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Price Escalation In contracts: Legal Remedies Available To Contractors In The Absence Of Price Escalation Clause In Agreement

Jayashree PK
26 May 2020 5:26 AM GMT
Price Escalation In contracts: Legal Remedies Available To Contractors In The Absence Of Price Escalation Clause In Agreement
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The legal framework on the absence of price escalation clause in contract is worth discussing and deliberating upon. A contractor who has encountered a series of problems leading to delays/latches in completion of contractual work is more often brought into this quagmire due to the fault of his employer. The employer fastens the contractor with the obligation to complete his work within the agreed period of contract, however, owing to delay in performance of reciprocal obligation by the employer, the contractual work gets extended beyond the stipulated date of completion. The contractor nevertheless assumes responsibility to complete his work beyond the contractual term, though voidable at his option. He is denied the benefit of performing extra work at enhanced rates and has been forced to work at original contract price. The employer is cognizant of the fact that prices of goods and services in the economy tend to escalate over a period which has a direct bearing on the work to be executed by the contractor, therefore denying the fair share of a contractor for incurring extra costs on goods and services is nothing less than a means of unjust enrichment. One sided, unreasonable, and arbitrary clauses in contract providing for extension of time without payment for work done at enhanced rates is clearly unlawful and against the public policy.

Mostly, the contracts provide for settlement of disputes by arbitration. When a dispute is referred for adjudication before the Arbitral Tribunal with regard to the contractor's claim for losses incurred by price escalation during the extended period of contract, the following factors have to be taken into consideration, such as :

  1. Who is responsible for the delay ?
  2. What are the repercussions of the delay in the completion of work ?
  3. How to apportion the consequences of the responsibility? [i]

Once it is found that the arbitrator has jurisdiction to find that there was delay in execution of contract due to the conduct of the employer, he is liable for the consequences of the delay, namely, increase in prices.[ii]

CAUSES OF DELAY IN COMPLETION OF WORK

The major factors responsible for causing delay in completion of work project/contract are :-

  1. Late supply of materials or equipment undertaken by the employer to be supplied under the contract,
  2. Late supply of resources like water & electricity,
  3. Late issue of drawings or change in design and pattern,
  4. Late handing over of site to contractor,
  5. Non-completion of Land Acquisition proceedings in most of the places,
  6. Additional allotment of work or increase in the quantity of work,
  7. Late release of payment of RA (Running Account) Bills/mobilisation advance (Mobilization Advance is a monetary payment made by the owner to contractor for initial expenditure of site mobilization and a fair proportion of job overheads)/escalation,
  8. Intervention of subcontractor/agency/vendor,
  9. Land in dispute or not being free from encumbrances,
  10. Force majeure circumstances or situations beyond the control of the contractor, adverse site conditions and such other unprecedented events.[iii]

The above factors are not exhaustive.

TYPES OF CLAIMS RAISED BY THE CONTRACTOR FOR WORK PERFORMED DURING THE EXTENDED PERIOD OF CONTRACT

The general claims raised by contractor for losses incurred due to price escalation during the extended period of contract include :

  1. Increase in material charges,
  2. Increase in labour charges,
  3. Increase in equipment charges,
  4. Increase in Transportation charges,
  5. Increase in electricity charges,
  6. Increase in lending rate for various SSI sector,
  7. Power cut,
  8. Increase in VAT and service taxes,
  9. Reimbursement of price variation and escalation due to extended stay,
  10. Losses incurred due to purchase of machinery, tools and plants lying over the site,
  11. Compensation for idling resources due to delays,
  12. De/Remobilization charges for carrying out delayed work,
  13. Compensation for loss of profit,
  14. Compensation for extra expenditure incurred on overheads, and other supervisory expenditure due to extended stay,
  15. Release of amount withheld by the employer towards liquidated damages,
  16. Release of Bank Guarantee,
  17. Losses caused by unlawful repudiation of contract by the employer and consequent termination of the contract,
  18. Losses due to funds borrowed from bank at commercial rate of interest.

LEGAL REMEDIES AVAILABLE TO CONTRACTORS IN THE ABSENCE OF PRICE ESCALATION CLAUSE IN AGREEMENT

The Hon'ble Supreme Court and the High Courts in India have widely dealt with the applicability of law on price escalation and culled out various principles and enunciated laws of contract to provide a remedy to an innocent party, who has suffered losses due to increase in prices and consequent delays in completion of work due to acts of the other party. The well-known maxim - ubi jus ibi remedium clearly applies in the present context which means where there is a right, there is a remedy.[iv] The judgments delivered by the Courts in India have shown that mere absence of price escalation clause in contract shall not preclude a contractor to claim compensation at escalated/revised rates from the employer. The Court or the Arbitral Tribunal as the case may be, must weigh the inconvenience caused to the innocent party.


