Damages under indian contract act

DAMAGES UNDER INDIAN CONTRACT ACT

Section 73 of the Contract Act is lays down the provision relating to damages. It provides that the party, who breaches a contract, is liable to compensate the injured party for any loss or damage caused, due to the breach of contract. For compensation to be payable, Two things should be taken into consideration (i) The loss or damage should have arisen as a natural consequence of the breach, or (ii)It should have been something the parties could have reasonably expected to arise from a breach of the contract. In the former case, an objective test would be applied where as in the latter case a subjective test would be applied. Under this section, the burden of proof lies on the injured party. This section, however, provides that compensation shall not be awarded for any remote or indirect loss sustained by the parties. Section 73 also provides that the same principles will apply for breach of a quasi-contractual obligation, i.e. in the event that an obligation resembling that created by contract has not been discharged, the injured party is entitled to receive compensation as if a contractual obligation has been breached.

Damages under Section 73 of the Act are compensatory and not penal in nature. The explanation to this section further provides that in estimating the loss or damage arising from a breach of contract, the existing cost of remedying the inconvenience caused may be taken into account.

There are two principles regarding compensation that flow from this section. Firstly where money can substitute the loss incurred, the aggrieved party is to be put in the same situation, as it would have been in had the contract been performed. This is qualified by the second principle, which imposes a duty upon the defaulting party to take reasonable steps to mitigate the consequences which arise as a result of the breach.

In the event that loss is suffered, the court has the discretion to award the aggrieved party nominal damages in recognition of his right. Further damages may also be awarded for loss of the party's positive or exceptional interests in the case of contracts to be performed in the future. Improper recession of a contract may also result in compensation for loss of profit being awarded under Section 73 as was held by the Supreme Court in the case of Dwarka Das v State of Madhya Pradesh.

In Sitaram Bindraban vs. Chiranjanlal Brijlalit was held that the parties to a contract can create, for themselves, special rights and obligations such as providing for themselves the measure of damages for breach. The Parties can also provide in a contract that in the event of breach, no compensation will be payable except for refund of amounts paid and such a term was held to be enforceable in Syed Israr Masood vs. State of Madhya Pradesh.With regard to measure of damages for breach of warranty, in Mangilal Karwa vs. Shantibai 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. Mardon 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 Dwarkadas 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 Foundry 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.

THE RULE RELATING TO REMOTENESS OF DAMAGES

The rule relating to remoteness of damage was found in Hadley vs. Baxendale wherein it was held that where two parties have made a contract which one of them has broken, the damages the other party ought to receive in respect of such breach of contract should be either such as may fairly and reasonably be considered as arising naturally i.e. in accordance with usual course of things from such breach of contract itself or such as may reasonably be supposed to have been in the contemplation of both parties at the time they made the contract as the probable result of breach of it. Where the special circumstances under which the contract was actually made were communicated by one party to the other and was thus known to both parties, the damages resulting from such breach which they would reasonably contemplate would be amount of injury which would ordinarily follow from breach of contract under the special circumstances so known to the parties or communicated. Where the special circumstances are wholly unknown to the party breaking the contract, he at the most can only be supposed to have had in his contemplation the amount of injury which would arise generally and in great multitude of cases not affected by any special circumstances from such breach of contract.

In M Licha Setty & Sons Ltd. vs. Coffee Board Bangalore the Supreme Court held that the principle of mitigation does not give any right to a party in breach of contract but is a concept that has to be borne in assessing damages. In this case it was held that the plaintiff must take all reasonable steps to mitigate the loss and if he fails to do so he cannot claim such loss which could have been avoided. The plaintiff is only required to act reasonably and whether he has done so or not is not a question of law but a question of fact in each case. He must act reasonably not only in his own interest but also in the interest of the defendant and lower the damages by acting reasonably in the matter. In case of breach of contract, the plaintiff is required to do more than act in ordinary course of business and where he is placed in embarrassment, the measures he takes to extricate himself ought not to be weighed in nice scales at the instance of party in breach. The plaintiff is under no obligation to destroy his property or to injure himself or his commercial reputation to reduce the damages payable by defendant.   

