Introduction

Indian Contract Act, 1872

Outsourcing of construction projects, particularly infrastructure projects concerning sectors such as Oil and Gas, Refinery, Petrochemicals, Power etc. Types of contracts:

• Design Bid Build • Management Contracting

• Design Build

DESIGN BID BUILD:

• Traditional means of construction and delivery module • Design and Construction performed by independent contractors -

separate contracts • Sequence - design of the project prepared by a Contractor and

Constructed by another Contractor • Construction phase initiated after conclusion of designing phase

• May cause delay in commencement of the construction

•Increasing costs due to multiple tenders + time

•Conflicts between contractors - technical aspects

•Mismatch of financial estimates

•Multiple point of contact - lack of responsibility + accountability

MANAGEMENT CONTRACTING:

•Traditional approach - Contractor is an intermediary for managing the project•Contractor undertakes the role of coordinating time, cost and quality control and thereby engages sub-contractors for the process as agent•Contractor assumes no responsibility - merely an intermediary

DESIGN BUILD:

• Designing + Construction entrusted to one Contractor • Single point of responsibility + single point of contact +

accountability • Eliminates risks • Construction can begin in spite of the entire design not

being completed• Engineering Procurement and Construction (EPC)

EPC CONTRACT – MEANING:

‘Turnkey Contract’ term is sometimes interchanged with EPC. EPC differs from Turnkey on scale of businesses. EPC linked - large scale business, whereas Turnkey with small scale or medium scale

•Contractor:

Responsible for design, construction and commissioning Associated with developing an operating facility + object to provide an output or operative process, e.g. a mine processing plant, power station etcAlmost all risk is allocated and transferred from the Owner to the Contractor. Owner only need look to the EPC Contractor to address any defect or dispute that arises

Contractor - must deliver facility for a guaranteed price by a guaranteed date and it must perform to the specified level

Failure - result in the Contractor incurring liabilities – damages, invocation of Guarantees and termination

Likely - high contract prices because of inclusion of contingencies and mark up to hedge against risks such as performance, cost increase, time extension, and potential loss

Contractor - through sub-contractors. However responsibility stays with Contractor

•Performance specification - outlines performance standards •When completed - Owner will only need to press the start button to commence operation of the facility•Time certainty - important to Owner - future obligations to provide product from the facility by way of off-take arrangements. There may be chain of contracts i.e. obligations and as such possible liabilities for non performance by the Owner. Protection is by way of Liquidated Damages

BANK GUARANTEE

•An undertaking issued by Contractor’s Bank - guaranteeing compensation to the Owner for loss arising out of beach due to non-completion or inadequate performance of the Contract.

Issued – pursuant to the terms and conditions of the contractUnconditional/ConditionalIrrevocable/RevocableIrrevocable - primary option with Owner to decide upon encashment of the same - Contractor estopped from instructing the bank otherwise.

•Governed by its own terms

•Independent contract between the Owner and the Bank •Disputes, if any, between the Owner and the Contractor - got no relevance with the BG

•Courts do not interfere with invocation of BG

PERFORMANCE BANK GUARANTEE:

• To guarantee the completion of a contract and/or obligations • To guarantee performance within a specified period • Assurance - timely completion, ensures compensation in

event of inadequate performance or unlikely delay

•Retained for a specified period subsequent to completion - safeguard against risks arising out of non performance or inadequate performance:

VariationsDefects Intellectual Property rights actionsPerformance Specifications

•Assures - creditworthiness of the contractor

COMPOSITE BANK GUARANTEE:

•A generic bank guarantee - -provided by Contractor within a specified period of time from the issuance of work order•Cover - entire period of contract•No interest bearing•May be specified - percentage of the total contract value •Cover entire risks arising to the Owner including mobilization advance

BID GUARANTEE:

Issued at initial stage of contractUnconditional commitment - ensure that the party to whom a contract is ultimately awarded will accept the award and proceed with the execution of the project Owner claim by simple statement - Contractor has not accepted the awardReplaced by a Performance Guarantee once project work starts

