"I realise that some of my criticisms may be mistaken; but to refuse to criticize judgements for fear of being mistaken is to abandon criticism altogether... If any of my criticisms are found to be correct, the cause is served; and if any are found to be incorrect the very process of finding out my mistakes must lead to the discovery of the right reasons, or better reasons than I have been able to give, and the cause is served just as well."

-Mr. HM Seervai, Preface to the 1st ed., Constitutional Law of India.

Monday, April 30, 2018

Reliance Interest in Contract Damages and Expectation Damages

In the past few weeks, we have been discussing the recently proposed amendments to the Specific Relief Act, 1963 (thisthis and this). In this post we discuss one of the most monumental contributions to contract law, Fuller & Perdue's paper, "The Reliance Interest in Contract Damages", which was published in two parts (Part 1 & Part 2). One of the main ideas in the paper was the popular (or notorious, depending on your view) three-fold classification of contract damages. We also discuss the reason why expectation damages are awarded in contract law.

The Three-Fold Classification of Damages

F&P classified the reasons for the award of damages into protection of three kinds of interests:
  • Restitution interests: The restitution interest consists of any benefit the promisee has provided the breaching party. For example, if a seller agrees to make monthly deliveries of a commodity in return for fixed payments due 60 days after each delivery and the buyer repudiates the contract after receiving and retaining two deliveries but making no payments, restitutionary damages would restore to the seller the value of the delivered goods.
  • Reliance interests: The reliance interest is measured by the promisee’s wealth in the pre-contractual position. Reliance damages provide compensation both for any benefit conferred on the breaching party and for any other reliance investments made by the promisee in anticipation of performance to the extent such investments cannot be recovered.
  • Expectation interests: The expectation interest is measured by the net benefit the promisee would receive should performance occur.

After making the three-fold classification, F&P observed:
  • In most instances, the restitution measure will provide the lowest amount of recovery and the expectation measure the highest recovery. 
  • However, the restitution measure will provide the strongest claim while the expectation measure will provide the weakest. The restitution measure seeks to correct unjust impoverishment of the breacher and the unjust enrichment of the non-breacher. In case of reliance interest, it seeks to correct the unjust loss suffered by the non-breacher but does not undo any corresponding gain of the breacher. 
The three-fold classification has attained a lot of prominence. Two papers could be referred to for a critique of the classification: Friedmann, The Performance Interest in Contract Damages (1995) 111 LQR 628 and Richard Craswell, Against Fuller & Perdue, 67 Uni Chi L Rev (2000). The two articles criticise F&P on numerous grounds. We do not need to go into these criticisms for the purpose of the present article but the classification presents a simple and a powerful analysis of the interests sought to be protected by contract law. F&P's contribution is regarded as influential so much that it has been regarded as the most famous contract article ever written (see Friedmann). Like many influential works, it appears that F&P's article went unnoticed for a long time. Later, it was dusted off from the graveyard of law review articles, taught, analysed and criticised.

The interesting trivia around the F&P article is that Perdue was a third year research assistant of Lon Fuller. The theoretical parts of the paper were written by Fuller himself and the case laws were researched by William Perdue Jr. Another interesting trivia is that Richard M Nixon, the former American president (the only President of the US to have resigned- notorious for the Watergate scandal) would have "almost served as Fuller's research assistant" for the article (see, William M. Wiecek, The History of the Supreme Court of the United States, p. 449, foot note 39). Fuller should be credited for the ethical decision to let Perdue be the co-author for the work. This is an important lesson for academicians in India. In an age where research supervisors hijack the work of research scholars and at times sexually abuse them, Fuller's action of acknowledging Perdue as the co-author should be the lesson that academicians should learn.

Why Expectation Damages?

The concept of "expectation damages" was further brought to the mainstream by the law and economics scholars, who argued that so long as performance is not inefficient (notice the double negative), expectation damages provide the incentive for the promisor to perform the contract. If there is no expectation damages, the promisee would be left with non-performance, which was not desirable from the social welfare point of view.

