Abstract

Supply contracts, most commonly defined as a legal agreement between the supplier and the purchaser, form an essential part of any infrastructure business as it defines substantive legal terms applicable to the parties and the remedies enforceable in case of a breach in the circumstance of purchase/sale.

In India, construction contracts for the sale and supply of goods are governed primarily by the provisions of the Indian Contract Act, 1872 and the Sale of Goods Act, 1930. However, the important legal principles under contract, sale of goods and specific relief law should be critically considered while interpreting key clauses of supply contracts as they often form a cause of dispute between the parties to the agreement. This article analyses certain extreme cases of interpretations of specific clauses of a construction or a supply contract and provides remedies that the contracting parties can adopt for effective enforcement. The article, thus, seeks to establish the Indian practice relating to commercial supply agreements and can be considered as a useful tool in interpreting major clauses in such contracts.

Introduction

In commercial law, the use of supply contracts remains of increasing importance and has been a subject of a range of commentaries both from a technical and a practical perspective. Primarily, commercial parties enter supply contracts broadly for two purposes – it ensures timely supply of products for a prescribed period and offers reliable cash flows, thus making any breach of such a contract a crucial operational block. There exist several legal issues that, while common to a commercial contract, are magnified in supply contracts and if not clearly understood, may lead to a range of issues post- breach in addition to the reputational loss it causes to the defaulting party.

Typically, the keystone of a commercial supply agreement lies in the seller’s obligation to sell and deliver and the buyer’s obligation to purchase and accept, resting on the following four elements: (a) specified quantities, depending upon the terms of the agreement, (b) at a designated point of delivery or the registered address of the buyer, (c) for a particular price and (d) within a particular period, if time is of the essence and a reasonable period of time, in any other case. It is also worth noting that commercial supply contracts present a challenging task for practitioners due to their high value and large volume, often resulting in high stakes in case of a dispute and offering an incentive to settle before any judgment is delivered by judges. Consequently, a majority of such practical difficulties often go unreported, making the analysis from a practical standpoint all the more crucial. Secondly, the synthesis of contract law developed as a result of English case laws as decided in the past differs quite significantly from what prevails today. Modern construction contracts, in contrast to erstwhile single-transaction supply agreements (mostly relating to the sale of land), are often complex sets of transactions. [1] Hence, the key terms need to be drafted with the utmost detail to regard all possible circumstances which may result in breach – certainly not an easy task for any practitioner.

This article analyses some of the key terms in construction contracts typical of the Indian market, in light of the Indian law and broadly discusses the important legal principles under contract, sale of goods and specific relief law that should be considered while interpreting key clauses of supply contracts. The article also traces, from a commercial perspective, the operation of these clauses and their effects on the parties to contract in case of default.

Key Supply Contract Clauses: Analyzing the Intricate Elements

1. Implied Warranties Disclaimers

A contract for sale of goods often implies a large number of terms in an agreement. These terms often provide for the right of the seller to sell the goods, that the goods are reasonably fit for the purpose for which they are purchased, that the goods conform to the description or that they are of satisfactory quality. [2] However, the extent to which the terms are implied is often subject to the test of ‘reasonability’. In the United Kingdom, section 14(1) of the Sale of Goods Act, 1979 provides that under a contract of sale, no implied warranty or condition as to fitness or quality for any particular purpose of goods supplied under a contract of sale exists between the parties. However, where the buyer relies on the seller’s skill and judgment and the goods are of a description which is in the usual course of the seller’s business to supply, an implied condition that the goods are reasonably fit for such purpose exists. [3]

While considering the implications arising from implied terms and conditions, Courts have distinguished them from an express contract or express warranty by holding that implied warranties are found on the presumed intention of the parties and upon reason. As a result, the implication which the law draws from what must have been the intention of the parties, it draws with the object of giving efficacy to the transaction and preventing such failure of consideration as cannot have been within the contemplation of either side.” [4] In considering the disclaimers of implied warranties, it is also important to note that the Indian courts recognize that parties to a contract can contractually waive such implied warranties. Section 62 of the Sale of Goods Act provides for an exclusion of implied terms and conditions stating “where any right, duty or liability would arise under a contract of sale by implication of law, it may be negative or varied by express agreement or by the course of dealing between the parties, or by usage, if the usage is such as to bind both parties to the Contract.” While in relation to immovable property, the High Court of Karnataka in the case of R.L. Pinto v. F.F. Menzes [5] held that it is open to the parties to waive the implied warranty of title by a contract to the contrary. It may be possible to extend the principle also to a sale of movable property and goods.

