CONTENT

1]INTRODUCTION
2]DAMAGES UNDER INDIAN CONTRACT ACT 1872
3]MEANING OF LIQUIDATED DAMAGES

ESSENTIAL OF LIQUIDATED DAMAGES

4]PROVISIONS

UNDER INDIAN CONTRACT ACT

UNDER ENGLISH LAW
CONCLUSION: COMMON FEATURES BETWEEN ENGLISH LAW AND INDIAN
LAW

5]DIFFERENCE BETWEEN LIQUIDATED DAMAGES AND PENALTY

6]TEST FOR DISTINGUISHING LIQUIDATED DAMAGES
7]CASE LAWS RELATED TO LIQUIDATED DAMAGES
8]CONCLUSION
9]REFERENCES

INTRODUCTION
If the party before entering into the contract already decides that
if any non- performance of duty or a breach of contract occurs
between the parties, then the amount of damages that were
decided before coming to contract would be compensated by
aggrieved party. These damages are so called as Liquidated
damages or ascertained damages.
For an order of liquidated damages, the following two conditions
must be met. Firstly, the amount of the damages identified must
roughly approximate the damages likely to fall upon the party
seeking the benefit of the term. Secondly, the damages must be
relatively vague at the time the contract is made that such a
clause will likely save both parties in the future while estimating
damages.
Often the term liquidated damages is mistaken or rather
confused with the term penalty. Thus, understanding the terms,
we can clearly distinguish between the two. A penalty can be said
to be a sum so stipulated in terrorem (with the object of coercing
the party into performing the contract), and thus an amount
qualifies to be a penalty if the sum named is extravagant and
unconscionable. It is also a penalty if the breach consists in
paying of money and the sum stipulated is greater than the sum
which ought to have been paid. However, liquidated damages are
a genuine, covenanted pre-estimate of damages as seen above.
They are both to be so judged on the facts of each case.
The question whether a particular stipulation in a contract is in
the nature of the penalty has to be determined by the court
against the background of various relevant factors, such as the
character of transaction and its special nature, if any, the relative
situation of the parties, the rights and obligations accruing from
such a transaction under the law and the intention of the parties
incorporating in the contract, the particular stipulation which is
contended to be penal in nature. If on such a comprehensive
consideration, the court finds that the real purpose for which the

stipulation was incorporated in the contract was that by reason of

its burdensome or oppressive character, it may operate in
terrorem over the promisor so as to drive him to fulfill the
contract, and then the provision will be held to be of Penalty.

DAMAGES UNDER INDIAN

CONTRACT ACT
As per the blacks law dictionary damages means any monetary
claim by, or ordered to be paid to a person as a compensation for
any loss or injury incurred by them. In Indian Contract Act,
damages are referred in terms of breach of contract, when a party
fails to perform the terms of the contract to which he is obligated,
then that party has to provide compensation to the other party
who has incurred the loss. The main purpose of compensation is
to restore the position of the injured or aggrieved party to the
economic position it would have been if the contract was not
breached.
Damages
are
further
divided
into general
damages and special damages.
General damages deal with those which have aroused naturally in
the usual course of breach. Special damages refer to damages
incurred under unusual circumstances and cannot be recovered
unless special circumstances are brought to the knowledge of the
other party.

MEANING OF LIQUIDATED
DAMAGES
As per black law dictionary liquidated damages means, an
amount contractually stipulated as a reasonable estimation of
actual damages to be recovered by one party if the other party
breaches the contract. i.e., When the terms of a contract are
broken, if a sum is named in the contract as the amount to be
paid in case of breach, the party complaining of the breach is
entitled, whether or not actual damage or loss is proved to have

been caused thereby, to receive compensation not exceeding the

amount so named
In laymans language, before entering into a contract the party
stipulates a sum of money which has to be paid by the one who
has breached the contract to the other party who has been
aggrieved and this sum of money has been termed as liquidated
damages.

ESSENTIAL OF LIQUIDATED DAMAGES

Three essential points seems to be occurred when dealing with
the liquidated damages
1]There must be a breach of contract
2]There must be a pre-determination of damages
3]Calculation must be genuine or burdensome.

PROVISIONS
UNDER INDIAN CONTRACT ACT 1872
In India, liquidated damages are dealt under Indian Contract Act,
1872 within section 73 and section 74. Sec. 73 states that when
a contract has been broken, the aggrieved party is entitled to get
compensation or any loss or damages which has been inflicted to
him/her naturally during the usual course of breach of contract or
about which the parties to the contract has prior knowledge when
they entered the contract.
Sec 74 states When a contract has been broken, and if a sum is
named in the contract as the amount to be paid for 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 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.
When the provision is read it implies that in Indian laws there is
no distinguish between the liquidated damages and the penalty,
as has been done in U.K. and USA. The word penalty was
introduced in Indian Contract Act by way of amendment in 1899.

