Damages under the law of Contract a remedy or a penalty.
‘Ubi Jus Ibi Remedium’, is a Latin maxim which means that ‘where there is a right there is a remedy’. The principle contemplated is that, when a person’s right is violated the victim will have an equitable remedy under law. The person whose right is being infringed has a right to enforce the infringed right through an action before the court of law. The two words ‘damages’ and ‘penalty’ are used in Section 73 and Section 74 of the Indian Contract Act, 1872. These two words have not been defined explicitly and therefore their interpretation depends upon the understanding and it might differ from case to case.
Section 2 (h) of the Indian Contract Act 1872 defines Contract as ‘an agreement enforceable by law’. Breach of contract is the term used to refer to a situation where one party breaks the promise they made in the contract. If the damage done is extensive and severe, the court may order to pay ‘damages’. The basic theory of damages is that they are compensation in monetary form.
Section 73 & 74 of the Indian Contract Act
The Indian Contract Act uses the words loss or damage under Section 73 as:- 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 cause 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 of damage sustained by reason of the breach. In case of breach, the aggrieved party has the right to sue for damages.
An uncommonly known fact is that Section 73 is based on a case law, i.e. Hadley v. Baxendale (I). The well-known rule in this case was stated by the Court as follows:
“Where two parties have made a contract which one of them has broken, the damages which the other party ought to receive in respect of such breach of contract should be either such as may reasonably and fairly be considered as arising naturally, i.e. according to usual course of things, from such breach of contract itself, or such as may reasonably be supposed to have been in the contemplation of both parties at the time they made the contract as the probable result of the breach of it.”
Section 74 states “Compensation of breach of contract where penalty stipulated for:-when a contract has been broken, if a sum is named in the contract as the amount 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 has been 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.”
Here it is worth noting that, penalty under law of contract does not mean punishment to the wrong doer. It is used in quite different sense. It is totally different from punitive damages. Punitive damages means monetary compensation awarded to an injured party that goes beyond which is necessary to compensate for losses and that is intended to punish the wrongdoer. The purpose of punitive damages is to punish the wrongdoer for outrageous misconduct and to deter the defendant and others from similar misbehaviour in the future. Whereas this is not the case of penalty.
Liquidated damages and Penalty
Where the contract itself addresses the issue of consequences of a breach and stipulated a penalty, Section 74 will come into picture. When such 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, to receive from the party who has broken the contract a reasonable compensation not exceeding the amount so named. However, it may award a lesser amount, depending on the case. Hence, the suffering party gets reasonable compensation but no penalty.
However there is an exception to Section 74 which states that if a party enters into a contract with the State or Central Government for the performance of an act in the interest of the general public, then a breach of such a contract makes the party liable to pay the entire amount mentioned in the contract.
Damages for breach are compensatory and not penalty
Under the Indian Contract Act 1872, there are six types of damages. They are compensatory, incidental, consequential, nominal, and liquidated and punitive damages.
Compensatory damages- as the name itself suggest are compensatory in nature. They are paid by the person who broke the contact to the non-beaching party for the value of what was not done or performed.
Incidental damages- these are the expenditures that were incurred by the non-breaching party to minimise the loss that flows from the breach.
Consequential damages- these are the damages incurred by the non-breaching party without action on his part because of the breach.
Nominal damages- they are to be paid when there has been a breach but the other party has not suffered any loss or if he has suffered any loss but is unable to prove it.
Liquidated damages- sometimes parties themselves specify how much should be paid in the event of a breach. Liquidated damages are awarded by the court when it is difficult to determine the actual loss suffered and the amount specified by the parties is reasonable.
Punitive damages- they are awarded with an intent to punish the wrong doer in a civil action. They are usually awarded in cases where the defendant has acted maliciously and wilfully.
There are other equitable remedies also that are awarded by the court when damages is not a reasonable remedy. Such other equitable remedies are injunction, specific performance and restitution of property.
It is well settled that the governing purpose of damages is to put the party whose rights have been violated in the same position, so far as money can do so, as if his rights have been observed. In other words, the objective of damages is to bring the aggrieved party in a position that he would have been if the contract was performed.
