An agreement enforceable by law is a contract.[i] There are times when a contract’s terms and conditions are not followed or are breached by one of the parties. The party who breaches the contract is referred to as the defaulting party.
There are remedies available in the event of a breach, which might include damages or compensation. The issue is that if a sum is indicated in an agreement, whether the party is obligated to pay that precise amount or not.
LIABILITY CLAUSE IN AGREEMENTS
In order to avoid calculation errors at later stage or under-compensation or any kind of inconvenience for recovery of damages,[i] drafters of agreement incorporate the limitation of liability clause, which can be referred to as incorporating the predetermined amount of damages.
A liability provision declares that once an agreement’s requirements are breached, one party will be forced to settle with the other. This clause restricts the quantity and variety of damages which that party can seek from the other. Such agreement allows owners to define their risks and reduce the time, expense, and danger of litigation by limiting the amount of damages that an operator can claim.[ii]
The clause can be helpful in calculating all the contingent liabilities or circumstances
that can obstruct the service, all potential harms and injuries and amount that can be required to settle the same or restore the position of the suffering party.
However to say that such a clause can make this as an absolute right, would be wrong. The amount so decided has to be genuine and not huge unnecessarily.
Secondly, other factors are to be considered that differ with each case, like mitigating circumstances or whether the party claiming damages was prudent enough in their action and has not committed any gross negligence on their part. In case of M Licha
Setty & Sons Ltd v. Coffee Board Bangalore, Hon’ble Apex Court held that while calculating the amount of damages, mitigating circumstances are to be considered because it is believed that parties must have acted in a prudent manner and complainant himself should have taken reasonable steps to reduce such loss if that was possible, however, if that was possible but he remains negligent towards it, he cannot ask for damages for that loss that could have been prevented.
DAMAGES
In a layman language, damages are referred to as loss or injury and in commercial world, damages are referred to as compensation or money that is paid by the defaulting party against loss or injury that the other party has suffered due to breach of contract.
TYPES OF DAMAGES
Broadly with respect to issue at hand, damages can be classified into two types:
1) Liquidated damages
2) Unliquidated damages
The main purpose of awarding damages is to restore or bring back the position of the suffering party, that he has suffered due to breach of contract by defaulting party. It is believed that damages are to be quantified in such a way that the position of the party who suffered injury or loss is restored, exactly how it would have been if such breach of contract did not occur.
The main reason of differentiation between the two types is that in Liquidated damages, amount of damage is pre-determined and mutually agreed to by both the parties while entering into the contract, however, in case of unliquidated damages, it
is the court who is required to assess and analyse the quantum of damages by analysing the ‘actual loss’ suffered by the party.
INDIAN CONTRACT ACT, 1872
“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.”[iv]
DAMAGES
Section 74 of the Indian contract act talks about the pre-determined amount of damages or penalty in the contract which refers to liquidated damages. However, on a plain reading of the section, we can see that even if amount is pre-determined:-
1- Not always the entire amount so decided has to be paid.
2- Compensation has to be reasonable.
3- Damages so awarded cannot exceed the amount so decided before by the way of contract.
4- Actual damage or loss need not always be proved.
JUDICIAL PERSPECTIVE
However, it is no doubt true that damages quantified should be reasonable and fair, and with respect to that, it becomes important to present an extract from a case law, which helped in developing the law of damages in India per se, i.e, Hadley v.Raxendale (1854)9 Ex 341.
The extract, “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 such as may fairly and reasonably considered either arising naturally i.e. according to the usual course of things, from such breach of contract itself or such as may be reasonably supposed to have been in the contemplation of
both parties at the time they made the contract, as the probable result of breach of it.”[v]
The judgement very well explains both the types of damages and mentions that even if parties have contemplated the damages, that too need to be fairly and reasonably construed.
In a landmark case of Fateh Chand v. Bal Kishan Das, Ltd. Apex court held that even though the amount of damages are liquidated, which means they are predetermined, compensation thereof also needs to be reasonable and should never exceed the pre-determined amount in the contract.
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In case of ONGC Ltd. v. Saw Pipes Ltd., (2003) 5 SCC 705, the Apex court referred to Fateh Chand case and observed that power of court is unqualified while awarding compensation but cannot go beyond the pre-determined amount in agreements. Also, the compensation so decided by the court has to be genuine and reasonable. Irrespective of the fact that whether loss has been proved or not, reasonable compensation has to be paid.
No party can arbitrarily demand any amount so written in the agreement also if it doesn’t seem to be reasonable. In case of Anoop Singh vs Gopal Krishan Bhuradia & Anr, Delhi High court held that section 74 does not confer any special benefit to either of the parties, and it allows court to award only reasonable compensation that cannot be more than pre-determined amount in agreement. The sum so decided by the parties can only be awarded if court is unable to compute the compensation and estimate by the parties seems to be a genuine estimate. However the same cannot be done if estimate is in the nature of penalty.
CONCLUSION
In the event of a breach of contract, if there exists a clause in the agreement that specifies an amount of damages that has to be paid on such breach, then if it seems to be reasonable compensation, it can be awarded and if it appears that less than such amount is reasonable then that can also be awarded. However, in cases where there is liquidated damage, court cannot award more than the specified amount.
Drafted and Settled by
Varun S. Ahuja (Partner)
Of Ahuja Law Offices
Email: alo@ahujalawoffices.com
Phone Nos: 011-49096435, 9810781997, 9971673660
Mr T S Ahuja : 9811586723
Vishal Pancholi : +852 63579542 ( Hongkong )