UNDER ENGLISH LAW

Earlier the provisions which were followed while differentiating the
penalty and liquidated damages was based on the differentiation
established by British law which stated that the aggrieved party
will not be entitled to of any excess of actual loss, if the sum was
not a genuine pre-determined or pre-estimated and therefore it
would amount to penalty. Under the common law, method used to
stipulate an liquidated damages was through a genuine preestimate of damages by mutual agreement. Also under English
law, the aggrieved part can claim damages without any actual
damage or when the damage is less than the stipulated amount.
Also under the English law, to a breach of contract is the amount
of damage is determined by a court as a penalty then it is
irrecoverable whereas if it has been determined as liquidated
damages it can be recovered.

CONCLUSION: COMMON FEATURES BETWEEN

ENGLISH AND INDIAN LAW
After seeing the various provisions both under Indian law and
English law we can conclude the common analogy between them.
Yet the distinction between liquidated damages and penalty is not
all together irrelevant to the section. Its relevance, in the first
place, arises from the fact that the amount contemplated by the
parties will be reduced only if it is appeared to be by way of
penalty. Otherwise the whole of it is recoverable as liquidated
damages. Secondly, the first explanation to this section uses the
word penalty. It provides that a stipulation for increased interest
from the date of default may be a stipulation by way of penalty.
Still another common feature between the English common law
and Indian law is shown by the decision of the supreme court in
Chunilal V. Mehta & Sons Ltd. Vs Century spg. & Mfg Co. Ltd.
where it has been held that by providing for compensation in
express terms the right to claim damages under the general law
is necessarily excluded.

DIFFERENCE BETWEEN PENALTY

AND LIQUIDATED DAMAGES
Penalty is something which is used in a contract to secure the
performance of the contract whose main purpose is to ensure the
payment of money which is specified to terrorise the offending
party. Also where the loss which has to be recovered is greater
than the pre-estimated loss then it amounts to penalty. Whereas
liquidated damages are compensatory in nature at the same time
are pre-estimated damages. The purpose of liquidated damages is
to promote certainty especially in commercial field.
Liquidated damages are based on the genuine pre-estimate of the
loss, whereas penalty is based on the doctrine of reasonable
compensation.
Also Sec.73 lays down the principles for damages pertaining to
difference between the cost and price of the goods and services
at the time of the contract and the time when the contract was
breached.
It is courts duty to determine whether the case in hand involves
liquidated damages or penalty, by determining the facts of the
case. Apart from it the court has to look into

Nature of transaction,
Right sand other obligation arising from the contract and the
transaction

And relative situation of the parties.

Penalty clauses are terms of contracts that seek to impose an
obligation to pay a sum of money in the event that the contract
has been breached. A traditional penalty clause amount would
include an amount the far exceeds the amount of damages that
would be sustained. In many jurisdictions penalty clauses are not
enforceable as a matter of public policy. The rationale is that
contract terms should not be used for party to profit from the
breach of a contract by the other party.

Penalty clauses are different than clauses for liquidated damages.

Liquidated damages clauses also impose an obligation to pay a
sum in the event of a Breach, however with liquidated damages
the intent is to only recover the amount of the damages you
sustain. So the real difference between the two is whether you are
trying to profit from the breach.
Calling a clause liquidated damages does not make it a true
liquidated damages provision. As mentioned above in interpreting
it a court would apply several tests to determine whether it is a
penalty or a liquidated damage. It would be considered a penalty
if:
1. The amount payable is excessive when compared to loss*.
2. The amount payable is greater than what should have been
paid
3. The amount payable would apply to minor versus major
breaches.
Liquidated damages clauses must be a genuine estimate of the
loss to be suffered by the party in the event of a breach. Whether
the term is a penalty clause or not is determined as of the time
the contract was formed. The amount only needs to be a genuine
estimate of the loss at that time. This means that irrespective of
whether the loss would have been greater or smaller at the time
of the actual breach does not apply as the parties agreed to
establish that as the amount. Where a non-breaching party made
a genuine effort to determine their loss and has acted in good
faith, the clause will not be classified as a penalty.
To avoid having a liquidated damages term from being considered
a penalty the amount needs to be a reasonable reflection of the
non-breaching partys expected loss for the breach. That means
that a single liquidated damages amount should not be applied to
all breaches. If the intent is to apply liquidated damages to
multiple different types of breaches, you should tailor the amount
of the liquidated damages for each different breach so each
represents a reasonable reflection of the loss for that breach.
Most of the time liquidated damages is applied only to the failure
to deliver on time.

