India: Curious Case Of Section 74 Of The Indian Contract Act

The law on liquidated damages is governed by Section 74 of the Indian Contract Act, 1872. This provision has been interpreted variedly by courts since its enactment during the colonial era. In this article we discuss the pertinent developments on this aspect of contract law and how Section 74 has been differently interpreted and applied by the Supreme Court basis the nature of the contract and the relevant facts and circumstances. In doing so, we examine whether the judgment in Kailash Nath Associates v. DDA¹ waters down the law enunciated in the case of ONGC v. Saw Pipes² with respect to requirement to prove actual loss for claiming liquidated damages under Section 74 of the Indian Contract Act, 1872.

One of the earliest enunciations on Section 74 is found in the decision of the Supreme Court in Fateh Chand v. Balkishan Dass³ (Fateh Chand). In this case, the plaintiff made a claim to forfeit a sum of Rs. 25,000 which consisted of Rs. 1,000 paid as earnest money and an advance amount of Rs. 24,000 which the defendant paid against delivery of possession of property. The plaintiff's above claim was based solely on his contractual entitlement. No evidence was led by plaintiff to prove that any actual loss was caused to him due to the breach committed by defendant. Speaking for the Constitutional Bench, Justice JC Shah held that, "[Section 74] does not justify the award of compensation when in consequence of the breach no legal injury at all has resulted ...". Accordingly, the plaintiff's claim for forfeiture of advance amount was rejected due to lack of proof that plaintiff suffered any loss or legal injury. Further, in the case of Fateh Chand, the Supreme Court considered the forfeiture clause to be in the nature of penalty. In this regard, the Supreme Court clarified that, "In all cases, therefore, where there is a stipulation in the nature of penalty for forfeiture of an amount deposited ... the court has jurisdiction to award such sum only as it considers reasonable, but not exceeding the amount specified in the contract as liable to forfeiture."  

Interestingly, a few years later, the decision in Fateh Chand came up for consideration before Justice JC Shah himself and two other judges of the Supreme Court in the case of Maula Bux v. Union of India⁴ (Maula Bux). In this case, the Supreme Court referred to its earlier decision in Fateh Chand and held as follows:  

"...the expression "whether or not actual damage or loss is proved to have been caused thereby" is intended to cover different classes of contracts which come before the Courts. In case of breach of some contracts it may be impossible for the Court to asses compensation arising from breach, while in other cases compensation can be calculated in accordance with established rules. Where the Court is unable to assess the compensation, the sum named by the parties if it be regarded as a genuine pre-estimate may be taken into consideration as the measure of reasonable compensation, but not if the sum named is in the nature of penalty. Where loss in terms of money can be determined, the party claiming compensation must prove the loss suffered by him."

The above interpretation of Section 74 does not dilute the law in Fateh Chand, but further clarifies that there may exist different classes of contracts to which the rule in Fateh Chand may not necessarily apply. Such different classes of contract are the ones where it may be impossible for the Court to assess compensation arising from breach and in such situations the sum named by parties if it be regarded as a genuine pre-estimate may be taken into consideration as the measure of reasonable compensation. However, where a party suffering breach was in a position to prove its loss, the situation would be different and the law laid down in Fateh Chand would apply.

Pertinently, while Maula Bux recognised that a different class of contract would require different interpretation of Section 74, it went on to apply the principles laid down in Fateh Chand. This was on account of the similarity in facts in Fateh Chand and Maula Bux, to the extent that the person claiming the liquidated sum was in a position to prove loss but, failed to do so.

The decisions in Fateh Chand and Maula Bux were followed in several other judgments of the Supreme Court. The most significant amongst these is the case of Oil & Natural Gas Corporation Limited v. Saw Pipes Limited⁵ (Saw Pipes). In this case, the Supreme Court was faced with a different class of contract as propounded in Maula Bux. In Saw Pipes, the appellant entered into a contract with respondent for purchase of casing pipes, the delivery of which had to be completed by respondent within a specified time, failing which liquidated damages would be payable. The respondent delayed the supply of casing pipes and appellant cleared the bills of respondent after deducting the liquidated damages. The respondent challenged the deduction before an arbitral tribunal on the ground that appellant did not suffer any loss due to delay in supply. The arbitral tribunal found that the appellant has wrongly deducted liquidated damages because delay in supply of the casing pipes was at the most only one of the reasons which delayed the actual production of gas and, therefore, appellant could not prove its specific loss vis-à-vis the delay in supply of the casing pipes.

