Delay, damages and burden of proof in EPC contracts: Unequal footing for employer and contractor?

India is going through an infrastructural metamorphosis where large scale projects are coming to the fore – be it railways, roads, construction, power etc. Such projects are either being executed through the standard EPC contracts or by following Fidic contracts when international funding is involved.

In any commercial transaction, disputes are a sine qua non. What is important is not how to handle the dispute but rather how to understand the proper and effective way of conducting contract management to ensure that disputes do not arise, and if disputes do arise, then to take an informative and objective decision based on data – whether to settle or litigate.

EPC contracts, more often than not, are faced with the issue of delay. Tenders contain a proposed time schedule, which is followed by a working schedule duly agreed by both the parties at the time of commencement of contract. Working schedules are often not adhered to due to factors commonly encountered in infrastructure projects, such as land acquisition, statutory approvals, environmental, forest clearances, etc.

Delay largely looms over four scenarios:

1. Delay attributable to the contractor: In such cases, the employer may be entitled to compensation, usually in the form of liquidated damages as stipulated under the contract.

 2. Delay attributable to the employer: The contractor may be entitled to claim damages for the actual losses suffered due to such delay i.e. prolongation claims.

 3. Delay attributable to both parties: In such circumstances, compensation may not ordinarily be granted if the delay is concurrent. However, if concurrent delay can be apportioned between parties, then delay may be attributable to one.

4. Delay not attributable to either party: Where delay is caused by events which is beyond the control of either the employer or the contractor.

As such, any entity should have a robust internal framework, where it is able to carry out delay analysis, based on data, as and when a critical timeline is not satisfied. Such delay analysis may be carried during the tenure of the contract or at the time of closure of contract. Prompt and effective delay analysis is crucial to deciding on the merits and scope of claims which one might have against the other. Without effective delay analysis, a breach of a party cannot be established in law. However, in practice, the common error that parties often commit is the mistake of directly attempting to quantify damages, without first establishing the breach.

Generally, in EPC contracts, when there is a breach because of delay, the employer takes recourse to compensation by way of liquidated damages as per the terms of the contract. On the other hand, the contractor takes recourse for compensation arising out of the breach on the basis of actual losses suffered. Though both the employer and contractor are seeking compensation arising out of breach because of delay, the legal remedy for the employer is guided by provision of section 74 of the Indian Contract Act, 1872 (‘Contract Act’) while that of the contractor is guided by provisions of section 73 of the Contract Act.

The legal jurisprudence in respect of Sections 73 and 74 of the Contract Act are diametrically opposite to each other. While Section 73 requires proof of actual loss, Section 74 allows compensation based on genuine pre-estimation. It may seem that the employer and the contractor are placed at a different, unreasonable footing, but that is the reality of the commercial transactions entered upon by parties at their free will.

The Delhi High Court in Jupiter Rubber (P) Ltd. v. Union of India, 2020 SCC OnLine Del 2706 (para 37), has explained the difference between claims under Sections 73 and 74 of the Contract Act. Under Section 73 of the Contract Act, the contractor must strictly prove the actual loss caused by the breach, while in contrast, under Section 74, an employer can recover a pre-agreed amount if it can show the genuine estimate of loss without proving the actual loss.

The contractor, to claim compensation, must establish a breach that has resulted in a loss. Therefore, it becomes critical that the contractor must produce entire chain of documents, such as email correspondences, financial reports, monthly progress report, minutes of meeting, daily progress report, weekly progress report, deployment of manpower and machinery, bank statements, UTR details, proof of payments made to third parties etc. to establish strict proof of actual loss arising out of breach. No doubt the nature of documents will depend on facts of a given case. The contractor must satisfy a strict burden of proof to establish a claim for loss requiring clear and contemporaneous evidence.

The Supreme Court in McDermott International Inc. v. Burn Standard Co. Ltd. (2006) 11 SCC 181, had recognised Hudson, Emden, and Eichleay formulae as legitimate computational tools for quantifying the contractor’s loss of overheads and profitability. However, there has been a shift in recent judicial pronouncements wherein a more stringent evidentiary threshold is now being regarded for quantification to justify the contractor’s loss of overheads and profitability. While the mathematical formulas remain a useful indicator for estimating the loss, the formulae are no longer considered to be an alternative for a substantive proof. The Supreme Court in Unibros v. All India Radio, 2023 SCC Online SC 1366 (Para 16) and Batliboi Environmental Engineers Limited v. Hindustan Petroleum Corporation Limited, (2024) 2 SCC 375 (Para 23) held that contractors must lead independent evidence like records or proof of declined tenders to establish rather than using mathematical formulas. The latest judicial pronouncements show that mathematical formulae are now only a guiding factor and cannot be solely relied upon. The contractor has to show actual evidence that their manpower, machinery, or resources would be deployed elsewhere if the delay had not happened.

Section 74, on the other hand, deals with the situation where the contract itself provide for the breach and the corresponding sum which is payable on such breach. The amount agreed between the employer and the contractor at the time of entering into the contract is treated as a pre-estimate of the loss that that may arise due to the delay caused by the Contractor. Since the pre-estimate of the loss is already given, the employer is not required to show the quantum of actual loss it suffered in the same manner as the Contractor must show in Section 73 of the Contract Act.

In cases such as Dhiraj Lakhamashi Shah v. Madhav Hari Karmarkar [2022 SCC OnLine Bom 1712; 19 & 24] and Devichand Construction v. UoI [2022 SCC OnLine Ker 826; 7 & 10], courts have held that the assessment or quantification of damages at the time of contract formation in itself acts as evidence of a genuine pre-estimate. Moreover, the inclusion of a cap on stipulated liquidated damages sum is additional evidence of a genuine pre-estimate. There is no burden upon the injured party to show genuine pre-estimate or to establish actual loss until and unless the contrary is established by the party disputing the liquidated damages clause. These decisions reaffirm the correct reading of Kailash Nath. Otherwise, the relevance of Section 74 would be rendered meaningless.

Be that as it may, at the cost of repetition, in EPC contracts, delay is inevitable. While both the employer and contractor seek compensation arising out of the delay, the employer and the contractor stand on different footings. A contractor is subject to a strict burden of proof under Section 73 of the Contract Act, and reliance on formulae without supporting document is no longer sufficient for claiming compensation. In contrast, the employer is not required to show the actual proof with the same degree of stringent conditions, provided that the liquidated damages clause shows a genuine pre–estimate as envisaged in Section 74 of the Contract Act.

The distinction between Sections 73 and 74 of the Contract Act shows that there is a need for disciplined approach to contract management in EPC contracts. It is important that focus be laid on timely delay analysis, maintaining proper documentation and clearly drafted contract clauses which are quintessential to prove claims. Ultimately, it is not the occurrence of delay, but the ability to demonstrate its impact with proper documentation, which would determine the outcome.

About the authors: Amit Meharia is the Managing Partner of MCO Legals (Meharia & Company). Shashwat Roy is an Associate at the Firm.

Disclaimer: The opinions expressed in this article are those of the author(s). The opinions presented do not necessarily reflect the views of Bar & Bench.

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