Liquidated Damages V. Penalty: Are Causation and Loss Really Required?,

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Liquidated Damages v. Penalty
Are Causation and Loss Really Required?,

Pooja Sharma*
In a contract, the parties may name a sum to be payable in the event of breach. If such sum is a genuine pre estimate of loss it is termed liquidated damages, and if it bears no reflection on the loss suffered, it is termed a penalty. Courts are reluctant to enforce penalty clauses and in such cases the sum stipulated is normally reduced. It has been perceptively observed by Fansworth that in comparison to the bargaining power which parties enjoy in negotiating their substantive contractual rights and duties, their power to bargain over their remedial rights is surprisingly limited. They are not at liberty to name an extravagant sum having no relation
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Position in India
Statutory codification in India resulted in the elimination of one distinction between liquidated damages and penalties observed in English law. As per s. 74 of the Indian Contract Act, 1872 (hereinafter referred to as the Act) irrespective of whether the stipulation is by way of liquidated damages or penalty, the court is entitled to award reasonable compensation, not exceeding the amount named in the contract. As already pointed out, under English law only penalties may be reduced to reasonable compensation
The Act also provides illustrations of what may be considered penalties 75% interest in case of default on a bond normally carrying 12% interest , doubling the amount to be delivered . Indian decisions tend to follow and incorporate the principles laid down in English decisions. The leading text is replete with references to English decisions.
The Hon'ble Supreme Court has held that if the parties regard a sum as reasonable, the Court should not reduce it in its discretion. Where the clause is one for liquidated damages, there is no question of ascertaining damages and such a clause excludes the right to claim unascertained damages. A stipulation for payment of 1.5% per day on the value of goods in case of delay has been held to be a penalty. However, an additional charge of 1% per month in case of non-payment of bills was held not to be a penalty. Where the government would suffer loss which it would be unable to prove, a pre-estimate

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