Whether Parties Have Unfettered Right to Exclude or Limit Their Liability for Breach of Contract

This article discusses the right of the parties to exclude or limit their liability for breach of contract as laid down under the Indian Contract Act, 1872. This article also discusses the position in India with landmark case laws.
Estimated Reading Time: 9 minutes

Introduction

The law of damages in India is codified in Sections 73 and 74 of the Indian Contract Act, 1872 (“Contract Act”). Section 73 of the Contract Act provides that a party that suffers breach of contract is entitled to receive from the party that 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 a breach. Section 73 of the Contract Act bars the grant of compensation for remote and indirect loss or damage sustained on account of breach of contract.

Damages

This bifurcation between damages towards losses, which naturally arise in the usual course of things (first limb) and losses that the parties knew, when they made the contract, to be likely to result from a breach of the contract (second limb), appears to be borrowed from the principle laid down in the celebrated English decision of Hadley v. Baxendale.[1] The first limb is popularly referred to as general damages, whilst the second limb is referred to as special damages i.e. additional loss caused by a breach on account of special circumstances, outside the ordinary course of things, which was in the contemplation of the parties.[2]

Parties to a contract can, and usually do, exclude liability for certain types of losses, which may be suffered by each or either party, or limit the amount of their liability pursuant to such loss. Though clauses limiting liability are by and large enforced, this may be subject to considerations such as bargaining power of the parties and public policy.

Position in India 

Whilst there is no express statutory bar in India against contractually excluding or limiting liability for damages, Section 23 of the Contract Act provides that the consideration or object of an agreement is unlawful inter alia if it is of such a nature that, if permitted, it would defeat the provisions of any law or if the court regards it as immoral or opposed to public policy. An agreement whose object or consideration is unlawful is deemed to be void.[3]

In the case of contracts where parties are found to have unequal bargaining power, it is important to be wary of the possibility that courts may refuse to enforce clauses excluding or limiting liability, which are found to be unconscionable. In 1986, the Supreme Court introduced to India the principle that courts will not enforce an unfair or unreasonable contract or an unfair or unreasonable clause in a contract, entered into between parties who are not equal in bargaining power. 

Illustrative instances of such inequality in bargaining power were enumerated, including where it is a result of the great disparity in the economic strength of the contracting parties, where the weaker party is in a position in which he can obtain goods or services or means of livelihood only on the terms imposed by the stronger party or go without them, where a man has no meaningful choice, but to give his assent to a contract or to sign on the dotted line in a prescribed or standard form or to accept a set of rules as part of the contract, however unfair, unreasonable and unconscionable a clause in that contract, form or rules may be.

Contracts that contain terms so unfair and unreasonable that they shock the conscience of the court were held to be void as opposed to public policy. Though the court was dealing with a provision for termination of employment, which was found to be unfair, the aforesaid findings were made in a more general context, and after referring to English judgements dealing with commercial matters, including contracts which contained exclusion or limitation of liability clauses. The court did, however, exclude applicability of this principle to cases where the bargaining power of the parties is equal or almost equal, or where both parties are businessmen, and the contract is a commercial transaction.

Leading case laws

In Bharathi Knitting Company v. DHL Worldwide Express Courier Division of Airfreight Ltd[4], the Supreme Court was dealing with a clause, which limited the liability of a courier company in case of any loss or damage to a shipment, in the terms and conditions printed on a consignment note for shipment of a package. The Supreme Court upheld the decision of the National Consumer Disputes Redressal Commission, which limited the amount awarded to the consignor for deficiency of service, to the amount specified in the limitation of liability clause. The court held that parties who sign documents containing contractual terms are usually bound by such contract and rejected the contention that there was no consensus ad idem between the parties on limitation of liability, in view of the National Commission’s finding of fact that the consignor had signed the consignment note.[5]

Also Read  Insolvency and Bankruptcy (Amendment) Ordinance 2020

In 2010, a Single Judge of the Delhi High Court dealt with the issue of whether contractual clauses can disentitle a person from claiming damages, which he is otherwise entitled to claim under law i.e., whether parties can contract out of Section 73 of the Contract Act. In this case, the court considered a clause in a government construction contract, which barred a claim for compensation by the contractor from being admitted, where works were delayed and time for completion was extended on account of certain specific instances beyond the control of the contractor.

