Enforceability of No Damage Clauses in the Contract

Section 73 of the Indian Contract Act, 1872 [“the Contract Act”] embodies the settled principle of law that a party is entitled to receive compensation from the party that has breached the contract on the account of which the innocent party has suffered losses. This position of law is a driving force for the parties to enter into contractual agreements. However, in some contracts, especially construction contracts, the employer tailor the contract in such a manner which disentitle the contractor from making any claims for compensation on account of delays in completion of work occasioned by the employer or for any reason whatsoever. Clauses of such nature are called prohibitory or no damage clauses which leaves the contractor to bear the cost of entire brunt of delay in completion of works which are not even attributable to him. An example of a prohibitory clause is as follows-

“No claim whatsoever for idle labour, additional establishments, cost of hire and labour charges of tools and plants etc. would be entertained under any circumstances. The contractor should consider the above factor while quoting his rate.”

Section 55 of the Contract Act governs the delay in performance of contract and liability ensuing thereto. The first paragraph of Section 55 caters to a scenario wherein time is made the essence of contract and the party fails to perform the contract within the specified time, making the contract voidable at the option of the promisee. The second and third paragraph of Section 55 recognizes the law of compensation stemming from Section 73 of the Contract Act. The second paragraph of Section 55 provides that if it was not the intention of the parties that time should be of the essence of the contract, the contract does not become voidable by failure to do such thing at or before the specified time; but the promisee is entitled to compensation from the promisor for any loss occasioned to him by such failure. The third paragraph of Section 55 is an extension of paragraph 1 and stipulates that if the promisee does not terminate the contract on the account of failure of the promisor to fulfill the contract within the stipulated timeline and, on contrary, accepts the performance of the contract at a delayed time, then the same does not entitle the promisee to claim compensation for any loss occasioned by the non-performance of the promise at the time agreed, unless, at the time of such acceptance, the promissee gives notice to the promisor of his intention to do so.

Section 23 of the Contract Act inter alia stipulates that an agreement which is against public policy is unlawful. Therefore, when the provisions of the Contract Act heavily lean towards the grant of compensation, can contractual clauses disentitle a person from claiming damages which a person is otherwise entitled to under law? Putting it differently, can a person who is guilty of breach of contract and is consequentially liable in law to pay damages under Section 73 of the Contract Act or other charges under Section 55 of the Contract Act, can prevent the aggrieved party from claiming the same by contractually so providing? This dilemma only increases when the dispute is referred to an arbitrator who finds himself bound by the contractual clauses, being a creature of the same.

The jurisprudence on the issue emanates from a judgment rendered by the Supreme Court in the General Manger Northern Railways & Anr. vs Sarvesh Chopra¹ [“Sarvesh Chopra”] wherein the Supreme Court found itself to be in agreement with the position of law laid down by the Andhra Pradesh High Court in A.P. Vs. M/s. Associated Engineering Enterprises, Hyderabad², wherein the court held that when a clause provides that neither party to the contract shall claim compensation “on account of delay or hindrances of work from any cause whatsoever”, an award given by an arbitrator ignoring such express terms of the contract was bad. However, the Supreme Court carved out various exceptions wherein a claim for compensation would still lie, even if the contractor has agreed by way of Contract that he would not be making any claim for compensation, in the following circumstances-

If the contractor repudiates the contract exercising his right to do so under Section 55 of the Contract Act.
The employer gives an extension of time either by entering into supplemental agreement or by making it clear that escalation of rates or compensation for delay would be permissible.
If the contractor makes it clear that escalation of rates or compensation for delay shall have to be made by the employer and the employer accepts performance by the contract in spite of delay and such notice by the contractor putting the employer on terms.

Therefore, the Supreme Court held that it is only in the aforementioned exceptional cases the contractor can seek compensation if the contractual terms disentitle him from seeking compensation in view of prohibitory clauses.

In K.N. Sathyapalan vs State of Kerala³, the Supreme Court was posed with a similar issue. Clauses of the contract inter alia stipulated that if the work is delayed due to reasons attributable to the government, the contractor would be granted extension of time on the condition that such extension of time would be subject to execution of a Supplemental Agreement to the effect that the contractor would not be eligible for any enhanced rate of the work done during the extended period. The dispute was referred to an arbitrator who allowed the claim of the contractor for compensation after giving a finding that the delay in completion was attributable to the Government due to which the contractor had suffered various losses. The Award of the Arbitrator was challenged before the High Court which held that the Arbitrator had exceeded its jurisdiction in granting claim of compensation despite there being a prohibitory clause in the Contract. When the matter came up before Supreme Court, the court set aside the decision of the High Court and restored the Award rendered by the Arbitrator and held that the parties would be bound by the terms agreed upon in the contract, but in the event one of the parties to the contract is unable to fulfill its obligations under the contract which has a direct bearing on the work to be executed by the other party, the Arbitrator is vested with the authority to compensate the second party of the extra costs incurred by him as a result of the failure of the first party to live up to its obligations. However, the aforesaid judgment is sub silentio upon the ratio laid down by the Supreme Court in Sarvesh Chopra (supra).