Ruxley Electronics and Construction ltd v Forsyth(II), case involving construction of a swimming pool, where the depth of the pool happened to be less than what was specified, the pool being otherwise useful, the court allowed the difference in value of the pool as provided and its value as it should have been provided. The court did not allow the cost of setting right the pool because that would have given the recipient wind full profits which are impermissible because the award of damages is to compensate the claimant ant not to punish the payer.
In Robinson v Harman (III) the defendant having agreed to grant a lease of a certain property to the plaintiff, refused to do so. The court allowed the plaintiff by way of damages the expenses incurred by him on the preliminary legal work and also for the profits which he would have earned if the lease had been granted to him.
Thus, damages are given by way of compensation for the loss suffered by the plaintiff and not for the purpose of punishing the defendant for the breach. Motive and manner of breach are not taken into account because generally “punitive damages are not recoverable for breach of contract.”
Initially in the case of Fateh Chand v Bal Kishan Das (IV), the Supreme Court stated that the aggrieved party is entitled to a reasonable compensation which should not exceed the sum of penalty or the pre-determined 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 approached the court only for relief. The court interpreted Section 74 as a legal liability in the case of breach of contract; whether either through pre-determined agreement compensation is paid or through penalty. While discussing the scope of Section 74 it stated that the Section deals with damages which are divided into two classes of cases:-
Where there is pre-determination of amount which has to be paid in cases of breach of contract.
Where the contract may contain any further stipulation in form of penalty.
In the case of Oil & Natural Gas Commission v Saw Pipes Ltd (V), the Supreme Court held that in case of damages Section 73 and Section 74 has to be read together and liquidated damages can be granted in those cases where it is difficult to prove actual loss or damage 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. If the terms are clear and unambiguous stipulating liquidated damages in case of the breach of the contract, unless it is held that such estimate of damages or compensation is unreasonable or is by way of penalty, the party who has committed the breach is required to pay such compensation and that is what is provided in Section 73 of the Indian Contract Act.
In the case of BSNL v Reliance (VI), there was a dispute relating to the caller Line Identification device, and it was discovered that the calls were manipulated which invoked method of computing charges and hence resulted in BSNL, levying a charge of Rs 9.81 crores on Reliance. The court made the observation in relation to the provisions of Section 74 that the damages to be provided should be based on the concept of reasonable compensation apart from it the court also stated that it is of no importance in characterising the damages as penalty.
Again the case of Kailash Natah Associates v Delhi Development Authority (VII), the Supreme Court said that liquidated damages can be awarded only if it is a genuine presentation of damages. ‘Reasonable compensation’ can be awarded not exceeding the amount of liquidated damages agreed upon. It was also reiterated that reasonable compensation or loss caused by breach of contract is sine qua non for the applicability of the statutory provision on liquidated damages.
The discussion suggest that Indian courts may be inclined to consider the principles of damages as flexible and capable of liberal application in matters concerning consumer rights. Nonetheless, the generally accepted principle that damages are compensatory in nature remains sacrosanct.
As there has been tremendous growth in technology, the parties entering into commercial transactions have become more cautious, thus making the parties deliberate even on minute details and specifications in order to secure their interests. As a means of safeguarding their respective interests, in case of breach, the parties generally negotiate and agree upon the various remedies that the injured party can invoke for compensation of loss. Therefore the primary conclusion is that damages is a reasonable compensation in case of breach of contract and they are adequate remedy and not penalty. Further it also appears to have concluded that in case of a penalty, damages will have to be proved. Penalty can be imposed only on limited events like delay in compensation of work or when there is delay in supply.
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UKHL 8,, AC 344
(1848) 1 Ex Rep 850, 154 ER 363
(1963) AIR 1405
(2003) 5 SCC 705
(2011) Vol.1 SCC 394
(2015) 4 SCC 136
Wellers law group
Avtar Singh, law of Contract and Specific Relief Act, 8th edition, Eastern Book Company, 2002.
Indian Journal of Research; Damages under law of contract.
3rd year BBALLB
KLE Society’s law college, Bengaluru