Liquidated Damages Scope and Application under Pakistan and UK Laws While Remedying Breaches under Commercial Contracts

LIQUIDATED DAMAGES---SCOPE AND APPLICATION UNDER PAKISTAN AND UK LAWS WHILE REMEDYING BREACHES UNDER COMMERCIAL CONTRACTS LIQUIDATED DAMAGES---SCOPE AND APPLICATION UNDER PAKISTAN AND UK LAWS WHILE REMEDYING BREACHES UNDER COMMERCIAL CONTRACTS "What is more in accordance with good faith among humans is to maintain the agreement they have made" [Ulpian] By Shafqat Mahmood Khan LL.M, Islamabad 1. Introduction As the principle of contract law which has been emerged by various Court decisions is that the parties who entered into a contract no doubt expected that the contract would be carried out, but they also contemplated the possibility of the contract not being carried out. So, keeping the possibility of contract not being carried out, the parties being supported by the law whose function is to enable rights to be vindicated and to provide remedies when duties have been breached stipulate a sum to be payable in the event of breach, in order to get the compensation from the party in default. Keeping in view this principle, the parties under the contract are entitled to claim compensation against the party in default. In claiming compensation in the form of damages, normally the law has prescribed criteria by which the parties at the time of signing a commercial contract may agree on certain fixed percentage related to the default in performance of the contract. If such sum is a genuine per estimate of loss it is termed as Liquidated Damages (LDs). In this article, we will discuss the scope of LDs under Pakistani and United Kingdom (UK) laws and its practical applications by the Pakistani and UK Courts while remedying breaches under commercial contract. The major discussions will be under Pakistan laws; however, UK Courts' major decisions will be discussed here for summary reference purposes. 2. Scope of LDs under Pakistan Law 2.1 Provision of LDs under Pakistan Law In Pakistan, the law dealing with the issue of LDs is Contract Act, 1872 and the relevant provision is Section 74 whose relevant part states as:-- "Where 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" The parties under section 74 of the Contract Act are allowed to stipulate and have the right to claim LDs in case of breach of a commercial contract. Where the parties have deliberately specified the amount of LDs there can be no presumption they at the same time, intended to allow the party who has suffered by the breach to give a go-by to the sum specified and claim instead a sum of money which was ascertained or ascertainable on the date of the breach. The LDs is not punishment and the parties may by an agreement fix a specified amount as LDs to avoid the difficulty that may be found in settling the actual damages that may accrue against the defaulting party on the breach of contract. The manifest intention is to get rid of future calculation and disputes. Similarly, the parties to a contract may stipulate the method of calculation of LDs instead of setting a specific amount but it must be the result of a "genuine pre-estimate of damages". Also, the party complaining of the breach is entitled to reasonable compensation not exceeding the penalty but is not entitled to enforce the penalty stipulated for in the contract. What is reasonable compensation is to be determined whenever a dispute arises and the contract is sought to be enforced. This position of LDs as a penalty and entitlement of reasonable compensation is discussed in detail in below headings. 2.2 Enforcement of LD Clause by Pakistan Courts When the parties have mutually agreed to some LDs clause, generally, Pakistani Courts are reluctant to interfere with such clause, as it is seen to be an interference with what the parties are otherwise quite to agree between themselves and the right to claim LDs is enforceable under S.74 of the Contract Act which is a statutory right given to the parties. And, where the sum named in the contract is the result of an honest and genuine pre-estimate of damages having regard to the nature of the transaction and the circumstances of the case, the Court is likely to award a sum of damages which is the same as or very close to the sum named in the contract. But, where the Court finds that the sum named in the contract has been stipulated as a penalty or as in "terrorem" to work as a deterrent to compel a party to fulfil its obligations under the contract, then the Court would refrain to grant such amount and itself determine the amount of actual loss suffered and which was reasonable in the circumstances of a particular case and award damages accordingly. Also, where the Court considers that sum mentioned in contract was not excessive or unreasonable, such Court may allow the same otherwise, would reduce the same to a figure that it considers reasonable. In either case, the damages awarded by the Court cannot exceed the sum of money specified in the contract. 2.3 Proof required In case a party alleges a breach of contract and LDs are entered in a contract itself then these will not automatically become due and in that case the plaintiff is under a legal obligation to prove the exact amount of damages, which he has allegedly suffered, irrespective of the specific amount mentioned in the Contract. Section 74 provides that LDs required positive evidence to show that such actual loss was suffered by the party claiming the damages and mere fixed amount stipulated as LDs would not be recoverable if the quantum of actual loss was not proved. So, in such-like cases the plaintiff, who is complaining the breach of contract and also demanding the damages, shall have to (a) first plead and then (b) comprehensively prove the damages (adduce evidence by bringing sufficient material on record in order to prove that he had suffered so much of losses) and for that purpose he has to convince the Court that:- (1) There should be Schedule of Payment and (2) It should be agreed upon/ accepted by the other Party (3) Even fixed amount stipulated