The judgment of Supreme Court in K.N. Sathyapalan (supra) was quoted with approval in a judgment rendered by a three-judge bench of the Supreme court in Assam Electricity Board and Ors. vs Buildworth⁴ emphasizing upon the principle laid down in K.N. Sathyapalan (supra). Notably, the Supreme Court, in the matter of Buildworth (supra) also read down the law laid down in Sarvesh Chopra (supra) by stating that “if a party to a contract does not rescind it by invoking Sections 55 and 56 of the Contract Act, 1872 and accepts the belated performance of reciprocal obligations, the other party would be entitled to make a claim for damages.”

The Supreme Court in Ramnath International Construction Pvt. Ltd. vs Union of India⁵ was concerned with the following prohibitory clause-

“11 (C) No Claim in respect of compensation or otherwise, howsoever arising, as a result of extension granted under Conditions (A) and (B) above shall be admitted”

While interpreting the aforesaid clause, the Supreme Court upheld its validity and stated that even if the employer/Union of India is at fault, the contractor would be disentitled to raise any claim for compensation in view of clause 11C of the Contract. However, surprisingly, the Supreme Court, in Asian Techs Ltd. vs Union of India⁶ while interpreting the same clause as reproduced hereinabove, took a contrary view and held that the aforesaid clause only prevents the department from granting damages, but it does not prevent the Arbitrator from awarding damages which are otherwise payable by the employer on account of breach of its contract.

The aforementioned decisions of the Supreme Court in Ramnath International and Asian Techs (supra), at stark variance with each other, were a cause for concern before a Division Bench of the Delhi High Court in Simplex Concrete Piles (India) Ltd vs Union of India⁷ , as to which decision to follow, while adjudicating a dispute arising out of an agreement containing prohibitory clauses. Notably, both the aforementioned decisions have been rendered by a strength of co-equal benches of the Supreme Court. The Delhi High Court, after referring to a conspectus of cases, found force in the principle of law that when there is a conflict between two decisions of equal benches, which cannot be reconciled, the courts must follow the judgment which appears to them to state the law accurately and elaborately. On the issue of disentitlement to damages to the contractor (because of ratio laid down in Ramnath International) or entitlement to damages (on account of ratio laid down in Asian Techs case), the Delhi High Court, in no uncertain terms held as follows-

i) Clauses which bar and disentitle a contractor to claim its just claims/damages/monetary entitlement, and which a contractor is entitled to by virtue of provisions of Section 73 and 55 of the Contract Act, are void by virtue of Section 23 of the Contract Act, being against Public Policy. The Delhi High Court defined “public policy” as follows, in the context of Section 23 of the Contract Act

“Public policy is a changing concept, it is not static but dynamic; it changes from time to time and the Courts have been empowered while interpreting this doctrine to resort to, judicial legislation euphemistically called interpretation, to further the public interest, equity, good conscience and justice.
A law which is made for individual benefit can be waived by an individual/private person, however, 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.”

ii) The rights created by Section 55 and 73 of the Contract Act cannot be contractually waived, as it is a matter of public policy that the sanctity of the contracts and bindingeness thereof would be given precedence over the entitltment to breach the same by virtue of contractual clauses with no remedy to the aggrieved party.

iii) To permit a contractual clause having the object to defeat the very contract itself, is a matter of grave public interest and if such a clause is allowed to stand, then, the same will defeat the very basis of existence of the Contract Act.

The Court however, expressed its helplessness in deciding as to which of the judgments of the Supreme Court viz. Ramnath International or Asian Techs (supra) should hold the field of law and stated that the observations of the court are limited to the facts and circumstances of the case at hand. The aforementioned decision of the Delhi High Court in Simplex Concrete Piles (supra) was quoted with approval in a recent judgment rendered by Delhi High Court in MBL Infrastructure Ltd. vs Delhi Metro Rail Corporation⁸.

A Division Bench of Calcutta High Court in State of West Bengal vs Pam Development Pvt. Ltd.⁹ was concerned with the power of the court to scrutinize an arbitral award with respect to claims awarded by the arbitrator despite the same being covered by prohibitory clauses under the agreement and whether the decision of the Supreme Court in Sarvesh Chopra (supra) qua the three exceptions, can be called on to assess the award under Section 34 of the Arbitration and Conciliation Act, 1996. Therefore, the Court had the occasion to read down the dictum laid down in Sarvesh Chopra and in doing so, observed that the decision of the Supreme Court in Sarvesh Chopra was given under the Section 20 of the Arbitration and Conciliation Act, 1940. The old Act was court centric which equipped the court with enormous powers to dissect the facts of the case, at the very outset, and only refer merits of the dispute to arbitration which is no longer the case under the 1996 Act under which the power of the court to adjudicate the dispute at reference stage and even at the stage of challenge, is heavily curtailed. Therefore, the court held that-

“Thus, the dictum at paragraph 15 of the report in Sarvesh Chopra has to be read in the context of the duty of the court under Section 20 of the 1940 Act. The court interpreted the facts, as it was obliged to do under the previous regime, and found that several of the disputes enumerated by the petitioner in the proceedings under Section 20 of the 1940 Act were not capable of being referred to arbitration. But the more important facet of the dictum in Sarvesh Chopra is that a no-damage clause is by no means the end of the matter in respect of a claim made under a prohibited head…”

