Loss of Profit and Profitability: Distinct Concepts, Frequently Confused

“Loss of profit” and “loss of profitability” are the most common claims raised in infrastructure projects in India; however, these terms are often used interchangeably, but they represent fundamentally different concepts.¹ Despite their distinct meanings, these terms are frequently confused in legal disputes, leading to misinterpretation that can have absurd consequences. Often times, the legal test for one is incorrectly applied to assess the other, resulting in significant confusion in court proceedings. Rectifying such errors is a prolonged process, by which time the parties involved may have already incurred substantial losses in terms of both time and money. This article aims to clarify the stark differences between the terms and provide insights into how they should be correctly applied while determining respective claims, including the various kinds of evidence that requires to be produced to prove a case of loss of profit and profitability.

Tracing the Origins and Defining the Divide: Understanding Loss of Profit and Loss of Profitability

“Loss of profit” refers to the loss of anticipated earnings resulting from the non-completion or prevention of work due to premature or unlawful termination, or breach of contract. For instance, a contractor factors 10% profit for executing a work worth Rs 100 crores, accordingly, the profit contemplated was Rs 10 crores. However, the employer terminated the contract after execution of Rs 80 crores worth of work, and so, the contractor is entitled to 10% loss of profit on remaining portion of the works which were illegally terminated. The legal foundation for claims of loss of profit arises under Section 73 of the Contract Act, 1872² (ICA), which entitles the aggrieved party to reasonable compensation for any loss/damage suffered due to the breach. This is a direct and foreseeable consequence of a contractual breach and typically follows as a matter of right.

“Loss of profitability” pertains to the loss of opportunity to undertake alternative projects during an extended contract period, where the contractor could have otherwise earned profits. It encompasses a reduction in the estimated profit margin due to the prolongation of contractual obligations, leading to tied-up resources and financial constraints. For instance, contractor expected to earn Rs 10 crores profit on a project scheduled for 24 months. Due to employer-caused delays, the project extended to 36 months. During this time, the contractor’s resources remained tied up, preventing them from pursuing other opportunities. The extension led to higher overheads, inflation, and lost opportunities, reducing the final profit to Rs 4 crores. The Rs 6 crores drop reflects loss of profitability. Loss of profitability requires a higher evidentiary threshold and it involves proving not only the extension of contractual obligations but also the resultant impact on contractor’s ability to generate profits elsewhere.³

The concepts find its origin in Robinson v. Harman⁴ and Livingstone v. Rawyards Coal Co.⁵ where the Court established the foundational principle of “reinstatement”. The ruling emphasised that the injured party should be compensated for the lost profit that would have been earned if the contract had been fulfilled as agreed, aiming to restore the party to the financial position they would have occupied but for the breach.

Proving the claim: Burden of establishing loss of profit and profitability

It is a well-established principle in law that in an action for damages, it is for the contractor to prove his losses with convincing evidence, showing how the loss was directly caused by employer’s actions/breaches.⁶ Simply providing a list of losses and damages without supporting evidence is insufficient. Now, the central issue that often arises is whether, once delay is attributed to the employer, a standard formula (based on contract value or methods like Emden/Hudson) is sufficient to award claims for loss of profit, or whether the contractor must provide specific evidence beyond the formula. The legal thresholds vary depending on jurisdiction, but generally, while formulae can offer a guideline, they are not conclusive on their own. This issue can be analysed through two frameworks: legislative and judicial.

(A) Legislative standards

Under Section 73 of the ICA⁷, a party breaching a contract must compensate the innocent party for losses that naturally arise or were reasonably foreseeable at the time of contracting. This principle is designed to ensure that the injured party is made whole to the extent that the breach can be reasonably predicted. Read with Section 55 of the ICA⁸, which deals with delay, compensation is also permitted for losses due to delayed performance.