PRINCIPLE OF REPUDIATION OF CONTRACT- SECTION 55 OF THE INDIAN CONTRACT ACT, 1872

In our country question of delay in performance of contract is governed by Section 55 and 56 of the Indian Contract Act, 1872.

Section 55 of the Indian Contract Act states that when a party to a contract promises to do a certain thing at or before a specified time, or certain things at or before specified time, and fails to do any such thing at or before the specified time, the contract or so much of it as has not been performed, becomes voidable at the option of the promisee, if the intention of the parties was that time should be the essence of the contract.

Effect of such failure when time is not essential – If it was not the intention of the parties that time should be of the essence of the contract, the contract does not become voidable by the failure to do such thing at or before the specified time; but the promisee is entitled to compensation from the promisor for any loss occasioned to him by such failure.

Effect of acceptance of performance at time other than that agreed upon – If, in case of a contract voidable on account of the promisor's failure to perform his promise at the time agreed, the promisee accepts performance of such promise at any time other than that agreed, the promisee cannot claim compensation for any loss occasioned by the non-performance of the promise at the time agreed, unless, at the time of such acceptance, he gives notice to the promisor of his intention to do so.

In simple terms, an abnormal rise in price of goods or services may frustrate the contract and the innocent party is not obligated to perform the contract. Failure on the part of the employer to perform a mutual obligation will enable the contractor to avoid the contract as the contract becomes voidable at his option in case time is the essence of the contract. Furthermore, a failure to perform contract within the stipulated time will entitle the innocent party to (a) terminate performance of the contract and put an end to all the primary obligations of both parties remaining unperformed; (b) claim damages from the contract breaker for committing fundamental breach of contract depriving the innocent party of the benefit of the contract i.e damages for loss of the whole transaction. If the contractor accepts the belated performance of reciprocal obligation on the part of the employer instead of avoiding the contract, he (contractor) cannot claim compensation for any loss occasioned by non-performance of the reciprocal promise by the employer at the agreed time unless he gives notice to the promisor of his intention to do so at the time of such acceptance. Under the Indian law, a contract entered into between the parties whereunder the contractor has undertaken not to make any claim for delay in performance of the contract due to an act of the employer, still a claim would be entertainable in one of the following situations : (i) if the contractor repudiates the contract exercising his right under Section 55 of the Contract Act, (ii) the employer gives an extension of time either by entering into supplemental agreement or by making it clear that escalation of rates or compensation for delay would be permissible, (iii) if the contractor makes it clear that escalation of rates or compensation for delay shall be made by the employer and the employer accepts performance by the contractor in spite of delay and such notice by the contractor puts the employer on terms.[v]


IMPOSSIBILITY OF PERFORMANCE & DOCTRINE OF FRUSTRATION – SECTION 56 OF THE CONTRACT ACT, 1872

In common law, frustration does not rescind the contract ab initio but brings the contract to an end forthwith automatically, in the sense that it releases both the parties from any performance of the contract while leaving undisturbed any legal rights already accrued or payments already made in accordance with its term.

Section 56 of the Contract Act reads thus :-

56. Agreement to do impossible act – An agreement to do an act impossible in itself is void.

Contract to do act afterwards becoming impossible or unlawful – A contract to do an act which, after the contract is made, becomes impossible or, by reason of some event which the promisor could not prevent, unlawful, becomes void when the act becomes impossible or unlawful.

Compensation for loss through non-performance of act known to be impossible or unlawful – When one person has promised to do something which he knew, or, with reasonable diligence, might have known, and which the promisee did not know, to be impossible or unlawful, such promisor must make compensation to such promisee for any loss which such promisee sustains through the non-performance of the promise.

