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Analysis Of The Issues And Challenges In Claiming Liquidated Damages under Indian Contract Act, 1872

The Indian Contract Act, 1872 (ICA) is a colonial act and much has changed or evolved in the way business is conducted. The act being old has a few loopholes which need to be relooked and corrected for the smooth conduct of business. One such loophole is in Sec. 73 and 74 of the ICA. Sec. 73 speaks about unliquidated damages which comes into play when liquidated damages clause is absent in in contract. Sec.74 speaks about liquidated damages.

These section deals with liquidated damages but the definition of liquidated damages is not provided in the act and the courts have often given confusing judgements in different cases. These judgements are often interpreted differently or the wrong interpretation. This research tries to solve the confusion between the important judgements related to liquidated damages. The need to prove the amount of damages caused by the aggrieved party makes it much more difficult to claim the liquidated damages.

There are few Contracts where the damages cannot be calculated in the case of breach of contract. Claiming liquidated damages amounting to the actual damages are difficult in these type of cases. The courts gives importance to the 'genuine pre estimate of damages'clause in the contract which the party who breaks the contract tries to take advantage over the clause to determine if it is liquidated damages or not. Further the contract law in India has no difference between penalty and liquidated damages as the compensation granted cannot exceed the amount specified in the contract.

Act and Definitions:
Black's Law dictionary defines Liquidated damages as:
"An amount contractually stipulated as a reasonable estimation of actual damages to be recovered by one party if the other party breaches; also If the parties to a contract have agreed on Liquidated Damages, the sum fixed is the measure of damages for a breach, whether it exceeds or falls short of the actual damages."

Section 73 of the ICA says:
"When a contract has been broken, the party who suffers by such breach is entitled to receive, from the party who has broken the contract, compensation for any loss or damage caused to him thereby, which naturally arose in the usual course of things from such breach, or which the parties knew, when they made the contract, to be likely to result from the breach of it".

Section 74 of the Contract Act reads as under:
"When a contract has been broken, if a sum is named in the contract as the amount to be paid in case of such 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 provided to have been caused thereby, to receive from the party who has broken the contract reasonable compensation not exceeding the amount so named, or the case may be, the penalty stipulated for."

Analysis of Court Judgements:
In Fateh Chand v. Bal Kishan Das AIR 1963 SC 1405 the Court while discussing the scope of Sec.74 stated that it deals with damages which are divided into two classes of cases:
  1. Where there is pre-determination of amount which has to be paid in cases of breach of contract
  2. Where the contract may contain any further stipulation in form of penalty.

The Supreme Court in Oil & Natural Gas Corporation Ltd vs Saw Pipes Ltd. (2003) 5 SCC 705 held that:
  1. Terms of the contract are required to be taken into consideration before arriving at the conclusion whether the party claiming damages is entitled to the same;
  2. If the terms are clear and unambiguous stipulating the liquidated damages in case of the breach of the contract unless it is held that such estimate of damages/compensation is unreasonable or is by way of penalty, party who has committed the breach is required to pay such compensation and that is what is provided in Section 73 of the Contract Act
  3. Section 74 is to be read along with Section 73 and, therefore, in every case of breach of contract, the person aggrieved by the breach is not required to prove actual loss or damage suffered by him before he can claim a decree. The Court is competent to award reasonable compensation in case of breach even if no actual damage is proved to have been suffered in consequences of the breach of a contract.
  4. In some contracts, it would be impossible for the Court to assess the compensation arising from breach and if the compensation contemplated is not by way of penalty or unreasonable, Court can award the same if it is genuine pre-estimate by the parties as the measure of reasonable compensation.

In Indian Oil Corporation Vs. Messrs Lloyds Steel Industries Ltd.; 2007 (144) DLT 659):
  • The Delhi Court held mere delay in construction and commissioning of the terminal at Jodhpur by the contractor did not entitle IOC to recover Liquidated Damages because there was no loss suffered by IOC.
  • The court found that the pipeline reached Jodhpur terminal much after the date of completion of construction and the terminal could not be put to commercial use without the pipeline reaching the terminal.

In Herbicides (India) Ltd. vs. Shashank Pesticides Pvt. Ltd. 180 (2011) DLT 243:
  • Merely because the stipulation of 'Liquidated Damages' is available in the contract, the aggrieved party cannot claim full amount of Liquidated Damages as a matter of right. Its entitlement would be to recover damages only to the extent of actual losses proved to have been suffered by it.
  • In those cases, where no actual loss is proved, but undeniably losses have been caused, the Courts would not be powerless to award reasonable damages to the aggrieved party.
  • There can be yet another type of situation where the nature of contract is such that assessing damages is not possible. In such a situation, the Court would be empowered to grant full amount of Liquidated Damages provided it is of the view that the same are fair and reasonable pre-estimate of damages agreed between the parties.

The judgement in the case of Kailash Nath Associates v. DDA (2015) 4 SCC 136 got in a new perspective of Sec.74 which was discussed:
  • Where the dispute was whether a delay in payment would attract Section 74 of the Contract Act even if the respondents subsequently sold the property at a significantly higher amount.
  • While analysing the scope of compensation to be awarded under Section 74 the Court held the expression "whether or not actual loss is proved to have been caused thereby" to mean that wherever it was possible for the party claiming compensation to prove the actual damage, such proof was not dispensed with.

