Claim For Loss Of Profit Vis-À-Vis Railway Contracts And Public Works Department Contracts

The claim for lost profits is widely accepted as “Loss of Profit” and is claimed under Indian legal regime by placing reliance upon Section 73 of the Indian Contract Act, 1872^[1] which provides for compensation on account of breach by a party to contract. The jurisprudence pertaining to the claim of loss of profit which gained momentum with the case of MC Dermott ^[2]has been significantly reshaped by the rationalization carved out in the cases of M/s Unibros v. All India Radio^[3] and Batliboi Environmental Engineers Limited v. Hindustan Petroleum Corporation Limited ^[4]recently delivered by the Supreme Court of India.

In such scenario, it is pertinent to analyze the legal landscape pertaining to the claim of loss of profit and bring clarity to enable drafting/formulating of acceptable claim in the infrastructure arbitration matters.

LEGAL FRAMEWORK FOR LOST PROFITS AND OVERSTAY

The concept of loss of profit had its genesis in the case of Robinson v. Harman ^[5]wherein taking into account the basic principle of “reinstatement” it has been held that the plaintiff is to be placed in the same position as it would have been had the contract been performed in accordance with the terms and conditions agreed.

The jurisprudence of “loss of profit” in reference to the works contract rolled in motion under the Indian Legal regime with the landmark judgment of A.T. Brij Paul Singh v. State of Gujrat, wherein the Apex Court has held that “where in a works contract, the party entrusting the work commits breach of the contract, the contractor would be entitled to claim damages for loss of profit which he expected to earn by undertaking the works contract”.^[6]

The law entitling the contractor to claim damages created an enigmatic situation of submission of inflated frivolous claims by the contractors. To address the issue, Indian Legal jurisprudence to an extent was toned in the case of Bharat Coking Coal Ltd. v. L.K. Ahuja^[7], (2004) 5 SCC 109, wherein the Apex Court developed the requirement of evidence for claiming loss of profit and held that in the absence of any proof of loss, compensation in terms of loss of profit shall not be granted. The relevant observations by the Apex Court are:

“It is not unusual for the contractors to claim loss of profit arising out of diminution in turnover on account of delay in the matter of completion of the work. What he should establish in such a situation is that had he received the amount due under the contract, he could have utilised the same for some other business in which he could have earned profit. Unless such a plea is raised and established, claim for loss of profits could not have been granted.”^[8]

Computation of Quantum of Loss of Profit

Though it is undisputed that a contractor is entitled to the claim for loss of profit if there is any delay attributable to the employer yet the issue of quantum of loss of profit remained a challenge for the contractors. The Apex Court addressed the issue in the case of Mc Dermott International Limited v. Burn Standard Co. Ltd,^[9] (2006) 11 SCC 181 wherein the Apex Court has recognized the popular formulae namely Hudson Formula, Emden Formula and Eichelay formula which calculate loss of profit along with loss of overhead.

Hudson Formula

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

Hudson Formula is the oldest and the most frequently used formulae for calculation of the lost overheads and profits and over the years have gained both contractor and judicial support, however, most of the time it does not result in a successful claim and is being viewed as an imaginary claim on account of the following issues and assumptions:

1. Inability of the contractors to comprehensively demonstrate the proper and systematic delay analysis on account of integration of delay attributable to the contractor and the department;
2. Assumption of integration of head office overheads with the lost profits and that both are inseparable;
3. Automatic application of percentage of overheads and profits applied in the tender irrespective of considering whether such percentage can be achieved in reality;
   [10] and
4. Assumption that all resources of contractor will be prolonged and utilized on that particular contract and that on account of such delay the contractor will not be able to undertake any other work.^[11]

Emden Formula

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

The Emden formula is the evolved formula of Hudson and has been widely accepted and has received judicial support^[12] as it uses the actual overhead cost rather than adopting a theoretical percentage.

Emden formula found application in many cases on account of its reliability and being based on verified data as it is premised on audited accounts of the sub-contractors to determine the real overheads.

Eichelay formula

Step 1: Establish the head office overhead costs attributable to the contract as follows: divide the final contract sum (excluding the claim for head office overhead) by the total revenue for the contract period, then multiply the result by the total head office overhead costs incurred during the actual period of performance of the contract.

Step 2: Divide the figure resulting from Step 1 by the number of days of actual performance of the contract, to establish a daily rate.

Step 3: Multiply the figure resulting from Step 2 by the number of days compensable delay.

