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India – How to claim damages for illegal termination of works contract

  
Works Contract
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In this article, Smita Singh, a qualified lawyer discusses how to prove contractor’s loss of profit for illegal termination of works contract.

Introduction

In the commercial world, it is common for contractors to enter into contracts for undertaking works for those who engage them (the employers), in anticipation of earning profits.

Usually, the contractor agrees to undertake such works for a price that includes cost of executing works like construction of building, manufacturing, supplying and erecting machinery etc, as well as the contractor’s expected profit.

In case of termination of such contract before completion, the contractor can claim value of the work actually undertaken. The contractor may not be able to claim value of incomplete work, to the extent it had not undertaken any work and had not incurred any costs.

However, if premature termination was brought about on account of employer’s breach, it may be possible for the contractor to claim expected profits that is lost on account of incomplete work.

This blog explains the legal position respecting such entitlement.

The statutory provision enabling claim for loss of profit

Section-73 of the Indian Contract Act, 1872, entitles a party suffering a breach of contract to receive from the breaching party compensation for loss/damage suffered on account of such breach. The innocent Party can claim two categories of damages viz.:

  • Direct damages i.e. loss that arose naturally from the breach;
  • Consequential damages which were reasonably in contemplation of the Parties to the contract at the time they made the contract, as probable result of the breach.

Loss of profit is a consequential damage. A claim for Loss of profit can thus be made only if special circumstances leading to such loss were in the knowledge of the Party in breach.

Burden of proving loss of profit

Under the law of evidence, the burden of proving entitlement for loss of profit, is placed on contractor claiming damages. The contractor should prove that:

  1. As a consequence of breach of contract the contractor suffered loss/damages;
  2. That such loss was in contemplation of the employer; and
  3. The measure of such loss.

In case of claim for loss or profit, it becomes difficult to establish with precision that what was expected profit that could not be realized on account of breach.

The expectation of profit implicit in the Works Contract

In a series of decisions the Supreme Court has settled the position that ordinarily a Contractor, while agreeing to undertake a Works Contract, reasonably expects to make profit. Reasonable expectation of profit is held to be implicit in the Works Contract. Thus, in cases of breach leading to improper termination of a works contract by employer, a contractor is presumed to have lost profit. Further, the measure of such loss is allowed to be based on some guesswork.

In Mohd. Salamatullah v. Govt. of A.P.[1]  the Supreme Court considered a case of breach of contract for manufacture and supply of guns, as a result of which the contract could not be completed. The court approved the grant of 15% of the contract price as damages in case of breach of contract. It held that the appellate court was not justified in interfering with the finding of fact given by the trial court regarding quantification of the damages even if it was based upon guesswork.

In A.T. Brij Paul Singh v. State of Gujarat[2], the Supreme Court recognized the position that in a works contract, if the party entrusting the work commits breach of the contract, the contractor is entitled to claim damages for loss of profit, which he expected to earn by undertaking the works contract. In said case, the Court without insisting  for direct proof the measure of profit lost, granted 15 per cent of the value of the remaining work, as damages for loss of profit.

In Dwaraka Das v. State of M.P.[3], Supreme Court considered a case wherein the High court  had denied the contractor’s claim for loss of profit on the ground that the contractor did not place any material on record, but had only relied upon assessment of the profits by the Income Tax Officer while assessing the income of the contractors from building contracts.

The Supreme Court relying on decisions in Mohd. Salamatullah and A.T. Brij Paul Singh wherein it had granted 15% of the contract price as loss of profit, held the contractor to be entitled to 10% of the contract price. The court stressed that when the termination of contract is contrary to law and terms of the agreement, the erring party is legally bound to compensate the other party to the agreement. The court further emphasized that in estimating the amount of loss of profits, court should make a broad evaluation instead of going into minute details

In J.G. Engineers Pvt. Ltd., Vs Union of India[4] the Supreme Court upheld the award of 10% of the value of incomplete portion of work, as loss of profit. In said case it was found that the employer was responsible for the delays/breaches; the contractor was not in the breach, and the employer had illegally terminated the contract.

The position as aforesaid is followed by several High Courts.[5]

In Kanchan Udyog Limited vs. United Spirits Limited[6] however Supreme Court insisted for proof of loss of anticipated profit. It did not accept profitability projections made in loan application, as proof of estimated profitability. In the said case the court also found that the party claiming compensation could not establish that the other party had committed any breach. Besides, the said case did not pertain to works contract.

Loss of profit not to be presumed where execution of contract was prolonged

There may be cases where the contractor completes the work, but the execution is delayed on account of breaches committed by the employer. In such cases, the contractor receives the full price including expected profits. The contractor can also prove and recover increased cost of execution (on account of escalation of cost of material and labour). Though it is possible for the contractor to recover loss of profit for prolonged period, the same may not be presumed. In order to claim loss of profit the contractor will have to lead cogent evidence. The position is succinctly stated by Supreme Court in Bharat Coking Coal Ltd. vs. L.K. Ahuja[7] in following words:

“Here when claim for escalation of wages bills and price for materials compensation has been paid and compensation for delay in the payment of the amount payable under the contract or for other extra works is to be paid with interest thereon, it is rather difficult for us to accept the proposition that in addition 15% of the total profit should be computed under the heading ‘Loss of Profit’. It is not unusual for the contractors to claim loss of profit arising out of diminution in turn over 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. In this case, no such material is available on record. In the absence of any evidence, the arbitrator could not have awarded the same. This aspect was very well settled in Sunleyn (B) & Co. Ltd. vs. Cunard White Star Ltd., [1940] 1 K.B. 740 by the Court of Appeal in England.”

Conclusion

In case of termination of a works contract owing to breach by the employer, the contractor can claim loss of anticipated profits in respect of incomplete portion of work. The courts, in the light of decisions of supreme court referred supra may award 10-15% of the value of incomplete work, as lost profit. Though the decisions suggest that such loss could be presumed or be based on guesswork, it is strongly recommended that the contractor leads credible evidence in support of his claim. This could include testimony of experts, records of profit made by similar ventures, reliable profitability projections made before undertaking the venture etc.

In situations where work is completed, but is delayed on account of employer’s defaults, the claimant ought to prove that he could have used the receivable under the contract if paid on time, to utilise the same in some other venture to earn profits.

[1] (1977) 3 SCC 590

[2] (1984) 4 SCC 59

[3] (1999) 3 SCC 500

[4] (2011) 5 SCC 758

[5] Mahanagar Gas Ltd. v. Babulal Uttamchand and Co., (2013) 2 Mah LJ ; Himachal Joint Venture v. Panilpina World Transport AIR 2009 Del 88; and Delhi Development Authority vs. Polo Singh MANU/DE/1882/2002

[6] MANU/SC/0699/2017

[7] MANU/SC/0335/2004

How to claim damages for illegal termination of works contract

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1 Comment

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  1. The profit motive of contractors has been elaborated. Measures must be taken to protect labour working under them

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