The parties to a contract are faced with unexpected turn of events such as wholly abnormal rise or fall in price. Law has adapted itself to economic changes. Marginal price rise may be ignored but when prices escalate out of all proportion from what could have been reasonably expected by the parties and making performance virtually impossible to the contractor, the law has to offer relief to the contractor in terms of price revision.[vi] The Supreme Court has recognized this in Tarapore & Co. Versus Cochin Shipyard Ltd,[vii] wherein it was laid down that when an agreement is predicated upon an agreed fact or situation which ceases to exist, the agreement to that extent becomes irrelevant or otiose. Once the rates become irrelevant on account of circumstances beyond the control of the contractor, it is open to the contractor to make a claim for compensation. In Easun Engineering Co. Ltd. Versus The Fertilisers and Chemicals (Travancore) Ltd,[viii] the Claimant-EASUN was aggrieved by the increase in the price of transformer oil subsequent to the contract. Since a 400 % increase in price due to certain unexpected war condition cannot be described as anything which would be normal in the ordinary trade conditions, it was pronounced that the abnormal increase in price due to war condition, is an untoward event or change of circumstances which "totally upsets the very foundation upon which parties rested their bargain". Therefore, EASUN can be said to be finding itself impossible to supply the transformers which it promised to do. The High Court thus, affirmed the Award passed by the arbitrator and observed that despite the contract being a firm price contract, EASUN was justified in asking for variation of price in transformer oil, in view of the force majeure conditions. The observation made by the Supreme Court of India in Alopi Prashad & Sons Ltd Versus Union of India [ix] is relevant. In this case, it was observed that the Indian Contract Act does not enable a party to a contract to ignore the express covenants thereof, and to claim payment of consideration for performance of the contract at rates different from the stipulated rates, on some vague plea of equity. The parties to an executory contract are often faced, with a turn of events which they did not at all anticipate--a wholly abnormal rise or fall in prices, a sudden depreciation of currency, an unexpected obstacle to execution, or the like. Yet this does not in itself affect the bargain they have made. If, on the other hand, a consideration of the terms of the contract, in the light of the circumstances existing when it was made, shows that the parties never agreed to be bound in a fundamentally different situation which has now unexpectedly emerged, the contract ceases to bind at that point not because the court in its discretion thinks it just and reasonable to qualify the terms of the contract, but because on its true construction it does not apply in that situation.


PRINCIPLE OF QUANTUM MERUIT -SECTION 70 OF CONTRACT ACT, 1872

According to Black's Law Dictionary, Quantum meruit means 'as much as he deserves'.[x] The expression describes the extent of liability in a contract implied by law. The law implies a promise to pay a reasonable amount for the labour and materials furnished by the innocent party, even when there is absence of a specific contract. It is an equitable remedy available to the courts when the courts are exercising their equitable jurisdiction under the law of restitution. In other jurisdictions, it is a method of assessing damages in contract cases. Thus, quantum meruit is a legal principle under which a person should not be obliged to pay, nor should another be allowed to receive, more than the value of the goods or services exchanged. It is closely related to the equitable concept of unjust enrichment. Although the existence of a quantum meruit remedy does not depend on a contract, yet it is a remedy in law of contract, where a contract has been breached but after one side received partial or full benefit, and the contract does not include a clause providing for this eventuality (such as a liquidated damages clause).[xi] The principle of quantum meruit has no application where there is a specific agreement in operation. The action of Quantum Meruit is allowed in Indian Courts under Section 70 of the Indian Contract Act, 1872 which states :

Section 70 of the Indian Contract Act – Obligation of persons enjoying benefit of non-gratuitous act- Where a person lawfully does anything for another person, or delivers anything to him, not intending to do so gratuitously, and such other person enjoys the benefit thereof, the latter is bound to make compensation to the former in respect of, or to restore, the thing so done or delivered.

When a party to a contract who has done additional work for another not intending to do it gratuitously and the other party has obtained benefit therefrom, the former is entitled to compensation for the additional work covered by the contract. If an oral agreement is pleaded, which is not proved, the innocent party will be entitled to compensation under Section 70 of the Indian Contract Act, 1872. Payment under this section can also be claimed for work done beyond the terms of the contract, when the benefit of the work has been availed by the other party.[xii] To illustrate, a person who does work or supplies goods under a contract, if no price is fixed, is entitled to be paid a reasonable sum for his labour and the goods supplied. In case the work is outside the contract, the terms of the contract can have no application; and the contractor is entitled to be paid a reasonable price for the work done by him.

COMPENSATION FOR LOSS OR DAMAGE CAUSED BY BREACH OF CONTRACT UNDER SECTION 73 & 74 OF THE CONTRACT ACT, 1872.