The Eichelay formula is used when it is not possible for the contractor to prove the loss of opportunity for claiming the loss of profits and the claim is based on the actual cost which is determined by comparing the value of work executed by the contractor within the contract period.

While recognizing the methods for computation of loss of profit, the Apex Court categorically cautioned that the application of the formulae will largely depend upon the facts and circumstances of a matter and question as to whether damages should be computed by taking recourse to one or the other formula would fall under domain of the arbitrator or concerned court.

Whether computation of loss of profit as per Hudson, Emden and Eichelay Formulae suffice to grant loss of profit?

Simplistically, acceptance of formulae for computation of loss of profit lead to a situation wherein party while relying on the judgments of A.T. Brij Paul Singh v. State of Gujrat^[13], and Mc Dermott International Limited v. Burn Standard Co. Ltd^[14], argue that a court or arbitral tribunal can grant loss of profit in terms of Section 73 of the Indian Contract Act, 1872 and that the loss is justified by the computation in accordance with the formulae i.e. Hudson, Emden and Eichelay.

While the Apex Court has emphasised the requirement of evidence in the case of Bharat Coking Coal Ltd. v. L.K. Ahuja^[15], however, lack of discussion on such requirement in reference to the Hudson, Emden and Eichelay Formulae resulted in granting of claim sans evidence.

The Apex Court recently in the case of Unibros v. All India Radio^[16] and Batliboi Environment Engineers Limited v. Hindustan Petroleum Corporation Limited & Anr.^[17], resolved the conundrum and settled the legal position regarding the requirement of evidence and its nature. The Apex Court observed that the Hudson formula does not apply in vacuum and it is imperative for the claimant to substantiate the presence of a viable opportunity through compelling evidence for claiming loss of opportunity. The evidence may include the details of potential projects, number of tendering opportunities received by the contractor, decline in the financials owing to the delay and extension. The relevant observations by the Hon'ble Apex Court are reproduced as hereunder:

Unibros v. All India Radio 2023 LiveLaw (SC) 817

16. To support a claim for loss of profit arising from a delayed contract or missed opportunities from other available contracts that the appellant could have earned elsewhere by taking up any, it becomes imperative for the claimant to substantiate the presence of a viable opportunity through compelling evidence. This evidence should convincingly demonstrate that had the contract been executed promptly, the contractor could have secured supplementary profits utilizing its existing resources elsewhere.

17. One might ask, what would be the nature and quality of such evidence? In our opinion, it will be contingent upon the facts and circumstances of each case. However, it may generally include independent contemporaneous evidence such as other potential projects that the contractor had in the pipeline that could have been undertaken if not for the delays, the total number of tendering opportunities that the contractor received and declined owing to the prolongation of the contract, financial statements, or any clauses in the contract related to delays, extensions of time, and compensation for loss of profit. While this list is not exhaustive and may include any other piece of evidence that the court may find relevant, what is cut and dried is that in adjudging a claim towards loss of profits, the court may not make a guess in the dark; the credibility of the evidence, therefore, is the evidence of the credibility of such claim.

Batliboi Environment Engineers Limited v. Hindustan Petroleum Corporation Limited & Anr., 2023 LiveLaw (SC) 817

22. The formula suggested by Hudson in his 10th edition of the book Building and Engineering Contracts for the computation of damages takes the head office and profit percentage as a proportion of the contract value. The formula assumes that the profit judged by the builder/contractor is in fact capable of being earned by her/him elsewhere had the builder/contractor been free to leave the contract at the proper time. The formula is couched on three assumptions. First, that the contractor is not habitually or otherwise underestimating the cost when pricing; secondly the profit element was realistic at that time; and lastly, there was no fluctuation in the market conditions and the work of the same general level of profitability would be available to her/him at the end of the contract period. Satisfaction of these assumptions should be ascertained when we apply Hudson's formula for computing the damages. Material should be furnished by the claimant to justify and assure that the assumptions for applying Hudson's formula are met.

Thus, a claim for loss of profit is maintainable on the ground that there has been delay in the execution of the contract, attributable to the employer, however, the loss incurred is to be well substantiated by cogent evidence and mere reliance upon the computation through the engineering formulas would not suffice the requirement of evidence so as to succeed in the claim.