ADVANCE PAYMENT GUARANTEE:

When mobilization advances to commence projects

Safeguard - commitment to return advance, if, it fails to proceed with the project

RETENTION/WARRANTYGUARANTEE:

•A part of the progress payments (running bill) is retained

•Cover any faults that may subsequently show up in the work performed

PRECAUTIONS:•Terms concerning the guarantee – clearly and specifically must be stated in the tender document/contract inviting bids from contractors•Whether unconditional and irrevocable •Form must be part of the tender document/contract inviting bids from contractors•When invocation - make sure there is a breach•When invocation – make sure loss arising from breach•When invocation – remember the principals of section 73 Contract Act, 1872•Remember there should be no unjust enrichmentIf, wrongful invocation – Contractor can challenge the same leading to damages

• Grounds/reasons for invocation – proper documentation and recording Court however, may interfere, if, there is established fraud or irreparable injustice involved in the case. The fraud must be as to the process of invocation of the BG.

Hindustan Steelworks -Vs- Tarapore & Co. & Another, 1996 SCC (5) 34Oil And Natural Gas Corporation –Vs- Jagson International Ltd., (2005) SCC Bom 810U.P. State Sugar Corporation vs. M/S. Sumac International Ltd. (1997) 1 SCC 568U.P. Cooperative Federation Limited –Vs- Singh Consultants and Engineers (P) Limited (1988)1 SCC 174Hindustan Steelworks –Vs- Tarapore & Co. & Another 1996 SCC (5) 34

•Before invocation – file caveats as applicable – avoid ex-parte orders

Damages

COMMON LAW:

•The Black’s Law Dictionary:“An amount contractually stipulated as a reasonable estimation of actual damages to be recovered by one party if the other party breaches; also If the parties to a contract have agreed on Liquidated Damages, the sum fixed is the measure of damages for a breach, whether it exceeds or falls short of the actual damages.”

Two thumb rule:

•Non-defaulting party - incurred actual loss as a result of the breach

•Loss must not be remote Hadley –Vs- Baxendale [1854] 9, Ex. 341: 96 R.R. 742.

•Compensate - non-defaulting party

•Non-defaulting party - to be placed - as far as the money can do, in the same position in which it would have been had there been no breach

•For the consequences directly + naturally arising from the breach

•Knowledge of circumstances leading to loss of profits imposes liability

As a reasonable man could have foreseen some loss of profit Mere knowledge not enough - should have been brought to the knowledge of the defaulting party that he accepts the contract with that knowledge at the time of contractNon defaulting party is only entitled to recover such part of the loss actually resulting as was at the time of the contract reasonably foreseeable as liable to result from the breachKnowledge ‘possessed’ - May be imputed or May be actual

•No one can be allowed to have unjust enrichment under the garb of claiming compensation for a breach•No loss from the breach no damages•At common law liquidated damages clause will not be enforced, if, its purpose is to punish the defaulting party rather than to compensate the non defaulting party - because it is a penalty•Court sitting in equity will seek to achieve a fair result and will not enforce a term that will lead to unjust enrichment

•In order for a liquidated damages clause to be upheld, two conditions must be met in Common Law:

Damages identified - must - roughly approximate the damages likely to fall upon the non defaulting party Damages must be sufficiently uncertain at the time of entering into the contract that such a clause will likely save both parties the future difficulty of estimating damages

ACTUAL DAMAGES:

•Section 73 of Indian Contract Act, 1872:

“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 the reason of the breach”

•Imposes a duty on the non defaulting party to mitigate its loss

Murlidhar Chiranjilal v. Harish Chandra Dwarkadas (1962) 1 SCR 653:“The injured party has to be placed in as good a situation as if the contract has been performed. The injured party is debarred from claiming any part of damages arising out of his neglect. The onus is on him to mitigate losses consequent to the breach of contract”M. Lachia Setty and Sons Ltd. v. Coffee Board, (1980) 4 SCC 636:“The principle of mitigation of loss does not give any right to the party who is in breach of the contract but it is a concept that has to be borne in mind by the court while awarding damages”

