Unravelling the Complexities of Loss of Profit Versus Loss of Profitability in Construction Disputes

Introduction

The momentum of science and technology advancements, driven by the surge in trade, commerce, and industrialisation, has escalated the demand for developmental projects.¹ Over the years, it has been observed that there has been a remarkable growth in construction and infrastructure projects in India. Correspondingly, India has prudently revised its arbitration legislation. This significant amendment presents an unprecedented opportunity to those in the construction and engineering sectors. The reformed arbitration, as originally intended, serves as an effective, quick, and sector-specific dispute resolution mechanism further making the process highly cost-effective, encouraging more industry specific professionals to leverage it in revamping the construction industry consistently with the rising demand.²

As construction projects face increasing complexity, the advent of construction disputes has skyrocketed. In these circumstances, contractors often raise a critical arbitration claim amongst other claims related to the loss of profit and loss of profitability. This claim seeks compensation for profit not realised due to unmet project objectives due to the termination of the project or reduced profit margin due to prolongation of the contract.

The author plans to provide a succinct introduction on the subject of construction contracts, elaborating on its evolution in India amidst the rapidly increasing number of infrastructure projects. Acknowledging the diverse types of such contracts, the author aims to establish an understanding of the significant disputes which typically arise from them, as illustrated in the contractors’ statements of claims. Further, the article shall be majorly dealing with the most contentious claims of construction disputes i.e. variances in the assertion of “loss of profit” and “loss of profitability” in relation to construction projects. Further, the article shall be making an in-depth analysis of various Supreme Court and High Court precedents, aiming to augment our comprehension of contractor’s raising of the claims in construction disputes.

Infrastructure development in India

In India, the infrastructure sector plays a pivotal role in catalysing overall national development.³ Receiving significant attention from the Government, this sector is subject to policies aimed at facilitating the time-bound creation of world-class infrastructure throughout the country. Unmistakably, the Government’s comprehensive approach to bolster the infrastructure segment is a linchpin in propelling India’s development trajectory in the global arena.

Amongst the diverse economic realms in India, the majority of private infrastructure is birthed from public-private partnership (PPP) projects, which contribute substantially to infrastructure investment.⁴ More than one-third of investment in the past decade has been from the private sector, revealing the significant impact of PPPs.⁵ Further, it is pertinent to note that PPPs not just contribute to the infrastructure development but also bridge the “infrastructure gap”, enhancing the overall efficiency of infrastructure service delivery.⁶ In furtherance to the same, Indian participation in the PPP structure, supports several models as follows:

(a) build-own-operate contracts;⁷

(b) build-operate-transfer (BOT) ‒ which is now divided into two variants i.e. BOT (toll) and BOT (annuity) & toll-operate-transfer model;⁸

(c) rehabilitate — operate-transfer;⁹

(d) hybrid annuity model and toll-operate-transfer model;¹⁰ and

(e) design-build-finance-operate-transfer (Dbfot).¹¹

Hence, the infrastructural augmentation in India is not merely a sectoral concern, but a holistic, multidimensional growth strategy.

The Indian construction industry, profoundly diversified and core to economic development, lacks a uniform construction contract format. However, it frequently employs contracts from esteemed global bodies such as International Federation of Consulting Engineers (FIDIC) and Institution of Civil Engineers (ICE), and also the model published by the nationally respected Indian Institute of Architects (IIA); a reflection of the amalgamation of international standards and local expertise.¹²

FIDIC forms of contract

Over the decades, FIDIC contract models have consistently demonstrated adaptability, evolving to align with changing market demands. Following are the various FIDIC contracts to date:¹³

FIDIC contract	Releasing year	Remark
Red Book (old)	It was first published in 1957, 4th and final edition was published in 1987.	Aims towards the civil engineering sector, as different than the mechanical/electrical engineering sector.14
Yellow Book	First was published in 1967, and the last edition, was published in 1987.	Aimed at mechanical/electrical engineering sector.15
Orange Book	Released in 1995.	First design and build contract released by FIDIC.16
Red Book (new)	Released in 1999.	This book is suited for the contracts wherein the majority of the designs rests with the employer.17
Yellow Book (new)	Released in 1999.	In this book, the contractors have the maximum responsibility of generating designs.18
Silver Book	Released in 1999.	Mostly responsible for the turnkey construction projects. According to this book, the contractor is responsible for generating maximum designs and a significant risk is vested on the contractor.19
Pink Book	It was first published in 2005, while the further edition, was published in June 2010.	Mostly an adaptation of the Red Book, that has been created to fit the purposes of multilateral development banks.20
Gold Book	Released in 2008.	First design-build and operate contract.21

Claims in construction disputes

Claims are a vital component of construction contracts as they offer resolutions to contentious issues involved in these contracts.²² Incorporating a comprehensive procedure for claims in accordance with the contract’s conditions can significantly diminish ambiguity, thereby facilitating an efficient resolution of disputes.

Effective pointers for evolution of claims in construction disputes

It is pertinent to bear in mind the following pointers for an effective claim management in addition to the exchange of the correspondences with the employers and the independent engineer ―²³

In the realm of construction disputes, most claims are typically categorised under several distinct heads:

(a) prolongation costs;

(b) price variation/inflation;

(c) scope variation;

(d) inappropriate deductions/amounts withheld;

(e) interest; and

(f) cost of arbitration.

