Liquidated Damages (Indian Law) — Section 74 Framework

Definition

Liquidated damages are pre-agreed monetary sums named in a contract as compensation payable on the occurrence of a specific breach. The purpose is to fix the compensation amount in advance so the parties don't have to litigate damages after the breach.

Statutory basis: Section 74

Section 74 of the Indian Contract Act, 1872 governs liquidated damages:

"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..."

The operative phrase is "reasonable compensation not exceeding the amount so named." Indian courts apply this strictly — the contractually named amount is a ceiling, not the awarded amount. The court will assess what reasonable compensation looks like based on actual loss and award up to (but not exceeding) the named amount.

The reasonable compensation test

The Supreme Court in Maula Bux v Union of India (1969) and Kailash Nath Associates v DDA (2015) clarified the Section 74 framework:

1. The named amount is a ceiling, not a floor.
2. The court will award reasonable compensation up to the named amount.
3. Where actual loss can be proved, compensation is calibrated to actual loss.
4. Where actual loss is genuinely difficult to prove (e.g., breach of confidentiality), the named amount becomes more defensible as a pre-estimate.

This is materially different from US/UK law, where contractually named liquidated damages are typically enforced as drafted (provided they're not a penalty). Indian courts always apply the reasonableness lens.

Drafting implications

To make liquidated damages defensible under Section 74:

• Frame as genuine pre-estimate: avoid "penalty" language. Use "agreed liquidated damages, being a genuine pre-estimate of the loss the Disclosing Party would suffer."
• Document the estimate basis: where possible, the contract should explain how the amount was calculated (cost of replacement, lost revenue, regulatory exposure).
• Calibrate to actual exposure: a ₹50 lakh liquidated damages clause for a ₹10 lakh contract looks like a penalty; ₹50 lakh for breach of a ₹2 crore confidentiality obligation looks like a pre-estimate.

Practical example

An NDA includes a liquidated damages clause: "The Receiving Party shall pay liquidated damages of ₹50 lakh per material breach of confidentiality, being a genuine pre-estimate of the loss the Disclosing Party would suffer."

If breach occurs, the Disclosing Party doesn't have to prove ₹50 lakh of actual loss. The court will assess what reasonable compensation looks like (likely between ₹10-50 lakh depending on the breach's impact) and award accordingly. The named amount caps the recovery but doesn't guarantee it.

Related reading

• Limitation of liability clauses — how liquidated damages interact with LoL caps
• Indemnification clauses — the related Section 124 framework
• NDA template — sample liquidated damages drafting
• Vendor agreement template — SLA credits as liquidated damages