Damages and Penalty

Under Section 73 and 74 of Indian Contracts Act.

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Electronic copy available at: http://ssrn.com/abstract=1724542

Damages and Penalty as held under Section 73 and

74 of the Indian Contract Act, 1872.
This article is aimed at making an analysis of the two most important and common words
used in contracts as to DAMGAES and PENALTY. These two words have been used under
the Indian Contract Act, 1872 viz. Sec. 73 and 74, but they have not been defines under the
same as to what does they mean or include.
A mere study of these sections could give anyone an idea as to in what is the meaning of
damages and penalty in the context in which it has been used in the said sections. But the fact
as to what is the exact meaning and what all it would included in the said section and how
these words have to be interpreted and construed is a matter of understanding and
interpretation in different cases where in the mean and the sense may differ.
In this article an effort has been made to analysis in depth all the perceptive and all the ways
in which these would can be construed so that it doesnt let the meaning of the section
change.
In the event of analysis the different meaning, definition and interpretations of different
scholar have been view with main focus being on the Act and judicial interpretation.
The fact is that both damages and penalty are a form of economic gain which are payable by
the defaulter to the innocent party that has suffered a loss due to the breach. This has been
observed by:
i.
ii.
iii.
iv.

Understanding as to what damages mean and ought to mean under Section 73.
Understanding as to what penalties mean and ought to mean under Section 74.
Analysing as to what is the difference between the two.
Critically examining as to the reason why penalty and damages are confused to
mean the same and what is that point of difference between the two word and
there usage.

Damages:
The Indian Contract Act, 1872 uses the words loss or damage under section 73 as:
Compensation for loss or damage caused by breach of contract. - When a contract has
been broken, the party who suffers by such breach is entitled to receive, form 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.
Such compensation is not to be given for any remote and indirect loss of damage sustained by
reason of the breach.

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Thus, damages or loss means compensation to the party who have suffered a loss due to the
breach of the contract payable by the defaulting party.

Meaning of damages:

Oxford dictionary: a sum of money claimed or awarded in compensation for a loss or

injury.
Blacks law dictionary: money claimed by, or, ordered to be paid to, a person as
compensation for loss or injury.
Damages are the sum of money which a person wronged is entitled to receive from
the wrong doer as compensation for the wrong.1

Definition:

McGregor on Damages defines the term as follows:

"Damages in the vast majority of cases are the pecuniary compensation
obtainable by success in an action, for a wrong which is either a tort or a
breach of contract, the compensation being in the form of a lump sum awarded
at one time, unconditionally and in Stirling (dollars)."

Judicial interpretation of damages:

In Sohm v Dixie Eye2, Justice Greenwood of the Court of Appeals of Utah adopted
these words:
"[D]amages generally refers to money claimed by, or ordered to be paid to, a person
as compensation for loss or injury.
"The term injury is sometimes used in the sense of damage, as including the harm or
loss for which compensation is sought, and has been defined as damage resulting from
an unlawful act; but in strict legal significance, there is, properly speaking, a material
distinction between the two terms, in that injury means something done against the
right of the party, producing damage, whereas damage is the harm, detriment, or loss
sustained by reason of the injury."

In R v Agat Laboratories Ltd.3, the Alberta Provincial Court adopted these words to
define damages:
"... money adjudged to be paid by one person to another as compensation for a loss
sustained by the latter in consequence of an injury committed by the former...

Frank Gahan, The Law of Damages 1(1936).

2007 UT App 255, 166 P.3d 614
3
[1998] A.J. No. 304
2

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"(T)he pecuniary satisfaction awarded by a judge or jury in a civil action for the
wrong
suffered
by
the
plaintiff....
"Damages fall under two heads: general damages, i.e., such damages as the law will
presume to flow from that which forms the subject-matter of the action; and special
damages, i.e., such other damages as can be recovered only if specially alleged and
specifically proved. When an action cannot be sustained unless there is special
damage, the subject-matter is described as not being actionable per se.
"Damages are either liquidated or unliquidated. Whenever the amount to which the
plaintiff is entitled can be ascertained by calculation or fixed by any scale or other
positive data, it is said to be liquidated or made clear. But when the amount to be
recovered depends on all the circumstances of the case and on the conduct of the
parties, and is fixed by opinion or by an estimate, the damages are said to be
unliquidated."

