[By Ritesh Raj]
The author is a student of NLSIU, Bangalore.
Introducing the Theories of Expectancy and Reliance in Damages
The theories of expectancy and reliance in assessing damages became discreet with the publication of LL Fuller and William R Perdue Jr’s paper. Reliance interest was defined as damages paid to restore the plaintiff to the pre-contractual status quo position as if the contract had never existed. The object is to compensate the plaintiff for the loss suffered by relying on the promise. Expectation interest is damages paid to put the plaintiff in the same position he would have acquired had the contract been performed. The object is to fulfil the plaintiff’s expectations to the extent possible.
In India, it is well-established that both damages cannot be claimed at once.[1] However, the distinction between the two becomes unclear in the periphery. Though the courts have explicitly mentioned not to award both the damages, it ends up doing the same.[2] Also while awarding, the courts have not followed a uniform principle for determining which damages to award: reliance or expectancy. This paper argues that expectancy damages should be the rule and reliance damages be an exception to the general rule. To that end, the first part elaborates on both the damages. The second part argues why this principle should be followed. The third part demonstrates how the courts have erred in following this principle. It recommends a test to do so. The final part concludes.
Expectancy Damages Should be the Rule, let Reliance Damages be an Exception
It has long been accepted that damages for breach of contract are given in order to put the plaintiff in the same situation he would have been in if the contract had been completed. This reasoning, however, is insufficient to persuade the courts to embrace the principle of expectancy damages as the rule and reliance damages as an exception. As a result, this section elaborates on the reasons why courts should adhere to this concept.
I. In circumstances when the breach is purely for monetary gain, expectation damages operate as a deterrence to breach of contract. An illustration: Mr X contracted to sell his car to a reselling company PLX. PLX, relying on the same, purchased some parts required to restore it (incurred expenditure). Mr X, however, breached the contract. PLX can now either claim the loss of profits (expectancy damages) that the company would have earned had the contract been performed or the expenditure wasted in buying those parts (reliance damages). If it’s claiming expectancy damages, it cannot claim reliance ones as it would have to buy parts if the contract was to be performed. Awarding expectation damages includes the wasted expenditure which is reduced to compute the loss of profits.
In this scenario, if Mr X broke the contract by selling his car to another firm TLX that paid more than PLX, it would be ethically wrong to award reliance damages. This is because the defendant is in a better position (received a greater amount for his car) at the expense of the plaintiff (wasted expenditure in buying parts for restoration). However, paying expectation damages would dissuade Mr X from breaking the contract since he would have to compensate PLX for lost earnings. This would limit the additional profit he would have gained from selling his car to TLX.
In essence, the fact that expectancy damages tend to be excessive than reliance damages acts as a deterrence to contract breaches.
II.[3] Reliance damages are not enough in cases where it is difficult to measure damages. In the very cases where calculating expectancy damages is difficult, it is the most important to award the same. However, since it is difficult and because the burden of proving that the damage has occurred often falls on the plaintiff,[4] reliance damages become the only viable remedy available. However, in RK Malik and Ors v Kiran Pal and Ors, where 29 children died in an accident, the SC awarded damages even for future prospects. The court held an extensive discussion about the children’s future possibilities based on how well they fared in school and awarded expectation damages as a result. Though estimating such damages may appear implausible and arbitrary, the court stated that even if the precise sum cannot be calculated, some fair recompense should be provided.
The above case demonstrates that expectancy damages can be awarded on the basis of just and reasonable compensation even in circumstances where they are difficult to quantify. The question now is why the courts do not follow suit in commercial cases. The reason for this is the feasibility and brainstorming that the courts must go through in determining how much expectation damages are justified. Because there is no bodily injury involved in commercial claims, the courts take the easy route. Bungo Steel Furniture Pvt Ltd v UOI is a case in point demonstrating the easy path the Tribunal adopted. While awarding damages for incomplete bins, the Tribunal awarded loss of profits as the difference between the contract price and the cost of the bins. It did not, however, take into account that the bins were still unfinished. So, the real loss of profits, which was ultimately awarded by the SC, would have been the difference between the contract price and the cost of labour and steel required for the manufacture of the incomplete bins. This shows that courts do award damages on the basis of feasibility. This should be avoided when awarding expectancy damages.
In essence, the courts should award expectancy damages to the extent possible. Feasibility should not be the basis for deciding whether expectancy damages are to be awarded or not.
III. Even illustrations under S 73 of the Indian Contract Act, 1872 (hereinafter, ‘the ICA’), prefer awarding expectancy damages to the extent possible. Out of the 18 illustrations given, expectancy damages were given in 12 of them. In illustration (b), there was no expectancy damage, so that can be excluded. Even in the remaining 5, reliance damages were awarded only because special circumstances of there being some expectancy losses were not communicated. It can be inferred from these illustrations that the legislative intent behind framing this section was to award expectancy damages to the extent possible and award reliance damages only in cases where the possibility of expectancy losses wasn’t communicated.
