Appeal by sellers under an agreement to sell against a decree refunding earnest money after the suit for specific performance was dismissed. Upholding the refund, the High Court held that forfeiture of earnest money falls under Section 74 of the Contract Act and that a seller who pleads and proves no loss cannot forfeit a substantial advance.
This page shows the compact analysis of this judgement. The full analysis — procedural history, issue-by-issue holdings with ratio and obiter, advocates, and paragraph-level evidence for every claim — is being added to the record in batches and will appear here when this judgement has been through it.
*** IN THE HIGH COURT OF DELHI AT NEW DELHI**
+ RFA No. 404/2018
%
14th May, 2018
RAJBIR SINGH & ANR. ..... Appellants Through: Mr. Yudhvir Singh, Advocate. Versus
JASWANT YAVDAV ..... Respondent
CORAM:
HON’BLE MR. JUSTICE VALMIKI J.MEHTA
To be referred to the Reporter or not?
VALMIKI J. MEHTA, J (ORAL)
C.M. Appl. No. 19752/2018 (for exemption)
C.M. stands disposed of.
RFA 404/2018 and C.M. Appl. No. 19751/2018 (for stay)
by the respondent/plaintiff with respect to the agreement to sell dated 21.10.2012 pertaining to subject land measuring 11 bighas 1 biswas,
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out of Khasra no. 38//2/2(4-13), 9(4-16) and 8/2(1-12) situated in Village Mitraon, Tehsil Najafgarh, New Delhi, however the trial court decreed the suit in favour of the respondent/plaintiff for recovery of Rs.20 lacs which was paid by the respondent/plaintiff to the appellants/defendants under the subject agreement to sell dated 21.10.2012. The total sale consideration for the agreement to sell was Rs.2,15,40,000/- out of which a sum of Rs.20 lacs was paid in advance as earnest money to the appellants/defendants by the respondent/plaintiff.
has considered this relevant aspect from paras 38 to 48 of the
impugned judgment, and these paras read as under:-
―38. Here, the court would refer to Section 74 of the Indian Contract Act, 1872 which lays down the law with respect to compensation for breach of contract where a sum is named or where penalty has been stipulated. The provision read as under:-
74. Compensation for breach of contract where penalty stipulated for- When a contract has been broken, if a sum is named in the contract as the amount to be paid in case of such breach, or if the contract contains any other stipulation by way of penalty, the party complaining of the breach is entitled, whether or not actual damage or loss is proved to have been caused thereby, to receive from the party who has broken the contract reasonable compensation not exceeding the amount so name or, as the case may be, the penalty stipulated for.
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to sell dated 21.10.2012(Ex PW1/6) inter alia clause 5 relates to the penalty clause as under:-
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of amount of Rs.1,000/- out of the amount paid of Rs.25,000/-. I may also note that nomenclature of a payment is not important and what is important is really the quantum of price which is paid. In the present case, the total price payable for the suit property is Rs.20,00,000/- and therefore 25% of the payment made s tricto sensu cannot be an earnest money, though it has been called so. Only a nominal amount can be an earnest money, inasmuch as, the object of such a clause is to allow forfeiture of that amount to a nominal extent as held in the case of Fateh Chand (supra). For example can it be said that 100% of the price or 75%/80% of the price or 50% of the price is earnest money so that it can be forfeited. The answer surely is in the negative. Such high amounts called earnest money will be in the nature of penalty and thus hit by Section 74 of the Indian Contract Act, 1872 in view of Fateh Chand’s case. The principles laid down in Fateh Chand’s case; that forfeiture of a reasonable amount is not penalty but if forfeiture is of a large amount the same is in the nature of penalty attracting the applicability of Section 74; have been recently reiterated by the Supreme Court in the case of V.K.Ashokan vs. CCE, 2009 (14) SCC 85.
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a written document is permissible vide Section 92 of the Indian Evidence Act, 1872.
a) If the earnest money is more than a token amount in comparison with the total consideration amount, the same is to be treated as a penalty in terms of Section 74 of the Contract Act. b) Loss has to be pleaded and proved by the seller/defendant in order to seek forfeiture of earnest money amount. c) Only a reasonable amount may be retained by the defendant as forfeiture of the earnest money in view of the penalty clause. In such a scenario, the plaintiff can seek refund of a substantial amount of earnest money, allowing for forfeiture of a reasonable sum to the defendants.
been recently considered by this Court in the case of M.C. Luthra Vs.
