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.

Padia Timbers & Contracting Through Tendering Process

A recent decision of the Supreme Court in Padia Timber v Vishakapatnam Port Trust is interesting on many counts. One, it is a rare decision by the Supreme Court construing general contract law (Sections 4 and 7 of the Indian Contract Act, 1872. Two, the Supreme Court overturned the decision of the trial court and the High Court notwithstanding that the case does not involve any new question of law that courts previously had not dealt with but that the lower courts (trial court and the High Court) did not deal with in this case. Three, the decision throws considerable light on government contracting practices and can act as a context in discussing such practices.  Four, this case relates to a notice inviting tender that was floated more than thirty years back (1990)! The matter was heard in the SC several times between 2007 and 2011 but it appears that the matter was not heard between 2011 and 2018.

The judgment reiterates the position that acceptance should be unconditional as per Section 7 and various decided cases. 

On facts, when  the appellant, Padia Timbers, submitted its bid, it made a revised quotation stating that inspection would have to be conducted at Padia Timber's depot an not otherwise. This is where government tendering practices are to be noted. Given the requirement of a rigorous and complaint free tendering process, government contracts usually state that the bidder must "accept" all the conditions stated in its offer.  If that is not the case, the Government entity generally rejects the bid if the non-acceptance pertains to a material provision. In this case, the error committed was that the Government entity went ahead with the tendering process and awarded the contract to the bidder despite deviation from the condition regarding inspection. What really happened making the port trust to proceed with the tendering process and awarding the contract is not clear and will be known if the tender file is perused.

The Court ultimately ordered the Port Trust to refund the earnest money to Padia Timber at an interest rate of 6% per annum from the date of institution of the suit (1994) till the date of refund. 

Vidya Drolia v DTC: Part I: Interesting Aspects- Arbitration Law as a Special Contract Law

 Vidya Drolia v Durga Trading Corporation is an interesting and important decision of a three judge Bench of the Supreme Court of India on arbitrability in Indian arbitration and the allocation of powers between the court and the arbitral tribunal to decide questions relating to arbitrability, especially in the context of Section 8 (where the court refers a dispute covered by an arbitration agreement to arbitration) and Section 11 (power of the supervisory court to arbitrators).

This post and the posts following this one are not run-of-the-mill case comments. Rather, the objective here is to discuss certain interesting points about this 242 page decision. 

The first interesting aspect covered in the judgement is the relationship between general contract law (covered in Sections 1-75 of the Indian Contract Act, 1872) and arbitration law, which deals with a type of special contract, that is, arbitration agreement. Paras  11 to 15 of the decision (p. 12-17) deal with this issue. 

According to the Court, the meaning of "agreement" is derived from Section 10 of the Indian Contract Act, 1872 ("Contract Act") and therefore, "an arbitration agreement should satisfy the mandate of Section 10 of the Contract Act..." (Para 11). Thus, the arbitration agreement should satisfy the general contract law requirements of free consent and other such requirements. A contract is an agreement enforceable by law. An arbitration agreement not enforceable by law is void and is not legally valid (Para 11). 

Thus, arbitration is "a matter of contract". The immediate implication of this is that "the parties are entitled to fix boundaries as to confer and limit the jurisdiction and legal authority of the arbitrator." (Para 15).

If an arbitration agreement is a contract, taking this proposition to its logical end, an arbitration agreement can be specifically enforced. The mechanism of specific enforcement is provided in Section 8 of the Arbitration and Conciliation Act, 1996. The question further arises, whether specific performance is the only remedy for breach of an arbitration agreement. 

Many jurisdictions and commentaries have explored the question of whether damages would lie where a party breaches an arbitration agreement. A popular commentary on the subject argues on the breach of an arbitration agreement: "If it is broken, an award of damages is unlikely to be a practical remedy, given the difficulty of quantifying the loss sustained." (Para 1.55, Redfern, Hunter et al, Redfern & Hunter on International Arbitration, 2015). See also, Julio César Betancourt, Damages for breach of an international arbitration agreement under English arbitration law, Arbitration International, Volume 34, Issue 4, December 2018, Pages 511–532, https://doi.org/10.1093/arbint/aiy030. Born argues:

"Nevertheless, while inadequate when considered alone, damages for breach of an arbitration agreement can be an appropriate supplementary means of enforcing arbitration agreements, by increasing the disincentives for such conduct. A few contemporary judicial decisions in the United States, England and Switzerland have either awarded damages for the breach of an arbitration agreement or indicated that the possibility for doing so existed. Nonetheless, some contemporary judicial decisions deny the existence of a right to damages for breaches of arbitration agreements (ironically, effectively resurrecting the historic hostility to arbitration agreements, but in reverse form)." (Gary B Born, International Commercial Arbitration 1305-1306 (2014).