[Note: The next part of this post cannot be understood unless the previous post is read]

Now read the hypothetical case discussed in the previous post (read carefully). The profit of Dintel in the transaction between Dintel and Denovo was Rs. 2,000 (Rs. 10,000- Rs. 8,000). The benefits out of the transaction for Denovo was Rs. 2,000.  But the profit of Dintel in the transaction between Dintel and Yechee was Rs. 5,000 (Rs. 13,000- Rs. 8,000). If Dintel was allowed to breach after compensating Denovo for Rs. 2,000, Dintel would still earn Rs. 3,000 (Rs. 5000-Rs 2000), which was provided as the justification for the efficient breach theory. It was a win-win situation for all the three parties (under the assumption that Denovo could make alternative arrangements). 

Now what would have happened if Yechee offered only Rs.11,000? After compensating Denovo (of Rs. 2000), Dintel would have earned a profit of only Rs. 1000, which was Rs. 1000 less than what it would've earned had it performed the contract with Denovo. Consider a scenario where Yechee offers only Rs. 11000 to Dintel, and if Dintel breaches the contract with Denovo, Denovo would have to pay Rs. 2000 for alternative procurement for another company CMD. In a case where expectation damages does not exist (and Dintel did not incur costs), Dintel would simply breach the contract with Denovo, leaving Denovo in the lurch, and go for Yechee's contract, thus earning a cool profit of Rs. 3,000. Denovo would then have to spend Rs. 2,000 extra and its profits from the sale of the laptop would be eroded, leaving Denovo worse off. Only if expectation damages existed would Dintel be prevented from breaching the contract with Denovo as it would earn a profit only of Rs. 1000 giving no incentive for Dintel to breach the contract with Denovo. 

This is the justification for expectation damages. More on the relevance of this discussion in the next post.

Thursday, April 12, 2018

Efficient Breach as a Justification for Specific Performance as an Exception

Readers may recollect the two recent posts in this blog (here and here) on the proposed amendments to the Specific Relief Act, 1963. Taking the topic forward, we discuss why damages and not specific performance is the default remedy. We discuss the efficient breach theory as popularised by Richard Posner and others. 

The Efficient Breach Theory

Efficicent breach theory was first introduced by Robert Birmingham in a 1970 article Breach of Contract, Damage Measures and Economic Efficiency, 24 Rutgers L Rev 273 (1970) and was subsequently developed by Richard Posner’s 1972 book titled, Economic Analysis of Law.

One of the most powerful theoretical justifications to the principle that damages should be the default remedy in case of contractual breaches and specific performance should be the exception is the efficient breach theory. As early as in 1897, OW Holmes famously stated: "The duty to keep a contract at common law means a prediction that you must pay damages if you do not keep it- nothing else." This is the battle cry of the proponents of the efficient breach theory.

The theory of efficient breach argues that damages as awarded by courts gives the promisor an incentive to perform the contract except when the result would be an inefficient use of resources. In such a case, the theory prescribes, promisor should be allowed to breach the contract so long as the victim is adequately compensated. The theory seems to be morally repugnant on the face of it but its appeal can be explained through a hypothetical example. 

What does the Theory Say? A hypothetical Case

Let us take a hypothetical case of laptop and processors business. The hypothetical case is slightly complicated and hence readers may pay close attention to each word in the case.

On 01.01.2018, manufacturers of processors, Dintel enters into contract to sell processors to Denovo Computers, a manufacturer of laptops. As per the contract, Dintel is supposed to deliver 100 units to Denovo on or before 01.07.2018. If Dintel breaches the contract, Denovo can procure the equivalent processors from another manufacturer, CMD at, say, around the same rate and without much delay. But Dintel's maximum capacity is only, say, 100 units in seven months.

Under the contract, Denovo is to pay Rs. 10000 per Processor or Rs. 10,00,000 by 01.08.2018 for delivery thereof. Dintel has to spend Rs. 8000 on manufacture, shipment and overheads. Denovo has to use the processors to manufacture laptops. On top of the cost it would incur for the processor, Denovo has to spend an extra Rs. 6000 per laptop (for other parts) and will sell the laptop at Rs. 18,000.
  • Total cost of producing the laptop = Rs. 8000 (cost of processor) + Rs. 6000 (other parts of the laptop) = Rs. 14,000.
  • Overall value created out of the deal= Rs. 18,000 (selling price) – Rs. 14,000 (cost) = Rs. 4000
  • Of the value of Rs. 4000, Rs. 2000 will go to Dintel (Rs. 10,000- 8000) and Rs. 2000 will go to Denovo [Rs. 18,000- (Rs. 10,000+6,000)]

