Time as Essence in Construction Contracts: Need for a Comprehensive Relook

The issue of time as essence in construction contracts is controversial and is frequently litigated. The law on the subject is largely unsatisfactory. In a paper titled "The Law on Time as Essence in Construction Contracts: A Critique" published in Volume 8 Issue 1 of the RGNUL Financial and mercantile Law Review (here), the law on the subject is critically evaluated. The paper argues that the precedent on the issue, Hind Construction Contractors v. State of Maharashtra, AIR 1979 SC 720 ("Hind Construction"), was wrongly decided and requires reconsideration. It also argues that:

• Hind Construction is no more relevant to the current times and provides incentives to inefficient contractors leading to delay in project completion; 
• Contracting parties do not appear to have circumvented the adverse effect produced by Hind Construction through the use of appropriate language in their contracts despite various decisions following the said decision; and 
• One of such reasons for the phenomena appears to be a lack of direction by courts as to what contracting language could constitute future courts to construe a contractual condition providing that time is of the essence as such.

The paper concludes by arguing that concludes by highlighting possible contractual clauses and contract management strategies that could further party intent that time is of the essence in construction contracts notwithstanding Hind Construction and later decisions following it.

Abstract of the Paper is provided below:

"The concept of time as essence in construction contracts is a controversial topic. Even though parties routinely provide in their agreements that time is of the essence, these clauses inevitably figure in construction disputes. Arbitral tribunals and courts have mostly decided such disputes holding those clauses to be of no legal effect, mainly by relying on the decision of a three-judge bench of the Hon’ble Supreme Court in Hind Construction Contractors v. State of Maharashtra. This paper argues that Hind Construction was wrongly decided, that it is not good law and that it requires reconsideration given the changing times. The paper further notes that parties do not appear to have circumvented the adverse effect of Hind Construction. Usually, in such situations, there is a change in contracting behaviour by the use of appropriate contracting language. Perhaps, this is due to the lack of direction by courts as to what appropriate language could be used in contracts to make time as the essence of the contract. This paper concludes by suggesting possible methods by which courts and arbitral tribunals could validly enforce time-as-essence clauses."

Critique of the paper is welcome as comments to this post. Readers can also write to lawbadri@gmail.com

* Image from here.

Digital Archives of the Parliament Library & Why Law Univs Must Focus on Researching This

Recently, the Parliament of India has made public its archives in digitised format in the form of a separate page called Parliament Digital Library. We have just skimmed the surface of the archives. The most important thing is that it brings together in one place the legislative history of most of Indian statues, including the ones made by the British. For instance, it contains the discussions of the Council of the Governor General of India on laws such as the Indian Contract Act, 1872 (9 April 1872), and other laws enacted during the period. We will try to have detailed posts on certain laws. But this is an important resource and is a must read for all interested in Indian law, especially law academicians and researchers. 

I think it is now the solemn duty of law universities to research on this and write a lot of articles on these subjects. These will provide a better perspective on the purpose of drafting a particular provision in a particular manner. These will gave considerable insight on how statutes were enacted in India during that period.  

For instance, on liquidated damages, James Stephen said in the Council: 

"The only other matter of importance on which we have differed with the Commissioners is the question of liquidated damages. The law of England on the question whether, when a man promises in a certain event to pay a specified sum, he is bound or not to pay it in full, is rather intricate; and, in order to avoid that intricacy, the Commissioner proposed to enact that, in all cases, Such penalties should be treated as liquidated damages. We agreed that the intricacy should be removed, but, for the reasons assigned in our report, thought that it should be removed by the converse operation of turning all liquidated damages into penalties. This we proposed to qualify by an exception, which, 8.S it stands in the Bill, is not very neat, and which I propose to amend· It applies to the case of bail-bonds, recognizances, and the like, and to persons who, under the orders of Government, give bonds for the due performance of public duties."

At another place, a member of the Council noted: "As to the provisions of section 74 of the Bill, on the subject of liquidated damages, HIS HONOUR would say that he believed the Committee had done great service in putting it into a shape which, although in some respects opposed to the English law, appeared to be fair and equitable." 

Thus, the section as it originally stood was based on fairness and equity! But the way in which it was construed during the early period of the Act till 1899, as this post goes to show, was totally contrary to the intent of the drafters and the Council. It is also interesting to note that the Indian Law Commissioners, sitting in England (?), wanted to make all penalties as liquidated damages, until contrary is shown. 

Some of the information contained in the archives, such as those discussed above relating to contract law, are already in public domain in the form of secondary sources. But it is excellent to access the primary sources. Hence the excitement in this post.  

Machi, open the webpage! 

Happy researching!

Retrospective Operation of the Specific Relief (Amendment) Act, 2018

As stated in several previous posts in this blog, the Specific Relief (Amendment) Act, 2018 (“2018 Act”) brings several substantive changes in the Specific Relief Act, 1963 (“1963 Act”) thereby drastically altering contract remedies. Given that these amendments were brought into force from 01.10.2018, questions are likely to arise as to the retrospective operation of various provisions.