Amounts payable for performance are not penalty clauses if the

performance is not met. For example, if you included a bonus for
early completion of work and the Supplier failed to complete the
work early, the failure to pay the bonus would not be a penalty or
liquidated damage as they are not connected with a breach.
The value of liquidated damages provisions is the parties agree on
the amount in advance and it relieves the non-breaching party
from having to prove their damage in court. The only thing that
the breaching party can challenge is whether there was a breach.
They could challenge that amount as representing a penalty, but
if the amount was properly established as a reasonable reflection
of the damage and was agreed by the parties, courts would most
likely will not view it as a penalty.

TEST OF DISTINGUISHING
LIQUIDATED DAMAGES
Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd
This is an English contract law case, concerning the extent to
which damages may be sought for failure to perform of a contract
when a sum is fixed in a contract. It held that only if a sum is of
an unconscionable amount will it be considered penal and
unenforceable.
It should not be confused with Dunlop Pneumatic Tyre Co Ltd v
Selfridge & Co Ltd, which held that the same resale price
maintenance practice was unenforceable against a third party
reseller as a matter of the English rule of privity of contract.

FACTS
Dunlop sued its tyre retailer, New Garage, for breaching an
agreement to not resell Dunlop tyres at a price lower than that
listed in the contract. The agreement then said if that did happen,

New Garage would pay 5 per tyre by way of liquidated damages

and not as a penalty.
The judge held the 5 sum was liquidated damages and
enforceable. The Court of Appeal held the clause was a penalty
and Dunlop could only get nominal damages. Dunlop appealed.
The principles outlined by Lord Dunedin in Dunlop were that:
1. A court must determine whether the payment stipulated is in
truth a penalty or liquidated damage. Where the Court finds
that the payment is a penalty, the provision will be
unenforceable.
2. The essence of liquidated damages is 'a genuine covenanted
pre-estimate of damage'.4
3. 'The question as to whether a sum stipulated is penalty or
liquidated damages is a question to be decided upon the
terms and inherent circumstances of each particular
contract, judged at the time of the making of the contract,
not as at the time of breach'.5
4. The following tests may assist in the interpretation of the
clause:
a. 'It will be held to be 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'.6
b. 'It will be held to 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'.7
c. '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

serious and others but riffling damage'. 8
d. 'It is not an obstacle to the sum stipulated being a
genuine pre-estimated of damage, that the
consequences of the breach are such as to make
precise pre-estimation almost an impossibility. On the
contrary, that is just the situation when it is probable
that pre-estimated damage was the true bargain
between the parties'.
The first three principles restated the core elements of the law of
penalties.
The tests suggested by Lord Dunedin in the fourth principle can
provide practical considerations when drafting liquidated
damages clauses.
Some of the most important considerations are that a liquidated
damages clause:
1. should not stipulate an amount that is greater than the loss
that could have followed the breach. Accordingly, the drafter
must confirm the factual scenario to ascertain whether or
not the amount it has chosen as liquidated damages exceeds
the loss; and
2. should try to avoid as much as possible stipulating a single
lump sum by way of compensation. For example, where
liquidated damages are triggered by a delay in the
performance by a party, the liquidated damages clause
could be drafted so that the amount is calculated by
reference to the number of days that the performance was
delayed.
It is important to note that regardless of the qualification given to
the amount as 'genuine pre-estimate', a court may always assess
whether in truth such amount is a genuine pre-estimate or a
penalty.

Great caution should therefore be exercised when attempting to

draft liquidated damages clauses, as they can be rendered
unenforceable if challenged in the courts. Appropriate enquiries
into the nature and probable extent of a loss should be made at
the time of drafting and appropriate advice should be taken with
respect to the solution.

Case laws related to liquidated

damages
Fateh Chand v. Bal Kishan Das
Initially in the case of Fateh Chand v. Bal Kishan Das AIR 1963 SC
1405, it mainly eliminated the refinement under English Law in
relation to the difference between the payment of liquidated
damages and stipulation of penalty. The S.C in this case stated
that the aggrieved party is entitled to a reasonable compensation
which should not exceed the sum of penalty or the predetermined amount which have to be paid after the breach of
contract. The court also stated that the application of these
provisions is not confined to the cases where the aggrieved party
approaches the court only for relief. In this case, the Court
interpreted Sec.74 as a legal liability in the case of breach of
contract, whether either through pre-determined agreement
compensation is paid or through penalty. The main purpose of
fixing a pre-determined amount and its benefits were discussed
by the court:

Method of pre-determining the loss at the time of entering a

contract facilitates the recovery of damages

At the same time reduces the calculation error.

