1. Background: –
Over the period of time, we have observed that the projects related to infrastructure development and energy is growing at a rapid rate[1] one of the key reasons for the same maybe because of the higher inflow of Foreign Direct Investment (FDI) which would ensure higher inflow of wealth and efficient galvanization of resources, but one of the key concerns pertaining to Construction projects are they are time consuming, expensive and requires complex technical knowledge.[2]
Now, it is no secret that we don’t live in an ideal world and thus many times things don’t turn out as we want it to be, thus it results to disputes and delays which thereby impacts the economy in a negative way. In such times, arbitral proceeding plays a crucial role to resolve the dispute in the most cost-effective manner possible.
It is well settled in law that time is the essence of contract, and thereby when the obligations are not settled in due course of time it results to dispute. We observe that 68%[3] of all the construction law disputes are resulted due to prolonged delay in fulfilling the obligations mentioned thereto in the agreement. As a result of such delay, the contractors seek for claims from their employers which includes the claim for liquidated damages. Now, we all know that liquidated damages are damages which cannot be quantified in terms of money (i.e., delay) thus an agreed sum is determined by both the parties in a contract. However, when such claims for liquidated damages (LD) are filed by the claimant in their statement of claim (SOC) the opposite party tries to derail the claim by stating the same is unreasonable, prima facie etc.
One of the key reasons for such replies to the filed SOC is that in many cases the government agreement is filed by the state itself therefore having an upper hand to draft the clauses in the agreement they unreasonably draft the exclusionary clause to their added advantage whereby they state i.e., In case of default the employee will not be liable to any compensation. [4]
However, the arbitrators are vested with the power of law to breach the consequences between the parties and reach at an amicable settlement. We in the next part would analyze the exclusionary clause and opine the validity of liquidated damages (LD) in the Construction agreement.
2. Exclusionary Clause a backdrop: Indian Perspective
The term exclusionary clause or an exclusion clause is an expression in contract law which is used to exclude or limit the liability of one of the parties in the contract, in case of a breach. We can mostly see the implementation of this clause in construction contracts, especially in those agreements in which one party is the government. Whenever this clause in implemented in a contract the employer in the agreement has no liability for damages even if the employer is at fault, this is because most of this construction contracts are pre-drafted government agreements where the contractor is at a weaker position to negotiate and change the terms of the agreement, it is expected from the contractors to accept the terms of the employer.[5] Now in these situations, which are created by the exclusionary clause there are some exemptions which are available to the contractor to safeguard their interest, they are i) using Section 54[6] off the Indian Contract Act, 1872, as the section states that if a promisor who does not perform his part of the promise will not be able to claim performance of the other party. In other words if the contractor can establish that the delay or error in the project is due to the omissions of the employer then Section 54 of the Indian Contract Act,[7] 1872 can be used against the exemption damages by the employer under the contract, ii) The Supreme court of India has concluded that a contractor who is not the defaulting party, would be entitle to receive damages if the contractor has given a notice of the their intention to claim damages for the fault(delay) of the employer.[8] iii) The Supreme court had also held that if the contract was entered by parties with unequal negotiating power then the court will not allow a unfair and unreasonable clause to be enforceable and will strike it down.[9]
However, the exclusionary clause tends to go against the contractors but time and again the courts have saved the contractors from being treated unfairly. In the next part we shall be explaining the procedure for computation of damages.
3. Procedure for Calculation of Damages: –
In an agreement pertaining to construction projects, it contains the operative clause of liquidated damages (LD). While the compensation amount is predetermined between the parties, in case of dispute, the arbitrator has to determine the liquidated damage (LD) to be awarded to the parties thereby it relies on certain formulas to determine the damage amount which shall be reasonable in nature. In the case of At Brij[10] the procedure for calculation of damages were profoundly defined.
Some of the key factors which are taken into consideration while estimating liquidated damages were like rent, removal cost, storage cost, finance cost, loss of income, fees and fines imposed by third parties, etc.[11]
There are three key calculation factors taken into account while calculating damages which are i) Hudson Formula ii) Emden Formula iii) Eichleay Formula.
This formula’s considers factors like overhead cost, contract period, period of delay, profit percentage, etc. to ascertain the actual loss ascertained thereto in order to award a reasonable compensation to the claimant. It is further settled in law that if an arbitrator chooses one formula over the other the same cannot be challenged before the Hon’ble Court.
While we understood the procedure undertaken by the arbitrator to calculate the damages, it is important to understand that there are certain grounds which are to be proved before the arbitral tribunal for the claim of damages.
4. Grounds for Claiming Liquidated Damages: –
Time is the essence of contract, thereby when the party fails to perform the terms mentioned thereto in the agreement, they are liable to pay the stipulated sum of compensation mentioned in the agreement. In the Indian context the general provision for claim of damages in case of breach of contract are mentioned in the Indian contract Act, 1872 under section 73 and 74. There are certain grounds which are to be proved by the claimant before being entitled to the claim of liquidated damages which will be mentioned briefly hereto.