Bengaluru City Civil Court Decides

One of the first decisions on this issue is from the XII Additional City Civil Court, Bengaluru in OS No. 5395/2011 (Somashekar v. Lt. Col. Appu Ramanand Sharma (Retd.). The suit is for specific performance of an agreement to sell an immovable property and has been pending from 2011. When the matter was at the stage of arguments, the Plaintiff argued that the amendments to the 1963 Act have done away with the discretion of courts to order specific performance and that if the agreement is proved, the court is obligated to order specific performance.

The court rejected the contention of the plaintiff on this issue and held that the 2018 Amendment was not retrospective. The court relied on Section 1(2) of the 2018 Amendment, which provided:

"It shall come into force on such date as the Central Government may, by notification in the Official Gazette, appoint and different dates may be appointed for different provisions of this Act and any reference in any such provision to the commencement of this Act shall be construed as a reference to the coming into force of that provision."

On the basis of the above provision, the court concluded that the amendment was given a prospective effect. While the reasoning is not completely in accord with the legal provisions, the court was correct in rejecting the contentions of the Plaintiff on retrospectivity because the cause of action arose prior to the suit in 2011.

While the decision does not have any precedential value, this is perhaps one of the earliest decisions on the issue.

Whether the 2018 Act is Retrospective?

On the question of retrospectivity of the 2018 Act, readers would do well to have a look at this blog post on the subject. This post puts forth the following points:

• The 2018 Act does not contain any savings clause or a transitory provision.
• The 2018 Act is in the nature of substantive law since it provides for substantive changes in the law of remedies.
• Remedial statutes are prospective.
• In view of Section 6 of the General Clauses Act, 1897, the rights and obligations accrued prior to the bringing into force of 2018 Act (01.10.2018) would stand undisturbed by the 2018 Act.
• The 2018 Act would be applicable to all breaches and disputes subsequent to bringing into its force.
• This is irrespective of whether the contract was concluded before the 2018 Act came into force.

Thus, any breach (or cause of action) that arose on or after 01.10.2018 would be governed by the 2018 Act. This is even if the contract was signed before 01.10.2018.

Whether Absence of a Savings Provision or Transitory Clause is a Lacuna?

It is suggested in the aforesaid post that there is no savings provision or transitory clause and a similar absence has caused several problems in the context of the Arbitration and Conciliation (Amendment) Act, 2015. The analogy of the problems regarding retrospectivity, a subject well-discussed in this blog, with that of the 2018 Act is misconceived. While the arbitration amendments were both procedural and non-procedural, the amendments in the 2018 Act are substantive in nature, as the above blog states. Therefore, there is no reason why such a provision should be there. Such savings provisions are not common when an amending statute amends substantive law (as it is known), unless specific reasons warrant otherwise.

Liquidated Damages under Indian Contract Law between 1872 & 1899

On 29 September 2018, we did a brief article review of S. Swaminathan’s erudite paper in the Chinese Journal of Comparative Law (link-subscription required) De-inventing the Wheel: Liquidated Damages, Penalties and the Indian Contract Act, 1872, 6 Chinese Journal of Comparative Law 103-127 (2018). This post is in respect of one of the topics addressed in the paper.

An important argument in the paper is that the 1899 amendment brought in the dichotomy of liquidated damages-penalty into the Indian Contract Act, 1872, before which such a dichotomy never existed. Although this view is more or less correct, it appears from a perusal of the decisions rendered prior to 1899 that the judges ended up judicially incorporating the dichotomy in their decisions. 

Section 74 as it Stood Originally

The original Section 74 was substituted by Section 4 of the Act VI of 1899. Para 1 of Section 74 as it originally stood read as below (Para 2 did not undergo any substantial amendment):

“Title to compensation for breach of contract in which a sum is named as payable in case of breach- When a contract has been broken, if a sum is named in the contract as the amount to be paid in case of such breach, the party complaining of the breach is entitled, whether or not actual damage or loss is proved to have been caused thereby, to receive from the party who has broken the contract reasonable compensation not exceeding the amount so named.”

One of the chief aims of the original Section 74 was to do away with courts inquiring as to whether the amount named is liquidated damages or a penalty. Swaminathan argues that this did not happen primarily owing to the amendments in 1899 which introduced the dichotomy:

“Just how did the exact opposite of what the drafters had envisaged come to be the state of the law and this, after they had been so careful about wanting to avoid the troublesome liquidated damages-penalty dichotomy?… The single most important contributing factor in bringing this about, it will be hypothesized, was an ambiguity unwittingly introduced by an amendment to section 74 in 1899 by a select committee headed by the ace draftsman Mackenzie Chalmers… However, the effect of the introduction of the word ‘penalty’ in the provision in sharp contrast to the neologisms used by the original provision was to prove troublesome. It was to create the misleading (and unintended) impression that the English concept of ‘penalty’ was being sought to be introduced into Indian law. Once penalty was in, liquidated damages was but not even a step away.”

“Controversy Surrounding “Sum is Named in the Contract”

The author also acknowledges that the way in which the original Section was drafted did not help matters and referred to the more controversial issue then regarding whether clauses providing for increased interest on account of default could be covered under the original Section 74:

"The phrase ‘sum named in the contract’ ostensibly meant that the provision applied only to in solido sums, thus leaving out stipulations for variations of interest, acceleration clauses which affected payment schedules rather than sums, and payments in specie. This ambiguity led to a great divergence of opinion among Indian courts on the applicability of section 74 to such clauses. A good fraction of the litigation on section 74 involved such stipulations.”

