This article is written by Mathews Savio, 2nd Year LL.B. (Hons.), Rajiv Gandhi School of Intellectual Property Law, IIT Kharagpur, pursuing Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution from Lawsikho.
Table of Contents
Introduction
Damages are the most favoured remedy in cases of breach of contracts. Damages are usually awarded in contract law to place the non-breaching party in the position he would have been in if the contract was performed duly. But a pertinent question to ask in such cases will be about the extent of liability of the breaching party.
Whether the breaching party is liable to compensate for all the losses, both direct and indirect, that the non-breaching party has suffered due to the breach of the contract? Are remote losses liable to be compensated?
The most important case law which addresses these questions is the English case of Hadley v. Baxendale ([1854] EWHC J70) of 1854. The case was decided in the Court of Exchequer by a bench led by Judge Sir Edward Hall Alderson.
The judgement sets a limit on the liability of the breaching party so that the damages imposed would not turn out to be too enormous to compensate. Such a cap on the liability of the contracting party is justified by the fact that unlimited liability will deter the common man from entering into commercial contracts. An uncapped liability will make contracting a risky business in which the parties will not be able to predict the monetary value of his promise.
The principle laid down in the judgement finds expression in the contract laws of most common law countries, including the Indian Contract Act, 1872.
This article tries to explain the rule of Hadley v. Baxendale along with its expression in the Indian Contract Act, 1872. The article also points to judgements where the rule was applied and the criticisms of the rule in recent times.
Facts of Hadley v. Baxendale (1854) 9 Exch 341
The facts of the English case of Hadley v. Baxendale involves a contract for carriage of a broken component of a mill. Hadley along with his partners were the proprietors of the City Steam Mills in Gloucester. The mill was involved in the cleaning and processing of food grains into flour and bran using steam power. On one of the days of operation of the mill, the crankshaft running the steam engine broke and production of the mill came to a halt.
The proprietors of the mill contacted the engineering firm W. Joyce & Co., based in Greenwich, to manufacture a new crankshaft. The manufacturers sought the broken crankshaft to be sent to them as a reference for the new component.
Hadley, through his agent, contacted Baxendale, who was operating the common carrier Pickford & Co. Both the parties agreed on a price for the shipping of the broken crankshaft and a deadline for the delivery was also agreed upon. Hadley did mention that it is extremely vital that the delivery is made within the deadline.
But the shipment was re-routed through London where the broken crankshaft was held in storage so that it can be despatched along with other items which were also to be shipped to Greenwich. The shipment reached the manufacturer several days after the deadline. All the while the mill at Gloucester remained shut down. Hadley suffered a severe loss due to the non-operation of the mill.
Aggrieved by his loss Hadley sued Baxendale for damages to compensate for the losses he has suffered due to the non-operation of the mill and possible loss of goodwill and customers.
Rule of Hadley v. Baxendale
The question before the Court of Exchequer was: whether Baxendale was liable to compensate for the non-operation of the mill?
The Bench held that Hadley cannot recover the loss of profits from Baxendale as the shutting down of the mill was not contemplated as a consequence of the breach of contract by the breaching party. Hadley at the time of contracting did not mention that the mill will be non-operational till the new crankshaft is installed. A party cannot be expected to compensate for what he was not able to reasonably contemplate at the time of entering into a contract.
The judges pointed to alternate circumstances where also a mill owner could be sending his machinery for repair. There could be a spare for such a vital component so that the mill can remain functional or the mill could remain functional even without the component. Since the component was so vital to the mill’s operation Hadley could have simply informed Baxendale of the nature of loss he stands to suffer if the delivery is not made on time. A reasonable man cannot be expected to come to that particular conclusion on his own.
Judge Sir Edward Hall Alderson laid down a general rule on damages in breach of contracts as:
“Where two parties have made a contract which one of them has broken, the damages which the other party ought to receive in respect of such breach of contract should be such as may fairly and reasonably be considered either arising naturally, i.e., according to the usual course of things, from such breach of contract itself, or such as may 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.”
The rule of Hadley v. Baxendale, as stated above, talks about two types of damages: general damages and consequential or special damages.
The general damages are the ones that naturally arise from the breach of a contract. For example, if Raj contracts with Jai so that Raj will supply a certain quantity of food grains at a certain price on a specified date but fails to carry out the obligation. Then the general damages in such a case will be equal to the difference between the price that Jai has to pay for buying the same quantity of food grains on the specified date from another seller. So, the general damages in such a case will be the difference between the market price and the contract price of the goods.
General damages can easily be contemplated by the parties to a contract as the natural consequence of a failure to carry out the contractual obligations and can be claimed by the non-breaching party. But consequential damages are more difficult to quantify.
Each party entering a contract will have multiple interests which may not be often shared among them or known to the other side. In such cases, the breach of contract can have several adverse impacts on the parties which though not arising directly from the breach may be consequential. Consequential damages aim to compensate for such remote losses.
