Risk allocation in commercial contracts

Introduction

Contracts are instruments expressing commercial intent, with definitive clauses[1] for scope, consideration, termination, etc., and ancillary clauses for safeguarding parties. In addition to outlining counter-obligations, commercially sound agreements should anticipate a response to unforeseen regulatory shifts, operational delays, and disruptions (be it natural or manmade). Contracts typically deploy these protective mechanisms to streamline expectations, mitigate risk and limit exposure.

This article examines popular mechanisms for contractually allocating and limiting risks to the benefit of all parties: clauses for events of force majeure and change-in-law to provision for uncertain contingencies; and clauses for liquidated damages and limitation of liability to calibrate financial exposure. The analysis in this article is confined to the terms of a contract between parties and does not examine any statutory provisions for risk allocation.

Provisioning for the uncertain: Events of ‘force majeure’, ‘change-in-law’

Force Majeure events as the new normal

Every clause in a contract serves as evidence of party intent, lending to the established proposition that no part of a deed is surplusage[2]. It is in this context that parties also provision for unforeseen events within a ‘force majeure’ clause. A force majeure clause allows a performing party to be protected from the consequences of any event beyond reasonable control[3].  The real-world salience of this clause has only grown sharper in recent years and the clause for force majeure has reclaimed its centrality to commercial transactions - determining whether a party can enforce, renegotiate, or exit a contract without incurring liability.[4]

When embedded as part of a contract, the occurrence of a ‘force majeure’ event would determine whether that contract is capable of being performed (e.g, excused, suspended, contractually reallocated) in that contingency. In a situation where a contract does not provide for uncertain events, the doctrine of frustration[5] would operate to acknowledge that performance of a promise may become impossible or unlawful due to events beyond the contemplation of the parties. Naturally, an express force majeure clause would automatically assert primacy over doctrinal remedies under Section 56 of the Indian Contract Act, 1872 (‘Contract Act’). 

The scope of relief that may be available to parties would be governed entirely by the language of this clause. Courts have refrained from stepping into the arena of contractual relations to absolve a party from performance merely because unforeseen events have rendered performance onerous[6].

Accordingly, a force majeure clause ought to be conscious of the necessity to delineate the trigger events, narrate obligations relating to ‘notice’ of force majeure, and the remedies thereof. It is also worthwhile to plan out whether the clause would operate to excuse performance or suspend consequences of non-performance on account of a force majeure event or altogether terminate all obligations of parties.

Change-in-Law events: for balancing a dynamic reality

A clause provisioning for ‘Change-in-law’ operates as a distant cousin to the force majeure clause. The ‘change-in-law’ clause is designed exclusively to insulate parties from the potential of legislative, regulatory, or policy changes occurring after contract execution. Clauses to characterise the consequence of a change-in-law are seminal, particularly in closely-regulated sectors such as power generation, infrastructure, and taxation. 

A ‘change-in-law’ clause is decidedly on a different footing from a force majeure clause, in both scope and object. A force majeure clause may absolve parties from consequences of non-performance, whereas a clause for ‘change-in-law’ merely recalibrates obligations inter se parties with the object of restoring economic equilibrium so that parties continue to meet their obligations with accompanying compensatory adjustments. In a sense, a clause for ‘change-in-law’ is intended to restore affected parties to the position they would have been in, but for the regulatory shift[7]. Thus, complications ensuing from policy changes are redressable under a ‘change-in-law’ clause and cannot be treated as an event of force majeure even though policy changes are a subset of uncertain events over which parties exercise little to no control.

Change-in-law clauses are also applied with caution and close attention to the language it is couched in. Contracts, especially those of government-regulated sectors, benefit from precise clauses that describe the jurisdictional reach of a transaction and the categories of laws/regulations that would be covered in a change-in-law clause. A useful illustration is available in the celebrated case of Energy Watchdog v. Central Electricity Regulatory Commission and Ors[8]. Here, the parties relied on the Indonesian coal pricing regulations arguing that the change in coal prices should be treated as a force majeure event hindering performance, and that such event should count as a change-in-law entitling them to compensatory relief. The Hon’ble Supreme Court rejected either argument, holding that the contractual definition of ‘Law’ was confined to laws in force in India. The Hon’ble Court then held that the object of a ‘change-in-law’ event is to restore the affected party to the same economic position as if that change in law had not occurred. Thus, a contract should endeavour to allay risks by optimally sorting the variables into different clauses for change-of-law and for force majeure situations so as to enlarge the protection base.

Calibrating for financial exposure: Damages, indemnification, and limitation of liability

In addition to actively anticipating and preventing risks from unforeseen events, it is also typical for contracts to fix upfront, the compensation for losses not yet quantified arising from breaches such as delays in performance. Sometimes, this is addressed through a clause for damages payable by the defaulting party to the aggrieved party. At other times, one party would undertake to protect the other party from all losses. 

