Professional Documents
Culture Documents
1 2 3 4
Section 73 of Indian Contract Act, 1872. (1999) 3 SCC 500 AIR 1958 Bom.291 AIR (1981) SC 2010
Mangilal Karwa vs. Shantibai5 it was held that the amount, which put the plaintiff in the position in which he would have been if the contract had been fulfilled. In Esso Petroleum Co. Ltd. vs. Mardon6 it was held that where during the pre-negotiation stage of a contract, the party who has special knowledge and expertise concerning the subject matter of negotiation, makes a forecast based on knowledge and expertise with an intention to induce the other party to enter into a contract, it is open to the court to treat the forecast being not only an expression of opinion but a continuing warranty. In such a case, if the estimate turns out to be made negligently and wholly unsound, the party making the forecast can be made liable for breach of warranty. In Murlidhar Chiranjilal vs. Harishchandra Dwarkadas7 the Supreme Court held that there are two principles on which damages are calculated in case of breach of contract of sale of goods. Firstly, he who proved a breach of a bargain to supply what he has contracted to get is to be placed so far as money can do it in as good situation as if the contract has been performed. Secondly, a duty is imposed on the plaintiff to take all reasonable steps to mitigate the loss consequent to breach, and he is debarred him from claiming any part of the damage which is due to neglect to take such steps. In Union of India vs. Raman Iron Foundry8 it was held that damages are the compensation which an injured party may be entitled to get on adjudication by court of law but he does not get them by reason of any existing obligation on the part of the party, in breach of contract, who has no pecuniary liability till the court has determined the question of breach and the amount of compensation therefore. The court will not determine pre-existing liability. Further, since the breach of contract does not result in any existing obligation by the party committing breach, the right to recover damages is not an actionable claim and cannot be assigned.
5 6 7 8 9
AIR 1956 Nag.221 (1976) 2 ALL ER 5 AIR (1962) SC 366 AIR (1974) SC 1265 (1854) 9 Exch. 341 AIR (1981) SC 182
10
This latter principle (stated above) has been recently reiterated by the Supreme Court in ONGC Ltd. v. Saw Pipes the Supreme Court held that In some contracts, it would be impossible for the Court to
11
assess the compensation arising from breach and if compensation contemplated is not by way of penalty or unreasonable, Court can award the same if it is genuine pre-estimate by the parties as the measure of reasonable compensation. The Supreme Court held that if the parties have pre-estimated such loss after clear understanding, it would be totally unjustifiable to arrive at the conclusion that the defaulting party is not liable to pay compensation. The Court in this case also held: y Terms of the contract are required to be taken into consideration before arriving at the conclusion whether the party claiming the compensation is entitled to the same; If the terms are clear and unambiguous stipulating liquidated damages in case of the breach of the contract, unless it is held that such estimate of damages/compensation is unreasonable or is by way of penalty, the party who has committed the breach is required to pay such compensation and that is what is provided in section 73 of the Contract Act. Section 74 to be read along with section 73 and, therefore, in every case of breach of contract, the person aggrieved by the breach is not required to prove actual loss or damage suffered by him before he can claim a decree. The court is competent to award reasonable compensation in case of breach even if no actual damage is proved to have been suffered in consequence of the breach of the contract. In some contracts, it would be impossible for the court to assess the compensation arising from breach and if the compensation contemplated is not by way of penalty or unreasonable, the court can award the same if it is a genuine pre-estimate by the parties as the measure of reasonable compensation.
Section 74 of the Act does not apply to negotiable instruments. It also does not apply in cases of persons entering into bail bonds and other similar instruments for the performance of public duties. Breach of any condition in such an instrument would require the person concerned to pay the entire sum mentioned therein. However, the explanation to the exception provides that a party who contracts with the Government does not necessarily undertake any public duties. It is important to note that by providing for compensation in express terms the right to claim damages under the general law is necessarily excluded.
the stipulated amount. In discerning the true nature of the contract and the compensation payable, the court must have regard to the terms and inherent circumstances at the time of the making of the contract and not at the time the breach occurred. The terms used by the parties are not conclusive and the court is not bound by their phraseology. If the term is stated to be a penalty but turns out to be a genuine pre-estimate of loss, it will be treated as liquidated damages. Sometimes there is a very thin line dividing provisions relating to liquidated damages and penalty. A distinction as to whether the stipulation is one by way of liquidated damages or penalty has been summed up by the House of Lords in Dunlop Pneumatic Tyre Co. Ltd. Vs New Garage and Motor Company Ltd12as follows: y y y The parties who use the expression `penalty or liquidated `damages may prima facie mean what they say, yet the expressions are not conclusive. The essence of a penalty is a payment of money in terrorem of an offending party; the essence of liquidated damages is a genuine pre-estimate of damages. The question whether a sum is a penalty or liquidated damages is a matter of construction of the particular contract, to be judged at the time of its formation and not at the time of its breach. To assist in this task of construction, various tests have been suggested, which if applicable to the case under construction may prove helpful or even conclusive. Some of the such tests are:
i)The sum stipulated shall be a penalty if it is extravagant and unconscionable in amount in comparison with greatest loss that could conceivably be proved to follow from breach. ii)It would be a penalty if breach consists only in not paying sum of money and sum stipulated is greater than sum which ought to have been paid; iii)Presumption (but no more) that it is a penalty when single sum made payable by way of compensation, or occurrence of one or more or all of such events, which may occasion serious damage or trifling damage, on the other hand; and iv)No obstacle to sum stipulated being a genuine pre-estimate of damage that consequences of breach are such as to make precise pre-estimation almost impossible. On the contrary, that is the situation when probably the pre-estimated damage was true bargain between parties. POSITION UNDER INDIAN LAW Section 74 of the Indian Contract Act reads as follows:- 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, as the case may be, the penalty stipulated for. In Fateh Chand v Balkishan Das13, the Supreme Court stated: Section 74 declares the law as to liability upon breach of contract where compensation is by agreement of parties predetermined or where there is a stipulation by way of penalty. But the application of the enactment is not restricted to cases where the aggrieved party claims relief as a plaintiff. The section does not confer a special benefit upon any party. It merely declares the law that notwithstanding any term in the contract for determining the damages or providing for forfeiture of any property by way of penalty, the Court will award to the party aggrieved only reasonable compensation not exceeding the amount named or penalty stipulated. The Court also held that the jurisdiction of the court to award compensation under section 73 in case of breach of contract is unqualified except as to the maximum stipulated, and compensation has to be reasonable. This section has to be read in conjunction with section 74, section 74 emphasizes that in case of breach of contract, the party complaining of the breach is entitled to receive reasonable compensation whether or not the actual loss is proved.
