Concept Clarification – "Liquidated Damages"

"Section 73. Compensation for loss or damage caused by 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."

The bold and underlined words in the quoted Section 73 i.e. "compensation for any loss or damage "caused" to him" are significant for claiming damages, which means sufferance of loss or damage is condition precedent. In other words, Claimant will not have any automatic right of lodging a claim - in absence of actual loss/ damage - on the basis of mere fact that in the contract there is a Liquidated Damages clause where a sum is named in the event of breach of contract by the Respondent.

Section 74 is the provision dealing with Liquidated Damages, without naming the same, and stating like: -

"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."

Here "Liquidated" means an amount which is "determined", "precise", "agreed", "certain". The claims are adjudicated either as per Section 73 or Section 74 vide two distinct categories:

a) claims based on a contract clause where the "amount of compensation" is not named/ specified, will fall under Section 73;

b) claims based on a contract clause where the amount is already named/ determined, at the time of entering into contract, will fall under Section 74.

Below table shows the requirements to be fulfilled for successful award of a claim: -

	Section 73	Section 74
"Legal injury" to be suffered in the sense of some loss/ damage (on account of breach of contract);	Mandatory	Mandatory
"Proof" of such loss/ damage	Mandatory	Not mandatory Note: - mandatory in a case where it is easily discernible
Quantification/assessment of such loss/ damage	Mandatory	Not mandatory Note: - mandatory in a case where in can be quantified

From above, it becomes quite clear that for the claims falling under Section 73 (without named amount of compensation in the contract clause) all the three requirements are mandatory. However, as regards a claim falling under Section 74 (named amount in the contract clause as pre-estimated loss/ damage) - "in some cases" - two of such requirements could be dispensed with i.e. (i) Proof of such loss/ damage and (ii) Precise Quantification and assessment of such loss/ damage for awarding the compensation. It is to be noted that the basic requirement is still to be fulfilled i.e. "Legal injury" suffered in the sense of some loss/ damage (on account of breach of contract).

It is settled law that - in a case when the party complaining of breach of the contract has not suffered legal injury in the sense of sustaining loss or damage, there is nothing to compensate him. When the section says that "an aggrieved party is entitled to compensation whether actual damage is proved to have been caused by the breach or not", it merely dispenses with the proof of 'actual loss or damage'. If liquidated damages are awarded to the petitioner even when the petitioner has not suffered any loss, it would amount to 'unjust enrichment', which cannot be countenanced and has to be eschewed." It is settled law that "whether or not actual damage or loss is proved to have been caused thereby" is intended to cover different classes of contracts which come before the Courts. In case of breach of some contracts it may be impossible for the Court to assess compensation arising from 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.

Difference between Liquidated Damages and Penalty is dealt with in detail and summarized: -

In ONGC vs. Saw Pipes 2003 (5) SCC 705: -

(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 consequence 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, the court can award the same if it is genuine pre-estimate by the parties as the measure of reasonable compensation."

In Kailash Nath Associates vs. DDA 2015 (4) SCC 136: -

1) Where a sum is named in a contract as LD, the Claimant can receive as reasonable compensation "such LD amount" only if it is a genuine pre-estimate of damages fixed by both parties and found to be such by the Court.

2) In other cases, where a sum is named in a contract as LD, "only reasonable compensation" can be awarded not exceeding the amount so stated.

3) Similarly, in cases where the amount fixed is in the nature of "penalty", only reasonable compensation can be awarded not exceeding the penalty so stated.

4) In both cases, LD amount or penalty is the "upper limit" beyond which the Court cannot grant reasonable compensation.

5) Reasonable compensation will be fixed on well known principles that are applicable to the law of contract.

6) 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.

7) 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.

8) 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.

9) Section 74 will apply to cases of forfeiture of earnest money under a contract. Where, however, forfeiture takes place under the terms and conditions of a public auction before agreement is reached, Section 74 would have no application.

In Gail(India) Limited vs Punj Lloyd Limited (judgment of 8 May, 2017) the Hon'ble Division Bench of Delhi High Court has surmised that in certain cases Liquidated Damages could be compensated without proof of actual loss, vide para 35: -

"35. This court is of the opinion that considering all these materials on record, the stipulation in clause 57.2.1 and the amounts deducted were by way of liquidated damages and a genuine pre-estimate of the loss calculated in monetary terms. They were not merely precautionary conditions not meant to be enforced, but conditions that could be insisted upon……….. These intermediate delay liquidated damages were of the kind contemplated in Maula Bux (supra) and Bharat Sanchar Nigam (supra), which the parties agreed, would be payable by one of them (Punj Lloyd) without proof of actual loss."

Some Judgments On The Subject: -

(1) Fateh Chand vs. Bal Kishan Das (AIR 1963 SC 1405)

(2) Maula Bux vs. Union of India ((1969) 2 SCC 554)

(3) ONGC vs. Saw Pipes ((2003) 5 SCC 705)

(4) Herbicides (India) Ltd. Vs. Shashank Pesticides (180 (2011) DLT 243)

(5) Kailash Nath Associates vs. DDA (2015 (4) SCC 136)

(6) Construction Design vs. DDA (SC – 04.02.2015)

(7) ATC Telecom vs. Videocon Telecom (Delhi High Court 14.09.2016)

(8) GAIL India Ltd. vs. Punj Lloyd Ltd. (Delhi High Court – 08.05.2017)

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