[Commercial Law Monologues] Liquidated damages: On whom does the burden of proof lie?

Under Indian law, ordinarily the burden of proving (a) loss or damage or legal injury, as well as (b) the extent, quantum and measure of such loss or damage, lies on the party making a claim for liquidated damages under Section 74 of the Indian Contract Act, 1872, as amended (“Indian Contract Act”). This is no different from a claim for unliquidated damages under Section 73 [See Section 105 of the Bharatiya Sakshya Adhiniyam, 2023, as amended (“Bharatiya Sakshya Adhiniyam”) and Maya Devi v. Lalta Prasad, reported at (2015) 5 SCC 588, at paragraph 19].

Therefore, the innocent party ought to discharge this initial burden during trial. Ordinarily, the party in breach does not bear any initial burden to show that the innocent party has suffered no loss because of the breach, or that the sum named in the contract is not a genuine pre-estimate of damages or is unreasonable or is a penalty.

However, the issue of burden of proof under Section 74 of the
Indian Contract Act is a subject-matter of some ostensible confusion. This is because the theoretical basis of the decision of the Supreme Court of India in Oil & Natural Gas Corporation Ltd. v. Saw Pipes Ltd., reported at (2003) 5 SCC 705 (“Saw Pipes Case”), is often misunderstood.

Despite where the initial burden lies, the onus of proof may, in certain situations, shift to the party in breach, as explained below. In those cases, the party in breach must show that no legal injury has been suffered because of the breach, or (even if such legal injury has been suffered) that the sum named in the contract is either not a genuine pre-estimate or is unreasonable or is a penalty.

It is evident from paragraph 67 of the decision of the Supreme Court in the Saw Pipes Case that the Court was proceeding in that case on the basis that in certain contracts, the occurrence of a loss or legal injury is so obvious that it requires no further proof. It can be presumed. [See Section 119 of the Bharatiya Sakshya Adhiniyam]

Further, the liquidated damages clause of the contract in the Saw Pipes Case expressly stated that the sum named was “an agreed, genuine pre-estimate of damages duly agreed by the parties” and that “agreed liquidated damages are not by way of penalty”.

In view of the nature of the contract and this express term in the contract,
the Court held that the onus to prove that (a) no loss or legal injury had been suffered by the innocent party, and (b) the sum named in the contract is not a genuine pre-estimate (and is unreasonable or a penalty) had shifted to the party in breach. [See Saw Pipes Case, at paragraphs 38, 40, 41, 63, 67, 68 and Bharat Sanchar Nigam Limited v. Haryana Telecom Limited, reported at 2010 (116) DRJ 157, at paragraphs 20, 21].

If for example, in the Saw Pipes Case, the contract that was being relied upon by the innocent party had been disputed by the party in breach, the innocent party would have had to discharge the burden of proving the contract to demonstrate that there was a sum agreed as a genuine pre-estimate by the parties, and that the parties even agreed that this sum was not in the nature of a penalty. The onus to prove otherwise would shift to the party in breach thereafter.

Therefore, it is only in the specific facts of each case (such as the nature of the contract, the terms of the contract, the nature of obligations and the state of evidence led during trial), that the onus of proof may shift to the party in breach to show that (a) no loss or legal injury had been suffered by the innocent party, and (b) the sum named in the contract is not a genuine pre-estimate and is unreasonable or a penalty. This shifting of onus is a continuous process in the evaluation of evidence during trial, in each case. [See A. Raghavamma v. A. Chenchamma, reported at AIR 1964 SC 136, at paragraph 12].

In Maula Bux v. Union of India, reported at 1969 (2) SCC 554 (“Maula Bux Case”), the Supreme Court held at paragraphs 6 and 7 that Section 74 of the Indian Contract Act dispenses with the proof of extent, quantum and measure of loss or damage only where it is impossible for the court to assess loss or damage, in accordance with “established rules” of quantification of the extent of loss or damage. It was also held that “[w]here loss in terms of money can be determined, the party claiming compensation must prove the loss suffered…” The Saw Pipes Case appears to extend this principle to proof of legal injury as well.

