DAMAGES & MITIGATION OF
LOSSES UNDER CONTRACTS
The backbone of any arrangement and/or commercial
transaction is contract. The agreement enforceable in law shall be contract.
The requisites of agreement is too well known to require elucidation. Still, to
recapitulate, sections 2 (h) of Indian Contact Act 1872 defines contract and
the foremost requisite of it is acceptance of terms of offer by persons of sound mind, and they should have
capacity to enter into agreement and is not declared insolvent and otherwise
capable of entering into contract and still, the agreement/contract is not
against public policy. Thus, the pre-requisites of a contract has to cross the
threshold as illustrated above. However, the broad contour of the discussion
here shall revolve around the aspect of breach of contract and consequential
claim of damages, law in that regard, besides, what are the obligation of
contracting parties are deliberated.
The basic object of the contract is to set out in
clear term, the respective obligation of parties. The document as a reminder
shall consistently convey to the parties the respective covenants to be met by
the parties. The purpose of the contract therefore is preemptive as well. The
breach occurs, when a party to a contract does not fulfill its obligation. If
breaches occurs the losses are the most likely result to the other party.
Though, breaches of obligation could be for variety of reasons such as due to force measure like act of god and situation
beyond control of contracting parties. These are exception to convention. What
if the breach does not occur due to force measure, but to subvert the contract
and breach the obligation for material gains. What liability in such an event
shall be cast on defaulting party. Yet again, whether , any default shall in
itself tantamount to breach? Moreover, what remedy does the other party shall
have in the event of breaches by the defaulting party? Whether Section 73,74
and 75 of Indian Contract Act shall answer all such elements has to be found
out. Another aspect would be, if a party to the contract suffers losses due to
the breaches by a defaulting party, whether any corresponding obligation is
also cast on a party not in breach, in order to raise a tenable claim in courts
of law. The law has thus, evolved wherein it is required of a party not in
breach to try and make effort to mitigate the losses arising due to breaches of
defaulting party and the sufferer may claim remainder of losses which could not
be mitigated even after due diligence and that shall fall within the parameter
of doctrine “Mitigation of Losses”
No doubt the basic objective of a contract is to
discerningly specify what are the terms or covenants agreed upon by the
parties. In the event of disputes, the probable litigation could be avoided if
the parties understands their respective fault line. The breach of contract if
alleged may lead to cancellation of instruments and/or the party who suffered
may seek injunction and damages. In order to claim damages, the party claiming
damages shall have to prove that wrong or breaches are committed by the other
party i.e defaulting party or parties and owing to the breaches the party who
suffered the breach shall be entitled to damages. However, the damages, as
claimed should be proximate, approximate or the one which may have direct
bearing to breaches. However, another terrain, which is equally important is
that a party who suffered losses or likely to suffer losses, whether the
efforts were made by such party to mitigate the losses so as to reduce the
burden of opposite party. That follows whether a party who suffered losses have
initiated or taken all such plausible steps to reduce the prospective losses or
not? This is a legal mandate for claiming damages. What therefore may emerge is
whether an unsuccessful
litigants
shall have to inevitably compensate a successful claimant? It is not so as a
matter of course. What would be necessary is to show direct bearing of the act
or conduct of defaulting party in causing losses to the other party. It
therefore follows that is a party to a
contract sits idle with a view to seek
accumulation of damages so as to claim compensation on higher side, that will
not be permissible. There cannot be premium to idleness. The action or reaction
of the party staring at losses or prospective losses shall have to act
promptly. The pith and substance of the doctrine of “mitigation of losses” is
that if a person who has sustained or suffered an injury or loss should take all
such plausible or reasonable steps so as to avoid any further injury or loss. Thus,
responsibility is cast on a party to make all efforts and that too at the
earliest to mitigate the losses so as to minimize the claim. The basic doctrine
of contract is that the non-breaching party should mitigate damages or risk.