However, both provisions are silent on how such compensation should be calculated.⁹ Mere breach does not entitle a party to damages, actual loss must be proven.¹⁰ Especially under Section 73, a party claiming compensation has the obligation to prove the losses suffered on account of breach of contract by the other party.¹¹ This gap has led to varied judicial interpretations on quantifying compensation, depending on the case context.

(B) Judicial standards for loss of profits

In 1984 in A.T. Brij Paul Singh v. State of Gujarat¹², the Supreme Court held that when a contractor submits his tender for the works, a reasonable expectation of profit is already implicit in it and its loss has to be compensated by way of damages if the other party to the contract is guilty of breach of the same. In view of this, for the first time, the Supreme Court went onto hold that it would be unnecessary to go into the minutest details of the works executed and a broad evaluation would be sufficient while granting loss of profits. This view was further reiterated in Dwaraka Das v. State of M.P.¹³, Himachal Joint Venture v. Panilpina World Transport¹⁴, and J.G. Engineers (P) Ltd. v. Union of India¹⁵. However, the Supreme Court in McDermott case¹⁶ and Associate Builders v. DDA¹⁷ upheld the awards which allowed the claims for loss of profitability purely based on formula.

This gave rise to a judicial trend where loss of profit was awarded in cases of illegally terminated contracts based on a percentage of the unexecuted portion, without always requiring detailed evidentiary proof. The rationale behind this approach was that a reasonable expectation of profit is inherent in a works contract, and if one party is guilty of breach, the other is entitled to compensation for the loss of profits.¹⁸ However, there are cases which have contradictory views.¹⁹

(C) Judicial standards for loss of profitability

In 2004, in Bharat Coking Coal Ltd. v. L.K. Ahuja²⁰, the Supreme Court held that while claiming loss of profit arising out of diminution in turnover on account of delay in completion of works; then in such a situation, the party claiming losses should show that had he received the amount due under the contract, he could have utilised the same for some other business in which he could have earned profits (ergo, loss of profitability or loss of opportunity to profit). It was thus firmly established that a claim for loss of profitability cannot be granted unless a specific plea is both raised and proven. The contractor must demonstrate through evidence that the delay resulted in missed opportunities or the inability to secure other contracts. Courts have consistently held that proof of actual loss is a condition precedent to applying any formula for computing loss of profit. In the absence of such substantiating evidence, the claim cannot be sustained, as mere reliance on formulae without factual support is insufficient to justify compensation.²¹ This became the standard of proof in Ferro Concrete case²², Essar Procurement case²³, among others.

In Hindustan Construction case²⁴ the Court held that a loss of profitability claim must meet two key criteria: proximity and measure. The claimant must prove: (i) a real opportunity to redeploy resources elsewhere; and (ii) that the alternative venture would have been profitable. Without such specific proof, the claim cannot be sustained. Similar position was reiterated and upheld in several other landmark judgments.²⁵

Recently, in State of W.B. v. S.K. Maji²⁶, the Court clearly distinguished between the terms “loss of profit” and “loss of profitability”.

Crunching the numbers: methods to quantify loss of profit and profitability

The uncertainty surrounding claim for loss of profitability was conclusively addressed in Batliboi case²⁷ and Unibros case²⁸. These rulings provided much-needed clarity, firmly establishing that a contractor must necessarily lead evidence to substantiate such claims. The courts held that mere reliance on standard formulas is insufficient and that documentary proof — such as financial records, tender opportunities lost, etc. — must be presented. The same is explained below:

In Batliboi v. HPCL²⁹, the case is regarding the delays in the completion of a turnkey contract for the design, supply, erection, testing, and commissioning of a sewage water reclamation plant. After completing 80% of the work, the contractor abandoned the project and subsequently claimed loss of profit and overheads due to project delays. The Arbitral Tribunal awarded 10% of the contract value for each claim without providing any clear reasoning or methodology for its calculation. A Single Judge upheld the award under Section 34³⁰ of the Arbitration and Conciliation Act, 1996³¹. However, on appeal under Section 37³² of the Arbitration and Conciliation Act, 1996, the Division Bench set aside the award. From the rulings of the Supreme Court, it is well-established that:

(a) The contractor must demonstrate that other work was available and would have been secured if not for the delay. This can be established through declined invitations to tender due to a lack of capacity.

