Introduction
Disputes arising due to delay in completion of an infrastructure construction contract may lead to a variety of claims, including that of claims towards loss of profit, liquidated damages, damages due to idling of plant, labour and machinery and increase in onsite and offsite over-head expenses. The law with respect to grant of damages, whether liquidated or unliquidated, has been discussed by the courts in a plethora of judgments. However, claims pertaining to loss of profit and profitability have been seldomly discussed.
The
The terms for loss of profitability and loss of profit are used interchangeably. Therefore, it is important to highlight the difference between the claims of loss of profit and loss of profitability-
- Claims arising due to delay in execution of the contract, where the contractor could have earned profit if it would have deployed its resources in another venture, leads to claims for loss of profitability; and
- Claims arising due to early termination of the contract or omission of a portion of work, wherein the contractor can claim for compensation for the expected profit of the balance of work, leads to claims for loss of profit.
Judicial Precedentspertaining to computation of loss of profit and profitability.
The principle rule for a claim resulting from a breach of contract, was laid down by the English Courts in Robinson vs. Harman2, wherein it was observed that the sum of money awarded to the party who has suffered the injury, should be the same quantum as s/he would have earned or made, if s/he had not sustained the wrong for which s/he is getting compensated.
Section 73 of the Indian Contract Act, 1872 (“ICA”) also provides that the party who suffers the breach is entitled to receive compensation for any loss or damage caused to him “which naturally arose in the usual course of things from such breach”. Elaborating further the
“9. It was not disputed before us 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. What must be the measure of profit and what proof should be tendered to sustain the claim are different matters. But the claim under this head is certainly admissible.”
Thus, the question that arises is, how does one substantiate a claim for loss of profit or profitability. Relying on the judgement of AT Brij Paul, the Supreme Court in the case of
“.. damages can be claimed by a contractor where the government is proved to have committed breach by improperly rescinding the contract and for estimating the amount of damages court should make a broad evaluation instead of going into minute details. It was specifically held that where in the works contract, 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. Claim of expected profits is legally admissible on proof of the breach of contract by the erring party.”
Further, towards the measure of damages, the courts held that a reasonable percentage of the value of the remaining parts of the work contract, which in this case was 10%, could be granted.
With respect to a claim for loss of profitability, it is imperative for the party seeking damages to prove the existence of an opportunity which has been denied on account of prolongation of the contract. To this effect, the
“A party should prove, existing opportunity, and that it could not avail the said opportunity due to prolongation which resulted in loss to such the party. The loss would have to be quantified and proved.”
Once a contractor has satisfied the arbitral tribunal that he had the opportunity to deploy his resources in another venture, the issue of quantification of loss arises. The
- The Hudson Formula - In case the contract provides for the head office overhead percentage, then the same can be taken from the contract.
- The Emden Formula - In this formula, the head office overhead percentage is arrived at by dividing the total overhead cost and profit of the contractor's organisation as a whole by the total turnover. This formula has the advantage of using the contractor's actual head office overhead and profit percentage rather than those contained in the contract.
- The Eichleay Formula - This formula is used where it is not possible to prove loss of opportunity and the claim is based on actual cost. Therefore, in this formula the total head office overhead during the contract period is first determined by comparing the value of work carried out in the contract period for the project with the value of work carried out by the contractor as a whole for the contract period.
That said, parties frequently dispute the computation made in the award regarding such claims and also the method adopted by the arbitral tribunal for making such calculations. In
Factual background of
Amongst other grounds, the award was thereafter challenged by HPCL, on the ground that the award is deficient being completely silent as to the method and the manner adopted for computation of the claim of loss of overhead and loss of profit/profitability. In order to justify the computation made in the award and also the principle or the method adopted by the Arbitrator, BEEL referred to the
Findings of the Supreme Court in
The
“16….. the computation of damages should not be whimsical and absurd resulting in a windfall and bounty for one party at the expense of the other. The computation of damages should not be disingenuous. The damages should be commensurate with the loss sustained. In a claim for loss on account of delay in work attributable to the employer, the contractor is entitled to the loss sustained by the breach of contract to the extent and so far as money can compensate.”
Elaborating further on the prerogative of the arbitral tribunal to choose a method for computation of damages, the Supreme Court held that -
“21…. The three formulae deal with theoretical mathematical equations, but are based on factual assumptions, and therefore can produce three different and unrelated compensation/damages. Therefore, while applying a particular equation or method, the assumptions should be examined, and the satisfaction of the assumption(s) ascertained in the facts and circumstances.”
With respect to the computation of quantum of damages through the
“22. 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.”
The
CONCLUSION
The
The judgment in
Footnotes
1. 2023 INSC 850
2. (1848) 1 Ex 850
3. (1984) 4 SCC 59
4. AIR 1999 SC 1031
5. 2020(3) Arb LR 463 (
6. (2006) 11 SCC 181
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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