What if no efforts are made or no reasonable steps
are taken by non breaching party for mitigating losses? In such an event the
breaching party may take defence that as the non breaching party have failed to
mitigate their loss therefore, lenient view may be taken against the breaching
party in an effort to
reduce
the level of damages. Generally, courts are sympathetic to the efforts made by
a claimant seeking to deal with a breach of contract.
It shall be incumbent on the party to the alleged
breach, i.e more oftently the defendant shall have to discharge the burden of
proving that the plaintiff or claimant has failed in its duty to make efforts
for mitigation of loss. These are question of fact. Conversely, the plaintiff
shall have the burden of proving that defendant should prove that the plaintiff
should have mitigated the loss and it was in the command of the plaintiff to do
so. It is a settled proposition in law that duty is cast on an innocent party
to mitigate the loss it has suffered. There is no straight jacket formula about
the steps taken in this regard. That will depend on the facts and circumstances
of each case. Suffice however to show that reasonable or plausible steps were
taken for mitigating the losses. If plaintiff/claimant is able to prove that
steps were taken for mitigation of losses, then even reasonable costs for
mitigation may be recovered from defendant.
SECTION 73-75 of INDIAN CONTRACT ACT 1872
The Indian Contract Act
1872 contains a comprehensive provision about damages and as regards duty about
mitigation of losses. Section 73 of Indian Contract Act 1872 may be reproduced
as under:
Section 73: Compensation for
loss or damage caused by breach of contract.
73. When a contract has been broken, the
party who suffers by such breach is entitled to receive, from the party who has
broken the contract, compensation for any loss or damage caused to him thereby,
which naturally arose in the usual course of things from such breach, or which
the parties knew, when they made the contract, to be likely to result from the
breach of it.
Such
compensation is not to be given for any remote and indirect loss or damage
sustained by reason of the breach.
Compensation
for failure to discharge obligation resembling those created by contract.—When
an obligation resembling those created by contract has been incurred and has
not been discharged, any person injured by the failure to discharge it is
entitled to receive the same compensation from the party in default, as if such
person had contracted to discharge it and had broken his contract.
Explanation.—In
estimating the loss or damage arising from a breach of contract, the means
which existed of remedying the inconvenience caused by the non-performance of
the contract must be taken into account.
The very expression 'the means which existed of remedying the
inconvenience' implies that a duty is
cast upon a person complaining of a breach of contract, to use reasonable
prudence and common sense and should take all probable steps available in order
to mitigate the loss arising owing to the breaches of defaulting party.
The test of reasonableness: It implies that under the given circumstances
whether a prudent man would act in a manner as the claimant has acted. In other
words, assuming that wrong would have been caused by claimant himself, whether
he would have acted in a same manner or not shall be the yardstick.
INTERPRETATION OF THE DOCTRINE OF DAMAGES
The plaintiff in order to be entitled to claim damages on the
breach of contract must take reasonable steps to mitigate the loss arising on
account of such breach/es.” It means that whether the plaintiff has taken steps
to mitigate the loss or not shall be a determinative factor for assessing
damages. If the plaintiff fails in duty to mitigate, the loss of the damages
claimed by him may be construed as if it has not arisen naturally and in the usual
course of situation. What is of paramount importance in the context is that the
person who has breached the contract should not suffer the burden of additional
damages which could be prevented had the claimant acted diligently and if
reasonable efforts were made in time to mitigate the damage. This clearly means
that plaintiff should not get more than the loss suffered and that too after
acting reasonably with a view to mitigate damages.
There
are Three (3) basic rules enunciated about mitigation of losses:
(i)
The
plaintiff cannot recover the loss consequent upon the default of the defendant,
if the plaintiff did not avoid the loss by taking reasonable steps.
(ii)
If
the plaintiff avoids or mitigates the loss, he cannot recover more than what
was reasonably required of him.
(iii)
Where the plaintiff suffers loss or incurs
expense by taking reasonable steps to avoid or mitigate the loss resulting from
the defendant’s default, he may recover further loss or expense from the
defendant.
No doubt, the plaintiff can also recover expenses or further loss
incurred by him in taking reasonable steps to mitigate his loss resulting from
the defendant’s breach. Such a claim can be raised even when the steps for
mitigation were unsuccessful or in fact may have accentuated the losses.