Ashok Kumar Khanna in RFA No. 780/2017 decided on 27.2.2018. In the case of M.C. Luthra (supra) , with reference to the Constitution Bench judgment of the Supreme Court in the case of
RFA No.404/2018 Page 5 of 36
Fateh Chand Vs. Balkishan Dass AIR 1963 SC 1045 , and as explained by the recent judgment of the Supreme Court in the case of Kailash Nath Associates Vs. Delhi Development and Another (2015) 4 SCC 136 , this Court has held that there cannot be forfeiture of an amount paid under an agreement to sell once no loss is pleaded and proved by a proposed seller under an agreement to sell. For refunding of the amount of earnest money/advance price paid under the agreement to sell Courts are entitled to invoke the powers under Order VII Rule 7 CPC because it is only when the relief for specific performance is denied would the stage arise for the refund of the amount paid under the agreement to sell, inasmuch as, otherwise if the agreement to sell would have gone through and the suit for specific performance decreed then the advance price/earnest money would have become part of the total sale consideration payable to the seller/defendant. In the case of M.C. Luthra (supra) the judgment of the Supreme Court in the case of Satish Batra Vs. Sudhir Rawal (2013) 1 SCC 345 has been explained and it was held that it is the ratio of the judgment of the Constitution Bench of five judges of the Supreme Court in Fateh Chand's case (supra) which will prevail and
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as explained in the case of Kailash Nath Associates (supra) . The relevant paras of the judgment in the case of M.C. Luthra (supra) are
paras 3 to 17, and these paras read as under:-
―3. Today counsel for the appellant/defendant/counter-claimant has, in spite of what is recorded in the order dated 12.9.2017 of appellant/defendant restricting the claim of forfeiture to a reasonable amount of Rs. 3 lacs out of Rs.9 lacs, argued by placing reliance upon the judgment of the Supreme Court in the case of Satish Batra Vs. Sudhir Rawal (2013) 1 SCC 345 that since the amount of Rs.9lacs was paid by the respondent/plaintiff to the appellant/defendant as earnest money, hence in accordance with the ratio in the case of Satish Batra (supra) the entire amount of Rs. 9 lacs can be forfeited by the appellant/defendant as permitted by Clause 8 of the agreement to sell. The impugned judgment of the trial court is therefore prayed to be set aside and the counter-claim of the appellant/defendant is prayed for being decreed for entitling the appellant/defendant to forfeit the entire amount of Rs.9 lacs received by the appellant/defendant from the respondent/plaintiff.
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―34. So far as counter claim of defendant for claiming that earnest amount of plaintiff is liable to be forfeited, law is well settled. If we go through the terms of the agreement Ex.PW1/1, stipulation in the shape of Clause 8 regarding forfeiture of earnest money cannot be termed as a penalty. Consequences for breach of the contract are provided in Chapter VI of the Contract Act which contains three sections, namely, section 73 to section 75. As per Section 73 of the Contract Act, the party who suffers by the breach of contract is entitled to receive from the defaulting party, compensation for any loss or damage caused to him by such breach, which naturally arose in usual course of things from such
RFA No.404/2018 Page 8 of 36
breach, or which the two parties knew when they make the contract to be likely the result of the breach of contract. This provision makes it clear that such compensation is not to be given for any remote or indirect loss or damage sustained by reason of the breach. The underlying principle enshrined in this section is that a mere breach of contract by a defaulting party would not entitle other side to claim damages unless said party has in fact suffered damages because of such breach. Loss or damage which is actually suffered as a result of breach has to be proved and the plaintiff is to be compensated to the extent of actual loss or damage suffered.
does not justify the award of compensation when in consequence of the breach no legal injury at all has resulted, because compensation for breach of contract can be awarded to make good loss or damage which naturally arose in the usual
RFA No.404/2018 Page 9 of 36
course of things, or which the parties knew when they made the contract, to be likely to result from the breach.‖
―From a review of the decisions cited above, the following principles emerge regarding ―earnest‖
(2) It represents a guarantee that the contract will be fulfilled or, in other words, ―earnest‖ is given to bind the contract.
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(3) It is part of the purchase price when the 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.‖
―The question then is whether the respondents are entitled to forfeit the entire amount. It is seen that a specific covenant under the
contract was that respondents are entitled to forfeit the money paid under the contract. So when the contract fell through by the default committed by the appellant, as part of the contract, they are entitled to forfeit the entire amount.‖
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are being accordingly decided.‖ (underlining added)
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has to be applied or it is the ratio of the judgments of the Supreme Court in the cases of Fateh Chand (supra) and Kailash Nath Associates (supra) which have to be applied. Also, if the ratio in the case of Satish Batra (supra) applies, then it is to be decided to what extent can the appellant/defendant be held entitled to forfeit the amount i.e whether appellant/defendant can forfeit the entire amount of Rs.9 lacs or only a lesser amount can be allowed to be forfeited by the appellant/defendant, and what is that lesser amount.
―5. We have heard the learned Counsel on either side at length. Facts are undisputed. The only question is whether the seller is entitled to retain the entire amount of Rs. 7,00,000/- received towards earnest money or not. The fact that the purchaser was at fault in not paying the balance consideration of Rs. 63,00,000/- is also not disputed. The question whether the seller can retain the entire amount of earnest money depends upon the terms of the agreement. Relevant clause of the Agreement for Sale dated 29.11.2005 is extracted hereunder for easy reference:
"e) If the prospective purchaser fail to fulfill the above condition. The transaction shall stand cancelled and earnest money will be forfeited. In case I fail to complete the transaction as stipulated above. The purchaser will get the DOUBLE amount of the
RFA No.404/2018 Page 13 of 36
earnest money. In the both condition, DEALER will get 4% Commission from the faulting party."