In Kailash Nath Associates v. Delhi Development Authority, reported at (2015) 4 SCC 136 (“Kailash Nath Case”), the Supreme Court used the expression “difficult or impossible to prove” in paragraph 43.6. In my view, the expression “difficult” cannot mean that it is merely inconvenient, expensive or onerous to prove damages, but it refers to something that is practically impossible. Otherwise, the expression “impossible” used with the expression “difficult” in the Kailash Nath Case would be rendered redundant.

The Supreme Court again held in Construction and Design Services v. Delhi Development Authority, reported at (2015) 14 SCC 263 (“Construction Design Case”), at paragraphs 14, 15, 17 and 18, that in contracts involving a claim for liquidated damages for delay in construction of public utility projects, it can be presumed that (a) some loss or legal injury has been suffered by the innocent property, and (b) the sum named in the contract is a genuine pre-estimate (and not unreasonable or a penalty), without actual proof.

However, the analysis in the Construction Design Case poses three challenges.

First, presuming that the extent, quantum and measure of loss or damage is impossible to prove does not always invite a presumption that even legal injury is impossible to prove. For example, even in public utility projects, it may sometimes be possible to demonstrate that the employer/State has suffered legal injury because it had to incur some cost by deploying extra resources (or some wastage of paid time of its resources), although the extent, quantum and measure is impossible to prove. There can be cases where these two aspects of (a) legal injury and (b) the extent, quantum and measure of loss or damage are not inter-dependent.

The Construction Design Case does not notice this exception, perhaps because it did not arise in the facts of that case or was not argued during the hearing.

Second, the basis of awarding only half of the amount claimed (or even half of the amount named in the contract as the upper limit of liquidated damages) is unclear. The Court appears to have proceeded on an intuitive basis, which is inconsistent with the observations in paragraph 43.2 of the earlier decision in the Kailash Nath Case that “[r]easonable compensation will be fixed on well-know principles…which are to be found inter alia in Section 73 of the Contract Act.” [See paragraph 17 of Construction Design Case].

It appears that the decision in the Kailash Nath Case was not brought to the attention of the Court in the Construction Design Case.

Third, having made both presumptions, i.e., that a loss or damage or legal injury would have occurred and that the exact extent, quantum and measure of loss or damage is impossible to prove, the decision proceeds on the basis that a uniform treatment would follow in such a situation irrespective of whether the sum named in the contract is liquidated damages, or a penalty.

Unlike the Saw Pipes Case, the contract did not record any express agreement amongst the parties in the Construction Design Case that the sum named was a genuine pre-estimate and not a penalty. On the contrary, in the facts of that case, the named sum had been specifically imposed by way of a penalty and not liquidated damages. [See paragraphs 4 and 15 of Construction Design Case].

This part of the approach in the Construction Design Case appears to be inconsistent with the decision of a larger bench of the Supreme Court in the Maula Bux Case, where it was held in paragraph 6 that “where a 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.”

Again, it appears that these aspects were not brought to the attention of or argued before the Court in Construction Design Case. It is hoped in an appropriate case that the Supreme Court will clarify these aspects in greater detail.

There are three features of the burden that an innocent party claiming liquidated damages from a party in breach must discharge under Indian law. First, that an innocent party has suffered a loss or damage. Second, that it is impossible to prove the extent, quantum and measure of the loss or damage. Third, that the sum named in the contract is a genuine pre-estimate, and not in the nature of a penalty.

The evolving judicial precedent in India demonstrates that with respect to all the three features, courts in India can make presumptions, draw adverse inferences, depending on the nature of the contract, the terms of the contract, the nature of obligations and the state of evidence led during trial. However, this is because of a continuous process of shifting of onus of proof during trial. The initial burden always lies on the innocent party making a claim for liquidated damages.

Gaurav Pachnanda is a Senior Advocate, based in New Delhi, whose practice is focussed on a wide range of commercial litigation.