Compensation vis-à-vis Section 74 of Contract Act

Section 73 of the Indian Contract Act, 1872 [“the Act”] envisages the general principle of law that a party which has suffered losses in consequence of a breach of contract is entitled to receive compensation for losses incurred by it from the party which has committed the breach. Section 74, on the other hand is applicable in those circumstances in which the parties contractually decide and pre-estimate the damages, which the innocent party would be entitled to receive as a consequence of breach of contract. Section 74, therefore, provides liquidated damages and Section 73 stipulates unliquidated damages that a party is entitled to receive in case of breach of Contract. While Section 73 is straight forward and in a given case, a party which has suffered losses as a consequence of breach, is entitled to seek compensation subject to proof of damage, it is Section 74 of the Act which has come up for interpretation by various courts for award of compensation as it demands adherence to various pre-requisites before compensation is awarded.

Application of Section 74 of the Contract Act

Section 74 of the Act stipulates the amount of compensation that the innocent party is entitled to receive in the following two circumstances-

When Liquidated Damages are provided in the Contract.
When the contract contains stipulation by way of penalty.

The Section further stipulates, in no uncertain terms that the party complaining of breach in the above two cases, is entitled to receive reasonable compensation from the party that has breached the contract, whether or not actual damage or loss is proved. Therefore, it begs a question, does the stipulation in Section 74 viz. “whether or not actual damage or loss is proved” completely gives a go-by to the general principle on the award of damages viz. that compensation can only be given for damage or loss suffered and if Damage or loss is not suffered, the law does not provide for a windfall? Section 74 is also silent upon what constitutes “stipulation by way of penalty”? Does forfeiture of money as a consequence of breach of contract, amounts to stipulation by way of penalty, attracting the rigours of Section 74 of the Act? The jurisprudence on Section 74 of the Act is given in the following landmarks cases which are discussed hereinbelow.

Fateh Chand vs Balkishan Das¹

Decades ago, a constitution bench of the Supreme Court laid down the law with respect to Section 74 of the Act. As per the terms of the Contract, the Plaintiff forfeited an amount of Rs 25,000/- paid by the Defendant, out of which Rs 1000/- constituted earnest money, as a consequence of breach of contract committed by the Defendant by failing to register sale deed within a particular period of time. While adjudging the amount of compensation receivable by the Plaintiff in terms of Section 74, as a consequence of breach committed by the Defendant, the Supreme Court observed as follows-

Section 74 not only applies to cases where an aggrieved party is seeking amount on account of breach of contract but also applies to cases where upon breach of contract, an amount received under contract is sought to be forfeited.
The expression “stipulation by way of penalty” applies to the following cases-
1. Cases involving penalty whether it is for payment on breach of contract or delivery of property in future, or
2. Forfeiture of right to money or other property already delivered.
Duty is imposed upon the courts not to enforce the penalty clause but only award reasonable compensation in terms of Section 74.
Barring the amount of Rs 1000/- which is the earnest money, the amount of Rs 24,000/- forfeited by the Plaintiff is in the nature of stipulation by way of penalty, in which case, as per Section 74, the court can only award reasonable compensation not exceeding the penalty stipulated for.
The terms “whether or not actual damage or loss is proved” only dispenses with the proof of actual loss or damage, it does not justify the award of compensation when in consequence of the breach no legal injury at all has resulted.
Cases involving stipulation by way of penalty in the nature of forfeiture of money already deposited, the court has jurisdiction to award such sum only as it considers reasonable.

The court observed that the Plaintiff has failed to prove losses incurred by it as a consequence of breach of contract and the amount of compensation awarded by the High Court equaling to 10% of the contract value is based on arbitrary assumption. Therefore, the court held that the amount of money forfeited by the Plaintiff i.e. Rs 25,000/- would be reasonable compensation in absence of any proof of losses

