1. Introduction:

When there is a breach of contract, liquidated damages and/or a penalty are due. While the terms penalty and liquidated damages may sound similar, there is a distinct difference between them. In this article, we will look at the laws that govern the payment of compensation in the event of a contract breach.

  1. Penalty and Liquidated Damages:

Will the Court accept the amount specified by the contract’s parties as a measure of damage if the parties specify the amount of compensation payable in the event of a breach of contract? The English and Indian laws treat this scenario differently. Let’s take a look at each of them:

British Law: The provided sum may be considered as a fine or liquidated damage under English law.

  • Liquidated damages: when the sum agreed upon by both parties represents an accurate estimate of the loss resulting from a potential breach of contract. As a result, the contract’s parties concur that the sum is a just reward for the breach.
  • Penalty: A penalty is when the sum agreed upon by all parties is excessive or is used to coerce the performing party into carrying out the commitment. In such circumstances, the quantity is ignored, and the party who suffered the loss is limited to the actual loss.

Indian Law: There is no distinction in Indian law between liquidated damages and penalties. The amount of compensation awarded cannot exceed the contract amount. According to Section 74 of the Indian Contract Act of 1872, if the parties settle the damages, the Court will not allow any additional damages. However, depending on the circumstances, it may award a lower sum. As a result, the victim receives reasonable compensation but no penalty.

There is an exception to Section 74, which states that if a party enters into a contract with the State or Central government for the performance of an act in the general public’s interest, then a breach of such a contract obligates the party to pay the entire amount specified in the contract.

Here are some principles to help you tell the difference between a penalty and liquidated damages:[i]

  • If the amount payable is far more than the likely damage for breach of contract, it is a penalty.
  • If a contract specifies an amount payable on a specific date and an additional sum if a default occurs, the additional sum is a penalty. This is because a simple payment delay is unlikely to cause harm.
  • Even if the contract specifies a sum as a “penalty” or “damages,” the Court must determine from the facts of the case whether the amount specified is, in fact, a penalty or liquidated damages.
  • While Indian law does not make a distinction between a penalty and liquidated damages, English law does. The Indian Courts place a strong emphasis on providing the harmed party with a fair settlement that doesn’t go over the agreed-upon sum.
  • Aside from these remedies:

It’s interesting to note that a breach of contract has other remedies besides suing for damages.

Here are some other options for those who are seeking remedies:

  • Recission of the contract: The revocation, cancellation, or repeal of a law, order, or agreement is referred to as rescission. If one party breaches the contract, the other party has the option to terminate it. He is also released from all contractual obligations. Additionally, he is entitled to reimbursement for any damages.
  • Quantum Merit: When the amount is not specified in a legally enforceable contract, a reasonable sum of money is paid to a person for services rendered. In layman’s terms, Quantum Meruit allows a party to be compensated for the value of work done or services rendered. While damages are compensatory in nature, Quantum Meruit is restitutory in nature because it is a reasonable compensation awarded based on a contract to remunerate.
  • Suit for specific contract: In some circumstances, monetary compensation for a contract breach is insufficient. In these situations, the Court may, at its discretion, order the party in default to fulfill the promise following the provisions of the contract in response to an action for a particular performance.
  • Suit for Injunction: The court can issue an injunction order to prevent a party from doing something that they have agreed not to do in a contract if they are violating these terms.
  • Section 75 of the Indian contract act, 1872: This provision states that if a party legitimately cancels a contract, he or she may be entitled to reimbursement for any losses or damages incurred as a result of non-performance.
  • Case Laws:

Chunilal V. Mehta and Sons Ltd. v. Century Spg. and Mfg. Co. Ltd.[ii]: According to the ruling in this instance, “the rights to claim damages under the general law are necessarily excluded by providing for compensation in explicit words.”

Fateh Chand v. Balkishan Das[iii]: In this decision, the Hon’ble Supreme Court ruled that any restitution provided to the person who had been wronged must be based on the real loss and cannot be greater than the sum prescribed as damages or a penalty.

  • Conclusion:

A penalty is defined as an amount that is greater than the actual loss incurred, whereas liquidated damages are defined as an amount that is a pre-estimate of the loss. If the contract specifies an amount payable at a certain time and an additional amount to be paid if a default occurs, the extra sum is referred to as a penalty. It is because a payment delay alone is unlikely to cause harm. It is upon the discretion of the court to determine whether the amount payable is liquidated damages or penalties. While English law distinguishes between the two, Indian law regards them to be synonymous. The amount of the penalty is excessive to prevent the parties from failing. The loss is accurately estimated using liquidated damages.

  • References:


[ii] (AIR 1962 SC 1314)

[iii] (AIR 1964) 1 SCR

Avtar Singh, Contract & SRA

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