The case law T.A Chowdhury Versus State of A.P & Ors., strikes at the root of the contracts prohibiting the contractor to claim compensation for work done beyond the agreed period of contract owing to fundamental breach of contract by the employer with well explained provisions of law.

Section 73 of the Act postulates that where 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, 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. Exception- Such compensation is not to be given for any remote and indirect loss or damage sustained by reason of the breach.

To ascertain that a contractor is entitled to compensation, it must be determined whether the provisions stipulating avoidance of compensation damages are unlawful. A clause in the contract making the party who breaches the contract not liable for compensation runs contrary to Section 73 of Contract Act. Therefore, a clause for extension of time in contract without compensation, which runs contrary to Section 73 of the Contract Act can be said to fall within the category of unlawful agreement. It is well settled that no agreement can override the statutory provisions of law and such agreement is void ab initio. A party who suffers by a breach of contract is entitled to claim damages at all events. He gets the compensation as a result of the breach of the contract and not by reason of any existing obligation on the part of the person in breach.[xiii] Therefore, a clause or condition granting extension of time cannot be read as a prohibition for grant of claim for escalation in case of breach of contract by the employer and such claim would be maintainable under Section 73 of the Indian Contract Act, 1872.[xiv]> In M.L. Mahajan Versus Delhi Development Authority & Anr[xv], it was held that claim for damages on account of prolongation of contract inasmuch as contractor was made to incur unnecessary expenditure due to fault of the employer in prolonging the contract was maintainable as per Section 73 and 74 of the Contract Act which gave entitlement to the contractor to claim damages/loss suffered due to breach of contract by the employer.

PRINCIPLE OF PERFORMING RECIPROCAL PROMISES- SECTION 54 OF THE CONTRACT ACT, 1872

Under Section 54 of the Contract Act, when a contract is consisting of reciprocal promises, such that one of them cannot be performed or that its performance cannot be claimed till the other has been performed and the promisor of the promise last mentioned fails to perform it, such promisor cannot claim the performance of the reciprocal promise and must make compensation to the other party to the contract for any loss which such other party may sustain by non-performance of the contract. The section gives an impetus to the principle of Lex non cogit Ad Impossiblia which means the law does not compel a man to do anything which he cannot possibly perform. Thus, when the performance of the contract cannot be achieved by law, the same cannot be made possible through contract itself. The said principle was applied in T.A. Choudhary Versus State of A.P. & Ors., supra, wherein the Contractor was expected to commence the work only after the site was handed over. It was held that handing over of the site is a sine qua non for performance of the contract and virtually in the realm of reciprocal promises. Once the Contractor is not expected to commence the work unless the site is handed over to him, it amounts to the promisor not performing his initial obligation and it becomes incumbent on the promisor's part to compensate for any loss sustained by the other party. The provision for extension of time cannot come in the way of claiming compensation for the loss sustained by the contractor in such a situation. In K.N. Sathyapalan (Dead) by LRs Versus State of Kerala & Anr., 2006(4)ARBLR275(SC), the court examined whether the contractor was entitled to compensation for the losses suffered by him on account of price escalation of materials that had taken place during the extended period of completion when such extension of time was necessitated by employer's failure, despite the absence of price escalation clause. It was held that ordinarily, the parties would be bound by the terms agreed upon in the contract, but in the event one of the parties to the contract is unable to fulfill its obligations under the contract which has a direct bearing on the work to be executed by the other party, the Arbitrator is vested with the authority to compensate the second party for the extra costs incurred by him as a result of the failure of the first party.[xvii] Similar observation has been made by the Delhi High Court in Ircon International Limited Versus C.R. Sons Builders and Developers, decided on 11 February, 2020[xviii] and Union of India Versus Haji CM Abdul Khader & Ors., Arbitration Appeal No. 41 of 2015, decided on20.12.2019.[xix] The said finding has been reiterated by the Apex Court in P.M. Paul [1989 Supp (1) SCC 368] and T.P. George case [(2001) 2 SCC 758][xx].

