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22 January, 2019
The Ease of Doing Business rankings released annually by the World Bank currently ranks India at 163 in Enforcing Contracts.[1] The importance placed by the Modi Government on these, and India’s overall dismal performance has forced the government to take several measures, especially in the field of enforcement of contracts.
The Indian Contract Act, 1872 (Contract Act) and the Specific Relief Act, 1963 (Act) are the two primary legislations governing the enforcement of contracts between parties. While the Contract Act lays down the general principles governing contracts and levy of damages for breach thereof, it also provides for an exception of awarding specific relief in the form of specific performance of contracts.
The Act, as is the common law position on this, originally provided for specific performance as a discretionary relief by Courts upon satisfaction of the “inadequacy test”, i.e., when it was proved that damages will be inadequate compensation for the breach. Damages remained the “usual, normal and natural remedy” for broken contracts and were payable in lieu of, or even in addition to, performance of the contract.[2]
Need for Change
The general rule of compensation by awarding damages, with the exception of compelling specific performance in certain cases, created a scenario wherein most instances of contractual breaches were litigated to determine the quantum of damages. With the floodgates open, it is no surprise that such breaches took years to adjudicate, as reflected in India’s rankings in the World Bank report. To remedy this, a six-member Expert Committee was constituted to study the changes needed in the Act to improve enforcement of contracts in India and consequently, improve India’s rating as an investment friendly destination.
Based on the Expert Committee’s Report released in May 2016 (Report), the Specific Relief (Amendment) Bill, 2017 (Amendment) was passed by the Parliament, which sought to flip this “general rule” by omitting §20, which allowed Courts wide discretion in awarding specific performance.
Instead, the Amendment introduced the concept of “substituted performance”, commonly referred to as the right to cover, basis which the innocent party has the option to arrange for performance of the contract by a third party or his own agency and recover the costs from the defaulting party. This is an extension of the mitigation principle, codified in the Contract Act, with the distinction that under substituted performance, losses can be claimed only after the contract has been performed by either a third party or by the innocent party’s agency.
The move is squarely aimed at ensuring that performance of civil/commercial contracts are not held to ransom, and instead, contractual performance is compelled in most instances, a practice prevalent in civil law systems.
Additionally, the Amendment emphasizes timely and unhindered completion of public utility projects by restricting grant of injunctions in infrastructure project contracts. These projects include transport, energy, water and sanitation, and social infrastructure sectors. The Amendment also contemplates establishment of special Courts to adjudicate such matters. Interestingly, with the insertion of §20C, the Amendment mandates that all suits filed under the Act shall be disposed-off within twelve months from the date of receipt of summons by the defendant, extendable by six months at the Court’s discretion.
Further, the Amendment allows appointment of technical experts, whose opinion shall constitute part of the record of the suit, by Courts to assist on any specific issue in the suit.
The Amendment, received Presidential Assent on August 1, 2018, and is effective from October 1, 2018; however, impact of the amendments and their application is yet untested.
Weighing the pros and cons
In a first for common law jurisdictions, the change brought about by the Amendment is an appreciable move towards encouraging and enforcing a behaviour of performance of contracts. Since compelling specific performance is now mandated as the first resort, parties will have fewer reasons to breach contracts and drag disputes to Courts.
The Amendment also avoids the risks associated with over-compensation or under-compensation while awarding damages for breach of contract. Introduction of the concept of substituted performance further emphasizes that performance of contracts is of paramount importance, whether by the contracting party or otherwise. Allowing damages in addition to specific performance acts as a further deterrent against instances of breach. Note that an innocent party only seeking to claim damages for breach may continue to do so under the Contract Act; it is only when specific performance is prayed for that the said provisions will apply.
Further, the focus on timely completion of contracts involving public utility is a welcome move in a country where several infrastructure projects remain in abeyance due to prolonged litigation.
The Amendment also severely restricts instances in which Courts may not grant specific performance, being (a) where substituted performance has been obtained; (b) contracts involving performance of continuous duties which the Court cannot supervise; (c) contracts dependent on personal qualifications of the parties; and (d) determinable contracts.
However, while the Amendment has been effected to limit instances of parties escaping performance of contracts, the Amendment, unlike the erstwhile §20, fails to consider the possibilities of unforeseeable hardship and inequitability in compelling specific performance. In fact, the Report (¶11.11(iii)) specifically stipulates that “rise or fall in prices or market value or change in circumstances after entering into the contract shall not be a factor for refusal of relief”.
Another pressing concern is applicability of the Amendment to existing contracts. The amendments while remedial, are neither declaratory nor clarificatory. Rather, the amendments alter the substantive rights relating to remedies that can be sought for contractual breach. Ideally, as explained in a previous post, the right to seek remedies comes into existence only at the time of occurrence of the breach.
Therefore, if the contract was executed prior to the Amendment, but the breach occurs post the amendments, the Amendment should apply to such contracts. This view is supported by the Supreme Court’s decision in Union of India v. Steel Stock Holders Syndicate ((1976) 3 SCC 108). However, definitive clarity on this is awaited.
M&A Contracts
It will be interesting to note the Courts’ emphasis on specific performance of contracts in the M&A space, specifically those involving acquisitions or investments. Often, damages are an insufficient remedy in case of breach of such contracts; therefore, historically, most M&A contracts stipulate that damages shall not be adequate remedy for any breach and the contract shall be specifically enforceable, substituting the traditional requirement for proof of inadequacy of damages.
With the flip in the general rule, while the need for inclusion of such a clause may have been negated, it remains to be seen how specific performance will be enforced in M&A contracts, especially given the complexities surrounding investments involving time sensitivity, personal qualifications of the parties, etc.
Another area of concern is the application of the now statutory concept of substituted performance of M&A contracts. M&A contracts being party specific, viability of substituted performance as an option may not be as relevant, but it will have to be explored on a case-to-case basis.
Further, prerogative of the Court to refuse specific performance on the ground that the contract, for instance in case of a joint-venture agreement, involves continuous performance of duties by the party, which the Court cannot supervise, creates certain impediments.
It is indeed a relief that the amended Act allows damages in addition to specific enforcement to prevent losses due to passage of time, as the determination of the dispute within eighteen months, may still prove to be too late in certain circumstances.
Conclusion
The erstwhile Act raised considerations of an economic analysis by the defaulting party, who could choose a course of action basis the cost of performance vis-à-visnon-performance of the contract. Holistically, the amendments appear to be focused on ensuring timely and effective contractual performance, and should help improve the “ease of doing business” in India.
While the amendments impact all industries, the special focus on infrastructure will further fillip India’s elaborate development plans.
Further, it is in this sector where damages generally prove to be an inadequate remedy. Implementation of specific performance as well as substituted performance by the judiciary, especially with respect to M&A contracts, and its receptiveness and actual reliance by contracting parties, however, remain to be seen.
For further information, please contact:
Ruetveij Pandya, Partner, Cyril Amarchand Mangaldas
ruetveij.pandya@cyrilshroff.com
[1] World Bank, Doing Business 2018, (October 31, 2017), available at: http://www.doingbusiness.org/data/exploreeconomies/india
[2] Report, ¶11.3.1
