Balancing Contractual Autonomy vis-à-vis Application of Section 74 of the Contract Act, 1872: Part II

[Lavanya Pathak and Pallavi Mishra are advocates practicing at the Delhi High Court.

This is a continuation from Part I]

Position Taken by High Courts at Bombay, Delhi and Madras

The recent judgements rendered by High Courts at Bombay, Delhi and Madras (discussed below) are instructive when it comes to offering clarity on the SC’s understanding of the law on liquidated damages and penalties.

In Ultratech Cement Ltd. v. Sunfield Resources Pty. Ltd., the Division Bench of the Bombay High Court repelled the appellant’s argument that the stipulated sum was in terrorem. The Court carefully examined the scheme of the provisions in light of the precedent laid down in Mahadeoprasad v. Siemens (India) Limited to hold that for the purposes of §74, damages must be proved in a “general sense” as the “…contract made between the parties estimating their damages is in itself evidence of damages”. The Division Bench further placed reliance on the judgement in K.P. Subbarama Sastri v. K.S. Raghavan, where the SC had held that the determination as to whether a particular contractual clause containing pre-determined calculation of damages is in the nature of penalty must be assessed against the background of various factors such as the character of the transaction, relative position and intention of the parties. Justice Kulkarni relying upon the SC judgements in Fateh Chand, Saw Pipes, and Kailash Nath enunciated that in the context of liquidated damages as agreed between the parties, upon breach of the contract, the suffering party would be entitled to receive compensation for any loss arising within the usual course, without having a necessity to lead evidence for proving damages. The Division Bench specifically opined that when an agreement is executed “…by the experts in the field and when an agreement is so arrived in their commercial wisdom, it cannot be construed that the intention of the parties was different from what they have agreed in having such a stipulation in the contract”. The burden in such a case would be on the party who contends that the stipulated amount in the agreement is unreasonable, to prove the same. It is clear that the Division Bench considered the precedents laid down in Saw Pipes and Kailash Nath to be in consonance with each-other, and further noted that the very purpose of agreeing to a genuine pre-estimate of damages was to avoid litigation and foster certainty; hence, unless specifically pleaded to be in the nature of penalty, the breaching party cannot evade its liability to pay damages that it had itself agreed to pay during the execution of the contract.

In Dhiraj Lakhamashi Shah v. Madhav Hari Karmakar, the Bombay High Court, yet again, considered the impact of a clause stipulating genuine pre-estimate of damages in a contract in context of §74 and reiterated the supremacy of party autonomy to the effect that “…the contract made by the parties estimating their damages, is in itself, an evidence on the quantum of such damages”. Justice Kulkarni further opined that a contractual clause agreed between parties would have a binding effect and can only be displaced if specifically challenged and established on “glaring materials”; “pleas lacking a foundation” cannot deprive the suffering party of its right to get the stipulated sum which was contemplated and negotiated at the time of execution of the contract. The Court further observed that when the term of the agreement envisages the award of damages, it is “unfair and unpalatable” for the breaching party to seek to override such an agreement by resorting to §§73 and 74 of the Contract Act.

Similarly, in Gail (India) Limited v. Punj Lloyd Limited, the Division Bench of the Delhi High held that clauses stipulating genuine pre-estimate of damages are “…not merely precautionary conditions not meant to be enforced, but conditions that could be insisted upon” without proof of actual loss. 

In M/s Phoenix Yule Ltd. v. Neyveli Lignite Corporation Limited, the Madras High Court while applying Saw Pipescategorically held that the assessment of reasonableness of damages as discussed in §§73 and 74 will come into play only when the terms of the contract are ambiguous and the estimate provided in the contract is proved to be unreasonable as per the principles laid down in Saw Pipes.


While the previous sections of the post examined the scheme of provisions and precedents, in what follows, this part delves into analysing the divergent views with respect to a court’s jurisdiction in determining the award of damages when the contract already contains a pre-determined estimate as agreed between the parties. One line of thought rests on the argument that the courts should ideally not displace the commercial wisdom and party autonomy that form the basis of contractual agreements, and thus award the damages as contemplated thereunder. The alternate argument emanates from the fundamentals of compensatory damages and principles of equity cautioning against unjust enrichment, and unconscionable bargain.  