LIQUIDATED DAMAGES:•Liquidated damages – go buy to principal of Hadley –Vs- Baxendale[1854] 9, Ex. 341: 96 R.R. 742: •Prove - breach has occurred•Loss calculation - an estimate of the costs resulting from the non performance (in practice, making that calculation may not be that easy)•Not defined under the Indian Contract Act, 1872, however, finds place in Section 74•Section 74 of Indian Contract Act, 1872:

“When a contract has been broken, 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, whether or not actual damage or loss is provided to have been caused thereby, to receive from the party who has broken the contract reasonable compensation not exceeding the amount so named, or the case may be, the penalty stipulated for.”

•Damages - amount parties designate/assess at the time of formation of contract•Non defaulting party - compensation upon a specific breach e.g. late performance•Do not depend upon the actual loss suffered – doubtful in light of interpretations•The calculation must be ‘genuine pre-estimate’ of anticipated loss in the event of the breach e.g. delay to the project•Onus - Owner to predict and genuinely estimate what the loss would be

•Sufficient, if, the non-defaulting party proves that he has suffered some loss

Indian Oil Corporation –Vs- Messrs Lloyds Steel Industries Limited; 2007 (144) DLT 659)]. Court held mere delay in construction and commissioning of the terminal at Jodhpur by the contractor did not entitle IOC to recover Liquidated Damages because there was no loss suffered by IOC.

•Should have a cap on the maximum liability to minimize the risk on one of the party and ensure no unjust enrichment•Should not be in form of penalty and should not be unreasonable•Breach must be established

Liquidated Damage – Penalty:

•LD is an estimate of the expected loss, pre-assessed and agreed at the time of making a contract•Penalty is a stipulation – to award and impose an amount - disproportionate or excessive•No prudent person would consider the same as a reasonable pre-assessment of damages arising out of the breach•LD represents reasonable stipulation of likely losses•Penalty is far from being reasonable and is intended to threaten the other party and to secure performance of the contract at any cost•Whether penalty or not to be determined against the back ground of factors, e.g. character of transaction and nature, the relative situation of the parties, the rights and obligations accruing and the intention of the parties in incorporating•Penalty is burdensome or oppressive character•Where it is possible to prove the actual loss, parties are not exempted from proving that

Case Laws:

Oil & Natural Gas Corporation Ltd v. Saw Pipes [(2003) 5 SCC 705]:•Terms of the contract - consideration - before concluding whether the party claiming damages is entitled to the same•Clear and unambiguous stipulation for liquidated damages - unless it is held that such estimate of damages/compensation is unreasonable or is by way of penalty, party who has committed the breach is required to pay such compensation and that is what is provided in Section 73 of the Contract Act.•Section 74 is to be read along with Section 73

•Every case of breach of contract, the person aggrieved by the breach is not required to prove actual loss or damage suffered by him before he can claim a decree. The Court is competent to award reasonable compensation in case of breach even if no actual damage is proved to have been suffered in consequences of the breach of a contract

•In some contracts, it would be impossible for the Court to assess the compensation arising from breach and if the compensation contemplated is not by way of penalty or unreasonable, Court can award the same if it is genuine pre-estimate by the parties as the measure of reasonable compensation.

