Liquidated Damages in Construction Contracts: Legal Principles and Evolving Jurisprudence

A clause for liquidated damages is a distinctive feature of construction Contract which entitles the employer to deduct from the amount payable to the Contractor, certain pre-estimated amount stipulated in the Contract, in the event of breach of Contract by the Contractor. Liquidated damages are governed by Section 74 of the Contract Act, 1872 [“the Act”]. This article discusses the evolving jurisprudence regarding enforceability of the liquidated damage clause and the principles applied to adjudicate a claim for recovery of liquidated damages [“LD”].

Claim for Damages under Section 73 and 74 of Contract Act

Section 73 of the Contract Act provides a statutory remedy for claiming compensation in the event of breach of Contract. It is grounded on the principle that the innocent party is entitled to be compensated from the party that has breached the contract. A claim for compensation under Section 73 of the Contract Act is governed by general principles for claiming compensation viz.

Breach of Contract
Proof of loss suffered by the party which suffered breach
Mitigation of losses by the party which suffered the breach

When Court is satisfied with the aforesaid conditions, the innocent party shall be entitled to compensation. It is pertinent to mention that mere breach of contract will not automatically result in the payment of damages unless a party is able to show that such loss or damage had arisen naturally in the usual course of things from such breach and that the breach must necessarily be coupled with some loss or damage, which resulted in an actionable claim for damages¹. Therefore, in order to seek compensation, it is essential to prove losses, in absence of which, Court would not be inclined to award damages.

Section 74 of the Contract Act, on the other hand, adds a nuance to a claim for compensation by pre-estimating the amount of damages that the party, which suffered the breach, would be entitled to receive, as opposed to a claim for compensation under Section 73 wherein the Court would have to adjudicate the amount of loss that can be awarded to a party upon examination of evidence in support thereof. Furthermore, Section 74 of the Contract Act, unlike Section 73, stipulates that a party would be entitled to the pre-estimated amount stipulated in the Contract “whether or not actual damage or loss is proved”. A plain reading of Section 74 suggests a deviation from the foundational principle under Section 73 viz. proof of damages is sine qua non for claiming damages.

Proof of Loss vis-à-vis claim for Liquidated Damages under Section 74

A claim for liquidated damages hinges upon the interpretation of the expression “whether or not actual damage or loss is proved” envisaged in Section 74 of the Contract Act. The interpretation of the above expression first fell for consideration before the Constitution Bench of the Supreme Court in the matter of Fateh Chand vs Balkishan Das² wherein the Supreme Court held that the expression merely dispenses with the proof of actual loss or damages; it does not justify the award of compensation when in consequence of breach no legal injury at all has resulted because compensation in result of breach can be awarded to make good loss or damage.

Subsequently, a three judge bench of the Supreme Court in Maula Bux vs Union of India³ held that the expression “whether or not actual damage or loss is proved” is intended to cover a different classes of Contract viz. Contracts wherein it is impossible for the court to assess compensation arising out of breach, in which event, the Court would award the liquidated damages mentioned in the contract provided they are pre-estimated and genuine. The Court, however, reiterated that where loss in terms of money can be determined, it is incumbent upon a party claiming compensation to prove losses suffered by him. In the aforesaid case the Government had forfeited the security deposit pursuant to termination of the Agreement due to breach of the Appellant. The Supreme Court observed that it was possible for the UOI to prove losses, however, it did not even attempt to do so and justified the forfeiture by placing reliance on Section 74. Due to failure to prove losses, when it was possible to do so, the Supreme Court held that the forfeiture of security deposit was not justified and directed the Union to refund the forfeited amount along with interest.

In Oil & Natural Gas Corporation vs Saw Pipes Ltd.⁴ an Arbitral Award was passed inter alia holding that in order to recover liquidated damages it was for the Appellant to establish that it has suffered breach. In absence of evidence of losses, the Arbitrator held that the Appellant was wrong to recover the liquidated damages. The said award was challenged on the premise that under Section 74, the party is not required to prove actual loss or damage and the Court can award pre-estimated damages mentioned in the Contract. The Supreme Court found that in the Contract between the parties it was not possible to prove exact loss or damage suffered by ONGC and in such an event the pre-estimated sum mentioned in the contract, which was genuine, and not by way of penalty, could be awarded to ONGC especially when the Respondent failed to lead evidence to establish that the pre-estimated sum was by way of penalty or in any way unreasonable.

In Kailash Nath Associates vs Delhi Development Authority⁵ the Supreme Court cemented the position of law vis-à-vis Section 74 of the Contract Act after a conspectus of various case laws on the issue. The Court categorically held that proof of damage or loss caused is a sine qua non for the applicability of Section 74 and reiterated that the expression “whether or not actual damage or loss is proved” 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 then the liquidated amount mentioned in the contract can be awarded, provided it is genuine pre-estimate and not by way of penalty.

