Forfeiture of Earnest Money involving State Entity: Compensation for Breach of Contract

Facts: The present appeal arises out of a public auction conducted by the Delhi Development Authority (“DDA”) wherein the appellant made the highest bid for a Plot. As per the terms and conditions of the auction, the appellant, being the highest bidder, deposited a sum of Rupees Seventy Eight Lakhs, being 25% of the bid amount, with the DDA, this being earnest money. DDA acknowledged receipt of the same and directed the appellant to deposit the remaining 75%. However, as there was a general recession in the industry, the appellant and persons similarly placed made representations for extending the time for payment of the remaining amount. The DDA set up a High Powered Committee to look into these representations. The High Powered Committee recommended granting the extension of time. Based on the report, DDA extended time for payment with varying rates of interest starting from 18% and going upto 36%. Another High Powered Committee was also set up by the DDA in order to find out whether further time should be given to the appellant and persons similarly situate to the appellant. The second High Powered Committee recommended that the time for payment be extended and specifically mentioned the appellant’s name as a person who should be given more time to pay the balance amount.
Despite the fact that DDA accepted the recommendations of the second High Powered Committee, nothing happened till 1987. Several letters had been written by the appellant to DDA from 1984 to 1987 but no answer was forthcoming by the DDA. Vide a letter dated 1.12.1987, DDA informed the Appellant that their case for relaxing the provisions of Nazul Rules, 1981, to condone the delay for the payment of balance premium in installments was referred to the Govt. of India, Min. of Urban Development. Before the case was further examined by the Govt. of India, Min. of Urban Development, the appellant’s consent for making payment of balance amount of 75% premium within the period as may be fixed alongwith 18% interest charges p.a. on the belated payment was inquired. The letter further stated that the schedule of payment and conditions if any will be as per the directions issued by the Ministry of Urban Development, Govt. of India. It is, however, made clear that this letter does not carry any commitment. The appellant replied to the said letter on the same day giving their consent. The Central Government informed the DDA that the land auctioned to the appellant was not Nazul land and, therefore, the Central Government would have nothing further to do with the matter.
Meanwhile, the appellant filed Writ Petition No.2395 of 1990 in the Delhi High Court in which it claimed that persons similar to the appellant, namely, M/s. Ansal Properties and Industries Private Limited and M/s Skipper Tower Private Limited had been allowed to pay the balance 75% premium and were in fact allotted other plots. Pleading Article 14, the appellant stated that they were entitled to the same treatment. By a judgment and order dated 2.9.1993, the Delhi High Court held that as the auction was held as per terms and conditions of the auction, a dispute regarding the same is a matter of contract and cannot be gone into in proceedings under Article 226 of the Constitution. It was further observed that on facts, the Court found no force in the contention raised on behalf of the appellant regarding discrimination. An SLP against this order was also dismissed on 16.12.1993 by the Supreme Court stating that the appellant is at liberty to take whatever steps are permitted to the appellant under law to challenge forfeiture of earnest money, which had been done by a letter of 6.10.1993 which stated that consequent upon appellant’s failure to deposit the balance 75% premium and dismissal of C.W.P. No. 2395 of 1990 by the Hon’ble High Court, Delhi, the bid/ allotment of the said plot in your favour has been cancelled and earnest money deposited by appellant at the time of auction has been forfeited.
The appellant then filed a suit for specific performance and in the alternative for recovery of damages and recovery of the earnest amount. Shortly after the suit was filed, the DDA reauctioned the premises which fetched a sum of Rs.11.78 Crores. The learned Single Judge by a judgment and order dated 10.9.2007 dismissed the appellant’s suit for specific performance and damages but ordered refund of the earnest money forfeited together with 9% per annum interest. A Division Bench of the Delhi High Court set aside the judgment of the Single Judge holding that the forfeiture of the earnest money by the DDA was in order.

