Penalties under English law are contractual terms that are not enforceable in court due to their punitive existence. It has been recognized as a matter of English contract law since at least 1720 that if a clause in a contract contains a penalty, then the clause is impracticable by the parties. The test on what constitutes a penalty, however, has evolved over time. Most recently, the Supreme Court restated the rule on contractual damages in Cavendish Square Holding BV v Talal El Makdessi, and Parking Eye Ltd v Beavis co-joined appeals.
In England, the law applicable to contractual penalties has been developed entirely by common law judges without general statutory intervention. The Apex Court noted that the penalty law under British law is an old, improperly constructed framework that has not survived well.
Liquidated damages and penalty
In the event of a breach of contract, liquidated damages and/or penalties are payable. While the terms, penalties, and liquidated damages may sound similar, there is a clear line between them. In this report, we’ll look at the laws governing the liability available in the event of a contract violation.
If the parties to a contract indicate the amount of compensation owed in the event of a contract violation, would the Court then consider this sum as a damage measure? The English and Indian Laws approach this case differently. Let’s look at every single one:
According to English law, the specified amount can either be interpreted as liquidated damages or penalty.
Liquidated damages: If the number fixed by all parties is a true estimate of the loss resulting from a future breach of the contract, then the damages are liquidated. And all contracting parties accept that the sum is just compensation for the violation.
Penalty: If the amount fixed by all parties is unrealistic or used to compel the executing party to complete the procedure, it is a penalty. In such cases, the amount is ignored and the person suffering cannot claim more than the overall injury.
The Indian legal system fails to distinguish between liquidated and punishable loss or damage. The awarded compensation cannot increase the total set out in the contract. Following on from Section 74 under the Indian Contract Act, 1872, the Court shall not allow any more if the parties fix the damages. However, a smaller sum can be awarded, depending on the situation. The suffering party then gets fair compensation with no fine.
There is a derogation of Section 74 Which states that if a party concludes a contract with the State or Central Government for the administration of the act in the interest of the general public, then a breach of that contract renders the party liable for payment of the full amount specified in the contract.
How to distinguish between Liquidated Damages and Penalties?
Here are some guidelines for distinguishing between fine and liquidated damage:
- Unless the amount owed exceeds the possible loss on contract violation, then it is fine.
- When a contract specifies a payment due at a given date and an additional amount if a default happens, then the extra amount is a penalty. This is because there is little risk that a simple delay in payment would cause harm.
- Even if the contract defines a sum as ‘penalty’ or ‘loss,’ the Court must determine the facts of the case if the amount specified in it is a penalty or liquidated injury.
- The essence of the penalty is the compensation of the defaulting party’s money as a terroem. In comparison, liquidated damages are the true pre-estimation of the loss.
- Though English law varies between fine and liquidated damage, there is no such distinction in India. The Indian Courts concentrate on providing the injured party with a fair compensation which does not increase the maximum set out in the contract.
Other Remedies Available
Intriguingly, trying to claim damages isn’t the only solution for a contract breach. Here are a few other appropriate remedies available to those suffering:
- Contract recession: Rescission means revocation, cancellation, or abrogation of law, order, or contract. If one of the parties violates the contract, the other may treat the contract as rescinded. Also, he is discharged from all contractual obligations. In addition, he can claim damages, if any.
Illustration: On June 5th, 2019, Pathoj agreed to deliver 50 boxes of pizza to Dev. Dev agrees to pay Rs 25,000 for the same upon receipt. However, on the given date, Pathoj fails to deliver the pizza boxes. Dev is therefore absolved of his duty to pay the sum. Furthermore, he can claim compensation from another seller for the losses suffered in procuring the pizza boxes.
- Quantum Meruit: Quantum Meruit means a sensible amount of money paid to a person for services rendered if the quantity is not specified in a contract that is legally enforceable.
In such cases, the law gives rise to a promise of payment since the service rendered indicates an agreement between both parties. Quantum Merit covers a situation where the part has been performed by the party delivering the service, but not all of the work he was supposed to do and receives compensation for the worth of the work done. Two essential requirements must be met for the implementation of this rule:
- The contract shall be discharged
- The claim is made by the party which failed to default.
