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January 25, 2013

Contract Demonstration And Damages


- Manizeh Mistry, Associate [ LawQuest ]

Manizeh Mistry

We enter into contracts on a daily basis without even being cognizant of it. Contract law is a combination of universality and common sense. It is universal because contemporary human society is based on a continuous exchange of goods and services. Common sense on the other hand is accessible, but not inconsequential. It is also profound, leading to contesting interpretations. Additionally, with changes in business practices, newer contexts arise, leading to these principles being applied to new relationships. Consequently, contract law governs the formation and performance of contracts.

While there has been tremendous development in trade and commerce in the twentieth century contract law and principles have remained the same. However, as trade and commerce developed, several principles have been used together by contracting parties to set up their rights and obligations. Similarly, in the case of breach of a contract, the Courts attempted to understand the intention of the parties in order to settle on compensation. Most often this proved to be unsatisfactory to the parties.

However, the business world soon came to realize that there is no harm done in contemplating that the contract may not be honoured and as a result decided to identify the damages itself as a part of the contract.

Breach And Termination Of Contract

For every breach of the terms of a contract, the suffering party has a right to compensation. However, if the breach is of the very essence of the contract, that party has the additional right to terminate the contract. Thus, when a party to a contract breaches a term, the innocent party has an option to either bring the contract to an end or continue with it. However, problems may be encountered as a contract has several terms. Some of the terms would be of great significance while other terms would only be supportive.

In the beginning, business practices were simple – a seller delivered and the buyer paid. In those times, breach of a term meant breach of the contract. However, as business practices evolved, contracts came to have several terms, but not all the terms of the contract were equally important. Another notion that garnered attention was whether the breach affected the contract in its 'entirety' or not. On further deliberation, the courts developed a distinction between the core part of the contract and its ancillary part. The innocent party could terminate the contract only when there was a breach of the core part. For the breach of the ancillary part, he or she could not terminate the contract, but could only claim damages. The core part hence came to be known as the "condition" and the ancillary part came to be known as the "warranty". The breach of a "condition" or of a term forming the core part of a contract is categorised as a 'repudiatory breach'.

The principles of repudiation of a contract have been formulated with the help of the landmark case Heyman and another V. Darwins Limited, where Viscount Simon LC held that, the repudiation of the contract by one party does not have any effect unless the other party accepts it. If one party so acts or expresses himself or herself, as to show that he or she does not mean to accept and discharge the obligations of the contract any further, the other party has an option as to the approach he or she may take up to deal with this breach of contract. Hence, it takes two to end a contract by repudiation.

Anticipatory Breach

In 'anticipatory breach' a party anticipates a breach and communicates to the other party that he or she may be breaching the contract. Of course, the intended breach must be of a repudiatory nature for the innocent party to get the right to terminate the contract. On receiving such intimation, the innocent party rightfully has the power to exercise the option of either terminating the contract or of continuing with the contract.

To elucidate the meaning of anticipatory breach more clearly let's review the Sir Alexander Cockburn CJ judgement in Frost V. Knight, where he states that, "the law with reference to a contract to be performed at a future time where the party bound to performance announced prior to the time his intention of not to perform it, may be noted. The promise if he pleases may treat the notice of intention as inoperative and await the time when the contract is to be executed, and then hold the other party responsible for all the consequences of non-performance, but in that case he keeps the contract alive for the benefit of the other party as well as his own; he remains subject to all his own obligations under it, and enables the other party not only to complete the contract if so advised, notwithstanding his previous renunciation of it, but also to take advantage of any supervening circumstance which would justify him in declining to complete it.

On the other hand the promise may, if he thinks fit, treat the repudiation of the other party as wrongful putting an end to the contract, and may at once bring his action on the breach of it; in which action he will be entitled to such damages as would have arisen from the non-performance of the contract at the prescribed time."

Termination Clause in Contracts

Contracts are voluntarily formed. The contracting parties are free to stipulate every aspect of the contract, including those on breach and termination. The general law on breach of contract and anticipatory breach is enforced only when the contract is silent on it. A contract can expressly provide the conditions of the contract and as a result, even if the consequence of the breach of the term is not of much significance, it would still be a repudiatory breach of the contract. Another means is to expressly provide the terms of the breach for which the innocent party can terminate the contract.

Remoteness of Damages

There is a breach of contract when a party fails to meet its obligation under the contract. Every breach of a term of a contract entitles the innocent party to claim compensation. In the case of a breach of a condition, the innocent party has a choice to either continue with the contract or to terminate it. In either case, the innocent party will retain the right to compensation for the breach. Parties come together in a contract for an equal exchange and therefore, a monetary equivalent is usually the adequate compensation for a breach. When a party is specifically required by the court to perform the contract, this remedy is called specific 'performance'.

The courts award 'specific performance' only in rare cases. It is the right of the state to demand a desired conduct from its people even if it means using the threat of punishment and penalty. Imposition of a penalty is the sole prerogative of the state. Individuals imposing penalties on each other amounts to usurping the powers bestowed on the state and this cannot be allowed. Hence in a contract, parties only have the right to be compensated for damages. They do not have the right to impose any penalty on the other party or to benefit from the breach.

