‘Loss of profit’ vs ‘loss of productivity’: A conceptual divide in ‘unliquidated damages’

In dictionary terms, ‘damages’ are ‘financial compensation for loss or injury’ or ‘money that is paid to someone by a person or organisation who has been responsible for causing them some injury or loss’. Thus, the primary element of damages is ‘loss or injury’.

Sections 73 to 75 of the Indian Contract Act, 1872 (Contract Act) provide for payment of damages to the party who has suffered the breach of a contract, as a means of compensation. Section 73 of the Contract Act expressly limits recovery of damages to losses that “naturally” arise from the breach or were in the parties’ contemplation.

Such a provision makes it amply clear that damages are compensatory in nature, with the effective essence being to put the injured party in the position they would have been but for the breach. Thus, the concept of damages as a remedy rests on the idea of compensating the injured party rather than punishing the defaulter.

Unlike Section 74 of the Contract Act, where a penalty or a sum is pre-specified and the party suffering breach has the right to claim that amount for breach of contract, unliquidated damages under Section 73 of Contract Act, are awarded through assessment of loss or injury caused to the party suffering breach of contract.

Only foreseeable and plausibly connected losses are compensable as damages, which must be quantified. It is a common understanding that once there is a breach, and that such a breach is established, it gives an automatic entitlement to damages - no steps are taken to prove and quantify such damages or efforts to mitigate such damages are justified. Proving the existence of a breach is half the war, while the main battle remains in proving/justifying the quantification and efforts of mitigation, failing which a party will end up getting only nominal damages. [Kanchan Udyog Limited vs. United Spirits-(2017)8SCC237 & Ahluwalia Contract India Ltd. v. UOI - (2017) SCC Online Del 11042]

The quantum of damages, being in nature of compensation and restorative in nature, are oftentimes difficult to ascertain in monetary terms owing to the reason that the loss sustained is difficult to prove with certainty of a mathematical demonstration or is to some extent contingent and incapable of precise measurement.

In Gambhirmull Mahabirprasad vs. The Indian Bank Ltd. [AIR 1963 Cal 163], the Calcutta High Court affirmed that the breach’s proximate cause governs recoverable loss. In the facts of the case, the Court allowed the claim for damages on the ground that the loss was “a direct consequence of the neglect” to act. However, following common law principles, the Court simultaneously disallowed speculative profits from future resale. This underscores that damages cover the actual loss flowing from the breach, not remote losses.

The difficulty of measuring the amount of damages has been addressed in depth in McDermott International Inc. vs. Burn Standard Co. Ltd. [(2006) 11 SCC 181], where the Supreme Court laid down pertinent formulae to be applied with respect to damages when the exact amount cannot be determined. However, pertinently, in Unibros vs. All India Radio (supra) the Court also cautioned that formulas (like Hudson’s) are only tools to measure losses when evidence exists, not substitutes for proof. However, caution may be taken that if a contract does not contemplate usage of a formulae, then such application by Arbitral Tribunal will be questioned at a later stage on the ground that such Tribunal had changed the terms and conditions of the original contract by importing fresh term into the contract.

Quantification of damages through a “rough guesswork” or a “rough and ready method” at places where it was difficult to quantify damages has been also been held permissible [Cobra Instalaciones Y Servicios SA & Shyam Indus Power Solution (P) Ltd. vs. Haryana Vidyut Prasaran Nigam Ltd. (2024 SCC OnLine Del 8133)].

“Loss of profit” and “loss of productivity” are often conflated in concept, but they are indeed distinct, albeit both arise when there is a delay.

In common parlance, loss of profit is the expectational income or profit anticipated to be earned upon completion of performance of a contract. In such a context, it arises when a breach prevents a party from realizing profit from the contract. Loss of productivity/ opportunity, on the other hand, is quantified as an operational loss rather than an expectational loss. This quintessentially reflects a claim for loss of opportunity due to a breach, i.e., had there been no delay in performance, i.e., no breach, then the party could have participated in another work. Loss of Productivity is in fact opportunity cost in economic terms.

