This article is written by Antara Basantani, SOA National Institute of Law, 3rdYear BALLB(H) student during an internship at LeDroit India.
Introduction
Damages are the most commonly chosen remedy in cases of contract violations. In contract law, damages are typically granted to restore the non-breaching party to the position they would have occupied had the contract been fulfilled properly. However, an important question arises regarding the extent of the breaching party’s liability.
Is the breaching party responsible for compensating all the losses, including both direct and indirect, incurred by the non-breaching party as a result of the contract breach? Should remote losses also be subject to compensation?
The key case law that tackles these issues is the English case of Hadley v. Baxendale ([1854] EWHC J70), decided in 1854. This ruling was issued by the Court of Exchequer, presided over by Judge Sir Edward Hall Alderson.
The decision establishes a limitation on the liability of the party in breach, ensuring that the awarded damages do not become excessively burdensome. Such a limit on the liability of the contracting party is warranted since limitless liability would discourage individuals from entering into commercial agreements. An unconstrained liability creates a precarious environment for contracting, where parties cannot accurately foresee the financial implications of their commitments.
The principle established in the ruling is reflected in the contract laws of various common law nations, including the Indian Contract Act of 1872.
This article aims to clarify the rule from Hadley v. Baxendale and how it is represented in the Indian Contract Act of 1872. It also highlights cases where the rule has been applied and discusses the criticisms of the rule in more recent times.
Facts of Hadley v. Baxendale (1854) 9 Exch 341
The English case of Hadley v. Baxendale centres around a contract for the transportation of a broken part from a mill. Hadley and his associates owned the City Steam Mills located in Gloucester. This mill specialized in cleaning and processing food grains into flour and bran using steam power. On a particular day, the crankshaft that powered the steam engine broke, causing production at the mill to stop.
The mill’s owners reached out to the engineering company W. Joyce & Co. in Greenwich to create a new crankshaft. The manufacturers requested that the broken crankshaft be sent to them for reference when constructing the new part.
Hadley, through his representative, contacted Baxendale, who was running the common carrier Pickford & Co. The two parties came to an agreement on the shipping price for the broken crankshaft and also set a deadline for delivery. Hadley emphasized that timely delivery was crucial. However, the shipment was diverted through London where the broken crankshaft was stored until it could be shipped alongside other items to Greenwich. The delivery to the manufacturer arrived several days past the agreed deadline. Throughout this period, the mill in Gloucester remained idle. Hadley incurred significant losses due to the mill’s shutdown.
Feeling wronged by his losses, Hadley filed a lawsuit against Baxendale seeking damages to cover the impact of the mill’s inactivity, as well as the potential loss of goodwill and customers.
Rule of Hadley v. Baxendale
The question before the Court of Exchequer was: whether Baxendale was liable to compensate for the non-operation of the mill?
The Bench held that Hadley cannot recover the loss of profits from Baxendale as the shutting down of the mill was not contemplated as a consequence of the breach of contract by the breaching party. Hadley at the time of contracting did not mention that the mill will be non-operational till the new crankshaft is installed. A party cannot be expected to compensate for what he was not able to reasonably contemplate at the time of entering into a contract.
The judges pointed to alternate circumstances where also a mill owner could be sending his machinery for repair. There could be a spare for such a vital component so that the mill can remain functional or the mill could remain functional even without the component. Since the component was so vital to the mill’s operation Hadley could have simply informed Baxendale of the nature of loss he stands to suffer if the delivery is not made on time. A reasonable man cannot be expected to come to that particular conclusion on his own.
Judge Sir Edward Hall Alderson laid down a general rule on damages in breach of contracts as:
Where two parties have made a contract which one of them has broken, the damages which the other party ought to receive in respect of such breach of contract should be such as may fairly and reasonably be considered either arising naturally, i.e., according to the usual course of things, from such breach of contract itself, 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.”
The rule of Hadley v. Baxendale, as stated above, talks about two types of damages: general damages and consequential or special damages.
General damages refer to the losses that inherently result from a contract breach. For instance, if Raj agrees with Jai to deliver a specific quantity of food grains at a predetermined price by a certain date but fails to do so, the general damages would be based on the difference between what Jai ends up paying to acquire the same volume of food grains from another seller on that date. Therefore, in this scenario, the general damages would be the variance between the market price and the contract price for the goods.
The parties involved in a contract can typically foresee general damages as the expected result of failing to fulfil contractual obligations, allowing the non-breaching party to claim them. In contrast, consequential damages tend to be more challenging to assess.
Each contracting party possesses various interests, some of which may not be communicated or understood by the other party. Consequently, a breach of contract can lead to several negative effects for the parties involved, which, although not a direct result of the breach, can be classified as consequential. Consequential damages are intended to cover such indirect losses.