Compensation for breaches through unliquidated and liquidated damages

Section 73 of the Contract Act embodies the compensatory principle that damages must arise naturally in the usual course of things or must be within the contemplation of the parties. Section 73 addresses unliquidated damages, i.e., compensation for actual loss or damage from breach, requiring proof of naturally arising or foreseeable harm which was originally enshrined in the landmark decision of Hadley v. Baxendale[9].  The Hon’ble Supreme Court has reinforced this principle and has held that the measure of damages under Section 73 for breach of a contract of sale is the differential between the market price prevailing at the place and date of breach and the contract price. Without proof of the market rate on the date of breach, no damages can be awarded[10]. The Hon’ble Supreme Court has also gone on to hold that a claim for unliquidated damages does not give rise to a debt until liability is adjudicated and damages assessed by a court or arbitral authority and therefore cannot be used as a self-help set-off against sums otherwise due to the opposite party[11].

Section 74 occupies a slightly distinct terrain. Where a contract identifies a sum payable upon breach, the aggrieved party is entitled to ‘reasonable compensation’ not exceeding the amount so named.  The mere existence of a clause for liquidated damages will not entitle a party to the automatic recovery of the sum so stipulated in the Contract. Any compensation sought must also be proven as reasonable and must not exceed the amount specified as liable to forfeiture[12]. Even a genuine pre-estimate would not entitle parties to sums towards damages, without concrete proof of breach that caused legal injury unto the Claiming party. Thus, a party claiming liquidated damages must lead evidence of loss and it is only in cases where proof is genuinely difficult or impossible that the pre-estimated amount may be awarded as reasonable compensation. Proof of damage or loss is a sine qua non for claims under Section 74[13]. 

A significant development to Indian law[14] was marked by the adoption of the ‘legitimate interest’ test formulated by the UK Supreme Court[15]. The Hon’ble Supreme Court, while discussing Cavendish, noted that a clause providing for the consequences of a breach of contract may be upheld when it resembles a genuine pre-estimate of loss with a view to protecting a legitimate commercial interest. The Hon’ble Supreme Court acknowledged that Indian courts have been cautious in applying this framework, emphasising where parties possessed of equal bargaining power negotiate the terms of a commercial contract, courts would be slow to characterise such agreed terms as unconscionable.

Clauses for liquidated damages, therefore, serve a specific commercial purpose.  They allow parties to agree upfront on the financial consequences of defined defaults, bringing certainty to what would otherwise be an expensive exercise in proving loss after the fact.  This, in turn, brings up an important distinction between actual ‘loss of profits’, and situations where a contract has merely become less profitable.

Indemnification and Limitation of Liability 

Clauses for indemnity serve to shield the parties from specific losses, such as third-party claims stemming from negligence, breach, IP infringement, or even product defects. The indemnity would typically cover payouts for the loss and also costs towards legal defence etc. These clauses are typically triggered by procedural requirements like notice on loss, with the indemnifying party controlling  the loss by taking charge of defending a claim or lawsuit in an indemnity clause.

Clauses for Limitation of liability, on the other hand, cap the overall exposure that an aggrieved party may face. Such exposure is typically quantified through contract value, while carving out specific exclusions for loss of profits, consequential damages, or punitive awards. Indemnities allocate specific heads of loss whilst limitation clauses cap overall exposure. A well-drafted, unambiguous clause setting out limits to liability would enable parties to contractually cap their liability to a specified amount. Where parties have consciously limited liabilities under a contract, such commercial allocation of risk will be rigorously upheld, and damages would be awarded only to the extent undertaken by the parties. As these clauses operate in tandem, they hold out significant benefits to all parties.

Conclusion

Contractual risk allocation has assumed heightened importance. Force majeure clauses and change-in-law provisions enable parties to plan for uncertainty. Equally, financial risk is managed via liquidated damages, while indemnity and limitation of liability clauses clarify who bears defined losses and how far the liability extends. As commercial relationships grow more complex, the importance of risk allocation lies in anticipating disruption as well as managing its consequences with clarity.

[The authors are Executive Partner, Associate Partner and Associate, respectively, in Commercial Disputes Team at Lakshmikumaran & Sridharan Attorneys, Chennai]

[1] Read article written by Krithika Jaganathan, Nirupama Shankar and Deepta R here. 

[2] JSW Infrastructure Ltd. v. Kakinada Seaports Ltd. [(2017) 4 SCC 170].

[3] Dhanrajamal Gobindram v. Shamji Kalidas & Co. [AIR 1961 SC 1285].

[4] Read article written by Charanya Lakshmikumaran, Yogendra Aldak and Rashi Srivastava here. 

[5] See Section 56, Indian Contract Act, 1872.

[6] Alopi Parshad & Sons Ltd. v. Union of India [AIR 1960 SC 588].

[7] Jaipur Vidyut Vitaran Nigam Ltd. v. Adani Power Rajasthan Ltd. [2025 INSC 770].

[8] (2017) 14 SCC 80.

[9] [1854] EWHC J70.

[10] Murlidhar Chiranjilal v. Harishchandra Dwarkadas [AIR 1962 SC 366].

[11] Union of India v. Raman Iron Foundry [AIR 1974 SC 1265].

[12] Fateh Chand v. Balkishan Das [AIR 1963 SC 1405].

[13] Kailash Nath Associates v. DDA [(2015) 4 SCC 136].

[14] BPL Ltd. v. Morgan Securities & Credits Pvt. Ltd. [(2025) INSC 1380].

[15] Cavendish Square Holding BV v. Makdessi [2015 UKSC 67].