Must loss resulting from breach of contract be proven?

Introduction
Facts
Arguments before high court
Court observations
Decision
Comment

Introduction

In Sudhir Gensets Ltd v Indian Oil Corporation Ltd(1) the Delhi High Court ruled on Sections 73(2) and 74(3) of the Contract Act 1857. The court held that the loss suffered by a party due to breach of contract need not be proven where parties have specifically agreed in the contract that the compensation in case of breach be:

• pre-set;
• tangible;
• liquidated damages; and
• not imposed by way of penalty.

Facts

Sudhir Gensets Ltd was given work orders by Indian Oil Corporation Ltd (LPG/Engg/3335, July 20 2000, and LPG/Engg/3386, September 15 2000) to supply, test and commission gensets at various locations. The work was to be completed by November 17 2000 and January 12 2001, respectively). However, the work was not completed by the specified dates and the appellant sought an extension of time from Indian Oil Corporation. The extension was not granted. Indian Oil Corporation also withheld an amount of Rs1,077,714 as liquidated damages from the dues payable to Sudhir. This was done as per Clause 13 of the special terms and conditions of the contract. Clause 13 read as follows:

"Vendor hereby agrees to pay to the corporation by way of liquidated damages and not as a penalty, an amount equal to (0.5%) of the arterial so delayed for each week part thereof of such delay in sitting of the equipment subject to a maximum of 10% (ten percent) of such prices."

Sudhir invoked the arbitration clause (Clause 23) and raised a claim for the recovery of the withheld amount before the sole arbitrator. In a ruling of May 1 2007 the arbitrator concluded that "time was of the essence in the contract". The delay had been caused by Sudhir. The arbitrator further observed that Indian Oil Corporation had rightfully withheld the money as liquidated damages and there was no question of it paying that amount to Sudhir. Sudhir could not be allowed to benefit from its own failure (ie, causing the delay in performance of the contract).

Sudhir appealed the decision to the Delhi additional district judge. Its main objection was that Indian Oil Corporation had withheld an amount out of the dues payable to Sudhir without proving the loss that it had suffered. Sudhir relied on Sections 73 and 74 of the act to argue that:

• the impugned award was illegal, perverse and against substantial legal provisions of law; and
• the arbitrator had ignored the material available on record inasmuch as:
  • the arbitrator had not considered material pieces of evidence (ie, the letters of November 16 2000 and September 19 2001 exchanged by Indian Oil Corporation and Sudhir); and
  • the arbitrator had also failed to notice that Indian Oil Corporation produced no evidence on which to invoke Clause 13 of the special terms and conditions before withholding Rs1,077,714.

In an order of May 5 2008 the additional district judge dismissed Sudhir's objections and upheld the arbitrator's findings. The judge held that:

• Sudhir had been responsible for delaying the supply, testing, commissioning and installation of the gensets beyond the deadline agreed in the contract. Indian Oil Corporation could not be blamed for the delay, as Sudhir claimed; and
• the recovery of Rs1,077, 714 by Indian Oil Corporation as liquidated damages by invoking Clause 13 did not violate Sections 73 and 74 of the act. Thus, Indian Oil Corporation was not required to pay that amount to Sudhir.

Furthermore, the judge held that in a case where damages are pre-set in accordance with the terms and conditions of the contract to which both parties had agreed, such liquidated damages were fully justified under the terms of the contract. Therefore, the arbitrator's award was not required to be set aside. The judge thus rejected Sudhir's petition.(4)

Arguments before high court

Sudhir filed an appeal challenging the order of the additional district judge before the Delhi High Court. It made similar arguments before the high court as it had before the lower court. In the appeal, Sudhir submitted that under Sections 73 and 74 of the act, compensation can be granted to the other party only on account of breach of a contract. However, where no loss has occurred, no compensation is due. Sudhir further submitted that the language of Section 74(5) provides that compensation be awarded only to the extent set down in the contract and, in some cases, it dispenses with the need to prove the loss based on a genuine estimate agreed by the parties in the contract. Thus, according to Sudhir, no compensation could be awarded where no loss or damage has been proven.

Sudhir further contended that the arbitrator had given no reasons in the May 1 2007 arbitral award either for holding it responsible for the delay, or for holding that Indian Oil Corporation was entitled to claim damages without proving the actual loss. For this reason, Sudhir contended, the impugned order passed by the additional district judge and the arbitral award were not sustainable and should be set aside. Further, in the absence of any evidence of actual loss caused to Indian Oil Corporation, it could not deduct the amount of Rs1,077 714 towards liquidated damages.

Indian Oil Corporation submitted that there was no infirmity in the impugned order in regard to the aspect of delay. The delay in supplying the goods was on the part of Sudhir. Indian Oil Corporation was entitled to invoke Clause 13 of the special terms and conditions without proving actual loss or damage because Clause 13 provided that the liquidated damages, as agreed between the parties, were a pre-estimate of the losses suffered by Indian Oil Corporation. No evidence of actual damage was required in such cases.