(b) The contractor must show a drop in turnover due to the delay, supported by books of accounts, to establish that the loss was directly attributable to the delay and not to other external factors. If a reduction in turnover cannot be established, the contractor is not entitled to lost profits but only interest on the capital employed.

(c) Loss calculation formulae, including the Hudson Formula, are rough approximations and should be used with caution to avoid double recovery, overlap with other claims, or unjust enrichment. Courts/tribunals must ensure that claims are not duplicated through variations or damages awarded for breach. The Supreme Court further emphasised guidelines for using the Hudson Formula, stating that it should be applied only as a last resort, and only where the contractor has provided credible evidence of actual financial loss.

The Court held that the computation of damages should not be whimsical and absurd resulting in a windfall and bounty for one party at the expense of the other and that the computation should not be disingenuous and should commensurate with the loss sustained. Additionally, while formulae such as Hudson’s, Emden’s, and Eichleay’s may be used to determine loss of overheads and profits, their application must be substantiated with relevant evidence to support the assumptions they rely upon. Formulae should only serve as a last resort, with claimants required to provide supporting materials such as invitations to tender, financial records, and other contemporaneous evidence. Formulae cannot be applied in a vacuum without a factual basis.

In Unibros case³³, delays in completing a construction contract — caused by the employer’s failure to timely hand over the site and drawings — led the contractor to claim compensation for price escalation, extended stay costs, and loss of profit. The Arbitral Tribunal rejected the first two claims for lack of evidence but awarded damages for loss of profit, reasoning that the defaulting party is liable for foreseeable losses and that it was reasonable to assume the contractor could have earned profits on other projects. It held that exact quantification of the loss was not necessary, and the best available evidence would suffice; the Hudson Formula was used to compute the claim. However, the Delhi High Court set aside the award under Section 34, and this was affirmed by the Division Bench under Section 37. On further appeal, the Supreme Court clarified that to succeed in a claim for loss of profit, the contractor must prove:

(a) delay in project completion;

(b) that such delay was not their fault;

(c) their reputation as an established contractor handling major works; and

(d) credible evidence to substantiate the alleged profit loss.

The type of evidence necessary to support a claim for loss of profitability will depend on the specific facts of each case but may include materials such as proof of alternative projects the contractor was unable to pursue due to the delay, records of tender invitations that had to be declined, financial statements showing reduced revenue, and relevant contractual provisions addressing delays and compensation. Furthermore, similar to the judgment in Batliboi case³⁴, although widely accepted, formulae like the Hudson Formula cannot be applied in a vacuum — they must be backed by substantive evidence clearly showing that the contractor suffered real financial losses and missed opportunities as a direct result of the delay.

In both these cases, the standard of proof reinforces a clear message that in a courtroom of construction claims, speculation gets no sympathy. Contractors are not compensated for the business they wish they did — they get paid for the business they can prove they lost.

Bridging the gap: Clarifying the proper use of these financial terms

In light of the foregoing, we suggest that courts and tribunals adopt a balanced and pragmatic approach when assessing claims for loss of profit and profitability. While claimants should be encouraged to present precise evidence wherever possible, it is equally important to recognise that absolute certainty is often impractical, particularly in cases involving prospective losses. Rigid evidentiary requirements should not lead to denial of legitimate claims, especially where substantial loss is apparent.³⁵ Instead, adjudicators should weigh available evidence holistically and apply a reasoned methodology to quantify damages as fairly as possible.

These evolving judicial trends raise an important question: Do they mark a fundamental shift from earlier principles, or are they a natural evolution, adapting to modern commercial realities? We lean toward the latter view and anticipate further developments in legal practice, which may well lead to the next chapter in this ongoing discourse, which will undoubtedly shape the future of commercial dispute resolution.