Damages are compensation for the losses suffered by one person due to the non-performance
of the other. It is normally in material i.e. monetary. It is either a part of contract if it could be
computed while entering into (liquidated damages) but if it cannot be computed than the
damages are claimed by the parties or ordered by the court in the event of breach.
Damages are in actually a way to make good the loss that the plaintiff or aggrieved person
suffers due to the failure of another person who willingly or unwillingly has failed to perform
his part of contract.
Damages are the basic remedy available for a breach of contract. It is a common law remedy
that can be claimed as of right by the innocent party. The object of damages is usually to put
the injured party into the same financial position he would have been in had the contract been
properly performed.
In general, damages are not awarded for non-pecuniary loss such as mental distress and loss
of enjoyment. Exceptionally, however, damages are awarded for such losses where the
contracts purpose is to promote happiness or enjoyment, as is the situation with contracts for
holidays Jarvis v Swan Tours.4
The innocent party must take reasonable steps to mitigate (minimise) his loss, for example,
by trying to find an alternative method of performance of the contract: Brace v. Calder.5
In short, damages are the actual financial loss of the wronged party that were in the
reasonable contemplation of both of the parties, at the time they contracted, as would
naturally arise from the wronged partys normal activity: Hadley v. Bexendale6 1845, and any
not so but of which the parties were expressly informed: Victoria Laundry v. Newman7 1945,
in loss aiming to put the wronged party in the position that he would have been if the contract
had been completed: Jarvis v. Swan Tours8 1973 general damages for distress or annoyance
4

[1973] QB 233
[1895] 2 QB 253; 36 Digest 392; [1895] 72 LT 829
6
(1854) 9 Exch 341
7
[1949] 2 KB 528
8
Supra 4
5

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being recoverable where comfort or freedom from discomfort (e.g. holiday contracts) is the
basis of a normal commercial contract: Alexander v. Rolls Royce Motor Cars9 1995 -but
Forthsyth v. Ruxley Electronics & Construction10 1995 did awarded for amenity and
disappointment (less deep pool than ordered); but ones must have taken steps to mitigate his
loss: Brace v. Calder11 1895.

Penalty:
The Indian Contract Act, 1872 uses the words penalty under section 74 as:
Compensation of breach of contract where penalty stipulated for :-When a contract has
been broken, if a sum is named in the contract as the amount 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 or 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, as the case may be, the penalty stipulated for.

In section 74 the words that have to be emphasized upon are sum is named, penalty.

The term sum is named gives out the meaning clearly that the amount that becomes
payable in the event of any breach is pre estimated and is provided for in the contract.
It is determined in the form of either damages or a stipulated penalty. Further, they
sum that is so specified is the reasonable compensation for the breach and in no case
the amount can be exceeded from what has been specified in the contract.

Thus, in short section 74 talks about liquidated damages and not other kind of
damages.
Liquidated damages: (not defined in the Indian Contract act, 1872)
If the sum fixed represents a genuine pre-estimate of the probable damages that is
likely to result from the breach, it is liquidated damages.12
An amount contractually stipulated as a reasonable estimate of actual damages to be
recovered by one party if the other party breaches.
It means that it shall be taken as the sum which the parties have by contract assessed
as damages to be paid whatever maybe the actual damage.13
A fixed figure of damages, which is not assessed for all circumstances, but is
graduated to correspond with passage of time between the making of contract and of
its breach, is a proper estimate of the damage to be anticipated from the breach, and is
recoverable as liquidated damages.14

[1995] TLR 25
[1995] ABC.L.R. 06/29
11
Supra 5
12
Avtar Singh, Law of Contract and Specific Relief, Eastern book Company, Ninth Edition, 2005, Pg: 452
13
Wallis v. Smith (1882) 21 Ch D 243,p. 267
14
Robophone Facilities Ltd. V. Blank [1966] 3 All ER 128, pp 137,140.
10

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Meaning of Penalty:

Oxford Dictionary: a punishment imposed for breaking a law, rule, or a contract.

Blacks Law Dictionary: punishment imposed on a wrongdoer, usu. in the form of

imprisonment or fine; esp., a sum of money exacted as punishment for either a wrong
to the state or a civil wrong.

An extra charge against a party who violates a contractual provision.

Excessive stipulated damages that a contract purports to impose on a party that

breaches.