for LDs does not automatically become payable if the quantum of actual loss is not proved as the same cannot be awarded without proving actual loss even fixed amount stipulated for LDs does not become automatically payable. In many cases, the apex courts have held at many occasions that LDs required positive evidence to show that such actual loss was suffered by the party claiming the damages and mere fixed amount stipulated as LDs would not be recoverable if the quantum of actual loss was not proved. In Allied Bank of Pakistan Ltd., Faisalabad v. M/s. Aisha Garments (2001 MLD 1955 Lahore), the Hon'ble Lahore High Court has held as:-- "In case a party alleges a breach of contract and wants to enforce a claim of damages /compensation through Court of law, then such a case is obviously covered and governed by the provisions of sections 73 and 74 of the Contract Act. Under section 74 of the Contract Act, when liquidated damages are entered in a contract itself, then in case of breach of such contract, the damages are to be assessed in the ordinary was, subject to that fixed amount as a maximum. In that case the plaintiff is under a legal obligation to prove the exact amount of damages, which he has allegedly suffered, irrespective of the specific amount mentioned in the contract, which is not at all a concrete proof and in such-like cases the plaintiff, who is complaining the breach of contract and also demanding the damages, shall have to first plead and then to prove the damages, suffered by him. We are of the considered view that liquidated damages under section 74 of the Contract Act, 1872, call for the proof and the person claiming such damages is under obligation to bring' sufficient material on record in order to prove that he had suffered so much of losses. Without proving the actual loss, even fixed amount stipulated as liquidated damages does not automatically become payable." [Emphasis added] Furthermore, in cases of 1988 CLC 1555 Karachi and 1986 MLD 754 Karachi, the Hon'ble Court has decided that under Section 74 of the Contract Act, the defendant cannot himself deduct the amount of LDs even though shown in the Contract but have to approach the Court or any other forum for ninagntheit was held that:-- 'Thus which he was entitled to determining and recover 'Thus if the plaintiff fails to prove the actual damages suffered by him he will not be entitled to recover simplicities damages on the basis of the liquidated damages provided in the contract. It is his duty to prove damages in a given case. Each case would depend on its own facts. In assessing damages under this provision of law there is a duty cast on the Court to award reasonable compensation to an aggrieved party that should not exceed the amount so named in the contract. In determining reasonable compensation a Court of law shall have to take into consideration the means available to a party to mitigate the damages. But the fact that a party failed to utilize bush opportunity would not necessarily absolve the party at fault from his liability under the contract." (Emphasis added] In 2004 CLD 984 Lahore, it is stated as "It is for the Court to determine what amount would be reasonable compensation in the circumstances of the case. If the Court considers that the sum mentioned is not excessive or unreasonable, it shall allow it otherwise will reduce it to the figure it considers reasonable. If on the other hand the stipulated amount is by reason oppressive and burdensome in character and may operate in terrorem so as to drive the party to complete the contract, the stipulation is a penalty and the Court can relieve the party of the penalty clause." So, based on what is discussed above, LDs will not automatically become due and it is the duty of the party to prove damages which he has allegedly suffered even a specific amount was mentioned in the Contract. 2.4 Award of LDs - Deciding Factor While awarding LDs, Pakistani Court considers the following principles/factors namely:-- Firstly, while exercising the unqualified discretion granted to it by section 74, the Court will naturally act with care and caution and in accordance with recognized principles; Secondly, in spite of mention of a specific sum in an agreement to be paid as damages to a party in the event of a breach by the other, the Court still has to hold that such amount would normally arise as damages to such a party in the case of a breach by the other; Thirdly, in cases, where the party complaining of the breach, in fact, suffered no damages at all and on the contrary gained some advantage in spite of the breach or where the Court finds that the sum mentioned 0 damages in the agreement in case of breach, is such that it could not reasonably arise from such breach, the Court may refuse to grant the same; Fourthly, it must be shown that this amount would reasonably arise as damages to the defendant in the case of non-performance of the condition in the agreement; and Finally, though the parties to a contract who use the words 'penalty' or 'LDs' may prima facie be supposed to mean what they say, yet the expression used is not conclusive. In such cases, the Court (a) look to the nature of the transaction; (b) the position of the parties at the time of the bargain; and (c) the comparative undue advantage or disadvantage which might result to the parties by the enforcement of such penal clause. 