An aspect to be considered is: whether the provision relating to costs as contained in Section 31A could be considered as damages for breach of an arbitration agreement? See, "Costs Allocation Under the Amended Indian Arbitration Law: A Critique" which criticizes the practice of Indian courts in not adhering to the spirit behind the enactment of Section 31A. Before Indian courts delves on these aspects, Indian courts should uniformly allocate costs as per the general rule provided in Section 31A(2)(a) that "unsuccessful party shall be ordered to pay the costs of the successful party". 

If not damages, whether courts could order costs on an indemnity basis for breach of arbitration agreement could be explored. Such a movement would, prima facie, be in the right direction.

More on the decision in another post.

No Injunction/ Interim Measure Against Infrastructure Projects: Calcutta HC Decides

Golden Edge Engineering Private Limited vs. Bharat Heavy Electricals Limited (18.06.2020 - CALHC) : MANU/WB/0558/2020 is an important decision under the Specific Relief (Amendment) Act, 2018. Petitioner was the contractor of the Owner, BHEL in respect of an Infrastructure Project as defined in Explanation to Section 21A r/w Schedule to the Specific Relief Act, 1963 (as amended) (SRA).

The Petitioner (Contractor), in an agreement entered into in 2017, contended that BHEL had delayed in providing the frontage for the work and in making payments. The Contractor also relied on the lockdown due to Covid19 to argue that delay in performance was beyond the control of the Contractor. The Contractor argued that despite assurances of completion, BHEL had gone ahead with floating a tender for performance of the remaining works that the Contractor was yet to complete. Consequently, the Contractor prayed for an injunction restraining BHEL from withdrawing the work from the Contractor and awarding it through a new tender to some other person.

The court rejected the said contentions on several grounds, some of which are provided below:

• BHEL allowed time to the Contractor to complete the work after the lockdown period but the after the lifting of restrictions, it cannot be said that there has been uncertainty as the availability of manpower. In reality, there has been no migration of workers from the State of Jharkhand, which is the state where the project is located.
• The Contractor could not adhere to the schedule even before the Covid19 pandemic. 
• The prayer granted in the petition was barred by the SRA, as amended. in terms of Sections 41(ha) and 20A. 
• There is no provision in the Tender/ Contract specifically restricting BHEL from proceeding on risk and cost.
• Even if there is a legal injury to the Contractor, the same can be adequately compensated in terms of money. 
• Balance of convenience is in favour of BHEL. As a PSU, if it is prevented from engaging a new contractor in case the existing Contractor is unable to perform, it will lead to a situation where BHEL will be stuck with the non-performing Contractor and substantial time will be wasted and project will come to a standstill in the event BHEL is unable to go ahead with the new tender. 

Comments

Para 42 of the judgment is interesting and important, for it seeks to examine the issues at stake if an injunction is passed. It deserves noting, as it is, in the judgment:

"42. So, the balance of convenience is entirely in favour of the Respondent as a Public Sector Undertaking engaged in power generation ought not to be prevented from engaging a new contractor if the existing contractor is unable to provide the requisite standard of work as the documents on record clearly show that ample opportunities have been provided and are being provided by the respondent to the petitioner to complete their outstanding work as per requisite standards but instead of utilising the same the petitioner intends to secure a monopoly and ensure the Respondent is stuck with the Petitioner in whatever performance and/or quality of work they offer. It is stated and submitted that the entire project has been severely lagging behind the requisite standards and the Respondent's employer i.e. the National Thermal Power Corporation has been constantly reprimanding the Respondent because of the cascading effect the Petitioner's under performance has been having on the entire project. A lot of time will be wasted and the project will come to a standstill in the event the Respondent is unable to go ahead with the New Tender and have a candidate ready to replace the Petitioner in the event of the failure to complete the work as such new tender would have to be conducted post the Petitioners failure."

There are three interesting points in the decision:

• In respect of infrastructure projects, courts will not grant stay in view of the statutory mandate pursuant to the amendments to the SRA.
• Covid19 cannot be used as an excuse in respect of infrastructure projects especially where the Contractor is unable to perform the contract expeditiously;
• Tendering processes in respect of risk and cost contracting can be commenced even before termination, and would not be a ground for granting injunction.  

All the three points made above are significant in the current context. The court, rightly, analysed the importance of not passing stay orders on infrastructure projects. The judgment seems to be in line with the recent legislative mandate and seeks to balance competing interests and further the general principle of specific relief: injunctions will not be passed when damages would be adequate remedy.

However, the ultimate conclusion that: "I am of the opinion that the petitioner would be left with a claim for equitable compensation as there would be no significant prejudice to the petitioner in the event of refusal to grant interim injunction at this stage." is not entirely clear. Was the court indicating that the Petitioner/ Contractor could pursue the remedy of seeking compensation but that no prejudice would be caused to the Contractor if its prayer was refused.

[full disclosure: Till early last year, this blawgger was an employee of BHEL. However, this blawgger was in no way connected to the case or the subject-contract.]

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.  

