The article is written by Naman Sherstra from the Department of Law, University of Calcutta. This article exhaustively discusses the contractual breach and the ways of calculating damages arising out of the breach.
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 fails or refuses 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 fulfill 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., 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.
Contractual breach: meaning and significance
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 condition in a manner as provided in the contract.
Section 39 of the Indian Contract Act, 1872 defines the breach of contract as ‘when a party has refused to do or non-performance his promises in contract, omit 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 two doors. C builds a house of 1180 sq. feet with 3 windows and one door, violating the terms of the contract. Here, B is entitled to the damages for the losses incurred in conformity with the contract.
So, the breach of a contract is a precondition for the injuries incurred to the suffered party in the form of damages as a remedy.
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.”
Types of contractual breach
On the basis of the intensity of the breach, the contractual breach is classified into three types:
A minor breach of contract also referred to as partial breach or immaterial breach refers to the situation where the breaching party fails to perform certain aspects of the contract but the other party still receives the object or services as specified in the contract. In such a type of breach, the other party fails to perform a part of the obligation as specified in the contract still it doesn’t affect the contract as the major part of the obligation is performed by the defaulter party. However, the remedy is available only when the injured party can prove that a minor breach has led to financial loss. So, in a case where the tailor delays in delivering the costume to his/her client at the stipulated time (as provided in the contract), it will not attract remedy till the injured party proves that such delay has incurred him/her financial losses.
A breach where the guilty party fails to perform some of the obligations of the contract and the other party receives a product/service which is substantially different from what mentioned in the contract. If the contract specifies the sale of the printers of Epson brand and the aggrieved party receives the same product of Canon brand, there is a material breach of contract. In case of material breach the injured/aggrieved party is not required to perform his obligation, and (s)he is entitled to the immediate remedy.
The anticipatory breach is a condition where the actual breach of contract doesn’t occur but either of the parties in the contract indicates that they are willingly not interested in performing their obligations. The claim of such breach shall only arise when either party to the contract have a clear indication of non-performance of the obligation under the contract.
The actual breach refers to a condition where the breach of the contract has already occurred as either of the parties have already not performed their duties/obligations by the provided deadline or they have incompletely or improperly performed their duties. Several kinds of remedies are available in such a breach.
What are damages
The term damages refer 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 the court desires the victim party to accept his mistake and pay adequate compensation to the affected party as the damages.
The principle behind the damages is explained by Fuller and Prude as damages may seek the protection of “expectation interest”, “reliance interest” or “restitution interest”. 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, 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, 1872 finds 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 in nature, the purpose behind the damages is to compensate the injured party for the loss and not to punish the victim party.
Ways to determine damages for different kinds of breaches
In order to ascertain the damages available, the injured party shall have to specifically prove that the breach of contract has incurred him/her financial losses. The injured party (plaintiff) must specify the kind of damages he is seeking before the court. Now, the court looks into the issue of whether the breach was substantial in nature or a partial one. There are some cases where the courts may award damages that go beyond the strict measure of compensation. The examples of non-compensatory damages are nominal damages, aggrieved damages, restitutionary damages. Damages for the breach of contract are subject to the principle of remoteness, causation and mitigation. Now, we shall analyse the approach of the Indian courts in determining the damages for breach of contract.
Remoteness of damages
The provision under Section 73 of the Indian Contract Act, 1872 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 vs. Baxendale, 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 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.
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 in relation to 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 important tests which is 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, 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. So, “but for” the defendant’s breach loss would not have been suffered.
In India, the Supreme Court has adopted the “but for” test in the case of Pannalal Jankidas v. Mohanlal and Another. In this case, the ordinance stated that the government shall fulfill wholly 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 causal 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.
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.”
So, the party claiming the breach of the contract or damages should have fulfilled the requisite part of the contract. Thus, before claiming the damages, the duty to mitigate losses is indispensable. The mitigation of the damages doesn’t provide any kind of rights to the parties, it is only used by the court for awarding damages.
