Termination of a work contract is a drastic step. If contract has been terminated wrongly, the counter effects also will be there. The Contractor will sue the Employer for damages. Hence, the Employers have to think ten times, before terminating a Contract.
Contractor is an entrepreneur who takes up contract works for a price that includes cost of executing works like construction of building, manufacturing, supplying and erecting machinery etc, as well as the contractor’s expected profit. Many risks will be there in execution of contract; and termination of contract is one of the major risks in contracting.
When a contract coalesced into frustration, Employers usually terminate the contract to safeguard their position. In case of termination of such contract before completion, the contractor can claim value of the work actually undertaken. The contractor may not be able to claim value of incomplete work, to the extent it had not undertaken any work and had not incurred any costs.
However, if premature termination was brought about on account of Employer’s breach, it may be possible for the contractor to claim expected profits that is lost on account of incomplete work. Further, if the Contractor proves that it has sustained other losses also due to the wrongful termination and such loses are in the knowledge and expectation of the parties while entering into the contract.
The legal position of the Contractor's entitlement of claims and damages relies on the terms of the contract and how the Contractor has implemented his Contractual Management techniques.
The statutory provision enabling claim for loss and damages:
Section-73 of the Indian Contract Act, 1872, entitles a party suffering a breach of contract to receive from the breaching party compensation for loss/damage suffered on account of such breach. The innocent Party can claim two categories of damages viz.:
Direct damages i.e. loss that arose naturally from the breach;
Consequential damages which were reasonably in contemplation of the Parties to the contract at the time they made the contract, as probable result of the breach.
Loss of profit is a consequential damage. A claim for Loss of profit can thus be made only if special circumstances leading to such loss were in the knowledge of the Party in breach.
Burden of proving loss of profit
Under the law of evidence, the burden of proving entitlement for loss of profit, is placed on contractor claiming damages. The contractor should prove that:
1. As a consequence of breach of contract the contractor suffered loss/damages;
2. That such loss was in contemplation of the employer; and
3. The measure of such loss.
In case of claim for loss or profit, it becomes difficult to establish with precision that what was expected profit that could not be realized on account of breach.
The expectation of profit implicit in the Works Contract
In a series of decisions the Supreme Court has settled the position that ordinarily a Contractor, while agreeing to undertake a Works Contract, reasonably expects to make profit. Reasonable expectation of profit is held to be implicit in the Works Contract. Thus, in cases of breach leading to improper termination of a works contract by employer, a contractor is presumed to have lost profit. Further, the measure of such loss is allowed to be based on contractual details to be furnished by the Contractor before a dispute resolution forum.
In "Mohd. Salamatullah v. Govt. of A.P." the Supreme Court considered a case of breach of contract for manufacture and supply of guns, as a result of which the contract could not be completed. The court approved the grant of 15% of the contract price as damages in case of breach of contract. It held that the appellate court was not justified in interfering with the finding of fact given by the trial court regarding quantification of the damages even if it was based upon guesswork. In "A.T. Brij Paul Singh And Ors. vs State Of Gujarat" case the Court held that it is well-established that the respondent was guilty of breach of contract in as much as the recession of contract by the respondent is held to be unjustified, and the plaintiff-contractor had executed a part of the works contract, the contractor would be entitled to damages by way of loss of profit, Adopting the measure accepted by the High Court in the facts and circumstances of the case between the same parties and for the same type of work at 15% of the value of the remaining parts of the work contract, the damages for loss of profit can be measured. The Supreme Court recognized the position that in a works contract, if the party entrusting the work commits breach of the contract, the contractor is entitled to claim damages for loss of profit, which he expected to earn by undertaking the works contract. In said case, the Court without insisting for direct proof the measure of profit lost, granted 15 per cent of the value of the remaining work, as damages for loss of profit.
Learn: How to Prove Construction Claims
In Dwaraka Das v. State of M.P., also Supreme Court considered a case where in the High court had denied the Contractor’s claim for loss of profit on the ground that the contractor did not place any material on record, but had only relied upon assessment of the profits by the Income Tax Officer while assessing the income of the contractors from building contracts.
The Supreme Court relying on decisions in "Mohd. Salamatullah and A.T. Brij Paul Singh" wherein it had granted 15% of the contract price as loss of profit, held the contractor to be entitled to 10% of the contract price. The court stressed that when the termination of contract is contrary to law and terms of the agreement, the erring party is legally bound to compensate the other party to the agreement. The court further emphasized that in estimating the amount of loss of profits, court should make a broad evaluation instead of going into minute details.
In "J.G. Engineers Pvt. Ltd., Vs Union of India", the Supreme Court upheld the award of 10% of the value of incomplete portion of work, as loss of profit. In said case it was found that the employer was responsible for the delays/breaches; the contractor was not in the breach, and the employer had illegally terminated the contract. The position as aforesaid is followed by several High Courts. [Mahanagar Gas Ltd. v. Babulal Uttamchand and Co., (2013) 2 Mah LJ ; Himachal Joint Venture v. Panilpina World Transport AIR 2009 Del 88; and Delhi Development Authority vs. Polo Singh MANU/DE/1882/2002].