The clause, therefore, stipulates that if the purchaser fails to fulfill the conditions mentioned in the agreement, the transaction shall stand cancelled and earnest money will be forfeited. On the other hand, if the seller fails to complete the transaction, the purchaser would get double the amount of earnest money. Undisputedly the purchaser failed to perform his part of the contract, then the question is whether the seller can forfeit the entire earnest money.
xxxxx xxxxx xxxxx
―The trial Court held that the sum was paid by way of deposit or earnest money which was primarily a security for the performance of the contract and that the Respondent was entitled to forfeit the deposit amount when the Appellant committed a breach of the contract and dismissed the suit." ( Shree Hanuman Cotton Mills case)
The High Court confirmed the decision taken by the trial Court. This Court, considering the scope of the term "earnest", laid down certain principles, which are as follows: (Shree Hanuman Cotton Mills case)
―21. From a review of the decisions cited above, the following principles emerge regarding "earnest"
(1) It must be given at the moment at which the contract is concluded.
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(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 the 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.‖
―5.The question then is whether the Respondents are entitled to forfeit the entire amount. It is seen that a specific covenant under the contract was that Respondents are entitled to forfeit the money paid under the contract. So when the contract fell through by the default committed by the Appellant, as part of the contract, they are entitled to forfeit the entire amount.
―12. ... the allottee having accepted the allotment and having made some payment on installments basis, then made a request to surrender the land, has committed default on his part and, therefore, the competent authority would be fully justified in forfeiting the earnest money which had been deposited and not the 10% of the amount deposited, as held by the High Court."
In that case, this Court took the view that the earnest money represented the guarantee that the contract would be fulfilled.
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words used in the agreement alone would not be determinative of the character of the "earnest money" but really the intention of the parties and surrounding circumstances. The Court held that the earnest money serves two purposes of being part-payment of the purchase money and security for the performance of the contract by the party concerned.
―15. Coming to the facts of the case, it is seen from the agreement dated 13.5.1994 entered into between parties - particularly Clause 1, which specifies more than one enumerated categories of payment to be made by the purchaser in the manner and at stages indicated therein, as consideration for the ultimate sale to be made and completed. The further fact that the sum of Rs. 38 lakhs had to be paid on the date of execution of the agreement itself, with the other remaining categories of sums being stipulated for payment at different and subsequent stages as well as execution of the sale deed by the Vendors taken together with the contents of the stipulation made in Clause 2.3, providing for the return of it, if for any reason the Vendors fail to fulfill their obligations under Clause 2, strongly supports and strengthens the claim of the Appellants that the intention of the parties in the case on hand is in effect to treat the sum of Rs. 38 lakhs to be part of the prepaid purchase-money and not pure and simple earnest money deposit of the restricted sense and tenor, wholly unrelated to the purchase price as such in any manner. The mention made in the agreement or description of the same otherwise as "deposit or earnest money" and not merely as earnest money, inevitably leads to the inescapable conclusion that the same has to and was really meant to serve both purposes as envisaged in the decision noticed supra. In substance, it is, therefore, really a deposit or payment of advance as well and for that matter actually part payment of purchase price, only. In the teeth of the further fact situation that the sale could not be completed by execution of the sale deed in this case only due to lapses and inabilities on the part of the Respondents - irrespective of bonafides or otherwise involved in such delay and lapses, the amount of rupees 38 lakhs becomes refundable by the Vendors to the purchasers as of the prepaid purchase price deposited with the Vendors. Consequently, the sum of rupees 38 lakhs to be refunded would attract the first limb or part of Section 55(6)(b) of the Transfer of Property Act itself and therefore necessarily, as held by the learned Single Judge, the Defendants prima facie became liable to refund the same with interest due thereon, in terms of Clause 2.3 of the agreement Therefore, the statutory charge envisaged therein would get
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attracted to and encompass the whole of the sum of rupees 38 lakhs and the interest due thereon.‖
―14. ...Further, it is not the description by words used in the agreement only that would be determinative of the character of the sum but really the intention of parties and surrounding circumstances as well, that have to be baked into and what may be called an advance may really be a deposit or earnest money and what is termed as 'a deposit or earnest money' may ultimately turn out to be really an advance or part of purchase price. Earnest money or deposit also, thus, serves two purposes of being part payment of the purchase money and security for the performances
of the contract by the party concerned, who paid it.‖
an error in reversing the judgment of the trial court.‖
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5 of the judgment of the Supreme Court in the case of Satish Batra (supra), and therefore in the case of Satish Batra (supra) it was held that earnest money paid under an agreement to sell can be forfeited without complying with the requirement of the seller pleading and proving that he has suffered a loss on account of breach of the agreement to sell by the buyer. It also needs to be noted that in Para 14 of the case of Satish Batra (supra) reference is made to the ratio of the judgment of the Supreme Court in the case of Videocon Properties Ltd.’s (supra) that words used in an agreement are not determinative of the character of the sum (received by a seller under an agreement to sell) and what is the character of the amount paid depends upon the intentions of the parties and the surrounding circumstances. The Supreme Court therefore held that whether or not an amount called as earnest money under the contract is or is not earnest money will have to be decided as per the facts and circumstances of each individual case.