1. Proof of Actual Loss: It is mentioned under section 74 of the Contract Act for payment of compensation by way of penalty stipulated for “whether or not actual damage of loss is proved” however in practice we have to keep in mind that firstly, penalty and liquidated damage are different in nature where one seeks to provide reasonable compensation the former aims to put on an obligation on the other party to not breach the contract. Lastly, one of the main contentions pointed out by the Hon’ble Supreme Court[12] that it is important to prove that the respondent had the knowledge that if there is delay in completing the agreement or breach the claimant is likely to suffer.[13]
2. Reasonable Compensation: The key object of the liquidated damage is to provide reasonable compensation to the party who has suffered due to the breach of the contract. It is practically impossible to ascertain the liquidated damage by the Hon’ble Court [14]thereby the court takes into account the respective sums mentioned by the parties and determines a genuine pre estimate which is to be awarded to the party and not in the nature of penalty.
3. Mutually Agreed: It is important to prove before the Hon’ble Court that the stipulated damage mentioned in the agreement is agreed upon by the parties. The Hon’ble Court[15] takes into account whether the liquidated damage clause is in form of threat or penalty and thereby determine amount of reasonable compensation to be awarded., even in absence of such clause if it is so foreseen that loss has incurred by the party due to the delay compensation for the same is awarded.
4. Level Playing Field: Due emphasis to the level playing field must be given before assessing a clause as LD or Penalty[16], if the pre estimated sum of compensation is based on cost and pricing it should be considered as genuine and not violative of the section 74 of the Contract Act.
5. Conclusion: –
The underlying idea behind the concept of liquidated damages clause is to not to enforce punitive damages on the defaulting party, rather impose a reasonable compensation for the non-compliance. While evaluating the clause, if the court finds that liquidated damage is excess of the actual loss then it shall be considered as penalty, thereby the parties should give proper reasoning to justify the reasonableness of the liquidated damage provision.
Inter alia, the parties must mention the grounds, formula for calculation, Intent and event which would trigger the liquidated damage clause. This clause should be carefully drafted and reviewed by the parties because the Devil lies in the details.
Notes
[1] Key aspects revamping the growth and trajectory in Infrastructure, Financial Express, (9th, July,2021), https://www.financialexpress.com/infrastructure/key-aspects-revamping-the-growth-trajectory-in-infrastructure/2254762/.
[2] How to fund construction disputes, Kluwer Blog,(9th July, 2021), http://arbitrationblog.kluwerarbitration.com/2019/12/24/how-to-fund-construction-disputes-relying-on-third-party-funding/.
[3] Delay & Damages in Construction Contract: A report from the 4th SCL -CIArb- India International Conference on Construction Law and Arbitration, Kluwer Blog(9th July,2021), http://arbitrationblog.kluwerarbitration.com/2020/02/18/delay-and-damages-in-construction-contracts-a-report-from-the-4th-scl-ciarb-india-international-conference-on-construction-law-arbitration/.
[4] Conference on Legal and Technical aspects of Arbitration, Law Senate Arbitration Law Firm,(9th July, 2021),https://www.lawsenate.com/events/conference-on-legal-and-technical-aspects-in-arbitration.html.
[5]Gaurav Rai, Exclusionary Clauses in Construction Contracts – Development of Jurisprudence vis-à-vis Arbitration, The Arbitration Workshop, (11th July, 2021) https://www.thearbitrationworkshop.com/post/exclusionary-clauses-in-construction-contracts-development-of-jurisprudence-vis-%C3%A0-vis-arbitration
[6] Indian Contract Act, 1872 § 54.
[7] Krrishan Singhania, Alok Vajpeyi, Exceptions to Exemption of liability Clauses in Cases of delay in Construction Contracts. Construction Time, (11th July, 2021) https://constructiontimes.co.in/exceptions-to-exemption-of-liability-clauses-in-case-of-delay-in-construction-contracts/
[8] Northern Railway V. Sarvesh Chopra, (2002) 4 SCC 45.
[9] Inland Water Transport Corporation v. Brojo Nath Ganguly, AIR 1986 SC 1571.
[10] 1984 SC 1703; (1984) 4 SCC 59.
[11]Delay Analysis using critical path Method Schedules, Elsevier, (11th July,2021), https://www.sciencedirect.com/science/article/pii/B9780128112441000124.
[12] Kailash Nath Associates V. Delhi Development Authority, (2015) 4 SCC 136.
[13] (2017) 11 SCC 801.
[14] Maula Bux V. Union of India, (1969) 2 SCC 554.
[15] Phulchand Exports Limited v O.O.O Patriot, (2011) 10 SCC 300.
[16] Bharat Sanchar Nigam Limited v Reliance Communication Limited, (2011) 1 SCC 394.
(Article Jointly Authored by Siddharth Addy and Aryaknath Bhattacharya)
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