This article is written by Kabir Jaiswal, a student of National University of Study and Research in Law, Ranchi (NUSRL) on Liquidation of damages in breach of contract and what to do if you have suffered losses due to a breach of contract, how will the damages be decided by the court?
Section 74 & Claim of Damages
Indian law doesn’t distinguish between a liquidated penalty and damages. The awarded compensation cannot exceed the amount specified in the contract. Under Section 74 of the Indian Contract Act of 1872, the Court will not allow more if the parties fix the damage. It can, however, award a smaller amount, depending on the case. The suffering party, therefore, receives reasonable compensation, but no penalty.
An exception to Section 74
There is an exception to Section 74, which states that if a party concludes a contract with the State or Central Government to carry out an act in the interest of the general public, A breach of such a contract then makes the party responsible for paying the entire amount specified in the contract.
Scope of Section 74 of the Indian Contract Act, 1872
- Firstly, if there is a pre-determination of the amount to be paid in the event of contract breach.
- And secondly, where the contract may contain any further penalty stipulation.
Section 75 of the Indian Contract Act, 1872
Under this section, if a party rightly rescinds a contract, it may claim compensation for any loss or damage caused by non- performance.
Quantum of Liquidated Damages
- With regard to the amount of liquidated damage, the Supreme Court of India held that if the court could not assess the compensation, the sum named by the parties may be considered as a measure of reasonable compensation if it is considered to be a genuine pre-estimate (although not if the sum named is in the nature of a penalty).
- Since the contracts do not quantify indirect consequential damages, however, the said principle laid down by the Supreme Court could also apply to such damages.
It is also a well- established position in law that losses in terms of money can be determined, the claiming party must prove the loss incurred by him. In addition, the causation principles and the attempt by parties to mitigate such losses also play a key role in determining damage liability.
Estimation of Damages
The object of the award of damages for breach of contract is to place the injured party in the position in which he would have been if the contract had been executed. Section 73 to Section 75 of the Contract Act deals with the rules relating to loss or damage resulting from contract breach. The rules lay down that:
- Damage is paid as compensation and reimbursement and not as sanctions. In fact, damage efforts are made to restore the party to the same position as if the contract had been carried out. (Hadley v. Baxendale)
- Compensation is paid for near losses, as in the normal course of events, natural, fair and reasonable may occur.
- No compensation may be paid for any losses that are remote or indirect as provided for in Section 73.
- Compensation may be paid for any loss or damage known to the party when the contract was entered into.
- No consideration is given to subsequent circumstances leading to an increase or a decrease in the amount of damage.
- A damage claim must be fair and reasonable.
Role of Reasonable Foreseeability
It can be concluded that the general principle with regard to the claiming of consequential damages by a non-defaulting party is that the non-defaulting party is only entitled to recover/claim any part of the damage or loss arising from the infringement by the defaulting party as reasonably foreseeable (as arising from the infringement at the time the contract was executed). The reasonably foreseeable damage or loss would depend, inter alia, on the knowledge possessed and shared between the parties.
Parties Determining Damages
In SitaramBindraban v. Chiranjanlal Brijlalit, It was held that the parties to a contract can create special rights and obligations for themselves, such as the measurement of infringement damages. In a contract, the Parties may also provide that, in the event of a breach, no compensation shall be payable except for the reimbursement of amounts paid and that such a term was deemed enforceable.
The Principle of Mitigation
In M Licha Setty& Sons Ltd. v. Coffee Board Bangalore, the Supreme Court held that the mitigation principle does not give any right to a party in breach of contract but is a concept to be borne in the assessment of damages. In this case, it was held that the complainant had to take all reasonable steps to mitigate the loss and if he failed to do so, he could not claim such losses that could have been prevented. The complainant is only obliged to act reasonably and whether or not he has done so is not a matter of law but in each case a question of fact. He must act reasonably not only for his own sake but also for the sake of the defendant and reduce the damage by acting reasonably in the matter.
In the event of a breach of contract, the complainant must do more than act in the ordinary course of business and if he is embarrassed, the measures he takes to remove himself should not be weighed on a nice scale in the event of a breach of contract. The complainant is not obliged to destroy his property or to injure himself or his business reputation in order to reduce the damages paid by the defendant.
Fixation of Pre-Determined Amount
In the case of Fateh Chand v. Bal Kishan Das, the Supreme Court stated that the grieved party is entitled to a reasonable compensation that should not exceed the amount of the penalty or the amount pre-determined to be paid after the breach of the contract. The court further stated that the application of these provisions is not limited to cases in which the grieved party approaches the court for relief only. In this case, the Court interpreted Section 74 as legal liability in the event of a breach of the contract whether compensation is paid by pre-determined agreement or by penalty.
The Court discussed the main purpose of determining a predetermined amount and its benefits:
- The pre-determination method of loss at the time of contract facilitates the recovery of damages.
- At the same time, the calculation error is reduced.
- It reduces costs and inconvenience and proves the real loss and damage.
- It reduces the risk of under-compensation and to a large extent avoids the problem in evaluation in cases where the results of the breach of contract are established.
Rule of Reasonable Compensation
The Supreme Court has recently reiterated this latter principle(as mentioned above) in ONGC Ltd. v. Saw Pipes it was discussed that “In some contracts, it would be impossible for the Court to assess the compensation arising from the breach, and if the compensation envisaged is not punishable or unreasonable, the Court may award the same compensation if it is genuinely pre-estimated by the parties as a reasonable compensation measure.”
The Supreme Court held that it would be completely unjustifiable to conclude that the defaulting party is not liable to pay compensation if the parties had pre-estimated such a loss after clear understanding. The Court also held in this case:
- The terms of the contract must be considered before concluding whether the party claiming the compensation has the right to the same.
- If the terms are clear and unambiguous, liquidated damages shall be stipulated in the event of contract breach, unless it is held that such estimate of damages/ compensation is unreasonable or a penalty, the party who has committed the infringement is obliged to pay such compensation and that is provided for in Section 73of the Contract Act, 1872.
- Section 74 to be read in conjunction with Section 73 and therefore in all cases of contract breach, The person grieved by the breach is not required to prove that he has suffered actual loss or damage before he can claim a decree. The court is competent to grant reasonable compensation in the event of a breach, even if no real damage has been demonstrated as a result of a breach of contract.
- In some contracts, it would be impossible for the court to assess the compensation resulting from the breach and if the compensation in question is not punishable or unreasonable, the court may award the same if it is a genuine preliminary assessment by the parties as a measure of reasonable compensation.
In Sudhir Gensets Ltd. v. Indian Oil Corporation, the court summarised:
- Firstly, where the actual loss and damage cannot be shown, the terms of the contract must be taken into account.
- Secondly, Section 74 and 73 must be dealt with together and stipulate pre-determined damages which are not unreasonable and do not amount to a penalty, and the party should pay such compensation in accordance with Section 73.
Evidence to prove Actual Loss
In Maula Bux v. Union of India, the Supreme Court held that a claimant may have to provide evidence to prove the actual loss or damage resulting from the breach if the adjudicating authority believes that compensation can be calculated in accordance with the settled rules in the given facts and circumstances.
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