The court was faced with two conflicting decisions of the Supreme Court, which interpreted the same clause. In the first decision, the Supreme Court held that the clause in question would bar the contractor’s entitlement to damages, in addition to extension of time for completion, on account of delay.  In the other, the Supreme Court held that the clause only prevented the department (relevant authority of the employer) from granting damages, but would not prevent an arbitrator from awarding damages, which were otherwise payable by the employer on account of its breach of contract

The Delhi High Court held as follows:

  1. Clauses which bar and disentitle a contractor from claiming damages, which it is entitled to claim by virtue of Sections 55 and 73 of the Contract Act, are void by virtue of Section 23 of the Contract Act.
  2. A law, which is made for individual benefit, can be waived by an individual, but when such law includes a public interest/public policy element, such rights arising from the law cannot be waived because the same becomes a matter of public policy/public interest.
  3. Provisions pertaining to breach of contract (including Sections 55 and 73 of the Contract Act) are the very heart, foundation, and basis of the existence of the Contract Act. According precedence to the sanctity and binding nature of contracts over the entitlement of a party to breach the contract by virtue of clauses with no remedy to the aggrieved party, is a matter of public policy.
  4. To permit a clause that has the object of defeating the contract itself is a matter of grave public interest and defeats the very basis of existence of the contract.
  5. Clauses such as the one in the present case would be void under Section 23 of the Contract Act, as they are violative of public interest and public policy.

It is also important to consider the scope of the clause excluding or limiting liability as well as any exceptions that may be specified therein.

In Simplex Infrastructure v. Siemens Limited[6], the Bombay High Court had occasion to consider a limitation of liability clause in a works contract. The petitioner therein sought certain interim reliefs, including restraint against encashment of a bank guarantee, pending conclusion of arbitral proceedings on various grounds, including the fact that the contract limited the petitioner’s liability to a certain amount. The limitation of liability clause excluded the petitioner’s liability for specific losses, including loss of production, loss of use, loss of profit, loss of information and/or data and any indirect or consequential damage, and capped the petitioner’s liability for all losses, claims or damages arising out of the contract.

However, the clause also provided that it would not apply to any damage or loss or claims caused or arising intentionally or by willful misconduct. The court prima facie found that the respondent therein invoked the bank guarantee inter alia to recover additional expenses that it had to incur on account of numerous defaults by the petitioner, and that such recoveries would not be covered by the limitation of liability clause, which was limited in scope. The court also found that the petitioner’s conduct would fall within the willful misconduct exception, and therefore the petitioner’s contention that its liability was capped under the contract was rejected.[7]

Also Read  Fresh Start Process

The Madras High Court also refused to enforce a clause limiting the liability of a dry cleaner, which was printed on the reverse of the bill handed over to the customer, to 50% of the market price or value of the articles in case of loss. The court found such a term to be opposed to public policy, public interest, and the fundamental principles of the law of contract and held that imposition of such a condition is in flagrant infringement of the law relating to negligence.

In Simplex Concrete Piles (India) Limited v. Union of India[8] , the contract appeared to contain a bar against the contractor’s remedy insofar as it barred the admission of a claim for compensation. The ratio in this decision, that a clause which bars a contractor from claiming damages which it is entitled to under Sections 55 and 73 of the Contract Act will be void by virtue of Section 23 of the Contract Act, is generic and may have far-reaching consequences. However, this decision by the Delhi High Court may be argued as being applicable only in the facts of that case viz. to a contract which bars the contractor’s remedy altogether.[9]

It is, therefore, important to draft and negotiate exclusion or limitation of liability clauses carefully. A commercial contract, which has actually been freely negotiated between the parties pursuant to legal advice, may specifically say so, in order to avoid any argument to the effect that there was any unequal bargaining power. Liability should be excluded for specific types of losses (loss of profit, loss of goodwill, etc.) as opposed to outright exclusion of liability for any loss which may be suffered. Whilst indirect and remote losses cannot be granted under Section 73 of the Contract Act, the second limb of Section 73 does provide for consequential losses, which parties knew to be likely to result from a breach of the contract.

Depending on the circumstances, it is advisable to record specific antecedents, which parties are aware of and to clarify that the parties are not aware of any other circumstances that are relevant to the performance of the contract. If this is followed, then parties will be held liable only for losses which they could have contemplated as recorded in the contract. This reduces exposure to the application of a subjective standard by a court or tribunal, to ascertain what losses the parties may have contemplated when they entered into the contract. It may also be prudent for parties who operate on standard form contracts to ensure that the other party signs the document, recording such standard terms.

Conclusion

The position in India appears to be that so long as parties were aware of the terms of the contract, a clause excluding or limiting liability will be enforced. Where parties have equal bargaining power and are able to participate in the drafting or negotiation of the contract, there cannot be any argument to avoid the applicability of such clauses. In the case of a standard form contract, it would appear that as long as the party that has no option but to accept the terms of such a contract, has notice of the terms and has signed the contract, then a clause excluding or limiting liability will be enforced.

Where a standard form contract has not been signed, the party seeking to oppose enforcement of a clause excluding or limiting liability could argue that such a clause is unreasonable and unfair on account of the unequal bargaining power of the parties.


[1] [1854] EWHC J70

[2] Hadley V. Baxendale, [1854] EWHC J70

[3] Indian Contract Act,1872

[4] [ (1996) 4 SCC 704]

[5] DHL COURIER CASE

[6] (2015) 5 Mah LJ 135

[7] Case Law of Simplex Infrastructure V. Siemens Limited

[8] [(2010) ILR 2 Delhi 699]

[9] ICSI Tax Journal

Most Read Articles

Hey there!

come here often?

Login To Come In