Whether any fetter or string could be attached to
the rights of encashment of bank guarantee by the beneficiary? The effort shall
be to analyze the whole gamut of law as evolved in this regard over the years
and the decisions arrived at and also whether the Courts or Arbitral Tribunal
is empowered to pass judgment to that effect or not shall be the another
dimension of the present write up. The overwhelming view in this regard shall
have to be weighed in the backdrop of facts of several cases with a view to
come to a plausible inference. Thus, the indulgence on precedents shall be the sine qua non. The dispute as regards
encashment of bank guarantee shall also be an adjunct to principles of Section
73 & Section 74 of India Contract Act 1872, since the breach of contract
shall be the precursor to any claim of encashment of bank guarantee.
LAW on encashment of bank
guaranteeAND COMPENSATION
(A) The law as
regard breach and consequent compensation may have the substantive reference in
a judgment reported as Fateh Chand Vs. Balkishan Das, (1964) 1 SCR 515, This is a a seminal judgment where it was held that the jurisdiction of the
Court of award compensation in case of breach is unqualified except as to the maximum
amount stipulated so long as the compensation is reasonable. This imposes a duty upon the court to award compensation according
to the settled principles. The phraseology of Section 74 was held to dispense with the proof of actual
loss or damages
but it did not justify
the award of compensation when in consequence of the
breach no legal injury at all has
resulted. It was, thus, clearly held
that a plaintiff has to prove a loss suffered by him in consequence of the breach of contract committed by the defendant. This legal position laid down by the Constitutional Bench of the Supreme Court
is good law till date and, thus, any judgment of the Supreme
Court of a Bench constituted of lesser number of Judges would, thus, have to be
read in the context of the seminal pronouncement.
(B)
In Maula Bux Vs. Union of India, (1969) 2 SCC 554, the forfeiture of security was upheld by the High Court, the amount forfeited being
held as no unreasonable under Section
74 of the Contract Act. The Supreme
Court set aside the order of the High Court
accepting the plea that the loss suffered by
the respondent therein
was capable of being measured and they could not seek
protection under the garb of Section
74 of the Contract Act. Since the respondent
had led no evidence that it had suffered loss,
it was held that the amount could not be forfeited.
(C)
Union
of India vs. Raman Iron Foundry,
(1974) 2 SCC 231. The claim for liquidated damages
for all practical purposes were held to stand on the same footing as the unliquidated damages in The
claim of unliquidated damages was, thus, held
not to give rise to a debt until the liability is adjudicated and damages assessed
by a decree or
order of a court or other adjudicatory authority. The appellant was held not to have any right or authority to appropriate amounts of other
pending bills of the respondent towards satisfaction of claim for damages against the respondent. The breach of contract does not instant incur any pecuniary
obligations, nor does the party complaining of the breach become entitled
to a debt due from the other
party. The only right which accrues at that moment is that the party aggrieved
by the breach of contract
has a right to sue for damages.
Thus, when damages are assessed, the court in the
first place must decide that the
defendant is liable and then it proceeds to assess as to what is the damage.
(D)
In State of Karnataka vs. Shree Rameshwara Rice Mills, (1987) 2 SCC 160, that there has to be an admission
of the breach of condition
and thereafter only the issue of quantification of damages would arise.
Having set out the aforesaid judgements, we consider
it appropriate at this stage to refer to the
Privy Council pronouncements in Bhai Panna Sing & Ors. Vs. Firm Bhai Arjan Singh-Bhajan Singh- Surjan Singh & Ors., 117 Indian Cases 485 PC, where while dealing
with the issue of damages,
Atkin, J. observed that the effect of Section
74 of the Contract Act is
to disentitle the plaintiffs to recover simpliciter
a sum by ways of liquidated damages and
that the plaintiff must first prove the damages they have suffered.
(E)
In Indian Oil Corporation vs. Lloyds Steel Industries Ltd., 2007 (4) Arb. LR 84: 2010 (4) R.A.J 263 (Delhi) the Indian Oil
Corporation (for short ‘IOC’) invoked a clause in the GCC for liquidated damages and recovered the maximum damages
possible even though
the work was completed to the
satisfaction of the IOC but there was delay in the execution of the work.
