Liquidated Damages vs Penalty — Section 74 — KSLU Contract I Notes

Liquidated Damages & Penalty (Section 74)

A contract says “pay ₹1 lakh if you’re late.” Is that an honest pre-estimate of likely loss, or a threat to scare the other side into performing? English law polices the difference strictly; Indian law takes a simpler road — and knowing that road is worth easy marks.

A sum fixed in advance

Parties often fix, in the contract itself, the sum payable on breach. English law distinguishes:

Liquidated damages — a genuine pre-estimate of the likely loss (enforceable as fixed); and
Penalty — a sum fixed in terrorem (to frighten), disproportionate to the likely loss (not enforceable beyond actual loss).

A. The Indian position — Section 74.

Section 74 abolishes this distinction for enforcement. Where a sum is named in the contract as payable on breach (or a penalty is stipulated), the party complaining of breach is entitled to reasonable compensation not exceeding the amount named — whether or not actual damage is proved. So Indian courts award reasonable compensation up to the stipulated sum; the named figure is a ceiling, not an automatic entitlement (Fateh Chand v Balkishan Das; Maula Bux v Union of India).

B. Key points.

The court awards reasonable compensation, not necessarily the named sum.
The stipulated amount is the maximum.
Actual loss need not always be proved, but the compensation must be reasonable.
Forfeiture of a deposit/earnest money is tested the same way — only a reasonable amount may be retained.

Section 74, 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…, 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.”

In Simple Terms: in India it does not matter whether the fixed sum is called liquidated damages or a penalty — the court simply awards reasonable compensation, capped at the figure the parties named.

flowchart TD
    S74["Sum fixed for breach (s.74)"]
    S74 --> LD["English: liquidated damages (genuine pre-estimate) — enforced"]
    S74 --> PEN["English: penalty (in terrorem) — not enforced"]
    S74 --> IND["INDIA (s.74): no distinction — reasonable compensation NOT exceeding the named sum"]
    IND --> CAP["Named amount = ceiling; actual proof not always needed (Fateh Chand)"]

Case Laws

[C-11] Fateh Chand v Balkishan Das (1963) — under s.74 the court awards reasonable compensation not exceeding the stipulated sum, whether it is called penalty or liquidated damages.
Maula Bux v Union of India (1969) — where actual loss is difficult to prove, the named sum may guide reasonable compensation, but forfeiture must be reasonable.

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