of the building as compensation, the rent lost, and the compensation paid to the lessee for the period the building had not let out on rent as per contractual norms. Consequential damages are covered under special damages, as the losses that are supposed to have been, in contemplation of both the parties during the execution of the contract.

  1. Damages for non-pecuniary losses

Generally, damages are given for the breach of contract to compensate for the pecuniary loss. However, there are certain circumstances where the injured party can claim non-pecuniary losses. Non-pecuniary damages are losses that are incapable of being assessed by arithmetic calculations. The damages for mental anguish or suffering may be provided as a non-pecuniary loss where the contract is itself to provide enjoyment. For example- Breach of contract of services to click photos in a marriage. The term finds its reverence in the reference made by Justice Lahoti in “Chitty on Contract” which states as under-

Normally, there is no damages provided to the plaintiff for anguish, injury to his feelings, mental distress, annoyance, loss of reputation, and social discredit caused due to the breach of the contract. The exception is limited to the contract whose performance is to provide peace of mind and relief from distress.

So, in a contract specifically providing the enjoyment or the peace of mind, failing to perform the same, the injured party can seek the damages caused to him due to non-performance of the terms as contemplation of the parties during entering into the contract.

Calculation of the amount of damages for breach of a contract 

Determining the amount of the damages in a breach of the contract is said to be of utmost importance. The computation of the quantum of damages depends upon the magnitude of the injury caused to the plaintiff for the contractual breach. Section 73 and 74 of the Indian Contract Act, only deals with the measures for damages, not the method for calculating the quantum of damages incurred to the injured party. The Apex Court in the case of McDermott International Inc. v. Burn Standard Co. Ltd (2006) discussed the formulae for the computation of the damages caused due to contractual breach in detail. The formulas are provided as below-

  1. Hudson Formula

The Hudson formula is derived from the Hudson’s Building and Engineering Contracts and is used in the computation of delay damages in construction claims. The formula is stated in the following terms-

(Contract Head Office overheads profit %) x (contract sum ÷ period in weeks) x delay in weeks

As provided in the Hudson formula, the Head office overhead profit percentage is taken from the contract. Nonetheless, Hudson Formula has got judicial reverence in many cases, but it has been criticized principally as it obtains the contract head office overheads profit percentage from the contract as the factor for calculating the cost, which may have a little or no relation with the actual head office costs of the contractor. The Indian courts have applied the Hudson formula in several cases to calculate the quantum of damages.

  1. Emden Formula

The Emden Formula is derived from Emden’s Building Contracts and Practice and provided as below-

(Head Office Overhead & Profit ÷ 100) x (Contract Sum ÷ Contract Period) x Delay Period

The Emden Formula is used to measure the head office overhead percentage by dividing the gross turnover by the amount of the contractor’s overhead costs and benefits. The benefit of this formula is that it uses real operating costs and profit percentages rather than those specified in the contract. In many judicial decisions in India, the Emden Formula has been praised for its accuracy in measuring damages.

  1. Eichleay Formula

The Eichleay Formula has been evolved from the American jurisprudence and derived in a case of Armed Services Board of Contract Appeals, Eichleay Corp. It is applied in the following manner-

These formulas are mainly used in calculating losses incurred to the party in the Construction contracts.

Important tips to be kept in mind while computing damages

For calculating the damages in the manner subsequent to the breach of contract the Apex Court has laid down two underlying principles in the case of Murlidhar Chiranjilal v. Harishchandra Dwarkadas (1960). These principles are provided as-

The legal provisions in the Contract Act don’t specifically provide the measure for computation of the damages, so most of the time the courts have given free hand to the arbitrators for computation of damages. Regarding the measurement of the damages, the parties in the contract may execute stipulated norms as a specific measure for the calculation of the damages for the breach of contract.

In a contract, where the seller delays in delivering the goods the damages are calculated proportionally after mitigating the losses by the plaintiff. With respect to the time and place for the assessment of the damages, generally, the time and place where the goods ought to have been delivered are the value of the goods to the purchaser of such goods at the time and place they ought to have been delivered, and it is taken into consideration. 

Conclusion 

Damages are viewed as a more advantageous remedy than the other options available for contract breach. For the aim of calculating the damages stemming from the contractual breach, the judicial authorities have used their discretion and adopted jurisprudence from foreign courts. However, due to an increase in the number of instances involving contractual breaches, contracting parties prefer to have arbitration procedures in place for calculating damages in the event that one of the parties breaches the contract in the future. The legitimate basis for awarding damages to the harmed party is to restore the rights and responsibilities that have been infringed as a result of the victim party’s breach of contract. The Supreme Court has interpreted the legislative objective of Sections 73 and 74 on several occasions in order to award damages to the injured/suffered party.

References 


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