Depending upon the relative bargaining power, either Dintel or Denovo may adjust the profit but would generally not make a loss-making deal, such as selling the processor at Rs. 6000 to Denovo (loss to Dintel) or at Rs. 13000 (loss to Denovo)

Although the above deal presents overall value to both parties, risks involved or new situations could make the deal unattractive to either one of them. One such situation is discussed below:

Consider a scenario where on 01.04.2018, YECHEE, a competitor to Denovo offers Rs. 13,000 per unit of 100 processors for delivery on 01.07.2018. YECHEE is offering so because it can produce the remaining parts in cheaper costs using its technology at just Rs. 3000. Please recollect that the overall value created in the transaction between Dintel and Denovo was Rs. 4000, that is, Rs. 18,000 (selling price) – Rs. 14,000 (production cost) = Rs. 4000. 

Whereas the overall value created in the transaction between Dintel and YECHEE would be [Rs. 18,000 (selling price) – (Rs. 8000 + Rs. 3000)] = Rs.  7000. [note that the production costs for YECHEE apart from the processor cost is just Rs. 3000.

Therefore, maximum social welfare (selling value minus production costs) would be achieved if the transaction between Dintel and YECHEE is allowed. In other words, if Dintel is allowed to breach the contract with Denovo, subject of course on payment of damages, both Dintel and Denovo will be well-off. This is, in simple, what the efficient breach theory prescribes: it would be socially optimal for Dintel to breach the contract and allow Dintel to enter into a deal with YECHEE provided Denovo is compensated. It will be a win-win situation for the victim of breach, for the promisor, and for the third party, YECHEE. Hence ,there will be no point in awarding specific performance, as specific performance will lead to a lesser overall societal value and will result in two disappointed parties (Dintel and YECHEE) of the three. This is the basis for the rule that specific performance will not be awarded where damages would adequately compensate the victim of breach. 

A Case for Specific Performance in the Above Scenario: Readers may recollect the assumption above that If Dintel breaches the contract, Denovo can procure the equivalent processors from another manufacturer, CMD at, say, around the same rate and without much delay. What if this assumption is not there? What if, owing to Dintel's breach, Denovo will not be able to supply laptops to its long-term customers, and which will lead to loss of reputation and a huge loss in market share such that the said losses would mean Denovo losing crores of rupees. Would breach still be allowed? In this situation, the breach would make Denovo seriously worse off, and would be a situation where damages would not adequately compensate Denovo. Therefore, specific performance would have to be ordered.

This is, in simple, the efficient breach theory.

Criticisms of the Efficient Breach Theory

So much was the theory’s influence that in 1983 Restatement (Second) of Contracts, the theory received a tentative endorsement” in the Introductory Note on Remedies with a caveat, which represents two broad strands of criticism- morally repugnant and reliance on false assumptions. In view of the criticisms, it appears that the theory was further refined but certain criticisms continued to be unsatisfactorily answered by the theory. 

Moral Repugnancy: This strand of criticism stems for the contract as a promise theory. 
  • The efficient breach theory encourages parties to a conduct (breaching the contract) which laws should condemn.
  • The theory allocates all gains from the wrong (breach) to the wrong-doer while affords no-loss-no-gain to the original buyer.
  • Critiques ask what will happen to the market and the sanctity of bargains if the chain goes on?
False Assumptions: Critiques argue that the theory is based upon several false assumptions.
  • It largely ignores transaction costs. It offers no account of how the breaching parties come to pay expectation damages- litigation will consumer lot of judicial and party resources which may even lead to huge costs making the transaction socially inefficient.
  • What happens especially in a situation like in India where it takes several years to award damages and to recover it, especially where the promisor refuses to pay damages?
  • The theory assumes perfect information. In actual world, damages measure and the calculations on profit/ overall welfare are complicated and unpredictable. Further, many meritorious cases fail due to lack of evidence or negligence of counsel/ parties.
  • The theory wholly ignores market reputation and repeat play, especially in long-term scenarios. Parties may not be cold-blooded and self-interested in such cases.
Despite the serious criticisms that the theory faces, the theory presents a power justification for the rule that specific performance should be the exception and damages should be the default remedy.

More on this topic in another post. 