What is “Stipulation by way of Penalty”

Another prong of Section 74 is the expression “stipulation by way of penalty” in which case the court, as held in Fateh Chand (supra), cannot enforce the penalty clause and only award reasonable compensation. The Section does not explain what constitutes stipulation by way of penalty, however, the constitution bench in Fateh Chand (supra) clarified that forfeiture of money paid under the contract, as a consequence of breach would amount to stipulation by way of penalty and attract section 74 of the Act. The same was further clarified by the Supreme Court in Kailash Nath (supra). Therefore, the compensation awarded in such cases is only reasonable compensation not exceeding the amount or penalty stipulated. Recently, the Supreme Court in BPL Limited vs Morgan Securities and Credits Pvt. Ltd⁶, explicated clause for “penalty” and “liquidated damages” as follows-

“84. Section 74 of the Indian Contract Act explicitly bars any liquidated damages to be paid which is in the nature of penalty. However, the Act does not define “penalty”. A clause is considered to be in the nature of penalty if it provides for “a payment of money stipulated as in terrorem of the offending party” (Dunlop Pneumatic Tyre Co. Ltd. v. New Garage & Motor Co. Ltd. (1915) AC 79) or, if the clause’s contractual nature is “deterrent rather than compensatory”. On the other hand, a clause is said to be one of liquidated damages if it is a genuine endeavour by the parties to stipulate the loss arising out of the breach in advance. The nature of the clause would also depend on its construction and the encompassing circumstances during the time of entering into the contract or at the time of doing the material variation in the contract. “

The difference between pre-estimated loss named in the contract and stipulation by way of penalty is that, in case of the former, if the court is unable to assess the damage or it is impossible for the court to assess the damage, then the court would be obliged to award the genuine pre-estimated amount of loss as mentioned in the contract as reasonable compensation. However, in case of the latter i.e. when the contract provides stipulation by way of penalty, the court will not enforce the penalty clause as held in Fateh Chand (supra) and will only award reasonable compensation that it deems fit. In both the cases, the liquidated amount or penalty mentioned in the contract is the upper limit beyond which the court cannot grant reasonable compensation.

Misapplication of the ratio laid down in ONGC vs Saw Pipes

In Saw Pipes (supra) the Supreme Court rendered the following finding with respect to Section 74 of the Contract Act

“64…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. Burden is on other party to lead evidence for proving that no loss is likely to occur by such breach” (emphasis supplied)

The aforementioned paragraph is often quoted by the parties pressing for enforcement of the LD clause in the contract, arguing that no loss whatsoever is required to be proved in case the LD is genuine pre-estimate, in view of the above finding of the Court. However, it is pertinent to note that the in the subsequent paragraph, the Court categorically observed that in the present case it is difficult to prove exact loss and in the such a case the LD mentioned in the Contract can be awarded if it is genuine pre-estimate and not by way of penalty-

“67…Similarly in the present case, delay took place in deployment of rigs and on that basis actual production of gas from platform B-121 had to be changed. It is undoubtedly true that the witness has stated that redeployment plan was made keeping in mind several constraints including shortage of casing pipes. Arbitral Tribunal, therefore, took into consideration the aforesaid statement volunteered by the witness that shortage of casing pipes was only one of the several reasons and not the only reason which led to change in deployment of plan or redeployment of rigs Trident-II platform B-121. 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 party who has committed breach of the contract is not liable to pay compensation.”(emphasis supplied)

In Maula Bux (supra) and Kailash Nath (supra) the Supreme Court categorically held that where it is possible to prove damages, it is incumbent upon the party to prove damages in absence of which losses cannot be awarded, for law does not provide for a windfall. Decades ago, the Constitution bench of the Supreme Court in Fateh Chand (supra) held that the expression “whether or not actual damage or loss is proved” envisaged in Section 74 of the Contract Act merely dispenses with the proof of actual loss or damages; it does not justify the award of compensation when in consequence of breach no legal injury at all has resulted because compensation in result of breach can be awarded to make good loss or damage. The aforesaid judgment is still a good law and rendered by a larger bench as opposed to the findings rendered by a Division Bench of the Supreme Court in Saw Pipes (supra). Section 74 would only come in operation when the party seeking enforcement of LD clause proves that in the case before court it is impossible to prove damages and the court finds that the amount stipulated in the Contract is genuine pre-estimate, and not by way of penalty.

