This article has been written by Subhi Pastor, pursuing a Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution from LawSikho.
Table of Contents
Introduction
An agreement to sell property contains terms and clauses regarding the sale and transfer of a property on a future date being agreed upon by both the parties and thus making them entering into legally binding obligations. Transfer of Property Act, 1882 defines the transfer of property as an act by a living person to himself or one or more living persons, in present or in future. As per Section 4(3) of The Sale of Goods Act, 1930, an agreement to sell becomes a sale when the time slips by or necessary conditions subject to which the property is to be transferred are fulfilled. However, Section 54 of the Transfer of Property Act clearly provides that a contract for the sale of the property is a promise to transfer the property in the future after certain terms and conditions are fulfilled and this per se does not create any rights or interest of the buyer in the property.
The distinction between a sale deed and agreement for sell
It is important to note the distinction between a sale deed and an agreement for sale. While Sale Deed is an actual transfer of ownership of property, a Sale agreement is a promise of a transfer of ownership on a future date contingent on fulfillment of certain conditions. In the case of Suraj Lamp & Industries Ltd v State of Haryana, the Hon’ble Supreme Court held that any contract of sale which is not a registered deed of conveyance would fall short of the requirement of Sections 54 and 55 of the Transfer of Property Act and thus immovable property could be transferred or conveyed lawfully only by a registered deed of conveyance. Therefore, a proper sale deed is to be executed after the agreement of sale in order for the buyer to get the right or interest in the property.
Essential clauses in an Agreement to Sell
1- Agreement to Sale contains an essential clause mentioning names of the parties, their ages and residential addresses, and the date on which the agreement was executed. It also has a description of the property to be transferred including the location.
2- There is a ‘Consideration Clause’ that mentions the amount of consideration to be paid along with the payment method and the date of payment.
3- Since an Agreement to Sale provides for transfer on a future date subject to certain conditions and obligations to be carried out by the buyer, it contains clauses that specify about time and method for completion of such obligations and date of possession of the property.
4- There are separate clauses regarding rights and liabilities on both the seller and buyer separately.
5- Agreement to Sale lists out clearance of all outstanding dues on the property. The first party assures that the property is free from all kinds of encumbrances, prior sale, mortgage, gift, will, trust, lease, loan, security, lien, court injunction, family disputes, income tax, or wealth tax attachment, etc.
6- Another important clause is the ‘Indemnity Clause’ that comes to the rescue of the buyer in case of any legal disputes arising out of a property in respect of future claims by any third party.
7- The ‘Penalty Clause’ is a clause that mentions that the party that breaches the contractual obligation is required to pay a certain amount to the other party which is generally greater than the reasonable amount that could be claimed due to loss or damages arising out of breach of contract. The main purpose behind such clauses is to punish the party that breaks out of the contract rather than providing compensation to the innocent party.
8- The ‘Termination Clause’ is to ensure protection to either party in case the other party breaches the contractor backs out. It also mentions termination in cases of no fault of the other party like the death of one of the parties.
Penalty clause in Agreement to Sale
An agreement to sale between the buyer and seller can go awry like any other contract thus it is important to have specific penalty clauses in the contract to be enforced in case either of the parties fails in carrying out obligations under the contract. The buyer or seller thus may seek damages for the breach of contract by enforcing penalty clauses when the other party defaults or may ask the court to compel the erring party for specific performance of the contract at its sole discretion. Therefore it is important to have specific penalty clauses in the contract because that acts as a deterrent from breaching the contract. Penalty clauses also come to the rescue when the actual amount of loss is more than the number of liquidated damages mentioned in the contract and thus to be awarded as a penalty.
Enforceability of Penalty clauses
In a landmark judgment, the highest court in England and Wales set out a new progressive test providing greater freedom to parties with equal bargaining power. The earlier position regarded unconscionable penalty clauses as unenforceable while distinguishing them from the liquidated damages clauses which were enforceable provided it was a genuine estimate of loss. However, the new test laid down in Cavendish Square Holding BV v Talala El Makdessi and ParkingEye Limited v Beavis provides that it is to be considered that “Whether the impugned provision is a secondary obligation imposing a detriment on the erring party to the legitimate interest of the innocent party in the enforcement of the primary obligation?” Therefore, now the court will consider if the sum or remedy stipulated in the penalty clauses is exorbitant and unconscionable, and thus not enforceable. In other words, parties have been given more freedom to contract since they are the best judges to decide if the provision dealing with consequences of breach of contract is legitimate while negotiating the contract terms.
Position in India
Section 73 of the Contract Act, 1872 provides for compensation for the unliquidated damages which are the direct and immediate results of a breach of contract. However, Section 74 deals with predetermined damages clauses. In Karsandas H. Thacker vs Saran Engineering Co Ltd, the Supreme Court held that when one party commits the breach of contract, the other party is entitled to damages or compensation for any losses caused or naturally arose in the usual course of business.
The question regarding the nature of the clause to be one that imposes a penalty is to be determined on the basis of a number of factors like nature and characteristic of the transaction, rights, and obligations arising out of such transaction, and most importantly the intention of parties in incorporating particular clause into the contract. In the case of K.P. Subbarama Sastri and Ors vs K.S. Raghavan and Ors, it was held that if the purpose is to drive the party to fulfill the contract by way of burdensome or oppressive character then it will be in the nature of the penalty clause.
In the case of ONGC VS Saw Pipe, the Supreme Court held that in order to ascertain the damages claimed, the court has to consider whether the terms of the contract are clear and unambiguous and not unreasonable or in the nature of penalty in order to award compensation. Further, the court held that the court is empowered to award reasonable compensation even if no actual damages have been proved. Further, in the case of Fateh Chand v Balkishan Das, the Supreme clearly stated the onus under Section 74 of Contract Act, 1872 is to award reasonable compensation and not the enforcement of penalty clauses which often can be unreasonable and against public policy.
Therefore, with regard to position in India, it can be concluded that a liquidated damages clause need not specifically state that the liquidated damages are not in the nature of penalty but the only requirement is that damages claimed or compensation be paid in lieu of breach of contract has to be reasonable.
Forfeiture of earnest money as a penalty
In the case of Kunwar Chiranjit Singh v Har Swarup, it was held that Earnest money forms the part of the purchase price when the transaction is carried forward and it stands forfeited when the transaction fails due to the fault of either party. The amount deposited as security for the due performance of the contract cannot be considered earnest money. It has been observed in a number of cases that forfeiture of a reasonable amount cannot be regarded as imposing a penalty. However, if it is in the nature of penalty then the court awards such some as it considers reasonable not exceeding the amount specified as liable to forfeiture.
Conclusion
In India, the doctrine of reasonable compensation governs the laws regarding compensation and damages arising out of breach of contract. The jurisdiction of granting relief under Section 74 does not extend to enforcing the penalty clauses in a contract. Furthermore, in the ONGC case, the Supreme Court has made it clear that in cases of breach of contract, no actual loss or damage is needed to be proved and in cases where it is not possible to prove damages, the estimated sum agreed upon by the parties will be awarded. If the court considers the amount to be unreasonable, then it can be reduced accordingly.
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