Liquidated Damages under the Indian Contract Act, 1872

What are Damages?

The claim for ‘Damages’ is the most commonly availed remedy under the law of contract for any breach of the same. This is based upon Latin maxim of “Ubi jus ibi remedium” which means where there is right, there is remedy. As per Mulla, “Damages are the pecuniary recompense given by the process of law to a person for the actionable wrong that another party has caused to him”.1

In simple terms, damages are defined as the monetary compensation awarded in a civil action to an affected party arising out of wrongful acts i.e. either breach of contract or tortious wrong, on the part of or caused by other party. For instance, when two persons agree to enter into and perform their mutual obligations in terms of an agreement, they tend to attain a particular position which rests upon the performance of the contract. Breach of such contract leads to the non-attainment of that position which the parties had expected to attain. Hence, the parties may suffer ‘expectation losses’. In case of breach, the defaulting party becomes obligated to either specifically perform the contract undertaken by him or to pay proportionate monetary compensation to the non-breaching party in order to restore their expected position as anticipated under the contract between parties. This monetary compensation covers the losses of the injured party and puts him in the post-contractual position.

Section 73 of the Indian Contract Act, 1872 (“Act”) prescribes damages or compensation for loss in case of breach of contract to the aggrieved party by the defaulting party.

What are Liquidated Damages?

Damages are said to be liquidated when they have been agreed and fixed by the parties while entering into the contract. Basically, it is the sum which one party agrees to pay to the other party on the default of one of the parties.3 The damages prescribed under the contract are explicit when a specific amount payable in case of default has been provided under the contract. Damages are implied when the actual amount is not specified in the contract, but the principle governing the calculation of the damages to be paid in case of breach are settled and specifically set out in the contract. For instance, the difference between contract price and market price on the date of actual breach of contract is an implied term. Therefore, in case of such implied terms, damages are called ‘pre-determinable damages’. These stipulations reflect good business sense as they ensure a certain degree of security for due performance of the contract.

Liquidated Damages vs. Penalty

At times, parties name an exorbitant and unreasonable sum as damages payable in the event of breach of contract which may not be the actual pre-estimate of the likely loss. Such unreasonable and highly disproportionate sum in relation to the likely loss or damage is created in terrorem i.e. to create fear in the mind of parties with a view to discourage breach of contract, which then gives it the nature of penalty. However, any sum which is provided as penalty is never awarded as damages for breach of contract under the law of contract. The Indian Courts do not enforce such a clause containing an unconscionable sum of money.

Assessment of Damages

Section 74 of the Act clearly stipulates that in case of breach of contract, if a particular sum is stipulated in the contract as the amount to be paid in case of such breach, whether or not actual damage or loss is proved to have been caused, the aggrieved party is entitled to receive from the opposite party who has breached the contract, a reasonable compensation not exceeding the amount so named.

The Hon’ble High Court of Delhi in the case of Vishal Engineers & Builders v. Indian Oil Corporation Limited5discussed the law on this subject. The Court took into account the observations of the Hon’ble Supreme Court in ONGC v. Saw Pipes which suggested that the Court is competent to award reasonable compensation in case of a breach, even if no actual damage is proved to have been suffered in consequence of the breach of the contract. The underlying reason for the same is that in certain kind of contracts it would not be possible for the Court to assess compensation arising from the breach. The Court in Vishal Engineers case summarized the legal position as under:

“Where it is impossible to assess the compensation arising from breach and that factor is coupled with the parties having agreed to a pre-determined compensation amount not by way of penalty or unreasonable compensation, then that amount can be awarded as a genuine pre-estimate of the loss suffered by a party. It cannot be read to mean that even if no loss whatsoever is caused to a party, it can still recover amounts merely be reason of the opposite party being in breach.”

Further, in Indian Oil Corporation v. Lloyds Steel Industries Limited, the Hon’ble High Court of Delhi while discussing the principle of ‘reasonable compensation’ held that in a particular case where there is a clause of liquidated damages, the Court will award to the party aggrieved only reasonable compensation which would not exceed an amount of liquidated damages stipulated in the contract. But, in situations wherein no loss is suffered, the amount stipulated as liquidated damages cannot be awarded. For this purpose, as held in Fateh Chand v. Balkishan Das, it is the duty of the Court to award compensation according to settled principles. Settled principles of law warrant not to award compensation where no loss is suffered, as one cannot compensate a person who has not suffered any loss or damage. There may be several cases where the actual loss suffered by the party is incapable of proof i.e. facts may be so complicated in a particular situation that it may be difficult for the aggrieved party to prove actual extent of the loss or damage. In such cases, Section 74 of the Act exempts the aggrieved party from such responsibility and enables such party to claim compensation notwithstanding any failure to prove the actual extent of the loss or damage provided the basic requirement for award of ‘compensation‘ i.e. the fact that the party actually suffered some loss or damage is established. In such cases the burden of proof has been either lowered or taken away. However, that does not mean that damages would be awarded without there being any loss whatsoever.

Thus, Section 74 of the Act imposes a statutory duty upon the Courts, subject to the maximum amount so stipulated in the penalty clause, to never enforce the penalty clause per se and to award only reasonable compensation. Therefore, it is for the Courts to determine, whether the particular sum stipulated in the contract in case of breach is penalty or not. Apart from this limitation, it seems that the Courts of India have unqualified power to award damages depending upon the facts and circumstances of the case. Such power of the Court is also provided under the provisions of Specific Relief Act 1963 (“SRA”). The relief of damages to be granted by the Court under the provisions of the Act and SRA shall be governed by law as well as equity and shall constitute a discretionary power of the Court. However, such discretion is to be exercised guided by sound and settled principles of law.

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