RISKS OF CONTRACTUAL LIABILITIES

Prof. Anil B. Suraj, IIM Bangalore

The Indian Legal System is inherently guided by the principles of ‘common law’. It is

founded on the basis that the law or legislation, or a contract, are important sources of

interpretation, but not the only sources to determine the eventual legal remedies. In relative

terms, Courts in India do look beyond the strict confines of provisions of a law and contract and

resort to factual or contextual interpretation on a regular basis. This explains the repeated

emphasis on ‘equitable’ remedies, in addition to only ‘legal’ or ‘contractual’ remedies. Therefore,

for purposes of resolving disputes and imposing liabilities, the facts of a particular/specific

instance are attributed with significantly higher value than the mere terms and conditions of a

contract, or provisions of the applicable law.

Contract-based liability:

Any agreement that is enforceable by law is defined to be a Contract [Section 2(h) of the

Indian Contract Act, 1872 – hereinafter referred to as “Contract Act”]. This simple, and universal,

definition enables the parties to structure and tailor various forms of business contracts,

including licenses and leases, in a manner as to reflect the agreed business and strategic interests.

The large part of the Contract Act is designed towards identifying basic terms and requirements,

which if violated, would render an agreement unenforceable. Thereby sending a clear message

1
that, but for certain non-violable basic conditions, a contract may contain any other clause that

shall purport to achieve the objectives as agreed to by the parties concerned.

A key development, especially with advent of e-commerce and online transactions, is the

over-whelming dominance of ‘standard form contracts’. A fundamental assumption made by the

Indian Contract Act, or for that matter any contract law across the globe, is that all contracts are

products of free and fair negotiation between the parties. The ‘standard form contracts’ typically

undermine this assumption. Foremost, there is no scope whatsoever for any negotiation in most

forms of ‘standard form contracts’, and even if there is a semblance of such an opportunity, it

may not be backed by adequate bargaining power. Recognizing that ‘standard form contracts’

may likely contain unilateral and unreasonable clauses, the Indian Supreme Court, way back in

1967, has laid down that – “A negative covenant … is not therefore a restraint of trade unless the

contract as aforesaid is unconscionable or excessively harsh or unreasonable or one-sided.” [In

the matter of: Niranjan Shankar Golikari v. The Century Spinning and Mfg. Co. Ltd., AIR 1967 SC

1098]. The approach of the Supreme Court has been to uphold the validity, in many senses the

inevitable necessity, of such ‘standard form contracts’, but with a caveat that the

clauses/conditions would be subject to scrutiny on the ground whether they are reasonably

balanced with respect to the expectations and obligations of the parties.

It must be noted that in general principles of contract, which is founded on allowing

utmost autonomy to the parties, even breach of contract is considered as a choice available to

any of the parties. It is not illegal to breach a contract. Of course, a breach of a contractual clause

or condition would necessarily lead to a potential claim of compensation or liability under the

Contract Act, which may be classified as follows:

2
1. Unliquidated damages (Section 73 of the Contract Act): If a contract does not make any

mention of liabilities, then the law assumes that the parties intended to leave this issue

undefined, and therefore, the default option assumed by the law is termed as

‘unliquidated damages’. In effect, depending on the assessment of the claims made, a

Court may award any reasonable amount as compensation to be paid by the party

breaching the contract. Section 73 states – “When a contract has been broken, the party

who suffers by such breach is entitled to receive, from the party who 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 the breach of it. Such compensation is not to

be given for any remote and indirect loss or damage sustained by reason of the breach.”

2. Liquidated damages: Section 74 of the Contract Act provides that – “When a contract has

been broken, if a sum is named in the contract as the amount to be paid in case of such

breach, or if the contract contains any other stipulation by way of penalty, the party

complaining of the breach is entitled, whether or not actual damage or loss is proved to

have been caused thereby, to receive from the party who has broken the contract

reasonable compensation not exceeding the amount so named or, as the case may be, the

penalty stipulated for.” Therefore, if the parties have expressed an assessment of likely

losses, or a benchmark of the financial loss that may be incurred if either of them do

potentially breach the contract, then the Indian Contract Act recognizes it as ‘liquidated

damages’. The effect of having to express it as a clause, unlike in the ‘unliquidated

damages’ status, would render such a ‘liquidated’ amount as the maximum limit. If by any

3
 chance the actual/reasonable losses to be compensated exceed the ‘liquidated damages’

limit, then the deserving party is left with no legal claim beyond the expressed limit. The

Indian Supreme Court has explained this as – “The Indian Legislature has sought to cut

across the web of rules and presumptions under the English common law, by enacting a

uniform principle applicable to all stipulations naming amounts to be paid in case of

breach, and stipulations by way of penalty, and according to this principle, even if there is

a stipulation by way of liquidated damages, a party complaining of breach of contract can

recover only reasonable compensation for the injury sustained by him, the stipulated

amount being merely the outside limit.” [Union of India v. Raman Iron Foundry, [1974]3

SCR 556]

3. Indemnity: Section 124 of the Contract Act states – “A contract by which one party

promises to save the other from loss caused to him by the contract of the promisor himself,

or by the conduct of any other person, is called a “contract of indemnity”.” While it is

possible for an indemnity clause to be ‘implied’ in certain business contexts (like

insurance), it is always advisable, and even legally preferred, to have an express clause

describing the scope of indemnity in any regular business contract. Essentially, indemnity

is the coverage against any potential claim, especially from ‘third parties’, or parties who

are not party to the contract, but may emerge anytime in the future to make a claim of

compensation. In such an eventuality, the clause of indemnity assures that one party shall

cover all – damages (compensation); costs (including any fees and incidentals); and any

sums (compromise/settlement amounts) – incurred in resolving such potential claims.