As per Alderson B's judgement in Hadley v. Baxendale, the court's criterion for awarding damages was to find out what the exact intent, purpose and awareness of the parties involved was. Where two parties have made a contract, which one of them has broken, the damages which the other party ought to receive in respect of such breach of contract should be such as may fairly and reasonably be considered either arising naturally, i.e. according to the usual course of things from such breach of contract itself.

It is thus stated that towards exploring the intents and plans of the parties, at first instance it should be seen whether any explicit or special arrangements were made. If there is no special arrangement, then it should be considered as practices which happen 'naturally' in a majority of cases. The court, thus, inferred that the loss of profits here cannot reasonably be considered as a consequence of the breach of contract as it could have been fairly and reasonably contemplated by both the parties when they made this contract.'

The Indian Contract Act also adopted the principle formulated in the Hadley v. Baxendale (1854) case. The principle has two parts in limiting the consequences of a breach of contract:

a. If the parties have in express terms or impliedly provided for the consequences, these should be followed.

b. Take the contract and its breach to be as it usually happens in general practice.

To summarize, for every breach of contract, the innocent party has the right to damages from the party in breach. The consequences of a breach are limited by what the parties have expressly or impliedly provided, or the way the class of contract is normally conducted.

Measure of Damages

There are two aspects to damages for breach of a contract. Firstly, how far we should take the consequences of the breach and the second aspect, having settled on the first, is the principle by which the damages should be measured. The principle for award of damages is to give the innocent party a sum of money that will put him in the position in which he would have been but for the breach. This is called 'performance interest'. Performance interest is the most common way of awarding damages.

In some cases performance interest is not an indication of the losses, or it is not possible to assess the losses. In these cases, the court may decide to put the parties in the position they would have been in if no contract had been made. This is called expectation interest.

Non-pecuniary Losses

Breach of a contract certainly leads to inconvenience, pain, and suffering for the other party. However, as the law continued to evolve, the courts, settled on the position that there would be no claims for mental agony, pain, and suffering. There were quite a few reasons for this. Firstly the court had already awarded damages for the economic aspect of the breach. Secondly, inconvenience, pain and suffering were one degree removed from the core of the contract. Thirdly, it would be impossible to assess the pain and suffering experienced by a person. Thus the law emerged that there would be no award of damages for inconvenience, pain, and suffering. However with the development of the consumer society today, the position of this law, in several cases, has appeared to be unjust. Therefore courts have attempted to carve out exceptions to this rule.

Liquidated Damages

With every breach of contract, the contracting parties began to realize that while the principles for compensation were clear, it was not easy for the courts to settle on the monetary value while awarding compensation. Contracts are voluntary in nature and are based on mutual trust and confidence. It was not conducive to this trust and confidence for the parties to bring in the possibilities that they could breach the contract. These two aspects were too contradictory in nature to be parts of the same affiliation. However, with experience, the parties realized that it was better to contemplate breach and stipulate on the damages, than to leave it for the courts to settle on it at a possible later date. These stipulated damages are called 'liquidated damages'. The innocent party has the right to damages for the losses; however, he or she must act prudently to minimize these losses.

The Supreme Court in ONGC V. Saw Pipes Limited made an exception to the rule laid down in Maula Bux V. Union of India. Following Maula Bux V. Union of India in every case, even if damages were stipulated, these had to be assessed. However, if the actual damages were to be established before the courts in all the cases, even if liquidated damages were stipulated, the very purpose of stipulating liquidated damages would be lost. On the other hand, if liquidated damages were to be awarded without establishing the actual damages, it would allow the contracting parties to impose penalties.

As per the exception made, the judgement passed in ONGC V. Saw Pipes Limited stated that if upon reading of the document as a whole, it can fairly be deduced from the words actually used therein that the parties had agreed on a particular term, there is nothing in law which prevents them from setting up that term. Further in construing a contract, the court must look at the words used in the contract unless they are such that one may suspect that they do not convey the intention correctly. If the words are clear, there is very little the court can do about it.

Therefore, when contracting parties have expressly agreed towards recovery of damages on account of breach of the contract by way of pre-estimated genuine liquidated damages and not by way of penalty duly agreed between parties, then there would be no justifiable reason for the Arbitral Tribunal to arrive at a conclusion in such a case.

Compensation and Penalty

The principle is that irrespective of the term, that is 'damage', 'compensation', or 'penalty', all the amounts are added up. It is then concluded that the party in breach had never intended to pay more than this amount. Thus, in no case should that party be made to pay more than this amount. Following this principle, the damages to be paid are calculated. If the actual damages are more than the total amount stipulated, the party pays only the total stipulated amount. If the actual damages are less, only an amount equivalent to the actual damages shall be payable.

Conclusion

In conclusion, the law emerges as a response to the specific context of the time and place, but tirelessly persists even when the context has completely undergone a transformation. However, laws do undergo restitution through other processes and even though the principles remain unchanged, they are adaptable in nature and become applicable in the new context. Thus, while the contract law derives from common sense, it has to be understood as an evolving body of principles constituted historically and internationally.

Disclaimer–The contents of this article are personal views of the author and are not a comprehensive consideration of the subjects discussed and are designed to provide preliminary, general information. Readers should not conclusively rely on the information as legal advice and should seek independent counsel before any action is taken with respect to these or other specific issues.



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