Law On Damages For Breach Of Contract

Contractual damages primarily find their source in law in Sections 73 and 74 of the Contract Act, 1872, of which Section 73 pertains to damages in general and Section 74 deals with what is generally known as "liquidated damages".

This piece focuses on the general principles of the law on damages for breach of contract under Section 73. It does not cover principles pertaining to liquidated damages covered by Section 74 or any aspects of the third paragraph of Section 73, that is, compensation for failure to discharge obligations resembling those created by a contract or of any quantum meruit claimss.

The main body of Section 73 is reproduced hereinbelow:

73. Compensation of 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 such 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 of remedying the inconvenience caused by non-performance of the contract must be taken into account.

Illustrations:

….

The principles of law on contractual damages under Section 73 of the Contract Act have been evolved by the Supreme Court in its numerous decisions on the issue and I have attempted to concisely enumerate and explain them hereinbelow:

(1) Section 73 begins with the words "When a contract has been broken", signifying that:

(a) The existence of a concluded contract is a sine qua non in a claim for compensation under Section 73. In the absence of a concluded contract, a claim under Section 73 would not be maintainable.^[1] Moreover, the contract must be valid and not void under any of the provisions of the Contract Act^[2], nor should it have become impossible of performance (unless such impossibility arises from an act of the defaulter or was anticipated and guarded against in the contract). However, it may be borne in mind that, in the case of void agreements, Section 65 of the Contract Act stipulates restitution of any advantage gained thereunder.

(b) It is only upon a breach of contract that there can be any question of awarding damages under this provision. The plaintiff is required to prove that there is a breach of contract by the defendant. Further, if the plaintiff has contributed to the breach, he cannot claim damages.^[3] Certain eventualities, such as those contemplated in Sections 53, 54, 63, 67 of the Contract Act, could also bar a party from claiming damages.

(2) A contract cannot provide that one party will be the arbiter to decide whether he committed breach or the other party committed breach. That question can only be decided by only an adjudicatory forum, that is, a court or an Arbitral Tribunal.^[4]

(3) Compensation is payable for breach of contract only where damage or loss is caused by such breach. If damage or loss is not suffered, the law does not provide for a windfall.^[5] In other words, damage or loss caused is a sine qua non for award of compensation. Where there has been no legal injury in consequence of the breach, there cannot be an award of compensation, because compensation for breach of contract can be awarded to make good loss or damage 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".

(4) A casual connection between the breach and the loss is a prerequisite for an award of damages. The Supreme Court^[6] has relied upon the following observations from Chitty on Contracts: "There must be a causal connection between the defendant's breach of contract and the plaintiff's loss. The courts have avoided laying down any formal tests for causation: they have relied on common sense to guide decisions as to whether a breach of contract is a sufficiently substantial cause of the plaintiff's loss." In the facts of that case, the court held that the breach alone was not the cause for loss of anticipated profits, much less was it the primary or dominant reason.

(5) Normally, the burden of proving that the party claiming damages has sustained damages and the measure of damages falls on the party claiming damages.^[7] What proof would be sufficient would depend on the facts and circumstances of the case. Moreover, in the case of some claims, such as loss of profit claims, it may not always be possible to prove the claim. The court has, on occasion, relied upon notional percentage of the contract price or investment to arrive at a figure of estimated loss of profit and awarded damages accordingly.^[8]

(6) The first paragraph of Section 73 speaks of compensation "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". The second paragraph of Section 73 prohibits award of compensation for "any remote and indirect loss or damage sustained by reason of the breach." The law is therefore clear that remote and indirect loss is not awardable by way of damages for breach of contract.^[9] As to what is a remote or indirect loss is something which the law cannot pre-determine since it is something the court must decide on the fact and circumstances of each case.

In one case^[10], relying upon Illustration (k) to Section 73, the Supreme Court held that where the parties did not know, on the date of making of the contract which was subsequently breached that the innocent party was to ultimately sell the goods to a third party on a future date, the parties could not have known of the likelihood of the loss actually suffered on this account by the innocent party and this loss was therefore a remote and indirect loss not awardable.

(7) The Explanation to Section 73 imposes on the plaintiff a duty to take all reasonable steps to mitigate the loss consequent upon the breach, and debars him from claiming any part of the damage which is due to neglect to take such steps.^[11]

(8) It is settled law that damages become due on the date when the breach of contract takes place, and are normally assessed by the reference to the date or time of breach.^[12] This rule is based on the principle that the injured party is presumed to be in knowledge of the breach as soon as it is committed and at that time he can take appropriate measures of mitigation to control the loss flowing from the breach. However courts may deviate from the aforesaid rule and fix appropriate date in the facts and circumstance of a case if the aforesaid presumptions cannot be established or it would not be reasonable to follow the rule.^[13]

An interesting case arose before the Privy Council^[14] in the context of certain share purchase agreements where the purchaser, on the date of delivery, refused to buy the shares. The shares had largely fallen in value on the date of the breach. Upon the breach by the purchaser, the seller did not sell the shares in the market on the date of the breach but subsequently sold them in tranches, predominantly at higher prices. The question which arose for consideration was whether the purchaser was entitled to the benefit of the higher price fetched by the seller on subsequent dates. These observations of the Privy Council are noteworthy:

"The question therefore is the general question and may be stated thus: In a contract for sale of negotiable securities, is the measure of damages for breach the difference between the contract price and the market price at the date of the breach – with an obligation on the part of the seller to mitigate the damages by getting the best price he can at the date of the breach – or is the seller bound to reduce the damages, if he can, by subsequent sales at better prices? If he is, and if the purchaser is entitled to the benefit of subsequent sales, it must also be true that he must bear the burden of subsequent losses. The latter proposition is in their Lordships' opinion impossible, and the former is equally unsound. If the seller retains the shares after the breach, the speculation as to the way the market will subsequently go is the speculation of the seller, not of the buyer; the seller cannot recover from the buyer the loss below the market price at the date of the breach if the market falls, nor is he liable to the purchaser for the profit if the market rises."