― AGREEMENT TO SELL AND PURCHASE This agreement is executed at Delhi, on this 15/09/2005
BETWEEN
Sh. M.C. Luthra s/o Sh. Mangal Das Luthra R/o H. No.691, Sector-V R.K. Puram, New Delhi
(hereinafter called the PARTY NO.1)
AND
Sh. Ashok Kumar Khanna S/o Sh. Sant Ram Khanna R/o D-32, Fateh Nagar, New Delhi (hereinafter called the PARTY NO.2)
The expression of both the Parties wherever they occur in the body of this agreement shall means, and include their respective heirs, legal representative, administrators, executors, successors, and assigns.
Whereas the Party No.1 is the exclusive owner of Flat No.D-504 Chankaya Cooperative Group Housing Society, Sector-4, Plot No.23 Dwarka, New Delhi.
The aforesaid property is free from all kind encumbrances such as prior sale gifts, mortgage, litigation, disputes, stay orders, attachments, notifications, acquisitions, charges liens, sureties etc.
Whereas the party No.1 for his bonafide needs and requirements has agreed to sell the aforesaid property for a total sale consideration of Rs.31,50,000/- (Rupees Thirty one lakhs & Fifty Thousands only) and Party No.2 has agreed to purchase the same on the following terms and conditions of this agreement:NOW THIS AGREEMENT WITNESSETH AS UNDER:-
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IN WITNESS WHEREOF BOTH THE PARTIES HAVE PUT THEIR RESPECTIVE HANDS ON THIS AGREEMENT IN PRESENCE OF THE FOLLOWING WITNESSES:-
WITNESSES:sd/1. sd/PartyNo.1 (SELLER) 2. sd/sd/(PURCHASER)‖ PartyNo.2 (emphasis added)
12.(i) Clause 8 of the agreement to sell in the present case entitling forfeiture of earnest money is no doubt similar to the clause which existed in Satish Batra’s case (supra), however a reference to Clause 1 of the agreement to sell shows that earnest money is only Rs.7,00,000/and not Rs.9,00,000/-. It is only Rs.7,00,000/- which is stated as earnest money in Clause 1 of the agreement to sell and with respect to the other amount of Rs.2,00,000/- it is stated that this is the 'balance amount'.
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Clause 2 of the agreement to sell then states that the 'balance sale consideration' amount would be Rs.22,50,000/- i.e parties understood that in case the agreement to sell goes through then what has been paid in terms of Clause 1 of the agreement to sell of Rs.7,00,000/- as earnest money will become part of the price to be paid under the agreement to sell.
(ii) Therefore in my opinion in the facts of the present case appellant/defendant cannot contend that earnest money amount was Rs.9,00,000/- and therefore this Court holds that the earnest amount is Rs.7,00,000/-.
13.(i) The issue to be decided then is that how much amount should the appellant/defendant be held entitled to forfeit. As already stated above in Satish Batra’s case (supra) besides holding that what is earnest money depends on facts and circumstances of each case, and in Satish Batra’s case (supra) ten percent of the total sale consideration being Rs.7 lacs was held in terms of the contractual clause to be entitled for being forfeited as earnest money as in Satish Batra’s case (supra) the sale consideration was Rs.70,00,000/-. When we see the facts of the present case it is seen that the total sale consideration is Rs.31,50,000/- and ten percent of which amount would therefore come to Rs.3,15,000/-. As already observed in Satish Batra’s case (supra) by referring to the ratio of Videocon Properties Ltd.’s case (supra) that merely because the amount is called as earnest money it will not automatically become earnest money and what is to be taken as the earnest money amount will depend upon the facts and circumstances of each case with the intentions of the parties.
(ii) With respect to the amount being called as earnest money and whether merely by that itself that the amount is called as earnest money it will become earnest money, it is seen that what is material is not label of the amount but the substance which has to be seen in view of the observations made in Para 14 of the judgment of the Supreme Court in Videocon Properties Ltd.’s case (supra) , which has been reproduced above. I have also in the judgment in the case of Shri Sunil Sehgal vs. Shri Chander Batra and Others , CS(OS) No. 1250/2006 decided on 23.9.2015 similarly held and have observed as under:-
"9. In the present case, defendants have led no evidence of any loss caused to them, and therefore, assuming that plaintiff is guilty of breach of contract, yet, the defendants cannot forfeit the amount of Rs.15 lacs lying with them. A huge amount of Rs.15 lacs out of the total sale consideration of Rs.79,50,000/- cannot in law be called earnest money. By giving a stamp of ‗earnest money‘ to advance price, the latter cannot become the former. What is to be seen is the substance and not the label. Only a nominal amount can be said to be earnest money and not an amount of Rs.15 lacs out of Rs.79.50 lacs, by noting that if suppose an amount of Rs. 30 lacs or 40 lacs would
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be called as earnest money by the parties, that would not take away the fact that such amount cannot be earnest money but would in fact be part of the price to be paid for sale." (underlining added)
(iii) I have also similarly held in the judgment passed in the case of Bhuley Singh Vs. Khazan Singh & Ors. in RFA No. 422/2011 decided on 9.11.2011 and the relevant Para 5 of the judgment reads as under:-
