Compensation Claim By Way Of Cost Escalation - On Account of Prolongation of Contract Period

Introduction

When under a contract an employer entrusts works to a contractor to be carried out in a time bound manner by supplying specified material and/or by deploying resources like staff, labour, machinery etc., the employer usually undertakes reciprocal obligations like delivering to the contractor the site, approved drawings and other inputs/approvals etc., as per agreed timelines. If the employer commits breach in performing such reciprocal obligations by delivering site etc. in time, the period of execution may get stretched.  As a consequence of prolongation of period of execution, the contractor may suffer losses on account of inter alia escalation of cost of material to be supplied or labour and machinery to be deployed for executing the works. The contractor can institute a suit to recover such losses. Such entitlement is traceable to section 73 of the Indian Contract Act 1872 which allows the party suffering losses as a result breach of contract to receive compensation from the party in breach.

Possible contractual terms governing escalation of cost

Broadly, the agreed terms between the employer and the contractor may present following three situations:

i) There is a specific provision for rise in price payable to the contractor on account of escalation of the cost of material, resources etc. as per agreed formula.

ii) There is no provision dealing with the effect of such price escalation.

iii) The contract makes the price agreed to be fixed and prohibits claim for escalation.

When contract allows escalation

The first situation poses no difficulty and in the event of contract period getting prolonged, it is open to the contractor to claim escalation based on agreed term/formula.

When contract does not provide for effect of cost escalation

In second scenario where contract is silent as to effect of price rise during an extended period of execution, the courts treat escalation as a normal and routine incident arising out of gap of time in the present inflationary age in performing any contract. Accordingly, they allow an increase in prices of materials and cost of deploying resources during the extended, period of the contract, if the delay is caused by employer’s breach.[1]

When contract prohibits escalation

In the third category of cases, i.e. in cases where the contract bars a claim for compensation on account of any delays or hindrances caused by the employer, generally speaking, the contractor may claim only extension of the period of the contract and the claim for compensation would normally not be maintainable[2].

Exceptions

However even when under the contract between the parties the contractor undertakes not to make any claim for delay in performance of the contract occasioned by an act of the employer, the claim may be tenable in one of the following situations[3].

(i) if the contractor repudiates the contract exercising the right to do so 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; or

(iii) if the contractor makes it clear that escalation of rates or compensation for delay shall have to be made by the employer and the employer accepts performance by the contractor in spite of delay and such notice by the contractor putting the employer on terms.

The courts generally adopt a liberal construction of a contractual term prohibiting price escalation during the period of the contract by holding that such embargo would not be carried beyond the period fixed by the contact when time is of the essence of the contract.[4]

There also may be an instance where the prohibition in regard to the payment of compensation for delayed work may be restricted by the contract upto only a given period. In such cases, the contractor is entitled to recover damages for the delay in excess of the period so stipulated[5]. If compensation is restricted for temporary stoppage of work, escalation could still be claimed for complete stoppage for long durations.[6]

In case of an increase in statutory wages, inspite of embargo against escalation the contractor may claim the differential wage on the ground that contractor was not anticipated to cut down its profit.[7]

The takeaway

A contractor while undertaking a work should insist for a clause to expressly permit escalation in case of prolongation of execution, particularly for reasons beyond his control. In absence of such clause also it may be possible to claim escalation by demonstrating default on the party of the employer. The contractor must be careful while accepting express embargo against price escalation and should restrict the same to contract period only.

[1] P.M. Paul v. Union of India, 1989 Supp (1) SCC 368, Food Corporation of India Vs. A. M. Ahmed & Co. (2006) 13 SCC 779, K. N. Sathyapalan V/s. State of Kerala and another (2007) 13 SCC 43,  Hyderabad Municipal Corporation v. M. Krishnaswami Mudaliar & Mudaliar and Anr. (1985) 2 SCC 9, State of U.P. v. Ram Nath International Construction (P) Ltd., (1996) 1 SCC 18 

[2] Ramnath International Construction (P) Ltd. v. Union of India, (2007) 2 SCC 453

[3] Northern Railway v. Sarvesh Chopra, (2002) 4 SCC 45

[4] Associated Construction v. Pawanhans Helicopters Ltd., (2008) 16 SCC 128

[5] U.P. SEB v. Om Metals & Minerals (P) Ltd., (2002) 9 SCC 512

[6] State of Maharashtra v. Nav Bharat Builders, 1991 Supp (1) SCC 68

[7] Tarapore & Co. v. State of M.P., (1994) 3 SCC 521 

 

Smita Singh 
on 02 July 2018
Published in Civil Law
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