A holistic reading of the ratio laid down in Saw pipes (supra) postulates that the Court enforced the LD clause in the Contract because in the said case it was not possible to assess damages and the LD amount stipulated in the contract was genuine and not by way of penalty. Admittedly, a paragraph can be read in isolation to suggest that the Court in the aforesaid case held that there is no requirement to prove losses at all in case LD amount is stipulated in the Contract. If such a reading of the aforesaid judgment is pressed into service then it would be against the very foundational tenets of law on compensation viz. proof of loss is sine qua non for claiming damages. Not to mention it would also be against the Constitution Bench judgment of the Supreme Court in Fateh Chand (supra).If liquidated damages are awarded even when the party has not suffered any loss, it would amount to unjust enrichment which cannot be countenanced and has to eschewed⁷. It is settled law that a judgment cannot be read as a statute, completely divorced from the context⁸.

The true essence and interpretation of the law laid down in Saw Pipes (supra) was succinctly captured by the Division Bench of Delhi High Court in the matter of Vishal Engineers & Builders vs Indian Oil Corporation Ltd⁹. In the aforesaid case the Contractor/Appellant completed works beyond the stipulated period of time as a consequence of which liquidated damages were recovered by the Respondent in terms of the Agreement. The dispute was referred to the Arbitrator who upheld the imposition of LD by relying upon the ratio laid down in Saw Pipes (supra)and inter alia held that losses were not capable of being proved and in such a case the liquidated damages become automatically payable. Section 34 filed by the Appellant challenging the Award was dismissed which led to filing of Appeal before Division Bench, which interpreted the law laid down in Saw Pipes (supra) as follows-

“22. Now turning to some of the latter judgements of the Supreme Court including the judgement in ONGC v. Saw Pipes Ltd. case (supra) relied upon by the learned single Judge. All that was said was that the court was competent to award a reasonable compensation in case of breach even if no actual damage is proved to have suffered in consequence of the breach of contract as in some contracts it would be impossible for the court to assess compensation arising from the breach. If the compensation contemplated is not by way of penalty or unreasonable the court can award the sum if it is a genuine pre-estimate of the loss to be suffered by a party as a measurement of reasonable compensation.

23.In our view these observations have to be read in the context of the pronouncement of the Constitution Bench pronouncement in Fateh Chand case (supra). If it is so, all that it implies is that where it is impossible to assess the compensation arising from breach and that factor is coupled with the parties having agreed to a pre-determined compensation amount not by way of penalty or unreasonable compensation then that amount can be awarded as a genuine pre- estimate of the loss suffered by a party. It cannot be read to mean that even if no loss whatsoever is caused to party it can still recover amounts merely by reason of the opposite party being in breach.”

26.We have thus no hesitation in concluding that if there was absence of any loss whatsoever, an aggrieved party cannot claim that it is still entitled to liquidated damages without, at least, proving a semblance of loss.” (emphasis supplied)

Therefore, the Division Bench of the High Court set aside the Award by awarding a refund of the LD amount to the Appellant along with interest.

If it is not possible to prove actual loss, the fact that some loss was suffered, has to be established

In Indian Oil Corporation vs Lloyds Steel Industries Ltd.¹⁰, the Delhi High Court was hearing a Section 34 Petition, challenging an Arbitral Award whereby the Arbitrator had held that the imposition of liquidated damages by the Petitioner for delay in execution of works by the Respondent, was not justified. The Court observed that since the Petitioner has not suffered any losses, it would be preposterous on the part of the Petitioner to submit that it should get the liquidated damages stipulated in the contract even when no loss is suffered. The Court further observed that Section 74 exempts party to prove actual loss only when it is difficult to prove losses, however, the basic requirement for award of compensation, that some loss was suffered, has to be established.

In Bharat Heavy Electricals Ltd. vs Kanohar Electricals Ltd.¹¹, the Division Bench of Delhi High Court was dealing with an Arbitral Award wherein inter alia the claim of refund of LD had been allowed by the Arbitrator on the ground that no loss was proved by the Appellant. The Court refused to interfere with the Award as the Appellant failed to prove losses and reiterated that Section 74 does not relieve the aggrieved party from proving that it had suffered a legal injury and a claim for compensation cannot be entertained unless the aggrieved party establishes that it suffered some loss or damage.

In Union of India vs M/s Krishna Constructions Company¹², the Petitioner terminated the contract awarded to the Respondent alleging delayed progress of work and forfeited the Performance Bank Guarantee in terms of the Contract. The Respondent/Contractor invoked Arbitration and submitted inter alia claim for refund of PBG. The Arbitrator inter alia held that although the termination of the contract by Union was legal, however, it cannot be allowed to forfeit the bank guarantee as it failed to establish it had suffered any loss due to delay by Respondent. In Section 34 proceedings, the Petitioner/Union relied upon Saw pipes (supra) to argue it was not required to prove losses. The Delhi High Court upheld the finding rendered by the Arbitrator viz. although the extent of loss or damage is not required to be proven, the fact that loss or damage has been suffered must be established, even to claim liquidated damages or penalty. The Court further held that the law laid down in Saw Pipes (supra) must be read in the context of Fateh Chand (supra) and cannot be interpreted to mean that a breach is compensable in damages, even if no loss is shown to have been suffered.

