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LIQUIDATED DAMAGES- INTERPLAY IN CONTRACTUAL DISPUTES AND ITS DIFFERENCE WITH PENALTY

By ISHIKA GOYAL


INTRODUCTION

MAXIMS

There is a renowned maxim, “UBI JUS IBI REMEDIUM[1], which means where there is a right, there is a remedy. In other words, if there is an infringement of any legal right of an individual, the law provides immunity to the innocent one to claim protection under the law regarding their legal rights.

So, there are two types of legal remedy: Judicial Remedy (remedies with the help of the court) and Extra-Judicial Remedy (remedies without the help of the court). Judicial Remedies can be liquidated damages or unliquidated damages. Extra-judicial remedies can be self-defense, abatement of nuisance, or re-entry on land.


ABOUT THIS ARTICLE

This article mainly focuses on gaining insight related to the concept of liquidated damages followed by the surrounding factors liquidated damages are different from the penalty and whether to prove an actual loss for claiming liquidated damages.


WHAT ARE LIQUIDATED DAMAGES?

An amount of money agreed upon by both parties to a contract in advance which one will pay on breaching a contract to another party or if a suit arises due to the breach is known as LIQUIDATED DAMAGE. It is a pre-determined estimated amount in the form of compensation, for the loss or harm due to the breach.

Liquidated Damages must be reasonable and based on a genuine estimation of potential loss. Generally, it is very pivotal for the parties to a contract to keep in mind, before determining, the genuine and actual loss incurred on breaching the contract. For instance, in the case of purchasing a house, if the buyer or seller breaches a contract, then the defaulted party pays the pre-determined amount to an aggrieved party, which is already mentioned in the clause of the Contract signed by them.


LIQUIDATED DAMAGES UNDER INDIAN CONTRACT ACT, 1872

SECTION 74 OF THE INDIAN CONTRACT ACT,1872

This section deals with the Liquidated damages i.e. damages stipulated for. Extract of section 74 for better understanding:

"Section 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."[2]

From the above provision, it is understandable that the party can decide any of the two compensation, Liquidated Damages, and Penalty, to pay to the suffered person when there is a breach of contract.

Further, as per the above provision, there is no need to prove the actual loss incurred by the aggrieved person.

Now, what’s the difference between LIQUIDATED DAMAGES and PENALTY? Also, when do the plaintiffs have to prove the loss suffered by them or when not?

Let's move further to know the answers to the above two questions.


Liquidated Damages vs Penalty

Both the Liquidated Damages and Penalty are a stipulation that will be decided by the parties before or at the time of entering into the contract. In case one party will not perform his part of the obligation, then he will pay the decided compensation to the other party.

But Liquidated damages should not be treated as a penalty as there are some differences between the two:

MEANING: Liquidated Damages are a genuine as well as reasonable pre-estimated stipulation that the party decided to keep in mind the probable loss suffered by any of the parties if there is a breach of contract. Whereas the penalty is an excessive and highly disproportionate amount to a likely loss i.e. not a genuine pre-estimate stipulation.

OBJECTIVE: Liquidated Damages are to be decided with the intention to re-instate the aggrieved party i.e. to place the suffered party in the same position in which it would have been if there is no breaching. Whereas the penalty is to be decided with the intention to secure the performance of a contract; and to create terror.

HOW THE COURT DIFFERENTIATE THE TWO: Here the court decides where the stipulation is in the nature of Liquidated Damage or Penalty based on the intention of the party. [ Refer to the case law BSNL VS. Reliance Communication Limited[3] and 3i Infotech Limited Tower #5 v. Tamil Nadu E-Government Agency[4]]

However, the bifurcation of liquidated damages and penalties is in English law but not in Indian law. Indian court decides the compensation on the actual loss suffered by the plaintiff, not more than the decided amount by the parties to a contract.


Whether the actual loss has to be proved by the plaintiff or not

The provision stated in section 74 of the Indian Contract Act, 1872 enables the person to claim compensation despite not being able to prove the extent of actual loss or damage. We can say this section acts as a protector for a person who suffered loss or damage due to a breach of contract.

 There are so many judgments that give more clarification on the above.

One of the earliest enunciations on Section 74 is found in the decision of the Hon'ble Supreme Court in the case of Fateh Chant v. Balkistan Das[5]. Supreme court held that "does not justify the award of compensation when in consequences of the breach no legal injury at all has resulted…". So, the plaintiff's claim for compensation was rejected due to a lack of evidence regarding the loss or legal injury suffered by the plaintiff. There is one more case similar to that, Indian Oil Corporation v. Lloyds Steel Industries Ltd.[6], in which the Hon'ble High court of Delhi held that Section 74 awarded compensation only when any loss or injury occurred i.e. proving the exact extent of the actual loss or damage isn’t necessary but demonstrating the actual loss is still the essential part for claiming compensation.