Contentions: Appellant contended that time may have been of the essence under the original terms and conditions of the auction. However, time had been extended on several occasions and, therefore, ceased to be of the essence. In answer to the letter dated 1.12.1987, the appellant promptly replied and said it would be willing to pay the entire 75% with 18% interest and, therefore, there was no breach of contract on the part of the appellant. Further, since the DDA sold the plot for 11.78 Crores, there was no loss caused to the DDA and, hence forfeiture of earnest money would not be in accordance with the agreement or in accordance with law.
DDA, rebutted these contentions and added that the case was covered by the judgment in Shree Hanuman Cotton Mills & Anr. v. Tata Aircraft Ltd., 1970 (3) SCR 127. Further that since the letter of 1.12.1987 had been issued under a mistake of fact, it would be void under Section 20 of the Contract Act and the said letter should, therefore, be ignored. If it is ignored, then the termination of the contract and the forfeiture of earnest money are completely in order as the appellant was in breach. The fact that the DDA ultimately sold the plot for a much larger sum, would be irrelevant inasmuch as the contractual term agreed upon between parties would entitle him to forfeit earnest money on breach without any necessity of proving actual loss.

Discussion:
I. The terms of the auction notice state that earnest money can be forfeited only in the case of default, breach, or non-compliance of any of the terms and conditions of the auction, or on misrepresentation by the bidder. It may be noted that the balance 75% which had to be paid within three months of the acceptance of the bid, was not insisted upon by the DDA. On the contrary, after setting up two High Powered Committees which were instructed to look into the grievances of the appellant, the DDA extended time at least twice. It is, therefore, very difficult to say that there was a breach of any terms and conditions of the auction, as the period of three months which the DDA could have insisted upon had specifically been waived. It is nobody’s case that there is any misrepresentation here by the bidder. Therefore, under the terms of the contract, without more, earnest money could not have been forfeited. Further, DDA specifically requested the appellant to give their consent to make the balance payable along with 18% interest charges on belated payment. This was on the footing that the Nazul Rules of 1981 would be relaxed by the Central Government. If, the Central Government was willing to condone the delay, DDA would be willing to take 75% of the outstanding amount along with 18% interest.
The argument that since the Central Government ultimately found that this was not a Nazul land, the letter was obviously based on a mistake of fact and would be void under Section 20 of the Contract Act was not accepted by the Court. Long after the Central Government informed DDA, DDA cancelled the allotment of the plot because the appellant had failed to deposit the balance 75%. DDA’s understanding, therefore, was that what was important was payment of the balance 75%.
Further, the argument that since the letter was “without prejudice” and since no commitment had been made, they were not bound by the terms of the letter was also not accepted. The letter was without prejudice and no commitment could have been given by the DDA because the Central Government may well not relax the Nazul Rules. On the other hand, if the Central Government had, later on, relaxed the Nazul Rules, DDA could not be heard to say that despite this having been done, DDA would yet cancel the allotment of the plot. That this could not have been done is clear because of the aforesaid construction of the letter and also because DDA is a public authority bound by Article 14 and cannot behave arbitrarily.

II. The Court held that Webb v. Hughes, V.C.M. 1870 would directly apply to the facts here. In that case, it was held:
“But if time be made the essence of the contract, that may be waived by the conduct of the purchaser; and if the time is once allowed to pass, and the parties go on negotiating for completion of the purchase, then time is no longer of the essence of the contract. But, on the other hand, it must be borne in mind that a purchaser is not bound to wait an indefinite time; and if he finds, while the negotiations are going on, that a long time will elapse before the contract can be completed, he may in a reasonable manner give notice to the vendor, and fix a period at which the business is to be terminated.”

The court affirmed therefore that the letter of cancellation and consequent forfeiture of earnest money was made without putting the appellant on notice that it has to deposit the balance 75% premium of the plot within a certain stated time. In the absence of such notice, there is no breach of contract on the part of the appellant and consequently earnest money cannot be forfeited.

The Court observed that Tilley v. Thomas, (1867 3 Ch.A 61) would not apply for the reason that the expression “without prejudice” was only used as stated above because the Central Government may not relax the Nazul Rules.

In Anandram Mangturam v. Bholaram Tanumal, ILR 1946 Bom 218, two separate judgments were delivered, one by Chief Justice Stone and the other by Chagla,J. as he then was. Stone C.J. held:-
“In my judgment, reading the correspondence as a whole, it at no stage passed from the melting pot of negotiations to crystallize as an agreement to extend the time for the performance of the contract. The attitude of the purchaser throughout the correspondence was: “Satisfy us that you are doing your best to obtain the goods from your suppliers and we will then consider fixing a new date for delivery of the goods to us”. On the other hand the attitude of the vendors throughout the correspondence was to avoid the purchaser’s demand and to simply say: “You know that we cannot effect delivery from our suppliers and until we do so we cannot deliver the goods to you”. There was never in my judgment any consensus ad-idem, no agreement, express or implied, to extend the time either to any particular date or to the happening of some future event. Mere forbearance in my opinion to institute proceedings or to give notice of rescission cannot be an extension of the time for the performance of a contract within the meaning of s. 63 of the Contract Act.”

