Damages and remoteness

1. Section 73: the rule

When a contract has been broken, the party who suffers by the breach is entitled to receive, from the party who has broken it, compensation for any loss or damage caused to him by the breach which:

• naturally arose in the usual course of things from the breach; or
• the parties knew, when they made the contract, to be likely to result from the breach.

Such compensation is not to be given for any remote and indirect loss or damage sustained by reason of the breach. The second paragraph applies the same rule to failure to discharge an obligation resembling one created by contract (the quasi-contracts in sections 68 to 72).

The Explanation provides that, in estimating the loss or damage, the means which existed of remedying the inconvenience caused by the non-performance must be taken into account. This is the statutory basis of the duty to mitigate.

The first illustration states the usual measure in sale of goods: A contracts to sell and deliver 50 maunds of saltpetre to B at a certain price, to be paid on delivery. A breaks his promise. B is entitled to receive from A, by way of compensation, the sum, if any, by which the contract price falls short of the price for which B might have obtained 50 maunds of saltpetre of like quality at the time when it ought to have been delivered.

2. Hadley v. Baxendale: the two limbs

In Hadley v. Baxendale (1854) the crankshaft of the plaintiffs' mill broke. They gave it to a carrier to take to the engineers at Greenwich as a pattern for a new one. The carrier delayed delivery, and the mill stood idle for several extra days. The plaintiffs claimed their lost profits. Alderson B. held the loss too remote and stated the rule that section 73 reproduces:

• First limb: damages that arise naturally, according to the usual course of things, from the breach.
• Second limb: damages that may reasonably be supposed to have been in the contemplation of both parties at the time they made the contract, as the probable result of the breach, because of special circumstances communicated to the defendant.

The carrier was not told that the mill would stop without the shaft. In the usual course a miller might well have a spare shaft, so the loss of profits did not arise naturally, and the special circumstance had not been communicated.

In Victoria Laundry v. Newman Industries (1949) the delivery of a boiler to a laundry was delayed by five months. The laundry recovered the ordinary profits it would have made from expanding its business, because the sellers, as engineers, knew it was needed for immediate use. It could not recover the profits from exceptionally lucrative dyeing contracts with the Ministry of Supply, of which the sellers knew nothing. Asquith L.J. restated the test as what was reasonably foreseeable as liable to result, in the light of the knowledge actually possessed. The Heron II (Koufos v. Czarnikow, 1969) later said that in contract the loss must be “not unlikely” to result, a stricter test than in tort.

3. Kinds of damages

• Ordinary or general damages: the loss that arises naturally from the breach (first limb), such as the difference between contract and market price.
• Special damages: loss arising from special circumstances, recoverable only if they were communicated at the time of contract (second limb).
• Nominal damages: a small sum awarded where a right has been infringed but no actual loss is proved. They recognise the breach.
• Exemplary or punitive damages: generally not awarded in contract, because compensation looks to the plaintiff's loss, not the defendant's conduct. The traditional exceptions are breach of promise to marry and a banker's wrongful dishonour of a customer's cheque, where injury to reputation is presumed.
• Damages for mental distress: allowed where the object of the contract was to give pleasure or peace of mind, as in Jarvis v. Swans Tours (1973), a ruined holiday.
• Liquidated damages: a sum fixed by the parties in the contract, governed in India by section 74.

4. Section 74: liquidated damages and penalty

Section 74 provides that when a contract has been broken, if a sum is named in the contract as the amount to be paid in case of breach, or if the contract contains any other stipulation by way of penalty, the party complaining of the breach is entitled, whether or not actual damage or loss is proved to have been caused, to receive from the party in breach reasonable compensation not exceeding the amount so named or the penalty stipulated.

English law distinguishes a genuine pre-estimate of loss (enforced in full) from a penalty (not enforced). Section 74 cuts across that distinction.

