Under the Indian Contract Act, 1872, Section 73 and Section 74 provide for unliquidated and liquidated damages respectively. Unliquidated Damages are the damages awarded by the courts on the basis and assessment of actual loss or injury caused to the party suffering breach of contract. Whereas, Liquidated Damages are the damages which the parties to the contract may agree to, as payment of a certain amount on the breach of contract.
The relevant parts of the sections are as follows:
Section 73: Compensation for loss or damage caused by breach of contract: When a contract has been broken, the party who suffers by such breach is entitled to receive, from the party who has broken the contract, compensation for any loss or damage caused to him thereby, which naturally arose in the usual course of things from such breach, or which the parties knew, when they made the contract, to be likely to result from the breach of it. Such compensation is not to be given for any remote and indirect loss or damage sustained by reason of the breach.
Section 74: Compensation for breach of contract where penalty is 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 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 or, as the case may be, the penalty stipulated for.
Proof of lo ss/injury in ca se of Liquidated Damage
Firstly, irrespective of the nature of damages, breach of contract is the pre-condition to claim the same. That is, there can be no claim for damages if there is no breach of contract between the parties. Secondly, to claim damages, the party making such claim has to establish the loss. It is understood that the reasonable compensation agreed upon as liquidated damages in case of breach of contract is in respect of some loss or injury and hence existence of such loss or injury is indispensable for such claim of liquidated damages. In some cases, the courts have demanded the parties to prove the degree of loss or damage suffered as a result of breach of contract.1
In the case of Maula Bux2, the court has specifically held that the court is competent to award reasonable compensation in a case of breach even if no actual damage is proved to have been suffered in consequence of the breach of contract. The court has, however, also specifically held that in case of breach of some contracts it may be impossible for the court to assess compensation arising from breach. In such a case, the sum named by the parties if it be regarded as a genuine pre-estimate may be taken into consideration as the measure of reasonable compensation, but not if the sum named is in the nature of a penalty. Where loss in terms of money can be determined, the party claiming compensation must prove the loss suffered by him. In the case of Iron & Hardware (India) Co. v. Firm Shamlal & Bros3, it was stated that an automatic pecuniary liability does not arise in the event of a breach of a contract which contains a clause for liquidated damages. Till the time, it is determined by the court that the party complaining of the breach is entitled to damages, the plaintiff shall not be granted compensation by the mere presence of a liquidated damages clause.
It is however, apparent from the above that this demand to prove the loss suffered, defeats the very purpose for which liquidated damages clauses are inserted in contracts. Section 74 of the Act emphasizes on reasonable compensation. Only if the compensation in the contract is by way of penalty, consideration would be different and the party would only be entitled to compensation for the loss suffered. But if the compensation named in the contract is a genuine preestimate of loss, which the party knew at the time of entering into contract, there is no question of proving such loss. Burden is in fact on the other party to lead evidence to prove that no loss is likely to occur by such breach.4
In the case of Oil & Natural Gas Corporation Ltd. vs. Saw Pipes Ltd, it was held that if the terms of the contract are clear and unambiguous stipulating the liquidated damages in case of the breach of the contract, unless it is held that such estimate of damages/compensation is unreasonable or is by way of penalty, party who has committed the breach is required to pay such compensation. However, in some contracts, it would be impossible for the court to assess the compensation arising from breach and if the compensation contemplated is not by way of penalty or unreasonable, court can award the same if it is genuine pre-estimate by the parties as the measure of reasonable compensation.
In the case of Indian Oil Corporation v. Lloyds Steel Industries Ltd5, the court held that:
"...The guiding principle is 'reasonable compensation'. In order to see what would be the reasonable compensation in a given case, the Court can adjudge the said compensation in that case. For this purpose, as held in Fateh Chand (supra) it is the duty of the Court to award compensation according to settled principles. Settled principles warrant not to award a compensation where no loss is suffered, as one cannot compensate a person who has not suffered any loss or damage. There may be cases where the actual loss or damage is incapable of proof; facts may be so complicated that it may be difficult for the party to prove actual extent of the loss or damage."
In the case Construction & Design Services v. Delhi Development Authority6, the apex court reconfirmed that the court must determine the reasonable compensation and then grant it to the injured party. It held as follows:
"Applying the above Principle to the present case, it could certainly be presumed that delay in executing the work resulted in a loss for which the respondent was entitled to reasonable compensation. Evidence of precise amount of loss may not be possible but in the absence of any evidence by the party committing breach, the court has to proceed on guesswork as to the quantum of compensation to be allowed in the given circumstances. Since the respondent also could have lead evidence to show the extent of higher amount paid for the work got done or produce any other specific material but it did not do so, we are of the view that it will be fair to award half of the amount claimed as reasonable compensation."
In the case of M/s. Herbicides (India) Ltd. v. M/s. Shashank Pesticides P. Ltd7, the court held in case of liquidated damages that "... even if it does not prove the actual loss/damage suffered by it, is entitled to reasonable damages unless it is proved that no loss or damage was caused on account of breach of the contract"
The provisions relating to liquidated damages are required to be drafted with clarity and one has to prove that the amount is a genuine pre-estimate of loss or injury suffered.8
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. However, as long as it serves a compensatory function, liquidated damages should be allowed without the requirement to prove exact losses.
Thus, 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 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.
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. Thus, it is the nature of the Liquidated Damages clause that needs to be considered, that is, whether it's a genuine pre-estimate of loss occurred on breach of contract or whether it is in form of penalty and deterrent in nature.9
1 Fateh Chand v. Balkishan Dass AIR 1963 SC 1405
2 (1969)2 SCC 554
3 AIR 1954 Bom 423
4 Oil & Natural Gas Corporation Ltd. vs. Saw Pipes Ltd (2003) 5 SCC 705
7 180 (2011) DLT 243
8 ONGC v. Saw Pipes (2003) 5 SCC 705
9 Dunlop Pneumatic Tyre Co. Ltd v. New Garage & Motor Co Ltd,  UKHL 1
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