With respect to the second exception to Section 16 which provides for an implied warranty of merchantable quality [6], the same is subject to a precondition that no implied condition exists with respect to defects ought to be revealed from an examination of the goods done by the buyer(s). Accordingly, where a Buyer has been given adequate opportunities of inspecting and verifying the goods being supplied, the implied warranty regarding fit for purpose can be considered as being excluded. In the case of Sorabji Hormusha Joshi and Co. v. V. M. Ismail, [7] the Court on evidence noted that where the Buyer has an opportunity to examine the goods and does not avail himself of such opportunity, then the benefits of implied warranty may not continue to be available to such buyer. The Court noted that “on evidence, it is clear that the first plaintiff who had an opportunity to inspect the goods did not avail himself of the same and was content to take delivery and having done so it does not lie in his mouth now to say that un-merchantable goods were fraudulently palmed off on him.” In the case of Provincial Government v. Nemichand Beharilal Jain, [8] the Court extended the argument to include contractual situations where the buyer had the right to inspect the goods before purchase but did not avail himself of the opportunities and held that even in such cases there would be no further implied conditions or warranties.

2. Limitation of Liability

A limitation of liability clause in a contract is generally valid and enforceable under Indian law except where the liability arises on account of fraud or gross negligence which are accepted exceptions to the principle of limitation of liability. The principle of limitation of liability has been provided under Section 74 of the Contract Act, “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,…to receive…reasonable compensated not exceeding the amount so named or, as the case may be, the penalty stipulated for.” The Supreme Court in the case of Fateh Chand v. Balkishan Das [9] has laid down that the party aggrieved is only entitled to reasonable compensation not exceeding the amount named or penalty stipulated, notwithstanding the terms of the Contract. Several other Indian cases such as Shree Hanuman Cotton Mills v. Tata Air Craft Ltd. [10]; Subbarayulu v. Arman Annamalai [11], Surjit Kaur v. Naurata Singh [12], etc. have also upheld that the liability of a party is limited under a contract, to a reasonable amount, and in any event not exceeding the specified sum agreed by the parties in the contract.

Notably, in the case of Bharathi Knitting Co. v. DHL Worldwide Express Courier Division of Airfreight Ltd. [13], the contract in question provided for a limitation of liability clause, but the Supreme Court held that the liability of DHL was limited to the amounts pre-agreed between the parties, establishing the rule with respect to limitation of liabilities in construction contracts.

3. Liquidated damages as exclusive damages

Liquidated damages, as defined in Manian Patter v. Madras Railway Co. [14] is the sum which the parties to the contract have assessed as damages to be paid whatever may be the actual damage. Under Section 74 of the Contract Act, ‘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,…to receive…reasonable compensated not exceeding the amount so named or, as the case may be, the penalty stipulated for.” [15] The Courts have held that if a particular contract provides for such damages, unless the party claiming the liquidated damages has wrongfully invoked the liquidated damages clause, it is considered binding upon the parties provided the same is not in the nature of a penalty or specified as in terrorem. [16]

The position that the Indian courts have consistently adopted is that mere use of the term ‘liquidated damages’ in a contract by itself is not decisive and that the same is not a penalty. [17] Usually, a stipulation in a contract defined as liquidated damages may well turn out to be a penalty in a given case, depending upon the facts and circumstances of each case. [18] Further, the ability of the claimant to prove that the amount of liquidated damages is a genuine pre-estimate of the loss that would in fact be suffered by the claimant on breach of the contract is also a crucial factor for the same to be considered as a penalty. Accordingly, the scope for judicial review remains even in circumstances where there exists an express acknowledgment in the liquidated damages clause [19], that the levies are a genuine pre-estimate of loss and not in the nature of a penalty [20].