"5. In my opinion, the appeal deserves to be allowed as the appellant/plaintiff has rightly claimed a lesser relief of Rs.5,00,000/instead of a sum of Rs.10,00,000/- as claimed in the plaint and which he is surely entitled to under Order 7(7) CPC. The Trial Court had framed a specific issue being issue no.2 as to whether plaintiff was entitled to recover Rs.5,00,000/- from the respondents/defendants paid against the receipt dated 5.1.2007 and therefore the argument of the counsel for the respondents/defendants that no issue was framed has no force. Once there was a specific issue, this issue could well have been urged so that the appellant/plaintiff could claim a sum of Rs.5,00,000/- from the respondents/defendants which was paid under the agreement to sell as an earnest amount on the basis of the undisputed position that the respondents/defendants did not plead or prove that loss had been caused to them so as to entitle them to forfeit the amount paid to them under the Agreement to Sell. The Constitution Bench of the Supreme Court in the case of Fateh Chand (supra) makes it more than clear that a mere breach of contract by a buyer does not entitle the seller to forfeit the amount as received, unless, loss is proved to have been caused to the prospective sellers/defendants/respondents. The Supreme Court in the judgment of Fateh Chand (supra) allowed forfeiture of amount of Rs.1,000/out of the amount paid of Rs.25,000/-. I may also note that nomenclature of a payment is not important and what is important is really the quantum of price which is paid. In the present case, the total price payable for the suit property is Rs.20,00,000/- and therefore 25% of the payment made s tricto sensu cannot be an earnest money, though it has been called so. Only a nominal amount can be an earnest money, inasmuch as, the object of such a clause is to allow forfeiture of that amount to a nominal extent as held in the case of Fateh Chand (supra). For example can it be said that 100% of the price or 75%/80% of the price or 50% of the price is earnest money so that it can be forfeited. The answer surely is in the negative. Such high amounts called earnest money will be in the nature of penalty and thus hit by Section 74 of the Indian Contract Act, 1872 in view of Fateh Chand’s case. The principles laid down in Fateh Chand’s case; that forfeiture of a reasonable amount is not penalty but if forfeiture is of a large amount the same is in the nature of penalty attracting the applicability of Section 74; have been recently reiterated by the Supreme Court in the case of V.K.Ashokan
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vs. CCE, 2009 (14) SCC 85 ." (underlining added) I therefore hold that the appellant/defendant can at best seek to forfeit, in accordance with the ratio in Satish Batra's case (supra), a sum of Rs. 3 lacs, and not a sum of Rs. 9 lacs as is claimed by the appellant/defendant, but even this amount of Rs. 3 lacs cannot be allowed to be forfeited and the reasons are given hereinafter.
39. The said view runs in the teeth of the decision of the Supreme Court reported as AIR 1970 SC 1986 Shree Hanuman Cotton Mills & Anr. V. Tata Aircraft Ltd. which holds that as against an amount tendered by way of security, amount tendered as earnest money could be forfeited as per terms of the contract .
40. We may additionally observe that original time to pay the balance bid consideration, as per Ex.P-I was May 18, 1982 and as extended by Ex. P-8 was October 28, 1982. That DDA could auction the plot in the year 1994 in the sum of Rupees 11.78 crore was immaterial and not relevant evidence for the reason damages with respect to the price of property have to be computed with reference to the date of the breach of the contract.”
“When a contract has been broken, if a sum is named in the contract as the amount to be paid in case of such breach, the party complaining of the breach is entitled, whether or not actual damage or loss is proved to have been caused thereby, to receive from the party who has broken the contract reasonable compensation not exceeding the amount so named.”
―74. Compensation for breach of contract where penalty stipulated for.— When a contract has been broken, if a sum is named in the contract as the amount to be paid in case of such breach, or if the contract contains any other stipulation by way of penalty, the party complaining of the breach is entitled, whether or not actual damage or loss is proved to have been caused thereby, to receive from the party who has broken the contract reasonable compensation not exceeding the amount so named or, as the case may be, the penalty stipulated for. Explanation .—A stipulation for increased interest from the date of default may be a stipulation by way of penalty.
Exception.— When any person enters into any bail-bond, recognizance or other instrument of the same nature, or, under the provisions of any law, or under the orders of the Central Government or of any State Government, gives any bond for the performance of any public duty or act in which the public are interested, he shall be liable, upon breach of any condition of any such instrument, to pay the whole sum mentioned therein.
Explanation.— A person who enters into a contract with Government does not necessarily thereby undertake any public
duty, or promise to do an act in which the public are interested.‖
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compensation is payable for breach of contract under Section 74 only where damage or loss is caused by such breach.
“The section is clearly an attempt to eliminate the somewhat elaborate refinements made under the English common law in distinguishing between stipulations providing for payment of liquidated damages and stipulations in the nature of penalty. Under the common law a genuine pre-estimate of damages by mutual agreement is regarded as a stipulation naming liquidated damages and binding between the parties: a stipulation in a contract in terrorem is a penalty and the Court refuses to enforce it, awarding to the aggrieved party only reasonable compensation. The Indian Legislature has sought to cut across the web of rules and presumptions under the English common law, by enacting a uniform principle applicable to all stipulations naming amounts to be paid in case of breach, and stipulations by way of penalty. ….
