LIQUIDATED DAMAGES

Guided By Prof. Vilas S. Mahajan

By Jay Pratap Singh Yadav FP14025

Nekzad Pandol FP14032

LIQUIDATED DAMAGE

Sum of money (agreed-to and written into a contract) specified as the total amount of compensation an aggrieved party should get, if the other party breaches certain part(s) of the contract. The contract also establishes what actions or failures to act constitute a breach.

For the agreement to be legally enforceable, the nature of the contract should be such that it is difficult to determine actual damages, and the amount of damages should be reasonable under the circumstances.

Otherwise law may regard the specified amount as a fine (included in the contract primarily to force its proper performance) and not a compensation for injury.

In such cases, the damages are deemed 'unliquidated damages' and are assessed by a court according to the merits of the case.

NECESSARY CONDITIONS

First, the amount of the damages identified must roughly approximate the damages likely to fall upon the party seeking the benefit of the term.

Second, the damages must be sufficiently uncertain at the time the contract is made that such a clause will likely save both parties the future difficulty of estimating damages.

EXAMPLE

Suppose Mr. A agrees to lease a store-front to Mr. B, from which Mr. B intends to sell jewelry. If Mr. A breaches the contract by refusing to lease the store-front at the appointed time, it will be difficult to determine what profits Mr. B will have lost because the success of newly created small businesses is highly uncertain. In such circumstance, it will be an appropriate for Mr. B to insist upon a liquidated damages clause in case Mr. A fails to perform.

HISTORY

Historically, this area of the law developed from Equity (law developed 300 years after common laws to assist common laws) which granted relief against the harshness of penal bonds.

A penal bond was a form of assurance whereby an individual would bind himself to pay a definite sum of money in the event he failed to perform another primary obligation.

The equitable principle granting relief against such bonds later was adopted by courts of law and remains today as the foundation for the rule that penalties are void and unenforceable.

INDIAN CONTRACT ACT 1872

CLAUSE 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.

INDIAN CONTRACT ACT 1872

THE CONSEQUENCES OF BREACH OF CONTRACTCLAUSE 73Compensation 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 hereby, which naturally arose in the usual course of things from such breach, or which the parties 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 stained by reason of the breach.

Case Study

BENEFITS

The purpose of such clauses is to promote certainty, especially in commercial contracts.

Parties to a contract would fix such a sum in advance at the time of making the contract because it facilitates calculation of risks; it reduces the difficulty and expense of proving actual damage or loss and facilitates recovery of damages.

It also avoids the difficulty in assessment, even where the consequences of breach are ascertainable and avoids the risk of under-compensation

It gives promise an assurance that party may safely rely on the fulfillment of the promise.

Real Case ExampleONGC v/s Saw Pipes

Published March 2011

Oil and Natural Gas Commission had placed an order on Saw Pipes for supply of equipment for off shore exploration, to be procured from approved European manufacturers. The delivery was delayed due to general strike of steel mill workers in Europe. Timely delivery was the essence of the contract. ONGC granted extension of time, but it invoked the clause for recovery of Liquidated Damages(1.5% / week delay of total amount) by withholding the amount from the payment to the supplier. ONGC deducted from the payment $3,04,970.20 and Rs 15,75,557 towards customs duty, sales tax and freight charges. Saw pipes disputed the deduction and matter was referred to arbitration.

Judgment

While the arbitral tribunal rejected Saw Pipe’s defense of force majeure, it required ONGC to lead evidence to establish the loss suffered by breach and proceed to hold, in absence of evidence of financial losses, that the deduction of Liquidated damages was wrongful. The award was challenged by ONGC; inter alia as being opposed to public policy ONGC’s case was that the arbitral tribunal failed to decide the dispute by not applying the prevailing substantive law, ignoring the terms of the contract and customary practices of usage of trade in such transactions. ONGC challenged the award as being patently illegal. The single judge and division bench of Bombay High Court dismissed the challenge. The Supreme Court set aside an arbitration award directing ONGC to refund $3,04,970.20 and Rs 15.76 Lakhs towards liquidated damages retained by it while making payment to the company.