Maula Bux vs UOI²

The Plaintiff entered into two separate agreements with the Government of India for which he paid security deposit amounting to Rs 10,000/- and Rs 85,00/- pertaining to two separate agreements for supply of goods. The Contracts terms stipulated that in the event of default in complying with the terms of the Agreements, the security deposit shall stand forfeited. As a consequence of default committed by the Plaintiff, the Defendant/Government of India terminated the Agreements and forfeited the Security deposit. On a suit filed by the Plaintiff for a recovery of the forfeited amount, the High Court held that the security deposit forfeited was in the nature of earnest money and the Defendant was entitled to forfeit it in the event of default committed by the Plaintiff. In appeal before the Supreme Court, the court observed as follows-

The money deposited by the Plaintiff under the contracts was not in the nature of earnest money but in the nature of security for guaranteeing the due performance of the contracts. Such deposits cannot be regarded as earnest money.
Relying upon Fateh Chand (supra) the court observed that the judgments which take the view that Section 74 of the Contract Act do not apply to cases of deposit for due performance of the contract, are no longer a good law.
Forfeiture of earnest money, if it is reasonable, does not fall under Section 74.
But if forfeiture of money is in the nature of penalty, then Section 74 will apply.
Defendant argued that forfeiture of money was a pre-estimate of damages for which the Defendant was not liable to prove actual damage or loss as per Section 74, however, the court although acceded to the proposition, but observed that it will apply in different facts and circumstances-
1. When the court is unable to assess the compensation, then the pre-estimate amount of damage, as named in the contract may be taken into consideration, but not in case when the sum named, is in the nature of penalty.
2. When loss in terms of money can be determined, the party claiming compensation must prove the loss suffered by him.
The Court observed that in the present case it was possible for the Defendant/UOI to prove the losses suffered by it, however, it did not even attempt to do so. Therefore, in view of the failure of the Defendant to prove losses, the court held that forfeiture of money was not justified and ordered refund of forfeited amount with interest.

Shri Hanuman Cotton Mills and Ors. vs Tata Aircraft Limited³

The Contractual terms stipulated that the Appellant shall deposit 25 % of the total value of the contract and such deposit would be in the nature of earnest money which would be forfeited in the event of default committed by the Appellant. As a consequence of default committed by the Appellant, the Respondent terminated the Agreement and forfeited the earnest money due to which the Appellant filed suit for recovery of forfeited money on the premise that forfeiture of money was in the nature of penalty which attracts Section 74, in which case the court can only award reasonable compensation. The three judge bench of the Supreme Court made the following observations-

The court held that the following elements would constitute a deposit or payment by way of “earnest money”
1. It must be given at the moment at which the contract is concluded.
2. It represents a guarantee that the contract will be fulfilled, or, in other words, ‘earnest’ is given to bind the contract.
3. It is part of the purchase price when 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.
Upon the bedrock of the above principles, the court adjudged that the clause specifically stipulated that the 25% amount deposited shall remain with the company as “earnest money”. Therefore, it cannot be disputed that the amount so deposited is not in the nature of earnest money when the clause categorically stipulates so.
The court observed that the submissions of the Appellant qua the unreasonable quantum of earnest money and that the forfeiture was in the nature of stipulation by way of penalty attracting Section 74, cannot be considered as the Appellant did not raise those issues before the lower court.
The ratio of Fateh Chand (supra) viz. that forfeiture of amount is in the nature of penalty and therefore Section 74 is attracted cannot be applied to the present case as the court in Fateh Chand (supra), with respect to the amount of Rs 1000/- recognized the principle that earnest money deposited can be forfeited. However, for the rest of the amount, which was admittedly not earnest money, the court applied Section 74 of the Act. However, in the present case, the entire amount is deposited as earnest money therefore, the decision in Fateh Chand does not apply.

Therefore, the court dismissed the Appeal and held that the Respondent was justified in forfeiting the amount of earnest money.

