The High Court of Delhi (High Court), in the recent judgment of Rajesh Gupta v. Ram Avtar1, partly set aside an arbitral award on the ground that the sole arbitrator had wrongly allowed forfeiture of earnest money which formed a substantial portion of the total consideration in favour of the respondent without the respondent proving the actual loss suffered by it.
The petitioner filed an application under Section 34 of the Arbitration and Conciliation Act, 1996 (Arbitration Act) to challenge an arbitral award dated 19.04.2012 delivered by a sole arbitrator.
The impugned award was rendered in the context of disputes pertaining to an 'Agreement to Sell and Purchase Cum Receipt' (Agreement) dated 05.12.2008, as per which, the petitioner agreed to purchase a manufacturing unit including the built-up factory, rights in a property located in Ghaziabad along with all movable assets (the Property) for a sale consideration of INR 1,60,00,000. Out of the sale consideration of INR 1,60,00,000, the petitioner paid a sum of INR 60,00,000 to the respondent, the receipt of which was expressly acknowledged in the Agreement as the receipt of 'earnest money'.
After entering into the Agreement, the petitioner claimed that the respondent had committed fraud by representing that the entire constructed area of the Property was 10,000 sq. ft. However, upon taking measurements, the actual constructed area was found to be only 6,500 sq. ft. Subsequently, the petitioner sent a legal notice calling upon the respondent to either refund the amount already paid i.e., INR 60,00,000, or in the alternative, execute the Agreement in respect of the factory premises based on actual measurements. When the respondent failed to respond to the said legal notice, the petitioner filed a suit before the High Court for recovery of the earnest money along with damages. In response, an application under Section 8 of the Arbitration Act was filed by the respondent, which was also allowed and the parties were referred to arbitration under the Delhi International Arbitration Centre.
Before the sole arbitrator, the petitioner claimed an amount of INR 1,20,00,000, which was twice the earnest money, as liquidated damages due to the failure on the part of the respondent in fulfilling his obligations under the Agreement. Additionally, besides costs, the petitioner also claimed pendente lite interest as well as future interest at the rate of 18% per annum and 5% per annum respectively to be compounded quarterly. All the claims of the petitioner were rejected by the sole arbitrator on the ground that it was incumbent upon the petitioner to make a reasonable inquiry as to the actual area of the property. Accordingly, the sole arbitrator held that the doctrine of 'caveat emptor' applied to the facts of the case. Furthermore, the sole arbitrator held that the claim of the petitioner was barred under the exception clause contained under Section 19 of the Indian Contract Act, 1872 (Indian Contract Act). This was in view of the fact that the petitioner could have discovered the truth with regards to the measurement of the premises with ordinary due diligence. The sole arbitrator also rejected the petitioner's contention that the sum of INR 60,00,000 paid by the petitioner was part payment of the consideration and not earnest money. Consequently, it was held that the respondent was entitled to forfeit the same in terms of the Agreement. Aggrieved by the decision of the sole arbitrator, the petitioner filed the present petition under Section 34 of the Arbitration Act challenging the award.
- Whether there was any misrepresentation on the part of the respondent with respect to the constructed area of the Property?
- Whether the sole arbitrator erred in denying the petitioner's claim for refund of INR 60,00,000?
While deliberating upon the first issue, the High Court noted that the Agreement expressly indicated that the respondent had constructed an area of 10,000 sq. ft. However, on an independent assessment by the architect, it was established during the arbitral proceedings that the constructed area was neither 6,500 sq. ft nor 10,000 sq. ft. but was actually 7,506 sq. ft. Therefore, the representation regarding the covered area as reflected in the Agreement was held to be incorrect. The High Court observed that although it is not stated explicitly in so many words, but it was discernible from the impugned award that the sole arbitrator was of the view that the reduced area was not material. The High Court opined that it was difficult to accept that a reduced area of the Property to the extent of almost 25% could be considered as not material. The High Court also observed that the principle of 'caveat emptor' did not apply where an express representation is made by the seller and is relied upon by the purchaser. The High Court then referred to the decision of the sole arbitrator holding the claim of the petitioner to be barred under the exception clause mentioned in Section 19 of the Indian Contract Act. In view of the limited scope of intervention under Section 34, and the general rule that a court could not supplant its understanding with that of the arbitrator, the High Court held that the arbitrator's observation on the claim being barred under Section 19 of the Indian Contract Act did not warrant any interference under Section 34 of the Arbitration Act.
For the second issue, the High Court noted that the sole arbitrator had held that the payment of INR 60,00,000 could not be taken up as part payment of the sale price as it was made in the nature of earnest money, and as per Clause 12 of the Agreement, the respondent was entitled to the entire earnest money in the event of the failure on the part of the petitioner to fulfill his obligations under the Agreement. In this regard, the High Court opined that the question of whether an amount of INR 60,00,000 could be considered as a guarantee for entering into a binding contract was also required to be considered keeping in view the quantum of the said amount. The fact that the amount was merely referred to as 'earnest money' in the Agreement would not necessarily cater to the question of the amount being in fact earnest money or being paid as part of the consideration. The High Court, thus, observed that a sum of INR 60,00,000 which represented substantial portion of the total consideration (i.e., 37.5%) could not be forfeited without the respondent establishing that he had suffered any loss. Reliance was also placed by the High Court on the decision in Kailash Nath Associates v. Delhi Development Authority and Anr.,2 to reiterate that Section 74 of the Contract Act applies to forfeiture of earnest money and the requirement to prove the actual loss is not dispensed with. Thus, the High Court held that without the respondent establishing that it had suffered any loss on account of the petitioner failing to close the transaction for the purchase of the Property, it would be impermissible for the respondent to forfeit the amount of INR 60,00,000, which admittedly is not a nominal amount and constitutes a substantial portion of the consideration. Accordingly, the impugned arbitral award was set aside to the extent that it accepts that the respondent was entitled to forfeit the amount of INR 60,00,000.
It is settled law, as held in a catena of judgments, that a description of words used in an agreement would not necessarily aid in determining the nature of the provision. Therefore, the mere use of the term 'earnest money' would not lead to an irrebuttable conclusion that the amount paid by a party was in nature of earnest money. Further, forfeiture of a substantial amount without any proof of the same would be impermissible in line with the judgments3 laid by the Hon'ble Supreme Court.
1. Rajesh Gupta v. Ram Avtar, O.M.P. Comm. 121 of 2020.
2. Kailash Nath Associates v. Delhi Development Authority and Anr., 2015 4 SCC 13
3. Kailash Nath Associates v. Delhi Development Authority and Another, 2015 4 SCC 136; Ashokan v. Assistant Excise Commissioner and Ors., 2009 14 SCC 85.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.