A failure to perform a primary obligation under a contract is a breach, which gives rise to a secondary obligation on the part of the contract-breaker to pay monetary compensation to the other party for the loss sustained in consequence of the breach. Under English law, this secondary obligation arises at common law [See Photo Production Ltd. v. Securicor Transport Ltd].

In India, Section 73 and Section 74 of the Indian Contract Act, 1872 are statutory embodiments of that secondary obligation.

More than a century ago, a Division Bench of the Madras High Court observed in Ponnuswami Naicken v. Nadimuthu Chetty as follows:

“It was then contended that the contract to pay a heavy rate of interest is by itself a stipulation by way of ‘penalty’ and can be relieved against under Sect. 74 of the Contract Act. Though the distinction between ‘penalty’ and ‘liquidated damages’ was abolished by the Contract Act, and however wide the powers of a Court may be to relieve against all stipulations which it considers penal irrespective of the language of the contract, it is quite clear that there cannot be a stipulation by way of penalty unless there is another antecedent promise; for the section says, that for the sum named to be treated as a penalty, it must be an amount to be paid in case of breach of the contract i.e., breach of an antecedent promise; a promise for consideration is a contract...

...The loan made by the lender is the consideration for the promise of the borrower to repay the amount of loan with the addition of another sum as interest for allowing the debtor to have the use, of the money (i.e.,) compensation for the money lent; but the interest is not compensation for the breach of the promise; for the promise is to pay the principal and interest..."

Recently, the Supreme Court of India discussed the distinction between primary obligations and secondary obligations in BPL Limited v. Morgan Securities and Credits Private Limited.

Under English law, parties are generally free to agree (a) whether a failure of performance would (or would not) constitute a breach or (b) whether the secondary obligation for a breach would be limited or excluded. Ordinarily, the contract is as much a repository of primary obligations as it is of secondary obligations, subject to certain exceptions and statutory restrictions. The validity of such an agreement would depend on whether the agreement retains the legal characteristics of a contract.

Under Indian law, the validity of such an agreement is governed by specific provisions of the Contract Act, inter alia, Section 23 to Section 28 and Section 74.

An exclusion clause is generally one which excludes or modifies either a primary or a secondary obligation. When a clause contractually limits the secondary obligation - the nature or quantum of liability for a breach of contract - it is only a “limitation of liability” clause. On the other hand, when a clause contractually excludes liability for certain specified breaches, it is an “exclusion of liability” clause.

Sometimes, a clause absolutely excludes the secondary obligation of a contract-breaker to pay any compensation in all conceivable situations of breach. For ease of reference, one can call it an “exclusion of entire liability” clause. Often, such a wide “exclusion of liability” clause compromises the essential legal characteristics of a contract at common law and would also offend Section 28 of the Contract Act.

A limitation of liability clause does something different. It does not exclude entirely the secondary obligation to pay compensation, but limits that compensation by agreement between the parties.

Similarly, an exclusion of liability clause does not exclude entirely the secondary obligation to pay compensation, but excludes liability for certain specified breaches of contract.

While the enforceability of an exclusion of entire liability clause might pose significant challenges, a limitation of liability clause and an exclusion of liability clause would ordinarily be valid under Indian law, as it is in English law.

For example, in Bharathi Knitting Company v. DHL Worldwide Express Courier, the Supreme Court held that if the parties have contracted to limit or cap their liabilities, normally they are bound by the contract and it would be for the party claiming otherwise to establish an exception to this principle. This was a case in which the parties had simply limited their liability to pay monetary compensation by an agreed cap on quantum.

Similarly, in ONGC v. Wig Brothers, while relying on Ramnath International Construction (P) Ltd v. Union of India, held that the clause in that contract was a clear bar to any claim for compensation for delays, in respect of which extensions had been sought and obtained by the contractor from the employer. Therefore, it set aside the award of the arbitrator, to the extent it was contrary to such specific exclusion. The parties had contractually agreed to an exclusion of liability clause that excluded payment of monetary compensation in respect of a specific breach of the employer (delay). Alternatively, a stipulation of this nature could be viewed as a limitation of liability clause by which the parties had limited the liability of the employer for causing delay to only granting an extension instead of monetary compensation.

In both cases, the secondary obligation of a contract-breaker to pay compensation to the aggrieved party for breach of contract was not entirely excluded.

In Syed Israr Masood v. State of Madhya Pradesh, the Supreme Court recognised that a stipulation excluding the liability to pay compensation in respect of a specified breach would be valid. However, it would not prevent the aggrieved party from repudiating the contract, if it constituted a fundamental breach of the contract.

According to me, the proposition that the Contract Act does not ordinarily invalidate a limitation of liability clause agreed between the parties is best evidenced by Section 74 of the Contract Act. This section provides that in certain situations, a genuine pre-estimate of damages fixed by the parties could be awarded as the compensation payable by the contract breaker to the aggrieved party. [See Fateh Chand v. Balkishan Dass and Kailash Nath Associates v. DDA]

The significant challenges arising in the context of validity of exclusion of entire liability clause under Indian law ought not to be conflated with the validity of a limitation of liability clause or an exclusion of liability clause.

In Simplex Concrete Piles (India) Ltd. v. Union of India, a single judge of Delhi High Court held that a contractual stipulation that barred a contractor from claiming damages for delay, even where the delay is caused by the employer, is void under Section 23 of the Contract Act.

The stipulation that was held to be void in this case was not an “exclusion of entire liability” clause but a stipulation that allowed only for extension of time instead of monetary compensation, like the one in the Ram Nath International case. The decision of the Delhi High Court in the Simplex case does not engage with this distinction at all.

Further, the decision of the Supreme Court in Asian Techs Limited v. Union of India, which was relied upon in the Simplex case, was based on waiver by conduct of the aggrieved party and did not analyse the validity of a stipulation of this nature, as a matter of doctrine.

In C&C Constructions Ltd v. IRCON International Ltd, the Supreme Court refused to examine the argument regarding the validity of a similarly worded stipulation which was being challenged based upon the Simplex case, because the argument had been raised for the first time before the Supreme Court. However, the Supreme Court upheld the stipulation on a different doctrinal basis of estoppel by conduct because the contractor had acted upon it and sought extension of time on three occasions.

While the decisions of the Supreme Court mentioned above have upheld the validity of limitation of liability and exclusion of liability clauses in several fact scenarios, the contours of the doctrinal distinction between a limitation of liability clause, an exclusion of liability, and an exclusion of entire liability clause have not yet been explored by the Supreme Court. Further, the scenarios in which the enforceability of even an exclusion of liability clause might pose challenges under Indian law are yet to be explored by the Supreme Court.

As a result, sometimes, different High Courts (or arbitral tribunals) incorrectly apply the grounds that might be potentially justified for invalidating an exclusion of entire liability clause, to a limitation of liability clause or an exclusion of liability clause as well. The Simplex case is one such example.

However, it is clear from the decisions of the Supreme Court discussed above that a stipulation that substitutes the secondary obligation of the contract-breaker to pay compensation with an alternative performance - for example, by granting an extension of time instead of paying compensation for having caused delay - is valid under Indian law.

It is hoped that in an appropriate case, the Supreme Court would explore these issues and clarify the theoretical basis of limitation of liability and exclusion of liability clauses under Indian law.

Gaurav Pachnanda is a Senior Advocate based in New Delhi.