Other Damages:
There may be cases where the contractor completes the work, but the execution is delayed on account of breaches committed by the Employer. In such cases, the Contractor receives the full price including expected profits. The contractor can also prove and recover increased cost of execution on account of escalation of cost of material and labour. It is possible for the Contractor to recover loss of profit for extended period, if the Contractor has made a case for the same by adopting the Contractual Management systems properly.
Lack of Contractual Management results in losing the valid claims:
In order to claim loss of profit, the contractor will have to lead cogent evidence. The position is succinctly stated by Supreme Court in Bharat Coking Coal Ltd. vs. L.K. Ahuja in the following words:
“Here when claim for escalation of wages bills and price for materials compensation has been paid and compensation for delay in the payment of the amount payable under the contract or for other extra works is to be paid with interest thereon, it is rather difficult for us to accept the proposition that in addition 15% of the total profit should be computed under the heading ‘Loss of Profit’. It is not unusual for the contractors to claim loss of profit arising out of diminution in turn over on account of delay in the matter of completion of the work. What he should establish in such a situation is that had he received the amount due under the contract, he could have utilised the same for some other business in which he could have earned profit. Unless such a plea is raised and established, claim for loss of profits could not have been granted. In this case, no such material is available on record. In the absence of any evidence, the arbitrator could not have awarded the same. This aspect was very well settled in Sunleyn (B) & Co. Ltd. vs. Cunard White Star Ltd., [1940] 1 K.B. 740 by the Court of Appeal in England.”
Be Cautious when the Contract is moving towards Termination:
Contractors if not implementing "Contractual Management" techniques in their works execution, they will invariable lose even eligible claims also. It is imminent for any Contractor to implement Contractual Management systems from the inception of the work execution. Every Contractor has to consider that Notice to Commence the Works is a Notice to Commence the "Contractual Management" also.
What is the "Contractual Management'? It is a science of understanding the Contract Agreement. It is an art of doing contractual business with negotiation skills. Negotiations not only means face to face deliberations. The Records maintained by the Contractor, the correspondence created by the Contractor, the management meetings attended by the Contractor also forms negotiation of issues and disputes. Contracts will not end with termination if the Contractor maintains good Contractual Management skills.
Keep in contact with Professionels to know how to infuse and empower your organization with Contractual Management systems. Contact>> PROFESSIONELS
Contractor is an entrepreneur who takes up contract works for a price that includes cost of executing works like construction of building, manufacturing, supplying and erecting machinery etc, as well as the contractor’s expected profit. Many risks will be there in execution of contract; and termination of contract is one of the major risks in contracting.
When a contract coalesced into frustration, Employers usually terminate the contract to safeguard their position. In case of termination of such contract before completion, the contractor can claim value of the work actually undertaken. The contractor may not be able to claim value of incomplete work, to the extent it had not undertaken any work and had not incurred any costs.
However, if premature termination was brought about on account of Employer’s breach, it may be possible for the contractor to claim expected profits that is lost on account of incomplete work. Further, if the Contractor proves that it has sustained other losses also due to the wrongful termination and such loses are in the knowledge and expectation of the parties while entering into the contract.
The legal position of the Contractor's entitlement of claims and damages relies on the terms of the contract and how the Contractor has implemented his Contractual Management techniques.
The statutory provision enabling claim for loss and damages:
Section-73 of the Indian Contract Act, 1872, entitles a party suffering a breach of contract to receive from the breaching party compensation for loss/damage suffered on account of such breach. The innocent Party can claim two categories of damages viz.:
Direct damages i.e. loss that arose naturally from the breach;
Consequential damages which were reasonably in contemplation of the Parties to the contract at the time they made the contract, as probable result of the breach.
Loss of profit is a consequential damage. A claim for Loss of profit can thus be made only if special circumstances leading to such loss were in the knowledge of the Party in breach.
Burden of proving loss of profit
Under the law of evidence, the burden of proving entitlement for loss of profit, is placed on contractor claiming damages. The contractor should prove that:
1. As a consequence of breach of contract the contractor suffered loss/damages;
2. That such loss was in contemplation of the employer; and
3. The measure of such loss.
In case of claim for loss or profit, it becomes difficult to establish with precision that what was expected profit that could not be realized on account of breach.
The expectation of profit implicit in the Works Contract
In a series of decisions the Supreme Court has settled the position that ordinarily a Contractor, while agreeing to undertake a Works Contract, reasonably expects to make profit. Reasonable expectation of profit is held to be implicit in the Works Contract. Thus, in cases of breach leading to improper termination of a works contract by employer, a contractor is presumed to have lost profit. Further, the measure of such loss is allowed to be based on contractual details to be furnished by the Contractor before a dispute resolution forum.