On appeal, the Supreme Court made it clear that in every case of breach of contract, the person aggrieved by the breach was not required to prove actual loss or damage. The Court held that, "... if the compensation named in the contract for such breach is genuine pre-estimate of loss ..., there is no question of proving such loss or such party is not required to lead evidence to prove actual loss suffered by him...". The decision of the Court in Saw Pipes has provided the much needed clarity on interpretation of Section 74. This is more so in disputes arising out of construction contracts where it is more often difficult or impossible to prove loss. For instance, in Saw Pipes, the Court has cited an example of delay in construction of a bridge and remarked that in such cases it would be impossible to ascertain the loss caused to the society due to the delay. Therefore, in terms of Saw Pipes, the requirement of proving loss is fact specific and varies depending on the nature of the contract.

Pursuant to Saw Pipes, the Supreme Court passed its decision in Kailash Nath Associates v. DDA⁶ (Kailash Nath). In this case, the petitioner-Kailash Nath was declared as a successful bidder by the respondent-DDA in relation to an auction proceedings. In this connection, the petitioner had deposited 25% of the bid amount as earnest money. However, without putting the petitioner to notice that it has to deposit the balance 75% of the bid within a certain stipulated time, the respondent had cancelled the allotment of petitioner and forfeited the 25% earnest money.

In the above facts and circumstances, the Supreme Court held that, "it would be arbitrary for DDA to forfeit the earnest money on two fundamental grounds. First, there is no breach of contract on part of the appellant ... And second, DDA not having been put to any loss, even if DDA could insist on a contractual stipulation in its favour, it would be arbitrary to allow DDA as a public authority to appropriate Rs ... without any loss being caused." Later in the judgment, the Supreme Court restated the principles applicable to Section 74. In doing so, the Court held that, "...like Section 73 and 75 of Contract Act, 1872, compensation is payable for breach of contract under Section 74 ... only where damage or loss is caused by such breach". The Court also held that, "...damage or loss caused is a sine qua non for the applicability of Section 74".

Relying on the above excerpts of Kailash Nath in isolation, it has been argued by some that the law in Saw Pipes has 'undergone a change' and that it is no longer a 'good' law (See arguments raised in MBL Infrastructure Ltd v. Ircon International Limited⁷ and Ultratech Cement Limited v. Sunfield Resources Pty. Ltd⁸). In other words, an oversimplistic and generalised argument is being advanced to state that, notwithstanding the nature of the contract, proof of actual loss is a pre-requisite for obtaining liquidated damages. In this regard, it is important to acknowledge that no legal principle can be applied in abstract. Each case has its own context due to which the understanding of the law keeps evolving. As indicated by the tabular representation below, the Supreme Court was faced with different factual scenarios while developing the above stated law on Section 74:

As evidenced above, the factual matrix in each of the above cases stands on a different footing. While Fateh Chand, Maula Bux and Kailash Nath were concerned with clauses on forfeiture, the relevant clause in Saw Pipes was on levy of liquidated damages. Further, the important distinction in all the above four cases is that in Fateh Chand, Maula Bux and Kailash Nath, the Supreme Court reached a conclusion that the person aggrieved could have proved his loss by adducing evidence. However, in Saw Pipes, the Supreme Court found that it was impossible to prove loss. Hence, the conclusion arrived in Fateh Chand, Maula Bux and Kailash Nath should not be confused with the conclusion reached in Saw Pipes. Further, the finding on facts in Kailash Nath puts it in a separate class altogether. In the said case, the Court reached a finding that there was no breach on part of the person whose money was forfeited. As such, the pivotal requirement to trigger application of Section 74 i.e., 'breach of contract' had not been satisfied in that case.

In view of the above, it may not be correct to interpret in abstract that the law in Saw Pipes has been re-written or diluted in Kailash Nath. This is more so since Kailash Nath itself acknowledges that, "It is only in cases where damage or loss is difficult or impossible to prove that the liquidated amount named in the contract, if a genuine pre-estimate of damage or loss, can be awarded."

To sum up, as would appear from the analysis above, the ruling in Saw Pipes is not disturbed by Kailash Nath. The criteria for application of Section 74 continues to be a fact driven exercise and hinges on a careful assessment of the possibility to prove loss. The rule in Fateh Chand, Maula Bux and Kailash Nath, that a party must prove its loss cannot be universally applied. Such application, without regard to facts of a case and the nature of the contract involved, would be antithetical to the very purpose for which parties agree to a genuine pre-estimate of liquidated damage in cases where it is impossible to prove loss. In other words, once the parties contractually agree to a genuine pre-estimate of damages, the contractual entitlement to the same should not be doubted on account of impossibility in proving actual loss caused due to the breach.

Foototes

1 (2015) 4 SCC 136

2 (2003) 5 SCC 705

3 AIR 1963 SC 1405

4 1969 (2) SCC 554

5 (2003) 5 SCC 705

6 (2015) 4 SCC 136

7 MANU/WB/0438/2017

8 MANU/MH/2733/2016

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