Critique of the Specific Relief (Amendment) Act, 2018

Over at Obiter Dicta, the respected Dr. Nilima Bhadbhade, one of the foremost experts in India on Contract and Specific Relief law, has penned a comprehensive critique on the Specific Relief (Amendment) Act, 2018. The post by Dr. Bhadbhade primarily argues that the amendment was a case of hurried legislation and was a comprehensive deviation from the Expert Committee Report. The post notes that the Ministry of Law & Justice did not publish the report but the same was made available through the RTI Act. This was probably a reference to our post making the Report public pursuant to an RTI application by us.

We had several posts in this blog (here, here, here and here) and elsewhere critiquing one particular aspect: the way in which the amendment affected the balance maintained by contract law between the interests of the victim of the breach and the perpetrator of breach. The post by Dr. Bhadbhade confirms the validity of the criticisms made, and coming from a person with immense expertise and who was a part of the Expert Committee, the Government should take it seriously to explore the option of amending the amendment to ensure that legitimate criticisms of the Act are addressed. 

Article Review: Shivprasad Swaminathan's De-inventing the Wheel: Liquidated Damages, Penalties and the Indian Contract Act, 1872

Shivprasad Swaminathan's latest article 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) presents an interesting read and is an article which every Indian lawyer- practitioner, judge or academician- should read, Good articles on Contract Law from an Indian perspective are rare and the paper provides deep insights on the subject. 

Ask any lawyer about what are essentially required to be established in a court to be entitled for liquidated damages and he is likely to scratch his head or mislead you. If you file a claim in a court (or an arbitral tribunal) for liquidated damages and furnish some evidence, you can only hope to god on whether the court will award you the said amount.  So the claimant ends up furnishing the best evidence he has, "whether or not actual damage or loss is proved to have been caused".

The key takeaways of the article are listed out below:

• The article provides a much-required drafting history of Section 74
• It also discusses the objective of Section 74- to no more get into the LD-penalty dichotomy and how the dichotomy was introduced through the 1899 amendments. 
• The article notes how the supposedly "landmark" decisions on LD repeatedly brought the dichotomy into S. 74 when it was not warranted at all.
• "Reasonable" was a "trouser word": its determination was by establishing unreasonableness. 
• The article also analyses the relatively recent judgement Kailash Nath v DDA and how the Supreme Court tried to construe Section 74 to mitigate the uncertainty brought about by the dichotomy. 

The author argues that a "trichotomy" was introduced in Kailash Nath- liquidated damages, other liquidated amounts and penalty in place of the standard dichotomy (See, Part II of the article). This blawgger is not sure if RF Nariman, J did that in the case.  We'll quote the relevant portion of the judgement from which the author seeks to draw this inference:

"Where a sum is named in a contract as a liquidated amount payable by way of damages, the party complaining of a breach can receive as reasonable compensation such liquidated amount only if it is a genuine pre-estimate of damages fixed by both parties and found to be such by the Court. In other cases, where a sum is named in a contract as a liquidated amount payable by way of damages, only reasonable compensation can be awarded not exceeding the amount so stated. Similarly, in cases where the amount fixed is in the nature of penalty, only reasonable compensation can be awarded not exceeding the penalty so stated. In both cases, the liquidated amount or penalty is the upper limit beyond which the Court cannot grant reasonable compensation.

Reasonable compensation will be fixed on well known principles that are applicable to the law of contract, which are to be found inter alia in Section 73 of the Contract Act.

Since Section 74 awards reasonable compensation for damage or loss caused by a breach of contract, damage or loss caused is a sine qua non for the applicability of the Section.

The Section applies whether a person is a plaintiff or a defendant in a suit.

The sum spoken of may already be paid or be payable in future.

The expression "whether or not actual damage or loss is proved to have been caused thereby" means that where it is possible to prove actual damage or loss, such proof is not dispensed with. It is only in cases where damage or loss is difficult or impossible to prove that the liquidated amount named in the contract, if a genuine pre-estimate of damage or loss, can be awarded."

Kailash Nath nowhere uses the phrase "other liquidated amounts". It appears that "liquidated amounts" referred to above is qualified by "payable by way of damages". Nariman's decision is that if the above said liquidated amount payable by way of damages is found by the court to be a genuine pre-estimate of damages fixed by both parties, then the said amount is reasonable compensation but if it is not a genuine pre-estimate of damages fixed by both parties, it is a penalty for which only reasonable compensation could be awarded. In sum, there seems to be no trichotomy.

Nevertheless, this is just a minor issue with the paper that's a brilliant read. The author admirably concludes that the Act has deviated from the drafter's design, which originally could accommodate the test of legitimate interests of the promisee in assessing reasonableness (and enforcement of) the LD clause. The test is currently in vogue post-Cavendish Square. The author argues that the Section as originally drafted without the dichotomy could accommodate the legitimate interest test "[b]ut it was not to be". Now that Canvedish is the law in the common law world, it is time for us to exorcise the dichotomy and embark on reforming the law. 

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.