Emden Formula For Calculating Construction Contract Damages Can't Apply To Dealership Agreements: Madras High Court

The Madras High Court has recently held that the Emden formula, developed to quantify damages in construction contracts, cannot ordinarily be used to assess compensation in disputes arising from automobile dealership agreements.

A Division Bench of Justice P. Velmurugan and Justice K. Govindarajan Thilakavadi observed that the formula is rooted in the unique features of construction contracts and cannot be mechanically extended to commercial distribution arrangements.

"A dealership agreement is a commercial distribution contract and not a construction contract. Damages under a dealership agreement must be proved under Sections 73 and 74 of the Indian Contract Act, on the basis of actual evidence, such as loss of profits, commission, business opportunities or investments, and cannot ordinarily be assessed through the Emden formula," the court ruled.

Allowing an appeal filed by Hyundai Motor India Ltd. against St. Antonys Cars Pvt. Ltd.,its dealer the bench set aside the Single Judge's order and the arbitral award insofar as it awarded compensation towards business transactions, training expenses, loss of investment, goodwill and marketing expenses, and future profits.

The court held that the arbitrator committed patent illegality by applying the Emden formula without any legal or factual basis in a dispute arising from an automobile dealership agreement.

The dispute arose from a non-exclusive automobile dealership agreement executed on August 24, 2009, under which Hyundai appointed St. Antonys Cars as its authorised dealer for the sale and service of Hyundai vehicles in the Kollam territory of Kerala. The appointment followed a Letter of Intent issued on August 9, 2007.

The dealer claimed it invested heavily in showrooms, workshops, employee training and marketing after believing, based on Hyundai's Letter of Intent, that the dealership would be exclusive. It alleged that Hyundai later imposed unrealistic sales targets, appointed competing dealers in the same territory and eventually terminated the dealership, resulting in substantial losses.

Hyundai disputed those allegations. It maintained that the dealer repeatedly failed to meet performance standards despite warning letters and show-cause notices and that the dealership was terminated on August 2, 2013 in accordance with the agreement, which permitted either party to end the arrangement by giving 30 days' notice.

The dispute was referred to arbitration. In an award dated March 15, 2019, the tribunal held that Hyundai had wrongfully terminated the dealership and directed it to pay more than ₹1.64 crore towards business transactions, training expenses, loss of investment, goodwill and marketing expenses, besides future profits. The tribunal calculated those damages using the Emden formula.

Hyundai challenged the award under Section 34 of the Arbitration and Conciliation Act, 1996. The Single Judge set aside only the award relating to future profits while upholding the remaining claims. Hyundai then filed the present appeal under Section 37.

Before the Division Bench, Hyundai argued that the Emden formula was devised for construction disputes involving delay, head office overheads and loss of profits, and had no application to an automobile dealership agreement. It also contended that the agreement expressly allowed termination on 30 days' notice and that St. Antonys Cars had failed to prove any actual loss.

Accepting those submissions, the court observed that the Emden formula assumes a contractor's labour, equipment and other resources remain tied to a delayed construction project, preventing it from taking up other work. Those assumptions, it held, have no application to an automobile dealership agreement.

"The Emden formula was evolved in the field of construction law for assessing head office overheads and loss of profit resulting from prolongation of construction contracts due to employer caused delay. It proceeds on the premise that the contractor's resources remain committed to the delayed project, thereby depriving the contractor of opportunities to undertake other works," the court observed.

The court further held that the arbitrator went beyond the terms of the agreement by treating Hyundai's termination as illegal even though the contract expressly permitted either party to terminate it by giving notice. It also observed that the burden of proving loss rested on the dealer, which failed to produce evidence establishing the quantum of damages it claimed.

The appeal was accordingly allowed. The court affirmed the tribunal's rejection of the dealer's claims relating to warranty payments and losses arising from SARFAESI proceedings.

However, it set aside the tribunal's award directing Hyundai to pay compensation towards business transactions, training expenses, loss of investment, goodwill and marketing expenses, and future profits.

For Appellant (M/s Hyundai Motor India Ltd.): Senior Advocate A.R.L. Sundaresan, assisted by Advocate P.R. Vandana, for M/s Surana and Surana.