In the realm of construction dispute, a considerable fraction is made up of obligatory delay claims, most often stemming from the actions sanctioned by the employer.²⁴ These claims could unfold in different ways but typically underline the loss of time impacted by the employer’s conduct.

Delay claims

Delay in providing with space:²⁵

(a) providing the “right of way”;

(b) delay in handing over the land; and

(c) delay in issuance of drawings/designs.

Delay due to hindrances/encumbrances:²⁶

(a) delay in payment by the employers for removal of utilities; and

(b) delay due to obstruction/hindrance by locals.

Among various delay claims and claims arising from employer’s default, the most contentious ones are those related to loss of profit and loss of profitability. These claim types often become a focal point of disagreements and disputes due to their complex nature and potential for significant financial implications. Determining the validity and assessability of such claims require a robust understanding of contract specifications, accurate project progress records, and thorough financial analysis.

In the subsequent part of this article, a comprehensive analysis will elucidate the distinction between the concepts of “loss of profit” and “loss of profitability”, using relevant case law precedents from the High Court and Supreme Court.

Concept of loss of profit and loss of profitability

The fundamental difference between loss of profit claims by contractors against employers and loss of profitability lies in the nature and circumstances of loss. Loss of profit, typically results from an unlawful or premature termination of a contract, reflecting a loss of anticipated profit due to unexecuted work.²⁷ Conversely, loss of profitability or business refers to a reduction in the anticipated profit margin due to a contract’s prolongation or loss of opportunity to undertake other profitable projects during the extended period of the contract.²⁸

Distinction between claim pertaining to loss of profit and loss of profitability

In the realm of construction contracts, fixed price bids are a prevalent approach, often submitted by contractors and normally the underlying expectation ensconced in these bids is to ensure that the total revenue generated from these construction projects covers not simply the direct costs associated with the project like materials, labour and equipment, but also reaches out to more extensive operational expenses such as overhead costs.²⁹ In project management, often the occurrence of unforeseen delays or extensions can lead to the contractor lodging claims pertaining to the loss of profit or loss of profitability. Though frequently used interchangeably, these terms signify distinct legal ramifications, comprehended properly only through a detailed interpretation of relevant case laws.

Claim for loss of profit

It has been envisaged in Section 73 of the Contract Act, 1872³⁰, that the compensation claims in instances where a project faces untimely termination or inexplicable delays, supporting that the aggrieved party’s loss of profit be recognised as a measure of recompense.³¹ Crucially, the feasibility of such claims hinges on whether the damages in question naturally materialise from the breach of contract or were reasonably foreseeable during the contract’s inception.

It was observed by the Supreme Court in A.T. Brij Paul Singh v. State of Gujarat³², that whenever the employer is responsible for the breach of contract, and such a breach is totally unjustified, wherein the contractor has already executed the part of the contract, then in that situation, the contractor shall be entitled to the damages by way of loss of profit.³³ Furthermore, in Dwaraka Das v. State of M.P.³⁴, the judicial standpoint towards the entitlement of the contractor for loss of profitability stood evidently confirmed.

Similarly, in Jeevat Construction v. Union of India³⁵, the Division Bench of Bombay High Court was of the following viewpoint:

20. …

17. When there is a breach of contract and wrongful termination, the party not in default is entitled to recover damages or compensation for the loss suffered. In a building contract, this normally takes the form of claim for loss of profits. In computing the damages and awarding the same, the party not in default, should as far as possible, be placed in the same position financially if the contract had not been terminated and had been performed.

In the realm of rising disputes in the construction contracts, it is indispensable to appreciate that notwithstanding the absence of tangible evidence, the awarding of loss of profit can be purely predicated on guesswork or guesstimates, under certain circumstances. This is typically the case only when a breach of contract has unquestionably occurred, sufficiently severe as to have undeniably inflicted damage to the contractor.³⁶

While judgments vary in proving the tangible proof of loss or basing claims largely on estimations or guesswork without delving into the intricate case details, it is imperative to identify the practicality of establishing valuations for loss of profit claims. Now when we look at some judgments, which relies on evidence for proving the loss of profit, the documents would include tender briefs, business strategies specifically crafted for profit generation, or any related agreements where the profit proportions of the project were agreed upon by the involved parties. Additionally, significant correspondences and concurrent records serve as viable evidence to establish the financial damage caused by the termination.³⁷

Taking into consideration the precedents of the court, it is clear that in cases involving breach of contract, a contractor is only entitled to compensation for loss of profit if sufficient evidence exists supporting their claim of loss caused by the unexecuted part of the agreement.³⁸ Interestingly, the courts have, at times, solely relied on guesswork or guesstimates to award such losses, particularly when the breach is manifestly obvious and an imminent loss is foreseeable. The Delhi High Court, in a significant ruling, conveyed an imperative judgment asserting that in circumstances where the contractor has been subjected to breaches and the detriment they experienced is intricate to substantiate, an equitable solution is to award compensation on a pro rata basis.³⁹ Further, it is pertinent to mention that the adjudicating bodies should take a note of reasonability to prevent undue enrichment of parties merely just through the claims of contractual breach.⁴⁰ Thus, the objective should not be the elevation of damages to the extent of reaping windfall profits, but rather a fair and balanced resolution of the dispute at hand.