This is correct. A perusal of the decisions between 1872 and 1899 reveal this aspect. There were divergent views of various High Courts on the question as to whether the original section applied even to a stipulation that could be categorized penalty although the amount of penalty was not “named” in the contract. See, for instance, H. Mackintosh v. Hunt (1877) ILR 2 Cal 202, where the Calcutta High Court held:

“We are of opinion that the contract to pay interest at 10 per cent, per mensem, if the principal sum of Rs. 400 were not paid on September 6th, the duo date of the promissory note, is not in the nature of a penalty… In such a provision there is nothing in the nature of a penalty more than there is in a provision, that the promissory note shall bear interest from the day of its date. The case seems to us to differ wholly from that class of cases in which a certain sum is agreed to be paid on a breach of contract, and therefore Section 74 of the Contract Act (IX of 1872) does not apply.”

A Full Bench of the Calcutta High Court upheld this view about twenty two years later in Deno Nath Santh v. Nibaran Chandra Chuckerbutty and Ors. MANU/WB/0158/1899 by holding that “this is not a sum named in the contract as the amount to be paid in case of such breach, and Section 74 does not apply.” There were equally a good number of cases where the fine distinctions between such clauses were made and contra view was upheld. See, for instance H. Mackintosh v. C. Crow and Anr. (1883) ILR 9 Cal 689 and a decision of the Full Bench of the Calcutta High Court in  Kala Chand Kyal v. Shib Chunder Roy I.L.R. 19 Cal. 392 (FB): MANU/WB/0013/1892.  It must also be noted that in cases where the courts held that Section 74 were not applicable, the debtor did not stand unprotected and could raise defences available to him in equity. See, for instance, H. Mackintosh v. Hunt (1877) ILR 2 Cal 202, Mackintosh v. Wingrove (1879) ILR 4 Cal 137 and Ram Prasad And Ors. v. Lalli (20 July 1886) (1887) ILR 9 All 74. Nevertheless, considering the decision of the Full Bench in Deno Nath (above), we are not sure the remedy was efficacious.

Now, coming back to Swaminathan’s article, the author argues: “Unsure about the applicability of this provision to such cases, Indian courts increasingly began to fall back on the English law to decide these cases.” The author seems to suggest from this argument that owing to the controversy regarding whether enhanced interest clauses were “sum named in the contract”, English law were relied on to decide those cases. The author’s argument that courts relied on English legal principles were the principles of equity. 

If the author's argument that the dichotomy was brought back into Indian law post 1899, in an ideal scenario, courts would never have referred to the dichotomy or decided the cases without referring to the “liquidated damages” and “penalty” nomenclatures. However, as we would see in the remaining portions of this post, the dichotomy never ceased to haunt Indian law post-1872.

Decisions Construing the Original Section 74 Pre-1899

In one of the earliest cases decided after the Indian Contract Act, 1872, H. Mackintosh v. Hunt (1877) ILR 2 Cal 202, the Calcutta High Court had to decide whether the clause was hit by Section 74. The Calcutta High Court held: “We are of opinion that the contract to pay interest at 10 per cent, per mensem, if the principal sum of Rs. 400 were not paid on September 6th, the duo date of the promissory note, is not in the nature of a penalty… The case seems to us to differ wholly from that class of cases in which a certain sum is agreed to be paid on a breach of contract, and therefore Section 74 of the Contract Act (IX of 1872) does not apply.” (emphasis supplied).  Notice above the use of “penalty” while referring to Section 74.

There are several other judgements which are in line with the above. Some of them are cited below along with the relevant observations of the court:

H. Mackintosh v. C. Crow and Anr. (1883) ILR 9 Cal 689: MANU/WB/0037/1883: “This section, it will be observed, does away with the distinction between a penalty and liquidated damages and this must be borne in mind in dealing with cases decided before the Contract Act, many of which turned upon this distinction. Under this section, whether a sum would formerly have been held a penalty or liquidated damages, if it be named in the contract as the amount to be paid in case of breach, it is to be treated, much as a penalty was before, as the maximum limit of damages.” Now, if the stipulated sum was to be treated as a penalty, it should be so determined and what followed was to import the test in English law. See, also Sungut Lal vs. Baijnath Roy and Anr. (17.06.1886 - CALHC) (1886) ILR 13 Cal 164: MANU/WB/0146/1886, where the dichotomy seems to have been used although the court recognised that Section 74 did away with it. Sundar Lal v Banke Behari (28.06.1893 - ALLHC) : MANU/UP/0058/1893 also imported the dichotomy although the Full Bench of the High Court held that the clause involved was not one to which Section 74 applied. Similar is the decision of Ram Prasad And Ors. v. Lalli (20 July 1886) (1887) ILR 9 All 74 where although the Allahabad High Court held that Section 74 did not apply nevertheless recognised the concept of penalty

See also, Dilbar Sarkar vs. Joysri Kurmi and A.M. Dunne and Ors. (12.08.1898 - CALHC) : MANU/WB/0261/1898 (“Undoubtedly, sec. 74 of the Contract Act has clone (sic done) away with the distinction between a penalty and liquidated damages and although, generally speaking, the distinction between these two classes of damages is fine, yet it is desirable to bear in mind that in some cases there is a broad distinction, In this case undoubtedly the sum agreed upon by way of damages was agreed upon as a penalty.”