Chagla, J. in a separate judgment held:-
“Under s. 55 of the Indian Contract Act, the promisee is given the option to avoid the contract where the promisor fails to perform the contract at the time fixed in the contract. It is open to the promisee not to exercise the option or to exercise the option at any time, but it is clear to my mind that the promisee cannot by the mere fact of not exercising the option change or alter the date of performance fixed under the contract itself. Under s. 63 of the Indian Contract Act, the promisee may make certain concessions to the promisor which are advantageous to the promisor, and one of them is that he may extend the time for such performance. But it is clear again that such an extension of time cannot be a unilateral extension on the part of the promisee. It is only at the request of the promisor that the promisee may agree to extend the time of performance and thereby bring about an agreement for extension of time.
Therefore it is only as a result of the operation of s. 63 of the Indian Contract Act that the time for the performance of the contract can be extended and that time can only be extended by an agreement arrived at between the promisor and the promisee.”

The Court observed that the aforesaid judgment would apply in a situation where a promisee accedes to the request of the promisor to extend time that is fixed for his
own benefit. Thus, in Keshavlal Lallubhai Patel and Ors. v. Lalbhai Trikumlal Mills Ltd 1959 SCR 213, this Court held:-
“The true legal position in regard to the extension of time for the performance of a contract is quite clear under s. 63 of the Indian Contract Act. Every promisee, as the section provides, may extend time for the performance of the contract. The question as to how extension of time may be agreed upon by the parties has been the subject-matter of some argument at the Bar in the present appeal. There can be no doubt, we think, that both the buyer and the seller must agree to extend time for the delivery of goods. It would not be open to the promisee by his unilateral act to extend the time for performance of his own accord for his own benefit.”

However, the Court observed that in the present case, the appellant is the promisor and DDA is the promisee. In such a situation, DDA can certainly unilaterally extend the time for payment under Section 63 of the Contract Act as the time for payment is not for DDA’s own benefit but for the benefit of the appellant.

The Court observed that the present case would be covered by two judgments of the Supreme Court. In Citi Bank N.A. v. Standard Chartered Bank, (2004) 1 SCC Page 12, this Court held:
“50. Under Section 63, unlike Section 62, a promisee can act unilaterally and may
(i) dispense with wholly or in part, or
(ii) remit wholly or in part,the performance of the promise made to him, or
(iii) may extend the time for such performance, or
(iv) may accept instead of it any satisfaction which he thinks fit.”

Similarly in S. Brahmanand v. K.R. Muthugopal, (2005) 12 SCC 764 the Supreme Court held:
“Thus, this was a situation where the original agreement of 10-3-1989 had a “fixed date” for performance, but by the subsequent letter of 18-6-1992 the defendants made a request for postponing the performance to a future date without fixing any further date for performance. This was accepted by the plaintiffs by their act of forbearance and not insisting on performance forthwith. There is nothing strange in time for performance being extended, even though originally the agreement had a fixed date. Section 63 of the Contract Act, 1872 provides that every promisee may extend time for the performance of the contract. Such an agreement to extend time need not necessarily be reduced to writing, but may be proved by oral evidence or, in some cases, even by evidence of conduct including forbearance on the part of the other party. [See in this connection the observations of this Court in Keshavlal Lallubhai Patel v. Lalbhai Trikumlal Mills Ltd., 1959 SCR 213 : AIR 1958 SC 512, para 8. See also in this connection Saraswathamma v. H. Sharad Shrikhande, AIR 2005 Kant 292 and K. Venkoji Rao v. M. Abdul Khuddur Kureshi, AIR 1991 Kant 119, following the judgment in Keshavlal Lallubhai Patel (supra).] Thus, in this case there was a variation in the date of performance by express representation by the defendants, agreed to by the act of forbearance on the part of the plaintiffs. What was originally covered by the first part of Article 54, now fell within the purview of the second part of the article. Pazhaniappa Chettiyar v. South Indian Planting and Industrial Co. Ltd. [AIR 1953 Trav Co 161] was a similar instance where the contract when initially made had a date fixed for the performance of the contract but the Court was of the view that “in the events that happened in this case, the agreement in question though started with fixation of a period for the completion of the transaction became one without such period on account of the peculiar facts and circumstances already explained and the contract, therefore, became one in which no time was fixed for its performance” and held that what was originally covered by the first part of Article 113 of the Limitation Act, 1908 would fall under the second part of the said article because of the supervening circumstances of the case.”