This recovery was resisted by
the contractor on the ground that there was no
damage payable. The dispute
was resolved in the arbitration by an
award which held that there was absence
of justification in invoking the clause of damages. It is at the stage of consideration of objections that the learned
single Judge, A.K.Sikri, J. (as
he then was) of this Court held that 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. Time was essence of the contract
providing for 16 months for completion of the work. This period was fixed keeping
in view that the terminal at Jodhpur would be
ready by that time and the pipeline would reach the said terminal. Thus,
while granting extensions, IOC
realized that the terminal was not
complete and, thus, it could not be
put to any use. The period of six (6) months was, thus, held to have
lost its significance inasmuch
as setting up of Jodhpur
Terminal was part of an integrated project and the Terminal
could not be put to commercial use before August, 1996, while the contractor had
successfully completed the work well
before that date. It would be useful to reproduce the observations
made in paragraphs 41 & 42, which read as under:
It is clear from the above that section 74 does not confer a special benefit upon any
party, like the petitioner in this
case. In a particular case where there is a clause of liquidated damages
the Court will award to the party
aggrieved only reasonable compensation which would not exceed an amount of liquidated damages stipulated in the
contract. It would not, however, follow there from that even when no loss is suffered, the amount
stipulated as liquidated damages
is to be awarded. Such a clause would operate when loss is suffered but it
may normally be difficult to estimate
the damages and, therefore, the genesis
of providing such a clause is that the damage are pre-estimated. Thus,
discretion of the Court in the matter of reducing the amount of damages agreed
upon is left unqualified by any specific limitation. The guiding principle is ‘reasonable compensation’. In order to see what would be the reasonable compensation in a
given case, the Court can adjudge the
said compensation in that case. For this purpose,
as held in Fateh Chand (supra) it is the duty of the Court
to award compensation according
to settled principles. Settled principles warrant
not to award a compensation where no loss is suffered as one cannot compensate a person who has
not suffered any loss or damage. There may be cases where the actual
loss of damage is incapable of proof;
facts may be so complicated that it
may be difficult for the party to prove actual extent of the loss of damage.
Section 74 exempts him from such responsibility and enables
him to claim compensation in spite of his failure to prove the actual extent of the loss or damage,
provided the basic requirement for award of
‘compensation’, viz., the fact that he has suffered some loss of damage is established. The proof of this basic requirement is not dispensed
with by Section 74. That the party complaining of breach of contract and claiming compensation is
entitled to succeed only on
proof of ‘legal injury’ having been suffered
by him in the sense of some loss or damage having been sustained on account of such breach, is clear from Section 73 and 74. Section 74 is only supplementary
to Section 73, and it does not make any
departure from the principle behind Section 73
in regard to this matter. Every case of compensation for breach of contract has to be dealt
with on the basis of Section 73. The words in Section
74 ‘Whether or not actual damage or loss is proved to have been caused thereby’ have been
employed to underscore the departure deliberately made by the Indian
legislature from the complicated principles of English Common Law, and also to
emphasize that reasonable compensation
can be granted even in a case where extent of actual loss or damage is incapable
of proof or not proved.
That is why Section 74 deliberately states that what is
to be awarded is reasonable compensation. In a case when
the party complaining of breach of the contract has not suffered legal injury in the sense of sustaining loss of damage,
there is nothing
to compensate him for; there is nothing to recompense, satisfy, or make amends. Therefore, he will not be entitled
to compensation (see State of Kerala v. United Shippers
and Dredgers Ltd.,
AIR 1982 Ker 281). Even in Fateh Chand (Supra) the
Apex Court observed in no uncertain
terms that when
the section says that
an aggrieved party is entitled to compensation
whether actual damage is proved to have
been caused by the breach or not, it merely dispenses with the
proof of actual loss or damage’. It does not justify the award of compensation whether a legal injury has resulted in
consequence of the breach,
because compensation is awarded to make good the loss or damage which naturally
arose in the usual course of things, or which the parties knew when they made the contract, to be likely to result from the breach. If liquidated damages are awarded to the petitioner
even when the petitioner has
not suffered any loss, it would amount to ‘unjust enrichment’, which cannot be countenanced and has to be eschewed.
(F)In Vishal Engineers & Builders vs. Indian Oil Corporation Ltd., 2012 (2) R.A.J.