"It is undoubted law that a plaintiff who sues for damages owes the duty of taking all reasonable steps to mitigate the loss consequent upon the breach and cannot claim as damages any sum which is due to his own neglect. But the loss to be ascertained is the loss at the date of the breach. If at that date the plaintiff could do something or did something which mitigated the damage, the defendant is entitled to the benefit of it. Staniforth v. Lyall is an illustration of this. But the fact that by reason of the loss of the contract which the defendant has failed to perform the plaintiff obtains the benefit of another contract which is of value to him does not entitle the defendant to the benefit of the latter contract: Yates v. Whyte; Bradburn v. Great Western Railway; Jebsen v. East and West India Dock Co."

"Their Lordships find that upon the appeal the officiating Chief Judge rested his judgment on a finding that the seller reduced his loss by selling the shares at a higher price than obtained at the date of the breach. This begs the question by assuming that loss means loss generally, not loss at the date of the breach. The seller's loss at the date of the breach was and remained the difference between contract price and market price at that date. When the buyer committed this breach the seller remained entitled to the shares, and became entitled to damages such as the law allows. The first of these two properties, namely, the shares, he kept for a time and subsequently sold them in a rising market. His pocket received benefit, but his loss at the date of the breach remained unaffected."

(9) The general principle for the assessment or measure of damages is compensatory i.e. that the innocent party is to be placed, so far as money can do so, in the same position, as far as compensation in money can do it, as if the contract had been performed. The Latin terms for this is restitutio in integrum. The fundamental basis thus is compensation for the pecuniary loss which naturally flows from the breach.^[15] This is known as "expectation interest" or "expectation loss", which includes within its sweep, loss of profit too. It is held that a claim by a contractor for recovery of amount as damages as expected profit out of contract cannot be disallowed on ground that there was no proof that he suffered actual loss to the extent of amount claimed on account of breach of contract.^[16] In a case pertaining to works contract, where the party entrusting the work committed breach of contract, the contractor is entitled to claim the damages for loss of profit which he expected to earn by undertaking the works contract. What would be the measure of profit would depend upon the facts and circumstances of each case. But that there shall be a reasonable expectation of profit is implicit in a works contract and its loss has to be compensated by way of damages if the other party to the contract is guilty of breach of contract cannot be gainsaid.^[17]

There is also a concept known as "reliance loss", the purpose of which is to put the plaintiff in the position in which he would have been if the contract had never been made. This loss may include expenses incurred in preparation by the innocent party's own performance, expenses incurred after the breach or even pre-contract expenditure but subject to remoteness. Ordinarily a party cannot recover both "expectation loss" and "reliance loss" since that would amount to double counting. The principle of "reliance loss" and its pitfalls, such as awarding the plaintiff for his own in efficiency or for making a bad bargain, have been briefly discussed by the Supreme Court in a recent case.^[18]

(10) In the assessment of damages, the court must consider only strict legal obligations, and not the expectations, however reasonable, of one contractor that the other will do something that he has assumed no legal obligation to do.^[19]

(11) There is nothing in the Contract Act which lays down the mode and manner of computation of damages. The method used for computation of damages would depend upon the facts and circumstances of each case. How the quantum of damages is to be determined is a matter which would fall for the decision of court / tribunal, which may insist on some proof of actual damages, and may or may not allow the parties to take recourse to one formula or the other. In a given case, the court of law or an arbitrator may even prefer one formula as against another. Different formulae can be applied in different circumstances and the question as to whether damages should be computed by taking recourse to one or the other formula, having regard to the facts and circumstances of a particular case, would eminently fall within the domain of the court / tribunal. ^[20]

(12) In one case, it was held that no damages are payable for mental agony in cases of breach of ordinary commercial contracts.^[21] In another case, it has been held that it is only the natural person who can claim damages for mental harassment and not the corporate entity.^[22]

Before parting, one significant feature of damages needs to be referred to and this cannot be done in any manner better than by reproducing the law as stated by Chagla C.J.^[23]:

"In my opinion it would not be true to say that a person who commits a breach of the contract incurs any pecuniary liability, nor would it be true to say that the other party to the contract who complains of the breach has any amount due to him from the other party. As already stated, the only right which he has is the right to go to a court of law and recover damages. Now, damages are the compensation which a court of law gives to a party for the injury which he has sustained. But, and this is most important to note, he does not get damages or compensation by reason of any existing obligation on the part of the person who has committed the breach. He gets compensation as a result of the fiat of the court. Therefore, no pecuniary liability arises till the court has determined that the party complaining of the breach is entitled to damages. Therefore, when damages are assessed, it would not be true to say that what the court is doing is ascertaining a pecuniary liability which already existed. The court in the first place must decide that the defendant is liable and then it proceeds to assess what that liability is. But till that determination there is no liability at all upon the defendant."

This view was approved by the Supreme Court which, on the basis of this proposition of law, held that a claim for damages for breach of contract is not a claim for a sum presently due and payable.^[24] However, in a recent case arising under the Insolvency and Bankruptcy Code, 2016 (IBC), the Supreme Court held that, in view of the definitions of "claim" and "debt" in the IBC, "debt" in the context of IBC is a liability or obligation in respect of a right to payment, even if it arises out of breach of contract, which is due from any person, notwithstanding that there is no adjudication of the said breach, followed by a judgment or decree or order.^[25]

Conclusion:

Post Covid-19, these issues are likely to arise in courts across the country and the law on damages would assume great significance. It would be interesting to see how the law evolves further as courts deal with such cases.