III. As regards the application of Article 14, the Court observed that T.P. Daver v. Lodge Victoria No. 363, S.C. Belgaum, 1964 (1) SCR 1, on which the Division Bench had relied was not an authority on Article 14 at all. It deals with clubs and the fact that rules or bye-laws which bind members of such clubs have to be strictly adhered to. On the other hand in ABL International Ltd. v. Export Credit Guarantee Corpn. of India Ltd., (2004) 3 SCC 553 at paras 22 and 23, the Supreme Court held:
“22. We do not think the above judgment in VST Industries Ltd. [(2001) 1 SCC 298 : 2001 SCC (L&S) 227] supports the argument of the learned counsel on the question of maintainability of the present writ petition. It is to be noted that VST Industries Ltd.[(2001) 1 SCC 298 : 2001 SCC (L&S) 227] against whom the writ petition was filed was not a State or an instrumentality of a State as contemplated under Article 12 of the Constitution, hence, in the normal course, no writ could have been issued against the said industry. But it was the contention of the writ petitioner in that case that the said industry was obligated under the statute concerned to perform certain public functions; failure to do so would give rise to a complaint under Article 226 against a private body. While considering such argument, this Court held that when an authority has to perform a public function or a public duty, if there is a failure a writ petition under Article 226 of the Constitution is maintainable. In the instant case, as to the fact that the respondent is an instrumentality of a State, there is no dispute but the question is: was the first respondent discharging a public duty or a public function while repudiating the claim of the appellants arising out of a contract? Answer to this question, in our opinion, is found in the judgment of this Court in the case of Kumari Shrilekha Vidyarthi v. State of U.P. [(1991) 1 SCC 212 : 1991 SCC (L&S) 742] wherein this Court held:
“The impact of every State action is also on public interest. … It is really the nature of its personality as State which is significant and must characterize all its actions, in whatever field, and not the nature of function, contractual or otherwise, which is decisive of the nature of scrutiny permitted for examining the validity of its act. The requirement of Article 14 being the duty to act fairly, justly and reasonably, there is nothing which militates against the concept of requiring the State always to so act, even in contractual matters.”
23. It is clear from the above observations of this Court, once the State or an instrumentality of the State is a party of the contract, it has an obligation in law to act fairly, justly and reasonably which is the requirement of Article 14 of the Constitution of India. Therefore, if by the impugned repudiation of the claim of the appellants the first respondent as an instrumentality of the State has acted in contravention of the abovesaid requirement of Article 14, then we have no hesitation in holding that a writ court can issue suitable directions to set right the arbitrary actions of the first respondent.”

The Court observed that based on the facts of this case, it would be arbitrary for the DDA to forfeit the earnest money on two fundamental grounds. First, there is no breach of contract on the part of the appellant as has been held above. And second, DDA not having been put to any loss, even if DDA could insist on a contractual stipulation in its favour, it would be arbitrary to allow DDA as a public authority to appropriate Rupees Seventy Eight Lakhs without any loss being caused. It is clear, therefore, that Article 14 would apply in the field of contract in this case and therefore the Supreme Court reversed the finding of the Division Bench on this aspect.

IV. As regards the reasoning which involves Section 74 of the Contract Act, the Court observed that Section 74 as it originally stood read thus:
“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, 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.”