Remarkably, in cases of construction contracts, the aggrieved party (either supplier or purchaser) is usually not entitled to claim damages in relation to the breach where liquidated damages are specified as pre-agreed quantified damages, leaving the liquidated damages as the only remedy. [21] This is due to the fact that the provision of compensation in express terms normally excludes the right to claim damages under the general law and hence, the parties to the contract cannot claim that such a right to claim damages is left unaffected. [22] The settled position of law is, therefore, clear – that where parties to a contract have specified an amount as liquidated damages that would be payable by a party in case of breach of the contract, such liquidated damages act as a cap on the amounts payable under the contract for such breach.

4. Force Majeure

Force majeure clauses are often found in sale and construction contracts governed by Indian law and have been held to be enforceable by the courts in various cases [23]. It is a well-established and recognized principle under Indian law encompassed within the ambit of the doctrine of frustration under which non-performance stands excused by reason of an impediment beyond its control which could neither be foreseen at the time of entering into the contract nor can the effect of the supervening event be avoided or overcome. [24] Enforceability of the clause, however, needs to be determined on a factual basis as to whether the contractually agreed force majeure event transpired or not, (including on facts whether the same was or was not in the control of the party, or whether the breach was or wasn’t on account of such force majeure event, etc.).

Typically, suppliers should ensure that the contractual terms give the right to declare force majeure in the event of a supply chain disruption. Further, the parties seeking to invoke force majeure should prove that there are no alternative means for the fulfillment of the contract. It is also necessary to define the events that constitute force majeure and set forth the obligations post the occurrence of the force majeure event (i.e. the operative effect).

5. Warranty remedies as sole remedies for failure of products to conform to warranties

Indian law does not permit an absolute exclusion of legal remedies and the right to approach courts [25]. Consequently, an absolute exclusion of the buyer’s right to approach the courts as well as to seek alternative remedies than the remedy of having the equipment repaired and/or replaced may not be legally enforceable in India. Section 21 of the Specific Relief Act, 1963, however, grants power to the courts to allow damages in addition to the relief for specific performance [26], notwithstanding the buyer being capable of being able to specifically enforce the performance of the contract. However, the Court in determining the amount of any compensation awarded under Section 21, is bound by the principles specified in section 73 of the Contract Act, 1872.

Remarkably, nothing precludes the seller from being able to take the defense that the liability of the seller is contractually capped and that an adequate remedy has been mutually agreed upon by both parties. Further, the seller can also take the defense that upon the performance of the actions to give effect to the remedy, the loss of the buyer would be fully compensated. It may happen that the court would uphold the argument by the seller and limit his obligations subject to the overall limitation of the liability clause. However, the above defenses do not in itself preclude the buyer from approaching the courts and seeking alternative remedies. As a result, a formulation based on pre-agreed quantification of all possible losses may be considered and the treatment of the same be done as liquidated damages if all the possible concerns faced by the seller are kept in mind. That is, the cost of repair/replacement is a genuine pre-estimate of the loss that would be suffered by the buyer on account of a breach of the warranties; and the liability of the seller is limited to either (i) payment of the cost of repair/replacement, or (ii) actual repair/replacement.

As per Section 74 of the Indian Contract Act, when the parties have contractually agreed to or placed a cap on the liability/amount that would need to be paid upon a breach of the Contract, the Court would not (except in certain exceptional situations, such as fraud, etc.) impose any damages/costs in excess of such amounts. Accordingly, the attempt is to limit the aggregate liability of the seller to the cost of repair/replacement and thereafter be able to further build on the defense that the seller is willing to remedy the buyer through repair/replacement and consequent damages should not be considered.

6. Safety and health indemnity

According to the provisions of the Indian Contract Act, parties are permitted to enter into a contract whereby one party promises to protect the other for any losses that it may suffer as a result of the conduct of the promisor or the conduct of any third party. A standard contract typically seeks to attain precisely this objective and clearly specifies that the obligation of the seller is to provide all warning, safety and health-related information concerning the set of equipment/ containers in which the set of equipment will be sold, to the buyer. The buyer then assumes the responsibility of transmitting and ensuring compliance with all the warning, safety and health relating information to all persons who in the buyer’s judgment would be exposed to/ use the set of equipment/ containers in which the set of equipment will be sold.

