Liquidated Damages in India: Kailash Nath Associates v DDA (SCI)

Recently, the Indian Supreme Court had the occasion to discuss the law on liquidated damages. A Bench consisting of Ranjan Gogoi & RF Nariman, JJ, through the latter summarised the law on liquidated damages:

"1. Where a sum is named in a contract as a liquidated amount payable by way of damages, the party complaining of a breach can receive as reasonable compensation such liquidated amount only if it is a genuine pre-estimate of damages fixed by both parties and found to be such by the Court. In other cases, where a sum is named in a contract as a liquidated amount payable by way of damages, only reasonable compensation can be awarded not exceeding the amount so stated. Similarly, in cases where the amount fixed is in the nature of penalty, only reasonable compensation can be awarded not exceeding the penalty so stated. In both cases, the liquidated amount or penalty is the upper limit beyond which the Court cannot grant reasonable compensation. 

2. Reasonable compensation will be fixed on well known principles that are applicable to the law of contract, which are to be found inter alia in Section 73 of the Contract Act. 

3. Since Section 74 awards reasonable compensation for damage or loss caused by a breach of contract, damage or loss caused is a sine qua non for the applicability of the Section. 

4. The Section applies whether a person is a plaintiff or a defendant in a suit. 

5. The sum spoken of may already be paid or be payable in future. 

6. The expression “whether or not actual damage or loss is proved to have been caused thereby” means that where it is possible to prove actual damage or loss, such proof is not dispensed with. 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. 

7. Section 74 will apply to cases of forfeiture of earnest money under a contract. Where, however, forfeiture takes place under the terms and conditions of a public auction before agreement is reached, Section 74 would have no application." 

The Indian law on liquidated damages has been less than clear on several aspects. This decision does not do much to clear the air. Some of the issues that require clarity/ discussion are:

1. How does a court determine whether the liquidated amount is a genuine pre-estimate of damages.?Parties deem such a provision to be efficient in case of litigation since liquidated damages is more or less a short cut to proving damages in case of breach of contract. In such a scenario, what precisely does the promisee have to show to establish that the liquidated amount is a genuine pre-estimate of damages. Surely, it should not be as rigorous as it is in Section 73. In practice, however, does this not mean that the promisee is forced to show that the liquidated amount is reasonable, especially in the absence of pointers from the court on whether and how should the promisee establish this? In other words, the court (and past decisions as well) is not clear whether the parameters for establishing reasonableness of the liquidated amount ex-post the breach (S. 73) is the same as those for establishing the liquidated amount to be a genuine pre-estimate and reasonable ex-ante the breach (S. 74). If the distinction is unclear or non-existent, S. 74 virtually becomes redundant (as S. 74 seeks to rationalise and simplify the law on party agreed damages).

2. It is well settled that liquidated damages is agreed by parties in many cases where assessment of damages is either difficult or in some cases impossible. Therefore, should not the level of determination of damage/ loss in Section 73 be more than in Section 74?

3. In point 6 above, the court mentions that it is only in cases where the actual damage/ loss is difficult/ impossible to prove, there are no specific parameters given on the kinds of cases in which such proof can be dispensed with so long as the liquidated amount is not unreasonable. But ONGC v SAW Pipes gives some indication on such types of cases, viz.,:

a) Delay/ breach in contracts for construction of a road or bridge

b) Delay/ breach caused is one of the several reasons for the legal injury (for example, delay in sending casings was one of the several reasons for postponing deployment of rigs).

Even so, it is important for an authoritative decision on those types of cases (a detailed illustrative list) where it is necessary to prove losses and those cases where it is difficult/ impossible to furnish proof of loss for breach. One reason why this point is being made is because while agreeing with the decision in Maula Bux case (where the contract was a government contract, the court held that a party had to prove losses despite the LD clause), the court in SAW Pipes stated that the need to prove loss in breaches in contract for construction of road or bridge could be dispensed with (if there is an LD clause) as it would be difficult/ impossible to estimate the loss to the society.

Therefore, unless, there is legal certainty on this issue, it would be inefficient for the parties to waste time in negotiating LD clauses when they have to prove losses even in cases where the parties have agreed on the LD. 

4. At Para 33 of the judgement, the court states that Section 74 is sandwiched between Sections 73 and 75 which deal with compensation for loss or damage caused due to breach of contract and that like the other two aforementioned Sections, compensation is payable under Section 74 only when there is a damage or loss caused by breach. Strictly speaking, the argument that since Section 74 is sandwiched between the other two sections providing for compensation for loss or damage on breach, Section 74 would also require loss or damage to be caused would be true only if the basis of arrangement of these sections by the drafters was based on loss or damage. It is one thing to say that there should be loss or damage and another thing to say that merely on breach there is legal damage or injury. Also, Section 74 does not expressly state that "compensation is payable for breach of contract under section 74 only where damage or loss is caused by such breach".

Lastly, the court held that DDA had not breached the contract at all. The question of damages would have arisen only if there was a contractual breach, In view of the determination that there was no breach of contract, was it necessary for the court to discuss the law on the need for proof of loss or damage under Section 74? 

Would love to the readers' views on these points.

The judgement can be downloaded from this link.