In "Mohd. Salamatullah v. Govt. of A.P." the Supreme Court considered a case of breach of contract for manufacture and supply of guns, as a result of which the contract could not be completed. The court approved the grant of 15% of the contract price as damages in case of breach of contract. It held that the appellate court was not justified in interfering with the finding of fact given by the trial court regarding quantification of the damages even if it was based upon guesswork. In "A.T. Brij Paul Singh And Ors. vs State Of Gujarat" case the Court held that it is well-established that the respondent was guilty of breach of contract in as much as the recession of contract by the respondent is held to be unjustified, and the plaintiff-contractor had executed a part of the works contract, the contractor would be entitled to damages by way of loss of profit, Adopting the measure accepted by the High Court in the facts and circumstances of the case between the same parties and for the same type of work at 15% of the value of the remaining parts of the work contract, the damages for loss of profit can be measured. The Supreme Court recognized the position that in a works contract, if the party entrusting the work commits breach of the contract, the contractor is entitled to claim damages for loss of profit, which he expected to earn by undertaking the works contract. In said case, the Court without insisting for direct proof the measure of profit lost, granted 15 per cent of the value of the remaining work, as damages for loss of profit.
Learn: How to Prove Construction Claims
In Dwaraka Das v. State of M.P., also Supreme Court considered a case where in the High court had denied the Contractor’s claim for loss of profit on the ground that the contractor did not place any material on record, but had only relied upon assessment of the profits by the Income Tax Officer while assessing the income of the contractors from building contracts.
The Supreme Court relying on decisions in "Mohd. Salamatullah and A.T. Brij Paul Singh" wherein it had granted 15% of the contract price as loss of profit, held the contractor to be entitled to 10% of the contract price. The court stressed that when the termination of contract is contrary to law and terms of the agreement, the erring party is legally bound to compensate the other party to the agreement. The court further emphasized that in estimating the amount of loss of profits, court should make a broad evaluation instead of going into minute details.
In "J.G. Engineers Pvt. Ltd., Vs Union of India", the Supreme Court upheld the award of 10% of the value of incomplete portion of work, as loss of profit. In said case it was found that the employer was responsible for the delays/breaches; the contractor was not in the breach, and the employer had illegally terminated the contract. The position as aforesaid is followed by several High Courts. [Mahanagar Gas Ltd. v. Babulal Uttamchand and Co., (2013) 2 Mah LJ ; Himachal Joint Venture v. Panilpina World Transport AIR 2009 Del 88; and Delhi Development Authority vs. Polo Singh MANU/DE/1882/2002].
Other Damages:
There may be cases where the contractor completes the work, but the execution is delayed on account of breaches committed by the Employer. In such cases, the Contractor receives the full price including expected profits. The contractor can also prove and recover increased cost of execution on account of escalation of cost of material and labour. It is possible for the Contractor to recover loss of profit for extended period, if the Contractor has made a case for the same by adopting the Contractual Management systems properly.
Lack of Contractual Management results in losing the valid claims:
In order to claim loss of profit, the contractor will have to lead cogent evidence. The position is succinctly stated by Supreme Court in Bharat Coking Coal Ltd. vs. L.K. Ahuja in the following words:
“Here when claim for escalation of wages bills and price for materials compensation has been paid and compensation for delay in the payment of the amount payable under the contract or for other extra works is to be paid with interest thereon, it is rather difficult for us to accept the proposition that in addition 15% of the total profit should be computed under the heading ‘Loss of Profit’. It is not unusual for the contractors to claim loss of profit arising out of diminution in turn over on account of delay in the matter of completion of the work. What he should establish in such a situation is that had he received the amount due under the contract, he could have utilised the same for some other business in which he could have earned profit. Unless such a plea is raised and established, claim for loss of profits could not have been granted. In this case, no such material is available on record. In the absence of any evidence, the arbitrator could not have awarded the same. This aspect was very well settled in Sunleyn (B) & Co. Ltd. vs. Cunard White Star Ltd., [1940] 1 K.B. 740 by the Court of Appeal in England.”
Be Cautious when the Contract is moving towards Termination:
Contractors if not implementing "Contractual Management" techniques in their works execution, they will invariable lose even eligible claims also. It is imminent for any Contractor to implement Contractual Management systems from the inception of the work execution. Every Contractor has to consider that Notice to Commence the Works is a Notice to Commence the "Contractual Management" also.
What is the "Contractual Management'? It is a science of understanding the Contract Agreement. It is an art of doing contractual business with negotiation skills. Negotiations not only means face to face deliberations. The Records maintained by the Contractor, the correspondence created by the Contractor, the management meetings attended by the Contractor also forms negotiation of issues and disputes. Contracts will not end with termination if the Contractor maintains good Contractual Management skills.
Keep in contact with Professionels to know how to infuse and empower your organization with Contractual Management systems. Contact>> PROFESSIONELS