India: "Computatıon Of Loss Of Profıt" By An Arbıtrator In Constructıon Contracts

Introduction

Disputes arising due to delay in completion of an infrastructure construction contract may lead to a variety of claims, including that of claims towards loss of profit, liquidated damages, damages due to idling of plant, labour and machinery and increase in onsite and offsite over-head expenses. The law with respect to grant of damages, whether liquidated or unliquidated, has been discussed by the courts in a plethora of judgments. However, claims pertaining to loss of profit and profitability have been seldomly discussed.

The Supreme Court, recently in Batliboi Environmental Engineers Limited vs. Hindustan Petroleum Corporation Limited and Another¹ (hereinafter referred to as “Batliboi”) was seized with a claim for loss of profit and profitability and considered the decision of the Arbitrator to award 10% of the contract value towards loss of overheads and another 10% towards loss of profits/profitability.

The terms for loss of profitability and loss of profit are used interchangeably. Therefore, it is important to highlight the difference between the claims of loss of profit and loss of profitability-

1. Claims arising due to delay in execution of the contract, where the contractor could have earned profit if it would have deployed its resources in another venture, leads to claims for loss of profitability; and
2. Claims arising due to early termination of the contract or omission of a portion of work, wherein the contractor can claim for compensation for the expected profit of the balance of work, leads to claims for loss of profit.

Judicial Precedentspertaining to computation of loss of profit and profitability.

The principle rule for a claim resulting from a breach of contract, was laid down by the English Courts in Robinson vs. Harman², wherein it was observed that the sum of money awarded to the party who has suffered the injury, should be the same quantum as s/he would have earned or made, if s/he had not sustained the wrong for which s/he is getting compensated.

Section 73 of the Indian Contract Act, 1872 (“ICA”) also provides that the party who suffers the breach is entitled to receive compensation for any loss or damage caused to him “which naturally arose in the usual course of things from such breach”. Elaborating further the Supreme Court of India in AT Brij Paul vs State of Gujarat³ (hereinafter “AT Brij Paul”) has held that –

Thus, the question that arises is, how does one substantiate a claim for loss of profit or profitability. Relying on the judgement of AT Brij Paul, the Supreme Court in the case of Dwarka Das vs State of Madhya Pradesh⁴, with respect to loss of profit where the contract was rescinded by the State as only 10% of the work was completed despite lapse of more than 9 months, had held that,

Further, towards the measure of damages, the courts held that a reasonable percentage of the value of the remaining parts of the work contract, which in this case was 10%, could be granted.

With respect to a claim for loss of profitability, it is imperative for the party seeking damages to prove the existence of an opportunity which has been denied on account of prolongation of the contract. To this effect, the Delhi High Court in NHAI vs. IJM Gayatri Joint Venture⁵had held that -

Once a contractor has satisfied the arbitral tribunal that he had the opportunity to deploy his resources in another venture, the issue of quantification of loss arises. The Supreme Court of India in McDermott International Inc. vs Burn Standard Ltd. and Ors.⁶ (hereinafter “McDermott's Case”) had an opportunity to answer this query and observed that Sections 55 and 73 of ICA, do not lay down the mode and manner of computation of damages or compensation. Therefore, “it is an accepted position that different formulas can be applied in different circumstances and the question as to whether damages should be computed by taking recourse to one or the other formula, having regard to the facts and circumstances of a particular case, would eminently fall within the domain of the Arbitrator.” In the McDermott's case, the Supreme Court further recognized certain formulas that the arbitral tribunal can depute for computation of damages which are as under –

1. The Hudson Formula – In case the contract provides for the head office overhead percentage, then the same can be taken from the contract.
   
   
2. The Emden Formula – In this formula, the head office overhead percentage is arrived at by dividing the total overhead cost and profit of the contractor's organisation as a whole by the total turnover. This formula has the advantage of using the contractor's actual head office overhead and profit percentage rather than those contained in the contract.
   
   
3. The Eichleay Formula - This formula is used where it is not possible to prove loss of opportunity and the claim is based on actual cost. Therefore, in this formula the total head office overhead during the contract period is first determined by comparing the value of work carried out in the contract period for the project with the value of work carried out by the contractor as a whole for the contract period.

That said, parties frequently dispute the computation made in the award regarding such claims and also the method adopted by the arbitral tribunal for making such calculations. In Batliboi, the Respondent had disputed the method and computation of the claim of loss of profit and profitability by the arbitrator.

Factual background of Batliboi

Hindustan Petroleum Corporation Limited (hereinafter “HPCL”) and Baltiboi Environmental Engineers Limited (hereinafter “BEEL”) entered into an agreement for execution of the work pertaining to construction of sewage water reclamation plant at Mumbai, which was to be completed within 18 months from the letter of intent dated 27.02.1992. However, as the work could not be completed within the said time frame, therefore, on the request of BEEL, several extensions of time were granted to it. BEEL continued to work on the site till 31.03.1996, and thereafter abandoned the work. At that stage, only 80% of the work could be completed by BEEL. Subsequently, BEEL invoked the arbitration clause and contended before the Arbitrator that as the delay in the execution of the work was attributable to HPCL, therefore, it was entitled to compensation for “loss of profit and profitability”. The Arbitrator allowed the claim of BEEL in part and directed HPCL to pay 10% of the contract value towards loss of overheads and another 10% towards loss of profits/profitability.

Amongst other grounds, the award was thereafter challenged by HPCL, on the ground that the award is deficient being completely silent as to the method and the manner adopted for computation of the claim of loss of overhead and loss of profit/profitability. In order to justify the computation made in the award and also the principle or the method adopted by the Arbitrator, BEEL referred to the Hudson's formula. In furtherance to the arguments of the parties, the Supreme Court analysed the situations when the Hudson's formula can be applied by an arbitral tribunal for computation of loss of profit/profitability.

Findings of the Supreme Court in Batliboi

The Supreme Court was of the opinion that the computation of damages depends on the factual matrix of any give dispute and the question of quantum should be within the scope of the arbitrator. That said, the Supreme Court further observed that –

Elaborating further on the prerogative of the arbitral tribunal to choose a method for computation of damages, the Supreme Court held that -

With respect to the computation of quantum of damages through the Hudson formula, the Supreme Court observed that -

The Supreme Court further clarified that it is the responsibility of the contractor to provide material to prove that the above assumptions were met. A further burden is placed on the contractor to prove that other opportunities were missed on account of prolongation of the contract. The Supreme Court after referring to the above observed that no justification or computation of the loss is expounded in the award. In the absence of such justification and calculation, the Court held that the award was merely on ipsi dixit without giving any reasons and/or basis for awarding the amount. Based on the above, the Supreme Court upheld the findings of the division bench of the High Court and set aside the award.

CONCLUSION

The Supreme Court has recommended that extreme caution should be exercised by arbitral tribunal while applying any formula for computing loss of profit/profitability. Further, any inaccuracies in the computation should not be overlooked. Proper analysis needs to be done and reasons need to be provided by the arbitral tribunal before awarding such claims, as a “conclusion without any discussion and reasons, is non-compliant and violates the mandate of sub - section (3) of Section 31 of the A& C Act, an aspect we would examine subsequently.”

The judgment in Batliboi also creates an obligation on the contractor claiming damages to provide sufficient material evidence in support of its claim. Mere proof of alternative opportunity will not be enough. The contractor should also prove the quantification of the loss.

Footnotes

1. 2023 INSC 850

2. (1848) 1 Ex 850

3. (1984) 4 SCC 59

4. AIR 1999 SC 1031

5. 2020(3) Arb LR 463 (Delhi)

6. (2006) 11 SCC 181

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.