By an amendment made in 1899, the Section was amended to read:
“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.
Explanation.—A stipulation for increased interest from the date of default may be a stipulation by way of penalty.
Exception.—When any person enters into any bail-bond, recognizance or other instrument of the same nature, or, under the provisions of any law, or under the orders of the Central Government or of any State Government, gives any bond for the performance of any public duty or act in which the public are interested, he shall be liable, upon breach of any condition of any such instrument, to pay the whole sum mentioned therein.
Explanation.—A person who enters into a contract with Government does not necessarily thereby undertake any public duty, or promise to do an act in which the public are interested.”
The Court observed that Section 74 occurs in Chapter 6 of the Indian Contract Act, 1872 which reads “Of the consequences of breach of contract”. It is in fact sandwiched between Sections 73 and 75 which deal with compensation for loss or damage caused by breach of contract and compensation for damage which a party may sustain through nonfulfillment of a contract after such party rightfully rescinds such contract. It is important to note that like Sections 73 and 75, compensation is payable for breach of contract under Section 74 only where damage or loss is caused by such breach.

In Fateh Chand v. Balkishan Das, 1964 SCR (1) 515, the Supreme Court held:
“The section is clearly an attempt to eliminate the somewhat elaborate refinements made under the English common law in distinguishing between stipulations providing for payment of liquidated damages and stipulations in the nature of penalty. Under the common law a genuine pre-estimate of damages by mutual agreement is regarded as a stipulation naming liquidated damages and binding between the parties: a stipulation in a contract in terrorem is a penalty and the Court refuses to enforce it, awarding to the aggrieved party only reasonable compensation. The Indian Legislature has sought to cut across the web of rules and presumptions under the English common law, by enacting a uniform principle applicable to all stipulations naming amounts to be paid in case of breach, and stipulations by way of penalty.

Section 74 of the Indian Contract Act deals with the measure of damages in two classes of cases (i) where the contract names a sum to be paid in case of breach and (ii) where the contract contains any other stipulation by way of penalty. We are in the present case not concerned to decide whether a covenant of forfeiture of deposit for due performance of a contract falls within the first class. The measure of damages in the case of breach of a stipulation by way of penalty is by Section 74 reasonable compensation not exceeding the penalty stipulated for. In assessing damages the Court has, subject to the limit of the penalty stipulated, jurisdiction to award such compensation as it deems reasonable having regard to all the circumstances of the case. Jurisdiction of the Court to award compensation in case of breach of contract is unqualified except as to the maximum stipulated; but compensation has to be reasonable, and that imposes upon the Court duty to award compensation according to settled principles. The section undoubtedly says that the aggrieved party is entitled to receive compensation from the party who has broken the contract, whether or not actual damage or loss is proved to have been caused by the breach. Thereby it merely dispenses with proof of “actual loss or damages”; it does not justify the award of compensation when in consequence of the breach no legal injury at all has resulted, because compensation for breach of contract can be awarded to make good loss or damage which naturally arose in the usual course of things, or which the parties knew when they made the contract, to be likely to result from the breach.”
Section 74 declares the law as to liability upon breach of contract where compensation is by agreement of the parties pre-determined, or where there is a stipulation by way of penalty. But the application of the enactment is not restricted to cases where the aggrieved party claims relief as a plaintiff. The section does not confer a special benefit upon any party; it merely declares the law that notwithstanding any term in the contract predetermining damages or providing 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. The jurisdiction of the court is not determined by the accidental circumstance of the party in default being a plaintiff or a defendant in a suit. Use of the expression “to receive from the party who has broken the contract” does not predicate that the jurisdiction of the court to adjust amounts which have been paid by the party in default cannot be exercised in dealing with the claim of the party complaining of breach of contract. The court has to adjudge in every case reasonable compensation to which the plaintiff is entitled from the defendant on breach of the contract. Such compensation has to be ascertained having regard to the conditions existing on the date of the breach.”