Definition:
A penalty is a sum which a party agrees to pay or forfeit in the event of a breach, but
which is fixed, not as a pre-estimate of probable actual damages, but as a punishment, the
threat of which is designed to prevent the breach, or as security, where the sum is deposited
to the covenant to pay is joined in by one or more sureties, to insure that the person injured
shall collect his actual damages. Penalties are not recoverable or retainable to such by the
person in whose favor they are framed15
Penalty has been defined to mean I promise to pay so much of money if I break certain terms
of the contract.16
It is a sum of money that is manifestly intended to be in excess of the amount which would
fully compensate the other party for the loss sustained by him in consequence of the breach of
the primary obligation.17

Judicial Interpretation:
The essence of a penalty is a payment of money stipulated as in terrorem of the offending
party, the essence of liquidated damages a genuine covenanted pre-estimate of damages.18
The House of Lords held in Dunlop Pneumatic Tyre Co Ltd. V. New Garage Motors Ltd.19
Held: (Lord Dunedin stated)
1. Though the parties to a contract who use the words penalty or liquidated damages
may prima facie be supposed to mean what they say, yet the expression used is not
conclusive. The Court must find out whether the payment stipulated is in truth a
penalty or liquidated damages. This doctrine may be said to be found passim in nearly
every case.
2. The essence of a penalty is a payment of money stipulated as in terrorem of the
offending party; the essence of liquidated damages is a genuine covenanted pre-

15

Charles T. McCormick, Handbook on the Law of Damages p. 146, at 600 (1935).

Gaumont British Pictures Corpn Ltd. V. Alexander [1936] 2 All ER 1686, p. 1693 per Potter J.
17
Photo Production Ltd. V. Securicor Transport Ltd. [1980] AC 287, [1980] 1 All ER 556, p. 557 per Lord
Diplock (HL).
18
Clydebank Engineering & Shipping Co. v. Don Jose Ramos Yzquierdoy Castaneda, (1905) AC 6.
19
(1915) AC 79: (1914-15) All ER Rep. 739, HL.
16

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estimate of damage (Clydebank Engineering and Shipbuilding Co. v Don Jose Ramos
Yzquierdoy y Castaneda20).
3. The question whether a sum stipulated is penalty or liquidated damages is a question
of construction to be decided upon the terms and inherent circumstances of each
particular contract, judged of as at the time of the making of the contract, not as at the
time of the breach (Public Works Commissioner v Hills21 and Webster v Bosanquet.22)
4. To assist this task of construction various tests have been suggested, which if
applicable to the case under consideration may prove helpful, or even conclusive.
Such are:
(a) It will be held to be penalty if the sum stipulated for is extravagant and
unconscionable in amount in comparison with the greatest loss that could
conceivably be proved to have followed from the breach. (Illustration given by
Lord Halsbury in Clydebank Case.)
(b) It will be held to be a penalty if the breach consists only in not paying a sum of
money, and the sum stipulated is a sum greater than the sum which ought to have
been paid (Kemble v Farren23). This though one of the most ancient instances is
truly a Corollary to the last tests. Whether it had its historical origin in the doctrine
of the common law that where A. promised to pay B. a sum of money on a certain
day and did not do so, B. could only recover the sum with, in certain cases,
interest, but could never recover further damages for non-timeous payment, or
whether it was a survival of the time when equity reformed unconscionable
bargains merely because they were unconscionable,a subject which much
exercised Jessel M.R. in Wallis v Smith24is probably more interesting than
material.
(c) There is a presumption (but no more) that it is penalty when a single lump sum is
made payable by way of compensation, on the recurrence of one or more or all of
several events some of which may occasion serious and others but trifling damage
(Lord Watson in Lord Elphinstone v Monkland Iron and Coal Co.25)

Comparison of Damages and Penalty:

After understanding the meaning of the terms Damages and Penalty it is now clear to
concluded as to the basic difference that is there between both terms.
But before analysing the difference between Damages and Penalty, it is required to look into
the difference that exists between Liquidated damages and Penalty. Where terms of a
20

Supra 18.
(1906) A.C. 368
22
(1912) A.C. 394
23
1829, 6 Bingham, 141
24
(1882) 21 Ch D 243
25
(1886) 11 AC 332: 181
21

