1. Factual Background and Procedural History
The present appeal in Sonali Power Equipments Pvt. Ltd. v. Chairman, Maharashtra State Electricity Board & Ors. arose from a contractual dispute concerning the levy of liquidated damages by the Maharashtra State Electricity Board (MSEB) for alleged delay in the supply of electrical equipment.
Contractual Framework
Sonali Power Equipments Pvt. Ltd. (the appellant), a registered supplier of electrical transformers, entered into a supply contract with MSEB for providing distribution transformers under specific technical and delivery conditions. The contract contained a liquidated damages clause, empowering MSEB to recover 0.5% of the contract value per week of delay, subject to a ceiling of 10%.
Despite eventual supply completion, MSEB deducted substantial sums as liquidated damages, asserting delayed delivery beyond the stipulated period. The appellant challenged these deductions as arbitrary and punitive, contending that MSEB had suffered no actual loss or delay in its distribution operations.
Proceedings Before Lower Forums
The appellant’s claim for refund was rejected by the Trial Court, which held that the clause for liquidated damages was contractual and binding, and therefore no separate proof of loss was necessary.
The High Court of Bombay upheld the finding, holding that MSEB was entitled to invoke the clause as per contractual terms.
Aggrieved, the appellant approached the Supreme Court under Article 136, assailing the concurrent findings.
The case was heard and decided on 17 July 2025, wherein the Supreme Court allowed the appeal and clarified the scope of Section 74 of the Indian Contract Act, 1872 on the enforceability of liquidated damages.
2. Identification of Legal Issues
The Supreme Court framed and examined the following issues:
- Whether liquidated damages stipulated in a contract can be recovered without proof of actual loss or injury suffered by the party alleging breach.
- Whether the courts below erred in treating Section 74 as permitting automatic enforcement of pre-estimated damages.
- What is the correct test for distinguishing between a genuine pre-estimate of loss and a penalty clause under Indian law?
3. Arguments of the Parties
Appellant (Sonali Power Equipments Pvt. Ltd.)
- The respondent failed to demonstrate any actual loss or injury caused by the delay in delivery of transformers.
- Section 74 of the Indian Contract Act does not authorize mechanical enforcement of a penalty merely because it is stipulated in the contract.
- The clause in question was penal in nature and required strict proof of loss or prejudice.
- Reliance was placed on:
- Fateh Chand v. Balkishan Dass, AIR 1963 SC 1405
- Kailash Nath Associates v. DDA, (2015) 4 SCC 136
- ONGC v. Saw Pipes Ltd., (2003) 5 SCC 705 (distinguished)
- Fateh Chand v. Balkishan Dass, AIR 1963 SC 1405
- The deduction was arbitrary, particularly when the supply was ultimately accepted without rejection or procurement loss.
Respondents (MSEB)
- The parties were commercial entities acting with equal bargaining power; the contract’s terms were clear and binding.
- The clause for liquidated damages was a genuine pre-estimate of loss, not a penalty.
- In large infrastructure contracts, loss from delay is inherently difficult to quantify; thus, pre-determined damages serve a legitimate compensatory function.
- Reliance was placed on ONGC v. Saw Pipes Ltd. (2003), which upheld recovery of pre-estimated damages when the clause was reasonable.
4. Court’s Analysis and Reasoning
The Supreme Court undertook a detailed exposition of Section 74 of the Indian Contract Act, 1872, which governs compensation for breach of contract where a sum is named as liquidated damages.
(a) Requirement of Proof of Loss
The Court reaffirmed that Section 74 does not dispense with proof of loss or damage.
While actual quantification may not always be possible, the existence of loss or injury must be established as a fact. The Court observed:
“The law does not recognize a windfall for breach. Compensation, whether stipulated or otherwise, must bear a rational nexus to loss sustained.”
(b) Interpretation of Section 74
The Court explained that Section 74 strikes a balance between two extremes:
- On one hand, preventing unjust enrichment through penalties;
- On the other, recognizing the commercial need for pre-estimation of loss in contracts where precise quantification is impracticable.
The Bench clarified that:
- If the stipulated amount represents a genuine pre-estimate of likely damages, it may be enforceable;
- However, the party claiming it must still show that some loss or injury occurred due to breach.
(c) Revisiting Saw Pipes and Kailash Nath
The Court distinguished ONGC v. Saw Pipes by emphasizing that the said judgment did not dispense with the requirement of showing loss altogether—it only relaxed the need for mathematical precision.
The subsequent decision in Kailash Nath Associates v. DDA (2015) correctly clarified that proof of loss, though not quantification, is mandatory.
(d) Findings on Facts
Applying these principles, the Court noted:
- MSEB continued its operations without disruption despite the alleged delay;
- The transformers supplied were accepted without reservation or alternate procurement;
- No evidence of loss to the Board or its consumers was produced.
Hence, deduction of liquidated damages was unwarranted and unsustainable.
(e) Policy Objective
The Court observed that contractual clauses for liquidated damages cannot become instruments of unjust enrichment. Public sector entities, in particular, must act fairly, proportionately, and consistent with Article 14 of the Constitution.
5. Final Conclusion and Holding
- The appeal was allowed.
- The orders of the Trial Court and High Court were set aside.
- MSEB was directed to refund the deducted liquidated damages with interest.
- The Supreme Court declared the following principle:
“A party invoking a clause for liquidated damages must establish that it suffered some loss or injury due to the breach. Section 74 does not authorize automatic recovery merely because a sum is named in the contract.”
This decision reinforces the compensatory—not penal—character of contractual damages under Indian law.
FAQs:
1. What are liquidated damages in contract law?
Liquidated damages are a pre-estimated amount agreed between parties as compensation for breach of contract, intended to represent probable loss rather than a penalty.
2. Can liquidated damages be recovered without proving loss?
No. The Supreme Court has clarified that proof of actual or probable loss is necessary, even if the amount is pre-determined.
3. What is the difference between a penalty and liquidated damages?
A penalty seeks to punish the defaulting party, while liquidated damages aim to fairly compensate for estimated loss.
4. Does Section 74 of the Indian Contract Act allow automatic compensation?
No. Section 74 requires the claimant to demonstrate that some loss or injury occurred. Compensation must be reasonable and related to the breach.
5. How does this ruling affect commercial contracts?
The judgment ensures fairness by preventing automatic deductions under penalty-like clauses and upholds the principle that damages must reflect genuine loss.
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