Section 73 of
the Indian Contract Act, 1872 prescribes grant of unliquidated damages, whereas
Section 74 provides liquidated damages. The unliquidated damages are not
quantified and, may be awarded through the courts of law after evaluation
of loss or damages that may have been incurred due to the acts of defaulting
party, Whereas, Liquidated Damages are the damages which the parties specify
in the contract.
DUTY IN CASE OF BREACH OF CONTRACT
The
claimant has certain duty in case of any breach of contract. Failure to
mitigate loss may prevent the innocent party from recovering damages for
avoidable loss. Defendants often assert that claimants have failed to mitigate
their loss in an effort to reduce the level of damages. Generally, courts are
sympathetic to the efforts made by a claimant seeking to deal with a breach of
contract. The requirement to take ‘reasonable steps’ is not a high standard. In
particular, the courts will typically reject criticism of a claimant seeking to
do its best to mitigate its loss when faced with a breach of contract,
particularly when decisions have to be made – often quickly – by a claimant
with imperfect knowledge. It is, after all, the defendant that has put the
claimant in the position of having to deal with a breach of contract. However,
the courts will penalize a claimant in damages where it has demonstrably and unreasonably
failed to take any steps to mitigate its loss, or where the steps that it has
taken are clearly inadequate. In circumstances where a claimant could, for
example, potentially mitigate its loss by selling goods in the market, the
court will usually expect to see evidence of meaningful
attempts
to do so. That should not be difficult if such attempts are genuine. A claimant
that gives the impression that it is more concerned with enhancing a claim than
mitigating loss should expect deductions in the damages awarded to it.
BURDEN OF
PROOF ON DEFENDANT
It is the
defendant who has the burden of proving that the claimant has failed in its
duty to mitigate loss. What exactly the claimant is required to do with respect
to mitigation is an issue of fact. The Court, for instance, will require that
the insured person act reasonably in seeking out medical treatment to get
better, but will not require the claimant to undergo surgery or treatment which
is dangerous or futile or where the likelihood of a successful outcome is
uncertain. While the plaintiff has the burden of proving the breach of
contract, the defendant must prove that the plaintiff could have and should
have mitigated the loss.
Following
a breach of contract, the innocent party has a duty to mitigate the loss it has
suffered. This duty requires reasonable steps to be taken to limit the losses
that are incurred (and also to avoid incurring unnecessary expenditure seeking
to remedy the breach). A claimant cannot simply sit on its hands watching
losses accumulate with the intention of recovering them in full from the
defendant. However, a claimant need not take unusual steps that would be
outside the normal course of business, or even incur
undue costs. The reasonable costs of mitigation are recoverable from the
defendant.
LAW
In a landmark
case Fateh Chand vs Balkishan Das AIR
1963 SC1405 the hon’ble Supreme
Court of India postulated that the aggrieved party is entitled
to appropriate compensation, not to exceed the amount of the penalty or the
amount pre-determined to be paid following the violation of the contract. The
Supreme Court has further held that application of these laws is not limited to
any circumstances. What thus, emerges are as under:
(i)
If
the amount payable substantially more than the likely harm for breach of the
contract, id It is a penalty.
(ii)
If
a contract specifies a sum payable on a specific date and also additional sum,
if a default occurs, such additional value may be referred to as a penalty.
(iii)
The
court shall be the ultimate arbiter to determine if the sums shall be “penalty”
or “damages,” in the appropriate cases.
The very object of such clauses
are to prescribe certainty. The risk and cost are needed to be adequately
contemplated and defined and in the event harm is caused these clauses shall
have to be referred to for seeking damages.
In Kailash Nath Associate Vs DDA (2015) 4 SCC
136, the Supreme Court has considered some important questions relating to
section 74 of the Indian Contract Act 1872. In fact, the conclusion of the apex
court has an obvious departure from some well-known principles of contract law,
the case warrants close attention. Section 74, of course, provides that the
claimant in a breach of contract case is entitled to ‘reasonable
compensation’ not exceeding the sum named in the contract as
payable in the event of breach. This was an intentional departure from the
distinction traditionally drawn by the common law or equity between penalties
and liquidated damages.