DOCTRINE OF CONTRA – PROFERENTEM

The doctrine of contra proferentum is a well-known principle of construction of a contract that if the terms applied by one party are unclear, an interpretation against that party is preferred. It clearly draws inference against the draftsmen in relation to an ambiguity existing in operation of a clause in the contract either in favour of one party or the other. The Hon'ble Delhi High Court in the case of National Highways Authority v. HCC Ltd., reported at (2014) 211 DLT 656[xxi], while applying the principle of contra proferentum held it is well settled law that where ambiguity or doubt exists in the words of an exclusion clause, then those words are construed against the party putting forth the document, and in favour of the other party. Applying the said principle, an exclusion clause in the contract granting extension of time for delay in performance of contract without price escalation due to the fault of an employer must be read against the employer and in favour of the contractor. It is because when a contract comes to an end due to efflux of time, the terms of the said contract also comes to an end, as a result thereof, the contractor is exposed to vagaries of price escalation in the economy. Therefore, such exclusion clause must be construed as a claim of escalation which cannot be rejected merely on the ground of absence of such a provision in the agreement.[xxii] Legally speaking, if the Arbitrator, thought that there has been a loss due to additional costs incurred by the contractor, the contractor would deserve to have the benefit of escalation of costs.[xxiii]


AGREEMENT AGAINST THE FREE CONSENT OF A PARTY ATTRACTS SECTION 14 OF THE CONTRACT ACT, 1872.

Necessitas non habet legem is an age-old maxim which means 'necessity knows no law'. A person may sometimes have to succumb to the pressure of the other party to bargain who is in a stronger position. As a usual practice, the employers threaten contractors either to agree with extension without escalation or to pay liquidated damages, and under such threat, against the free consent of the contractors, make them sign a supplemental agreement, amounting to coercion and undue influence. This attracts Section 14 of the Contract act where free consent is defined. Any agreement contravening the Indian Contract Act is void and cannot be enforced. The supplemental agreement is thus illegal, void and cannot be enforced, meaning thereby the contractors are fully entitled to escalation of claim notwithstanding the illegal supplemental agreement. Although it may not be strictly in place but we cannot shut our eyes to the ground reality that in a case where a contractor has made huge investment, he cannot afford not to take from the employer the amount under the bills, for various reasons which may include discharge of his liability towards the banks, financial institutions and other persons. In such a situation, the public sector undertakings would have an upper hand. They would not ordinarily release the money unless a "No-Demand Certificate" is signed.[xxiv]

Views Are Personal Only.

[i] JG Engineers Private Limited versus Union of India and Another, (2011) 5 SCC758

[ii] P.M. Paul v. Union of India, AIR 1989 SC 1034

[iii] Factor influencing Decisions on Delay Claims in construction contracts for Indian scenario by Nitin Chaphalkar and published in Australasian Journal of Construction Economics and Building, 14 (1) 32-44

[iv] Text on Civil Procedure, Sixth Edition, by CK Takwani at p. 39.

[v]General Manager Northern Railways & Ors. Versus Sarvesh Chopra, (2002) 4 SCC 43; State of A.P. v. Associated Engg. Enterprises, AIR 1990 AP 294; Raj Kumar Bahal v FCI, AIR 1990 Raj 64.

[vi] Law of Contract and Specific Relief, 10th Edition, by Dr. Avtar Singh at p.400.

[vii] (1984) 2 SCC 680, at pg. 715.

[viii] AIR 1991 Mad 158.

[ix] AIR 1960 SC 588

[x] Black Law Dictionary, Edition 8th, 2012. P.1573

[xi] Doctrine of Quantum Meruit and Doctrine of Unjust Enrichment: An Overview, Chapter 5, Link- https://shodhganga.inflibnet.ac.in/bitstream/10603/76575/14/14_chapter%205.pdf

[xii] Food Corporation of India & Ors Versus Vikas Majdoor Kamdar Sahkari Mandli Limited, (2007) 13 SCC 544

[xiii] 2004 (3) ALD 357; State Of U.P. vs Chandra Gupta & Co, AIR 1977 All 28.

[xv]99 (2002) DLT 512

[xvi] 2004 (3) ALD 357 (Supra).

[xvii] K.N. Sathyapalan (Dead) by LRs Versus State of Kerala & Anr., [(2007) 13 SCC 43]

[xviii] Ircon International Limited Versus C.R. Sons Builders and Developers, decided on 11 February, 2020

[xix] Union of India Versus Haji CM Abdul Khader & Ors., Arbitration Appeal No. 41 of 2015, decided on 20.12.2019

[xx] T.P. George case [(2001) 2 SCC 758

[xxi](2014) 211 DLT 656

[xxii] Tarapore & Co Versus State of Madhya Pradesh, 1994 SCC (3) 521, JT 1994 (2) 162.

Kimti Lal Vohra Versus Haryana State & Ors, MANU/PH/0373/2015

Ircon International Limited (supra)

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