• Fateh Chand v. Balkishan Das, 1963 INSC 1, AIR 1963 SC 1405. A buyer of property in Delhi paid Rs 1,000 as earnest money and Rs 24,000 more on delivery of possession. When the sale fell through, the seller claimed to forfeit the whole Rs 25,000. The Court held that section 74 applies to every stipulation for payment on breach, whether it is a penalty or liquidated damages, and the court must award only reasonable compensation up to the named sum. The seller could keep the earnest money of Rs 1,000 but had to refund Rs 24,000, since no loss was shown.
• Maula Bux v. Union of India, 1969 INSC 189, (1969) 2 SCC 554. Forfeiture of a reasonable amount paid as earnest money is not a penalty, but security deposits forfeited without proof of loss, where loss could have been proved, were held to be a penalty subject to section 74.
• Oil & Natural Gas Corporation v. Saw Pipes Ltd., 2003 INSC 241, (2003) 5 SCC 705. ONGC deducted liquidated damages for delayed supply of pipes. The Court held that where the stipulated sum is a genuine pre-estimate of the loss, and the loss is of a kind difficult to prove, the party may recover it without proving actual loss. An arbitral award that refused the deduction for want of proof was set aside.
• Kailash Nath Associates v. Delhi Development Authority, 2015 INSC 22, (2015) 4 SCC 136. The DDA forfeited the earnest money of a highest bidder who had delayed payment, and later re-auctioned the plot at a higher price. The Court held that section 74 applies to forfeiture of earnest money where it is in the nature of a penalty; that proof of actual loss is dispensed with only where it is difficult or impossible to prove; and that where no loss is caused, no compensation can be awarded. The DDA suffered none, so forfeiture was set aside. The Court explained Saw Pipes in those terms.

5. Duty to mitigate

The Explanation to section 73 requires the injured party to take reasonable steps to reduce his loss. He cannot recover loss he could have avoided. In Murlidhar Chiranjilal v. Harishchandra Dwarkadas, 1961 INSC 125, AIR 1962 SC 366, the Supreme Court held that the Explanation and the first illustration to section 73 embody the principle that the plaintiff must take reasonable steps to mitigate, and that a buyer of goods ordinarily recovers the difference between the contract price and the market price on the date of breach, because he could have bought in the market then. The duty is only to act reasonably; he need not take risky or extraordinary steps, and the burden of proving failure to mitigate is on the defendant.

6. Ascertainment of damages

• Sale of goods: the difference between contract price and market price at the date and place of delivery (illustration (a) to section 73; sections 56 and 57, Sale of Goods Act, 1930).
• Carriage: the value of goods lost or damaged, and loss from delay only if the second limb is satisfied.
• Failure to pay money: ordinarily interest, not consequential loss.
• Building contracts: the reasonable cost of completing or remedying the work.
• Anticipatory breach: measured by reference to the date fixed for performance, subject to mitigation from the date of acceptance of the repudiation.

7. Section 75

A person who rightfully rescinds a contract is entitled to compensation for any damage he has sustained through the non-fulfilment of the contract. Rescission and damages are not alternatives. The illustration: A, a singer, contracts with B, the manager of a theatre, to sing at his theatre two nights a week for two months at Rs 100 a night. On the sixth night A wilfully absents herself, and B in consequence rescinds the contract. B is entitled to claim compensation for the damage he has sustained through the non-fulfilment of the contract. (These are the facts of the first illustration to section 39, carried one step further.)

8. Problem

A contracts to supply a generator to B's cold storage by 1 April. A is not told that B has already contracted to store a merchant's mangoes from 1 April. The generator arrives on 20 April; the mangoes, kept without power, rot. B claims (i) the profit he would have earned on the cold storage in April and (ii) the Rs 5 lakh he paid the merchant for the rotten mangoes.

Issue. Which of B's losses are recoverable under section 73.

Law. Section 73 and Hadley v. Baxendale: losses arising naturally, and losses within the contemplation of both parties at the date of contract. Victoria Laundry separates ordinary profits from special contracts.

Application. A supplier of a generator to a cold storage knows it is needed to run the business, so the ordinary loss of use for April arises naturally from the delay (first limb). The liability to the merchant flows from a particular contract that A was not told about; it falls under the second limb, and the condition of communication is not met. B was also bound to mitigate, for example by hiring a generator if one was reasonably available.

Conclusion. B recovers the ordinary loss of April's use (reduced by what he could reasonably have saved), but not the Rs 5 lakh paid to the merchant.

How this is examined

As a 10-mark essay: “Explain the rules regarding damages for breach of contract” or “Explain the rule in Hadley v. Baxendale”. Cover section 73, both limbs, Victoria Laundry, kinds of damages, mitigation and section 74. As a short note: liquidated damages and penalty (with Fateh Chand and Kailash Nath), nominal damages, or the duty to mitigate. Remoteness problems like the one above are common in Part C.