Claim for loss of profitability

It is pertinent to highlight that the claims for the loss of profitability are not generally allowed in the absence of evidence in addition to proving that the delay was solely attributable to the employer. The contractor while proving the actual loss, should meticulously gather, document and present professionally emphasising on the magnitude of the loss.

In most legal precedents studied, the judgment often cites a “claim for loss of profit”, however, the underlying assertion could be better interpreted as a “loss of profitability”. This distinction is integral as it implies that the burden to authenticate an actual loss is stipulated solely for damages resulting from delays. This requirement should not be misconstrued as applicable to the potential loss of profits associated with unexecuted works due to a breach/termination of contract. In the later part of the article, the author through the lens of various case laws, shall be interpreting the concept of loss of profitability.

The Supreme Court, while addressing the calculation of loss of profit arising from the termination of contract, underscored the importance of three key formulae ‒ the Hudson formula, Emden formula, and Eichleay formula.⁴¹ It is also imperative to note that any alleged loss suffered by the contractor must be substantiated through diligently pleaded claims and corroborating evidence; lack of which may weaken the contractor’s stance and credibility.⁴²

Further, the Supreme Court elaborating on the concept of the claim for the loss of profitability in its landmark judgment Unibros v. All India Radio⁴³, diligently analysed the concept, viewing it through the specific lens of loss of profit. The Court judiciously observed various grounds for claiming loss of profit in scenarios where a contract is unexpectedly prolonged i.e.: (1) there must be a delay in completion of the contract; (2) such delay is not attributable to the contractor; (3) the contractor must have an established business, handling substantial projects; and (4) there must be credible evidence to substantiate the claim of loss of profitability.⁴⁴

Further, the Supreme Court in Batliboi Environmental Engineers Ltd. v. Hindustan Petroleum Corpn. Ltd.⁴⁵, made its observation pertaining to the claims for loss of profitability under the pretext of loss of profit, either due to the delay in the completion of contract, the contractor has to provide convincing evidence which substantiates the existence of a viable opportunity. This evidence ought to incontrovertibly illustrate that prompt execution of the contract would have enabled the contractor to procure supplementary profits via the utilisation of its resources elsewhere.⁴⁶ Following are the evidence that would substantiate the claim for loss of profitability i.e.: (1) the status of the contractor as an established contractor which can be evinced through awards and other accolades; (2) available work that could not be taken by the contractor can be evidenced through invitations to tender for potential projects, etc.; and (3) documents and contemporaneous records that clearly evince the fact that the staff, equipment and machinery involved in the project could not be used in the subsequent project indicating the shortage of staff resulting in loss amongst other evidences.⁴⁷

In a recent Calcutta High Court ruling, a notable distinction was drawn between loss of profit and loss of profitability.⁴⁸ The Court noted that for a loss of profit claim arising from breach or termination of a contract, there is no obligation to substantiate the actual loss. In contrast, for a loss of profitability claim, which tends to arise from a reduced profit margin due to the extension of the contract, the claimant must present compelling evidence showing sustained loss.⁴⁹

In relation to the claims of loss of profitability, it is of utmost importance for the contractor to demonstrate and provide compelling evidence to establish the legitimacy of his claim. Although most of the cases we witness in construction dispute claims pivot around the concept of loss of profit, it is pivotal to distinguish it from a distinct situation when there is a reduction in profit margin consequential to the prolongation of the contract; here we are talking about the claim for loss of profitability.

Concluding remarks

A meticulous examination of the judicial precedents reveals a divergent judicial stance when it comes to extrapolating the notions of loss of profit and loss of profitability within the framework of disputes arising from construction contracts.

Hence, in relation to loss of profit, as long as a breach is substantiated, the need for additional evidence of actual loss is deemed unnecessary. The logic surrounding this stance is rooted in the premise that within a works contract, there exists a reasonable expectation of profit. In this respect, the sole requirement is to establish the implicit profit percentage within the contract, providing a basis for calculating potential profit/loss linked to unfulfilled contractual obligations or unexecuted works.

In case of loss of profitability, the strategic onus rests on the contractor to demonstrate, through concrete contemporaneous documents, the degree of loss sustained. For instance, this could be substantiated by producing a comprehensive list of potential projects or works, for which the claimant was notably eligible, but was rendered incapable of undertaking due to the prolongation of the contract.

This sustained legal scrutiny affirms the complexity and the multidimensional nuances of these financial concepts and their connotations within contractual obligations and compensatory jurisprudence. Despite the courts not explicitly providing a standard method for assessing a claim of loss of profit and loss of profitability, they have endowed the Arbitral Tribunal with the autonomy to award these claims based on the individual circumstances.

However, there is a pressing need for a jurisprudential guideline or judicial precedent aiming to aid the differentiation and settlement of these claims grounded on the respective context.