“Loss Of Profit” And “Loss Of Profitability” – The Standard Of Proof And Need For Distinction
Introduction
Loss of profit and loss of profitability are two distinct concepts. The Hon’ble Delhi High Court in Ajay Kalra v. DDA1, while observing the frequent conflation of these concepts noted that a claim for loss of profit – or lost profits – is a claim for loss incurred due to the non-completion/ prevention from completing of the contract on account of breach committed by the respondent. While a claim for loss of profitability – or opportunity costs – is a claim for the loss incurred due to the delay in the project attributable to the respondent, due to which the claimant has lost the opportunity to earn profits through other projects after the contractual period. Since the nature of these two types of claims is different, so is the requirement of the standard of proof required to establish these claims before an arbitral tribunal. Despite these differences, the Indian courts have synonymously used the terms “loss of profit” and “loss of profitability” thereby conflating these distinct concepts and leading to confusion regarding the standard of proof required to establish them. This article shall summarize the judicial pronouncements laying down the standard of proof required to prove claims of “loss of profit” and “loss of profitability” which will reinforce the need to distinguish these different types of claims.
The Standard of Proof for Claims Relating to Loss of Profit
It is settled law that, to prove a claim for loss of profit due to illegal termination of the contract, once it is held that the employer was guilty of breach of a partly executed contract, the contractor would be entitled to damages by way of loss of profit. In holding so, and while interpreting Section 73 of the Indian Contract Act, 1872, the Hon’ble Supreme Court has observed in A.T. Brij Paul Singh and Ors. v. State of Gujarat,2 that a contractor who submits a tender for a works contract reasonably expects to make a profit and if the employer is found guilty of breaching the contract, the contractor shall be entitled to compensation in the form of damages. The court went on to hold that, for estimating the amount of damages, a broad evaluation by the court would suffice instead of going into minute details. It is to be noted that in this case the Hon’ble Supreme Court set aside the impugned judgment of the Gujarat High Court on the ground that in respect of disputes arising out of a similar contract, the High Court had upheld the claim (granted by the trail court) of damages for loss of profit on the remaining work at 15% of the price of the work, without requiring any evidence therefor. Thus, the requirement by the High Court of adducing evidence for proving loss of profit in that case, and rejection of the claim on the ground of failure to adduce such evidence, was erroneous. In effect, the Hon’ble Supreme Court laid down the law that the contractor is not required to prove losses in order to succeed in a claim for loss of profit when it has been held that the contractor is guilty of breaching the contract/prematurely terminating it.
Further, the Hon’ble Supreme Court, in Dwaraka Das v. State of Madhya Pradesh and Ors.3, relied upon its decision in A.T. Brij Paul Singh and Ors.4 and Mohd. Salamatullah and Ors. v. Government of Andhra Pradesh5 to hold that once it is held that a party has breached a contract and that breach is contrary to the terms agreed, the erring party would be legally bound to compensate the other party, without the latter being required to adduce evidence to prove loss.
Continuing this jurisprudence, the Hon’ble Supreme Court has held in MSK Projects India (JV) Limited v. State of Rajasthan & Another6 that a claim of expected profits is legally admissible on proof of the breach of contract by the erring party, as a reasonable expectation of profit is implicit in a works contract and its loss has to be compensated by way of damages once the breach on part of the other party is established and no other proof of loss shall be required.
The Standard of Proof for Claims Relating to Loss of Profitability
Contrary to the standard for proving Loss of Profit, a claim of loss of profitability due to delays must be substantiated with evidence to prove the actual loss which was likely to have been suffered. The claimant must demonstrate that the delay was caused solely by the employer and must provide documented proof of the loss suffered.
This principle was reinforced in the case of National Highways Authority of India v. Hindustan Construction Co. Ltd.7, where the Hon’ble Delhi High Court emphasized that claims for loss of earning capacity and profit essentially represent ‘opportunity cost’. To succeed in such claims, the claimant must satisfy two critical criteria: proximity and measure. The claimant must demonstrate that it had a viable alternative venture where resources could have been deployed, and that this alternative would have generated profits.
The ruling of the Hon’ble Supreme Court in Bharat Coking Coal Ltd. v. L.K. Ahuja8 further reinforced this principle. The Court upheld an arbitrator’s decision to reject a claim for loss of profit due to delay in completing work. The Court noted that the claimant must establish that, had they received the contractually due amounts, they could have utilized these funds in another profitable venture. Without such proof, claims for loss of profitability could not be sustained. Although the term 'loss of profits' was used, the essence of the claim was ‘loss of profitability’, which requires concrete proof of actual loss due to delay.
In McDermott International Ltd. v. Burn Standard Co. Ltd.9, the Hon’ble Supreme Court examined three widely accepted formulae for calculating loss of profitability: Hudson, Emden, and Eichleay. The Court clarified that different formulas may be applied depending on the specific circumstances of each case, and that the choice of formula would be the arbitrator’s discretion, reflecting the need for flexibility in handling such claims. Nonetheless, the Court reiterated the fundamental requirement that any claim for damages must be supported by thorough documentation and evidence.
Recently, the Hon’ble Apex Court in Batliboi Environmental Engineers Ltd. v. Hindustan Petroleum Corporation Ltd. and Anr.10 while holding that the contractor needs to lead evidence to justify claim of loss of profitability, also noted the nature of evidence which needs to be led. It held in this respect that the contractor “has to prove that there was other work available that he would have secured if not for the delay”. This may be proved by producing invitations to tender which were declined due to insufficient capacity to undertake other work or from the books of accounts to demonstrate a drop in turnover and establish that this result is from the particular delay rather than from extraneous causes. The Court, while upholding the setting aside of the award wherein the arbitrator had awarded 10% of the contract value as loss of profitability without any evidence being led, held that the computation of damages should not be absurd, disingenuous and “result in a windfall and bounty for one party at the expense of the other” but should be commensurate with the loss sustained. It validated the use of Hudson, Emden and Eichleay formulae for computing damages albeit on the condition that material should be furnished to justify and assure the assumptions underlying such formulae.
Another seminal judgment in this regard in the recent decision of the Hon’ble Supreme Court in Unibros v. All India Radio11 where, in a fact situation of work being delayed by 42 months resulting in delay claims, the court held that in making a claim for loss of profitability, it is essential for the contractor to establish that had the contract been executed promptly, it could have secured supplementary profits utilizing its existing resources elsewhere. It listed down four criteria which would need to be satisfied by the contractor: (a) that there was a delay in the completion of the contract, (b) that such delay was not attributable to the claimant, (c) that the Claimant was an established contractor and (d) credible evidence to substantiate the claim for loss of profitability. Since the fourth condition was not satisfied in that case, the court confirmed the setting aside of the award on the ground that no evidence was tendered to support the claim for loss of profitability.
Overall, these rulings establish that while the use of specific formulas for calculating damages is flexible, the claimant must always substantiate its claim with clear and credible evidence of the actual loss suffered. This evidentiary burden ensures that compensation claims for loss of profitability are not only justified but also accurately measured.
Conclusion
It is clear from the analysis above that claims relating to “loss of profit” and “loss of profitability” are fundamentally different. The cause of action for preferring these claims is different in as much as loss of profit claims arise from a factual scenario wherein a partly executed contract has been prematurely and illegally terminated. Whereas claims relating to loss of profitability are essentially delay related claims seeking compensation in the form of opportunity costs. As can be ascertained from the cases discussed above, the courts have recognized this difference and laid down differing standards of proof for establishing these claims.
Disclaimer: This article was first published in the S&A Law Offices - 'Indian Legal Impetus' newsletter in August 2024.