Oil and Natural Gas vs Saw Pipes Ltd.⁴

The aforesaid is a landmark decision upon the purport of Section 34 of the Arbitration and Conciliation Act, 1996. An Award was passed by the Arbitrator inter alia holding that in order to recover liquidated damages it was for the Appellant to establish that is has suffered losses because of breach. In absence of evidence of losses, the Arbitrator held that the Appellant was wrong to recover 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 loss given in the contract. The Supreme Court observed as follows-

When parties have expressly agreed by way of contract as to the recovery of Liquidated Damages which is not by way of penalty,, the arbitral tribunal was not justified in concluding that the Appellant was required to prove loss.
As per Section 74 , the party complaining of breach is entitled to receive reasonable compensation whether or not actual loss is proved.
If compensation named in the contract is by way of penalty then consideration would be different and the party is only entitled to reasonable compensation.
But if compensation named in the contract is by way of genuine pre-estimate of loss, then 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 the opposite party to lead evidence and prove that no loss is likely to occur by such breach.
Court referred to the ratio laid down in Maula Bux and recognized the principle that in cases where it is possible to prove losses, the party complaining of breach must prove the same to claim compensation. Applying the same ratio to facts of present case, the court held that it was not possible to prove exact loss or damage in which case the party complaining of breach is entitled to pre-estimate losses named in the contract.
There is nothing on record to prove that the compensation contemplated is unreasonable.
The contract also provided that the liquidated damages are not by way of penalty.

Therefore, in the above terms, the court held that the Appellant was entitled to Liquidated Damages even in absence of proof of actual losses.

Satish Batra vs Sunil Rawal⁵

In the aforesaid matter, the Supreme Court specifically dealt with the issue whether the seller is entitled to forfeit the earnest money deposit where the sale of an immovable property falls through by reason of the fault or failure of the purchaser. As per the terms of the Agreement, the Plaintiff deposited Rs 7,00,000/- as earnest money with the Defendant, being 10% of the total value of the property. When the Plaintiff failed to pay the balance consideration the Defendant forfeited the earnest money. The Plaintiff filed a suit for recovery of earnest money. The High Court held that the Defendant is only entitled to Rs 50,000/- and the rest of the earnest money i.e. Rs 6,50,000/- is bound to be refunded to the Plaintiff. In Appeal, the Supreme Court observed as follows-

After referring to the decision of the Supreme Court in Shree Hanuman Cotton Mills (supra) the court held that to justify the forfeiture of advance money being part of ‘earnest money’ the terms of the contract should be clear and explicit.
Relying upon the decision of Supreme Court in Videocon Properties Ltd vs Dr. Bhalchandra Laboratories and Ors⁶ the court also observed that by merely describing that the amount is ‘earnest money’ cannot, solely, be the determinative of the character of the sum.
It is the intention of the parties and surrounding circumstances, that also have to be looked into for determining as to whether the advance payment was in the nature of earnest money or was it in the nature of ‘part payment.’
If it is the former i.e. ‘earnest money’ then forfeiture of money is justified. However, if the advance is paid as ‘part payment’ then the forfeiture clause will not apply.
Since the clause in the present contract specifically provided for forfeiture of ‘earnest money’, the Court held that the Defendant was justified in forfeiting the amount.

Kailash Nath Associates vs Delhi Development Authority⁷

Under the terms of the auction the Appellant deposited a sum of Rs 78,00,000/-, being 25% of the bid amount with the Respondent/DDA, as earnest money. The terms of the auction further stipulated that in case of default of the terms of auction, the earnest money shall be forfeited. Later DDA informed the Plaintiff that the land to be auctioned to the Plaintiff was not a Nazul Land and therefore terminated the Agreement and forfeited the earnest money. Thereafter, the DDA reauctioned the land and sold it for Rs 11.78 Cr. Suit was filed by the Plaintiff for specific performance and in the alternative recovery of the earnest money. The Division Bench of Delhi High Court held that the forfeiture of earnest money by the Defendant was justified. In Appeal, the Supreme Court held as follows-

As per the terms of the auction, the earnest money could be forfeited only in the event of breach committed by the Appellant. Since the Appellant did not commit breach, the earnest money could not have been forfeited.
DDA cannot forfeit the earnest money as it did not suffer any loss.
Like Section 73 and 75, compensation is payable under Section 74, only where damage or loss is caused by breach of contract.
Fateh Chand’s Case states that all stipulations naming amounts to be paid in case of breach would be covered by Section 74.
Forfeiture of earnest money in the case of Fateh Chand 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.
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.
Damage or loss caused is a sine qua non for the applicability of Section 74.
The sum spoken of may already be paid or be payable in future.
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.
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.
The most basic principle on the award of damages is 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.

