Understand Liquidated Damages

Liquidated damages refer to a pre-agreed amount of money that a party to a contract is obligated to pay to the other party in the event of a breach of contract. The amount of liquidated damages is typically specified in the contract and is intended to compensate the non-breaching party for the losses or harm suffered as a result of the breach.

The purpose of liquidated damages is to provide a predetermined amount of compensation to the non-breaching party, without the need to prove actual damages in court. This can be helpful in situations where it may be difficult to quantify the actual losses suffered by the non-breaching party, or where the process of proving damages in court may be time-consuming and expensive.

Liquidated damages (“LD”) are commonly used in construction contracts, where delays or other breaches can result in significant losses for the project owner. They are also used in other types of contracts, such as employment contracts, leases, and sales agreements.

It is important to note that the use of liquidated damages must be reasonable and not excessive. Courts may review liquidated damages provisions to ensure that they are not a penalty and do not violate public policy. If the liquidated damages are found to be unreasonable or excessive, the court may refuse to enforce them.

A typical LD clause in construction contracts goes like this- “If the Contractor fails to complete the Works within the specified time, the Contractor must pay the Employer liquidated damages for each week of delay at 0.5% of the Contract Price, capped at 5% of the Contract Price.”

Over the years, the Supreme Court of India has established various principles governing the levy of Liquidated Damages- 

📌LD can only be levied if there is breach by a party. (JG Engineers vs Union of India & Anr- 2011) 

📌If the contract specifies LD for a breach, then general damages cannot be claimed for the same breach. (Steel Authority of India Ltd. vs. Gupta Brothers Steel Tubes Ltd.- 2009)

📌The party claiming LD has to prove legal injury. (ONGC Ltd vs Saw Pipes Ltd- 2003)

📌LD must be proportionate to the losses actually suffered due to the breach. If proven otherwise, the court may award damages only to the extent of actual losses suffered by the claimant. The burden of proof rests on the party committing the breach. (Kailash Nath vs DDA & Anr- 2015)

📌LD cannot be recovered unilaterally by a party. It needs to be confirmed by an arbitrator or court. (Tulsi Narayan Garg v. M.P. Road Development Authority-2019)

These principles may assist a contractor in successfully deflecting a claim for Liquidated Damages