Section 74 of the Indian Contract Act deals with the measure of damages in two classes of cases (i) where the contract names a sum to be paid in case of breach and (ii) where the contract contains any other stipulation by way of penalty. We are in the present case not concerned to decide whether a covenant of forfeiture of deposit for due performance of a contract falls within the first class. The measure of damages in the case of breach of a stipulation by way of 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 of the case. 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 that imposes upon the Court duty to award compensation according to settled principles. The section undoubtedly says that the aggrieved party is entitled to receive compensation from the party who has broken the contract, whether or not actual damage or loss is proved to have been caused by the breach. Thereby it merely dispenses with proof of "actual loss or damages"; it does not justify the award of compensation when in consequence of the breach no legal injury at all has resulted, because compensation for breach of contract can be awarded to make good loss or damage which naturally arose in the usual course of things , or which the parties knew when they
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made the contract, to be likely to result from the breach.”(At page 526, 527)
Section 74 declares the law as to liability upon breach of contract where compensation is by agreement of the 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 predetermining damages or providing for 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 jurisdiction of the court is not determined by the accidental circumstance of the party in default being a plaintiff or a defendant in a suit . Use of the expression "to receive from the party who has broken the contract" does not predicate that the jurisdiction of the court to adjust amounts which have been paid by the party in default cannot be exercised in dealing with the claim of the party complaining of breach of contract. 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 the breach.”(At page 530)
“Forfeiture of earnest money under a contract for sale of property-movable or immovable-if the amount is reasonable, does not fall within Section 74. That has been decided in several cases :Kunwar Chiranjit Singh v. Har Swarup, A.I.R.1926 P.C.1; Roshan Lal v. The Delhi Cloth and General Mills Company Ltd., Delhi, I.L.R. All.166; Muhammad Habibullah v. Muhammad Shafi, I.L.R. All. 324; Bishan Chand v. Radha Kishan Das, I.D. 19 All. 49. These cases are easily explained, for forfeiture of a reasonable amount paid as earnest money does not amount to imposing a penalty. But if forfeiture is of the nature of penalty, Section 74 applies. Where under the terms of the contract the party in breach has undertaken to pay a sum of money or to forfeit a sum of money which he has already paid to the party complaining of a breach of contract, the undertaking is of the nature of a penalty.
Counsel for the Union, however, urged that in the present case Rs. 10,000/- in respect of the potato contract and Rs. 8,500 in respect of the poultry contract were genuine pre-estimates of damages which the Union was likely to suffer as a result of
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breach of contract, and the plaintiff was not entitled to any relief against forfeiture. Reliance in support of this contention was placed upon the expression (used in Section 74 of the Contract Act), "the party complaining of the breach is entitled, whether or not actual damage or loss is proved to have been caused thereby, to receive from the party who has broken the contract reasonable compensation". It is true that in every case of breach of contract the person aggrieved by the breach is not required to prove actual loss or damage suffered by him before he can claim a decree, and the Court is competent to award reasonable compensation in case of breach even if no actual damage is proved to have been suffered in consequence of the breach of contract. But the expression "whether or not actual damage or loss is proved to have been caused thereby" is intended to cover different classes of contracts which come before the Courts. In case of breach of some contracts it may be impossible for the Court to assess compensation arising from breach, while in other cases compensation can be calculated in accordance with established rules. Where the Court is unable to assess the compensation, the sum named by the parties if it be regarded as a genuine pre-estimate may be taken into consideration as the measure of reasonable compensation, but not if the sum named is in the nature of a penalty. Where loss in terms of money can be determined, the party claiming compensation must prove the loss suffered by him.
In the present case, it was possible for the Government of India to lead evidence to prove the rates at which potatoes, poultry, eggs and fish were purchased by them when the plaintiff failed to deliver "regularly and fully" the quantities stipulated under the terms of the contracts and after the contracts were terminated. They could have proved the rates at which they had to be purchased and also the other incidental charges incurred by them in procuring the goods contracted for. But no such attempt was made.”(At page 933,934)
“From a review of the decisions cited above, the following principles emerge regarding "earnest":
(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 the transaction is carried out.
(4) It is forfeited when the transaction falls through by reason of the default or failure of the purchaser.
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(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” (At page 139)
“The learned Attorney General very strongly urged that the pleas covered by the second contention of the appellant had never been raised in the pleadings nor in the contentions urged before the High Court. The question of the quantum of earnest deposit which was forfeited being unreasonable or the forfeiture being by way of penalty, were never raised by the appellants. The Attorney General also pointed out that as noted by the High Court the appellants led no evidence at all and, after abandoning the various pleas taken in the plaint, the only question pressed before the High Court was that the deposit was not by way of earnest and hence the amount could not be forfeited. Unless the appellants had pleaded and established that there was unreasonableness attached to the amount required to be deposited under the contract or that the clause regarding forfeiture amounted to a stipulation by way of a penalty, the respondents had no opportunity to satisfy the Court that no question of unreasonableness or the stipulation being by way of penalty arises. He further urged that the question of unreasonableness or otherwise regarding earnest money does not at all arise when it is forfeited according to the terms of the contract.