In view of the above terms, the court held that the in absence of losses proved by the DDA, the forfeiture of earnest money was not justified and therefore, the court ordered refund.

M.C. Luthra vs Ashok Kumar Khanna ⁸

In this matter, a single judge bench of the Delhi High Court found itself in conflict with respect to the divergent views of the Supreme Court on the issue of forfeiture of earnest money in the event of breach committed by the party. As per the Agreement, the Plaintiff deposited Rs 7,00,000/- as earnest money which was forfeited by the Defendant in terms of the Agreement when the sale fell through. Plaintiff brought a suit for recovery of earnest money which was allowed by the Trial court. In Appeal, the Delhi High Court observed as follows-

The court observed that there are two views on the issue by Supreme Court. One view is flowing from the law laid down in the constitution bench judgment of Supreme Court in Fateh Chand (supra) that forfeiture of money is in the nature of stipulation by way of penalty in which case Section 74 is attracted. The same is further affirmed by another decision of the Supreme Court in Kailash Nath (supra) which categorically states that Section 74 applies to forfeiture of earnest money.
At the same time there are another line of decisions starting from Shree Hanuman (supra) and more recently, the decision of Supreme Court in Satish Batra (supra) which state that so long the ‘earnest money’ is specifically mentioned in the contract and it provides forfeiture of the same, then forfeiture of earnest money is justified and for the said purpose the party is not required to plead and prove losses.
The Court differed with the law laid down in Satish Batra (supra) and stated that all the judgments referred to in Satish Batra (supra) are of bench strength lesser than the constitution bench judgment in Fateh Chand (supra).
Relying upon Fateh Chand and Kailash Nath (supra), the court held that whenever there is a breach of contract then earnest money which is forfeited because of the breach, whether by a plaintiff or a defendant in a contract, the forfeiture is of that amount which are in fact liquidated damages specified under a contract and that for claiming damages under a contract, whether liquidated under Section 74 of the Contract Act or unliquidated under Section 73 of the Contract Act, existence of loss is a sine qua non. In other words, if no loss is caused to a seller who has in his pocket monies of buyer, then the seller can only forfeit a nominal amount unless the seller has pleaded and proved that losses have been caused to him on account of the breach of contract by the buyer.
Once there is no pleading of loss suffered by a seller under an agreement to sell, then large amounts cannot be forfeited though so entitled to a seller under a clause of an agreement to sell/contract entitling forfeiture of ‘earnest money’ because what is forfeited is towards loss caused, and that except a nominal amount being allowed to be forfeited as earnest money, any forfeiture of any amount, which is not a nominal amount, can only be towards loss if suffered by the seller. Thus if there is no loss which is suffered by a seller then there cannot be forfeiture of large amounts which is not a nominal amount, simply because a clause in a contract provides so.

Therefore, in absence of any losses proved by the Appellant, the Court held that it was not justified in forfeiting large amounts and is only entitled to Rs 50,000/- of nominal amount.

ANALYSIS- Section 74 of the Contract Act

Section 74 applies in following circumstances-

When there is a genuine pre-estimate losses/liquidated damages mentioned in the contract.
When the contract contains stipulation by way of penalty.

When the aforementioned elements are present in the contract and the party complaining of breach is seeking compensation then Section 74 is attracted. The measure of damages that is awarded as a consequence of breach under section 74 is ‘reasonable compensation’ which is not exceeding the amount named in the contract or the penalty stipulated for.

