The relief of damages is pivotal under the law of contract. Damages constitute the compensation awarded to a contracting party for any injury or loss suffered by such party as a result of a breach by the counterparty. Such injury or loss may or may not always be capable of being quantified and it varies with the facts and circumstances of each case.

Sections 73 and 74 of the Indian Contract Act, 1872, [Contract Act] are crucial with respect to damages. Section 73 of the Contract Act provides that when a party is aggrieved by a breach by another, he is entitled to claim compensation from the party committing the breach, even if it is not provided for in the contract.

Section 74 of the Contract Act, on the other hand, deals with a pre-determined amount of compensation already stipulated in the contract which the party committing a breach would be liable to pay to the affected party. It is pertinent to note that such an amount is named in the contract as compensation and may constitute liquidated damages or damages by way of penalty. Often a forfeiture clause within a contract is also treated as a penalty clause.

In either case, the requirement of proof of loss suffered by the party claiming damages based on such a contractual entitlement has been a subject of consideration in a number of decisions of the Supreme Court.

The decisions of the hon’ble Supreme Court in the matters of Fateh Chand v. Balkishan Das, Maula Bux v. Union of India, Oil & Natural Gas Corporation Limited v. Saw Pipes Limited and Kailash Nath Associates v. Delhi Development Authority & Anr. have been crucial in this regard. 

Although the above decisions have dealt with factually different cases, the essence of the judicial interpretations of Section 74 of the Contract Act can be summed up as follows:

i. Under a liquidated damages clause, a party is not entitled to anything beyond reasonable compensation and the stipulated amount is merely the upper limit within which such compensation can be awarded.

ii. Liquidated damages can be recovered only and only if actual loss has been suffered, not otherwise.

iii. The stipulated amount may be awarded as compensation in exceptional cases where it is impossible or difficult to quantify loss, provided that the amount so stipulated in the contract is found to be a genuine pre-estimate of damages. In all other cases, it is necessary for the claimant to prove such loss through evidence.

iv. As per the settled contract law principles, laid out in Section 73 of the Contract Act, reasonable compensation shall be determined.

In a recent set of cross appeals under Section 37 of the Arbitration and Conciliation Act, 1996, [the Act] came up for consideration before a division bench of the hon’ble Delhi High Court, wherein it emphasized on the necessity of evidence to substantiate loss when claiming damages and clarified that the mere presence of a penalty or liquidated damages clause did not exempt the party claiming damages from proving the loss suffered due to the breach. 

The disputing parties namely, Sudershan Kumar Bhayana and his wife (the owners) had entered into a Collaboration Agreement with Mr. Vinod Seth (the builder) as per which the builder was to construct a three-storied building on the property owned by the owners. It was agreed that the builder would bear the cost of construction and pay an additional amount of ₹ 64 lakhs and in return the builder would retain the second floor of the new building. A registered sale deed to that effect was executed by the owners in favour of the builder. However, before the building could be completed, disputes arose between the parties and the owners terminated the Collaboration Agreement.

The builder, vide a petition under Section 9 of the Arbitration and Conciliation Act, 1996, inter alia, sought interim reliefs to restrain the owners from alienating the rights on the second floor of the subject property. In pursuance of the said proceedings, the matter was referred to Arbitration and an Arbitrator was appointed with the consent of the parties.

Both, the owners and the builder filed their statement of claim and counterclaim, respectively. The owners claimed damages alleging breach of contractual obligations on the part of the builder which caused the owners to terminate the collaboration agreement. The builder on the other hand, claimed that the delay was caused due to the acts of the owners, making it difficult for the builder to complete the work within the stipulated time frame.  It was the builder’s case that he had paid an amount of ₹ 45 lakhs out of the agreed aforementioned amount of ₹ 64 lakhs and acknowledged a balance amount of ₹19 lakhs to be paid further to the owners. The builder also claimed to have incurred an amount of ₹ 36,92,400 towards the partial reconstruction of the subject property.

Although the Arbitral tribunal accepted the claims of the builder that he had paid an amount of ₹ 45 lakhs to the owners and had incurred expenses of ₹36,92,400 for reconstruction of the subject property, it ruled that the builder was guilty of breaching the agreement and that the owners were entitled to damages as per the terms of the same. However, the Arbitral Tribunal also accepted that the builder would be entitled to the refund of ₹ 45 lakhs, together with the cost of construction, from the owners.

The said arbitral award was challenged by the builder by way of an application under Section 34 of the Act before the High Court of Delhi.  While considering the said application to set aside the arbitral award, the learned single judge modified the arbitral award and reduced the quantum of damages on the ground that the tribunal erred in calculation of the damages to be awarded.  The hon’ble judge also held that the earnest money of ₹ 45 lakhs was liable to be forfeited on account of the builder’s breach.

Both parties being aggrieved by the judgement of the learned single judge preferred appeals under Section 37 of the Act.

When the cross appeals came up for consideration before the hon’ble division bench, the Court noted that the principal issue before the Court was whether the award of damages was justified in the absence of concrete evidence of loss suffered by the owners.

The hon’ble division bench opined that the learned single judge had modified the arbitral award and substituted its decision in its place, which was fundamentally flawed and beyond the scope of Section 34 of the Act, which does not permit such modifications to the arbitral award.

Further, the Court clarified that even if the agreement contained a penalty or liquidated damages clause, the owners had to  prove the loss suffered before they could be awarded damages under the said clause. The division bench relied on the hon’ble Supreme Court’s decision in the Kailash Nath case in this regard.

Further, the Court reiterated the well settled position of law that the party claiming damages, must meet the three essential ingredients namely,

a. there must be a breach of the contract;

b. the other party must have suffered an injury as result of such breach; and

c. the injury suffered must be proximate and a direct result of such breach.

The hon’ble Court observed that the delay caused by the builder did not result in the owners suffering any harm or incurring any cost. The owners had relied on the penalty clause to seek damages against the builders but had neglected to plead or prove that they had suffered any actual damage due to the delay in completion of the construction. Additionally, the owners also never averred that the loss suffered by them was incapable of being proved or that the penalty stipulated in the agreement was a genuine pre-estimate of damages.

The hon’ble division bench set aside the impugned order of the single judge and with respect to the arbitral award, it set aside the same to the extent of claims awarded in favour of the owners.

The above decision has once again reiterated that to claim and obtain an order of damages under a contractual clause which stipulates a pre-determined amount of compensation, it is necessary to plead and prove the damages. The mere presence of a clause in the contract cannot be the sole criteria to award damages to the party complaining of the breach.  

It is to be noted that there is no single formula which can be applied for quantifying the damages. But having said that, a party claiming damages is  expected to plead as well as prove the damages wherever possible to be awarded a reasonable compensation under a liquidated damages/penalty clause.

About the authors: Mahua Roy Chowdhury is the Managing Partner of Royzz & Co. Angel Mary Aju is an Associate at the Firm.