Internal Submission : Contracts - I

“Liquidated Damages”
Guided By: Ms. Arman Dalal Prepared by: Gaurav Mundra
Roll no: C - 41
 Breach of Contract
What is a Contract ?
• Contract is a legally binding promise made between two parties
• Each party to a contract promises to perform a certain duty, or pay a certain amount for a specified item
or service.
• The purpose of a contract being legally binding is so each party will have legal recourse in the event of a
breach.
Breach of Contract
• Breach of contract occurs when the promise of the contract is not kept, because one party has failed to
fulfill their agreed upon obligations, according to the terms of the contract
• Breaching can occur when one party fails to deliver in the appropriate time frame, does not meet the
terms of the agreement, or fails perform at all
• If one party fails to perform while the other party fulfills their obligations, the performing party is entitled to
legal remedies for breach of contract
 Remedies to Breach
Following remedies are available
• Damages for the loss sustained
• A decree for specific performance
 Can be granted only when damages are an inadequate remedy
 Court supervise the execution of the contract
 Contract is certain, fair and just
• Injunction
 Means of enforcing a contract or a promise to forbear
 May be only means of enforcing a specific performance

The law to damages is governed by Contract Act, whereas the law to specific performance and injunction is
regulated by the Specific Relief Act
Note: We shall be discussing the Damages piece in this presentation
 Liquidated Damages & Penalty
LD - The parties to the contract may agree at the time of contracting that, in the event of a breach, the party
in default shall pay a stipulated sum of money to the other, or may agree that in the event of breach by one
party any amount paid by him to the other shall be forfeited. It is a genuine pre-estimate of damages likely to
flow from the breach.
Penalty - However, this liquidated damage shall be distinguished from the term penalty which is an amount
intended to secure performance of the contract.
It can be discussed under following four heads
• Rules governing the measure of damages (S. 73)
• Compensation for breach of contract where penalty is stipulated for (Difference between penalty and
liquidated damages) (S. 74)
• Rights of party rightfully rescinding a contract (S. 75)
• Quantum Meruit (a reasonable sum of money to be paid for services rendered or work done when the
amount due is not stipulated in a legally enforceable contract.)
 Section 73 & 74 : Contract Act
• Section 73 provides as under:
“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.”
 Case I - Fateh Chand v Balkishan Das, 1963
• The Constitutional Bench in Fateh Chand was dealing with a clause in a sale deed which provided that, if for any
reason the vendee fails to get the sale-deed registered by the date stipulated, the amount of Rs. 25,000 (Rs. 1,000
paid as earnest money and Rs. 24,000 paid out of the price on delivery of possession) would stand forfeited. 

• The above condition which provided for forfeiture of Rs 24,000 was considered by the 5 judge bench to be a
stipulation in the nature of penalty rather than an liquidated damage. The Court held it to be covered under Section 74
of the Contract Act since it contains the phrase, “as the case may be, the penalty stipulated for.” The Court observed
as follows: 

 “The expression if the contract contains any other stipulation by way of penalty widens the operation of the
section so as to make it applicable to all stipulations by way of penalty, whether the stipulation is to pay an
amount of money, or is of another character, as, for example, providing for forfeiture of money already paid.”
 The Court speaking though JC Shah went to rule that for an LD Clause which is in the nature of a penalty,
reasonable compensation not exceeding the amount stipulated has to be awarded depending upon what the
Court considers to be reasonable. 

• Also, while interpreting the phrase, “whether or not actual damage or loss is proved to have been caused thereby”, the
Court held that it merely dispenses with the requirement of proof of actual loss or damages but nonetheless the
necessity that there has been a legal injury suffered by the party is a prerequisite before awarding compensation
under Section 74 of the Contract Act. 
 Case II – Maula Baux vs Union of India, 1969
• The Supreme Court in this case was again dealing with a situation of forfeiture of an amount that has already
been paid under a contract and adjudicated that such a fact situation would be a penalty covered under
Section 74 of the Contract Act. Significantly, while interpreting the phrase, “whether or not actual damage or
loss is proved to have been caused thereby”, it observed the following:

 “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.

 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.”

• From the above observations of the 3 Judge Bench of the Supreme Court speaking though JC Shah J, it is
clear that the Court has held that in situations where it would be difficult to assess compensation, the sum
named by the parties can be considered to be a genuine pre-estimate and as a reasonable compensation to be
paid in situations where the clause is an LD Clause.
 Case III – Oil & Natural Gas Corporation Ltd vs Saw Pipes Ltd,
2003
Landmark case: Framing of guidelines for reasonable compensation
 “Recovery from the contractor as agreed liquidated damages are not by way of penalty, a sum equivalent
to 1% (one percent) of the contract price of the whole unit per week for such delay or part thereof (this is an
agreed, genuine pre- estimate of damages duly agreed by the parties) which the contractor has failed to
deliver within the period fixed for delivery in the schedule, where delivery thereof is accepted after expiry of the
aforesaid period. It may be noted that such recovery of liquidated damages may be upto 10% of the contract price
of whole unit of stores which the contractor has failed to deliver within the period fixed for delivery
 While interpreting the contours of the above LD Clause, the Court speaking through MB Shah J laid down certain
key pointers relevant for interpretation of LD Clause being the following:
 “If parties knew when they made the contract that a particular loss is likely to result from such
breach, they can agree for payment of such compensation.” The Court went on to observe that in such a
situation, the necessity of leading evidence is discretionary, and it may not be required in situations unless
the Court concludes that no loss is likely to occur because of the event which triggered the LD Clause. 
 It went on to hold that: “when parties have expressly agreed that recovery from the contractor for
breach of the contract is pre-estimated genuine liquidated damages and is not by way of penalty
duly agreed by the parties, there was no justifiable reason for the arbitral tribunal to arrive at a
conclusion that still the purchaser should prove loss suffered by it because of delay in supply of
goods.”
 Most importantly, it was stated that in situations where the LD Clause is a pre-estimate, the burden would be on
the other party to lead evidence for proving that no loss is likely to occur by such breach. 
 Contrary
Decisions
Saw Pipes decision contrary to Fateh Chand?

• The Constitutional Bench in Fateh Chand had observed that Section 74 merely dispenses with proof of
"actual loss or damages” but the requirement of demonstrating legal injury still persists under Section 74.

• Therefore, the Saw Pipes ruling that when parties have agreed to a genuine pre-estimate in the LD
Clause, there may not be any requirement of proving evidence to prove loss unless the Court comes to
conclusion that there may not be any legal injury suffered by a party claiming the benefit of LD Clause,
appears to be consistent with the decision of Fateh Chand. 
 Concluding Thoughts (Three cases)
• From a conjoint reading of the observations and rulings in the 3 (three) decisions of the Supreme Court, it
can be stated that parties may be able to take benefit of an LD Clause and the requirement of proof that
is strictly applicable to a Section 73 situation may not be applicable under an LD Claim particularly where
the parties have expressly stated that the estimate of damages is a pre-estimate that is agreed between
the parties and is not in the nature of a penalty. 

• However, to overcome the Maula Bux observations of the Supreme Court where the 3 Judge Bench has
ruled that, “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” if the Court is unable to assess the
compensation, the parties may consider adding an acknowledgment by the parties that it would be
impossible or extremely difficult to exactly quantify such loss and therefore, the estimate is to be
considered as a genuine pre-estimate in the event a breach leads to trigger of an LD Clause