12 13
In Steel Authority of India V Gupta Brothers Steel Tubes Ltd14 Supreme Court held that there is no impediment or any obstacle for the parties to a contract to make provisions of liquidated damages for specific breaches only, leaving other types of breaches to be dealt with as unliquidated damages. There is no principle which requires that once the provision of liquidated damages has been made in the contract, in the event of breach of one of the parties, such clause has to be read covering all types of breaches although parties may not have intended and provided for compensation in express terms of all types of breaches. The purpose of such clauses is to promote certainty, especially in commercial contracts. Parties to a contract would fix such a sum in advance at the time of making the contract because it facilitates calculation of risks; it reduces the difficulty and expense of proving actual damage or loss and facilitates recovery of damages. It also avoids the difficulty in assessment, even where the consequences of breach are ascertainable and avoids the risk of under-compensation; the party may otherwise not be able to recover indirect, consequential loss by the rule of remoteness. It gives promisee an assurance that he may safely rely on the fulfilment of the promise. The Supreme Court also framed the following guidelines in the ONGC v Saw Pipes15 case for arriving at the reasonable compensation vide section 74 of the Contract Act: Before deciding that a claimant is entitled to any compensation the terms of the contract must be considered; where such terms are unambiguous the sum named therein must be awarded unless such sum is found to be by way of a penalty or in any case unreasonable. In all cases of breach, section 74 is to be read with section 73 and therefore it is not essential for a party to prove actual losses before claiming a decree; a court is competent to award reasonable compensation in case of breach irrespective of the existence of any such proof. Sometimes it is impossible for the court to determine the damages with certainty in which case the court can safely award the stipulated sum if it is the genuine pre-estimate of damages by the parties as the measure of reasonable compensation. It suffices here to note that, subject to one important qualification, it is unnecessary to distinguish between a penalty and liquidated damages in India. The qualification is that s. 74 allows a court to award such reasonable compensation whether or not actual damage or loss is proved to have been caused , and the Supreme Court has held that the sum named in the contract will be taken to represent reasonable compensation in any case where it is unable to assess actual loss (Maula Bax v Union of India16) In short, in a significant number of cases, the claimant is entitled to the benefit of a liquidated damages clause without further ado. However, the Court has also held that this benefit is unavailable if the sum is thought to represent a penalty not, as in English law, because that makes it unenforceable, but because there is then no reason to consider that the sum reflects reasonable compensation . The significance of this distinction has been considered by the Delhi High Court in its recent judgment in Sudhir Gensets v Indian Oil Corporation17. The appellant, Sudhir Gensets [ SGL ] had agreed to supply certain equipment to IOC by a specified deadline, and Clause 13 of the contract provided that it would pay liquidated damages of 0.5 % of the value of the goods delayed per week, subject to a maximum of 10 % of the total value. SGL, for a variety of reasons, could not supply in time, and a finding of fact was made that the fault was not that of IOC. Accordingly, IOC deducted (the significance of this is considered at the end) a sum of about Rs. 10 lakh, and SGL challenged it in arbitration proceedings on the ground that IOC had not adduced proof of loss. Before the High Court, obvious reliance was placed by IOC on the language of s. 74, and the proposition advanced was that it is unnecessary to offer proof of loss. The High Court, after a detailed reference to the decision of the Supreme Court in ONGC v Saw Pipes, accepted this contention, holding that the figure in question represented the value the parties placed on the loss IOC would suffer on account of any delay in delivery. The Court rightly clarified that this result would not follow if the sum named in the contract is found to be a penalty, because there is then no room to assume that it represents a reasonable estimate of losses or reasonable compensation for the purpose of awarding damages under s. 74.
14 15 16 17
COMMON FEATURES BETWEEN ENGLISH LAW AND INDIAN LAW After seeing the various provisions both under Indian law and English law we can conclude the common analogy between them. Yet the distinction between liquidated damages and penalty is not all together irrelevant to the section. Its relevance, in the first place, arises from the fact that the amount contemplated by the parties will be reduced only if it appears to be by way of penalty. Otherwise the whole of it is recoverable as liquidated damages. Secondly, the first explanation to this section uses the word penalty . It provides that a stipulation for increased interest from the date of default may be a stipulation by way of penalty . Still another common feature between the English common law and Indian law is shown by the decision of the Supreme Court in Chunilal V. Mehta &Sons Ltd. v. Century Spg. & Mfg Co. Ltd18, where it has been held by the Court that by providing for compensation in express terms the right to claim damages under the general law is necessarily excluded .
18