Quantum Meruit enables a party to account for the expense of the work performed or services provided, in simple terms. Although damages are compensatory in nature, Quantum Meruit is restitutory, because it is a fair remedy for remuneration provided by the implication of a contract.
In the following situations, an argument for the quantum meruit arises:
- When an agreement is deemed void or becomes void
- If a person does some tasks or delivers goods without ‘free of charge’ intention to do so.
- Where there is a contract to render services either express or implied, but no reference of remuneration is given.
- When one party fails to conclude a deal.
- The contract is separable, and the party that has not foreclosed has gained the portion-performance benefit.
- The contract is indivisible and is not appropriate for a lump sum but the performance. In such cases, the contracting party may claim the lump sum and the other party may deduct some amount for the bad work done.
- Specific Performance Suit: There are instances where injuries on breach of a contract are not an adequate remedy. In such cases, the Court may, in its discretion on a particular performance case, direct the defaulting party to fulfil the commitment according to the contract terms.
- Suit for an injunction: If a party has agreed not to vacuum a contract but refuses these terms, then the court may issue a restraining order to prevent the party from doing what it has agreed not to do.
Illustration: Pathoj is a well-known artist on youtube. He is signing a contract with the producer Dev. He agrees in the contract to work for him exclusively for the next 2 years. He does, nevertheless, enter into a contract with just another producer of Raybit, to act in his upcoming short Video. The Court may issue an injunction restraining Pathoj from continuing to work with any other producer.
According to Section 75 of Indian Contract Act 1872, According to this, if a party rightly revokes a contract, then he can seek compensation for any loss or damage suffered as a result of contract non – compliance.
Illustration- Pathoj is a drummer and concludes a contract with the owner of a nightclub, Ayush. Pathoj accepts to play at Ayush’s club every Friday and Saturday night, according to the contract. The deal is against a fee of 5,000 Rs per night for the next two months. Pathoj deliberately absents from the club on the fourth night, and Ayush revokes the deal. Ayush will seek liability for the loss suffered because of Pathos’s inability to fulfil his obligation, as he does so fairly.
In Fateh Chand v Balkishan Das, the apex Court stated that Section 74 declares the law to be liable on infringement of the contract where compensation is predetermined by agreement of the parties or where provision is made by way of penalty. However, the application of the enactment is not limited to cases where the aggrieved party claims relief as a plaintiff. The section does not confer a special benefit on any party to the proceedings. It merely declares that, notwithstanding any provision in the contract for the calculation of damages or deprivation of any property by way of penalty, the Court shall grant to the party aggrieved only fair compensation not exceeding the amount specified or the penalty stipulated.
The goal of these clauses is to encourage certainty, particularly in the case of commercial contracts. The parties to the contract should set such an amount in advance at the time of the contract, as it enables the estimation of risks; eliminates the complexity and cost of proving real injury or loss and encourages the recovery of damages.
This also prevents problems in the calculation, except when the effects of the breach can be ascertained and eliminate the possibility of under-compensation; otherwise, the party may not be able to recover indirect, cumulative damages through the remoteness law. It gives the promise assurance that he can confidently rely on the fulfilment of the promise.
We may infer the common comparison between them, after seeing the different provisions both under Indian law and English law. Yet not all of the discrepancies between liquidated losses and penalties are insignificant to the segment.
Firstly, its importance comes from the fact that the amount envisaged by the parties can only be reduced if it appears to be by way of punishment. Otherwise, the entirety can be recovered as liquidated damages.
Secondly, the word penalty is used in the first explanation to this section. It provides that a stipulation relating to increased interest from the default date may be a penalty stipulation. The Supreme Court’s decision in Chunilal V Mehta & Sons Ltd. v. Century Spg& Co Mfg. Ltd. reflects yet another shared feature between English common law and Indian law. Where it has been held that the right to claim damages under general law is necessarily excluded by providing for compensation in express terms.
 UKSC 67
(1964) 1 SCR 515
AIR 1962 SC 1314