COMPENSATION FOR BREACH OF CONTRACT WHERE PENALTY IS STIPULATED FOR

Section 74 of the Act deals with the situation where the parties to a contract agree that the contract itself will stipulate the penalty for the breach of the contract i.e. liquidated damages. The main principle behind this section is to promote certainty in commercial contracts. Section 74 provides that damages, not exceeding the amount stipulated in the contract, must be given to the injured party on breach of the contract. It further provides that such damages must be given to the injured party irrespective of any actual loss or damage proved by them. The explanation to Section 74 distinguishes between a genuine pre-estimate of the damages and a penalty. A penalty would be a sum of money, which is stipulated in order to dissuade a person from breaching a contract. When a contractual obligation is one of debt, the rule against a penalty would not apply to the sum payable. However, if a higher rate of interest is payable from the date of default, this would be construed as a penalty.

This distinction between estimated damages and a penalty is significant when enforcing one's rights in court. In the former, the courts do not have the discretion to question the amount agreed upon as damages by the parties. However, in the case of a penalty that is stipulated, even though the courts may not reject the claim in its entirety, they have the discretion to reduce an unconscionable amount to what they may perceive as reasonable. However, it is pertinent to note that no claim of liquidated damages is maintainable unless the promisee is proved to have sustained loss due to the default of the promisor. One cannot compensate a person who has not suffered any loss or damage. Therefore, in the absence or proof of damage for any breach of obligations, no sum of money named in a contract can be claimed. There may be cases where the actual loss or damage is incapable of proof. Section 74 exempts a party from such responsibility and enables him to claim compensation in spite of his failure to prove the actual extent of the loss or damage, but the party must establish that he has suffered some loss or damage. The proof of this basic requirement of “loss/damage” is not dispensed with by Section 74. It merely dispenses with the proof of the “actual loss/damage”. The courts, in such cases where it is difficult to ascertain the precise amount of damages, have the discretion to award reasonable compensation to the aggrieved party.

The Supreme Court has, in Maula Bux v. Union of India held that:-

  • A claimant may have to lead evidence to prove the actual loss or damage resulting from the breach, if the adjudicating authority were of the view that in the given facts and circumstances, compensation can be calculated in accordance with the settled rules.
  • However, if the adjudicating authority were of the view that in the facts and circumstances in question, it will be impossible for the Court to assess the compensation, then the Courtsmay take into consideration the sum named by the parties “if it be regarded as a genuine pre-estimate … but notif the sum named is in the nature of a penalty”.

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 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:

  • 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.

PENALTY AND LIQUIDATED DAMAGES

Often the term ‘liquidated damages' is mistaken or rather confused with the term ‘penalty'. Thus, understanding the terms, we can clearly distinguish between the two. A penalty can be said to be a sum so stipulated in terrorem (with the object of coercing the party into performing the contract), and thus an amount qualifies to be a penalty if the sum named is extravagant and unconscionable. It is also a penalty if the breach consists in paying of money and the sum stipulated is greater than the sum which ought to have been paid. However, liquidated damages are a genuine, covenanted pre-estimate of damages as seen above. They are both to be so judged on the facts of each case. The question whether a particular stipulation in a contract is in the nature of the penalty has to be determined by the court against the background of various relevant factors, such as the character of transaction and its special nature, if any, the relative situation of the parties, the rights and obligations accruing from such a transaction under the law and the intention of the parties incorporating in the contract, the particular stipulation which is contended to be penal in nature. If on such a comprehensive consideration, the court finds that the real purpose for which the stipulation was incorporated in the contract was that by reason of its burdensome or oppressive character, it may operate in terrorem over the promisor so as to drive him to fulfill the contract, and then the provision will be held to be of Penalty.

POSITION UNDER ENGLISH LAW

Under English Common Law, parties may name a sum to be payable in case of breach, which if classified by the court as a penalty is irrecoverable but if classified as liquidated damages is recoverable. However, the Law of Contracts in India does not recognise any qualitative difference in the nature of damages, as section 74 eliminates the somewhat elaborate refinement under Common Law. In case of a penal clause, damages will be assessed in the usual way, and the plaintiff may even recover a sum greater than 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 inDunlop Pneumatic Tyre Co. Ltd. Vs New Garage and Motor Company Ltd as follows:

  • 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 moneyin terroremof 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: -
    1. 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.
    2. 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;
    3. 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
    4. 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.” InFateh Chand v Balkishan Das , 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.

In Steel Authority of India V Gupta Brothers Steel Tubes Ltd 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 vSaw Pipes case for arrivingat 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 isprovedto 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 India) 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 inSudhir Gensets v Indian Oil Corporation. 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, IOCdeducted(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 adducedproof 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 inONGC 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 wouldnotfollow if the sum named in the contract is found to be apenalty, 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.

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. Ltd, 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”.