India ranks at #164 in the world rankings for ‘enforcing contracts’ given by the World Bank, and at #100 in the same rankings for “ease of doing business”. Certainly, this is a cause of concern and it is only natural for the Government to take steps towards improving the state of affairs pertaining to contracts’ enforcement and faster dispute resolution. Several much-anticipated reforms are already in the pipeline – the Arbitration (Amendment) Bill, 2018; the Specific Relief (Amendment) Bill, 2018; an Ordinance amending the Commercial Courts, Commercial Division and Commercial Appellate Division of High Courts Act, 2015 and so on. While it remains to be seen how all these well-intentioned legislations will pan out in the practical scenario, we herein examine one aspect of the proposed amendment to the Specific Relief (Amendment) Bill, 2018 (“Bill”), and how it will affect performance of contracts in India and their enforcement.
The Bill introduces a new concept of “substituted performance” by amending existing provisions of the Specific Relief Act, 1963 (“Act”). Briefly, the proposed provision [ see End Note 1] , like the overall intent of the Bill, seeks to make specific performance a rule, rather than an exception. This is done by giving the promisee (the aggrieved party), a right to have the (breached) contract performed through a third party or by his own agency. The promisee can then recover the expenses and other costs incurred for such ‘substituted performance’ from the promisor (the defaulter). On the procedural front, the aggrieved party is first required to put the defaulter at notice to cure the default, and on expiry of the cure period, if the promise is still not performed, the aggrieved party can exercise substituted performance. Though the amendment specifically clarifies that exercising such substituted performance does not limit other rights of the aggrieved party, like claiming compensation, it conveys a clear message that specific performance should be adhered as a rule.
Position prior to the Bill
The concept of “substituted performance” is not a novel one in common law, and exists in various forms. However, the term has been used for the first time in the legislations governing Indian contracts, in the Bill. Also known as the “right to cover”, it ensures that the aggrieved party can obtain performance of a contract from a third party in case of non-performance (inability or breach) by the counterparty who fails to perform and the right to recover the consequent loss suffered by the performing party. “Cover costs” refer not to the price paid for the substituted goods, but rather to the costs incurred in locating the substitute and making a second transaction.
Existing contracts incorporate this in the form of “Risk Purchase”, which is a right available to the buyer/purchaser of services or goods against the service provider, supplier or manufacturer. There are also some exceptions to availing this right of Risk Purchase, i.e., when the goods or services procured or performed are of different specifications; or when the purchase is on basis of substantially different terms and conditions.
Section 73 of the Indian Contracts Act, 1872 (“Contract Act”) deals with the consequences of breach of contracts. This Section entitles the aggrieved party to recover from the defaulter compensation for any loss or damages resulting from the breach of contract. Damages are based on the difference between the contract price and the market price. This Section also adds an Explanation, which provides that “In estimating the loss or damage arising from a breach of contract, the means which existed of remedying the inconvenience caused by non-performance of the contract must be taken into account.”. This implies that if the seller defaults, the buyer may have to buy the services or goods elsewhere at an additional cost, and this cost will be taken into account when calculating the extent of damages.
In various judgements, High Courts across the country have upheld the spirit of Section 73 of the Contract Act and held that it is not necessary that on default by the seller to deliver, the plaintiff should have actually purchased the goods elsewhere and only then claim the difference. The damages can be claimed based on prevailing market prices.
Thus, looking at the examples and provisions above, though the remedy of substituted performance was, in essence, already available to the aggrieved party under law (and by way of express rights in agreements between the parties), enforcement was limited and guarded strictly by the tests of foreseeability and mitigation. Losses had to be proved with certainty in order to avail benefit of the same and so merely having a remedy similar to substituted performance was essentially, not enough.
Need for introducing “Substituted Performance”
A six-member Expert Committee (“Committee”) was constituted to review the current working of the Act and address issues relating to enforcement of contracts in India. Their recommendations highlighted that the need to expressly introduce the concept of “substituted performance” or “right to cover” is a significant consideration under Indian law. A party to a contract must have the right to complete performance by himself or through a third party at the cost of the promisor, and to claim the amount he spends for this purpose.
These recommendations translated into the Bill. By way of the amendment, the procedure adopted for availing the remedy of substituted performance becomes more uniform as it mandates a condition of notice to be served on the defaulting party for a period of not less than thirty (30) days prior to carrying out the risk purchase. Additionally, it also makes the remedy easier to prove in light of essentials laid down under law, and not governed by individual agreements which lay down the parties’ own remedial systems.
Furthermore, and perhaps most importantly, this introduction is well in line with the agenda of the Bill which is to increase ease of doing business in India and to ensure enforceability of contracts with greater effectiveness. In addition to the fact that damages are often an inadequate remedy in terms of the quantum of compensation, it is also well understood that damages do not fulfil the end purpose of the contract and do not effectively provide the parties what they sought out to achieve in the first place.