Similarly, in Maula Bux v. Union of India (UOI), 1970 (1) SCR 928, it was held:
“Forfeiture of earnest money under a contract for sale of property-movable or immovable-if the amount is reasonable, does not fall within Section 74. That has been decided in several cases :Kunwar Chiranjit Singh v. Har Swarup, A.I.R.1926 P.C.1; Roshan Lal v. The Delhi Cloth and General Mills Company Ltd., Delhi, I.L.R. All.166; Muhammad Habibullah v. Muhammad Shafi, I.L.R. All. 324; Bishan Chand v. Radha Kishan Das, I.D. 19 All. 49. These cases are easily explained, for forfeiture of a reasonable amount paid as earnest money does not amount to imposing a penalty. But if forfeiture is of the nature of penalty, Section 74 applies. Where under the terms of the contract the party in breach has undertaken to pay a sum of money or to forfeit a sum of money which he has already paid to the party complaining of a breach of contract, the undertaking is of the nature of a penalty. Counsel for the Union, however, urged that in the present case Rs. 10,000/- in respect of the potato contract and Rs. 8,500 in respect of the poultry contract were genuine pre-estimates of damages which the Union was likely to suffer as a result of breach of contract, and the plaintiff was not entitled to any relief against forfeiture. Reliance in support of this contention was placed upon the expression (used in Section 74 of the Contract Act), “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”. It is true that in every case of breach of contract the person aggrieved by the breach is not required to prove actual loss or damage suffered by him before he can claim a decree, and the Court is competent to award reasonable compensation in case of breach even if no actual damage is proved to have been suffered in consequence of the breach of contract. But the expression “whether or not actual damage or loss is proved to have been caused thereby” is intended to cover different classes of contracts which come before the Courts. In case of breach of some contracts it may be impossible for the Court to assess compensation arising from breach, while in other cases compensation can be calculated in accordance with established rules. Where the Court is unable to assess the compensation, the sum named by the parties if it be regarded as a genuine pre-estimate may be taken into consideration as the measure of reasonable compensation, but not if the sum named is in the nature of a penalty. Where loss in terms of money can be determined, the party claiming compensation must prove the loss suffered by him.
In the present case, it was possible for the Government of India to lead evidence to prove the rates at which potatoes, poultry, eggs and fish were purchased by them when the plaintiff failed to deliver “regularly and fully” the quantities stipulated under the terms of the contracts and after the contracts were terminated. They could have proved the rates at which they had to be purchased and also the other incidental charges incurred by them in procuring the goods contracted for. But no such attempt was made.”

In Shree Hanuman Cotton Mills and Anr. v. Tata Aircraft Limited, 1970 (3) SCR 127 it was held:
“From a review of the decisions cited above, the following principles emerge regarding “earnest”:
(1) It must be given at the moment at which the contract is concluded.
(2) It represents a guarantee that the contract will befulfilled or, in other words, ‘earnest’ is given to bind the contract.
(3) It is part of the purchase price when the transaction is carried out.
(4) It is forfeited when the transaction falls through by reason of the default or failure of the purchaser.
(5) Unless there is anything to the contrary in the terms of the contract, on default committed by the buyer, the seller is entitled to forfeit the earnest”
“The learned Attorney General very strongly urged that the pleas covered by the second contention of the appellant had never been raised in the pleadings nor in the contentions urged before the High Court. The question of the quantum of earnest deposit which was forfeited being unreasonable or the forfeiture being by way of penalty, were never raised by the appellants. The Attorney General also pointed out that as noted by the High Court the appellants led no evidence at all and, after abandoning the various pleas taken in the plaint, the only question pressed before the High Court was that the deposit was not by way of earnest and hence the amount could not be forfeited. Unless the appellants had pleaded and established that there was unreasonableness attached to the amount required to be deposited under the contract or that the clause regarding forfeiture amounted to a stipulation by way of a penalty, the respondents had no opportunity to satisfy the Court that no question of unreasonableness or the stipulation being by way of penalty arises. He further urged that the question of unreasonableness or otherwise regarding earnest money does not at all arise when it is forfeited according to the terms of the contract.
In our opinion the learned Attorney General is well founded in his contention that the appellants raised no such contentions covered by the second point, noted above. It is therefore unnecessary for us to go into the question as to whether the amount deposited by the appellants, in this case, by way of earnest and forfeited as such, can be considered to be reasonable or not. We express no opinion on the question as to whether the element of unreasonableness can ever be considered regarding the forfeiture of an amount deposited by way of earnest and if so what are the necessary factors to be taken into account in considering the reasonableness or otherwise of the amount deposited by way of earnest. If the appellants were contesting the claim on any such grounds, they should have laid the foundation for the same by raising appropriate pleas and also led proper evidence regarding the same, so that the respondents would have had an opportunity of meeting such a claim.”