It could thus be observed that importation of the dichotomy into Indian jurisprudence was not a phenomenon merely attributable to the 1899 amendment. As these cases, and many more, go to show, notwithstanding the doing away of the distinction, the dichotomy never went away. The implications of this inference may have an impact on the villainous portrayal by the authorof the 1899 amendment as having brought back the dichotomy. The 1899 amendment at the most normalized the importation of the dichotomy, which never went away, except in a miniscule number of cases.

Cases Decided on the Basis of the Original Section 74 Without Importation of the English principles

On the other side of the spectrum is the interesting case of Nait Ram vs. Shib Dat and Ors. (15.12.1882 - ALLHC) : MANU/UP/0103/1882. The suit was for the recovery of the principal amount of Rs. 200 issued under bond to the defendant and for Rs. 400 towards liquidated damages for breach of the bond. The plaintiff did not lead any evidence towards loss and the munsiff’s court applied Section 74 and declared the amount claimed towards LD as excessive thereby considerably reducing the claim towards liquidated damages. On appeal, the appellate court termed the decision regarding assessment of liquidated damages as erroneous and held Rs. 100 as LD to be reasonable.

On further appeal, the Division Bench of the Allahabad High Court recognised the legislative intent behind enactment of Section 74: to eliminate the LD-penalty dichotomy: “The section appears to have been introduced to obviate the difficulties which exist in distinguishing liquidated damages, from penalty under the English Law and the effect of it is, that the Court are not bound to award the entire amount of damages agreed upon by the parties in anticipation of the breach of contract. The only restriction is that the Court cannot decree damages exceeding amount previously agreed upon by the parties.”

On how reasonableness has to be determined, the court held: “The discretion of the Court in the matter of reducing the amount of damages agreed upon is left unqualified by any specific limitation though of course the expression "reasonable compensation" used in the section necessarily implies that the discretion so vested must be exercised with care, caution, and on sound principal (sic principles).”

On how the discretion has to be exercised, the court’s decision deserves summarizing:

• Damages should be commensurate with the injury sustained.

• It should be assessed with the view to restoring the advantage to the plaintiff that he might have received if the contract had been performed.

• Where it is impossible to arrive at the exact damages, courts award the amount named, and nothing more.

Thereafter, the court held that this was not a case where it was impossible to arrive at the damages. On the assessment of damages, the court basically repeated the manner in which damages would be proved in a claim for general damages under Section 73. 

Another similar decision is that of Brahmaputra Tea Co. Ld. v. E. Scarth (MANU/WB/0175/1885 : (1885) ILR 11 Cal 545). The defendant entered into an agreement with the plaintiff to serve as an assistant tea planter for a salary. Clause 8 of the agreement named a sum as damages in case of breach of the agreement. The plaintiff initiated a suit to recover, inter alia¸ the named sum from the defendant as per clause 8 of the agreement. The plaintiff did not lead any evidence in the trial on the actual loss suffered and merely relied on the amount named in clause 8 of the agreement. However, the trial court held that the plaintiff was entitled to an amount that was far lesser than the amount stipulated in the agreement. On appeal, a two judge Bench of the Calcutta High Court consisting of McDonell and Macpherson, JJ was of the view that it was not necessary for the plaintiff to prove damages or loss. The Bench was of the opinion that the trial court erred in reducing the amount of compensation. It held:

“…the agreement by the defendant himself, so he knew full well what he was doing and what risk he was incurring, and, so far as we can see, there was no reasonable or sufficient ground for his act. No doubt the Court has a discretion to fix what it considers reasonable compensation; but when the parties have already agreed among themselves as to what the penalty should be, we think the Court should not, in fixing the compensation, wholly ignore the amount agreed on, unless this is, on its face, wholly unreasonable with reference to the position of the parties and the breach provided against.”

The court felt that the Liquidated Damages named in the agreement was not “wholly unreasonable” and must have been agreed between the parties after taking into consideration to all the circumstances attending the consequences of breach. However, the court doubted if the amount named in the agreement could be considered as reasonable “in the absence of any proof to the contrary”. Consequently, the court exercised its discretion in the matter and awarded a sum which was approximately half-way between the amount specified in the judgement of the trial court and the amount named in the agreement.

Thus, it would seem that even from the beginning, courts were grappling with the inconsistency in the text of the statute: on the one hand, the plaintiff was not required to prove the actual loss caused by the breach and, on the other, the court could grant only reasonable compensation for which it had to allow the parties to lead evidence on the reasonableness of the amount named in the contract. A way of resolving it was to simply suggest, like Nait Ram that damages should be proved akin to a claim under Section 73. Another way was to award damages in the absence of proof as a fraction (or percentage) of the amount in the contract as it happened in Brahmaputra Tea Co. in 1885 (see above) and in Construction and Design Services vs. Delhi Development Authority MANU/SC/0099/2015, one hundred and thirty years later.