Both loss of profit and loss of profitability/ opportunity are branches of the same tree of ‘damages’ and the branches are primarily formed in the nature of circumstances in which the loss was incurred.

For example, if the contractor delays the construction of a power plant and in making it operational, the owner could have generated revenue had there not been the delay. In such event, the owner may claim for loss of profit for no power generation between the scheduled and actual completion date or diminished rate of power generation between the period. In the similar pretext, while construction of the said power plant, if the owner caused project delays may be in terms of land, drawing or the like, the contractor may incur various overhead costs for the extended period of the project or have lost the opportunity to utilise such labour at a different or new project which is in nature of loss of productivity/ opportunity to earn for the contractor.

While it is commonly seen that many contracts tend to expressly bar either or both parties from claiming damages, the issue that opens up for discussion is the right of a party to a legal remedy and whether such clauses amount to restraint thereof.

Such restrictive clauses are explicitly void and invalid. The right to claim compensation in the breach of contractual obligation is an integral part of statutory contract law and cannot be taken away in any circumstance. [Simplex Concrete Piles (India) Ltd. vs. Union of India [2010 SCC OnLine Del 5114] and MBL Infrastructures vs. DMRC Ltd. [2023 SCC OnLine Del 8044]].

To manage the issues arising out of a claim for damages, contracts must spell out the manner of treatment of losses to limit uncertainty, specify how losses would be recoverable and expressly exclude indirect losses; supported by contemporaneous data, i.e., determining the requirement of level of proof.

Levy of damages is indispensable when it comes to breach of a contract. However, liability of such damages can be limited by way of specific bar in contract but cannot be excluded in totality as same will be contrary to provisions of Contract Act.

As in the case of any other form of actual damages, loss of profit or loss of productivity/ opportunity are both consequential losses, recoverable only if foreseeable and proved – it must satisfy the rigours of Section 73 of the Contract Act i.e., breach, efforts of mitigation, loss & quantification, thereafter.

Notably, while any ‘formula’ or ‘rough guess work’ may be applied, it ought to be backed by a proof of loss supported with corroborating evidence for claiming entitlement to recovery of such losses. To succeed on a profit-loss or loss of productivity/opportunity claim, the party must show (i) delay in completion attributable to the other party in the contract; (ii) absence of party’s own fault; and crucially (iii) contemporaneous evidence of the lost opportunities or possible profit (like potential tenders where it could qualify within the relevant time period or delay in other work due to engagement of labour here) or loss of profit i.e., increase in cost (iv) efforts of mitigation of such loss.

Although both loss of profit or loss of productivity/ opportunity arise out of prolongation of the contract, there lies a thin divide between the concepts, the confluence of which often leads to the possibility of double claim. Applicability of loss of profit vs loss of productivity may lie in the type of categorisation of the loss and the party applying.

Practically, there always lies a difficulty in establishing either loss of profit or loss of productivity/opportunity. It is insufficient to just establish a breach and expect damages. To recover lost profits or loss of expected profits, the party must show what profit was truly lost. A mere assertion, speculation or conjecture of a certain percentage loss of profit or possible productivity loss is insufficient without backup or being tied directly to the breach. [Bharat Coking Coal Ltd. vs. LK Ahuja - (2004) 5 SCC 109]. In doing so, the possibility of an overlap between loss of profit and loss of productivity/ opportunity often clouds such claims, resulting in double recovery, leading to unjust enrichment - for example, a party being restored to original position upon the rescission of the contract and simultaneously claiming damages in either form of loss of profit from the project or opportunity cost or claim for overheads/ prolongation cost while also claiming loss of profit, since overhead already includes profit margin component.

About the authors: Amit Meharia is the Managing Partner of MCO Legals (Meharia & Company). Paramita Banerjee is an Associate Partner 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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