The 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.”
In simple terms, Liquidated Damages is a pre-determined estimate of losses or damage, which the parties agree while making the contract, as likely to arise in case of a breach.
In Oil and Natural Gas Corporation Ltd. V. SAW Pipes Ltd.,. the court held that section 74 be read along with Section 73 of the Indian Contract Act, 1872 when we deal with liquidated damages. This case also clarified the concept of unliquidated damages in Indian law. The Supreme Court held that unliquidated damages could be awarded if the party claiming damages proves that actual loss has occurred due to the breach of contract Let us understand Section 73 and Section 74 of the Indian Contract Act. Pay attention to the underlined words in the sections, which will be discussed further in this Article.
Section 73 of The Indian Contract Act, 1872:
73. Compensation for loss or damage caused by a breach of contract.—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.
Such compensation is not to be given for any remote and indirect loss or damage sustained by reason of the breach.
Section 74 of The Indian Contract Act, 1872:
74. Compensation for breach of contract where penalty stipulated for —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 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.
Explanation—A stipulation for increased interest from the date of default may be a stipulation by way of penalty.]
Liquidated damages stipulating reasonable compensation would ordinarily be awarded against the party causing breach of a contract.
Compensation higher than the liquidated damages stipulated in the contract -Improper.
In the case of Mahanagar Telephone Nigam V Tata Communication Limited – It was held that no compensation higher than the liquidated damages stipulated in the contract governing the relationship of the parties could be affixed to the defaulting party. In view of section 74 of the Indian Contract Act, 1872, the party incurring loss could claim only that sum which had been stipulated as liquidated damages in the event of default by any party.
In Fateh Chand V. Balkishan Das, the plaintiff made a claim to forfeit a sum of Rs. 25000/- received by him from the defendant. The sum of Rs. 25000/- consisted of two items -Rs. 1000/- received as earnest money and Rs. 24000/- agreed to be paid by the defendant as out of sale price against the delivery of possession of the property. With regard to earnest money, the court held that the plaintiff was entitled to forfeit the same. With regard to claim of remaining sum of Rs. 24000/-, the court referred to section 74 of the Indian Contract Act and observed that section 74 deals with the measure of damages in two classes of cases (i) where the contract names a sum to be paid in case of breach, and (ii) where the contract contains any other stipulation by way of penalty. The court observed thus:
“The measure of damages in the case of breach of a stipulation by way of penalty is by section 74 reasonable compensation not exceeding the penalty stipulated for. In assessing damages, the Court has, subject to the limit of the penalty stipulated, jurisdiction to award such compensation as it deems reasonable having regard to all the circumstances of the case. The jurisdiction of the Court to award compensation in case of breach of contract is unqualified except as to the maximum stipulated, but compensation has to be reasonable, and that imposes upon the Court duty to award compensation according, to settled principles. The section undoubtedly says that the aggrieved party is entitled to receive compensation from the party who has broken the contract, whether actual damage or loss is proved to have been caused by the breach. Thereby it merely dispenses with proof of “actual loss or damages”; It does not justify the award of compensation when in consequence of the breach no legal injury at all has resulted, because compensation for breach of contract can be awarded to make good loss or damage which naturally arose in the usual course of things, or which the parties knew when they made the contract, to be likely to result from the breach.” (No one can be allowed to make an unjust enrichment under the garb of claiming compensation for a breach.) The Court further observed as under: –
“…. Duty not to enforce the penalty clause but only to award reasonable compensation is statutorily imposed upon courts by section 74. In all cases, therefore, where there is a stipulation in the nature of penalty for forfeiture of an amount deposited pursuant to the terms of contract which expressly provides for forfeiture, the court has ” jurisdiction to award such sum only as it considers reasonable, but not exceeding the amount specified in the contract as liable to forfeiture.”
From the aforesaid decision, the court was not dealing with a case where the contract named a sum to be paid in case of breach but with a case where the contract contained stipulation by way of penalty. This case reiterated the principle that genuine liquidated damage must reflect a fair estimation of potential losses. If a predetermined sum is excessively punitive or disproportionate to the actual loss suffered, it may be categorized as a penalty and deemed unenforceable. The ruling underscored the importance of maintaining a balance between providing compensation to the aggrieved party and preventing the imposition of punitive obligations on the party in breach.
It is important to differentiate liquidated damage and penalty because while penalty clause will not disentitle a claim for unliquidated damages; However, a liquidated damages clause would prevent additional remedies by way of unliquidated damages.
Section 74 to be read along with Section 73 of The Indian Contract Act, 1872
In Oil and Natural Gas Corporation Ltd. V. SAW Pipes Ltd., the delay took place in the deployment of rigs, and on that basis, actual production of gas from platform B-121 had to be changed. In such a contract it was difficult to prove the exact loss or damages suffered by one party because of breach of contract by the other party.