The reasonable steps taken by the plaintiff to mitigate shall totally depend upon the facts and the circumstances of the cases. Nonetheless, in such cases it must be ensured that the plaintiff not only acts in his favour but also in the favour of the defendant, lowering the damages in a reasonable manner failing to which he shall not be entitled to the damages which could have easily avoided. 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. vs. Coffee Board, Bangalore, 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 vs. State of Madhya Pradesh, the court held that the mitigation of damages is incorporated under Section 73 of the Contract Act, 1872. 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.
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 he is also liable to compensate for the losses and damages “consequent on 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 the special damages, as the losses that are supposed to have been, in contemplation of both the parties during the execution of the contract. Direct losses cover overhead costs, decreased profits whereas incidental loss happens after gaining the knowledge of the incident which could be in the form of transportation cost for goods due to the default of the purchaser or to find an alternative customer.
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 for the purpose of providing 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.
Tips and tactics to calculate the amount of damages for the breach of a contract
The ascertainment of the damages in a breach of the contract is 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, 1872 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, discussed the formulae for the computation of the damages caused due to contractual breach in details. The formulas are provided as below:
The Hudson formula is derived from the Hudsons 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
- Where Contract Head Office and profit percentage submitted in the tender.
- Dividing the total overhead costs and profit of the organisation as a whole by the total turnover of the organisation arrives at the head office percentage.
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 criticised 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.
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
In this formula, the total overhead cost of the contractor’s organisation is divided by the total turnover, which results in the percentage based on the contractor’s actual head office overhead instead of one contained in an isolated contract.
The Emdon formula is used to calculate the head office overhead percentage by dividing the sum of overhead costs and profit of the contractor’s organization by the total turnover. This formula has the advantage as it uses the actual overhead costs and the profit percentage rather than those mentioned in the contract.
Indian courts have paid reverence to the Emden formula in several judicial decisions for the purposes of calculating the damages. Norwest Holst Construction Ltd. v. Cooperative Wholesale Society Ltd., Beechwood Development Company (Scotland) Ltd. v. Mitchell, are some of the cases where the foreign courts have used the Emdon Formula for computing the damages.
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:
- Step 1- Overhead is allocable in the contract. The portion of the overhead allocated to the project is calculated by this method.
- Contract Billings ÷ Total Billings for contract Period) x Total Overhead for Contract Period
- Step 2- Daily Allocable Overheads/ Overhead rates. It is a method for calculating the daily allocation of Office Overhead.
- (Allocable Overheads ÷ Total Days of Contract)
- Step 3- Daily Overhead Rate/ Amount of Unabsorbed Overhead. This is a method of multiplying the compensable delays by the rate of daily allocable overhead.
- Step 4- Daily Allocable Overheads/ Daily Overhead Rates x No. of days of delay. This formula is used for calculating damages where it is not possible to prove the loss of opportunity and the claim is based on actual costs.
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. These principles are provided as:
- As the breach of contract is proved, the injured party claiming the damages is placed in a manner as the money could put him in a good situation, as if the contract wouldn’t have been performed; and
- The plaintiff is also duly bound to mitigate all the losses arising out of the breach and prevent him from claiming any kind of damages which is a consequence of his failure to mitigate the damages.
The legal provisions in the Contract Act don’t specifically provide the measure for computation of the damages, so most of the times the courts have given free hand to the arbitrators for the purpose of 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 is 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. For the purpose of determining the market value of the goods in course of the assessment of damages, the court refers to the buying price of the goods from where the purchaser can get that item.
Damages are considered a more advantageous remedy over the other remedies available for the breach of the contract. The judicial bodies have applied their own discretion and borrowed the jurisprudence from foreign courts for the purpose of computing the damages arising out of the contractual breach. However, due to the increasing number of cases due to the contractual breach, the parties in the contract prefer to have arbitration clauses for the calculation of the damages, if in the future any of the parties suffers the breach of the contract. The reasonable justification behind providing the damages to the suffering party is to restore the rights and obligations that have been violated due to the breach of the contract by the victim party. The apex court has time to time interpreted the legislative intent of Section 73 and 74 for the purpose of awarding damages to the injured/suffered party.