The relief of damages is pivotal under the law of contract. Damages constitute the compensation awarded to a contracting party for any injury or loss suffered by such party as a result of breach by the counterparty. Such injury or loss may or may not always be capable of being quantified and it varies with the facts and circumstances of each case.
Sections 73 and 74 of the Indian Contract Act, 1872, [Contract Act] are crucial with respect to damages. Section 73 of the Contract Act provides that when a party is aggrieved by a breach by another, he is entitled to claim compensation from the party committing the breach, even if it is not provided for in the contract, for the loss or damage caused as a result of the breach.
Section 74 of the Contract Act, on the other hand, deals with a pre-determined amount of compensation already stipulated in the contract which the party committing breach will be liable to pay to the affected party. It is pertinent to note that such amount is named in the contract as compensation and may constitute liquidated damages or damages by way of penalty. Often a forfeiture clause within a contract is also treated as a penalty clause.
In either case, the requirement of proof of loss suffered by the party claiming damages basis such contractual entitlement has been a subject of consideration in a number of decisions of the Supreme Court.
The decisions of the Hon’ble Supreme Court in the matters of Fateh Chand v. Balkishan Dass, Maula Bux v. Union of India, Oil & Natural Gas Corporation Limited v. Saw Pipes Limited and Kailash Nath Associates v. Delhi Development Authority & Anr. have been crucial in this regard.
Although the above decisions have dealt with factually different cases, the essence of the judicial interpretations of Sec. 74 can be summed up as follows:
Under liquidated damages clause, a party is not entitled to anything beyond reasonable compensation and the stipulated amount is merely the upper limit that can be awarded.
Liquidated damages can be recovered only and only if actual loss has been suffered, not otherwise.
Only for exceptionally rare and difficult cases where it is impossible to quantify proof, that the stipulated amount may be awarded, if it is found to be a genuine pre-estimate of damage. Otherwise, it is necessary for the claimant to prove such loss through evidence.
As per the settled contract law principles laid out in Section 73 of the Contract Act, 1872, reasonable compensation shall be determined.
In a recent case, in a set of cross appeals under section 37 of the Arbitration and Conciliation Act, 1996, [The Act] came up for consideration before a Division Bench of the Hon’ble Delhi High Court, when it emphasized on the necessity of evidence to substantiate loss when claiming damages and clarified that mere presence of a penalty or liquidated damages clause did not exempt the party claiming damages from proving the loss suffered due to the breach.
The disputing parties namely, Sudershan Kumar Bhayana and his wife (the owners) had entered into a Collaboration Agreement with Mr. Vinod Seth (the Builder) as per which the builder was to construct a three-storied building on the property owned by the owners. It was agreed that the builder would bear the cost
of construction and pay an additional amount of Rs. 64 lakhs and in return the builder would retain the second floor of the new building. A registered sale deed to that effect was executed by the owners in favour of the builder. However, before the building could be completed, disputes arose between the parties and the Owners terminated the Collaboration Agreement.
The builder filed an application under Section 9 of the Arbitration and Conciliation Act, 1996, inter alia, sought interim reliefs to restrain the owners from alienating the rights on the second floor of the subject property. In pursuance of the said proceedings, the matter was referred to Arbitration and an Arbitrator was appointed with the consent of the parties.
Both, the owners and the builder filed their statement of claim and counterclaim, respectively. The owners claimed damages alleging breach of contractual obligations on the part of the builder which caused the owners to terminate the collaboration agreement. The builder on the other hand, claimed that the delay was caused due to the acts of the owners, making it difficult for the builder to complete the work within the stipulated time frame. It was the builder’s case that he had paid an amount of Rs 45 lakhs out of the agreed aforementioned amount of Rs 64 lakhs and acknowledged a balance amount of ₹19,00,000/- to be paid further to the owners. The builder also claimed to incur an amount of Rs 36,92,400/- towards the partial reconstruction of the subject property.
Although the Arbitral tribunal accepted the claims of the builder that he had paid an amount of Rs 45 lakhs to the owners and had incurred expense of Rs 36,92,400/- for reconstruction of the subject property, it ruled that the builder was guilty of breaching the agreement and that the owners were entitled to damages as per the terms of the same. However, the Arbitral Tribunal also accepted that the builder would be entitled to the refund of Rs 45 lakhs, together with the cost of construction, from the owners.
The said arbitral award was challenged by the builder by way of an application under section 34 of the Act before the High Court of Delhi. While considering the said application to set aside the arbitral award, the learned single bench modified the Award and reduced the quantum of damages on the grounds that the Tribunal faulted in calculation of the damages to be awarded. The Hon’ble Judge also held that the earnest money of 45 lakhs was liable to be forfeited on account of the builder’s breach.
Both parties being aggrieved by the judgement, preferred appeals under section 37 of the act against the order of the Learned Single Judge.
When the cross appeals came up for consideration before the Hon’ble Division Bench, the court noted that the principal issue before the court was with respect to the damages awarded to the owners for the builder's breach of contract and whether in the absence of concrete evidence substantiating the loss suffered by the owners, the award of damages was justifiable.
The Hon’ble Division Bench opined that the Learned Single Judge had modified the Arbitral Award and substituted its decision in its place, which was fundamentally flawed and beyond the scope of Section 34 of the Act, which does not permit such modifications to the Arbitral Award.
The Court held that the scope of Section 34 of the Act, only allows for setting aside an arbitral award if any of the limited grounds set out therein, is established. Further, the court clarified that even if the agreement contained a penalty or liquidated damages clause, the Owners had to prove the loss suffered before they could be awarded damages under the said clause. The Ld. Division Bench relied on the Hon’ble Supreme Court’s decision in the Kailash Nath case in this regard.
Further, the court reiterated the well settled position of law that the party claiming damages, must meet the three essential ingredients namely,
there must be a breach of the contract
the other party must have suffered an injury as result of such breach and
the injury suffered must be proximate and a direct result of such breach.
The Hon’ble Court observed that the delay caused by the builder did not result in the owners suffering any harm or incurring any cost. In such circumstances, a claim for damages was not sustainable merely by placing reliance on a penalty clause especially as the Owners had not pleaded that the delay in completing the construction caused them to suffer any damages. The Owners merely relied on a penalty clause without producing any evidence to prove the loss suffered by them due to the breach by the Builder. Additionally, the owners also never averred that the loss suffered by them was incapable of being proved or that the penalty stipulated in the agreement was a genuine pre-estimate of damages.
The Hon’ble Division Bench set aside the impugned order of the Single Judge and with respect to the Arbitral Award, it set aside the same, to the extent of claims awarded in favour of the Owners.
The above decision has once again reiterated that to claim and obtain an order of damages under a contractual clause which stipulates a pre-determined amount of compensation, it is necessary to plead and prove the damages. The mere presence of a clause in the contract cannot be the sole criteria to award damages to the party complaining of the breach.
It is to be noted that there is no single formula which can be applied for quantifying the damages. But having said that, a party claiming damages is expected to plead as well as prove the damages wherever possible to be awarded a reasonable compensation under a liquidated damages/penalty clause.
[AIR 1963 SC 1405]1
[ 1970 AIR 1955]2
[AIR 2003 SC 2629]3
[(2015) 4 SCC 136]4
[2023 SCC Online Del 6097]