CLAIM OF LOSS OF PROFITS IN RAILWAY CONTRACT AND PWD CONTRACT

Though no specific rules apply to the drafting and preparation of a claim for loss of profit yet the comprehensive claim can only be prepared after taking into consideration the peculiar facts and terms and conditions of the contract. The tender documents released by the Railways Authorities and the Public Works Department are peculiar in nature since they by express covenants bar right to compensation in case breach of any essential term of the contract which make it difficult to succeed in the claim for loss of profit. Illustrative clauses from the tender documents are reproduced as hereunder:

Clause 17 – A of General Conditions of Contract – Extension of Time

Subject to any requirement in the contract as to completion of any portions or portions of the works before completion of the whole, the contract shall fully and finally complete the whole of the works comprised in the contract (with such modifications as may be directed under conditions of this contract) by the date entered in the contract or extended date in terms of the following clauses:-

1. If any modifications have been ordered which in the option of the Engineer have materially increased the magnitude of the work, then such extension of the contracted date of completion may be granted as shall appear to the Engineer to be reasonable in the circumstances, provided moreover that the Contractor shall be responsible for requesting such extension of the date as may be considered necessary as soon as the cause thereof shall arise and in any case not less than one month before the expiry of the date fixed for completion of the works.
2. If in the opinion of the Engineer the progress of work has any time been delayed by any act or neglect of Railway's employees or by other contractor employed by the railway under sub-clause (4) of clause 20 of these conditions or in executing the work not forming part of the contract but on which contractor's performance necessarily depends or by reason of proceeding taken or threatened by our dispute with adjoining or to neighboring owners or public authority arising otherwise through the contractor's own default etc. or by the delay authorized by the Engineer pending arbitration or in consequences of the contractor not having received in due time necessary instructions from the Railway for which he shall have specially applied in writing to the Engineer or his authorized representative then upon happening of any such event causing delay, the Contractor shall immediately give notice thereof in writing to the Engineer within 15 days of such happening but shall nevertheless make constantly his best endeavors to bring down or make good the delay and shall do all that may be reasonably required of him to the satisfaction of the Engineer to proceed with the works. The contractor may also indicate the period for which the work is likely to be delayed and shall be bound to ask for necessary extension of time.
   The Engineer on receipt of such request from the contractor shall consider the same and shall grant such extension of time as in his opinion is reasonable having regard to the nature and period of delay and the type and quantum of work affected thereby. No other compensation shall be payable for works so carried forward to the extended period of time, the same rates, terms and conditions of contract being applicable as if such extended period of time was originally provided in the contract itself.
   [18]

Clause 29 – Shifting of Electrical Telegraph Wires:

In some stretches, high tension grid towers/electric telegraph/telephone wires or posts etc. are to be shifted. It is expected that the electric lines/towers will be shifted in good time but in case there is any delay on this account suitable extension in date of extension will be considered and given to the contractor for only the effected portion and no compensation whatsoever in respect or due to the delay thus caused will be payable and contractor has to adopt such methods of execution of earthwork so as not to cause any damage to the existing structure lines etc.

Clause 30 – Handing Over of Site for Work:

The entire land required for this work is available. However, Railway may not hand over the entire land required for completion of this work for making bank/cutting or excavation to the contractor(s) due to any unavoidable reasons. Land may be handed over in different stretches, which may not be continuous. Contractors(s) will be required to carry out the work in available strectes. If some stretch of land cannot be handed over to the contractor for borrowing earth or making bank/cutting within the contract period then suitable extension will be granted without any payment of claim to the contractor. ^[19]

Validity of Restrictive Clauses of the Governmental Contracts

Whilst under the Indian Legal regime there is no specific bar in contractually limiting or excluding the liability in case of breach by either of parties to contract, Section 23 of the Indian Contract Act, 1872 ^[20]which deals with “What considerations and objects are lawful and what not” gets attracted against such restrictive covenants. Section 23 of the Indian Contract Act, 1872 reads as follows:

The consideration or object of an agreement is lawful, unless

• it is forbidden by law ; or
• is of such a nature that, if permitted, it would defeat the provisions of any law; or
• is fraudulent ; or
• involves or implies, injury to the person or property of another; or
• the Court regards it as immoral, or opposed to public policy. In each of these cases, the consideration or object of an agreement is said to be unlawful. Every agreement of which the object or consideration is unlawful is void.^[21]

A bare reading of the aforesaid provision of Section 23 of the Indian Contract Act, 1872 explains that the agreement/provisions which defeats the provisions of law or opposed to the public policy are void. The aforementioned clauses incorporated in the Railways and PWD contracts bar and disentitle the contractor from damages/compensation which it is entitled under the terms and provisions of Section 55 and Section 73 of the Indian Contract Act, 1872.

