Let us first learn Law relating to Liquidated damages in India.
Section 73 in The Indian Contract Act, 1872
Compensation for loss or damage caused by breach of contract.—When a contract has been broken, the party who suffers by such breach is entitled to receive, from the party who has broken the contract, compensation for any loss or damage caused to him thereby, which naturally arose in the usual course of things from such breach, or which the parties knew, when they made the contract, to be likely to result from the breach of it. —When a contract has been broken, the party who suffers by such breach is entitled to receive, from the party who has broken the contract, compensation for any loss or damage caused to him thereby, which naturally arose in the usual course of things from such breach, or which the parties knew, when they made the contract, to be likely to result from the breach of it.” Such compensation is not to be given for any remote and indirect loss or damage sustained by reason of the breach. Compensation for failure to discharge obligation resembling those created by contract.—When an obligation resembling those created by contract has been incurred and has not been discharged, any person injured by the failure to discharge it is entitled to receive the same compensation from the party in default, as if such person had contracted to discharge it and had broken his contract. —When an obligation resembling those created by contract has been incurred and has not been discharged, any person injured by the failure to discharge it is entitled to receive the same compensation from the party in default, as if such person had contracted to discharge it and had broken his contract.” Explanation.—In estimating the loss or damage arising from a breach of contract, the means which existed of remedying the inconvenience caused by the non-performance of the contract must be taken into account.
Section 74 in The Indian Contract Act, 1872
74 Compensation for breach of contract where penalty stipulated for:- [When a contract has been broken, if a sum is named in the contract as the amount to be paid in case of 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. Explanation. — A stipulation for increased interest from the date of default may be a stipulation by way of penalty.]
(Exception) — When any person enters into any bail-bond, recognizance or other instrument of the same nature or, under the provisions of any law, or under the orders of the [Central Government] or of any [State Government], gives any bond for the performance of any public duty or act in which the public are interested, he shall be liable, upon breach of the condition of any such instrument, to pay the whole sum mentioned therein. Explanation. — A person who enters into a contract with Government does not necessarily thereby undertake any public duty, or promise to do an act in which the public are interested.
Section 75 in The Indian Contract Act, 1872
Party rightfully rescinding contract, entitled to compensation.—A person who rightfully rescinds a contract is entitled to compensation for any damage which he has sustained through the non-fulfilment of the contract. —A person who rightfully rescinds a contract is entitled to compensation for any damage which he has sustained through the non-fulfilment of the contract.” Illustration 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 rupees for each night’s performance. On the sixth night, A willfully absents herself from the theatre, and B, in consequence, rescinds the contracts. B is entitled to claim compensation for the damage which he has sustained through the non-fulfilment of the contract. 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 rupees for each night’s performance. On the sixth night, A willfully absents herself from the theatre, and B, in consequence, rescinds the contracts. B is entitled to claim compensation for the damage which he has sustained through the non-fulfilment of the contract.”
Companies Act, 1956
Winding Up:
E-City Media Private Limited vs Sadhrta Retail Limited in CP No.367 of 2009, the Hon’ble High Court of Judicature at Bombay has held that “The Petition for winding up cannot be maintained upon a claim for damages. Damages become payable only when they are crystallised upon adjudication. Until and unless an adjudication takes place with a resultant decree for damages, there is no debt due and payable. Damages require adjudication. Until then, the liability of a party in alleged breach of a contract does not become crystallised.”
In case of Union of India vs Raman Iron Foundry (1974 AIR 1265, 1974 SCR (3) 556), it has been held that “the claim for unliquidated damages does not give rise to a debt until the liability is adjudicated upon and damages assessed by an adjudicatory authority. When there is a breach of contract, the party who commits the breach does not instantly incur any pecuniary obligation nor does the party complaining of the breach become entitled to a debt due from the other party. The only right which the party aggrieved by the breach has is the right to sue for damages, and this is not an actionable claim.
Inference : Under old Companies Act liquidated damages were not permitted in Winding Up proceedings.
Insolvency and Bankruptcy Code, 2016 ( IBC Act)
Section 3(11) of the Code provides that “Debt” means a liability or obligation in respect of a claim which is due from any person and includes a financial debt and operational debt.
