Liquidated Damages under Indian Contract Law between 1872 & 1899

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.

Thereafter, the court held that this was not a case where it was impossible to arrive at the damages. On the assessment of damages, the court basically repeated the manner in which damages would be proved in a claim for general damages under Section 73. 

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.