Closing Remarks

In the light of Cavendish Square, is it not the time to move on and bring about a more nuanced and predictable model of determination of Liquidated Damages? The reasonableness standard does not offer certainty and inevitably allows promisors to challenge the imposition in courts regularly.  

Specific Relief (Amendment) Act, 2018 Brought into Force from 1 October

We had done several posts on the Specific Relief (Amendment) Bill, 2018 and later Act.  See this post for a compilation of the past posts. On 19.09.2018, the Government of India has appointed 1 October 2018 as the date from when the new provisions would come into force. The Gazette Notification is available here.

Interesting times ahead. We'll keep readers posted on the developments. 

Part II: Party Autonomy and NOM Clause in the UK SC: Rock Advertising v MWB Business Exchange

In the previous post we discussed the majority opinion of the UK Supreme Court on whether an agreement could be amended orally despite a "No Oral Modification" (NOM) clause. In this post we discuss the minority view and the Indian position on the subject.

The Minority View

The minority view of Lord Briggs calls for a more open possibility of an oral modification to the agreement despite the NOM clause. Lord Brigg's view was that parties could not only unbind themselves from what they had agreed, they could also unbind themselves orally of any procedural restrictions to vary the agreement. But the agreed departure from the NOM will not be "lightly inferred". The underlying policy reasons for his differing view are aptly summed up in the concluding portions of the minority opinion and are quoted here:

"31. In my view this more cautious recognition of the effect of a NOM clause, namely that it continues to bind until the parties have expressly (or by strictly necessary implication) agreed to do away with it, would give the parties most of the commercial benefits of certainty and the avoidance of abusive litigation about alleged oral variation for which its proponents contend. It would certainly do so in the present case. It would probably leave only those cases where the subject matter of the variation was to be, and was, immediately implemented, where estoppel and release of the NOM clause by necessary implication are likely to go hand in hand. While it might in theory also leave open the case where it is alleged that the parties did have the NOM clause in mind, and then agreed to do away with it orally, that seems to me to be so unlikely a story that a judge would usually have little difficulty in treating it as incredible (if denied), and therefore as presenting no obstacle to summary judgment on the contract in its unvaried form.

32. In proposing this perhaps cautious solution to the problem thrown up by this case I am comforted by the perception that it represents an incremental development of the common law which accords more closely with the conceptual analysis adopted in most other common law jurisdictions, as Lord Sumption has described. By contrast the more radical solution which he proposes would involve a clean break with something approaching an international common law consensus, unsupported by any societal or other considerations peculiar to England and Wales. There may be cases where a pressing need to modernise the common law justifies such a break, perhaps in the expectation that other common law jurisdictions will in due course follow, but this case is not, in my opinion, one of them."

The Indian Position

In India, the Supreme Court has perhaps taken a view that more-or-less accords with the minority view of Lord Briggs. In BPCL v Great Eastern Shipping, the Supreme Court held that although ordinarily silence does not mean acceptance of an offer but in certain cases when the offer is coupled by silence but the conduct leads to the inference of acceptance, such acceptance would be acceptance subsilentio and a contract would deemed to have been formed. 

The acceptance subsilentio principle would equally apply to modifications "subsilentio" even in the context of a NOM clause. In Carrier Airconditioning and Refrigeration Pvt. Ltv. v. Linc Digital Systems Pvt. Ltd., the Delhi High Court had to decide whether the agreement could be extended beyond its validity period by conduct of the parties when there was a NOM clause. The court cited the BPCL case of the Supreme Court (discussed above) and held on facts that the conduct of the parties as evidenced by correspondences exchanged between them showed that they continued to bind themselves to the terms and conditions of the agreement. On that basis, the court concluded that the parties had by conduct extended the agreement despite the NOM. See also, Wire and Wireless India Pvt. Ltd. v. Information TV Pvt. Ltd. MANU/TD/0093/2011. 

The Indian position is not yet as chiselled as the English position is. However, the Indian precedents are more or less in line with the minority view of the decision of the UK Supreme Court, which needs no changes or interference.

Specific Performance v Substituted Performance: Critique of the Proposed Amendments to Specific Relief Act

So far, we've had about five posts on the Specific Relief (Amendment) Bill, 2018 (pdf) providing a virtually unbridled right to specific performance:

Download the Expert Committee Report on Amendments to the Specific Relief Act

Why Should Specific Performance not be the Default Remedy: A Critique of the Recently Proposed Amendments

Efficient Breach as a Justification for Specific Performance as an Exception

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

Comments on the Specific Relief (Amendment) Bill, 2018

In this last post on the subject, we discuss why the amendment goes much beyond the Expert Committee's Report (pdf) on Specific Performance and is likely to lead to draconian results, especially for innocent promisors.

Whether the Bill Prioritises Specific Performance over Damages?

The Bill seeks to amend Section 10 such that the court's discretion is removed and specific performance is mandatorily ordered except in certain limited exceptions. Section 14. The heading of Section 10 is also sought to be changed from "Contracts which can be specifically enforced" to "Specific performance in respect of contracts". The Expert Committee also recommended the heading to be changed but the Committee's recommendation was to change it to "Specific performance and injunctions in respect of contracts". (See para 18.9).

