liquidated damages and penalty

The Indian Contract Act,1872 is a statute which governs the law of contract in India, its enforcement, various provisions regarding non-payment and breach. Damages can be of two types one is Liquidated damages, and another one is unliquidated damages. In case of breach of contract, the party who is injured by the breach can bring an action for damages in terms of money or by specific performance against the wrongdoer. Damages are provided with an intention, so as to compensate the aggrieved party, and he is placed, as far as the money can do, in the same position in which he would have been if the contract would have been performed. However, courts ensure that no one is allowed to make an unjust enrichment in the shadow of claiming compensation.

Liquidated Damage

If the amount fixed by all parties is a genuine estimate of the loss by a future breach of contract, then it is liquidated damages. Thus, the parties to the contract while deciding the terms and condition of the contract agree upon the fixed amount as fair compensation. In the case of a breach, the party at default shall pay the agreed amount of compensation to the aggrieved party. It is pre-accessed loss likely to arise out of the breach.

The Courts, while dealing with the issue of the validity of imposition of LD by one party to the contract on the other, read Section 73 & 74 of the Contract Act together.

Penalty and Liquidated Damages

When there is a breach of contract, damages are paid. However, in colloquial terms penalty and liquidated damages might sound similar; however, there is a thin line difference to the same. A penalty can be said to be a sum so agreed in terrorem, with the object of coercing the party into performing the contract. An amount qualifies as a penalty if the sum named is exorbitantly high and unconscionable. It is also in the nature of a penalty when the breach consists of paying off money, which is greater than the sum which it ought to have been paid.

Also, if the stipulated amount in question is of nature of penalty has to be determined by the court, taking into consideration the relevant factors such as nature of transaction, obligations accruing from such a transaction,  relative situation of the parties, intention of the parties while incorporating a particular stipulation which is contented to be penal in nature. After analyzing all these parameters, at the end of such a comprehensive consideration, the court finds out the real purpose for including this speculated amount, is burdensome and oppressive in character, then the provision can be held to be a penalty.

Whether in all the cases, courts should allow the grant of the full amount of Liquidated Damages?

Merely, because the parties have agreed to have a clause expressing the number of damages in case of breach of the contract, the aggrieved party must not have the liberty to claim the full amount as a matter of right. The aggrieved party must be entitled to recover the damages only to the extent of actual losses proved to have been suffered by it. In the cases, where no actual loss is proved, but undeniable losses have been caused, the court would not be powerless to award reasonable damages to the aggrieved party. In another case where the nature of the breach is such that it is impossible to access the damage, in such a case court would be empowered to grant full compensation. Also, in the case of partial breaches, the court is over-powered to grant full damages as agreed by the parties.[1] The substantial loss incurred by the aggrieved party might be considerably less in reference to the liquidated damage as initially agreed. This will cause unreasonable harm to the victim.

Whether LD can be recovered without proving the actual loss?

The court has repeatedly held that the provisions of LD are no different from Liquidated Damages, and in both situations, the breach, and damages are to be proved. However, in the case where it is impossible for the court to assess the compensation arising from the breach, the court can award the full liquidated damages if it is found to be genuine pre-estimate by the parties as a measure for reasonable compensation.

In the case of ONGC v. Saw pipes[2], the Supreme Court of India held that Arbitral tribunal was erroneous in refusing to award LD in favor of ONGC for want of proof of actual losses. Supreme Court held that in such contracts it would be difficult to prove exact loss after finding the compensation provided the same was not unreasonable. Thus, the Supreme Court upheld imposition of LD by ONGC on Saw Pipes Ltd.[3]

Can Liquidated Damages be reduced proportionately depending upon the status of performance of the contract till the date of imposition of Liquidated Damages?

This was another pertinent issue before the Court and Arbitrators are whether the number of Liquidated Damages provided for under the contract can be reduced proportionately depending on the quantum of work done till the date of occurrence of the breach.

While it’s true that, wherever it is possible to prove actual damages, the party claiming LD will have to prove the losses actually suffered by it, and limit its claim only that amount and not the full amount as initially agreed. However, reducing the amount of LD will amount to re-writing of contract, which is not permissible under law. Further, such concept goes contrary to the basic idea of providing the LD, i.e., the parties taking the informed decision prior to entering into a contract and providing for the pre-estimated damages.[4]



[1] Herbicides (India) Ltd. vs. Shashank Pesticides Pvt. Ltd. 180 (2011) DLT 243.

[2] Oil & Natural Gas Commission v. Saw Pipes Ltd, (2003) 5 SCC 705.

[3] “Liquidated Damages, Section 73, Section 74” (Singhania And PartnersNovember 29, 2017) <> accessed May 28, 2019.

[4] “Liquidated Damages, Section 73, Section 74” (Singhania And PartnersNovember 29, 2017) <> accessed May 28, 2019.

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