← The hardest concepts in Indian law
In one breath
Section 73 of the Contract Act gives compensation for loss that naturally arises from a breach or that the parties knew was likely, while section 74 lets a party who sues on a clause fixing a sum payable on breach recover only reasonable compensation, not exceeding that sum. Indian law therefore does not enforce penalties as written, and the court asks what is reasonable.
The picture
The parking fine
A car park prints a charge on its ticket for anyone who overstays. The fine is set before any car arrives, so that no one has to prove the exact loss from a blocked space. But if the charge were ten times the cost of the space and a driver contested it, a court would look hard at it. The car park may keep what is fair for its loss and no more.
Section 73 is the ordinary rule: the injured party gets compensation for the loss that arose naturally in the usual course of things, or that both sides knew was likely, but nothing for remote or indirect loss (Hadley v Baxendale). Section 74 deals with a pre-agreed sum. Whether the clause is called liquidated damages or a penalty makes no difference. The party who suffers the breach may recover reasonable compensation up to the stated sum, whether or not actual loss is proved, but the court may award less. In Fateh Chand the Court cut an excessive forfeiture down to what was reasonable.
Where the picture stops working
A parking fine is a fixed number, while section 74 sets only a ceiling, and the court looks at the facts to decide what is reasonable. The picture also leaves out that, where loss is capable of being proved, the court expects some proof, and that where the loss is hard to measure, the stated sum is often accepted as a fair estimate (Kailash Nath Associates). It also differs from English law, which asks whether the clause is a genuine pre-estimate of loss.
How it really works
- 1Identify the breach and ask what loss flowed from it. Under section 73, compensation covers loss that naturally arose in the usual course of things, or that both parties knew was likely.
- 2Exclude remote and indirect loss, and ask whether the injured party took reasonable steps to reduce the loss.
- 3If the contract names a sum to be paid on breach, whether as damages or as a penalty, section 74 applies.
- 4The court may award reasonable compensation, not exceeding the sum named, and the injured party need not prove the exact loss where the loss is difficult to assess.
- 5If the named sum is excessive, the court reduces it to what is reasonable in the circumstances.
Why people get it wrong
- Thinking a clause called liquidated damages is automatically enforceable. Section 74 applies whether it is called a penalty or not, and the court asks what is reasonable.
- Thinking the injured party always gets the named sum. It is a ceiling, and the court may award less.
- Treating damages as payable for every consequence of a breach. Remote and indirect loss is excluded.
- Assuming the English rule on penalties applies. Section 74 has its own wording and has produced its own decisions.
A worked example
The facts are invented
A builder agrees to complete a house by June and the contract says that for every month of delay he will pay the buyer 5,000 in rupees, up to a maximum of 60,000. He is four months late. The buyer, who rented another flat at 12,000 a month, claims 48,000 in rent, and the builder says that the clause caps the claim at 20,000.
The clause is a section 74 clause. The buyer need not prove the exact loss and may recover reasonable compensation not exceeding the stated amount, which here is 20,000 for four months. If the buyer can show larger loss, the clause still limits the claim to the named sum. If the stated sum had been grossly higher than any possible loss, say 5,00,000 a month, the court would award only what is reasonable.
Try it
A contract says that a party who breaches must pay a stated sum. The sum is far more than the loss the other party suffered. What will the court usually do?
Landmark authorities
Read the sources themselves; this list is a starting point.
- Hadley v Baxendale, (1854) 9 Exch 341
- Fateh Chand v Balkishan Dass, AIR 1963 SC 1405
- Maula Bux v Union of India, (1969) 2 SCC 554
- Kailash Nath Associates v Delhi Development Authority, (2015) 4 SCC 136
Where to go next
Courses
Case briefs
Dictionary
More hard concepts in India law
- Free consent, coercion and undue influence (Contract law)
- Promissory estoppel against the State (Contract and administrative law)
This page is an educational overview. It is not legal advice and not a substitute for the sources: the statute, the rule, the case itself. India has a written Constitution, central and State legislation, and a unified court system under the Supreme Court. Each page states the usual formulation of the rule and names landmark decisions, with the citations as they are usually given in the Supreme Court Cases and All India Reporter series. The criminal codes and the law of evidence were replaced by new statutes, so the pages on criminal law state the doctrine and the decisions and mostly leave out section numbers; check the current text of any statute you rely on. Personal laws differ by community. This is a study aid, not legal advice, and an Indian advocate should check anything you need to rely on.