At this juncture it is also pertinent to discuss the recent judgment of Supreme Court in the matter of Consolidated Construction Consortium Ltd. vs Software Technology Parks of India¹³. The Appellant was awarded works for construction of office building, by the Respondent. There was delay of about 10 months in completion of the works. The Respondent granted extension of time to the Appellant, however, while granting each extension, the Respondent reserved its right to levy liquidated damages upon the Appellant in terms of the Contract. Consequently, due to delay in completion of project, the Respondent recovered certain amount as liquidated damages. Appellant invoked arbitration proceedings wherein it inter alia sought refund of the LD amount deducted by the Respondent. However, the Arbitral Tribunal, returned a categoric finding that the Appellant caused delay in execution of works and the LD deducted by the Respondent was reasonable compared to the losses suffered by the Respondent. Therefore, the claims of the Appellant were rejected. Appellant challenged the award under Section 34 wherein the Court set aside the Arbitral Award. Respondent Appealed before the Division Bench under Section 37, which allowed the appeal, upholding the LD deducted by the Respondent. Appellant impugned the aforesaid order in Appeal before Supreme Court. The Supreme Court observed that the single judge under Section 34 erred in interfering with the award as the view taken by the Arbitrator was a plausible view. Due to limited scope of Section 34, the Court held that the Award could not be interfered with. Consequently the Appeal was dismissed.

A bare perusal of the judgment suggests that the Supreme Court has validated deduction of LD amount in case of delay by Contractor, provided each time the extension of time is granted by the employer, the employer reserves his right to levy LD. However, it is pertinent to note that in this case, the Supreme Court has not expounded upon the position of law on liquidated damages, emanating from Fateh Chand (supra). All that the Supreme Court has done is apply the limited scope of Section 34 of the Arbitration Act, 1996 to the Award rendered by the Arbitrator. The Ld. Arbitrator had returned categoric findings that-

The Appellant/Contractor has caused delay in execution of works.
The Respondent/employer had produced evidence to establish losses.
The LD levied by the Respondent was reasonable compared to the losses suffered by the Respondent.

It is settled law that the an Arbitrator is the master of quality and quantity of evidence and has the last word on facts and law. If a view is taken by an Arbitrator is a plausible view, the same cannot be interfered with by Court under Section 34 proceedings¹⁴. Finding of delay is finding of fact which court will not interfere with under Section 34 proceedings¹⁵. Therefore, the Supreme Court correctly observed that since the view taken by the Ld. Arbitrator was a plausible view, the same did not require any interference.

Even otherwise, if the facts of the aforesaid case are tested from the lens of Section 74 of the Contract Act. It is pertinent to note that this is not a case wherein the Respondent/Employer levied LD upon the Contractor without proving any losses whatsoever. This is a case wherein the Respondent proved losses, if not actual, but endeavoured to prove losses by placing material on record and the Ld. Arbitral Tribunal, after perusing the record returned a finding that losses were in fact suffered by the Respondent due to delays caused by the Appellant. Therefore, the conditions for invoking Section 74 were fulfilled, viz.

Proof of loss;
Pre-estimated amount stipulated in the contract which was genuine as observed by the Ld. Arbitral Tribunal.

Therefore, this was a fit case for awarding liquidated damages to the Respondent.

From a conspectus of the aforesaid judgments, it emerges that in order to claim the liquidated amount or genuine pre-estimated damages, as stipulated in the contract, the party must satisfy the following aspects to the court-

There was a breach of contract.
The losses suffered by the party due to the breach are impossible to prove.
The party must prove some losses, if unable to prove actual loss.
The pre-estimated amount of damages as mentioned in the contract is genuine and not by way of penalty.

When the aforementioned conditions are satisfied, the would be inclined to award liquidated damages as mentioned in the contract. In other cases i.e. wherein it is possible to prove damages, then the party cannot be dispensed with the burden to prove losses for claiming liquidated damages. As observed by the Supreme Court in Kailash Nath (supra) compensation can only be given for damage or loss suffered. If damage or loss is not suffered, law does not provide for a windfall.

Adjudication of breach/delay, precedes imposition of Liquidated Damages. Whether the other party committed breach cannot be decided by party alleging breach

In State of Karnataka vs Shree Rameshwara Rice Mills¹⁶ the Supreme Court held that adjudication upon the issue relating to a breach of condition of contract and adjudication of assessing damages arising out of the breach are two different and distinct concepts and the right to assess damages arising out of a breach would not include a right to adjudicate upon as to whether there was any breach at all.