It decreases the expense and inconvenience while proving

the actual loss and damage.

It reduces the risk of under-compensation and in cases

where the results of the breach of contract are ascertain, in it to
an extend avoids the problem in assessment.

In this case Court while discussing the scope of Sec.74 stated

that it deals with damages which are divided into two classes of
cases:
1.

First where there is pre-determination of amount which has

to be paid in cases of breach of contract
2.
And second, where the contract may contain any further
stipulation in form of penalty.
Oil & Natural Gas Commission v. saw Pipes Ltd
In the case of Oil & Natural Gas Commission v. saw Pipes Ltd,
where the S.C. held that in case of damage sec.73 and sec.74 has
to be read together and liquidated damages can be granted in
those cases where it is difficult to prove the actual loss or
damages which have been incurred provided that it should be
reasonable compensation. In the course of deciding compensation
in such cases the terms and conditions should be taken into
consideration.
Sudhir Gensets Ltd. v. Indian Oil Corporation, the court kept in
view holdings in the case of Oil and Natural Gas Commission v.
Saw Pipes Ltd and summarised it:

Firstly, where the actual loss and damages cannot be shown

in those cases the terms of the contract has to be considered.

Sec. 74 and Sec. 73 has to be dealt together and per the

terms stipulate pre-determined damages which are not
unreasonable and is not amounting to penalty, then as per Sec.
73 the party should pay such compensation.
BSNL v. Reliance
In the case of BSNL v. Reliance[4], where there was a dispute was
relating to the Caller Line Identification device, and as was
recovered that the calls of CLI has been manipulated which
invoked method of computing charges and hence resulted in
BSNL, levying a charge of Rs. 9.89 cr. on Reliance. The same
maxim that is the use of pre-determination or pre-estimation
genuine loss as the best indicator of reasonable compensation

which was used in the case of Fateh Chand, the court made
observation in relation to Sec.74 that the damages to be provided
should be based on the concept of reasonable compensation
apart from it court also stated that it is of no importance in
characterising the damage as penalty or as a requisite.
In this case the court also stated that the liquidated damages
serve the purpose of avoiding litigation which is very useful and
promotes certainty in commercial cases.
Kailash Nath Associates v. DDA
The judgement in the case of Kailash Nath Associates v. DDA[5],
new perspective of Sec.74 was discussed,where the Court
declared that under Sec.74, in case of breach of contract the
party will be entitled to damages in form of reasonable
compensation which must not exceed the sum which has been
pre-determined in the contract. The question which was
determined in this case was whether forfeiture is barred under
Sec.74, where as in the common law penalty rule is basically not
applied in the case of forfeiture. Before the amendment of 1899
all Indian cases follow the common law perspective, but the
amendment broadened the purview of Sec.74. The amendment
inserted the clause any other stipulation by way of penalty in
Sec.74, which was first addressed in the case of Fateh Chand v.
Bal Kishan Das. In the present case of Kailash Nath, the apex
court held that Sec.74 does not extend to the jurisdiction of
granting relief in cases of penalty when the provision of the
section does not apply in terms. Where in earlier cases the court
stated that Sec.74 extends to those cases where there are
unavoidable circumstances.

Conclusion
Hence, liquidated damages are easy to impose when compared
with penalty. Also penalty can be imposed on limited events like
delay in completion of the work or when there is delay in supply.
Also in Indian Contract Act, there is no specific differentiation in

relation to liquidated damages and penalty. Apart from it there are

still questions in relation to Sec.74 which has to be clarified. Also,
there is no specified criteria for the distinction of the liquidated
damages and penalty as it is only on the hands of the judge who
at the time of proceeding caters it as liquidated damages or
penalty.

REFERENCES
BOOKS REFFERED
1) AVTAR SINGH STUDY OF CONTRACT ACT AND SPECIFIC RELIEF
1872
2) R.K. BANGIA - LAW OF CONTRACTS I

OTHER SOURCES
Adjudication of claim for damages under Sec.73, 74 and 75 of
Indian Contract
Act http://www.manupatra.co.in/newsline/articles/Upload/30C28D
5D-262B-4A4A-AE17-C4D86F92BCE0.pdf
http://indiacorplaw.blogspot.in/2010/12/supreme-court-inbsnl-v-reliance.html.
http://www.lawteacher.net/free-law-essays/contractlaw/damages-under-indian-contract-act-law-essays.php
Cases Citation

[1]
[2]
[3]
[4]
[5]

AIR 1963 SC 1405

(2003) 5 SCC 705
1973 AIR (SC) 1098
(2011) 1SCC 394
(2015) 4 SCC 136