On 29 September
2018, we did a brief article review of S. Swaminathan’s erudite paper in the
Chinese Journal of Comparative Law (link-subscription required) De-inventing
the Wheel: Liquidated Damages, Penalties and the Indian Contract Act, 1872, 6
Chinese Journal of Comparative Law 103-127 (2018). This post is in respect of
one of the topics addressed in the paper.
An important argument in the paper is that the 1899 amendment brought in the
dichotomy of liquidated damages-penalty into the Indian Contract Act, 1872,
before which such a dichotomy never existed. Although this view is more or less
correct, it appears from a perusal of the decisions rendered prior to 1899 that
the judges ended up judicially incorporating the dichotomy in their decisions.
Section 74 as it
Stood Originally
The original
Section 74 was substituted by Section 4 of the Act VI of 1899. Para 1 of
Section 74 as it originally stood read as below (Para 2 did not undergo any
substantial amendment):
“Title to
compensation for breach of contract in which a sum is named as payable in case
of breach- 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, 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.”
One of the chief
aims of the original Section 74 was to do away with courts inquiring as to
whether the amount named is liquidated damages or a penalty. Swaminathan argues
that this did not happen primarily owing to the amendments in 1899 which
introduced the dichotomy:
“Just how did
the exact opposite of what the drafters had envisaged come to be the state of
the law and this, after they had been so careful about wanting to avoid the
troublesome liquidated damages-penalty dichotomy?… The single most important
contributing factor in bringing this about, it will be hypothesized, was an
ambiguity unwittingly introduced by an amendment to section 74 in 1899 by a
select committee headed by the ace draftsman Mackenzie Chalmers… However, the
effect of the introduction of the word ‘penalty’ in the provision in sharp contrast
to the neologisms used by the original provision was to prove troublesome. It
was to create the misleading (and unintended) impression that the English
concept of ‘penalty’ was being sought to be introduced into Indian law. Once
penalty was in, liquidated damages was but not even a step away.”
“Controversy
Surrounding “Sum is Named in the Contract”
The author also acknowledges
that the way in which the original Section was drafted did not help matters and
referred to the more controversial issue then regarding whether clauses
providing for increased interest on account of default could be covered under
the original Section 74:
"The phrase ‘sum
named in the contract’ ostensibly meant that the provision applied only to in
solido sums, thus leaving out stipulations for variations of interest,
acceleration clauses which affected payment schedules rather than sums, and
payments in specie. This ambiguity led to a great divergence of
opinion among Indian courts on the applicability of section 74 to such clauses.
A good fraction of the litigation on section 74 involved such stipulations.”
This is correct.
A perusal of the decisions between 1872 and 1899 reveal this aspect. There were
divergent views of various High Courts on the question as to whether the original
section applied even to a stipulation that could be categorized penalty
although the amount of penalty was not “named” in the contract. See, for
instance, H. Mackintosh v. Hunt (1877) ILR 2 Cal
202, where the Calcutta High Court held:
“We are of
opinion that the contract to pay interest at 10 per cent, per mensem, if the
principal sum of Rs. 400 were not paid on September 6th, the duo date of the
promissory note, is not in the nature of a penalty… In such a provision there
is nothing in the nature of a penalty more than there is in a provision, that
the promissory note shall bear interest from the day of its date. The case
seems to us to differ wholly from that class of cases in which a certain sum is
agreed to be paid on a breach of contract, and therefore Section 74 of the
Contract Act (IX of 1872) does not apply.”
A Full Bench of
the Calcutta High Court upheld this view about twenty two years later in Deno Nath Santh v. Nibaran Chandra Chuckerbutty and Ors. MANU/WB/0158/1899 by holding that “this is not a sum named in the
contract as the amount to be paid in case of such breach, and Section 74 does not
apply.” There were equally a good number of cases where the fine distinctions
between such clauses were made and contra view was upheld. See, for instance H. Mackintosh v. C. Crow and Anr. (1883) ILR 9 Cal 689 and a decision of the Full Bench of the Calcutta
High Court in Kala
Chand Kyal v. Shib Chunder Roy I.L.R. 19 Cal.
392 (FB): MANU/WB/0013/1892. It must
also be noted that in cases where the courts held that Section 74 were not
applicable, the debtor did not stand unprotected and could raise defences
available to him in equity. See, for instance, H.
