‘Liquidated dam-ages’ means a sum fixed up in advance, which is a fair and genuine pre--estimate of the probable loss that is likely to result from the breach.
‘Pen-alty’ means a sum fixed up in advance, which is extravagant and uncon-scionable in amount in comparison with the greatest loss that could conceiv-ably be proved to have followed Item the breach. Thus the essence of a penalty is a payment of money stipulated as per the terms of the offending party.
Sometimes the parties fix up at the time of the contract the sum payable as damages in case of breach. In such a case, a distinction is made in English Law as to whether the provision amounts to ‘liquidated damages’ or a ‘penalty’. Courts in England usually allow ‘liquidated damages’ as stipulated in the contract, without any regard to the actual loss sustained. ‘Penalty’ clauses, however, are treated as invalid and the courts in that case calculate damages according to the ordinary principles and allow only rea-sonable compensation.
Under the Indian Law Section 74 does away with the distinction be-tween ‘liquidated damages’ and ‘penalty’. This Section lays down that the Courts are not bound to treat the sum mentioned in the contract, either by way of liquidated damages or penalty, as the sum payable as damages for the breach. Instead the courts are required to allow reasonable compensation so as to cover the actual loss sustained, not exceeding the amount so named in the contract. Thus, according to the section, the named sum, regardless whether it is a penalty or not, determines only the maximum limit of liability in case of the breach of contract. The section does not confer a special benefit upon any party; it merely declares the law that notwithstanding any term in the contract pre-determining damages or pro-viding for forfeiture of any property by way of penalty, the Court will award to the party aggrieved only reasonable compensation not exceeding the amount named or penalty stipulated.
Exception. There is, however, one exception provided for by Section 74 to the above rule. When any person enters into any bailbond, recognizance or other instrument of the same nature, or under the provisions of any law or under the orders of the Government, gives any bond for the performance of any public duty or act in which the public are interested, he shall be liable to pay the whole sum mentioned therein upon breach of the condition of any such instrument.
Illustrations
(a) A contracts with B to pay Rs 1,000 if he fails to pay B Rs 500 on a given day, A fails to pay B Rs 500 on that day. B is entitled to recover from A such compensation, not exceeding Rs 1,000 as the court considers reason-able. [illustration (a) to Section 74]
(b) A undertakes to repay B a loan of Rs 1,000 by five equal monthly installments with a stipulation that, in default of payment of any installment, the whole shall become due. This stipulation is not by way of penalty and the contract may be enforced according to its terms. [Illustration (j) to Section 74]
(c) A borrows Rs 100 from B, and gives him a bond for Rs 200 payable by five yearly installments of Rs 40, with a stipulation that, in default of payment of any installment, the whole shall become due. This is a stipulation by way of penalty. [illustration (g) to Section 74]
Stipulation regarding payment of interest. The Explanation added to Section 74 states, “a stipulation for increased interest from the date of default may be a stipulation by way of penalty.” It implies that such a stipulation maybe considered a penalty clause and disallowed by the courts, if the enhanced rate is exorbitant.
Illustration [(d) to Sec. 74]. A gives B a bond for the repayment of Rs 1,000 with interest at 12 percent per annum at the end of six months, with a stipulation that in case of default interest shall be payable at the rate of 75 per cent p.a. from the date of default. This is a stipulation by way of penalty and B is only, entitled to recover from A such compensation as the court considers reasonable.
The following rules must also be noted in connection with payment of interest
(a) Unless the parties have made a stipulation for the payment of interest or there is a usage to that effect, interest cannot be recovered legally as damages, generally speaking {Mahabir Prasad vs Durga Datt).
(b)Where a contract provides that the amount should be paid without interest by a particular date and on default it will be payable with interest, such a stipulation may be allowed if the interest is reasonable. If the interest is exorbitant, the courts will give relief.
(c) Payment of compound interest on default is allowed, only if it is not at an enhanced rate (Bhushan Rao vs Subayyal).
Sometimes the parties fix up at the time of the contract the sum payable as damages in case of breach. In such a case, a distinction is made in English Law as to whether the provision amounts to ‘liquidated damages’ or a ‘penalty’. Courts in England usually allow ‘liquidated damages’ as stipulated in the contract, without any regard to the actual loss sustained. ‘Penalty’ clauses, however, are treated as invalid and the courts in that case calculate damages according to the ordinary principles and allow only rea-sonable compensation.
Under the Indian Law Section 74 does away with the distinction be-tween ‘liquidated damages’ and ‘penalty’. This Section lays down that the Courts are not bound to treat the sum mentioned in the contract, either by way of liquidated damages or penalty, as the sum payable as damages for the breach. Instead the courts are required to allow reasonable compensation so as to cover the actual loss sustained, not exceeding the amount so named in the contract. Thus, according to the section, the named sum, regardless whether it is a penalty or not, determines only the maximum limit of liability in case of the breach of contract. The section does not confer a special benefit upon any party; it merely declares the law that notwithstanding any term in the contract pre-determining damages or pro-viding for forfeiture of any property by way of penalty, the Court will award to the party aggrieved only reasonable compensation not exceeding the amount named or penalty stipulated.
Exception. There is, however, one exception provided for by Section 74 to the above rule. When any person enters into any bailbond, recognizance or other instrument of the same nature, or under the provisions of any law or under the orders of the Government, gives any bond for the performance of any public duty or act in which the public are interested, he shall be liable to pay the whole sum mentioned therein upon breach of the condition of any such instrument.
Illustrations
(a) A contracts with B to pay Rs 1,000 if he fails to pay B Rs 500 on a given day, A fails to pay B Rs 500 on that day. B is entitled to recover from A such compensation, not exceeding Rs 1,000 as the court considers reason-able. [illustration (a) to Section 74]
(b) A undertakes to repay B a loan of Rs 1,000 by five equal monthly installments with a stipulation that, in default of payment of any installment, the whole shall become due. This stipulation is not by way of penalty and the contract may be enforced according to its terms. [Illustration (j) to Section 74]
(c) A borrows Rs 100 from B, and gives him a bond for Rs 200 payable by five yearly installments of Rs 40, with a stipulation that, in default of payment of any installment, the whole shall become due. This is a stipulation by way of penalty. [illustration (g) to Section 74]
Stipulation regarding payment of interest. The Explanation added to Section 74 states, “a stipulation for increased interest from the date of default may be a stipulation by way of penalty.” It implies that such a stipulation maybe considered a penalty clause and disallowed by the courts, if the enhanced rate is exorbitant.
Illustration [(d) to Sec. 74]. A gives B a bond for the repayment of Rs 1,000 with interest at 12 percent per annum at the end of six months, with a stipulation that in case of default interest shall be payable at the rate of 75 per cent p.a. from the date of default. This is a stipulation by way of penalty and B is only, entitled to recover from A such compensation as the court considers reasonable.
The following rules must also be noted in connection with payment of interest
(a) Unless the parties have made a stipulation for the payment of interest or there is a usage to that effect, interest cannot be recovered legally as damages, generally speaking {Mahabir Prasad vs Durga Datt).
(b)Where a contract provides that the amount should be paid without interest by a particular date and on default it will be payable with interest, such a stipulation may be allowed if the interest is reasonable. If the interest is exorbitant, the courts will give relief.
(c) Payment of compound interest on default is allowed, only if it is not at an enhanced rate (Bhushan Rao vs Subayyal).
What is Liquidated Damages and Penalty
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