The Supreme Court in Fateh Singh, Maula Bux and Kailash Nath (supra) has succinctly clarified that the expression “whether or not actual damage or loss is proved” does not justify compensation when the party has not suffered any losses at all as a consequence of breach. The said expression only dispenses with the proof of actual loss or damage, the expression does not completely do away with the obligation of the Party to prove losses in general. The Supreme Court further clarified in Maula Bux and Kailash Nath (supra) that only in cases when it is impossible for the court to assess damages, the liquidated damages as mentioned in the contract can be awarded as reasonable compensation. However, when losses in terms of money can be determined, then the party claiming compensation must prove the loss suffered by him. The Supreme Court in Saw Pipes (supra) has although categorically held that when compensation in the contract is mentioned as a genuine pre-estimate of loss, then the party need not prove such loss or lead evidence to prove actual loss. However, the court only reached that conclusion after taking cognizance of the ratio laid down in Maula Bux (supra) that only in cases wherein the court finds it impossible to assess damages then the sum named in the contract can be awarded as reasonable compensation. Therefore, the court gave a specific finding in the judgment that it is not possible to assess damages and therefore, the pre-estimate loss as mentioned in the contract may be awarded.

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. 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.

Therefore, in order to seek the liquidated amount or genuine pre-estimated loss, as mentioned 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 pre-estimated amount of damages as mentioned in the contract is genuine.

Following the law laid down in Maula Bux and Kailash Nath (supra), only when the aforementioned conditions are satisfied, the court can 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.

Does Forfeiture of Earnest Money paid under the Contract attract Section 74?

The constitution bench of Supreme Court in Fateh Chand (supra) held that forfeiture of money as a consequence of breach amounts to a stipulation by way of penalty and therefore, Section 74 would be applicable to such a case. However, it is pertinent to mention that the law laid down in Fateh Chand (supra) is being erroneously applied by the Courts to justify the forfeiture of earnest money. In the facts and circumstances of Fateh Chand (supra) the parties conceded that the earnest money may be forfeited and therefore the court did not venture into the legality of forfeiture of earnest money. Resultantly, the ratio in Fateh Chand cannot be used as an authority to justify the forfeiture of earnest money. The Supreme Court in Kailash Nath (supra) was cognizant of this fact and therefore held in categoric terms that Section 74 would be applied to forfeiture of earnest money and unless the party complaining of breach proves losses, the forfeiture of earnest money is not justified.

From the ratio laid down in Shree Hanuman Cotton Mills and Satish Batra (supra) it appears that the court has justified the forfeiture of earnest money so long the amount so forfeited under the terms of contract, specifically finds mention in the terms of the contract as “earnest money” The Supreme Court in Satish Batra also observed that only the amount mentioned as earnest money can be allowed to be forfeited and not the amount paid as an advance in the nature of part payment towards the contract. Therefore, it is imperative to ascertain whether the amount so forfeited under the contract was in the nature of earnest money or towards part payment of the contract.

The ratio laid down in Shree Hanuman Cotton Mills (supra) cannot be used as a precedent to justify the forfeiture of earnest money as the court in that case, itself conceded that it is not going into those aspects of the case as the Appellant did not raise the issue before the lower court with respect to forfeiture of the amount amounted to a penalty or the amount forfeited is so large that forfeiture is bad in law. Therefore, the court, only in those circumstances upheld the forfeiture of earnest money. However, while upholding the forfeiture, the court erroneously drew sustenance from the ratio laid down in Fateh Chand (supra) and held that in that case court justified forfeiture of earnest money which is factually incorrect.

Admittedly, there are two lines of judgments on the issue having divergent views. The line of judgments flowing from Fateh Chand (supra) hold the view that forfeiture of amount under the contract amounts to stipulation by way of penalty and therefore attract Section 74 of the Contract Act in which case the party must prove losses as held by Supreme Court in Kailash Nath (supra). However, the line of judgment flowing from Shree Hanuman Cotton Mills and Satish Batra (supra) hold the contrary view viz. forfeiture of earnest money is justified even if no losses are proved so long the contract unambiguously states that the amount so deposited is ‘earnest money’ and the same shall be forfeited in the event of breach. The Single Judge Bench of Delhi High Court in M.C. Luthra (supra) was posed with the above difficulty as to which view to follow with respect to forfeiture of earnest money. The Court sided with the view taken by Fateh Chand and Kailash Nath (supra) after observing that the law laid down in Satish Batra (supra) and judgments referred to therein are of a bench strength lesser than the constitution bench judgment of Supreme Court in Fateh Chand (supra). The Delhi High Court also clarified that merely because a sum is mentioned as ‘earnest money’ in the contract, the sum does not take the character of earnest money. Earnest money can only be a nominal amount of total consideration. For illustrative purposes, if out of total consideration of Rs 10 Lakh, Rs 5 lakh is termed as earnest money in the contract then it would not be enforceable as it constitutes a large amount Therefore, the court held that in case of forfeiture of earnest money section 74 would be attracted and the party seeking forfeiture is liable to prove losses incurred by it to justify the forfeiture. In the absence of losses, the party is only entitled to nominal amounts and not large amounts of money.