In Bharat Sanchar Nigam Ltd. vs Motorola India Pvt. Ltd.¹⁷, clause 15.2 obligated the Respondent/Contractor to pay liquidated damages in the event of delay in delivery. Clause 16.2 on the other hand entitled the Appellant/Employer to recover liquidated damages in the event the Respondent causes delay. The aforesaid clause further stipulated that the quantum of LD assessed and levied by the Appellant/Employer shall be final and binding. The Appellant alleged that the Respondent caused delay and therefore imposed LD upon the Respondent in terms of clause 16.2 of the Contract. The Supreme Court observed that as per clause 16.2 what is made final and binding is quantum of LD to be imposed upon the Respondent and not fixing of liability as to which party caused delay. Therefore, court held that before LD can be imposed it is necessary to first adjudicate which party caused delay and fix liability. Fixing of liability is primary, while the quantification, which is provided for under clause 16.2 is secondary to it. The Appellant argued that as per clause 16.2 it has unilateral right to determine and impose LD. However court refused to entertain that argument and observed that if such a contention is accepted then a party would be liable to pay damages of whatever amount the other party demands which would be in violation of Section 28 and 74 of Contract Act.

In J.G. Engineers vs Union of India¹⁸ the Respondent/Employer terminated the contract and imposed LD on the Contractor/Appellant for allegedly causing delay in execution of works. Clause 2 of the Contract empowered the Engineer to impose LD on the Contractor for failing to adhere to the time schedule. The Clause further stipulated that the amount of compensation payable by the Contractor in such an event shall be decided by the Engineer whose decision shall be final. Supreme Court held the aforesaid clause does not make the decision regarding which party caused delay, final. What is made final is the decision regarding consequential issues relating to quantification of LD. The Supreme Court placed reliance on BSNL vs Motorola (supra) and categorically observed that whether the other party committed breach cannot be decided by the party alleging breach. A Contract cannot provide that one party will be arbiter to decide whether he committed breach or the other party committed breach. That question can only be decided by only an adjudicatory forum, i.e. a Court or an Arbitral Tribunal. The Arbitrator in the aforesaid case had returned finding that it was the Respondent who caused delay and therefore it was not entitled to impose LD on the Contractor. Therefore, Supreme Court did not find any reason to interfere with the Award.

In Aditya and Rashmi Construction Pvt. Ltd. vs State of Jharkhand & Ors.¹⁹, the Division Bench of Jharkhand High Court was dealing with a Writ Petition seeking quashing of letter issued by the Respondent, terminating the Contract awarded to the Petitioner for construction of Bridge. The Respondent also imposed liquidated damages on the Petitioner for causing delay in construction. The Petitioner argued that the delay was entirely attributable to the Respondent and in absence of determination as to which party was responsible for delay, the imposition of LD by the Respondent was illegal and arbitrary. The High Court returned finding that it was in fact Respondent which caused delay in execution of works and placed reliance upon Rameshwara Rice Mills and J.G. Engineers (supra) to hold that whether either of the parties were responsible for committing breach of terms of Contract has to be adjudicated by a Court or Tribunal and it cannot be decided unilaterally by one of the parties to the Contract. In view of the above, the Court allowed the Petition and quashed the letter issued by Respondent terminating the Contract and also set aside the LD imposed by the Respondent.

Liquidated Damages cannot be imposed on the Contractor when delay in execution of works is attributable to the Employer

In J.G. Engineers vs Union of India²⁰ the Respondent/Employer terminated the contract and imposed LD on the Contractor/Appellant for allegedly causing delay in execution of works. The Supreme Court, upon perusal of record and the Award rendered by the Arbitrator, observed that it was the Appellant which was responsible for delay in execution of works and not the Respondent/Contractor. Court held that once the Arbitrator had recorded the finding that the Contractor was not responsible for the delay and that the termination was wrongful, the question of Respondents claiming levy of liquidated damages or extra expenditure incurred for completion of balance works at Risk and Cost of the Contractor, does not arise. Similarly, in Aditya and Rashmi Construction (supra) the Division Bench of Jharkhand High Court observed that when the delay was entirely attributable to the Respondent/Employer, the action of the Respondent for terminating the Contract and demanding liquidated damages from the Petitioner was illegal.

In Oil & Natural Gas Corporation Ltd. vs Astra Construction²¹, the Gauhati High Court was adjudicating Section 37 Petition wherein the Petitioner had awarded works to the Respondent which could not be completed within the stipulated period of time and were completed by the Respondent/Contractor within the extended period of time granted by the Contractor. Each extension application filed by the Respondent seeking extension alleged delay entirely attributable to the Petitioner. However, the Petitioner recovered liquidated damages from the Respondent for failing to complete the works within the stipulated period. The Respondent invoked arbitration inter alia seeking refund of the LD amount. The Arbitrator inter alia returned finding that the delay was entirely attributable to the Petitioner and thus LD imposed was illegal. The Award was rendered in favour of the Respondent and Section 34 filed by the Petitioner assailing the Award was dismissed leading to filing of Section 37 Petition in Appeal. The High Court observed that the delay in execution of works was in fact substantially attributable to the Respondent and the Arbitrator was correct in holding that when delay was attributed to the Respondent, the LD imposed was unjustified. The High Court also justified the award rendered by the Arbitrator to the extent of overheads and price escalation awarded, despite restrictive clauses present in the Agreement, drawing sustenance from the ratio laid down in General Manager, Northern Railway & Anr. vs Sarvesh Chopra²².