In ONGC Ltd. v. Saw Pipes Ltd., (2003) 5 SCC 705, it was held:
“64. It is apparent from the aforesaid reasoning recorded by the Arbitral Tribunal that it failed to consider Sections 73 and 74 of the Indian Contract Act and the ratio laid down in Fateh Chand case [AIR 1963 SC 140: (1964) 1 SCR 515 at p. 526] wherein it is specifically held that jurisdiction of the court to award compensation in case of breach of contract is unqualified except as to the maximum stipulated; and compensation has to be reasonable. Under Section 73, when a contract has been broken, the party who suffers by such breach is entitled to receive compensation for any loss caused to him which the parties knew when they made the contract to be likely to result from the breach of it. This section is to be read with Section 74, which deals with penalty stipulated in the contract, inter alia (relevant for the present case) provides that 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, the party complaining of breach is entitled, whether or not actual 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. Section 74 emphasizes that in case of breach of contract, the party complaining of the breach is entitled to receive reasonable compensation whether or not actual loss is proved to have been caused by such breach. Therefore, the emphasis is on reasonable compensation. If the compensation named in the contract is by way of penalty, consideration would be different and the party is only entitled to reasonable compensation for the loss suffered. But if the compensation named in the contract for such breach is genuine pre-estimate of loss which the parties knew when they made the contract to be likely to result from the breach of it, there is no question of proving such loss or such party is not required to lead evidence to prove actual loss suffered by him.
67……..In our view, in such a contract, it would be difficult to prove exact loss or damage which the parties suffer because of the breach thereof. In such a situation, if the parties have pre-estimated such loss after clear understanding, it would be totally unjustified to arrive at the conclusion that the party who has committed breach of the contract is not liable to pay compensation. It would be against the specific provisions of Sections 73 and 74 of the Indian Contract Act. There was nothing on record that compensation contemplated by the parties was in any way unreasonable. It has been specifically mentioned that it was an agreed genuine pre-estimate of damages duly agreed by the parties. It was also mentioned that the liquidated damages are not by way of penalty. It was also provided in the contract that such damages are to be recovered by the purchaser from the bills for payment of the cost of material submitted by the contractor. No evidence is led by the claimant to establish that the stipulated condition was by way of penalty or the compensation contemplated was, in any way, unreasonable. There was no reason for the Tribunal not to rely upon the clear and unambiguous terms of agreement stipulating pre-estimate damages because of delay in supply of goods. Further, while extending the time for delivery of the goods, the respondent was informed that it would be required to pay stipulated damages.
68. From the aforesaid discussions, it can be held that:
(1) Terms of the contract are required to be taken into consideration before arriving at the conclusion whether the party claiming damages is entitled to the same.
(2) If the terms are clear and unambiguous stipulating the liquidated damages in case of the breach of the contract unless it is held that such estimate of damages/compensation is unreasonable or is by way of penalty, party who has committed the breach is required to pay such compensation and that is what is provided in Section 73 of the Contract Act.
(3) Section 74 is to be read along with Section 73 and, therefore, in every case of breach of contract, the person aggrieved by the breach is not required to prove actual loss or damage suffered by him before he can claim a decree. The court is competent to award reasonable compensation in case of breach even if no actual damage is proved to have been suffered in consequence of the breach of a contract.
(4) In some contracts, it would be impossible for the court to assess the compensation arising from breach and if the compensation contemplated is not by way of penalty or unreasonable, the court can award the same if it is genuine pre-estimate by the parties as the measure of reasonable compensation.”