In this case, the petitioner Kailash Nath was declared as a successful bidder by the respondentDDA in relation to an auction proceedings. In this connection, the petitioner had deposited 25% of the bid amount as earnest money. However, without putting the petitioner to notice that it has to deposit the balance 75% of the bid within a certain stipulated time, the respondent had cancelled the allotment of petitioner and forfeited the 25% earnest money. The Supreme Court held that, it would be arbitrary for DDA to forfeit the earnest money on two fundamental grounds.
  1. There is no breach of contract on part of the appellant
  2. DDA not having been put to any loss, even if DDA could insist on a contractual stipulation in its favour, it would be arbitrary to allow DDA as a public authority to appropriate Rs ... without any loss being caused."
  3. Later in the judgment, the Supreme Court restated the principles applicable to Section 74. In doing so, the Court held that, .like Section 73 and 75 of Contract Act, 1872, compensation is payable for breach of contract under Section 74 ,only where damage or loss is caused by such breach.. The Court also held thatdamage or loss caused is a sine qua non for the applicability of Section 74..

Relying on the judgement of Kailash Nath , it has been argued by some that the law in Saw Pipeshas 'undergone a change' and that it is no longer a 'good' law. In other words, an oversimplistic and generalised argument is being advanced to state that, notwithstanding the nature of the contract, proof of actual loss is a pre-requisite for obtaining liquidated damages. In this regard, it is important to acknowledge that no legal principle can be applied in abstract.

Each case has its own context due to which the understanding of the law keeps evolving.
The bone of contention in almost all cases has been the use of the expression 'whether or not actual damage or loss is proved to have been caused thereby' in section 74. by reference to section 73 despite there being a named sum in the contract?'

In Maula Bux v Union of India, the Supreme Court explained that the expression is intended to cover different classes of contracts. In case of breach of some contracts it may be impossible for the court to assess compensation arising from the breach. It is in these circumstances that the sum named by parties may be taken into consideration as the measure of reasonable compensation, provided it is a genuine pre-estimate and not in the nature of a penalty.

Where loss in terms of money can be determined, the party claiming compensation has necessarily to prove the loss suffered and in such instances, the courts are bound to assess the reasonableness of compensation claimed. It is while doing so that the courts will apply the principles under section 73.

Thus, in every case a party must prove the extent of the loss suffered by it. The exception, however, was for cases where the damage was difficult or impossible to prove and in such cases the requirement to prove the extent of loss was dispensed with.

In each of the above cases stands on a different footing. While Fateh Chand, Maula Bux and Kailash Nath were concerned with clauses on forfeiture, the relevant clause in Saw Pipes was on levy of liquidated damages. Further, the important distinction in all the above four cases is that in Fateh Chand, Maula Bux and Kailash Nath, the Supreme Court reached a conclusion that the person aggrieved could have proved his loss by adducing evidence.

However, in Saw Pipes, the Supreme Court found that it was impossible to prove loss. Hence, the conclusion arrived in Fateh Chand, Maula Bux and Kailash Nath should not be confused with the conclusion reached in Saw Pipes. Further, the finding on facts in Kailash Nath puts it in a separate class altogether. In the said case, the Court reached a finding that there was no breach on part of the person whose money was forfeited. As such, the pivotal requirement to trigger application of Section 74 , 'breach of contract' had not been satisfied in that case.

In view of the above, it may not be correct to interpret in abstract that the law in Saw Pipes has been re-written or diluted in Kailash Nath. This is more so since Kailash Nath itself acknowledges that, "It is only in cases where damage or loss is difficult or impossible to prove that the liquidated amount named in the contract, if a genuine pre-estimate of damage or loss, can be awarded."

To sum up, as would appear from the analysis above, the ruling in Saw Pipes is not disturbed by Kailash Nath. The criteria for application of Section 74 continues to be a fact driven exercise and hinges on a careful assessment of the possibility to prove loss. The rule in Fateh Chand, Maula Bux and Kailash Nath, that a party must prove its loss cannot be universally applied.

Such application, without regard to facts of a case and the nature of the contract involved, would be antithetical to the very purpose for which parties agree to a genuine pre-estimate of liquidated damage in cases where it is impossible to prove loss. In other words, once the parties contractually agree to a genuine pre-estimate of damages, the contractual entitlement to the same should not be doubted on account of impossibility in proving actual loss caused due to the breach.

The interpretation of landmark cases makes the concept of liquidated and unliquidated damages clear. The distinction between penalty and damages is also clear as there in no difference in Indian Contract Law because the damages should not exceed the stipulated amount.

The study has also shown the power of the court to decide the damages reasonably in cases where it is not possible to calculate the damages caused to the aggrieved party. Therefore it is clear that the intention of providing damages is to recover the loss incurred by the complainant, return the complainant to the position he had before the breach and to minimize penalizing the respondent.

  1. Coldwell D., Burchett Williams A., Celeste, M, Liquidated Damages, Franchise Law Journal, Jstor, (2010).
  2. Nishith Desai Associates, Law Of Damages In India,, Website, (2019).
  3. Shubhra Wadhawan, Revisiting Liquidated Damages In India, SCC Online, (2018).
  4. Priti Suri, Contractual Penalties, Actual And Liquidated Damages: Walking The Fine Line, E-Newsline, PSA Legal, (2020).
  5. Siddharth Addy, Analysis Of Liquidated Damages Clause In Commercial Agreement, Corporate Law Articles, TaxGuru, (20221).
  6. Bhumesh Verma, India: Importance Of Liquidated Damages Clause In A Contract, Corp Comm Legal, Mondaq, (2017).
  7. Naresh Thacker, Enforcing A Claim For Liquidated Damages In India: Key Messages, Economic Laws Practice, Mumbai, (2019).
  8. Justine Brazil, When Is A Liquidated Damages Clause Unliquidated And How To Ensure Certainty In Your Contract, IR Global, England, (2021).
  9. Vikas Goel, Abhishek Kumar, Liquidated Damages � A Chimera Without Proven Loss, Merger And Acquisition, Singhania, (2016).
  10. Sapna Jhangiani, The Benefits And Drawbacks Of Liquidated Damages Clauses, Hotel, (2016).

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