Elucidate with examples of the difference between ‘damages’, ‘liquidated damages', and ‘penalty’ under the Indian Contract Act.

Question: Elucidate with examples of the difference between ‘damages’, ‘liquidated damages’, and ‘penalty’ under the Indian Contract Act. [DJS 2018]

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Answer

Damages, in Contract law, refer to monetary compensation for loss or injury caused by the wrongful act of another. Section 73 provides compensation for loss or damage caused by the breach of contract. For example, ‘A’ contracts to repair B’s house in a certain manner, and receives payment in advance. ‘A’ repairs the house, but not according to contract. ‘B’ is entitled to recover from ‘A’ the cost of making the repairs conform to the contract.”

The parties to a contract may determine beforehand the amount of compensation payable in the event of a breach. According to English law, a sum so fixed may fall in any of the following two categories

(1) Liquidated damages, or

(2) Penalty

An illustration of “penalty” is Ford Motor Co v. Armstrong [(1915) 31 TLR 267 (CA)] The defendant, a retailer, received from the plaintiffs, supplies of cars and parts and agreed not to sell any item below the listed price. A sum of £250 was payable for every breach as “agreed damages“. A breach has taken place, a majority of the Court of Appeal held that the sum fixed was a penalty as it might happen that a part sold in the breach was of lesser value than the damages payable.

In The Indian Contract Act Section, 74 of the act talks about “liquidated damages and penalty”. If the sum fixed represents a genuine pre-estimate of the probable damage that is likely to result from the breach, it is liquidated damages. A sum less than the amount of probable damage is also regarded as liquidated damages. The whole of such sum is recoverable. A well-known illustration is Dunlop Pneumatic Tyre Co Ltd v. New Garage & Motor Co Ltd. [1915 AC 79 (HL)]

In this case, a manufacturer of tyres supplied a number of tyres to a dealer on the condition that they would not be sold below the list prices and that liquidated damages, not penalty, of £5 would be payable for every tyre sold in breach of the agreement. The dealer committed a breach. The question was whether the above sum was intended as genuine compensation for the loss suffered.

The House of Lords held it to be liquidated damages. Lord Dunedin stated the effect of cases in the following propositions:

(1) The expression used by the parties is not conclusive. The court must find out whether the payment stipulated is in truth a penalty or liquidated damages.

(2) The essence of a penalty is a payment of money stipulated as ‘in terrorem‘ of the offending party; the essence of liquidated damages is a genuine covenanted pre-estimate of damage. Clydebank Engg & Shipbuilding Co Ltd v. Don Jose Ramos Yzquierdoy Castaneda, [1905 AC 6]

(3) The question of whether a sum stipulated is a penalty or liquidated damages is a question of construction to be decided upon the terms and inherent circumstances of each particular contract. Public Works Commr v. Hills, [1906 AC368]

(4) To assist this task, various tests have been suggested

1. It will be held to be a penalty if the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach.
2. It will be a penalty if the breach consists only in not paying a sum of money and the sum stipulated is a sum greater than the sum which ought to have been paid.
3. There is a presumption (but no more) that it is a penalty, when “a single lump sum is made payable by way of compensation, on the occurrence of one or more or all of several events, some of which may occasion a serious and others but trifling damage”.

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Law of Contract Mains Questions Series: Important Questions for Judiciary, APO & University Exams

1. Law of Contract Mains Questions Series Part-I
2. Law of Contract Mains Questions Series Part-II
3. Law of Contract Mains Questions Series Part-III
4. Law of Contract Mains Questions Series Part-IV
5. Law of Contract Mains Questions Series Part-V
6. Law of Contract Mains Questions Series Part-VI
7. Law of Contract Mains Questions Series Part-VII
8. Law of Contract Mains Questions Series Part-VIII
9. Law of Contract Mains Questions Series Part-IX
10. Law of Contract Mains Questions Series Part-X