The Hon’ble Supreme Court held that:
- Terms of the contract must be considered before arriving at the conclusion whether the party claiming damages is entitled to the same.
- 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, the 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.
- Section 74 is to be read along with Section 73; therefore, in every case of breach of contract, the person aggrieved by the breach is not required to prove actual loss or damage (Note: this part is further elaborated in Maula Bux v. Union of India case) 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 consequence of the breach of a contract.
- In some contracts, it would be impossible for the Court to assess the compensation arising from the breach and if the compensation contemplated is not by way of penalty or unreasonable, the Court can award the same if it is genuine pre-estimate by the parties as the measure of reasonable compensation.
No Loss or damage suffered – No Compensation.
In Maula Bux v. Union of India, the Court held that:
“…. It is true that 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, and the Court is competent to award reasonable compensation in case of breach even if no actual damage is proved to have been suffered in consequence of the breach of contract. But the expression “whether or not actual damage or loss is proved to have been caused thereby” is intended to cover different classes of contracts that come before the Courts.In case of a breach of some contracts, it may be impossible for the Court to assess compensation arising from the breach, while in other cases compensation can be calculated in accordance with established rules. Where the Court is unable to assess the compensation, the sum named by the parties if it be regarded as a genuine pre-estimate may be taken into consideration as the measure of reasonable compensation, but not if the sum named is in the nature of a penalty. Where loss in terms of money can be determined, the party claiming compensation must prove the loss suffered by him.”
In the present case, it was possible for the Government of India to lead evidence to prove the rates at which potatoes, poultry, eggs, and fish were purchased by them when the plaintiff failed to deliver “regularly and fully” the quantities stipulated under the terms of the contracts and after the contracts were terminated. They could have proved the rates at which they had to be purchased and the other incidental charges incurred by them in procuring the goods contracted for. But no such attempt was made. Hence, the claim for damage was not granted.
Herbicides (India) Ltd. vs. Shashank Pesticides Pvt. Ltd. 180 (2011) DLT 243, It was held by the Delhi High Court that:
- If a party to the contract commits a breach of the contract, the party who suffers loss/damage on account of such breach is entitled to receive such compensation from the party in breach of the contract which naturally arose in the usual course of business, on account of such breach or which the parties to the contract knew, at the time of making the contract, to be likely to result on account of its breach. However, the party suffering on account of the breach is entitled to recover only such loss or damage that arose directly and is not entitled to damages that can be said to be remote.
- In case the agreement between the parties provides for payment of liquidated damages, the party suffering on account of breach of the contract even if it does not prove the actual loss/damage suffered by it, is entitled to reasonable damages unless it is proved that no loss or damage was caused on account of breach of the contract. In such a case, the amount of reasonable damage cannot exceed the amount of liquidated damages stipulated in the contract.
Any other interpretation would render the words “whether or not actual damage or loss is proved to have been caused thereby” appearing in Section 74 of the Indian Contract Act redundant and therefore the Court needs to eschew such an interpretation.
- If the amount stipulated in the contract, for payment by the party in breach of the contract, to the party suffering on account of breach of the contract is shown to be by way of penalty, the party suffering on account of the breach is entitled only to a reasonable compensation and not the amount stipulated in the contract. If it is shown by the party in breach of the contract that no loss or damage was suffered by the other party on account of the breach of the contract, the party in breach of the contract is not liable to pay any amount as compensation to the other party.
- If the nature of the contract between the parties is such that it is not reasonably possible to assess the damages suffered on account of breach of the contract, the amount stipulated in the contract, for payment by the party in breach should normally be accepted as a fair and reasonable pre-estimate of damages likely to be suffered on account of breach of the contract and should be awarded.
Therefore, it is important to understand that liquidation clauses can be suitable in scenarios in which there is a potential for losses due to a breach, and it might be challenging to accurately quantify those losses at the time of contract formation. Conclusion: Thus, a plaintiff can recover damages to the extent of the claim being reasonable compensation for the injury sustained by him, and not the entire sum laid down as liquidated damages. The liquidated amount or penalty is the upper limit. The plaintiff must prove the extent of the loss suffered by it, except in the cases where the damage was difficult or impossible to prove and, in such cases, the requirement to prove the extent of the loss was dispensed with. The pre-determined nature of liquidated damages establishes a foundation of assurance and predictability. It furnishes an upfront comprehension of the financial consequences tied to breaches. Beyond this, it acts as robust discouragement against potential violations, capable of expediting dispute resolution processes when conflicts arise. On the contrary, unliquidated damages bring an increased level of adaptability to the table. They ensure equitable compensation for the genuine losses encountered by the affected party. This becomes particularly advantageous in scenarios in which gauging the potential repercussions of a breach is intricate or unclear at the inception of the contract.
