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Author - Advocate Palak Nenwani

The Black’s Law Dictionary defines ‘Liquidated Damages’ as “An amount contractually stipulated as a reasonable estimation of actual damages to be recovered by one party if the other party breaches; also If the parties to a contract have agreed on Liquidated Damages, the sum fixed is the measure of damages for a breach, whether it exceeds or falls short of the actual damages.”  ‘Liquidated Damages’ is but a pre-estimated damage, which the parties agree while making the contract, as likely to arise in case of a breach.

The law as promulgated in the Indian Contract Act reads as under

Section 73 

“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 

“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.”

The definition in Section 73 of the Indian Contract Act necessarily pre-supposes that the damages are payable only if some loss has been occasioned by the breach. The Courts, while dealing with the issue of validity of imposition of ‘Liquidated Damages’ by one party to the contract on the other, read Section 73 & 74 of the Contract Act. The damages are awarded to recompense the aggrieved party, in the India common law. The aggrieved party has to be placed, in the same position in which it would have been if no breach had occurred. 

Fateh Chand v. Bal Kishan Das AIR 1963 SC 1405 In this case Court while discussing the scope of Sec.74 stated that it deals with damages which are divided into two classes of cases: First where there is pre-determination of amount which has to be paid in cases of breach of contract And second, where the contract may contain any further stipulation in form of penalty.

The Hon’ble Supreme Court in Oil & Natural Gas Corporation Ltd vs Saw Pipes Ltd. (2003) 5 SCC 705 held that “(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 consequences 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, Court can award the same if it is genuine pre-estimate by the parties as the measure of reasonable compensation.”

Delhi High Court in [Indian Oil Corporation Vs. Messrs Lloyds Steel Industries Limited; 2007 (144) DLT 659)] In this case the Court held mere delay in construction and commissioning of the terminal at Jodhpur by the contractor did not entitle IOC to recover Liquidated Damages because there was no loss suffered by IOC. The court found that the pipeline reached Jodhpur terminal (on 31.08.1996) much after the date of completion of construction (31.03.1996) and the terminal could not be put to commercial use without the pipeline reaching the terminal. Herbicides (India) Ltd. vs. Shashank Pesticides Pvt. Ltd. 180 (2011) DLT 243 Merely because the stipulation of ‘Liquidated Damages’ is available in the contract, the aggrieved party cannot claim full amount of Liquidated Damages as a matter of right. Its entitlement would be to recover damages only to the extent of actual losses proved to have been suffered by it. In those cases, where no actual loss is proved, but undeniably losses have been caused, the Courts would not be powerless to award reasonable damages to the aggrieved party. There can be yet another type of situation i.e. where the nature of contract is such that assessing damages is not possible. In such a situation, the Court would be empowered to grant full amount of Liquidated Damages provided it is of the view that the same are fair and reasonable pre-estimate of damages agreed between the parties. 

After the judgement in the case of Kailash Nath Associates v. DDA (2015) 4 SCC 136  a new perspective of Sec.74 was discussed, where the dispute was whether a delay in payment would attract Section 74 of the Contract Act even if the respondents subsequently sold the property at a significantly higher amount. While analysing the scope of compensation to be awarded under Section 74 the Court held the expression “whether or not actual loss is proved to have been caused thereby” to mean that wherever it was possible for the party claiming compensation to prove the actual damage, such proof was not dispensed with. 

Thus, in every case a party must prove the extent of the loss suffered by it. The exception, however, was for cases where the damage was difficult or impossible to prove and in such cases the requirement to prove the extent of loss was dispensed with.