The Court observed regarding the aforesaid thus:
It will be seen that when it comes to forfeiture of earnest money, in Fateh Chand’s case, counsel for the appellant conceded on facts that Rs.1,000/- deposited as earnest money could be forfeited.
Shree Hanuman Cotton Mills & Another which was so heavily relied by the Division Bench again was a case where the appellants conceded that they committed breach of contract. Further, the respondents also pleaded that the appellants had to pay them a sum of Rs.42,499/- for loss and damage sustained by them. This being the fact situation, only two questions were argued before the Supreme Court: (1) that the amount paid by the plaintiff is not earnest money and (2) that forfeiture of earnest money can be legal only if the amount is considered reasonable. Both questions were answered against the appellant. In deciding question two against the appellant, this Court held:-
“But, as we have already mentioned, we do not propose to go into those aspects in the case on hand. As mentioned earlier, the appellants never raised any contention that the forfeiture of the amount amounted to a penalty or that the amount forfeited is so large that the forfeiture is bad in law. Nor have they raised any contention that the amount of deposit is so unreasonable and therefore forfeiture of the entire amount is not justified. The decision in Maula Bux’s [1970]1SCR928 had no occasion to consider the question of reasonableness or otherwise of the earnest deposit being forfeited. Because, from the said judgment it is clear that this Court did not agree with the view of the High Court that the deposits made, and which were under consideration, were paid as earnest money. It is under those circumstances that this Court proceeded to consider the applicability of Section 74 of the Contract Act. (At page 143)”
From the above, it is clear that this Court held that Maula Bux’s case was not, on facts, a case that related to earnest money. Consequently, the observation in Maula Bux that forfeiture of earnest money under a contract if reasonable does not fall within Section 74, and would fall within Section 74 only if earnest money is considered a penalty is not on a matter that directly arose for decision in that case. The law laid down by a Bench of 5 Judges in Fateh Chand’s case is that all stipulations naming amounts to be paid in case of breach would be covered by Section 74. This is because Section 74 cuts across the rules of the English Common Law by enacting a uniform principle that would apply to all amounts to be paid in case of breach, whether they are in the nature of penalty or otherwise. It must not be forgotten that as has been stated above, forfeiture of earnest money on the facts in Fateh Chand’s case was conceded. In the circumstances, it would therefore be correct to say that as earnest money is an amount to be paid in case of breach of contract and named in the contract as such, it would necessarily be covered by Section 74.

The Court observed that it must, however, be pointed out that in cases where a public auction is held, forfeiture of earnest money may take place even before an agreement is reached, as DDA is to accept the bid only after the earnest money is paid. In the present case, under the terms and conditions of auction, the highest bid (along with which earnest money has to be paid) may well have been rejected. In such cases, Section 74 may not be attracted on its plain language because it applies only “when a contract has been broken”. In the present case, forfeiture of earnest money took place long after an agreement had been reached. It is obvious that the amount sought to be forfeited on the facts of the present case is sought to be forfeited without any loss being shown. In fact it has been shown that far from suffering any loss, DDA has received a much higher amount on re-auction of the same plot of land.

The Court, on a conspectus of the above authorities, stated the law on compensation for breach of contract under Section 74 to be as follows:-
1. Where a sum is named in a contract as a liquidated amount payable by way of damages, the party complaining of a breach can receive as reasonable compensation such liquidated amount only if it is a genuine pre-estimate of damages fixed by both parties and found to be such by the Court. In other cases, where a sum is named in a contract as a liquidated amount payable by way of damages, only reasonable compensation can be awarded not exceeding the amount so stated. Similarly, in cases where the amount fixed is in the nature of penalty, only reasonable compensation can be awarded not exceeding the penalty so stated. In both cases, the liquidated amount or penalty is the upper limit beyond which the Court cannot grant reasonable compensation.
2. Reasonable compensation will be fixed on well known principles that are applicable to the law of contract, which are to be found inter alia in Section 73 of the Contract Act.
3. Since Section 74 awards reasonable compensation for damage or loss caused by a breach of contract, damage or loss caused is a sine qua non for the applicability of the Section.
4. The Section applies whether a person is a plaintiff or a defendant in a suit.
5. The sum spoken of may already be paid or be payable in
future.
6. The expression “whether or not actual damage or loss is proved to have been caused thereby” means that where it is possible to prove actual damage or loss, such proof is not dispensed with. It is only in cases where damage or loss is difficult or impossible to prove that the liquidated amount named in the contract, if a genuine pre-estimate of damage or loss, can be awarded.
7. Section 74 will apply to cases of forfeiture of earnest money under a contract. Where, however, forfeiture takes place under the terms and conditions of a public auction before agreement is reached, Section 74 would have no application.

Held: The Court held that the Division Bench has gone wrong in principle. There has been no breach of contract by the appellant. Further, the Court did not accept the view of the Division Bench that the fact that the DDA made a profit from re-auction is irrelevant, as that would fly in the face of the most basic principle on the award of damages – namely, that compensation can only be given for damage or loss suffered. If damage or loss is not suffered, the law does not provide for a windfall. The Court restored the judgment and order of the Single Judge.

See the following judgment: M/s. Kailash Nath Associates v. Delhi Development Authority (Supreme Court of India, 2015)


Author: Vikrant Narayan Vasudeva
Photo by Hartwig HKD/ CC BY-ND 2.0

Advertisements