Operational Debt as defined under Section 5(21) means “a claim in respect of the provision of goods or services including employment or a debt in respect of the repayment of dues arising under any law.”
NCLAT in 21/I&BP/NCLT/MAH/2018 Under Section 9 of the I&B Code, 2016In the matter of TATA Chemicals Limited v/s.Raj Process Equipment and Systems Private Limited it was held that, The claim of the Operational Creditor is not based on the operational debt, because goods/services was to be rendered by the Corporate Debtor himself. It has been argued that the claim of the Operational Creditor is not relating to the goods/services including employment or the debt in respect of the repayment of the dues, but it is related to non payment of the advance money and claiming further compensation on account of the alleged loss incurred by the Operational Creditor. The same is not covered under the definition of the Operational Debt as provided under Section 5(21) of the Code.
Inference: Liquidated damages is not operational debt.
Arbitration and Liquidated damages:
Where a sum is named in a contract as a liquidated amount payable by way of damages, the party complaining of a breach can receive as reasonable compensation such liquidated amount only if it is a genuine pre-estimate of damages fixed by both parties and found to be such by the Court. In other cases, where a sum is named in a contract as a liquidated amount payable by way of damages, only reasonable compensation can be awarded not exceeding the amount so stated. Similarly, in cases where the amount fixed is in the nature of penalty, only reasonable compensation can be awarded not exceeding the penalty so stated. In both cases, the liquidated amount or penalty is the upper limit beyond which the Court cannot grant reasonable compensation.
Fateh Chand vs Balkishan Das 7 Judge Bench of Supreme Court held
While considering provisions of Section 74 observed that the section is clearly an attempt to eliminate the somewhat elaborate refinements made under the English common law in distinguishing between stipulations providing for payment of liquidated damages and stipulations in the nature of penalty. Under the common law a genuine pre-estimate of damages by mutual agreement is regarded as a stipulation naming liquidated damages and binding between the parties: a stipulation in a contract in terrors is a penalty and the Court refuses to enforce it, awarding to the aggrieved party only reasonable compensation. The Indian Legislature has sought to cut across the web of rules and presumptions under the English common law, by enacting a uniform principle applicable to all stipulations naming amounts to be paid in case of breach, and stipulations by way of penalty.
In all cases, therefore, where there is a stipulation in the nature of penalty for forfeiture of an amount deposited pursuant to the terms of contract which expressly provides for forfeiture, the court has ” jurisdiction to award such sum only as it considers reasonable, but not exceeding the amount specified in the contract as liable to forfeiture
Supreme Court in Oil and Natural Gas Corporation Ltd vs. Saw Pipes Ltd. (2003) 5 SCC 705. That was also a case dealing with a clause that provided for recovery of agreed liquidated damages where there was default on the part of the Respondent to deliver within the period fixed for delivery. In those circumstances, the Supreme Court held as follows:-
“64. It is apparent from the aforesaid reasoning recorded by the arbitral tribunal that it failed to consider Sections 73 and 74 of Indian Contract Act and the ratio laid down in Fateh Chand’s case (supra) wherein it is specifically held that jurisdiction of the Court to award compensation in case of breach of contract is unqualified except as to the maximum stipulated; and compensation has to be reasonable. Under Section 73, when a contract has been broken, the party who suffers by such breach is entitled to receive compensation for any loss caused to him OMP (COMM.) 339/2017 Page 9 which the parties knew when they made the contract to be likely to result from the breach of it. This Section is to be read with Section 74, which deals with penalty stipulated in the contract, inter alia [relevant for the present case] provides that when a contract has been broken, if a sum is named in the contract as the amount to be paid in case of such breach, the party complaining of breach is entitled, whether or not actual 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. Section 74 emphasizes that in case of breach of contract, the party complaining of the breach is entitled to receive reasonable compensation whether or not actual loss is proved to have been caused by such breach. therefore, the emphasis is on reasonable compensation. If the compensation named in the contract is by way of penalty, consideration would be different and the party is only entitled to reasonable compensation for the loss suffered. But if the compensation named in the contract for such breach is genuine pre-estimate of loss which the parties knew when they made the contract to be likely to result from the breach of it, there is no question of proving such loss or such party is not required to lead evidence to prove actual loss suffered by him. Burden is on the other party to lead evidence for proving that no loss is likely to occur by such breach. Take for illustration: if the parties have agreed to purchase cotton bales and the same were only to be kept as a stock-in-trade. Such bales are not delivered on the due date and thereafter the bales are delivered beyond the stipulated time, hence there is breach of the contract. Question which would arise for consideration is– whether by such breach party has suffered any loss. If the price of cotton bales fluctuated during that time, loss or gain could easily be proved. But if cotton bales are to be purchased for manufacturing yarn, consideration would be different.”