Court observations

After a detailed examination of the arguments led by the parties, the judge observed that in regard to the delay in the supply of the gensets, the letter of November 16 2000 clearly shows that Sudhir caused the delay, and it would be incorrect to say that the delay was on the part of Indian Oil Corporation. Further, the observations made by the arbitrator in the arbitral award of May 1 2007 showed the correct consideration: the arbitrator made reference to the correspondence exchanged between the parties and concluded that this showed that Sudhir was responsible for the delay.

On the issue of whether Indian Oil Corporation was entitled to deduct damages from the amount payable to Sudhir by invoking Clause 13, the judge made the following detailed observations. Sudhir cited Fateh Chand v Balkishan Dass,(6) in which it was held that:

"The measure of damages in the case of breach of a stipulation by way of penalty is by Section 74, reasonable compensation not exceeding the penalty stipulated for. In assessing damages the Court has… jurisdiction to award such compensation as it deems reasonable having regard to all the circumstances of the case… The section undoubtedly says that the aggrieved party is entitled to receive compensation from the party who has broken the contract, whether or not actual damage or loss is proved to have been caused by the breach. Thereby it merely dispenses with the proof of actual loss or damages; it does not justify the award of compensation when in consequence of the breach no legal injury at all has resulted."(7)

In response to the above, Indian Oil Corporation relied on the judgment of the Supreme Court of India in ONGC v Saw Pipes.(8) In that case the impugned award directing the appellant to refund the amount deducted for breach of contract with interest was set aside. After a detailed analysis of the facts and opinion of the Supreme Court, the judgment was summed up as follows:

• The contract terms are required to be taken into consideration before concluding as to whether the party claiming damages is entitled to them.
• If the terms clearly stipulate the liquidated damages for breach of contract, then unless damages are unreasonable or constitute a penalty, the party which committed the breach must pay such compensation as per Section 73 of the act.
• Section 74 of the act is to be read along with Section 73 of the act. Therefore, in case of breach of contract, the party aggrieved by the breach need not prove actual loss or damage suffered.
• In some contracts, where it is impossible to assess the compensation arising from the breach, the court can award this if the parties have agreed a realistic pre-estimate as the measure of reasonable compensation.

Decision

ONGC lays down the law as to how the provisions of Sections 73 and 74 of the act are to be interpreted when dealing with clauses in a contract providing a pre-estimate of loss or damage in the form of liquidated damages. In the case at hand Indian Oil Corporation and Sudhir had agreed in Clause 13 of the special terms and conditions that if there was a delay in delivery of material, Sudhir would pay Indian Oil Corporation by way of liquidated damages.

Further, in light of ONGC, it is now settled that where there is a predetermined amount for damages, that amount can be deducted by way of liquidated damages from a specified amount payable by the respondents to the appellant. This was so in the case at hand.

The court also opined that in light of ONGC, none of the judgments cited by Sudhir was of any help to its case. It held that the arbitrator had been justified in dismissing Sudhir's claim for return of the withheld amount. The additional district judge was also justified, for the same reasons, in upholding the arbitrator's findings.

Finally, the court held that it was well settled that the civil court could not act as an appellate court to dissect the reasoning of the arbitral tribunal. The scope of objections are limited by Section 34 of the Arbitration and Conciliation Act 1996. Once the court is satisfied that the arbitrator has made an award after taking into consideration all the available facts and that the award is in accordance with the applicable law, its job is done. Therefore, the order of the additional district judge was fully justified and did not call for interference from the high court. Consequently, the Delhi High Court dismissed Sudhir's appeal.

Comment

In light of this case, the current situation is that under Sections 73 and 74 of the act, if an amount is named in the contract as compensation for breach of contract by way of penalty, the offended party is entitled only to reasonable compensation for the loss suffered. However, if the compensation named in the contract for such a breach is a genuine pre-estimate of the loss that would occur from a breach, such loss need not be proven. Therefore, the emphasis is on reasonable compensation. The burden is on the breaching party to prove that no loss is likely to occur by such breach.

In the case at hand, the parties had agreed to fix Sudhir's liability, under Clause 13 of the special terms and conditions, for the payment of damages. It was not a case of penalty. The amount recovered as damages (ie, Rs1,077,714) was prefixed by the parties with regard to the loss suffered by Indian Oil Corporation on account of a delay in supplying the equipment. In such circumstances, it was not necessary for Indian Oil Corporation to prove actual damages.

For further information on this topic please contact Bishwajit Dubey or Anushree Tripathi at Amarchand & Mangaldas & Suresh A Shroff & Co by telephone (+91 11 4159 0700), fax (+91 11 2692 4900) or email ([email protected] or [email protected]).

Endnotes