Illustration (r) is a case in point, defining the limits of awarding expectancy damages to the extent possible. In the same, A contracted with B to convey B from Calcutta to Sydney in A’s ship. However, the ship did not sail in the proposed time and B was detained in Calcutta and had to go through another ship which reached later than the time A’s ship was supposed to. Here, B is entitled to any excess he had to pay for another ship and for the expense incurred during the detention. But not for the losses he incurred because of reaching late (remoteness of damage). So, expectancy damages were awarded only to the extent possible and justifiable.
In essence, the legislative intent was to award expectancy damages to the extent possible. So, mere feasibility and difficulty in proving should not become the reason for not awarding so.
Tracing The Principle: The Indian Scenario
It is also established law in India that damages are awarded to put the plaintiff in the same position as if the contract had been completed.[5] Be it the 1967 SC case, or the recent 2022 case of Sikkim HC, courts have attempted to adhere to this principle.[6]
However, the Indian courts have erred in following this principle to the extent possible. In the case of UOI v Jain Associates,[7] both the arbitrator as well the HC erred in following the settled law. First, the arbitrator awarded both reliance and expectancy damages, putting the plaintiff in a better position than if the contract had been performed. Second, although the HC dismissed the arbitrator’s decision on appeal, it erred in determining which one to award. It granted reliance damages in the “interest of justice and fair play,” notwithstanding the fact that the loss of profits (expectancy damages) had been assessed properly. Following these broad guidelines of “justice and fair play” in determining which damages to award can lead to arbitrary decisions, as demonstrated by this verdict. Even if the contract was fulfilled completely without any breach, the expense (reliance loss) would have occurred. Expectancy damages were the correct ones to award. Though the SC remanded the case for further consideration, this case highlights the necessity of a test to determine which damages to award.
Again, in the case of Dyna Technologies Pvt Ltd v Crompton Greaves Ltd, though the claimant was able to prove expectancy damages, the tribunal did not award the same. This again demonstrates the requirement of a test.
Further, in the case of Kanchan Udyog Limited v United Spirits Limited, both damages were awarded initially. The HC ruled that both damages could not be awarded. And because the loss of profits could not be satisfactorily proven, reliance damages were awarded. This was also affirmed by the SC. However, the court did not consider that the plaintiff anticipated losses instead of profits (though he still claimed loss of profits). Awarding reliance damages would put the plaintiff in a better position than if the contract was performed. It would have been appropriate if the court had awarded reliance damages after deducting the net losses that the plaintiff would have incurred regardless of whether the contract was breached or not.
The Test
The above chapter demonstrates that there are no structured guidelines which the courts follow in deciding which damages to award. This section provides for the same.
A test recommended by Christopher T Wonnell can be considered. He provided for three essentials to be fulfilled if reliance damages were to be awarded. First, full contract enforcement would be unfair (for the defendant) in view of the defendant’s severe and unreasonable hardship caused by a mistake or change in circumstances (E1). Second, notwithstanding the change in circumstances, the plaintiff could have reasonably been expected to rely on the promise (E2). Third, the defendant has not acted unreasonably in relation to his contractual duties, that is, the breach wasn’t exacerbated as a result of his fault (E3).
One might argue that these are still broad guidelines which different courts might interpret differently. However, some amount of discretion is required to take into account the peculiar facts of individual cases. These broad guidelines strike a fine balance between completely arbitrary principles like “justice and fair play” and strict rules like “no reliance damages are to be awarded”.
Following this test in Kanchan Udyog solves the problem of deciding which damages to award. First, the full enforcement of the contract would have been unfair to the defendant as he would have incurred great losses (E1). Second, because the defendant was an expert in the field, the plaintiff can reasonably be expected to rely on his promise (E2). Third, it was the defendant who took steps to mitigate the plaintiff’s damages. So rather than exacerbating the effects of the breach, he attempted to dampen its effects (E3). Thus, the court rightly awarded reliance damages.
Conclusion – An Exception to the Exception
It can be concluded that due to the peculiarity of cases, no rigid rules can be structured to determine which damages to award. Thus, there may be some exceptional of exceptional cases where, except for the peculiarity of the facts, reliance damages or even both damages are awarded. However, the courts should still endeavour to adhere to certain general guidelines to ensure that the rule of expectancy damages is observed and reliance damages are treated as an exception. Thus, the Wonnell test has been proposed for the Indian scenario to ensure that the principle is followed to the extent possible.
[1] This is also fair because awarding both damages would entail counting the same losses twice and would put the company in a better position than if the contract had been performed. See here for an illustration.
[2] Pollock and Mulla, The Indian Contract Act and Specific Relief Acts (16th edn, LexisNexis 2022) s 73.11.13.
[3] This section is only used to argue that courts award damages based on feasibility. It should not be meant to construe that expectancy damages should be awarded the way it was awarded in these cases.
[4] Pollock and Mulla (n 2) s 73.21.
[5] Pollock and Mulla (n 2) s 73.21.
[6] But because there are no guidelines to be followed, it has been arbitrary and thus, in certain cases though it was possible to award expectancy damages, the courts still end up awarding reliance damages. This necessitates a test.
[7] [1994] 4 SCC 665.