Monday, April 9, 2018

Specific Performance as the Default Remedy in India? The Specific Relief (Amendment) Bill, 2018

We did a small post on the Specific Relief (Amendment) Bill, 2018 on 28 March 2018.  The Bill has been passed by Lok Sabha on 15.03.2018 (as usual, without discussions). This post is in continuance of the said post on the topic and discusses the proposed amendments to the Specific Relief Act, 1963 making specific performance as the default remedy and damages as the exception.

Proposed Amendment

The Statement of Objects and Reasons to the 2018 Bill states, among other things, that the Specific Relief Act, 1963 confers wide discretionary powers on courts to decree specific performance due to which awarding damages is the general rule and granting specific performance is the exception, that by enacting the 2018 Bill it is proposed to do away with the discretion so as to make specific performance as the default/ general remedy and that the alternative remedy of performance through third party would be the exception. The relevant portions of the Statement of Objects and Reasons for the 2018 Bill are extracted below:

"[The 1963 Act] also confers wide discretionary powers upon the courts to decree specific performance and to refuse injunction, etc. As a result of wide discretionary powers, the courts in majority of cases award damages as a general rule and grant specific performance as an exception... In view of the above, it is proposed to do away with the wider discretion of courts to grant specific performance and to make specific performance of contract a general rule than exception subject to certain limited grounds. Further, it is proposed to provide for substituted performance of contracts, where a contract is broken, the party who suffers would be entitled to get the contract performed by a third party or by his own agency and to recover expenses and costs, including compensation from the party who failed to perform his part of contract. This would be an alternative remedy at the option of the party who suffers the broken contract."

For the aforesaid purposes, the following amendments are proposed to be made in the Specific Relief Act, 1963:

Section 10 of the existing 1963, which enumerates cases where, and conditions in which, specific performance of contract is enforceable, is sought to be replaced with the following provision: “10. The specific performance of a contract shall be enforced by the court subject to the provisions contained in sub-section (2) of section 11, section 14 and section 16.”

Section 11 relates to contracts where the act agreed to be done is in the performance of a trust. Section  11(1) is sought to be amended to substitute the phrase “contract may, in the discretion of the court” with "contract shall". After the amendment, Section 11(1) will read: "11... (1) Except as otherwise provided in this Act, specific performance of a contract shall be enforced when the act agreed to be done is in the performance wholly or partly or a trust."

Section 14 is sought to be replaced with the following:

14. The following contracts cannot be specifically enforced, namely:— 
(a) where a party to the contract has obtained substituted performance of contract in accordance with the provisions of section 20; 
(b) a contract, the performance of which involves the performance of a continuous duty which the court cannot supervise; 
(c) a contract which is so dependent on the personal qualifications of the parties that the court cannot enforce specific performance of its material terms; and 
(d) a contract which is in its nature determinable."

Except for ground 14(a) above, the rest of the grounds are available in the existing Section 14. The new Section 14 proposed does away with few of the existing grounds viz., contracts where compensation for breach is an adequate remedy, and contracts running into minute or numerous details. The new ground sought to be amended, that is, contracts where the victim of breach has obtained substituted performance is the subject of the amendment proposed to Section 20 of the 1963 Act.

The existing sub-heading for Sections 20 to 24 of the 1963 Act, "Discretion and Powers of Court" is sought to be replaced with the sub-heading “Substituted performance of contracts, etc.”. The existing Section 20 titled "Discretion as to decreeing specific performance" is sought to be replaced with a section on Substituted Performance. The new section proposed reads as under:

20. Substituted performance of contract- (1) Without prejudice to the generality of the provisions contained in the Indian Contract Act, 1872, and, except as otherwise agreed upon by the parties, where the contract is broken due to non-performance of promise by any party, the party who suffers by such breach shall have the option of substituted performance through a third party or by his own agency, and, recover the expenses and other costs actually incurred, spent or suffered by him, from the party committing such breach. 
(2) No substituted performance of contract under sub-section (1) shall be undertaken unless the party who suffers such breach has given a notice in writing, of not less than thirty days, to the party in breach calling upon him to perform the contract within such time as specified in the notice, and on his refusal or failure to do so, he may get the same performed by a third party or by his own agency: 
Provided that the party who suffers such breach shall not be entitled to recover the expenses and costs under sub-section (1) unless he has got the contract performed through a third party or by his own agency. 
(3) Where the party suffering breach of contract has got the contract performed through a third party or by his own agency after giving notice under sub-section (1), he shall not be entitled to claim relief of specific performance against the party in breach. 
(4) Nothing in this section shall prevent the party who has suffered breach of contract from claiming compensation from the party in breach."

