Breach Of Contract | Can't Forfeit Security Deposit Towards Risk Liability In Absence Of Loss/Damage: Kerala High Court

The Kerala High Court has recently ruled that in the case of a breach of contract, one party cannot forfeit the security deposit towards risk liability when they have not suffered any loss or damage.

A Division Bench of Justice P.B. Suresh Kumar and Justice C.S. Sudha observed that it was settled that when the question is one of forfeiture of the security deposit in case of breach of contract, such sum does not ipso facto go to the respondents.

"If the party complaining is in a position to adduce evidence whereby the court can assess reasonable compensation, then without proof of actual loss, damages will not be awarded and amount mentioned by the contract will be penalty. In such circumstances, it has been held that the security amount is liable to be forfeited." 

The respondent awarded certain railway work between Shornur and Mangalore and between Kottikulam and Kasaragod stations to the appellant, who is a contractor, in 2000 for almost ₹1.20 crores to be completed within nine months.

Alleging breach on the appellant's part, the respondent terminated the contract before expiry of the completion period. As disputes arose between them, arbitration proceedings were initiated.

An amount of ₹ 3 lakhs deposited as a security deposit and an amount of ₹ 46,959/- towards advertisement charges had been deducted by the respondent from the final bill as the amount towards risk liability.

The appellant was the claimant before the Arbitral Tribunal which passed an award disallowing their claims except claim 1 for release of ₹ 3,46,959/-, the risk liability amount. This claim was partly allowed to the tune of ₹ 46,959/-. All the other claims were rejected.

Aggrieved by this, the appellant approached the District Court with an application under Section 34 of the Arbitration and Conciliation Act which was also dismissed.

Challenging this order of the District Court, the appellant moved the High Court. 

The question before the Bench was whether there is any infirmity in the finding of the Tribunal that the respondent is entitled to forfeit the security deposit of ₹ 3 lakhs towards risk liability in the absence of any loss or damage.

According to the Tribunal, since the breach of the contract had been committed by the appellant, the security deposit of ₹ 3 lakhs is liable to be forfeited and therefore, only an amount of ₹ 46,959/- was allowed.

However, in the award itself, it was stated that no loss/damage had been caused to the respondent. Therefore, Advocates Santha Varghese, Ranjith Varghese and Rahul Varghese appearing for the appellants submitted that the forfeiture of ₹3 lakhs was patently wrong, illegal and perverse.

Standing Counsel S. Ananthakrishnan for Railways appeared for the respondents in the case. 

The Court referred to Section 74 of the Indian Contract Act and noted that in cases under this provision, it is not necessary for the party claiming compensation to prove that actual damage or loss has been caused.  

So the question was whether even in the absence of legal injury, compensation is liable to be paid for breach simpliciter.

The Court noted that the proof of the extent of actual damage or loss suffered is dispensed with in Section 74.

"Under Section 74, whether it is a case of liquidated damages or penalty, what the party faced with the breach gets is only reasonable compensation, subject to the limit of the amount stipulated in the contract itself. Section 74 dispenses with proof of the extent of real or actual or factual loss or damage, but provides for grant of reasonable compensation, subject to the condition that it shall not exceed the sum stipulated as penalty in the contract."

However, the Bench clarified that this would not mean that there need not be any loss or damage. What is meant is only that proof of actual damage or loss is not necessary, it was observed. 

Coming to the facts of the case, the Division Bench declared that Section 74 could not have been invoked because the Award does not say that any sum has been named in the contract as the amount to be paid in case of a breach.

"In other words, the parties had never made a genuine pre-estimate of the amount to be paid in the event of any damage or loss likely to be caused by the breach or that there is any clause relating to liquidated damages in the contract."

Further, the compensation payable under Sections 73, 74 and 75 is only for loss or damage caused by the breach and not account of the mere act of breach. If in any case the breach has not resulted in or caused any loss or damage to a party, he cannot claim compensation.

Reliance was placed on the Apex Court decision in Union of India v. Rampur Distillery & Chemical Co. Ltd. (AIR 1973 SC 1098) where it was held that a party to a contract taking security deposit from the other party to ensure due performance of the contract, is not entitled to forfeit the deposit on ground of default when no loss is caused to him in consequence of such default.

As such, the Court held that the Tribunal was wrong in rejecting the appellant's claim for release of the amount of security deposit. This finding in violation of the provisions of Sections 73 to 75 of the Contract Act, is certainly in contravention of the fundamental policy of Indian Law as contemplated in Section 34(2)(b)(ii) of the Act.

Therefore, the impugned order to the extent it disallows claim for the release of security deposit of ₹ 3 lakhs towards risk liability amount was set aside and the appeal was allowed. 

Since the amount was withheld without any justification, it was to be returned by the respondent to the appellant with interest @ 6% p.a. from the date of moving the claim before the Tribunal till realisation and costs.

Case Title: M/s Devchand Construction v. Union of India

Citation: 2022 LiveLaw (Ker) 108

Click Here To Read/Download The Order