Mackintosh v. Hunt (1877) ILR 2 Cal 202, Mackintosh v. Wingrove (1879) ILR 4
Cal 137 and Ram Prasad And Ors.
v. Lalli (20 July 1886) (1887) ILR 9 All 74. Nevertheless, considering the
decision of the Full Bench in Deno Nath (above), we are not sure the remedy was
efficacious.
Now, coming back to Swaminathan’s article, the author argues: “Unsure about the applicability of this provision to such cases, Indian courts increasingly began to fall back on the English law to decide these cases.” The author seems to suggest from this argument that owing to the controversy regarding whether enhanced interest clauses were “sum named in the contract”, English law were relied on to decide those cases. The author’s argument that courts relied on English legal principles were the principles of equity.
If the author's argument that the dichotomy was brought back into Indian law post 1899, in an ideal scenario, courts would never have referred to the dichotomy or decided the cases without referring to the “liquidated damages” and “penalty” nomenclatures. However, as we would see in the remaining portions of this post, the dichotomy never ceased to haunt Indian law post-1872.
Decisions
Construing the Original Section 74 Pre-1899
In one of the
earliest cases decided after the Indian Contract Act, 1872, H. Mackintosh v. Hunt (1877) ILR 2
Cal 202, the Calcutta High Court had to decide whether the clause was hit by
Section 74. The Calcutta High Court held: “We are of opinion that the contract
to pay interest at 10 per cent, per mensem, if the principal sum of Rs. 400
were not paid on September 6th, the duo date of the promissory note, is
not in the nature of a penalty… The case seems to us to differ wholly
from that class of cases in which a certain sum is agreed to be paid on a
breach of contract, and therefore Section 74 of the Contract Act (IX of 1872)
does not apply.” (emphasis supplied).
Notice above the use of “penalty” while referring to Section 74.
There are
several other judgements which are in line with the above. Some of them are
cited below along with the relevant observations of the court:
H.
Mackintosh v. C. Crow and Anr. (1883) ILR 9
Cal 689: MANU/WB/0037/1883: “This section, it will be observed, does away with
the distinction between a penalty and liquidated damages and this must be borne
in mind in dealing with cases decided before the Contract Act, many of which
turned upon this distinction. Under this section, whether a sum would formerly
have been held a penalty or liquidated damages, if it be named in the contract
as the amount to be paid in case of breach, it is to be treated, much as a
penalty was before, as the maximum limit of damages.” Now, if the stipulated
sum was to be treated as a penalty, it should be so determined and what
followed was to import the test in English law. See, also Sungut Lal vs. Baijnath Roy and
Anr. (17.06.1886 - CALHC) (1886) ILR 13 Cal 164: MANU/WB/0146/1886, where the dichotomy
seems to have been used although the court recognised that Section 74 did away
with it. Sundar Lal v
Banke Behari (28.06.1893 - ALLHC) : MANU/UP/0058/1893 also imported
the dichotomy although the Full Bench of the High Court held that the clause
involved was not one to which Section 74 applied. Similar is the decision of Ram Prasad And Ors. v. Lalli (20
July 1886) (1887) ILR 9 All 74 where although the Allahabad High Court held
that Section 74 did not apply nevertheless recognised the concept of penalty
See also, Dilbar Sarkar vs. Joysri Kurmi and A.M. Dunne and Ors. (12.08.1898 - CALHC) :
MANU/WB/0261/1898 (“Undoubtedly, sec. 74 of the Contract Act has clone (sic
done) away with the distinction between a penalty and liquidated
damages and although, generally speaking, the distinction between these two
classes of damages is fine, yet it is desirable to bear in mind that in some
cases there is a broad distinction, In this case undoubtedly the sum agreed
upon by way of damages was agreed upon as a penalty.”
It could thus be
observed that importation of the dichotomy into Indian jurisprudence was not a
phenomenon merely attributable to the 1899 amendment. As these cases, and many
more, go to show, notwithstanding the doing away of the distinction, the
dichotomy never went away. The implications of this inference may have an
impact on the villainous portrayal by the authorof the 1899 amendment as having brought back
the dichotomy. The 1899 amendment at the most normalized the importation of the
dichotomy, which never went away, except in a miniscule number of cases.
Cases Decided on
the Basis of the Original Section 74 Without Importation of the English
principles
On the other
side of the spectrum is the interesting case of Nait Ram vs. Shib Dat and Ors.
