When a contract is breached, the aggrieved party is entitled to damages to compensate for the loss suffered. Courts follow specific rules to determine the amount and type of damages to be awarded, primarily aiming to place the injured party in the position they would have been in had the contract been performed. These rules are largely derived from common law principles, notably the landmark case of Hadley v. Baxendale, and are codified in statutory provisions.

Key Rules for Awarding Damages:

1. Compensatory Nature (Restitutio in Integrum): The primary goal of damages is to compensate the injured party for actual loss suffered, not to punish the breaching party. The damages should be such as to make good the loss, not to enrich the plaintiff.

2. Remoteness of Damage (Hadley v. Baxendale): This is the most crucial rule. Damages are recoverable only for losses that are not too remote. The rule, established in Hadley v. Baxendale (1854), states that damages must be:

   • Naturally Arising: Such as may fairly and reasonably be considered to arise naturally, i.e., according to the usual course of things, from the breach of contract itself; or
   • Contemplated by Parties: Such as may reasonably be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of the breach of it. This covers special circumstances communicated to the breaching party.
   • Losses falling outside these two categories are generally considered too remote and are not recoverable.

3. Duty to Mitigate Losses: The injured party has a duty to take all reasonable steps to mitigate (minimize) the loss caused by the breach. They cannot recover damages for losses that could have been avoided by taking reasonable action. For example, if a buyer breaches a contract to purchase goods, the seller must try to resell the goods to another party to reduce their loss.

4. Measure of Damages: The measure of damages is typically the difference between the contract price and the market price on the date of the breach. For specific performance contracts, it might be the cost of completing the work or the diminution in value.

5. Liquidated Damages and Penalties: Parties may pre-agree on a sum payable in case of breach (liquidated damages). Courts will enforce this sum if it is a genuine pre-estimate of the likely loss. However, if the sum is extravagant and unconscionable, intended to terrorize the breaching party, it will be deemed a 'penalty' and only actual loss will be awarded.

6. Nominal Damages: If a breach occurs but the injured party suffers no actual loss, the court may award nominal damages (a small sum) to acknowledge the breach of a legal right.

7. Exemplary/Punitive Damages: Generally, these are not awarded in contract law, as the aim is compensation, not punishment. However, in rare cases involving breach of promise to marry or where the breach involves tortious elements, they might be considered.

Statutory Provisions (e.g., Indian Contract Act, 1872):

• Section 73: Codifies the rule in Hadley v. Baxendale, stating that compensation for loss or damage caused by breach of contract should be for losses that naturally arose in the usual course of things from the breach, or which the parties knew, when they made the contract, to be likely to result from the breach. It explicitly excludes compensation for remote and indirect loss or damage.
• Section 74: Deals with liquidated damages and penalties, stating that if a sum is named in the contract as the amount to be paid in case of 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 proved to have been caused thereby, to receive from the party who has broken the contract reasonable compensation not exceeding the amount so named or, as the case may be, the penalty stipulated for.
• Section 75: Provides for compensation to a party rightfully rescinding a contract, entitling them to compensation for any damage which they have sustained through the non-fulfillment of the contract.

These rules and provisions ensure a structured and fair approach to awarding damages, balancing the need to compensate the injured party with the principle of not imposing disproportionate liability on the breaching party.