The perplexity of proving the actual loss is mainly realized in public utility contracts in which the state is an aggrieved party or a plaintiff. If the nonperformance of the contract happened then it caused harm to the public at large as public utility contracts are those contracts that benefit the society. So, it's difficult to calculate the quantum of the harm and even prove it. The Hon'ble Supreme Court in the case of Construction and Design Services v. Delhi Development Authority[7] held a similar verdict and awarded half of the stipulation amount mentioned in the contract, since the compensation clause provided an upper limit of that and did not provide the fixed sum, due to the absence of evidence regarding the loss or damage, part of the amount is reasonable as Liquidated Damages and remaining can be treated as penalty.

In one of the cases, the Hon'ble High Court of Madras clarifies the difference between Penalty and Liquidated Damages on the basis of proving and this case is 3i Infotech Limited Tower #5 v. Tamil Nadu E-Government Agency. In this case, the court held that: “…. On the contrary, if it is concluded that the stipulation is by way of penalty, the person claiming such penalty would be required to prove loss accurately, including the quantum of loss, and claim reasonable compensation on that basis.” It means if the stipulation is in the nature of Liquidated Damages, then the person claiming it may or may not prove the exact extent of loss depending upon the circumstances but has to prove that some loss or damage has occurred. In case of a penalty, the suffering person has to prove both the accurate loss or damage and the quantum of that loss and damage.

There is one more case Kailash Nath Associates v. DDA[8], the Hon'ble Supreme Court made a clarification about the position qua requirement of the accurate loss or damage suffered in consequence of breach of contract. The court observed that: “…Since Section 74 awards reasonable compensation for damage or loss caused by a breach of contract, damage or loss caused is a sine qua non for the applicability of the Section...”. Further in this case court also held that: “The expression ‘whether or not actual damage or loss is proved to have been caused thereby’ means that where it is possible to prove actual damage or loss, such proof is not dispensed with. 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.” (The same verdict was also given in the case Maula Bux v. Union of India[9])

To all the above observations by the Hon’ble Court, a famous Maxim “Injuria Sine Damnum”[10] come into the picture which means injury without damage i.e. infringement of legal right without any loss, harm, etc. And if there is any infringement of the legal right of any person without actual harm then it is actionable in the court of justice.


Additional concepts related to Liquidated Damages

Section 23 of Specific Relief Act, 1963

There's a provision in section 23 of the Specific Relief Act, 1963 which says that the claiming of Liquidated Damages does not restrict the parties to a suit from claiming specific performance. The extract of the provision thereunder:

“Section 23. Liquidation of damages not a bar to specific performance. –

(1)  A contract, otherwise proper to be specifically enforced, maybe so enforced

through a sum named in it as the amount to be paid in case of its breaching and

the party in default is willing to pay the same, if the court, having regard to the terms of the contract and other attending circumstances, is satisfied that the sum

was named only for the purpose of securing the performance of the contract and not for the purpose of giving to the party in default an option of paying money in lieu of specific performance.

(2)  When enforcing specific performance under this section, the court shall not also decree payment of the sum so named in the contract.”[11]

So, the person claiming Liquidated Damages is not barred from claiming other relief, specifically specific performance. If the person claims specific performance along with Liquidated Damages and the court thinks it reasonable to claim both or in the view that the Liquidated Damage alone does not provide reasonable relief to an innocent person then the court awarded both the claim. (You can take reference from the case Chinna Munuswami Nayudu v. Sagalaguna Nayudu Andr.[12])


Limitation Period for Claiming Liquidated Damages

The limitation period for filing a suit related to a breach of contract for seeking compensation is three years as per Part II of the Schedule to Limitation Act,1963. According to this schedule, the period commences on the date the contract is breached or broken.[13]


Conclusion

Now we can conclude that Liquidated Damage is a type of pre-estimated stipulation that is in the nature of compensation. One should critically evaluate the Liquidated Damages so as to ascertain whether the compensation is a penalty or the genuine pre-estimated stipulation, to know that the person claiming Liquidated Damages, has no need to prove the quantum of loss or damage suffered by them in courts.

 

 

 

 

     

 

 

 


[1] Sardar Amarjit Singh Kalra v. Promod Gupta & Ors. On 17 December 2002, the Hon'ble Supreme Court recognized this maxim as a fundamental principle of law.

[2] Indian Contract Act, 1872; Section 74

[3] BSNL v. Reliance Communication Ltd., (2010)

[4] 3i Infotech Limited Tower #5 v. Tamil Nadu e-Government Agency and Ors., (2019)

[5] Fateh Chant v. Balkistan Das, AIR 1963 SC 1405

[6] Indian Oil Corporation v. Lloyds Steel Industries Ltd., (2007)

[7] Construction and Design Services v. Delhi Development Authority (2015)

[8] Kailash Nath Associates v. DDA (2015)

[9] Maula Bux v. Union of India, 1969 (2) SCC 554

[10] Law Of Tort; Landmark Cases: Ashby v. White (1703) and Sain Das v. Ujagar Singh (1940) 

[11] Specific Relief Act 1963, Section 23

[12] Chinna Munuswami Nayudu v. Sagalaguna Nayudu Andr., AIR (1926) MADRAS 699

[13] Limitation Act, 1963; Schedule 1 Part II

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