Liquidated Damage Clauses: Did Kailash Nath Dilute the Saw Pipes Position?

Bar & Bench March 14 2019
liquidated damages

By Jeevan Ballav Panda and Satish Padhi

There has been a lot of debate both at an academic forefront and among the practitioners about the impact of the division bench decision of the Supreme Court in Kailash Nath Associates v Delhi Development Authority (2015) 4 SCC 136 (Kailash Nath) on liquidated damage clauses (LD Clause). Also, specifically its effect on the decision rendered by an earlier division bench of the Supreme Court in Oil and Natural Gas Corporation Limited v. Saw Pipes Limited (2003) 5 SCC 705 (Saw Pipes). 

Common questions surrounding this range from whether the Saw Pipes position has been diluted by Kailash Nath? Post Kailash Nath, would loss necessarily ought to be proved in every case even though the parties have provided for a genuine pre-estimate of loss in the LD Clause? Is there a requirement to prove loss even in situations where it would be difficult or impossible to prove loss? 

This piece focuses on answering the above questions by analysing critically the decision rendered in Kailash Nath and discerning the ratio of the judgment. Further, it analyses a few decisions rendered post-Kailash Nath to see how subsequent judgments have considered the Saw Pipes position, given the observations in Kailash Nath.

In an earlier piece, we had analysed the legal position emanating from Constitutional Bench decision of Fateh Chand, 3 Judge bench decision in Maula Bux and a division bench decision in Saw Pipes.

Read Here: Liquidated Damages Saga: What does Fateh Chand, Maula Bux and Saw Pipes lead to?

Division Bench Decision of the Supreme Court in Kailash Nath

The Supreme Court was dealing with an earnest money clause which provided for the following:

In case of default, breach or non-compliance of any of the terms and conditions of the auction or mis-representation by the bidder and/or intending purchaser, the earnest money shall be forfeited.”

The Auction terms also envisaged the following payment mechanism:

When the bid is accepted by the DDA, the intending purchaser shall be informed of such acceptance in writing and the intending purchaser shall, within 3 months thereof, pay to the Delhi Development Authority, the balance 75% amount of the bid, in cash or by Bank Draft in favour of the Delhi Development Authority or by Cheque guaranteed by a Scheduled Bank as “good for payment for three months” in favour of the Delhi Development Authority. If the bid is not accepted, the earnest money will be refunded to the intending purchaser without any interest unless the earnest money is forfeited under para 2 (iv) above.”

The Delhi Development Authority (“DDA”) cancelled the allotment of the plot on account of allegedly non-payment of balance 75 per cent of premium in a timely manner by Kailash Nath. 

The Division Bench of the Delhi High Court held that the forfeiture of the earnest money by the DDA was in order. 

The Supreme Court speaking through Justice RF Nariman taking into account various correspondences exchanged between the parties arrived at the position that there was no breach of the auction terms and conditions by Kailash Nath. Accordingly, it observed that:

“It may be noted that the balance 75% which had to be paid within three months of the acceptance of the bid, was not insisted upon by the DDA. On the contrary, after setting up two High Powered Committees which were instructed to look into the grievances of the appellant, the DDA extended time at least twice. It is, therefore, very difficult to say that there was a breach of any terms and conditions of the auction, as the period of three months which the DDA could have insisted upon had specifically been waived. It is nobody’s case that there is any misrepresentation here by the bidder. Therefore, under sub-clause (iv), without more, earnest money could not have been forfeited.”

Also, notably DDA fetched around INR 11.78 Crores on re-auction of the premises post cancellation of the allotment to Kailash Nath thereby clearly receiving a higher amount on re-auction. 

In this backdrop, the Supreme Court held that “compensation can only be given for damage or loss suffered. If damage or loss is not suffered, the law does not provide for a windfall.” (emphasis supplied) 

Revisiting the Saw Pipes Position

The Supreme Court speaking through Justice MB Shah had observed that if parties have agreed on a genuine pre-estimate of liquidated damages, then in such a situation there may not be any requirement to prove actual loss suffered on account of breach of events for which LD Clause is triggered. 

Decisions Post Kailash Nath: How have other Courts interpreted Kailash Nath on LD vis-à-vis Saw Pipes?

A division bench of the Calcutta High Court in MBL Infrastructures Limited v. Ircon International Ltd., 2018 (1) ARBLR 168 (Cal) observed that the law written by a two-judge bench cannot be overruled by another division bench and the law continues to be as per Saw Pipes position. The Calcutta High Court surmised the following:

“It does not appear that the law laid down in such aspect on ONGC has been completely re-written in Kailash Nath Associates. Indeed, the law written by a two-Judge Bench of the Supreme Court could never have been overruled by another Bench of similar strength. At the highest, paragraph 43.6 of the report in Kailash Nath Associates succinctly enunciates the law without deviating from what was recognised to be the law in Saw Pipes. The law continues to be as it was when Saw Pipes was written”. 

Similarly, the Delhi High Court in Mahanagar Telephone Nigam Limited v. Haryana Telecom Limited (2017), 163 DRJ 425, while dealing with a challenge to an arbitral award reaffirmed the Saw Pipes position by setting aside an arbitral award on the ground that while interpreting the LD Clause, the arbitrator has decided contrary to the ratio emanating from the Saw Pipes decision. 

The Court speaking through Justice S Muralidhar observed the following:

“Specifically, the AT has overlooked the legal position as explained in ONGC v. Saw Pipes Limited (supra) and, in particular, its observation that “in some contracts, it would be impossible for the court to assess the compensation arising from breach and if the compensation contemplated is not by way of penalty or unreasonable, the court can award the same if it is genuine pre-estimate by the parties as the measure of reasonable compensation.” (….) Specifically, the plea of MTNL in para 8 of its reply that it purchases materials from several sources and “the delay caused by one of the suppliers by itself cannot be pleaded and proved” and, therefore, the present case “falls within that class where the Court may not be able to assess the compensation on account of breach of contract to supply some material” was not even discussed by the AT.”

Testing the Saw Pipes Position vis-à-vis Kailash Nath: Can Kailash Nath’s observations be considered to be a ratio on LD Clause? 

Marginal Note of Section 74 reads as follows: “Compensation for breach of contract where penalty stipulated for”.

Section 74 begins with “Where a contract has been broken”. Hence, it is clear that Section 74 of the Indian Contract Act, 1872 (“Contract Act”) gets triggered only when there is a breach of contract by a party and not otherwise. 

Given that in Kailash Nath, the Supreme Court has clearly held on facts that there is no breach of the contract itself by Kailash Nath, the observations on the requirement of proof of loss by the Supreme Court may not be construed to be a ratio in the context of Section 74 of the Contract Act. Therefore, in an ideal scenario, it may not be construed to have diluted the Saw Pipes position on LD Clause.

 

About the authors: Jeevan Ballav Panda is a Partner and Satish Padhi is a Senior Associate with the Dispute Resolution Team of Khaitan and Co and are based out of New Delhi. They can be reached at [email protected] and [email protected] respectively. 

Disclaimer: Views expressed in this article are personal and are not attributable to the Firm or Bar & Bench in any manner.

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