4
 Indemnity clauses can be limited to a particular amount as agreed to by the parties, or

left unlimited. Not mentioning any amount/limit would mean it is unlimited.

4. Unlimited/statutory damages: There are possibilities of parties being subjected to

liabilities that go beyond the confines of the terms and conditions of a contract. They may

arise owing to certain statutory/legal penalties (like in tax laws; immigration regulations;

employment/labour law compliance; accident or health and safety claims); or may arise

due to the Courts finding it reasonable to impose certain compensatory liabilities (due to

‘torts’, like violation of privacy or confidentiality). Tortious form of liability, i.e., liability

arising from ‘torts’, also referred to as a civil wrong, are prevalent in countries that follow

‘common law’ principles, like India. A point to note is that no amount of disclaimers and

language to the contrary in a contract will be able to mitigate/overrule/apportion the risk

of such liabilities, as these are construed to be liabilities imposed by law. Therefore, they

are truly ‘unlimited’ in nature, and though avoidable, unforeseen too.

----------------------------

Illustration – on contractual liabilities:

Producer ‘A’ is a company that outsources the designing and fabrication of product ‘P’ to

Company ‘B’. Let us assume that ‘P’ has four components (1-2-3-4), of which ‘3’ & ‘4’ are only

software. As the contract allows for sub-contracting, Company ‘B’ further outsources component

‘4’ to an individual ‘C’. Eventually, within the stated time period, ‘C’ delivers component ‘4’ to ‘B’,

and thereafter, Company ‘B’ delivers the entire ‘P’ (with all four components) to Producer ‘A’.

The contract between ‘A’ & ‘B’ is fully complied and all deliverables, and respective payments,

5
are satisfied. Let us assume that the payment given to ‘B’ for the entire deliverable of ‘P’ is an

amount of 2x.

Four years later, it is found that Producer ‘A’ has made huge profits on the sales of ‘P’

across the globe. However, ‘D’ files a claim of violation of IPRs against ‘A’, and alleges that

component ‘4’ of product ‘P’ has infringed/violated D’s Copyrights. ‘D’ is claiming an amount of

10x as compensation for the alleged infringement (the claims can be staggering as they would be

a factor of extent of sales of ‘P’ and the consequent commercial profits/proceeds accrued.)

Some quick points of contract law to consider:

1. ‘A’ is liable to respond, and assuming that D’s claims are valid, may even be asked by the

Court to pay as much as 10x.

2. If the contract between ‘A’ & ‘B’ has an indemnity clause, and it particularly identifies a

claim on the basis of IPR violation as being within the scope of such an indemnity, then

‘A’ can certainly rely on ‘B’ to recover the entire sum of 10x, as well as, all other costs

incurred in defending against D’s claims. Typically, in reality, ‘B’ shall literally ‘subrogate’

or replace ‘A’ in the litigation and try its best to defend against D’s claims, as it would in

any case be liable to reimburse all expenses to ‘A’.

3. If the contract between ‘A’ & ‘B’ has an indemnity clause, and it particularly identifies a

claim on the basis of IPR violation as being within the scope of such an indemnity, but it

also limits the extent of liability to 4x, then ‘A’ can only recover a total amount of 4x from

‘B’, and since ‘A’ has already paid a sum of 10x to ‘D’, the difference is a loss to be borne

by only ‘A’.

6
 4. If the contract between ‘A’ & ‘B’ does not have an indemnity clause, then ‘A’ cannot rely

on ‘B’ to recover any part of the 10x paid to ‘D’, unless the contract has a clear condition

that ‘B’ shall have to adhere to all IPRs in delivering ‘P’. If so, then it would amount to a

breach of contract, and ‘A’ can claim compensation for the 10x that has been paid owing

to a ‘natural consequence’ of this breach. However, no additional claims on costs, or

losses (like loss of brand/reputation) can be recovered, since there is no indemnity clause.

5. If the contract between ‘A’ & ‘B’ does not have an indemnity clause, but it has a clear

condition that ‘B’ shall have to adhere to all IPRs in delivering ‘P’, and it also has a

‘liquidated damages’ clause of 4x, then it would amount to a breach of contract, but ‘A’

cannot claim compensation exceeding 4x. The difference is a loss to be borne only by ‘A’.

6. Of course, it is an entirely different issue as to whether ‘B’ is in any financial capacity to

adequately satisfy all the liabilities arising out of such a contract.

7. All points mentioned above with respect to ‘A’, in a similar manner, apply to ‘B’ in the

contract between ‘B’ & ‘C’. The likelihood of recovering the staggering amounts of

compensation would, quite obviously, be very constrained, since ‘C’ is just an individual.

-------------------------------------