PENALITY & LIQUIDATED DAMAGES

Written By :- Saba Siddiqui (Amity Law School)

The parties to a contract may provide before hand, the amount of compensation payable in case of failure to perform the contract. In such cases, the question arises whether the courts will accept this figure as the measure of damage.

English Law: According to English law, the sum so fixed in the contract may be interpreted either as liquidated damages or as a penalty.

If the sum fixed in the contract represents a genuine pre-estimate by the parties of the loss, which would be caused by a future breach of the contract it is liquidated damages. It is an assessment of the amount which in the opinion of the parties will compensate for the breach. Such a clause is effective and the amount is recoverable. But where the sum fixed in the contract is unreasonable and is used to force the other party to perform the contract; it is penalty. Such a clause of disregarded and the injured party cannot recover more than the actual loss.

Indian Law: Indian law makes no distinction between ‘penality’ and liquidated damages’ The Courts in India award only a reasonable compensation not exceeding the sum so mentioned in the contract. Section 74 of the Contract Act lays down if the parties have fixed what the damages will be, the courts will never allow more. But the court may allow less. A decree is to be passed only for reasonable compensation not exceeding the sum named by the parties. Thus, Section 74 entitles a person complaining of breach of contract to get reasonable compensation and does not entitle him to realise anything by way of penalty. Exception: Where any person gives any bond to the Central or State government for the performance of any public duty or act in which the public are interested, on breach of the condition of any such instrument, he shall be liable to pay the whole sum mentioned therein.

Example 1: A contracts with B, that if A practices as a surgeon in Kolkata, he will pay B ` 50,000. A practices as a surgeon at Kolkata, B is entitled to such compensation not exceeding ` 50,000 as the court considers reasonable.

Example 2: A borrows ` 10,000 from B and gives him a bond for ` 20,000 payable by five yearly instalments of ` 4,000 with a stipulation that in default of payment, the whole shall become due. This is a stipulation by way of penalty.

Example 3: A undertakes to repay B, a loan of ` 10,000 by five equal monthly instalments with a stipulation that in default of payment of any instalment, the whole shall become due. This stipulation is not by way of penalty and the contract may be enforced according to its terms.

Distinction between liquidated damages and penalty

Penalty and liquidated damages have one thing in common that both are payable on the occurrence of a breach of contract. It is very difficult to draw a clear line of distinction between the two but certain principles as laid down below may be helpful.

  1. If the sum payable is so large as to be far in excess of the probable damage on breach, it is certainly a penalty.
  2. Where a sum is expressed to be payable on a certain date and a further sum in the event of default being made, the latter sum is a penalty because mere delay in payment is unlikely to cause damage.
  3. The expression used by the parties is not final. The court must find out whether the sum fixed in the contract is in truth a penalty or liquidated damages. If the sum fixed is extravagant or exhorbitant, the court will regard it is as a penalty even if, it is termed as liquidated damages in the contract.
  4. The essence of a penalty is payment of money stipulated as a terrorem of the offending party. The essence of liquidated damages is a genuine pre-estimate of the damage.
  5. English law makes a distinction between liquidated damages and penalty, but no such distinction is followed in India. The courts in India must ascertain the actual loss and award the same which amount must not, however exceed the sum so fixed in the contract. The courts have not to bother about the distinction but to award reasonable compensation not exceeding the sum so fixed.

Besides claiming damages as a remedy for the breach of contract, the following remedies are also available:-

  1. Recession of Contract :- When a contract is broken by one party, the other party may treat the contract as rescinded. In such case he is absolved of all his obligations under the contract and is entitled to compensate for any damages that he might have suffered.

Example:- A promise B to deliver 50 bags of cement on a certain day. B agrees to pay the amount on reciept of the goods. A failed to deliver the cement on the appointed day. B is discharged from his liability to pay the price.

  1. Quantum Meruit:- Where one person has rendered service to another in circumstances which indicate an understanding between them that is to be payed for although no particular remuneration has been fixed, The law will infer a promise to pay. Quantum Meruit i.e; as much as the party doing the service has deserved. It covers the case where the party injured by the breach had at time of breach had done, part but not all of the work which he is bound to do under the contract and seeks to be compensated for the value of the work done. For the application of this doctrine, two conditions must be fulfilled:
  • It is only available if the original contract has been discharged.
  • The claim must be brought by a party not in default.

The object of allowing a claim on Quantum Meruit is to recompensate the party or person for the value of the work that he has done. Damages are compensatory in nature while Quantum Meruit is restitutory. It is but reasonable compensation awarded on the implication of contract to remunerate. Where a person orders from a wine merchant 12 bottles of whiskey and 2 of brandy, and the purchaser accepts them, the purchaser must pay a reasonable price for the brandy.

  • The claim for quantum meruit arises in the following cases:
    • When an agreement is discovered to be void or when a contract becomes void .
    • When something is done without any intention to do so gratuitously.
    • Where there is an express or implied contract to render services but there is no agreement as to remuneration .
    • When one party abandons or refuses to perform the contract.
    • Where a contract is divisible and the party not in default has enjoyed the benefit of part performance.
    • When an individual contract for a lump sump is completely performed but badly the person who has performed the contract can claim the lump sump, but the other party can make a deduction for bad work .

Example 1: X wrongfully revoked Y’s (his agent) authority before Y could complete his duties. Held, Y could recover, as a quantum meruit, for the work he had done and the expenses he had incurred in the course of his duties as an agent.

Example 2: A agrees to deliver 100 bales of cotton to B at a price of 1000 per bale. The cotton bales were to be delivered in two installments of 50 each. A delivered the first installment but failed to supply the second. B must pay for 50 bags.

  1. Suit for specific performance: Where damages are not an adequate remedy in the case of breach of contract, the court may in its discretion on a suit for specific performance direct party in breach, to carry out his promise according to the terms of the contract.
  2. Suit for injunction: Where a party to a contract is negating the terms of a contract, the court may by issuing injunction orders, restrain him from doing what he promised not to do.

Example: N, a film star, agreed to act exclusively for a particular producer, for one year. During the year she contracted to act for some other producer. Held, she could be restrained by an injunction.

Party rightfully rescinding contract, entitled to compensation (Section 75)

A person who rightfully rescinds a contract is entitled to compensation for any damage which he has sustained through non-fulfilment of the contract.

Example: A, a singer, contracts with B, the manager of a theatre, to sing at his theatre for two nights in every week during the next two months, and B engages to pay her 100 for each night’s performance. On the sixth night, A willfully absents herself from the theatre, and B, in consequence, rescinds the contract. B is entitled to claim compensation for the damage which he has sustained through the non-fulfilment of the contract.