Law of contracts
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This article is written by Bhumi Agarwal who is pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from LawSikho.

Introduction

Whenever there is a breach of contract the aggrieved party asks the other party to compensate the damages or loss caused to it. Here at this moment, there comes a picture of the penalty and damages given by the party committing the breach to the aggrieved party. In this article, we will discuss in detail:

  • the meaning of contract,
  • breach of contract,
  • types of contract,
  • remedies available on breach of contract and, 
  • difference between liquidated damages and penalty as per Indian and English law in detail with few case law.

What is a Contract?

As per Section 2(h) of the Indian Contract Act, 1872, “a contract is an agreement enforceable by law”. It refers to any agreement which is formed out of free consent, lawful consideration, and with a lawful object and signed and executed by a legally competent person.

What is a Breach of Contract?

Breach of Contract in simple terms means breaking of the terms of a contract by non-performance of the promise mentioned under an agreement by either party(ies). It is a civil wrong where a party or parties to a contract fail to fulfill its obligations whether partially or completely.

Even if the party(ies) behaves in a manner that clearly shows its intention to not perform their obligations willingly in near future can also result in the breach of contract.

It is the responsibility of the judge or an arbitrator to decide the kind of breach in contract and its compensatory value to provide relief to the aggrieved party after proper analysis of facts and shreds of evidence related to the given contract and the concerned parties.

Types of Breaches

Based on the intensity of loss occurred breaches can be of two types-

  • Immaterial breach of contractIn this kind of breach, the loss or damage that occurs is not so huge and grievous and can be compensated easily without going into long court proceedings.

Eg: A promises B to deliver him a computer and the service to start it.  A delivers the computer and provides for its installation but the C service provider forgot to tell the password to A.

Here, this is a very minor loss and can be compensated very easily by contacting C (service provider).

  • Material Breach– In this case, the loss occurred by a party is a major or serious loss.

Eg: A promises B to deliver him 500 computers on the due date as per the contract but delivers only 400 computers. Here, B has incurred a great loss and so can sue A for such breach.

Based on time of breach they can further be of two types:

  • Anticipatory breach: It occurs when either party to a contract refuses to fulfill its obligation as per the contract before the time of its fulfillment/performance but after the contract is enforced.

Ego: A promises to provide B with a dozen of shirts by the 20th of March but on the 18th of March denies to deliver it to A.

  • Present breach: It occurs when the party commits the breach or refuses to fulfil its obligation at the time of its performance.

Eg: A was required to deliver a certain property to B on the 3rd of March but he neither delivered it to B on the 3rd nor provided any prior notice for the inconvenience of the same. So, the breach herein will be considered as a present breach.

Remedies for a breach of contract

Chapter VI of the Indian Contract Act, 1872 deals with the Remedies provided for the compensation of loss or damages caused due to the breach of contract.

Any party(ies) to the contract which fails to fulfil its obligation or break the terms of a contract willingly, shall be liable to compensate the aggrieved either through penalty or through damages.

Other remedies available that can be claimed by the aggrieved party are:

  • Rescind- It means to revoke or cancel a contract completely by the aggrieved party on the breach of any of the obligations by the other party.

As per Section 75 of the Indian Contract Act, 1872, if a party rescinds/ revokes a contract rightfully, then can claim for any damages sustained due to breach of such contract.

  • Specific Performance- In this Court order, the party committing the breach to perform its part of obligations as was agreed in the contract.
  • Injunction – It is a kind of remedy in which the court orders and restricts the party from further breach of its obligations or to put a stop to the omission of the Act promised. 

Now the remedy of damages and penalty are discussed below in detail as per both, the Indian and English Law.

Difference between Liquidated damages and Penalty

If the parties cause a breach of a contract then, it shall be liable to pay for the losses incurred to the aggrieved party which shall be the amount known as liquidated damages/penalty.

These damages or penalties are the same as per Indian Law but different things as per the English law.

English Law

As per English law, the amount stated in the contract can be either penalty or liquidated damages.

Liquidated damages: If the parties to a contract mutually agree and pre-fix an amount as compensation amount and if this amount pre-fixed is reasonable, then such amount is termed as liquidated damages. This is an amount fixed before or at the time of contract to fix such breaches if occur in the future. The Court cannot order the party to pay an amount more than this fixed amount to the aggrieved party for losses incurred.

Penalty: If the amount fixed by the party(ies) is not reasonable and is not properly estimated but is laid down in the contract to create a fear in the minds of parties to the contract to abide by its obligations and not to breach any term/obligations as per the agreed contract. It is usually an amount higher than the normal loss that can be incurred by either party due to the breach. The parties in such a case are not awarded this penalty completely but only the sum amounting to the actual loss. 

Indian Law 

There is no distinction between a penalty and liquidated damages as per Indian Law. In Section-74 of the Indian Contract Act, 1872 it is held that any party if breaks or breaches the contract, then, the amount to be paid in such breach of contract is by the way of penalty/damages or any other form stipulated, and the party claiming for such breach is entitled; whether or not the actual damage or loss is proved, to receive from the party committing such breach a reasonable compensation not exceeding the amount so mentioned and is usually decided by the Courrt after looking over the facts and circumstances for the same.

Exception – In case of contracts with the Government for the general public, such breach is compensated by paying the entire amount of the contracts back to the Authority.

Illustrations

  • A contracts with B to pay Rs 1000, if he fails to pay B Rs 500 on a given day. A fails to pay B Rs. 500 on that day. B is entitled to recover from A such compensation not exceeding Rs.1,000, as the Court considers reasonable.
  • A gives a recognizance binding him in a penalty of Rs. 500 to appear in Court on a certain day. He forfeits his recognizance. He is liable to pay the whole penalty.
  • A borrows Rs. 100 from B and gives him a bond for Rs. 200 payable by five yearly installments of Rs.40, with a stipulation that, in default of payment of any installment, the whole shall be due. This is a stipulation by way of penalty.

Case laws

Chunilal V. Mehta and Sons Ltd. v. Century Spg. and Mfg. Co. Ltd. (AIR 1962 SC 1314)

In this case, it was held that “by providing for compensation in expressed terms the rights to claim damages under the general law is necessarily excluded.”

Fateh Chand v. Balkishan Das (AIR 1964) 1 SCR- In this case, the Hon’ble Supreme Court held that compensation given actually to the aggrieved party shall be based on the actual loss and cannot exceed the amount stated as damages or penalty stipulated. 

Summary

When the amount fixed is greater than the real loss incurred, it is known as a penalty however an amount that could be a pre-estimate of the loss is known as liquidated damages.

If the contract specifies an amount that is payable at a certain time and an additional amount to be paid if a default happens, then the extra sum is a penalty. It is because a delay in payment alone is not likely to cause damage.

It is upon the discretion of the court to determine whether the amount payable is liquidated damages or penalty.

The Indian law considers each as synonymous however the English Law differentiates among the two.

The penalty is an exaggerated amount to deter the parties from defaulting. Liquidated damages are a real estimate of the loss.

References


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