Section 74 of the Indian Contract Act reads that in case of breach of contract, if a predetermined sum or amount has been decided, then the party which has complained and suffered from this breach is entitled to get the compensation so decided. It is not necessary to prove that the damage or loss has incurred, simply breaching the contract would also make the party liable for paying the damages. This section mentions about liquidated damages as the amount for causing damage or breach is fixed while formulating the contract itself.
Even though Section 74 has been laid
down clearly in the act, there are various interpretations applied during
application in case of disputes and breaches in the courts of law. Literal and
Golden Rule of Interpretation can be best applied to these sections.
Literal Rule of Interpretation
Under this rule of interpretation, the words of the statute, preamble, clauses are interpreted exactly with the words that are used. No other meaning is to be derived by the judges other than what has been provided with. When we go by this rule of interpretation for Section 74 of the Act-
Part
I- “Compensation
for breach of contract where penalty stipulated for: - 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, …”
Part II- “… 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.”[1]
By the second part of the section, it is clear and definite that the non-breaching party shall be entitled to the amount or the penalty even if there is no actual proof of damage in order to receive such a pre-determined amount. Amount received by the complaining party shall not exceed the specified sum in the contract.
There have been cases with respect to liquidated damages wherein the court considered the literal interpretation of the clauses and supported the notion of providing compensation to the non-breaching party even where there is no proof of damage. There are certain situations where it would be impossible to prove the exact loss suffered by the party, thereby the courts ordered the breaching party to pay the damages.
In the case of Fateh Chand v. Balkishan Das[2], the Plaintiff contracted to sell leasehold rights in a piece of land and in a building to the defendant. The Plaintiff received the sum of Rs. 25,000 for delivering the possession, but the sale was not completed before the expiry of the stipulated in the agreement. The clauses of the contract specifically mentioned that if the vendee fails to get the sale-deed registered by a given date, the amount of Rs. 25,000 {Rs. 1,000 (earnest money) + Rs. 24,000 (actual payment when delivered the possession)} would stand forfeited.
The
two main focus points of the case were-
1. 1. Penalty even in the
form of forfeiture of right to money would be considered if the courts find the
sum to be reasonable, but not exceeding the amount specified.
2. 2. That the non-breaching party has to prove only the legal injury in order to get compensation by the breaching party, and the fact that there is no requirement to prove actual loss or damages.
In the case of Maula Baux v. Union of India[3], similar grounds were raised by the defending party as in the case of Fateh Chand v. Balkishan Das. The Appellant had failed to perform his part of the contract of supplying potatoes, eggs and fish, which ultimately led to forfeiting of the payments by the defendant. This was then contested in the court. It was also held by the Supreme Court that in some cases of breach, it may be impossible for the courts to assess the compensation, if in such cases the genuine pre-estimated sum can be given as a reasonable compensation. It was also mentioned that section 74 is interpreted differently for different classes of contract.
In the case of Oil & Natural Gas Corporation Ltd. vs. SAW Pipes Ltd.[4] the appellant wanted the supply of casing pipes from the respondent within a stipulated period of time, failure of which would give rise to payment of liquidated damages. The respondent delayed the supply, leading to delay in producing of the gas. Aftermath of which the appellant deducted certain amount claiming it be the damages. The respondent challenged such deduction and the arbitration tribunal held that the appellant was wrong in doing so as he did not face any loss, it was merely a delay.
Following the same principle laid
down in Section 74 of the Act, Supreme Court held that the award which was set
aside by the arbitral tribunal was not right. Court held if the pre-determined
liquidated damages in the agreement are reasonable, then the non-breaching
party need not prove the actual loss incurred.
Golden Rule of Interpretation
Golden Rule of Interpretation can be seen as an extension to the Literal Rule of Interpretation. Under this the judge can provide for another meaning of a certain word or a clause if the literal meaning derived seems to be unjust. This is done to avoid to remove the absurdity as well as to protect the actual intent of the legislature which made the act. Golden Rule can be used in narrow sense as well as in a wider sense.
There are various cases in which court asked for actual proof of damages incurred by the non-breaching party in order to get the pre-determined liquidated damages which are mentioned in contract. When this happens, it can be observed that the courts did not observe the literal interpretation of the act, rather, they looked at the overall intent of the legislation and the specific section to determine what would be just. This is done because there are various times when the non-breaching party did not actually face any loss from the breach. The intent of the act and the sections is to put the victim back to its original position that sustained before the contract. Henceforth it is to be understood that compensation is not provided to make the non-breaching party into a better position, but only the original position had the contract not been made.
In the case of Indian Oil Corporation v. Messers Lloyds Steel Industries Limited[5], there was a delay in execution of the contract which required designing, detailed engineering, procurement, supply, fabrication and commissioning of Petroleum Product Terminal at Jodhpur by the respondent. Thereby the Plaintiff claimed liquidated damages pre-estimated in the contract for the breach incurred. Upon investigation of the facts, it was found out that even though there was a delay on part of the respondent, the pipeline that had to be installed by the Plaintiff reached much later, this proves that there was no actual loss as without installation of the pipeline the terminal could not be put into use. Henceforth, the court did not award the compensation to the non-breaching party as there was no actual proof of the damage or injury.
In the case of Kailash Nath Associates v. Delhi Development Authority[6], there was a public auction conducted by the Delhi Development Authority. The Appellant made the highest bid for the said land for Rs. 3.12 crores. As per the terms of the auction, Rs. 78 lakhs (25%) were deposited and hence seen as the earnest money. Later without giving a proper notice of payment of rest of the 75% of the amount within a prescribed time, the Delhi Development Authority cancelled the allotment of the bidder and forfeited the 25% earnest money.
In this case, the Supreme Court firstly held that there was no breach of the contract on the part of the Appellant, and secondly, as the Delhi Development Authority went ahead and sold the property at much higher price amounting to Rs. 11 crores, there was no loss incurred. Henceforth, where there is no of breach of contract, there can be claim for damages. Also, section 73-74 shall only apply in cases where the non-breaching party actually suffers a loss. The Supreme Court ordered that the earnest money amounting to Rs. 78 lakhs cannot be forfeited.
With the above cases, it is quite
clear that sometimes the judges instead of going by the literal words of the
statutes or the clauses, look at the intent behind the same and what would be
just for the parties to the contract. In the above cases, mere use of the words
defined in Section 74 would lead to undue advantage of one party, and
unnecessary suffrage of the other party. The supreme importance in the case of
breach of contracts and providing damages is to make the non-breaching victim
party in a position it would have been had the contract not made, and not to
better their situation.
[1] Section 74. Indian Contract Act, 1872
[2] Fateh Chand v. Balkishan Das. AIR 1963 SC 1405.
[3] Maula
Baux v. Union of India. AIR 1970 SC 1995.
[4] Oil & Natural Gas Corporation Ltd. v. SAW Pipes
Ltd. AIR 2003 SC 2629.
[5] Indian Oil Corporation v. Messers Lloyds Steel Industries Limited. 2007 (4) ArbLR 84 (Delhi).
[6] Kailash Nath Associates v. Delhi Development Authority. 2015 4 SCC 136.
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