Section 16 deals with cases where specific performance of a contract cannot be enforced in favour of a person. Section 16(a), which "(a) who would not be entitled to recover compensation for breach" is proposed to be replaced with "(a) who has obtained substituted performance of contract under section 20" in line with the aforesaid amendments.

Section 16(c) provides that specific performance cannot be enforced in favour of a person who fails to aver in the pleadings and prove that he has performed or always has been reading and willing to perform the essential terms of the contract which are to be performed by him. The requirement of averment is sought to be removed. The same change is proposed in Explanation (ii) to Section 16(c). After the amendment, Section 16(c) with its explanations will look like this:

"Specific performance of a contract cannot be enforced in favour of a person-
(c) who fails to aver and prove that he has performed or has always been ready and willing to perform the essential terms of the contract which are to be performed by him, other than terms the performance of which has been prevented or waived by the defendant. 
Explanation.—For the purposes of clause (c),—
(i) where a contract involves the payment of money, it is not essential for the plaintiff to actually tender to the defendant or to deposit in court any money except when so directed by the court;
(ii) the plaintiff must aver prove performance of, or readiness and willingness to perform, the contract according to its true construction


The proposed set of amendments seek to do away with the general rule in contract law that damages will be the default remedy and specific performance will be the exception. In our earlier post, we had suggested that the amendments sought to be made are far-reaching. We reiterate the view because the Bill seeks to alter the legal position which has been in vogue for more than 200 years (see, for instance, Harnett v Yielding (1805)). Although Scots law and certain civil law jurisdictions have specific performance as a default remedy, damages as the default remedy is the near universal rule in common law jurisdictions. The present amendments seek to alter this approach in India.

We will look at the theoretical arguments for and against the above-discussed proposal in the 2018 Bill in another post.  

Tuesday, April 3, 2018

Prospectivity, Retrospectivity & the Arbitration & Conciliation (Amendment) Bill, 2018

This blog had several posts on the topic of the retrospective application of the 2015 amendments to the arbitration law. The posts are given below:

The issue was finally but partially settled by the Supreme Court in the case of BCCI v. Kochi Cricket (2018).  The purpose of this post is two-fold: one, to look at the 2018 amendment Bill and see if the criticisms of the Bill by the Supreme Court in BCCI v. Kochi Cricket are in order. The second and the more important purpose is to examine if the proposal of the Government in the form of S 87 as provided in the 2018 Bill is in order.

The 2018 Bill and its History

The 2018 Bill in its present form was pursuant to the recommendations of the High Level Committee which was formed to look into, among other things, the recent amendments to arbitration law and suggest measures to improve arbitration in India.

The Statement of Objects and Reasons to the 2018 Amendment Bill lists out the purposes of the Bill, which includes, among other things, “to clarify that section 26 of the Arbitration and Conciliation (Amendment) Act, 2015, is applicable only to the arbitral proceedings which commenced on or after 23rd October, 2015 and to such court proceedings which emanate from such arbitral proceedings, to address the divergent views given by various Courts.”

Section 15 of the Bill seeks states: “Section 26 of the Arbitration and Conciliation (Amendment) Act, 2015 shall be omitted and shall be deemed to have been omitted with effect from the 23rd October, 2015.” Thus, Section 26 of the 2015 Act is sought to be retrospectively omitted. This is sought to be replaced, in effect, with Section 13 of the Bill, which seeks to introduce Section 87 to the 1996 Act. Section 87 reads:

"87. Unless the parties otherwise agree, the amendments made to this Act by the Arbitration and Conciliation (Amendment) Act, 2015 shall—
(a) not apply to—
(i) arbitral proceedings commenced before the commencement of the Arbitration and Conciliation (Amendment) Act, 2015;
(ii) court proceedings arising out of or in relation to such arbitral proceedings irrespective of whether such court proceedings are commenced prior to or after the commencement of the Arbitration and Conciliation (Amendment) Act, 2015;
(b) apply only to arbitral proceedings commenced on or after the commencement of the Arbitration and Conciliation (Amendment) Act, 2015 and to court proceedings arising out of or in relation to such arbitral proceedings."
These amendments are pursuant to recommendations made by the High Level Committee, which stated: “Section 26 of the 2015 Amendment Act may be amended with retrospective effect to provide that unless parties agree otherwise, the 2015 Amendment Act shall apply only to arbitral proceedings commenced on or after the commencement of the 2015 Amendment Act and to court proceedings arising out of or in relation to such arbitral proceedings.”