In our opinion the learned Attorney General is well founded in his contention that the appellants raised no such contentions covered by the second point, noted above. It is therefore unnecessary for us to go into the question as to whether the amount deposited by the appellants, in this case, by way of earnest and forfeited as such, can be considered to be reasonable or not. We express no opinion on the question as to whether the element of unreasonableness can ever be considered regarding the forfeiture of an amount deposited by way of earnest and if so what are the necessary factors to be taken into account in considering the reasonableness or otherwise of the amount deposited by way of earnest. If the appellants were contesting the claim on any such grounds, they should have laid the foundation for the same by raising appropriate pleas and also led proper evidence regarding the same, so that the respondents would have had an opportunity of meeting such a claim.”(At page 142)
“64. It is apparent from the aforesaid reasoning recorded by the Arbitral Tribunal that it failed to consider Sections 73 and 74 of the Indian Contract Act and the ratio laid down in Fateh Chand
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case [AIR 1963 SC 140: (1964) 1 SCR 515 at p. 526] wherein it is specifically held that jurisdiction of the court to award compensation in case of breach of contract is unqualified except as to the maximum stipulated; and compensation has to be reasonable. Under Section 73, when a contract has been broken, the party who suffers by such breach is entitled to receive compensation for any loss caused to him which the parties knew when they made the contract to be likely to result from the breach of it. This section is to be read with Section 74, which deals with penalty stipulated in the contract, inter alia (relevant for the present case) provides that when a contract has been broken, if a sum is named in the contract as the amount to be paid in case of such breach, the party complaining of breach is entitled, whether or not actual loss is proved to have been caused, thereby to receive from the party who has broken the contract reasonable compensation not exceeding the amount so named. Section 74 emphasizes that in case of breach of contract, the party complaining of the breach is entitled to receive reasonable compensation whether or not actual loss is proved to have been caused by such breach. Therefore, the emphasis is on reasonable compensation. 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. 67……..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 preestimated such loss after clear understanding, it would be totally unjustified to arrive at the conclusion that the party who has committed breach of the contract is not liable to pay compensation. It would be against the specific provisions of Sections 73 and 74 of the Indian Contract Act. There was nothing on record that compensation contemplated by the parties was in any way unreasonable. It has been specifically mentioned that it was an agreed genuine pre-estimate of damages duly agreed by the parties. It was also mentioned that the liquidated damages are not by way of penalty. It was also provided in the contract that such damages are to be recovered by the purchaser from the bills for payment of the cost of material submitted by the contractor. No evidence is led by the claimant to establish that the stipulated condition was by way of penalty or the compensation
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contemplated was, in any way, unreasonable. There was no reason for the Tribunal not to rely upon the clear and unambiguous terms of agreement stipulating pre-estimate damages because of delay in supply of goods. Further, while extending the time for delivery of the goods, the respondent was informed that it would be required to pay stipulated damages. 68. From the aforesaid discussions, it can be held that:
(1) Terms of the contract are required to be taken into consideration before arriving at the conclusion whether the party claiming damages is entitled to the same.
(2) If the terms are clear and unambiguous stipulating the liquidated damages in case of the breach of the contract unless it is held that such estimate of damages/compensation is unreasonable or is by way of penalty, party who has committed the breach is required to pay such compensation and that is what is provided in Section 73 of the Contract Act.
(3) Section 74 is to be read along with Section 73 and, therefore, in every case of breach of contract, the person aggrieved by the breach is not required to prove actual loss or damage suffered by him before he can claim a decree. The court is competent to award reasonable compensation in case of breach even if no actual damage is proved to have been suffered in consequence of the breach of a contract.
(4) In some contracts, it would be impossible for the court to assess the compensation arising from breach and if the compensation contemplated is not by way of penalty or unreasonable, the court can award the same if it is genuine preestimate by the parties as the measure of reasonable compensation.”
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“But, as we have already mentioned, we do not propose to go into those aspects in the case on hand. As mentioned earlier, the appellants never raised any contention that the forfeiture of the amount amounted to a penalty or that the amount forfeited is so large that the forfeiture is bad in law. Nor have they raised any contention that the amount of deposit is so unreasonable and therefore forfeiture of the entire amount is not justified. The decision in Maula Bux's [1970]1SCR928 had no occasion to consider the question of reasonableness or otherwise of the earnest deposit being forfeited. Because, from the said judgment it is clear that this Court did not agree with the view of the High Court that the deposits made, and which were under consideration, were paid as earnest money. It is under those circumstances that this Court proceeded to consider the applicability of Section 74 of the Contract Act. (At page 143)”
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been shown that far from suffering any loss, DDA has received a much higher amount on re-auction of the same plot of land.
7 . 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.
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(i) As per the facts existing in the case of Kailash Nath Associates (supra) the Single Judge of the High Court had held that since no damages were suffered by DDA therefore DDA could not forfeit the earnest money. (Para 30 of Kailash Nath Associates's case (supra )).
(ii) The Division Bench of the High Court however set aside the judgment of the Single Judge by holding that amount tendered as earnest money can be forfeited because and simply forfeiture of amount called as earnest money can be forfeited in terms of the contract. (Para 30 of Kailash Nath Associates's case (supra) reproducing Para 39 of the Division Bench judgment of the High Court).