However, it is pertinent to observe that in the decision of Kailash Nath (supra), the Supreme Court held that forfeiture of earnest money was not justified in the face of failure of the other party to prove losses and ordered entire refund of the amount. However, in case of M.C. Luthra (supra), despite failure of the other party to proves losses, the court still held the party entitled to nominal amount of Rs 50,000/- as opposed to the entire forfeited amount. The three judge bench in Maula Bux, (supra) have held that forfeiture of money, if it is reasonable, does not fall under Section 74. In such circumstances, it is imperative to discern that whether the amount as mentioned in the contract is actually earnest money or it is an amount towards part payment of the contract. If the amount sought to be forfeited is nominal, then such amount would be considered reasonable for forfeiture of earnest money and the ratio of Maula Bux (supra) will be applied. However, if the amount is found not be in the nature of earnest money, then the same constitutes stipulation by way of penalty, in which case Section 74 would be attracted and the party would be required to prove damages to justify forfeiture of amount.

In view of the author, the decision in Kailash Nath (supra) is the only decision which must be applied to put a quietus to the subject issue. In Kailash Nath (supra) the Supreme Court, after considering the ratio laid down by the constitution bench in Fateh Chand (supra), has categorically held that Section 74 is applicable to cases of forfeiture of earnest money. That being the case, the party must plead and prove the losses suffered by it to justify the forfeiture of earnest money. In the absence of proof of loss, the earnest money deposited must be refunded, as done in Kailash Nath (supra) by Supreme Court.

Therefore, the following position of law emerges with respect to forfeiture of earnest money-

Forfeiture of earnest money amounts to a penalty and therefore rigours of Section 74 are attracted.
Section 74 imposes a duty upon the courts not to enforce a penalty clause but only award reasonable compensation not exceeding the penalty stipulated.⁹
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.¹⁰
It is imperative to ascertain whether the amount sought to be forfeited is in the nature of earnest money or comprises of part payment towards contract. By giving a stamp of ‘earnest money’ to advance price, the latter does not become the former.¹¹
Forfeiture of earnest money, if reasonable, would not fall under Section 74.¹²

Whether the party is entitled to forfeit the earnest money as a consequence of breach of contract, largely depends upon the facts and circumstances of the case and the discretion of court. From the conspectus of the above cases, what is abundantly clear is that if the party seeking forfeiture is unable to prove losses, then the party is not entitled to forfeiture of the entire amount of earnest money (going by the ratio laid down in Fateh Chand, Maula Bux and Kailash Nath) but only the nominal amount as held in M.C. Luthra (supra). In some facts and circumstances, the court would not even allow forfeiture of nominal amount and order refund of the entire earnest money, as done in Kailash Nath (supra).

Conclusion

From a conspectus of the above cases the fundamental position of law, on the law of compensation, that emerges is that compensation cannot be awarded unless the party complaining of breach has proved that it suffered losses. The expression “whether or not actual damage or loss is proved” has been clarified by the Supreme Court in Fateh Chand, Maula Bux, and Kailash Nath (supra) by stating that the said expression shall only apply to cases wherein it is impossible to prove the loss, in which case the court shall award the genuine pre-estimate loss as mentioned in the contract as reasonable compensation. However, if it possible for the party to prove losses, and it does not even attempt to do so, then the said expression shall not apply and the party shall not be entitled to compensation, as observed in Maula Bux (supra). Compensation can only be given for damage or loss suffered. If damage or loss is not suffered, the law does not provide for a windfall¹³.

By Daksh Pandit