According to the rule of Hadley v. Baxendale, consequential damages can be claimed by the non-breaching party only if both the parties to the contract were aware of the possibility of such losses arising from the breach of contract. It is also to be noted that the rule on consequential damage is applied based on the knowledge of the parties at the time of contracting and according to the standard of a reasonable man.
The rule about consequential damages is effectively limiting the liability of the parties to a contract in the event of a breach of a contract. For example, consider the same situation we discussed in case of general damages involving the delivery of food grains by A to B on a specified date. If the food grains were required by B as input to his food processing industry and a failure of A to deliver the items on time will lead to halting of operation of the industry. A will be liable for the loss of profit only if B had informed him that the production will have to be stopped in case of delay in delivery of food grains.
The rule of Hadley v. Baxendale has wide acceptability and is incorporated in the contract laws of most common law jurisdictions.
Rule of Hadley v. Baxendale in Indian Contract Act, 1872
The rule of Hadley v. Baxendale is incorporated in the first proviso of Section 73 of the Indian Contract Act, 1872. The Section, in full, states that:
“73. Compensation for loss or damage caused by breach of Contract– 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.
Compensation for failure to discharge obligation resembling those created by contract- When an obligation resembling those created by contract has been incurred and has not been discharged, any person injured by the failure to discharge it is entitled to receive the same compensation from the party in default, as if the person had contracted to discharge it and had broken his contract.
Explanation- In estimating the loss or damage arising from a breach of contract, the means which existed to remedy the inconvenience caused by the non-performance of the contract must be taken into account.”
The rule as embedded in Section 73 of the Indian Contract Act, 1872 had been used to decide several seminal cases by the Indian Judiciary.
Application of the rule by Indian courts
One of the earliest case laws in India applying the rule of Hadley v. Baxendale was Madras Railway Co. v. Govinda Rau. In this case, the petitioner Govinda Rau was a tailor who employed the Railway Company to ferry his sewing machine and clothes to Karamadai, where the former was to set up shop during a local festival. But the delivery of the goods was delayed and Govinda Rau had to return without being able to run his business.
Rau sued the Railway Company for damages to compensate for his travel expenses and for the profits lost from operating his business during the festival.
The High Court of Madras did not entertain the claim for damages for lost profit, citing the provisions of Section 73 of the Indian Contract Act, 1872, as Rau had not informed the Railway Company of the date by which the goods were to be delivered or the purpose for which the goods are being transported.
Another application of the rule is seen in Union of India v. Hari Mohan Ghosh. The case was related to a lost consignment of artificial silk which was under transportation by the Indian Railways. Hari Mohan the owner of the goods sued the railways for the value of the goods and the lost profit. The Guwahati High Court did not grant damages for the lost profit as the Railways was not aware of the nature or the purpose of the goods transported.
Contemporary critiques of the Rule of Hadley v. Baxendale
Although the rule of Hadley v. Baxendale is widely accepted, modern commentators have raised objections. Critics argue that the rule has evolved into a strict principle that limits the ability to claim damages for unaddressed events in a contract.
In today’s dynamic business environment, where large corporations engage in high-stakes and impactful commercial transactions, it is expected that parties comprehend all potential consequences of a breach of contract. Technological advancements have created a scenario in which the outcomes of a contract breach can at least be reasonably predicted, if not determined with certainty.
Moreover, businesses are expected to remain vigilant even after entering into contracts for any changes in circumstances that could lead to completely different repercussions from a breach. Parties are also anticipated to proactively guard against such eventualities. Therefore, the inflexibility of the rule of Hadley v. Baxendale, which permits compensation only for losses anticipated at the time of the contract, may be undermining principles of fairness and equity.
Nonetheless, despite these criticisms, the rule of Hadley v. Baxendale continues to be widely accepted in jurisdictions that follow English common law.
Conclusion
The principle established in Hadley v. Baxendale restricts the liability of contractual parties. In cases of contract breach, this rule dictates that the party at fault must compensate only for losses that naturally arise from the breach and for those losses the parties could have reasonably foreseen when entering into the contract.
This rule encourages commercial contracting by capping the financial repercussions of a breach. Compensatory damages should be provided only for the most direct outcomes of a breach.
Nonetheless, as business practices evolve and technology advances, even the most remote effects of a breach can now be anticipated and managed. Consequently, some scholars argue that the Hadley v. Baxendale rule is outdated and requires revision.
In spite of these criticisms, the Hadley v. Baxendale principle remains widely applicable and accepted across many jurisdictions that follow English common law.