Under the provisions of section 124 of the Contract Act, 1872 which lays down the principle of indemnity, where a buyer has agreed to indemnify the seller for any losses arising from the buyer’s conduct in respect of the safety, health, warning information, i.e. the buyer’s failure to fulfill its obligation to communicate/ transmit and ensure compliance the safety, health, warning information, and the safety information was found to be inadequate or incorrect, and some liability arises on account of the same, then notwithstanding the indemnification obligation of the buyer, the liability may still revert to the seller.

7. Waiver of consequential damages/lost profits

Section 73 of the Contract Act makes provision for compensation for loss or damage caused by the breach of a contract. Section 73 lays down that an injured party may recover compensation for any loss or damage caused to him due to the breach “which naturally arose in the usual course of thing from such breach or which the party knew, when they made the contract, to be likely to result from the breach of it”. Compensation is generally not likely to be given for any remote and indirect loss or damage sustained by reason of the breach.

Consequently, a party can only claim compensation for damage or loss that may fairly and reasonably be considered as arising according to the usual course of things from the breach of contract or such as may reasonably be supposed to have been in the contemplation of both parties at the time they made the contract, as the probable result of the breach of it. This position under the Common Law that damage or loss characterized as consequential loss is recoverable if it was in contemplation of parties at the time when they made the contract, as the probable result of the breach of it or if it arises naturally from the breach of contract, is also applicable in India. A determination of this sort (that is, whether the losses are consequential or not) is a question of fact and the intention of the parties plays a very important role in determining the same. In the case of Bharathi Knitting Co. v. DHL Worldwide Express Courier Division of Airfreight Ltd. [27], a clause in the contract between the respondent and the plaintiff, for the courier of certain goods provided that “DHL shall not be liable in any event for any consequential or special damages or other indirect loss however arising whether or not DHL had knowledge that such damage might be incurred including but not limited to loss of income, profits interest, utility or loss of market”. The Supreme Court of India has held that the aforementioned clause was enforceable and the plaintiff could not claim any damages over and above those specified in the contract.

Conclusion

Commercial construction supply contracts have a rich history in the Indian legal landscape, with increased prevalence in current times bound to result in judicial consideration of many key clauses in years to come. The challenge that remains for the courts is to give effect to the commercial intention of the parties, without affecting the rights and obligations of either the purchaser or the seller in an adverse manner and to set a balanced precedent that neither favors nor disregards any party to contract. Consequently, the drafting of such agreements must be given utmost consideration and practical nuances be regarded deeply, to avoid any commercial disputes at the time of termination. The parties need to assess the impacts over terms of the agreement and any risk that may arise in the future with respect to clauses discussed above can certainly not be ignored at the time of drafting.

However, these developments over time have continued to be a ‘legacy’ of such contracts and it is expected that the law would encourage both parties to act in a commercially reasonable fashion. Although this article concerns the application of commercial supply contracts in the construction industry, the analysis of key terms is useful for other private contracts in infrastructure dealings as well. A consideration of the clauses as mentioned above has the underlying purpose of making supply contracts ‘simple, flexible, uniform and predictable’.

About the Author

Hatim Hussain is a Rhodes Scholar and an alumni of the Gujarat National Law University (GNLU).

Editorial Team

Managing Editor: Naman Anand

Editor in Chief: Akanksha Goel and Aakaansha Arya

Senior Editor: Kanak Mishra

Associate Editor: Jhalak Srivastav

Junior Editor: Kshitij Pandey

Preferred Method of Citation 

Hatim Hussain, “Analyzing Supply Contracts: Interpretation of Major Clauses and the English Practice relating to Commercial Agreements” (IJPIEL, 11 June 2021)

<https://ijpiel.com/index.php/2021/06/11/analyzing-supply-contracts-interpretation-of-major-clauses-and-the-english-practice-relating-to-commercial-agreements/>

Endnotes

[1] Louis Chiam and Vishal Ahuja, Long-Term Supply Contracts – Time for Review 25 Australian Resources & Energy LJ 149 (2006).