In Rajasthan Urban Infrastructure Development Project vs M/s National Builders, Baroda C.B.²³, the Division Bench of Rajasthan High Court was hearing a Section 37 Petition wherein the Appellant had awarded works to the Respondent for widening and strengthening of road. The work prolonged beyond the stipulated period and extension of time was granted by the Appellant subject to imposition of liquidated damages in terms of contract. The Respondent referred disputes to arbitrator who inter alia awarded refund of the LD amount recovered by the Appellant. Section 34 filed by the Appellant was dismissed, leading to filing of Section 37 Petition. The High Court observed that out of 463 days delay in completion of work, delay of 458 days was attributable to the Appellant/Employer and in such circumstances the imposition of liquidated damages by the Appellant, was rightly set aside by the Arbitrator.

When time for performance of Contract is set at large, the Employer cannot claim Liquidated damages

In M/s URC Construction (P) Ltd. vs M/s Airport Authority of India²⁴ the Madras High Court was adjudicating Section 34 Petition wherein the Respondent had awarded works to the Petitioner for construction of Metro station at Chennai Airport. The Petitioner/Contractor could not complete the work within the stipulated period of 14 months and submitted applications for extension of time to the Respondent. The Respondent granted 20 extensions of time to the Petitioner for completing the works and while granting each extension, the Respondent reserved its right to recover liquidated damages. It is also pertinent to note that the extension granted by the Respondent were provisional in nature. Consequently, the Respondent imposed LD on the Contractor for failing to complete the project within stipulated time. The Petitioner invoked Arbitration inter alia seeking refund of LD which was awarded by the Arbitrator. The Petitioner/Contractor challenged the award to the extent of rejection of its other claims and the Respondent also mounted a separate challenge under Section 34.

The Court upheld the finding of the Arbitrator that the parties by their very conduct set the time at large viz. the Respondent/Employer instead of granting extensions of time under the relevant clause of the Agreement, granted provisional extensions and the Petitioner/Contractor accepted such extensions and continued to work. The parties by their very conduct departed from contractual mechanism and procedure for extension of time. Therefore, the court observed that since time was set at large by the conduct of the parties and completion of work not merely progress of work was substantially delayed, the withholding of amount by way of liquidated damages by the Respondent/Employer was invalid. The Arbitral Tribunal had held that the Petitioner would be entitled to the refund of the aforesaid amount along with interest computed from the date of reference to the Tribunal. However, the High Court held that this finding of AT, on interest, is erroneous and the Petitioner is entitled to interest on the aforesaid amount from the date the amount was withheld by the Respondent/Employer.

In Arosan Enterprises Ltd. vs Union Of India²⁵ the Supreme Court discussed factual circumstances which can be interpreted to discern that parties by their very conduct gave a go-by to the original timelines stipulated in the contract. The Court observed that extension of time should be sought very categorically by the Contractor and not in a vague and casual manner. In the event the Employer grants extension beyond the original period mentioned in the Contract, there must be a future date mentioned for completion of the Contract. If the Employer does not mention a future date for completion of Contract and the Contractor carries on with the performance of Contract beyond the original stipulated date, then the Court would be constrained to give a finding that the parties by their very conduct, gave a go-by to the original timeline, setting time at large.

Liquidated Damages cannot be imposed retrospectively

In J.G. Engineering (supra) the timeline for completion of project was till 09.01.1995, however due to alleged delay by Contractor/Appellant, the Respondent terminated the Contract on 14.03.1995. It is pertinent to note that during execution of Contract and up till the termination, the Respondent did not impose liquidated damages upon the Contractor/Appellant. However, only when the Contractor submitted its claims to the Arbitrator on 17.04.1997, , the Respondent levied liquidated damages on the Contractor on 30.09.1999, for the period 10.01.1995 to 14.03.1996. The Supreme Court observed since the Respondent granted extensions of time to the Contractor without levy of liquidated damages, and in view of the finding of the Arbitrator that the Contractor did not cause any delay, the Respondent could not have retrospectively levied liquidated damages upon the Contractor.

If the Employer fails to impose Liquidated Damages in the initial Extension of time, then the Employer cannot levy Liquidated Damages while granting subsequent Extension of Time to the Contractor.