The Committee gave the following justifications for its recommendation:
  • The continuing confusion regarding the prospective applicability of the 2015 amendments were creating a negative investment climate.
  • Applying the 2015 amendments to court proceedings relating to arbitrations which commenced prior to 23.10.2015 would result in uncertainty and prejudice to the parties, and would lead to inconsistencies.
However, the Supreme Court inBCCI v. Kochi Cricket criticised the said amendment proposal and stated:
  • The Government should keep the objectives of the 2015 amendments in mind before bringing in a proposal to insert Section 87.
  •  The effect of Section 87 would be to put the various amendments to the 1996 law in the back-burner, especially as regards S. 28 and 34. If so, the old law would continue to apply resulting in delay and increased court interference in the proceedings. 
  • In fact, the Law Commission had proposed an amendment similar to Section 26.

Now, two things are striking when one reads the aforesaid summary. The Supreme Court has indirectly chided itself in derailing the 1996 Act by observing that if Section 87 in its present form is enacted, it “would mean that in all matters which are in the pipeline, despite the fact that Section 34 proceedings have been initiated only after 23rd October, 2015, yet, the old law would continue to apply resulting in delay of disposal of arbitration proceedings by increased interference of Courts, which ultimately defeats the object of the 1996 Act.” (Para 57, BCCI v Kochi Cricket).

The Supreme Court’s decision that the 2015 amendments are prospective does not comport with its foot note 4 in the judgement where it cites with approval HRD Corporation (Marcus Oil and Chemical Division) v. Gail (India) Limited (Formerly Gas Authority of India Ltd.) 2017 SCC Online 1024.

The 2015 amendments, especially as regards narrowing grounds under Section 34, cannot be applied to arbitral awards passed before 23.10.2015. Take a situation where an arbitral award is rendered by an arbitral tribunal on 25.07.2015 dismissing both the claims and the counter-claims filed. The claimant challenges the award by filing an application challenging under Section 34 on, say, 31.07.2015 questioning the dismissal of claims, and the counter-claimant files the application under Section 34 on, say 21.10.2015, challenging the dismissal of counter-claims. Assume that the court decided the Section 34 application of the claimant by 22.10.2015 itself and sets aside the award. but the counter-claimant's application is still pending Would this mean that in respect of the claimant’s Section 34 application the pre-2015 position would apply (wider grounds) and in respect of the counter-claimant’s Section 34 application the post-2015 position would apply (narrower grounds)?

While the Supreme Court’s intent is good, applying the 2015 amendments to pending court proceedings would lead to a lot confusion, which India will do well to avoid.

Perhaps, the best way forward is for the legislature is to re-draft Section 87:
  • to save certain provisions in the 2015 Act which expressly provides for retrospectivity [such as S. 8(ii)]
  • to generally provide that the 2015 amendments will not apply retrospectively to arbitrations commenced prior to 23.10.2015, except in those limited cases as contemplated above.
  • to apply certain provisions to pending arbitration related court-proceedings or such proceedings filed after 23.10.2015 in respect of arbitrations commenced prior to 23.10.2015, such as S 2(I)(A) which has to read with S. 42 of the 1996 Act, S 2(I)(B), 4(i) and (ii), S 6(i), (ii) and (iii) (since the law as it stood before 23.10.2015 was the same), S 6(v), (vi), (vii), (viii)(ix)(because the 60 day limit is not going to affect anyone adversely from a substantive point of view and such 60 days in pending applications should commence from 23.10.2015 or the date of filing or from the date of bringing into force of the altered Section 87), S 19 (in view of the objects),
  • to apply certain provisions to pending arbitration related court-proceedings only prospectively such as Section 18, S 9, etc
The above classification would do a great deal in balancing the interests that both the SC and the High Level Committee sought to protect.