[2] Sale of Goods Act, 1979, Section 12-14, (India).

[3] Sale of Goods Act, 1979, Section 14(3), (India).

[4] Puravankara Projects Ltd. v. Hotel Venus International and Ors, 2007 (6) ALT 1 (SC).

[5] R. L. Pinto v. F.F. Menzes, AIR 2001 Kant 41.

[6] That is, “where goods are bought by description from a seller who deals in goods of that description (whether he is the manufacturer or producer or not)”.

[7] Sorabji Hormusha Joshi and Co. v. V. M. Ismail, AIR 1960 Mad 520.

[8] Provincial Government v. Nemichand Beharilal Jain, AIR 1941 Nag 203.

[9] Fateh Chand v. Balkishan Das, AIR 1963 SC 1405.

[10] Shree Hanuman Cotton Mills v. Tata Air Craft Ltd, (1970) 3 SCR 127.

[11] Subbarayulu v. Arman Annamalai, AIR 1944 Mad 526.

[12] Surjit Kaur v. Naurata Singh, AIR 2000 SC 2927.

[13] Bharathi Knitting Co. v. DHL Worldwide Express Courier Division of Airfreight Ltd, AIR 1996 SC 2508.

[14] Manian Patter v. Madras Railway Co., (1905) 29 Mad 118.

[15] Indian Contract Act, 1872, Section 74, (India).

[16] K P Subbarama Sastri v. K S Raghavan, AIR 1987 SC 1257; Sabina D’Costa v. Joseph Antony, AIR 1984 Kant 122; The English case of Dunlop Pneumatic Tyre Co. Ltd. v. New Garage & Motor Ltd, (1915) AC 79 is often referenced as the same sets out various conditions to distinguish between penalties and liquidated damages.

[17] Reliance is placed on the English case of Kembble v. Farren, [1824-34] All ER Rep 641 where a sum expressly declared by the parties to be ‘liquidated and ascertained damages and not a penalty or penal sum or in the nature thereof’, was held to be a penalty.

[18] Union of India v. Vasudeo Agarwal, AIR 1960 Pat 87; Geo Pictures Ltd. v. Neelakandaru Goapalkrishnaru, AIR 1971 Ker 274; ONGC v. SAW Pipes Ltd., AIR 2003 SC 2629.

[19] It should be noted that the aforementioned Clause 6.2 does not contain this additional language, however in clauses such as Clause 4.7 and 19.2 (which are in relation to limiting the liability of the Seller), we have provided for this language in the marked up agreement).

[20] In the case of Bharat Sanchar Nigam Ltd. v. Motorola India Pvt. Ltd., AIR 2009 SC 357 the court held that parties cannot by contract exclude judicial review of the amount of liquidated damages by the court.

[21] Fateh Chand v. Balkishan Das, AIR 1963 SC 1405.

[22] See, Sir Chunilal Mehta v. Century Spinning and Manufacturing Co. Ltd., AIR 1969 SC 1314. This position has also been followed by SC in Steel Authority of India v. Gupta Brother Steel Tubes Limited, 2009 10 SCC 63; Shiva Jute Baling Ltd. v. Hindley and Co. Ltd., (1960) 1 SCR 569.

[23] G.A. Galia Koytwala and Co. Ltd. v. K.R.L. Narsimhan, AIR 1954 Mad 119 (DB); Lal Mohan Ghosh v. Ramanath Shaha, AIR 1954 Tri 17.

[24] Industrial Finance Corporation of India Ltd. v. The Cannanore Spinning & Weaving Mills Ltd. and Ors., (2002) 5 SCC 54.

[25] India Contract Act, 1872, Section 28, (India).

[26] The words ‘in addition to’ have been incorporated after the Specific Relief (Amendment) Act, 2018. This was also held in the case of Indian Iron & Steel Co. ltd. v. C. G. Engineering Private Ltd., AIR 1983 Cal 6.

[27] Bharathi Knitting Co. v. DHL Worldwide Express Courier Division of Airfreight Ltd., AIR 1996 SC 2508.