390, the
Division Bench of the Delhi High Court on considering Sections 73 and 74 of the Contract Act, the
decisions rendered by the Supreme Court in Fateh Chand vs. Bal Kishan
Das (1964) 1, SCR, 515 and Maula Bux vs Union of India, (1969) 2 SCC, 554,
Union of India vs. Raman Iron
Foundry (1974) 2 SCC 231 and a decision
of the Privy Council in Bhai Panna Singh & Ors. Vs. Firm Bhai Arjan Singh-Bhajan Singh – Surjan Singh, 117,
Indian Cases, 485 (Privy Council) and decision of the Delhi High Court in Indian Oil Corporation vs. Lloyd Steel Industries Ltd. (2007) 4 Arb. LR, 84, held that the liquidated damages stipulated in the contract are
not payable, as the complaining party
has not suffered any loss. In this
regard the Delhi High Court observed as under:
“12. Section 73 of the Contract Act, thus, contemplates award of damages for losses
suffered by breach of contract
by the opposite party. Section
74 of the Contract
Act stipulates that in case
of such a broken contract if a
sum is named in the contract as the
amount to be paid in case of such breach, whether or not actual damage or loss is proved to have been caused thereby, the
aggrieved party is entitled to
receive from the opposite party who has broken the contract, a reasonable compensation not exceeding the amount so named.
13.
The question which, thus, arises is whether in view of such a stipulated
amount damages are liable
to be paid ipso facto without any further proof qua issue of sufferance of damages or quantification
or something more is required to be done.
The duty of the court not to enforce the penalty clause,
but only to award reasonable compensation has been held to be statutorily imposed upon courts
by Section 74 of
the Contract Act. The court just has to
adjudge in every case, reasonable compensation
for breach of contract having regard to the conditions which existed on the date of
the breach [ref: Fateh Chand case (supra)]
(G)
In Indian Oil
Corporation vs. M/s Lloyds Steel Industries Ltd., (2007) 4
Arb. LR 84, the Delhi High Court held as under:
“38. Notwithstanding the above, the petitioner still wants damages
to be recovered from the respondent on the spacious plea that liquidated damages
mentioned in the contract are predetermined damages
and, therefore, in view of provisions of Section 74 of the
Indian Contract Act, the petitioner was entitled to these damages and it was
necessary for the petitioner to prove these damages. The legal position, as explained by the Supreme Court in ONGC v. Saw Pipes (Supra), which has
already explained above, is not in doubt. However, it is only when there is a loss suffered and once that is proved, it is not for the arbitrator or the Court to examine the
actual extent of the loss suffered
once there is a pre-estimation thereof. Moreover, the compensation, as stipulated in the contract has to be reasonable. In a particular case where the
defaulting party is able to demonstrate that
delay/default has not
resulted in any loss being suffered by the other party, then that party cannot claim the
damages only because
in the contract there is a stipulation regarding liquidated damages. The Supreme Court in ONGC v. Saw Pipes
(Supra) referred its earlier judgment in the case of Fateh
Chand (supra) and Mula Bux (Supra).
(H)
Kailash Nath
Associates vs DDA, (2015) 4 SCC 136
The Petitioner Kailash Nath was declared as the
successful bidder by respondent in relation to auction proceedings of a plot of
land. The Petitioner had deposited 25% of the bid money as earnest money.
However, without giving notice to the Petitioner, the respondent cancelled the
bid and forfeited the earnest money deposited by it.
In the above facts and circumstances, the
Supreme Court held that it would be arbitrary for respondent to forfeit the
earnest money on two fundamental grounds. First, there is no breach of contract
on part of the appellant and second, respondent not having been put to any
loss, even if it could insist on a contractual stipulation in its favour, it
would be arbitrary to allow respondent as a public authority to appropriate
earnest money without any loss being caused.
In the judgment, the Supreme Court restated the principles applicable to
Section 74. In doing so, the Court held that, “…like Section 73 and 75 of
Contract Act, 1872, compensation is payable for breach of contract under
Section 74 … only where damage or loss is caused by such breach”. The Court
also held that, “…damage or loss caused is a sine qua non for the applicability
of Section 74”.
It is clear from the above that Section 74 does not confer a special benefit upon any party.
Where there is a clause of liquidated damages the Court will
award to the party aggrieved only reasonable compensation which would not
exceed an amount of liquidated damages stipulated in the contract. It would not, however, follow
therefrom that even when no loss is suffered, the
amount stipulated as liquidated damages
is to be awarded. Such a
clause would operate when loss is
suffered but it may normally be
difficult to estimate the damages and, therefore, the genesis of providing such a clause is that the damages are pre-estimated. Thus, discretion of the
Court in the matter of reducing the
amount of damages agreed upon is left
unqualified by any specific limitation. The guiding principle is ‘reasonable compensation’
As regards adequacy of compensation in a given case, the court can adjudge the said compensation in case to case
basis. As held in Fateh Chand (supra)
it is the duty of the Court
to award compensation according to settled
principles. Where no loss is suffered, one cannot compensate a person
who has not suffered any loss or damage.