In Welspun Speciality Solutions Ltd. vs Oil and Natural Gas Corporation²⁶ the Respondent/Employer had awarded contract to the Appellant for supply of pipes. Respondent granted various extensions of time to the Appellant who satisfied the contract within the extended time period. It is pertinent to note that for the first two extensions granted to the Appellant, the Respondent did not impose liquidated damages for delay in completion of project. However, for subsequent extension, the Respondent imposed liquidated damages upon the Appellant who invoked the Arbitration proceedings inter alia seeking refund of the Ld. amount. The Arbitral Tribunal held as follows-

Time was not the essence of contract as the Contract contained provisions for Extension of time and liquidated damages.
Since time was not the essence of Contract, the liquidated damages as stipulated in the contract cannot be awarded. Compensation has to be awarded on the basis of actual loss.
ONGC would not be entitled to losses incurred which it incurred during the extended period wherein it waived right to levy liquidated damages.

Therefore, the Arbitral Tribunal held that ONGC would not be entitled to liquidated damages as time was not the essence of contract. In such circumstances, it would be awarded losses actually incurred by it. The aforesaid Award was challenged by both the parties and ultimately carried in Appeal before Supreme Court. The Supreme Court held that the finding of the Ld. Arbitral Tribunal that time was not the essence of Contract is beyond reproach as the Tribunal correctly held that time was not the essence of contract when contract contained clauses such as extension of time and levy of liquidated damages. The Court further observed that ONGC had waived its right to levy liquidated damages as it failed to impose the same while granting the initial extension of time. Therefore, the Court held that when ONGC failed to levy LD in initial extension of time granted to the Appellant, its right to levy LD in subsequent extension, unless expressly stipulated in the contract, cannot be validated. The decision in Saw pipes (supra) was distinguished by stating that in that particular case ONGC granted all extensions while reserving its right to levy LD. Therefore, the Supreme Court upheld the Award passed by the Ld. Arbitral Tribunal.

The aforesaid judgment poses a problematic legal authority in the realm of construction Contracts. While it is true that a contract containing clauses for extension of time and liquidated damages stultifies the express stipulation in the contract that time is essence of contract. This position of law has emanated from three judge bench judgment of Supreme Court in Hind Construction vs State of Maharashtra²⁷. Moreover, in Mcdermott International Inc. vs Burn Standard Co. Ltd. and Ors.²⁸ the Supreme Court categorically observed that in construction contracts, generally time is not of the essence. However, does that stand to reason that if time is not the essence of Contract, it would automatically curtail the right of the Employer to impose LD in terms of the Contract? In Welspun (supra) the Ld. Arbitral Tribunal had rendered the following finding which was not disturbed by the Supreme Court-

“Since time was not the essence of the contract, the measure of damages specified under Clause/ Liquidated damages, which was the essence of the contract, cannot be regarded as appropriate for determining the loss sustained by ONGC”

It is pertinent to note that in URC Construction (supra) the Madras High Court had observed that extension of time clauses are inserted in the Agreement so as to obviate consequence of time being set at large. So long the contract contains clause for extension of time and extensions are so granted, the employer would not lose his right to impose liquidated damages. However, when extensions are not granted and the Contractor performs contract beyond stipulated timeline or if extension is granted, however the same is provisional in nature and alien to the express terms of Contract, as was the case in URC Construction (supra), then in that case time would be set at large and only in that case the Employer would lose his right to impose LD notwithstanding the express stipulation in the Contract. In fact in Consolidated Engineering (supra) the Supreme Court had upheld the Arbitral Award, wherein the Tribunal had awarded LD to the Employer who had imposed the same on the Contractor while granting several extensions of time in terms of the Contract by reserving its right to impose LD.

Secondly, while it is true that the contract in the aforesaid case did not provide an express stipulation permitting ONGC to reimpose LD after failing to levy it in the initial stages of granting extension. However, the contract also did not stipulate that if ONGC fails to impose LD in the initial stages, it shall lose its right to impose LD in the subsequent stages. It is settled law that Arbitral Tribunal has to render an Award within four corners of the Agreement. Reading the aforesaid stipulation in the Contract, where none existed, amounts to rewriting the terms of the Agreement making the Arbitral Award patently illegal and liable to be set aside under Section 34.

Essence of Time and Claim for Damages under Section 55 of Contract Act

Section 55 of Contract Act postulates three broad categories of cases relating to contracts where time is stipulated for performance viz.

First paragraph– Stipulates that when time is essence of Contract and a party to the Contract fails to perform the Contract within the stipulated time, then the Promisee is entitled to terminate the contract and sue the party/Promisor for damages.
Second paragraph– Applies when time is not of essence of Contract and the performance of Contract is delayed. In such a case the Promisee is entitled to seek compensation from the party/promisor who caused delay in performance of work. It is pertinent to note that in this case, merely because of performance was delayed, does not entitle the Promisee to terminate the Contract unlike in first paragraph which stipulates non-completion of Contract within the stipulated time, a condition, for breach of contract, entitling the Promisee to terminate the same and sue for damages.
Third paragraph– Applies when time was originally the essence of Contract, however, the Promisee accepted delayed performance of work. In such a case it is mandatory for the Promisee to issue Notice to the Promisor putting him to notice that he would be seeking compensation for the delayed performance of works.

