Loss of profit is a tool often used in a claim for damages and is mainly seen in claims arising from infrastructure contracts, where the injured party will always have a claim for loss of profit due to the overdue contract. or termination of the contract before its completion.
On the basis of section 73 of the Indian Contract Act, 1872, a claim for damages can be successful if the damage caused arose naturally in the ordinary course of events or that the parties knew at the time of the conclusion of the contract. that it was probably the result of a violation. The extent of damage, however, does not include consequential loss or damage at a distance.
The Apex tribunal in AT Brij Paul Singh v. State of Gujarat 1, analyzing the orders of the High Court, observed that, in order to decide on the claim for loss of profits, it was not necessary to go into the smallest details of the work carried out and only an overall assessment would be adequate.
In Bharat Coking Coal Ltd. v LK Ahuja 2, the Apex Court laid down an important principle to claim a loss of profit, observing that “It is not uncommon for contractors to claim a loss of earnings resulting from reduced turnover due to a delay in completing the work. What he would have to establish in such a situation is that if he had received the amount owed under the contract he could have used it for another business in which he could have made a profit ”and“ at Unless such a means is raised and established, claiming for loss of profit could not have been granted. “The Apex Court has recognized that a simple claim for damages may not be enough and that it is necessary to prove how the loss was suffered.
The Apex Court, while deepening the law of damages, established some of the important principles on the basis of which the actual claim for damages must be assessed. In McDermott International Inc. v. Burn Standard Co. Ltd. 3 (McDermott case), the Court recognized the following formulas for determining the amount of damages:
“(A) Hudson’s formula:…
In the Hudson formula, the percentage of head office overhead is taken from the contract. Although the Hudson’s formula has received legal backing in many cases, it has been criticized primarily because it adopts the percentage of contract head office overhead as a cost factor and this may have little or no effect. in relation to the actual costs of the contractor’s head office.
(b) Emden’s formula:…
Using Emden’s formula, the percentage of head office overhead is obtained by dividing the total overhead and profit for the entrepreneurial organization as a whole by the total revenue. This formula has the advantage of using the actual head office and the contractor’s profit percentage rather than those contained in the contract. This formula has been widely applied and has received legal support in a number of cases.
(c) Eichleay’s formula:
The Eichleay Formula was developed in America and takes its name from a case heard by the Armed Services Contracts Appeal Board, Eichleay Corp …
This formula is used when it is not possible to prove the loss of an opportunity and the claim is based on the actual cost. The formula shows that the total head office overhead over the term of the contract is first determined by comparing the value of the work performed during the term of the contract for the project with the value of the work performed by the contractor in the project. whole for the period of the contract… The Eichleay formula is considered by the Federal Circuit Courts of America to be the exclusive means of compensating a contractor for overhead costs.
The Court in McDermott further observed that (i) the use of the above formulas was not prohibited or inconsistent with Indian laws (ii) the calculation would depend on the facts and circumstances of each case and ( (iii) the use of one formula over the other to determine the amount of damages would be within the jurisdiction of the arbitrators and would not warrant the intervention of a court.4
In Braithwaite Burn and Jessop Construction Company Limited v Rail Vikas Nigam Ltd. 5, it was argued that due to the prolonged and indefinite duration of the project, the applicant had to maintain his resources until the substantial completion of the works and was not allowed to demobilize his resources, which prevented the petitioner to mitigate their loss due to overhead and loss of earnings. Thus, the applicant was entitled to the extended stay allowance by adopting the Emden formula.
The Delhi High Court ruled that the extended stay allowance was essentially a claim for damages and therefore proof of the injury was essential. It was necessary for the complainant to prove the damage he had suffered as a result of the overhead costs which formed the basis of the complaint and for an attribution of loss of profit to be passed on, the damage had to be established.
Essar Procurement Services Ltd. v Paramount Constructions, 6 the Court set aside the arbitration award because the claim for loss of profit was allowed by the arbitral tribunal simply on the basis of the Hudson formula and not on the basis of any evidence.
In NTPC Limited v Sri Avantika Contractors (I) Limited 7, the Delhi High Court ruled that Articles 73 and 74 of the Contract Act 1872 require actual damage or loss and the evidence cannot be suppressed and that if a party has not suffered any loss, even if the defaulting party commits a breach, in the absence of proof of the damage, the opposing party cannot be attributed the claim for loss of profit.
Most damages claims are assessed on the basis of the facts and circumstances of each case. However, the principles enunciated in the McDermott case provide a roadmap for achieving quantification. Loss of profit claims are never objectively quantified and most of the time parties present inflated claims in the hope that part of it may be successful. However, the law, as stated and prescribed, clearly requires that such claims be proven and established. While there may be a reasonable expectation of profit, the same must be proven. One wonders whether the courts have not been too lenient in allowing such loss claims to succeed, on the basis of a simple declaration of use of resources elsewhere, without having to provide real proof that such resources would have been deployed without such a mishap. Is this the case with the shepherd who cries out wolf?
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