Kailash Nath Associates –Vs- DDA [(2015) 4 SCC 136]:

•The party complaining of a breach can receive as reasonable compensation, if, it is a genuine pre-estimate of damages fixed by both parties and found to be such by the Court•In other cases, only reasonable compensation can be awarded not exceeding the amount so stated•In cases where the amount fixed is in the nature of penalty, only reasonable compensation can be awarded not exceeding the penalty so stated•In both cases, the liquidated amount or penalty is the upper limit beyond which the Court cannot grant reasonable compensation•Reasonable compensation - will be fixed on well known principles - Section 73 of the Contract Act

•Where it is possible to prove actual damage or loss, such proof is not dispensed with•Where damage or loss is difficult or impossible to prove than the liquidated amount named in the contract, if a genuine pre-estimate of damage or loss, can be awardedConcerns from Kailash Nath Associates –Vs- DDA: •How to determine - genuine pre-estimate of damages at the time of entering into contract•It is more or less a short cut to proving damages in case of breach of contract•Section 74 cannot be as rigorous as section 73•Parties have agreed and then why change the same•If, section 74 on same par with section 73, then what is the difference?

Pros:

•Facilitates calculation of risks•Reduces difficulty of proving actual damage or loss•Reduced expense of proving actual damage or loss •Facilitates recovery of damages•Avoids the difficulty in assessment as it avoids the taxation proceedings•Avoids the risk of under-compensation e.g. remoteness.

Precautions:•The liquidated damages amount should be a ‘genuine pre-estimate’.•Keep a copy of the calculation sheet should be kept on file•Get as much data possible before estimating the loss.•Document any negotiations which led to the ‘agreed’ amount.•Document calculations in the contract or in correspondence.•Ensure that the amount does not amount to a penalty. If penalty more likely court will take a different view•If sectional completion - apportion liquidated damages between the sections.•Make provision in the contract for a reduction of liquidated damages in the event of partial possession.•Try to avoid calculation/formulae for arriving at liquidated damages•Ensure through acts or deeds, the right to liquidated damage is not waived•Think whether the arbitrator will have jurisdiction

PRECAUTIONS

•Avoid uncalled liability arising out the clauses – specific, clear and unambiguous•Define with precision the Scope of Work:

Fundamental clauseSuccess of the whole contract depends Clarity and simple language outline of the work to be undertaken

Comprehensive - works are expressly covered, works are expressly excluded, what works are dependent or responsibility of the third party.

Time is essence and depends on same

If not possible at the time of contract (but to be avoided), reserve right to include in future or have with annexure etc.

Linked to formulating the pricing, rights and liabilities of the parties

•Extension of Time:

Important issue - risks associated

Completion of the project on the envisaged timelines is of utmost importance

Delays - unprecedented loss to the Owner.

The more complex the Project - more will be chain of contracts, leading to chain of claims and liabilities

To safeguard is to have - Lump sum or Performance guarantee

The grounds of the extension in time - Clarity and simple language and limited

Force majeure (extra care to be given), change in law, change in scope of work - may give rise to entitlement to extension

Will attract extra cost - escalation clause to be taken care of and specified how and when same crystallise

•Responsibility for obtaining the respective permits and licences•Variation procedures e.g. change in scope of work•Tests and taking over procedures•Defect notification and operation period•Intellectual property rights and their protection, licences and know how for plants;•Insurance and securities/guarantees •Exit clause e.g. arbitration etc.

•Termination: Owner always has more extensive termination rights than the ContractorOwner may terminate, amongst others, when Contractor fails to perform/discharge its duties i.e. breach (most favourable) and change in market conditions

Clearly state the instances of terminationKeep in mind the issue of arbitration whether wide or selective clauseThe consequences of wrongly terminating contract can be significant and lead to claims in damages from contractorSubstantial factual backup e.g. documentationsIdentify evidence

Contractor has the right:To deliver the worksTo get paid for completed worksTo the overheadTo profit to be earned out of the project (unless there are express words to the contrary in the Contract)Terminated – Contractor’s obligation to perform works ceases - obligations to perform the works up to the point of termination is not rendered ineffective. Try to have express word to that effect

What is the effect on sub-contractors?

Define procedure for termination

After Termination & Timescales: Valuation processRisk and cost

Payment of work doneJoint measurementBringing in a new Contractor to complete partially completed works will alwaysMobilization periodsRisk and CostTender process Design liabilityProgramme and liability for delayBalance of risk

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