According to the rule of Hadley v. Baxendale, consequential damages can be claimed by the non-breaching party only if both the parties to the contract were aware of the possibility of such losses arising from the breach of contract. It is also to be noted that the rule on consequential damage is applied based on the knowledge of the parties at the time of contracting and according to the standard of a reasonable man.
The rule about consequential damages is effectively limiting the liability of the parties to a contract in the event of a breach of a contract. For example, consider the same situation we discussed in case of general damages involving the delivery of food grains by A to B on a specified date. If the food grains were required by B as input to his food processing industry and a failure of A to deliver the items on time will lead to halting of operation of the industry. A will be liable for the loss of profit only if B had informed him that the production will have to be stopped in case of delay in delivery of food grains.
The rule of Hadley v. Baxendale has wide acceptability and is incorporated in the contract laws of most common law jurisdictions.
Rule of Hadley v. Baxendale in Indian Contract Act, 1872
The rule of Hadley v. Baxendale is incorporated in the first proviso of Section 73 of the Indian Contract Act, 1872. The Section, in full, states that:
“73. Compensation for loss or damage caused by breach of Contract– When a contract has been broken, the party who suffers by such breach is entitled to receive, from the party who has broken the contract, compensation for any loss or damage caused to him thereby, which naturally arose in the usual course of things from such breach, or which the parties knew, when they made the contract, to be likely to result from the breach of it.
Such compensation is not to be given for any remote and indirect loss or damage sustained by reason of the breach.
Compensation for failure to discharge obligation resembling those created by contract- When an obligation resembling those created by contract has been incurred and has not been discharged, any person injured by the failure to discharge it is entitled to receive the same compensation from the party in default, as if the person had contracted to discharge it and had broken his contract.
Explanation- In estimating the loss or damage arising from a breach of contract, the means which existed to remedy the inconvenience caused by the non-performance of the contract must be taken into account.”
The rule as embedded in Section 73 of the Indian Contract Act, 1872 had been used to decide several seminal cases by the Indian Judiciary.
Application of the rule by Indian courts
One of the earliest case laws in India applying the rule of Hadley v. Baxendale was Madras Railway Co. v. Govinda Rau. In this case, the petitioner Govinda Rau was a tailor who employed the Railway Company to ferry his sewing machine and clothes to Karamadai, where the former was to set up shop during a local festival. But the delivery of the goods was delayed and Govinda Rau had to return without being able to run his business.
Rau sued the Railway Company for damages to compensate for his travel expenses and for the profits lost from operating his business during the festival.
The High Court of Madras did not entertain the claim for damages for lost profit, citing the provisions of Section 73 of the Indian Contract Act, 1872, as Rau had not informed the Railway Company of the date by which the goods were to be delivered or the purpose for which the goods are being transported.
Another application of the rule is seen in Union of India v. Hari Mohan Ghosh. The case was related to a lost consignment of artificial silk which was under transportation by the Indian Railways. Hari Mohan the owner of the goods sued the railways for the value of the goods and the lost profit. The Guwahati High Court did not grant damages for the lost profit as the Railways was not aware of the nature or the purpose of the goods transported.
Contemporary criticisms to the Rule of Hadley v. Baxendale
Despite the wide acceptability of the rule of Hadley v. Baxendale contemporary writers have criticised it. It is argued that the rule has taken the form of a rigid principle that acts to curtail any claim of damages for events not mentioned in a contract.
In the changing business climate where large companies are entering into high value and high impact complex commercial dealings the parties are expected to understand all the possible consequences of a breach of contract. The advancements in technology have brought in a situation where all the consequences of a breach of contract can be predicted at least as likely, if not definitely.
Also, enterprises are expected to keep up their vigil even after contracting for any change in circumstances that may lead to an altogether different consequence from breach of a contract. The parties are also expected to guard against such possibilities. Thus, the rigidity of the rule of Hadley v. Baxendale which allows damages only for losses contemplated at the time of contracting may be counter-acting fairness and equity.
Despite the criticism, the rule of Hedley v. Baxendale still holds wide acceptability in English common law jurisdictions.
Conclusion
The rule of Hadley v. Baxendale limits the liabilities of the parties to a contract. In the event of a breach of the contract, according to the rule, the breaching party is to pay damages only for the losses naturally occurring from such breach and the losses which the parties could reasonably contemplate at the time of contracting.
The rule promotes contracting in commercial transactions as it limits the cost of a breach. The compensatory damages are to be paid only for the most proximate consequences of a breach.
However, with the change in business practices and advancements in technology the remotest consequences of a breach of contract can be predicted and mitigated. So, several writers believe that the rule of Hadley v. Baxendale is obsolete and needs revision.
Despite the criticisms, the rule of Hadley v. Baxendale is still widely applicable and acceptable in most English common law jurisdictions.
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