As stated in an earlier post, the proposed amendment does not make specific performance as the first remedy but provides an option to the victim of the breach to either seek specific performance, or claim damages, or even claim the costs and expenses of substituted performance. In other words, the victim of the breach is empowered to decide the remedy of her choice. 

Why does the Bill not Balance the Interests of the Victim with that of the Promisor?

In the previous post, we had argued that Contract law does a fine balancing act between the interests of the victim whose contract was broken and at the same time ensures that the promisor who broke the contract is not made to pay the price and suffer as a consequence of the breach: contract law's focus is not to punish the breaching party but to satisfy the expectations of the promisee. We request readers to access the previous post for the discussion on this fine balancing act, which was discussed with an example.

It is true, as was acknowledged in the previous post, that Indian contract law does a bad job of compensating the victim and within reasonable time. Hence, the recommendation of the Expert Committee to provide for specific performance is fine. Recognising the fine balancing act that we're talking about, the Committee has also sought to protect this equilibrium: A perusal of Para 18.13 of the Committee's Report would reveal that the second ground that is sought to be a ground for refusing specific performance is where the party seeking specific performance could reasonably obtain substituted performance from another source on comparable terms, including price and time. Please recollect the lengthy example we discussed in the previous post where it was possible for Gowri to obtain substituted performance from Shyamu but even so Gowri sought to obtain specific performance from the original promisor Ramu, which would have resulted in disastrous consequence (and possibly loss of life) for the promisor, and which the law could not have intended.

The Committee's recommendation is in line with international practice. For instance, Article 7.2.2(c) of the UNIDROIT Principles of International Commercial Contracts provides that specific performance cannot be sought where the promisee "may reasonably obtain performance from another source". A similar provision can be found in Article 9:102(d) of the Principles of European Contract Law. (See, Para 12.2.2. of the Committee Report.

Why is the New Section 14 beyond the Committee's Recommendations and Erroneous?

Despite the recommendations by the Committee, the Government has sought to exclude this requirement and provide instead that specific performance cannot be claimed where a party to the contract "has obtained substituted performance". The difference between the clause recommended by the Committee and the one in the proposed Section 14(a) is that the proposed one excludes only those contracts for which substituted performance has been obtained while the one recommended by the Committee excluded cases where substituted performance "could be reasonably" obtained. Courts would have had the leeway to eliminate the injustice likely to be caused by an order for specific performance had the recommendation of the Committee been accepted. Instead, the Government chose to adopt a draconian provision that could result in substantial injustice, as in the case of Gowri discussed in the previous post.

There is absolutely no reason or justification why the Government did what it did: disregard the fine balancing act sought to be maintained by the Expert Committee and replace with a provision is draconian and is likely to cause substantial injustice. This is especially true especially in cases involving poor, uneducated or illiterate litigants. Considering the corruption in the legal system, it would do well to provide such safeguards as recommended by the Committee. Also, the recommendation by the Committee would only further genuine cases of efficient breach theory (see this post) where transaction costs of obtaining substituted performance are reckoned in the calculation.

There is also another problem with Section 14 of the 2018 Bill. It states that the "following contracts cannot be specifically enforced" but Section 14(a) does not strictly speak of a contract but of a situation "where a party to the contract has obtained substituted performance..."  

How to Remedy this Defective Provision?

There are two options to remedy this situation: the first option is for the Government to introduce amendments Clause 14(a) and incorporate the recommendations of the Expert Committee. The Bill is not yet an enactment; it has only been passed by Lok Sabha. The second option is to be exercised by the courts; in case the Bill in its current form is passed, the courts should construe Section 14(a) such that "has obtained substituted performance" would be read as "has or could reasonably obtain substituted performance." 

"Court May Refuse Specific Performance"

In Section 14, the Committee recommended: "(1) The Court may refuse to grant specific performance or injunction in the following cases, and in no others..." Note that the term used is "may". This means that even if the grounds in Section 14(1) for refusing specific performance, the court could still enforce specific performance. However, this is not found in the Bill. Section 14 of the Bill simply starts off with the expression: "The following contracts cannot be specifically enforced..." Thus, it appears that the Government avoided the phrase used by the Committee. But does it mean that the Government chose to reject the Committee's recommendation on the issue? We are not too sure.  

Committee's Report and the Bill does not go the Whole Way

In Para 11.9, the Committee recommended that Section 14 should have limited grounds on which specific performance could be refused. The Committee stated: "Such change will cast the burden of proving the grounds of refusal on the party against whom such relief is sought.." However, the Committee did not clearly cast the burden on the promisor while making its recommendations on the text of the amendments. Section 10 merely proposed that the victim would be entitled to specific performance, "unless relief can be refused under sections 14, 16 or 41..." (see Para 18.10). However, even this Section does not clarify who has to prove the availability of a reasonable source for substitute performance. Similarly Section 14 of the Bill also does not clearly cast the burden. 

Of course, owing to Section 103 of the Indian Evidence Act, 1872, it could be argued that the the burden of proof of the availability of reasonable substitute would  be on the person who would wish to be believe in its existence. It could also be argued that the plaintiff/ victim cannot be expected to prove the negative: that no reasonable substituted performance is available. On the other hand, the facts regarding substituted performance could very well be especially within the knowledge of the victim/ plaintiff, who then has to establish that no reasonable substitute was available as per the mandate of Section 106 of the Indian Evidence Act, 1872.