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contract specify a sum payable for non-performance, it is a question of construction whether

this sum is to be treated as a penalty or as liquidated damages.
As per Blacks Dictionary:
1. If the sum payable is so large as to be far in excess of the probable damage on breach,
it is almost certainly a penalty.
2. If the same sum is expressed to be payable on any one of a number of different
breaches of varying importance, it is again probable a penalty, because it is extremely
unlikely that the same damage would be cause by these varying breaches.
3. Where a sum is expressed to be payable on a certain date, and a further sum in the
event of default being made, this later sum is prima facie a penalty, because mere
delay in payment is unlikely to cause damages.
4. It is to be noted that the mere use of the word liquidated damages is not decisive, for
it is the task of the Court and not of the parties to decide the true nature of the sum
payable.26
As has been discussed above while understanding Penalty about the way Liquidated
Damages, they are so closely related and interwoven that it is really difficult to give an exact
point of difference. Its only in the way it is to be construed from the contract itself at the
time of making it and not at the time of breach.
Difference between Damages (not Liquidated Damages) and Penalty.

Penalty is the sanction for the breach of the parties imposed in the form of punishment
whereas damages are an agreed sum of money that the parties consent to pay in the
event of breach.

Damages are reasonable compensation where as penalties are not.

Penalty is for enforcement of the obligation of performance on the said party whereas
damages are to compensate the party which suffers a loss due to non performance of
the said party.
This is the generic difference but the distinction has been abolished in India. The courts
award reasonable compensation not exceeding the stipulation. The courts knock down
agreements which are unconscionable and extravagant.27
Section 74 is clearly an attempt to eliminate the somewhat elaborate refinements made
under the English Common Law in distinguishing between stipulations providing for
payment of the liquidated damages and stipulations in the nature of penalty the Indian
Legislation sought to cut across the web of rules and presumptions under the English
Common Law by enacting a uniform principle applicable to all stipulations naming the
amount to be paid in case of breach and stipulations by way of penalty.28

26

P.S. Atiyah, An Introduction to the Law of Contract 316-17 (3d ed. 1981)
Pueshpendra Motilal Singh v. Commercial Automobile, (1999) 2 MPLJ 319 at p. 324.
28
Fateh Chand v. Balkrishna Das, AIR 1963 SC 1405.
27

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Conclusion:
Thus, it is clear that there is a difference between the two as to the fact that penalty is limited
to the extent to which the sum is stipulated in the contract and has been agreed by the parties
although it is required to prove the fact that actual damages have accrued or not. Whereas
damages can be awarded by the court to the extent to which the innocent party has suffered a
loss or as per the stipulation in the agreement without ascertaining the fact of the amount of
loss that has actually occured. It can also exceed the amount that has been mentioned in the
contract. Penalty whereas cant exceed or be claimed in excess of the sum that has been
named in the contract between the parties. Penalty is awarded in case of breach and it is not
in the form of compensation. Damages are reasonable compensation whereas penalties are
not.29 Thus, an aggrieved party should claim for damages which can put them in a better
position in order to get the amount even for the mental trauma etc. that has been suffer by the
innocent party due to breach.
The reason as to why damages and penalty are confused is mainly due to the liquidated
damages which as per the Indian Contract Act have not been differentiated. But the damages
in general are not the same as that of Penalty which is clear from the above analysis.
In ONGC Ltd. v. SAW Pipes Ltd.30 it has been held with regards to damages and penalty as
under:
1. The stipulation providing for damages is by way of penalty, it can grant reasonable
compensation upon proof of damages.
2. In case of penalty damages need to be proven.
3. Damages are a reasonable compensation whereas penalties are not.

29
30

Infra 30
AIR 2003 SC 2629

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References used:
1. RG Padia, Mulla Indian Contract and Special Relief Acts, LexisNexis Butterworths,
12th Edition, 2008.
2. Avtar Singh, Law of Contract and Specific Relief, Eastern book Company, Ninth
Edition, 2005.
3. Kamakshya Prasad, The Law Of Damages, Compensation, Interim relief,
Maintenance & Interim Maintenance, Modern Law Publications, Second Edition,
2010.
4. Bryan A. Garner, Blacks Law Dictionary, Thomson West, Eighth Edition, 2007.
5. http://www.duhaime.org/LegalDictionary/D/Damages.aspx
6. http://legalcatch.wordpress.com/2007/09/11/contract-law-summarised-explanationsdefinitions-cases

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