When a contract has been broken, is a party, who suffers from such breach, entitled to compensation, and in what circumstances? What are liquidated damages? What is a stipulation by way of penalty?

Question: When a contract has been broken, is a party, who suffers from such breach, entitled to compensation, and in what circumstances? What are liquidated damages? What is a stipulation by way of penalty?

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Answer

Section74 of the act states that “When a contract has been broken, if a sum is named in the contract as the amount 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, whether or not actual damage or loss or 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.”

The Section basically talks about the liquidated damage that the affected party is entitled to. This Section states that if there is any clause in the contract which states that in case of breach by either party the defendant shall be liable to pay the certain specified amount then the plaintiff can claim the amount if there is a breach in contract.

It means that the plaintiff can claim the amount mentioned in the contract (also called liquidated amount) from the defendant in case there is a breach of contract. It can be further deduced that amount stipulated in the contract can be claimed even if the actual loss or the damage was proved by him or not.

If this sum is a genuine pre-estimate of damages likely to flow from the breach, it is called liquidated damages. If it is not a genuine pre-estimate of the loss, but an amount intended to secure the performance of the contract, it may be a penalty.

In the Indian Contract Act 1872, there is no distinction made between liquidated damages and penalties. All stipulations in a contract providing for the consequences of a breach are treated in the same manner. In both cases, a measure of damages is a reasonable compensation not exceeding the amount of penalty stipulated.

The caveat as per this rule is that the amount stipulated in the contract is the maximum amount that the plaintiff can claim. Cases may arise that the court can award compensation less than the stipulated amount if it appears reasonable as per the circumstance of the case, but the no case the amount awarded by the court should be more than the stipulated amount.

English law regarding the liquidated damage and penalty is somewhat different from what has been followed in India

1. Firstly, as per English law, there is a differentiation between the liquidated damage and the penalty, whereas as per the Indian law, Section 74 has dispensed with the need of providing separate provision for penalty and liquidated damage
2. Secondly, as per English law, the court must either accept the liquidated amount in full or reject in toto, but as per Indian law, the court either accepts the full amount or can reduce the amount to what appears reasonable as per the situation.

In the case of Fateh Chand,[AIR 1963 SC 1405] the court has explicitly said that Section 74 of the Act is an attempt to reduce all the refinements of the English Law by eliminating the difference between liquidated damage and penalty.

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