It is also pertinent to note that, as a rule of contracts, damages do not cover indirect losses of the parties, which may include the price in seeking and enforcing performance from a third party in lieu of the party originally envisaged, and several other costs which would not have occurred in the first place, had the contract been performed as per the contractual specifications and standards. Being able to avail substituted performance allows the aggrieved party to be restored to the position it would have been in had the breach not occurred, which may be the most effective alternative available in the event of a breach.
“Substituted Performance” in other jurisdictions
Globally, there are a few examples of provisions similar to the proposed amendment under the Bill. Under the Spanish Civil Code, the remedy of specific performance is provided under Article 1098 where “if a person obliged to do something should fail to do it, it shall be ordered to be done at his expense”. Such person can also be ordered to undo anything done. Additionally, under Article 1096, where a specific thing is to be delivered, the creditor may compel the debtor to perform delivery, and if such thing is generic or indeterminate, he may request performance of the obligation at the debtor’s expense. There is a similar example under the Ethiopian Civil Code (Article 1778) which provides that “where fungible things are due, the creditor may be authorised by the court to buy at the debtor’s expense the things which the debtor assumed to deliver”.
While both the aforementioned Codes incorporate a concept of substituted performance, the focus is on the promisor meeting the expenses, that is, substituted performance at the expense of the promisor. On the other hand, under the Bill, the proposed amendment goes beyond this focus of merely expensing the promisor. The Bill elaborates a specific process for claiming substituted performance, giving notice to the promisor to perform in the absence of which performance will be substituted, while also preserving the promisee’s right to damages. Thus, the Bill shifts the focus from merely expensing the promisor to a more elaborate and effective protection of the rights of a promisee and ensuring that specific performance is observed as a rule.
Though not as elaborate as the Bill, the Quebec Civil Code (Article 1602) comes close to incorporating a concept of substituted performance where the creditor (promisee) is first required to notify the debtor (promisor) of availing the right to substituted performance, which puts the debtor in default and allows the creditor to get contract performed at debtor’s expense.
Other variants of this concept are contained in the Uniform Commercial Code of District of Columbia [see End Note 2] (United States) which allows substituted performance if a “commercially reasonable substitute” is available. Another skeletal variant of this concept is also available under the Uniform Civil Procedure Rules of New South Wales (Australia) [see End Note 3] , where “if a judgment requires a person to do an act and the person does not do the act, the court may direct that the act be done by a person appointed by the court.” This person can be directed to pay costs of this substituted performance as well. In the United Kingdom, the concept of (in principle) specific performance by substituted performance was introduced in common law (fairly) recently in the case of Liberty Merican Ltd. v. Cuddy Civil Engineering Ltd. [see End Note 4] where the court ordered the defaulter to deposit in court a sum as a result of its failure to provide a performance bond. The court held that even though the contract requirement of providing a performance bond is not completed, depositing the amount in court would, in principle, provide equivalent rights to the aggrieved party.
In comparison to these examples from other jurisdictions, the proposed provision in the Bill is more elaborate both in procedure and substance. As noted above, the focus under the Bill is on allowing the promisee to have the contract performed, whether by himself or by having a third-party step into the shoes of the defaulter. Of course, the necessary corollary of this performance is that the costs should be borne by the defaulter, and that the aggrieved party still has the right to claim compensation.
Post amendment position and looking ahead
When the Bill comes into effect to amend the Act, the discretion vested with the Courts to decree specific performance will be taken away and the amended Section will provide, as a rule, specific performance of contract by substituted performance. As a result, the aggrieved party will then have a legal remedy (and a right) to attain performance of the contract at the cost of the party committing the breach. This amendment looks promising as it is bound to result in a change in contract behaviour between parties and encourage performance of contract obligations, thereby acting as a deterrent to breach by the promisor. Once implemented, this remedy of specific performance by substituted performance can become the default remedy available to the parties as it is one of the only remedies which achieves the same result as the actual discharge of obligations of the agreement.
For the defaulter, the amendment incorporates sufficient safeguards as well. A reasonable opportunity is given to the defaulter by putting him to notice and allowing a cure period of not less than thirty (30) days. This prevents the right of substituted performance being exercised in an unfair manner by the promisee. Further, once substituted performance is sought (e.g. by a third party), the promisee can no longer ask for specific performance from defaulter. Another noteworthy change is that the aggrieved party is only allowed to recover costs of substituted performance after having actually incurred such costs, which is a shift from the earlier position where only a reference to the prevailing market costs was adequate.
The true impact of the amendment will be seen once it is adopted. While the impact will be pan-industry, industries like construction and infrastructure are likely to benefit the most, where damages often do not adequately compensate breach of contract. Once the remedy is available in law, new contracts being drafted may even prompt parties to include specific clauses identifying the procedure of achieving substituted performance. Whether parties choose to amend existing contracts remains to be seen, though even if they are not amended, in the event of a breach, specific performance (including through substituted performance), which was an equitable remedy hitherto, will become a legal remedy and be granted as a rule rather than an exception.
[The authors are respectively, Senior Associate in Corporate law practice, Lakshmikumaran & Sridharan, Bangalore, and Principal Associate in Lakshmikumaran & Sridharan (UK) LLP, London]