We are not very sure if the Expert Committee sought to leave it for courts to come up with the onus: going by the recommendations of the Committee in para 11.9, it appears that the burden was supposed to be cast on the defendant. We are also not altogether sure if the Government consciously had a view to leave it to the courts to construe the provision and cast the onus accordingly. 

We therefore suggest that Section 14 of the Bill be modified to state: The following contracts cannot be specifically enforced "All contracts can be specifically enforced unless the promisor in breach of the contract establishes that...  Note that it is sufficient if the party breaching contract establishes one ground in Section 14.  

Download the Expert Committee Report on Amendments to the Specific Relief Act

Followers of this blog are well-aware that the recent Expert Committee Report on the Amendments to the Specific Relief Act, 1963 was not in public domain. Despite several requests to the Law Ministry, the Report was kept away from public domain. 

Pursuant to an Right to Information Act, 2005 application by this blawgger, the Ministry has sent a copy of the Report. We take this opportunity to thank the Deputy Secretary & CPIO of the Legislative Department to have acted in consonance with the letter and the spirit of the Right to Information Act, 2005 and disclosed the Report. 

Readers can access a scanned copy of the Report from this link (pdf). Happy Reading! 

Why Should Specific Performance not be the Default Remedy: A Critique of the Recently Proposed Amendments

Edward Fry in his epochal work on Specific Performance prophesied:

"It may be suggested that [] a perfect system of jurisprudence ought to enforce the actual performance of contracts of every kind and class, except only when there are circumstances which render such enforcement unnecessary or inexpedient, and that it ought to be assumed that every contract is specifically enforceable until the contrary be shown. But so broad a proposition has never, it is believed, been asserted by any of the judges of the court of chancery, or their successors in the high court of justice, though, if prophecy were the function of a law writer, it might be suggested that they will more and more approximate to such a rule."

This prophecy did not become true in English law but might in India.

Readers may recollect the three recent posts in this blog (here, here, and here) on the proposed amendments to the Specific Relief Act, 1963. In this post, we critically evaluate the proposed amendment making specific performance as the default remedy. As a prelude to this discussion, we draw readers' attention to a previous post in this blog where we stated that the proposed amendments sought to do away with the general rule in contract law that damages would be the default remedy and specific performance would be the exception. 

The amendment 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 argue in this post that the said proposal should be re-thought. We supply reasons in this post for this. Before this, we wish to give two disclaimers: One, most of the members of the Expert Committee who proposed the amendment have tremendous experience in the subject. Yet, with a lot of deference, we state that the approach might not be altogether correct. The second, and the most important disclaimer is that we have not yet read the report as it is not in the public domain, and therefore, we are not in a position to completely fathom why the report so suggests. Anyway, we can only hazard a guess: India has a dismal rate of contract enforcement, and the report intends to correct this state of affairs by making such contracts specifically enforceable. We also think that this paper (by one of the members of the Committee) might throw some light on why the Committee so proposed.

Before Critiquing the Proposal, let us briefly see what the amendment proposes.

Proposed Amendments on Specific Relief

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.”

Note that the newly proposed Section 10 refers to Section 14. The existing Section 14, which enumerates grounds that are not specifically enforceable, 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 and the one which we are concerned about is where where compensation for breach is an adequate remedy. The proposed Section 14 replaces this ground with where the victim of breach has obtained substituted performance.

Note that 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 20 provides the victim of breach "the option of substituted performance through a third party or by his own agency." 

Therefore, a victim of breach under the new regime would have the following options:

• seek substituted performance under the new S. 20,
• seek specific performance under the new S. 10, if he has not sought substituted performance under the new S. 14, or
• claim damages or liquidated damages [the new S 20(1) on substituted performance starts off with the phrase "without prejudice to the generality of the provisions contained in the Indian Contract Act, 1872...".]

Thus, the victim of breach can claim any of these things. The law as it stands now provides that specific performance cannot be ordered when compensation for non-performance is an adequate relief [S. 14(1)(a)].

Strictly speaking, it is not that specific performance is proposed to be made as the default remedy; rather, all three (or four, if you include liquidated damages) are the default remedies.

Why is Specific Performance not the Default Remedy?

Specific Performance is not the default remedy but damages is, in India. The law allows the promisor to 'efficiently' breach the contract, which under circumstances, is socially optimal (see this post).(this ground is not without counter-arguments). In many cases, specific performance is unduly harsh on the promisor (more on this later).

What is the Problem with Damages being the Default Remedy?

Damages is difficult to prove. Even then at times parties suffer special damages but for reasons do not foresee (although they should) at the time of contracting. Owing to the difficulty of proof, damages are, most of the times, undercompensatory. In many cases in India, the road to recovering the money is a long drawn process and results in substantial injustice to the victim of the breach. In pursuing the legal remedies, the victim is often not even compensated for the costs incurred. The victim has better information than the courts as to the adequacy of damages, and the courts/ legislature should not forcibly impose such a standard on the victim.