(iii) Supreme Court in the case of Kailash Nath Associates (supra) as per Para 44 of its judgment holds that the Division Bench of the High Court had gone wrong in principle because compensation can be awarded (where there is breach of contract) only if loss or damage is suffered i.e where there is no loss or damage suffered as a result of breach of contract no compensation can be awarded as law does not provide for a windfall i.e large amounts though called contractually as earnest money cannot be forfeited unless loss is pleaded and proved to have been suffered. These observations have cross-reference to Para 34 of the judgment of Kailash Nath Associates's case (supra) where with reference to the para of Fateh Chand's case (supra) it is held that the language of Section 74 of the
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Contract Act that 'whether or not damage or loss is proved to have been caused by breach' is the language that such language only discharges proof of actual loss but that does not justify award of compensation where in consequence of breach no injury/loss has at all resulted.
(iv) Earnest money is an amount to be paid in case of breach of contract, and named in contract as such, and that forfeiture of earnest money is covered under the entitlement to liquidated damages under Section 74 of the Contract Act vide Para 40 in the case of Kailash Nath Associates (supra).
(v) The language of Section 74 of the Contract Act that "whether or not actual loss or damage is proved to have been caused thereby" means only that where it is difficult or impossible to prove loss caused by the breach of contract then the liquidated damages/amount (being the amount of earnest money) can be awarded vide Para 43(6) of Kailash Nath Associates's case (supra) but where nature of contract is such that loss caused because of breach can be assessed and so proved then in such cases loss suffered must be proved to claim the liquidated damages of earnest money. This finding has cross reference to Para 37 of judgment in Kailash Nath Associates's case (supra) where the observations of Supreme Court in Para 67 of the case of ONGC Ltd. Vs. Saw Pipes Ltd. (2003) 5 SCC 705 are quoted that liquidated damages are awarded where it is difficult to prove exact loss or damage caused as a result of breach of contract.
(vi) Even where liquidated damages can be awarded under Section 74 of the Contract Act because loss or damages cannot be proved in a contractual breach yet if the liquidated damages (earnest money) are a penalty amount by its nature i.e prescribed liquidated damages figure is unreasonable, then for the liquidated damages amount or earnest money amount forfeiture cannot be granted/allowed and that only reasonable amount is allowed as damages with the figure of liquidated damages being the upper limit vide Para 43(1) of Kailash Nath Associates's case (supra).
"66. There is another aspect of the matter which cannot be lost sight of. If damages cannot be calculated and the terms of the contract provides therefor only for penalty by way of liquidated damages, having regard to the provisions contained in Section 74 of the Indian Contract Act a reasonable sum only could be recovered which need not in all situations even be the sum specified in the contract. (See Maula Bux vs. Union of India and Shree Hanuman Cotton Mills vs. Tata Air Craft Ltd .)
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The Court also observed: (AIR p. 1411, para 11)
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contract which expressly provides for forfeiture, the court has jurisdiction to award such sum only as it considers reasonable, but not exceeding the amount specified in the contract as liable to forfeiture.‖
and that,
― 14 . … There is no ground for holding that the expression ‗contract contains any other stipulation by way of penalty‘ is limited to cases of stipulation in the nature of an agreement to pay money or deliver property on breach and does not comprehend covenants under which amounts paid or property delivered under the contract, which by the terms of the contract expressly or by clear implication are liable to be forfeited.‖ (AIR p. 1412, para 14)
(emphasis added)
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the forfeiture clause, and actual forfeiture only of a lesser and a reasonable amount should be allowed instead of the large amount/penalty as stated under a contract as being entitled to be forfeited and that too merely because a contractual clause allows such a forfeiture.‖
there is no illegality in the impugned judgment which directs refund of the advance price/earnest money paid to the appellants/defendants
by the respondent/plaintiff under the subject agreement to sell, inasmuch as there is no dispute that appellants/defendants have not pleaded or proved any loss caused to them on account of any alleged
breach of the agreement to sell by the respondent/plaintiff.
MAY 14, 2018 VALMIKI J. MEHTA, J AK
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3 issues framed by the court
Whether a seller under an agreement to sell can forfeit earnest money without pleading and proving loss caused by the buyer's breach?
Whether forfeiture of earnest money paid under an agreement to sell falls within Section 74 of the Indian Contract Act, 1872?
Whether refund of the advance could be granted under Order VII Rule 7 CPC when the suit for specific performance was dismissed?
Colour shows how this judgement treated each authority
M.C. Luthra Vs. Ashok Kumar KhannaRelied on¶47
M.C. Luthra Vs. Ashok Kumar Khanna in RFA No. 780/2017 decided on 27.2.2018
Fateh Chand Vs. Balkishan DassFollowed¶49
Fateh Chand Vs. Balkishan Dass AIR 1963 SC 1045 · Who else cites this
Kailash Nath Associates Vs. Delhi Development and AnotherFollowed¶49
Kailash Nath Associates Vs. Delhi Development and Another (2015) 4 SCC 136 · Who else cites this
Satish Batra Vs. Sudhir RawalExplained¶49
Satish Batra Vs. Sudhir Rawal (2013) 1 SCC 345 · Who else cites this
3 provisions across 2 enactments
Rajbir Singh & Anr.
Jaswant Yavdav
Valmiki J. Mehta
As recorded by the court registry
Judgements on the same questions, provisions and authorities, from every court
