In this article, Smita Singh discusses how to enforce a claim for liquidated damages.

Introduction

A Party to a contract suffering breach is entitled to recover from the party in breach, compensation for loss or damage resulting from such breach[1]. Compensation is payable only for such loss or damage in either of the two cases.

• Naturally arose in the usual course of things from such breach or
• Which the parties knew at the time of making the contract to be likely to result from the breach.

Specifying Liquidated damages

Often, the parties while entering into a contract stipulate named sums payable as compensation, in case of breach by any Party, to the Party suffering breach. The amount so named/quantified is known as liquidated damages. A question arises if in case of breach, party suffering breach is by default entitled to claim the named sum as damages even without having to prove having sustained any actual loss.

Section 74 of the Contract Act

Law governing liquidated damages is embodied in Section 74 of the Contract Act. It provides that 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 the penalty stipulated for.

Deciphering “whether or not actual damage or loss is proved”

The expression “whether or not actual damage or loss is proved to have been caused thereby” have been subject matter of debate. Relying on said expression, it is often suggested that irrespective of whether the party complaining of breach proves that it suffered losses, it is entitled to sum named in the contract as liquidated damages, unless the same is shown to be in the nature of penalty. This blog analyses the authorities on point to demonstrate that only in cases where loss in terms of money is difficult or impossible to prove, that the sum named in the contract can be awarded without insisting for proof of loss, provided further that the same is not in the nature of penalty and represents a genuine pre-estimate of damage or loss.

Fatechand v. Balakrishna Dass

A five Judge Bench of Supreme Court in Fatechand v. Balakrishna Dass,[2] one of the earliest decision on point, held that under section 74 of the Contract Act, even though aggrieved Party is entitled to receive compensation from the Party in breach, whether or not actual damage or loss is proved, only the “proof” of “actual loss or damage” is dispensed. Therefore, award of compensation when as a consequence of the breach no legal injury at all had resulted, was not justified. It was stressed that the compensation for breach of contract can be awarded to make good loss or damage which naturally arose in the course of things or which the parties knew when they made the contract, to be likely to result from the breach.

Maula Bux v. Union of India

In a subsequent decision in Maula Bux v. Union of India[3], a three judge bench of the Supreme Court clarified that the expression “whether or not actual damage or loss is proved to have been caused” is intended to cover class of contracts wherein in case of breach it may be impossible for the court to assess compensation arising from breach. In such class of cases where the court is unable to assess the compensation, the sum named by the parties, if it is regarded as genuine pre-estimate, can be awarded. However, in other cases where compensation in terms of money can be calculated, the party claiming compensation must prove the loss sustained on account of breach of contract.

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ONGC Ltd., v. Saw Pipes Ltd

In a later decision in ONGC Ltd., v. Saw Pipes Ltd.[4], a Division Bench of the Supreme considered a case where the parties did not dispute that the stipulation for liquidated damages in the contract was not by way of penalty. In facts of the said case the Bench concluded that it was difficult to prove exact loss or damage which the party suffered on account of breach. The Bench observed that if the terms of contract stipulating liquidated damages in case of breach of the contract are clear, unless it is held that such estimate of damage/compensation is unreasonable or is by way of penalty, party who committed the breach is required to pay the compensation. It further observed that in every case of breach of contract the person aggrieved by breach is not required to prove actual loss or damage and the court is competent to award reasonable compensation even if no actual damage is proved.

Construction and Design Services v. DDA

Another Division Bench of the Supreme Court in Construction and Design Services v. DDA[5], on facts held that evidence of precise amount of loss may not be possible. The bench without adverting to the ratio in Fatehchand and Maula Bux which were cited, by referring to Saw Pipes only held that in absence of any evidence by the Party in breach that no loss was suffered by the Party complaining of breach, the court has to proceed on guess work as to the quantum of compensation to be allowed in given circumstances. In spite of noticing that the Party suffering breach could have led evidence to show the extent of higher amount paid for getting the work done, proceeded to award half of the amount claimed as reasonable compensation.  In said case the Division Bench presumed that delay in execution of work resulted in loss for which, the Party complaining of breach was entitled to reasonable compensation.

Kailashnath Associates v. DDA

In Kailashnath Associates v. DDA[6], on a review of precedents, another Division Bench of the Supreme Court summed up the law of compensation to breach of contract under Section-74 of the Contract Act. It held that under Section-74 damage or loss caused is a pre-condition for applicability of the said provision. The Bench reiterated that the expression “whether or not actual damage or loss is proved to have been caused thereby” does not imply that even where it is possible to prove actual damage or loss, such proof is dispensed with. It is only in cases where damage or loss is difficult or impossible to prove, that liquidated amount named in the contract can be awarded, provided the same represents a genuine pre-estimate of damage or loss. The Bench reiterated the most basic principle on award of damages viz. that compensation can only be given for damage or loss suffered; if no damage or loss is suffered, the law does not provide for a windfall.

Law of burden of Proof

In class of cases involving breach of the contract where it is possible to prove the actual damage/loss sustained on account of breach, the fact whether any damage/loss was actually suffered is likely to be within exclusive possession of the party suffering breach. Under the Law of Evidence[7] when any fact is especially within the knowledge of any person, the burden of proving that fact is upon him. Therefore, the burden of proving that the party complaining of breach, where it is possible to prove the actual damage/loss in terms of money, should rest with such party.

Summing up

The decisions in Fatehchand, Maula Bux and Kailashnath Associates make the position of law as to entitlement of party complaining breach to sum named in the contract by way of liquidated damages clear. In cases where loss in terms of money is difficult or impossible to prove alone and the sum named in contract is not in the nature of penalty, the sum so named, can be awarded as compensation without insisting for proof of loss. In all other cases, the party claiming damages is required to prove the actual loss.

In Saw Pipes also Supreme Court had found that the loss resulting from breach was difficult to prove and the compensation specified was not unreasonable or by way of penalty. Saw Pipes does not appear to lay down that even in cases where it is possible to prove the loss sustained in terms of money; but the Party complaining of breach does not put forth such proof, the court can award the sum named. In Construction and Design Services also in the facts of the case the Division Bench concluded that evidence of precise amount of loss was not possible, though it was also observed that the Party complaining of breach could have led evidence to show kind of losses. The observation suggests that even in cases where a party can prove loss but does not do so, the loss can be presumed. This seems to be in conflict with the ratio in Fatehchand, Maula Bux and Kailashnath Associates.

In any event decisions in Saw Pipes and Construction and Design Services, both rendered by Division Bench could not lay down anything contrary to the ratio laid down by larger Benches in Fatechand and Maula Bux.

References

[1] Section-73 of the Indian Contract Act

[2] AIR 1963 SC 1405

[3] (1969) (2) SCC 554

[4] (2003) 5 SCC 705

[5] (2015) 14 SCC 263

[6] (2015) 4 SCC 136

[7] Section-106 of the Indian Evidence Act