Moreover, there may be cases where the
actual loss or damage is incapable of proof; or facts may be so complicated that it may be difficult
for the party to prove actual extent
of the loss or damage.
No doubt, Section
74 stipulates that to claim compensation even if
tangible evidence is not forthcoming, still, if the basic requirement for award of ‘compensation’, viz. the fact that he has suffered some loss or damage is established, compensation can
still be grated.
The proof of this basic requirement is not dispensed with by Section 74. That the party complaining of breach of contract and claiming
compensation is entitled
to succeed only on proof of legal injury having been suffered by him in the sense of some loss or damage having been sustained on account
of such breach, is clear from Sections 73 and 74. Section 74 is
only supplementary to Section 73, and
it does not make any departure from the principle behind Section 73 in regard
to this matter. Every case of compensation for breach of contract has to be dealt with on the basis of Section 73.
The words in Section 74 ‘whether or not actual damage or loss is proved to have been caused thereby’
have been employed to underscore the
departure deliberately made by Indian legislature from the complicated principles of English
Common Law, and also to emphasise that reasonable compensation can be granted even in a case were extent of actual
loss or damage is incapable of proof or not proved.
One
may note that Section 74 states that what
is to be awarded is reasonable compensation. It appears to be a deliberate inclusion.
In a case when the party complaining of breach of the contract has not suffered legal injury in the sense of sustaining loss or damage, there is nothing to
compensate him for; there is nothing
to recompense, satisfy, or make amends. Therefore, he will not be entitled to
compensation (see State of Kerala v.
United Shippers and Dredgers Ltd., AIR 1982
Kerala 281). Even in Fateh Chand (supra) the Apex Court observed in no uncertain
terms that when the section
says that an aggrieved party is entitled
to compensation whether actual
damage is proved to have been caused
by the breach or not, it merely dispenses with the proof
of ‘actual loss or
damage’. It does not justify the award of compensation whether
a legal injury has resulted
in consequence of the breach,
because compensation is awarded to make good the loss or damage which naturally
arose in the usual course of things, or which the parties knew when
they made the contract, to be likely to result from the breach. If liquidated
damages are awarded to the petitioner even
when the petitioner has not suffered any loss, it would amount
to ‘unjust enrichment’, which cannot be countenanced and has to be eschewed.
REMARK
From the foregoing what therefore emerges is that parties to
a contract that, in the event of breach, the party in default shall pay a stipulated sum of
money to the other. However, the stipulated sum has to be a
genuine pre-estimate of damages likely to flow from the breach and is termed as ‘liquidated damages’. It thus flows that if
it is not a genuine pre-estimate of the loss, but
an amount intended to secure
performance of the contract, it may be a penalty.
Interestingly, in Fateh Chand
(supra), the Supreme
Court explained this principle in the following
words:
“…Section 74 declares the law as to liability upon breach of contract, where compensation is by agreement
of parties predetermined or
where there is a stipulation by way
of penalty. But the application of the enactment is not restricted to cases where the aggrieved party claims relief as a plaintiff. The section does
not confer a special benefit upon any
party. It merely declares the law that notwithstanding any term in the contract for determining the damages or providing the forfeiture
of any property by way of penalty,
the court will award to the party aggrieved
only reasonable compensation not exceeding the amount named or penalty stipulated.”
The court also observed:
“The court has to adjudge
in every case reasonable compensation to which the plaintiff is
entitled from the defendant on breach
of the contract. Such compensation has
to be ascertained having regard to the conditions existing on the date of breach.
The measure of damages in the case of breach of a stipulation by way of a penalty
is by section 74 reasonable compensation not exceeding
the penalty stipulated for. In assessing
damages the court has, subject to the limit of the penalty
stipulated, jurisdiction to award such compensation as it deems reasonable having
regard to all the circumstances. Jurisdiction of the Court to award compensation in case of breach of contract is unqualified except as to the maximum
stipulated; but compensation has to be reasonable, and imposes upon the court a duty to award
compensation according to settled principles.”
-------
Anil
K Khaware
Founder
& Senior Associate
Societylawandjustice.com
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