It is imperative to understand that the provisions of Section 55 and Section 73 of the Indian Contract Act, 1872 are the very heart and foundation of the contract, thereby permitting such clauses would not only defeat the existence of the contract but also violate the statutory scheme encompassed under the Indian Contract Act, 1872. Further, such clauses in the contract is a matter of public policy as leaving no remedy to the party in case of breach vitiate the binding nature of contract and hinder the smooth operation of the commercial transactions resulting into the non-conducive environment for the business operations.

The Apex Court and several High Courts in the catena of judgements namely MBL Infrastructures Limited v. Delhi Metro Rail Corporation ^[22]and Simplex Concrete Piles (India) Limited v. Union of India,^[23] while declaring such contractual clauses against the public interest and public policy in express terms set at naught such clauses in light of Section 23 of the Indian Contract Act, 1872 for being in teeth of the statutory intendment envisaged under Section 55 and Section 73 of the Indian Contract Act, 1872.

The jurisprudence evolved creates a critical situation for the contractors as the contractors while focusing on execution of the project work also has to ensure that to succeed in claim of loss of profit in future has to maintain sufficient corroborating evidence by way of getting the bids rejected while participation in bidding process on account of impact of prolonged projects, dip in financial statements etc. Notably to calculate there exists different formulae yielding different results, though the suitability of the formulae depends upon the legal context yet it is advisable that Emden and Eichelay formulae should be preferred to succeed in claim for it being based on actual and verified data.

Authors: Susshil Daga, Managing Partner, Ashish Sharma, Associate and Pragya Khubani, Associate At Amicus Legal. Views are personal.

1. The Indian Contract Act, 1872, Section 73. ↑

2. Mc Dermott International Limited v. Burn Standard Co. Ltd, (2006) 11 SCC 181. ↑

3. M/s Unibros v. All India Radio, 2023 LiveLaw (SC) 918. ↑

4. Batliboi Environmental Engineers Limited v. Hindustan Petroleum Corporation Limited, 2023 LiveLaw (SC) 817. ↑

5. Robinson v Harman (1848) 1 Ex Rep 850. ↑

6. A.T. Brij Paul Singh v. State of Gujrat, (1984) 4 SCC 59. ↑

7. Bharat Coking Coal Ltd. v. L.K. Ahuja, (2004) 5 SCC 109. ↑

8. Ibid. ↑

9. Mc Dermott International Limited v. Burn Standard Co. Ltd, (2006) 11 SCC 181. ↑

10. Radoven Majer, Helena Ellingerova & Jozef Gasparik, Methods for the Calculation of the Lost Profit in Construction Contracts, Available at https://www.researchgate.net/publication/340623519_Methods_for_the_Calculation_of_the_Lost_Profit_in_Construction_Contracts (Last accessed on 02 January 2025). ↑

11. Aceris Law, Overheads and Profit Claims in Construction Arbitration, Available at https://www.acerislaw.com/overheads-and-profit-claims-in-construction-arbitration/ (Last accessed on 02 January 2025). ↑

12. Norwest Holst Construction Ltd. v. Coop. Wholesale Society Ltd, [1998] EWHC Technology 339]; Beechwood Development Co. (Scotland) Ltd. v. Mitchell, MANU/SCCS/0200/2001; Harvey Shopfitters Ltd. v. Adi Ltd., MANU/UKWA/0265/2003. ↑

13. Supra 6. ↑

14. Supra 9. ↑

15. Supra 7. ↑

16. Supra 3. ↑

17. Supra 4. ↑

18. Indian Railway Standard General Conditions of Contract, Available at https://www.iricen.gov.in/iricen/Works_Manuals/GCC_%20Nov%202018.pdf (Last accessed on 02 January 2025). ↑

19. Tender Document for the work of “Providing Limited Height Subway (17 Nos) in lieu of existing level crossings between Haripur & Marwar Jn. Stations of Ajmer – Marwar Jn. Section in connection with elimination of existing level crossing gates, Tender No. All/Const./LHS/T/4. ↑

20. The Indian Contract Act, 1872, Section 23. ↑

21. Ibid. ↑

22. MBL Infrastructures Limited v. Delhi Metro Rail Corporation, 2023 SCC OnLine Del 8044. ↑

23. Simplex Concrete Piles (India) Limited v. Union of India, 2010 SCC OnLine Del 821. ↑