In Saisudhir Energy Ltd. vs. NTPC Vidyut Vyapar Nigam Ltd., SLP(C) 4289-4290/2018 it was held that, court followed the judgment of the Supreme Court in the case of ONGC vs. Saw Pipes Ltd., 2003(5) SCC 705 and noted as follows:-
“96. The Supreme Court had reversed the finding of the Arbitral Tribunal and held that liquidated damages would be payable as genuine estimate of the losses and made the following observations:-
“64. It is apparent from the aforesaid reasoning recorded by the Arbitral Tribunal that it failed to consider Sections 73 and 74 of the Indian Contract Act and the ratio laid down in Fateh Chand case wherein it is specifically held that jurisdiction of the court to award compensation in case of breach of contract is unqualified except as to the maximum stipulated; and compensation has to be reasonable. Under Section 73, when a contract has been broken, the party who suffers by such breach is entitled to receive compensation for any loss caused to him which the parties knew when they made the contract to be likely to result from the breach of it. This section is to be read with Section 74, which deals with penalty stipulated in the contract, inter alia (relevant for the present case) provides that when a contract has been broken, if a sum is named in the contract as the amount to be paid in case of such breach, the party complaining of breach is entitled, whether or not actual 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. Section 74 emphasizes that in case of breach of contract, the party complaining of the breach is entitled to receive reasonable compensation whether or not actual loss is proved to have been caused by such breach.
M/S Univabs Sleepers Pvt. Ltd vs Union Of India 16 Arba/46/2017 … on 12 October, 2018 Chattisgadh High Court held that,
“the Court cannot correct errors of the Arbitrators, it can only quash the award leaving the parties free to begin the arbitration again if it is desired” does not allow the Commercial Court exercising jurisdiction under Section 34 of the Act of 1996 nor this Court to modify or correct the award. The parties have to be left to work out their remedy before the Arbitrator. Consequently, it will be open for the Claimant-Contractor to take recourse to remedy of arbitration seeking adjudication on his additional claims No.1, 3, 8 (a & b) and 11 on its own merits as also claiming compensation and award of damages for breach of contract and if any such proceedings are commenced, the Arbitrator will have to proceed on the premise that breach of contract has already been established.”
Inference: Where a sum is named in a contract as a liquidated amount payable by way of damages, the party complaining of a breach can receive as reasonable compensation such liquidated amount only if it is a genuine pre-estimate of damages fixed by both parties and found to be such by the Court Where a sum is named in a contract as a liquidated amount payable by way of damages, the party complaining of a breach can receive as reasonable compensation such liquidated amount only if it is a genuine pre-estimate of damages fixed by both parties and found to be such by the Court
CPC and liquidated damages as Mesne Profits: in Fatehchand (Supra)
It was held that,
The plaintiff is undoubtedly entitled to mesne profits from the defendant and ‘mesne profits‘ as defined in s. 2 (12) of the Code of Civil Procedure are profits which the person in wrongful possession of property actually received or might with ordinary diligence have received therefrom, together with interest on such profits, but do not include profits due to improvements made by the person in wrongful possession. The normal measure of mesne profits is therefore the value of the user of land to the person in wrongful possession.
Conclusion:
No liquidated damages can be claimed in winding up petition under old 1956 Act and the same ratio applies to IBC 2016 provisions.
Under Arbitration Act Where a sum is named in a contract as a liquidated amount payable by way of damages, the party complaining of a breach can receive as reasonable compensation such liquidated amount only if it is a genuine pre-estimate of damages fixed by both parties and found to be such by the Court.
In case of civil suit Plaintiff is entitled mesne profits the value of the user of land to the person in wrongful possession.
Shruti Desai
25th May,2020
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