Where time is essence of Contract, Section 55 confers two distinct options on the Promisee in the event the performance of Contract is delayed-

The Promisee may terminate the Contract and sue for damages in which the first paragraph Section 55 applies and no notice is required to be issued for seeking compensation.
If the Promisee chooses not to terminate the contract for failure of Promisor to perform within the stipulated timelines (when time was of essence) and elects to accept delayed performance, the Contract subsists, and para 3 of Section 55 is invoked. In such a case, it is mandatory for the Promisee to issue notice to the Promisor to claim compensation for delayed performance failing which he would not be awarded compensation.

It is only in case when time is not of essence, i.e. para 2 of Section 55, that the Promisee is not obligated to issue notice to the Promisor for seeking compensation, and maintain a case for seeking compensation for delayed performance of works. Section 55 governs entitlement to compensation for delay, while Section 74 governs quantification where the contract stipulates pre-estimated damages.

The three judge bench of Supreme Court in Hind Construction (supra) held that the whether time is of essence, has to be inferred from the intention of the parties gathered from the terms of the Contract. Even if the Contract expressly provides that time is of essence, the aforesaid stipulation must be read in conjunction with other provisions of Contract. If the Contract contains clauses for extension of time and penalty in case of delay, such clauses would render the express stipulation vis-à-vis time of essence, ineffective. The object and purpose of specifying that time is of the essence of Contract is to treat time as a condition, as opposed to a warranty, under the Contract and thereby enable the aggrieved party to treat non-compliance as a repudiatory breach that justifies termination²⁹.

In Mcdermott (supra) the Respondent, BSCL awarded a EPC/Turnkey offshore Contract to the Appellant, MII. Timeline for completion was 20 months. However, MII could complete the work in 34 months alleging delay on the party of BSCL, resulting in a claim for compensation, amongst other claims, being referred to the Arbitral Tribunal. The Tribunal awarded damages to MII for delays caused by the BSCL in completion of works. The Award was ultimately carried in Appeal before Supreme Court wherein the Respondent/BSCL argued that since time was essence of contract, failure to issue notice on the party of MII, as per para 3 of Section 55 of Contract Act, would render its claim for compensation illegal. The Supreme Court however, categorically observed that, generally, in construction contract, time is never of essence. Moreover, it was never the case of BSCL, before the Arbitrator, that time was of essence. Therefore, the Supreme Court held that that MII was not obligated to issue prior notice before seeking compensation and its claim for compensation would be governed by para 2 of Section 55 of the Contract Act and thus maintainable.

Conclusion

From a conspectus of the aforesaid judgments, it emerges that while Section 74 of the Contract Act dispenses with strict proof of loss, the award of liquidated damages is neither automatic nor punitive, and must bear a reasonable nexus with the loss contemplated by the parties at the time of contract. It is essential to prove losses not only for claiming unliquidated damages under Section 73 but also for claiming liquidated damages under Section 74. Section 74 is only supplementary to Section 73 and it does not make any departure from the principle behind Section 73³⁰, viz. proof of loss is sine qua non for claiming damages. The expression “whether or not actual damage or loss is proved” envisaged in Section 74 of the Contract Act, as interpreted by the Constitution Bench in Fateh Chand (supra), merely dispenses with the proof of actual loss or damages; it does not justify the award of compensation when in consequence of breach no legal injury at all has resulted. The aforesaid judgment still remains a good law. In Saw Pipes (supra) although the Supreme Court has observed that party is not required to prove losses in case the LD stipulated in the Contract is pre-estimate and genuine, however, the court also held that in the facts of that case it was not possible to prove losses, hence LD could be awarded which was reasonable. The Division Bench of the Delhi High Court in Vishal Engineer (supra) clarified the interpretation of law laid down in Saw Pipes (supra) and held that the observations in the aforesaid judgment cannot be read to mean that even if no loss whatsoever is caused to party, it can still recover amounts merely by reason of breach by opposite party. The Delhi High Court similarly observed in UOI vs Krishna Constructions (supra) and clarified that the law laid down in Saw Pipes (supra) must be read in the context of Fateh Chand (supra) and cannot be interpreted as holding that a breach is compensable in damages, even if no loss is shown to have been suffered. If it is not possible to prove actual loss, the party seeking compensation must prove at least some loss was suffered. Court will not apply Section 74 in a vacuum. Damages can only be provided for losses suffered. If damages or loss is not suffered, the law does not provide for a windfall³¹.

By Daksh Pandit