The Court further observed that the law laid down in Sarvesh Chopra need not be strictly construed since a judgment is not read as a statute or an edict on stone and the essence of the judgment in Sarvesh Chopra is that even a prohibitory clause and its application is open to interpretation which is the exclusive domain of the arbitrator. Therefore, after going through a conspectus of case laws, the Court held that once a party accepts the belated performance of a reciprocal obligation, the other would be entitled to make a claim for damages and if the former party is found to be in breach, the prohibitory or no-damage clauses in the contract for its benefit may be legitimately interpreted by the arbitrator to lose their applicability during the extended period of the work. If the arbitrator, on his appreciation of the circumstances leading to the extension of the period of completion of the work, finds the employer to be in breach which results in the work not being completed on time, the arbitrator’s finding that the prohibitory clauses would not apply to the extended period would not be outlandish or per se perverse. However, even on such finding if the quantum of the amount awarded shocks the conscience of the court, the court can interfere with the quantum.

The aforementioned decision, is however sub silentio upon the applicability of law laid down by the Supreme Court in Ramnath International (supra) wherein the Supreme Court strictly construed the no damage clause and held that the contractor would be disentitled to raise any claim for compensation in view of prohibitory clause in the contract.

In National Thermal Power Corporation Ltd. vs V.U. Seemon and Anr.¹⁰, the clause in the contract inter alia stipulated that in the event of delay in handing over of the site by the employer, the contractor would only be entitled to extension of time and no extra claim would be entertained on this account. The work prolonged beyond the stipulated time envisaged in the contract. The Delhi High Court observed that when the delay in execution of the project is found to be attributable to the employer by the Ld. arbitrator in his award then “there was no bar on the claimant to claim compensation for losses/damages occasioned by such delay on the part of NTPC”.

In North Eastern Electric Power Corporation Ltd. vs Patel Engineering¹¹, the contractor encountered site conditions which were at stark variance from what was indicated in the bid documents. As a consequence of which the contractor incurred additional cost for which it submitted its claims to the Arbitrator. The employer vehemently relied upon disclaimer clauses in the Agreement which inter alia stipulated that the bidder shall be entirely responsible for inspecting and examining the site and no claim would be entertained by the contractor on the ground of lack of information provided. The Meghalaya High Court inter alia observed that in commercial contracts the disclaimer clauses must not be read to a point of absurdity and the prohibition clauses in the agreement must be clear and unambiguous-

“102…In commercial contract, the disclaimers must not be read to a point of absurdity..

105…A prohibition has to be clear, categorical and unambiguous since a prohibition on such amount would be contrary to the natural right of a contractor to claim damages for breach upon putting the employer on notice and proceeding with the work notwithstanding the breach.”

In Governor of Tamil Nadu vs GMR Outer Ring Road Pvt. Ltd¹², the employer relied upon the disclaimer clauses in the contract which inter alia enjoined the contractor to make itself aquqainted with the site conditions and scope of work, etc. The clauses further categorically stipulated that the employer shall not be liable for any inadequacy, mistake or error with regard to information provided in the documents or otherwise determined by the contractor on its own examination. The Meghalaya High Court, however, held that the aforesaid clause does not bar a claim for compensation.

“36…A perusal of the above clauses makes it very clear that the above clauses deal only with regard to the representation of the accuracy and completeness of the information. Therefore, only for inaccuracy and incompleteness in providing information Concessionaire confirms that it shall have no claim whatsoever against GOTN. These clauses cannot be used as a total bar for claiming any monetary bar on account of breach of the contract of the parties. Therefore, it cannot be said that on the basis of the disclaimer clause, which is meant for different aspect, the parties are barred from claiming any compensation for material breach, certainly the same is not enforceable under Section 28 of the Indian Contract Act. Similarly, claiming damages for material breach is statutory right as per Section 55 and 73 of the Indian Contract Act. The same cannot be taken away lightly. Therefore, the contention that merely because GOTN provided information put in all aspects, it cannot be a ground to deny the compensation when the alignment including the levels were not properly given and the representation found to be wrong at a later point of time. Therefore, claim for losses suffered is maintainable.“

Conclusion

No damage or Prohibitory clauses disentitling the contractor from claiming compensation militates against Section 73 of the Contract Act. Clauses of such nature have been construed to be against the Public policy of India by the Delhi High Court in Simplex Concrete Piles (supra) and the Supreme Court also, as observed herein above, has read down the law laid down in Sarvesh Chopra. The recent trends also show that courts now lean towards upholding the claims of compensation despite there being a prohibitory clause in the contract by giving it a purposive interpretation leaning towards the statuary right to claim damages as a consequence of breach under Sections 55 and 73 of the Contract Act. However, there do not seem to be uniformity in the decisions of the Supreme Court. The contrary stances of the Supreme Court Ramnath International and Asian Techs (supra) has thrown the applicability of no damage clauses into doubt and a resounding judgment is required from the apex court after taking into account the aforementioned decisions.

By Daksh Pandit