It may
be worthwhile to refer to in nutshell , the circumstances in Kailash Nath
(Supra).In an auction conducted by the
Delhi Development Authority (‘DDA’) Kailash Nath Associates’ (‘KNA’)
had offered bid for one of the plots and it was accepted. A sum of Rs. 78 Lakhs
i.e equivalent to 25% of auction value was paid as earnest money. The terms of
auction stipulated that DDA was entitled to forfeit this amount in case of any default,
breach or non-compliance of any of the terms and conditions of the auction. One of these terms was that KNA had to pay the
remaining 75% within three months. This KNA was unable to do so, but DDA, at
its request, extended the deadline on the understanding that KNA would pay 18%
interest. Eventually, some six years after the bid was accepted, DDA decided to
forfeit the earnest money and cancelled the allotment. It then re-auctioned the
property and was able to sell it for around Rs. 11 crores, nearly three times
the amount KNA had agreed to pay. KNA sought specific performance and, in the
alternative, a refund of
the earnest money. The specific performance claim failed but it is held that it
was entitled to a refund.
The Supreme Court has considered the
factor that DDA had in fact reaped advantage as the plot was sold to a price three
times higher than earlier auction price. Therefore, if the earnest money
deposited by KNA was to be forfeited, the DDA would have unduly and wrongfully
enriched itself and that was held as contrary to basic principles of damages in
as much as damages can only be given for as compensation
for damage or loss suffered. If damage or loss is not suffered, the law does
not provide for a windfall. The Supreme Court had also granted 9% p.a interest
to KNA, rather than 7% as prescribed in contract. It was so, because DDA having
chosen to contest the case vigorously even on refund of earnest money, when no loss
caused to it, shall stands on a different footing.
The
requirement to take ‘reasonable steps’ is not a high
standard.
In particular, the courts will typically reject criticism of a claimant seeking
to do its best to mitigate its loss when faced with a breach of contract,
particularly when decisions have to be made – often quickly – by a claimant
with imperfect knowledge. It is, after all, the defendant that has put the
claimant in the position of having to deal with a breach of contract. However,
the courts will penalize a claimant in damages where it has demonstrably and unreasonably
failed to take any steps to mitigate its loss, or where the steps that it has
taken are clearly inadequate. In circumstances where a claimant could, for
example, potentially mitigate its loss by selling goods in the market, the
court will usually expect to see evidence of meaningful attempts to do so. That
should not be difficult if such attempts are genuine. A claimant that gives the
impression that it is more concerned with enhancing a claim than mitigating
loss should expect deductions in the damages awarded to it.
CONCLUSION
The law of damages as evolved over the years has some basic
principles i.e., A party who claims breach of contract by a defaulting party
must take all such measures as may be deemed reasonable in the circumstances so
as to mitigate the loss. A claimant shall be entitled to claim damages on account
of breach of contract only if the claimant has taken all plausible steps to
mitigate the loss arising out of such breach or breaches. The claim of damages
shall not be awarded to a party sitting idle, but it will be expected of a suffering
party that all reasonable steps were taken by him with a view to mitigate the
loss. If a suffering party fails to take such measures as narrated above, the
party in breach may claim reduction in the claim of damages of sufferer.
It is thus incumbent on the claimant to take all reasonable steps
to mitigate the losses as soon as the claimant came into the knowledge of a
breach. This will be a relevant/ determining factor for awarding damages. There
may also be a situation where damages may be caused to a claimant in the
natural course of events, in such an event the claimant shall be obligated to carry
out rectification or repairs themselves, rather than allowing their damage to accentuate
by remaining oblivious to it. However , it also follows that a claimant will
not be required to act against the interests of innocent parties to reduce
recoverable loss. Further, the claimant is not required to sacrifice their
commercial reputation in order to avoid losses suffered by a breach of
contract.
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Anil
K Khaware
Founder & Senior Associate
Societylawandjustice.com
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