(15.12.1882 - ALLHC) : MANU/UP/0103/1882. The suit was for the recovery of the
principal amount of Rs. 200 issued under bond to the defendant and for Rs. 400
towards liquidated damages for breach of the bond. The plaintiff did not lead
any evidence towards loss and the munsiff’s court applied Section 74 and
declared the amount claimed towards LD as excessive thereby considerably
reducing the claim towards liquidated damages. On appeal, the appellate court
termed the decision regarding assessment of liquidated damages as erroneous and
held Rs. 100 as LD to be reasonable.
On further
appeal, the Division Bench of the Allahabad High Court recognised the
legislative intent behind enactment of Section 74: to eliminate the LD-penalty
dichotomy: “The section appears to have been introduced to obviate the
difficulties which exist in distinguishing liquidated damages, from penalty
under the English Law and the effect of it is, that the Court are not bound to
award the entire amount of damages agreed upon by the parties in anticipation
of the breach of contract. The only restriction is that the Court cannot decree
damages exceeding amount previously agreed upon by the parties.”
On how
reasonableness has to be determined, the court held: “The discretion of the
Court in the matter of reducing the amount of damages agreed upon is left unqualified
by any specific limitation though of course the expression "reasonable
compensation" used in the section necessarily implies that the discretion
so vested must be exercised with care, caution, and on sound principal (sic
principles).”
On how the
discretion has to be exercised, the court’s decision deserves summarizing:
- Damages should be commensurate with the injury sustained.
- It should be assessed with the view to restoring the advantage to the plaintiff that he might have received if the contract had been performed.
- Where it is impossible to arrive at the exact damages, courts award the amount named, and nothing more.
Another similar
decision is that of Brahmaputra
Tea Co. Ld. v. E. Scarth (MANU/WB/0175/1885 : (1885) ILR 11 Cal 545). The
defendant entered into an agreement with the plaintiff to serve as an assistant
tea planter for a salary. Clause 8 of the agreement named a sum as damages in
case of breach of the agreement. The plaintiff initiated a suit to recover, inter
alia¸ the named sum from the defendant as per clause 8 of the agreement.
The plaintiff did not lead any evidence in the trial on the actual loss
suffered and merely relied on the amount named in clause 8 of the agreement.
However, the trial court held that the plaintiff was entitled to an amount that
was far lesser than the amount stipulated in the agreement. On appeal, a two
judge Bench of the Calcutta High Court consisting of McDonell and Macpherson,
JJ was of the view that it was not necessary for the plaintiff to prove damages
or loss. The Bench was of the opinion that the trial court erred in reducing
the amount of compensation. It held:
“…the agreement
by the defendant himself, so he knew full well what he was doing and what risk
he was incurring, and, so far as we can see, there was no reasonable or
sufficient ground for his act. No doubt the Court has a discretion to fix what
it considers reasonable compensation; but when the parties have already agreed
among themselves as to what the penalty should be, we think the Court should
not, in fixing the compensation, wholly ignore the amount agreed on, unless
this is, on its face, wholly unreasonable with reference to the position of the
parties and the breach provided against.”
The court felt
that the Liquidated Damages named in the agreement was not “wholly
unreasonable” and must have been agreed between the parties after taking into
consideration to all the circumstances attending the consequences of breach.
However, the court doubted if the amount named in the agreement could be
considered as reasonable “in the absence of any proof to the contrary”. Consequently,
the court exercised its discretion in the matter and awarded a sum which was
approximately half-way between the amount specified in the judgement of the
trial court and the amount named in the agreement.
Thus, it would
seem that even from the beginning, courts were grappling with the inconsistency
in the text of the statute: on the one hand, the plaintiff was not required to
prove the actual loss caused by the breach and, on the other, the court could
grant only reasonable compensation for which it had to allow the parties to
lead evidence on the reasonableness of the amount named in the contract. A way
of resolving it was to simply suggest, like Nait Ram that damages should be
proved akin to a claim under Section 73. Another way was to award damages in the
absence of proof as a fraction (or percentage) of the amount in the contract as
it happened in Brahmaputra Tea Co. in 1885 (see above) and in Construction
and Design Services vs. Delhi Development Authority MANU/SC/0099/2015, one
hundred and thirty years later.
Closing Remarks
In the light of
Cavendish Square, is it not the time to move on and bring about a more nuanced and
predictable model of determination of Liquidated Damages? The reasonableness
standard does not offer certainty and inevitably allows promisors to challenge the imposition in courts regularly.
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