Alan Schwartz wrote an important paper titled "The Case for Specific Performance" 89 Yale L. J. 271 (1979) where he argued that the victim has to be provided the option of deciding to go for damages or specific relief depending on which of those two will properly compensate her. Schwartz argued:

"The compensation goal of contract law can be achieved by requiring the promisor to pay damages or by requiring the promisor to render the promised performance. Under current law, a promisee is entitled to a damage award as of right but the court retains discretion to decide whether specific performance should be granted. Because specific performance is a superior method for achieving the compensation goal, promisees should be able to obtain specific performance on request."

[The compensation goal that Schwartz was referring to was to put the victim in the position as if the contract was performed.]

This is what the Bill proposed to do: provide the victim the option to either choose, without limit, specific performance or damages (substituted performance can by assumed to be a type of damages)

Which of these Two, then?

Thus, the Bill seeks to make out a strong case for specific performance. But this should not be so. The reason is the fine balancing act played by contract law between the victim of the breach and the promisor who broke the contract. What is this fine balancing act about?

For a movie-maker, a conflict between characters is good because that gives scope to develop a character and take the movie forward. But conflict is not good in real life. Law should ensure that conflict is either resolved, or at the least, avoided. When specific performance is the default remedy, the conflict is neither avoided nor resolved but the promisor and the victim are put in a conflict zone, ripe for the deepening of conflict and even for sabotage of one's interests by the other. To take an analogy, specific performance as the default remedy is like death penalty in criminal law; it calls for the blood of the guilty. We quote Lord Hoffmann extensively in this part of the post; he puts it so aptly: "[The order for specific performance] yokes the parties together in a continuing hostile relationship. [It] prolongs the battle." (Co-operative Insurance Society Ltd v. Argyll Stores [1997] UKHL 17).

So, by awarding damages, law seeks to provide the equivalent to the promisee's expectation out of the contract. Damages put an end to the warring parties and protects the expectation interests of the victim. Lord Hoffmann says: "A remedy which enables [the victim] to secure, in money terms, more than the performance due to him is unjust... An award of damages [] brings the litigation to an end. The defendant pays damages, the forensic link between them is severed, they go their separate ways and the wounds of conflict can heal."

That law does a miserable job out of protecting the expectation interest of the victim, especially in the Indian context, is no excuse for putting the parties in the hostile zone by making specific performance the default remedy or providing a chance to the victim to get more out of the breach than what warrants. We always look for shortcuts instead of reforming what is to be reformed: the judicial system and the delays. We bye-pass it by 'reforming' only the contract law enforcement parts of it, and do a bad job with it.

Consider this example: There is a village Sitapur where Ramu, a mango retailer, promises to deliver 100 kg of mangoes to Gowri for Rs. 1000 (Rs. 10/ kg) on a particular date. Ramu thinks he will invest Rs. 800 that he has with him for buying mangoes from the wholesale market, sell it to Gowri, and get Rs. 200 as profit (at Rs. 2/kg). On the date when he is supposed to go to the wholesale market, his child falls sick and is to be admitted in the hospital. Ramu expects that he will have to spend about Rs. 700 for the hospital. So he tells Gowri that he will not be able to perform the contract. Gowri is angry at Ramu and shouts at Ramu that he is no man as he cannot even keep his promise! So she threatens to teach Ramu a lesson. Gowri enquires with another retailer Shyamu who agrees to sell the mangoes at Rs. 1100 (at Rs. 11/ kg). Still angry at Ramu, she gives a complaint to the village Panchayat. The elders of the Panchayat summons both Ramu and Gowri and a sitting is held on a sunny Sunday. Ramu, whose daughter's surgery is scheduled to be held the next day attends the sitting. After hearing both the parties, the Panchayat says that even the Parliament of India in its infinite wisdom has amended the Specific Relief Act, 1963 to give the option to the victim of breach to decide on whether the victim wants specific performance or damages. So the elders ask Gowri. Gowri says she wants specific performance. Ramu's implores with Gowri to forgive him and his cries that unless he pays up Rs. 700 to the hospital, his daughter will not be operated on and might die fails to move Gowri. Suddenly Shyamu jumps up and says he'll provide a solution. He says that if Gowri buys Shyamu's mangoes at Rs. 11/ kg and if Ramu pays to Gowri that Rs. 1/ kg extra that Gowri has to shell out to Shyamu, Gowri will get the mangoes, Shyamu will make a profit (at Rs. 3/kg) and Ramu will have to shell out Rs. 1/ kg (Rs. 100), which he will be able to do even after paying up for his daughter's surgery. Shyamu says if the solution he proposed is adopted, Shyamu, Gowri and Ramu will all get what they want. What should the Panchayat do?

We'll leave the readers to answer the question in the way they wish to but we'll conclude with the words of Lord Hoffmann: "[T]he purpose of the law of contract is not to punish wrongdoing but to satisfy the expectations of the party entitled to performance... From a wider perspective, it cannot be in the public interest for the courts to require someone to carry on business at a loss if there is any plausible alternative by which the other party can be given compensation."

[Note: In understanding and writing several on concepts of Contract Law Theory, this blawgger has substantially used Mindy Chen-Wishart's superb text book on Contract Law. The specialty of the book is it presents theoretical aspects of contract law in a simple manner.]

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 (this, this 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.

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.