In the context  of the above precedents, it is the authors’ view that the High Courts have sought to apply the law laid down in Saw Pipes and Kailash Nath, albeit stressing on different aspects of these decisions, with  different courts  placing  reliance on different shades of the precedents. However, all in all, the question that remains to be considered is whether §74 should play a part in displacing an agreement between parties stipulating payment of a sum on breach, especially when the breaching party has not placed on record any materials to dispute that the clause does not represent a genuine pre-estimate of damages.

Considering the inclusion of the liquidated damages-penalty dichotomy in Indian law by the courts, it undeniably flows from a reading of §74 that even though a contract falls within the private realm of two parties, the court is not powerless to grant relief against clauses in the nature of a penalty. The use of the word ‘reasonable compensation’ predicates the jurisdiction of the court to adjust the ‘sum named in the contract’ to be awarded to ensure that the clause is not enforced in terrorem. However, §74 does not lay down a straight-jacket formula to determine whether a clause stipulating pre-estimated damages constitutes an imposition of penalty or not, and is required to be tested in context of agreement between the parties, as laid down by the precedents discussed above.

In the authors’ view, the approach taken by the courts should hinge on preserving the sanctity of the contract by making a presumption in favour of enforcement of a contractual clause as inserted by the parties based on their commercial wisdom. To this extent, it is a mixed question of law and fact as to whether a clause constitutes penalty or not. However, the courts should set a rigorous standard of proof upon the breaching party claiming the clause to be in the nature of penalty or disputing the quantum of damages to be paid. Further, it is suggested that in cases where there is evidence of the fact that the inclusion of a clause stipulating pre-determined damages was a product of negotiation between the parties on a level playing field, the court should refrain from invoking its jurisdiction to vary the quantum to be awarded. At this juncture, it is necessary to consider the relatively recent decision of the UK Supreme Court in the case of Cavendish Square Holding BV v Talal El Makdessi (“Cavendish”) and ParkingEye Limited v. Beavis where the liquidated damages-penalty dichotomy has been blurred by stating that the law should respect the contractual bargain between the parties and not necessarily fall into the semantics of categorising a clause as penalty, which had in fact been agreed to between the parties in their commercial wisdom. The Court also reiterated that “…the starting point at common law is that parties should be kept to their bargains, and it is for those objecting that a clause is penal to establish its exorbitant nature” [Shivprasad Swaminathan, ‘A Centennial Refurbishment of Dunlop’s Contractual Concepts’ (2016) 45 Common Law World Review 248-256].

While the question as to whether or not the amount fixed in the contract is a genuine pre-estimate of damages or a penalty will have to be determined according to the facts of each case, the judicial practice should proceed on the assumption that proving damage in a ‘general sense’ is an onerous burden upon the suffering party who may be unable to place evidence for arriving at an exact quantum. In such situations, the courts should examine the terms of the contract to understand the extent to which the clause containing the genuine pre-estimate of damages contemplates the possibility of such breach along with determining the underlying intention of the parties for inclusion of such clause, which would enable the courts to distinguish such provisions from a penalty, the aim of which is to extract compensation which exceeds the degree of losses actually suffered by a party.

A contract identifies and allocates risks between parties. Breach of contract means that the party claiming loss would be required to prove the same – which is something a party might want to anticipate in advance and provide for. It is here that the inclusion of a sum stipulating for payment on breach serves as an important tool for certainty and speedy resolution. In context of the commercial wisdom of the parties, the courts must always proceed on a rebuttable presumption favouring a clause which was negotiated keeping in view the complexities of a contract, in which case the interference by courts is merited only when prima facie evidence is established that the clause stipulating genuine pre-estimate of damages is in fact in the nature of penalty.

Considering the departure made by Cavendish from the traditional liquidated damages-penalty dichotomy under the English law, scope of amendment remains in Indian law to in fact return to the ‘original’ intent of the legislature which had sought to ‘eliminate the elaborate refinements between liquidated damages and penalty by using a neutral term ‘stipulated sums’. The idea is to minimise judicial interference to protect the contractual autonomy of parties who negotiated the inclusion of a clause stipulating genuine pre-estimate of damages. A conservative approach towards courts’ exercise of jurisdiction to override contractual clause would allow the parties to preserve the sanctity of an agreement which constitutes a fundamental aspect of contractual law.


– Lavanya Pathak & Pallavi Mishra

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