2.5 Legal issues - LDs penalty or not? In Pakistan, while deciding whether a LDs clause is a penalty or not, the Court takes following into consideration:- (a) Whether the contract refers to the clause as a LDs clause or a penalty; (b) Where the estimate of loss is imprecise, whether the sum is a genuine pre-estimate of the losses that would be sustained or whether it was disproportionate to the actual losses sustained; (c) Whether such an imbalance of bargaining power existed between the parties at the time of the contract, that one party effectively dictated the terms of the contract; and (d) The essence of a penalty is a payment of money stipulated as in terrorem of the offending party; the essence of LDs is a genuine pre-estimate of damage. Likewise, in UK, in the case of Dunlop Pneumatic Tyre Company, Pany, Limited v. New Garage and Motor Company, Limited (1915) AC 79, the following classic principles were laid down by the House of Lords in determining whether a clause operates as or a LDs clause:-- a Penalty "It will be held to be a penalty if the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach. It will be held to be a penalty if the breach consists only in not paying a sum of money, and the sum stipulated is a sum greater than the sum which ought to have been paid. It is no obstacle to the sum stipulated being a genuine pre-estimate of damage that the consequences of breach are such as to make precise pre-estimation an impossibility. On the contrary, that is just the situation when pre-estimated damage was the true bargain between the parties. Though the parties to a contract who use the words penalty' or 'liquidated damages' may prima facie be supposed to mean what they say, yet the expression used is not conclusive. The Court must find out whether the payment stipulated is in truth a penalty or liquidated damages The essence of a penalty is a payment of money stipulated as in terrorem of the offending party; the essence of liquidated damages is a genuine pre-estimate of damage." A more contemporary statement of law is contained in the judgment of Colman J in Lordsdale Finance plc v Bank of Zambia [19961 QB 752:- "...whether a provision is to be treated as a penalty is a matter of construction to be resolved by asking whether at the time the contract was entered into the predominant contractual function of the provision was to deter a party from breaking the contract or to compensate the innocent party for breach. That the contractual function is deterrent rather than compensatory can be deduced by comparing the amount that would be payable on breach with the loss that might be sustained if breach occurred." 3. Scope of LDs under UK Law The difference that exists between LDs and Penalty in the UK law is not recognized by the Section 74 of the Contract, Act. Section 74 seeks to resolve the difficulties in the UK law doctrine of damages. It dispenses with fine distinctions between the claim of damages based on the principle of LDs and those imposed by way of penalty. It has enacted a uniform principle that in either case, the Court has to award reasonable compensation, not exceeding the amount as named in the contract. UK courts have always been reluctant to enforce agreements which are oppressive or punitive in nature. However, wherever possible, they will uphold provisions in commercial contracts which have been freely entered into by the parties of comparable bargaining power. This has certainly been the case in the context of LDs clauses which have become a useful, commercial mechanism for determining or fixing damages payable by one party to another party under a commercial contract in the event of a default by the first party of its contractual obligations and thereby reduce the risk of litigation between the contracting parties. As discussed above in Dunlop Pneumatic Tyre Company, Limited and Lordsdale Finance plc, a clause is penal if it provides for "a payment of money stipulated as in terrorem of the offending party" to force him to perform the contract. If, on the other hand, the clause is a genuine attempt by the parties to estimate in advance the loss with a genuine pre-estimate of damages agreed upon by the parties is regarded as LDs. But a stipulation in a contract in terrorem is a penalty. In the case of LDs, the contract is binding upon the parties as in the case of penalty, however, the Court refuses to enforce it and awards to the aggrieved party reasonable compensation. Similarly, a LDs clause will not be enforced if its purpose is to punish the wrongdoer/party in breach rather than to compensate the injured party (in which case it is referred to as a penal or penalty clause). One reason for this, it could be said, is that the enforcement of the term would, in effect, require an equitable Order of specific performance. However, courts sitting in equity will seek to achieve a fair result and will not enforce a term that will lead to the unjust enrichment of the enforcing party. 4. Concluding Principles From various cases, especially the ratio decided given in a landmark judgment of Province of West Pakistan v. Messrs Mistri Patel and Co. (PLD 1969 SC 80) which has been used as a reference case in almost all the future cases related to the subject, the apex Courts have deduced the following principles:. (a) That if a party suffers loss on account of breach of contract on the part of the other party, and if the control provides a sum as LDs, the aggrieved party will be entitled to recover the loss to the amount provided as LDs; (b) That even if a contract provides a sum as LDs in case of breach, an aggrieved party will not be entitled to recover the same without proving that he has suffered loss; (c) That the Court in a fit case may grant nominal damage,' in case of breach of a contract against the default in, party even in the absence of any proof of loss; (d) That the Court may decline to enforce a penal clause of contract including a clause relating to penal interest; finally, (e) The ratio of the majority cases seems to be that even: under section 74 of the Contract Act the Court is bound to allow the amount mentioned as the LDs in a commercial contract due to the reasons mentioned above. End Notes 2010 CLC 706 Lahore (Qari Muhammad Hanif v. Ihsart Ullah Khan) 2010 MLD 192 Karachi (Dr. Muhammad Junaid v. Karachi Development Authority) 2007 CLD 508 Karachi (Messrs National Bank of, Pakistan v. Messrs Marhaba Textile Ltd.) 2007 YLR 109 Lahore (Harappa Textile Mills Limited v. Messrs B.A.S.F. Pakistan (Pvt.) Limited] 2006 CLD 394 Karachi (Messrs United Bank Limited v. Messrs M.Esmail and Company (Pvt.) Limited] 2005 CLC 912 Lahore (Messrs Nigah-e-Karimee Enterprises v. Trust Investment Bank Limited) 2004 CLD 824 Lahore (Hunza Packages (Pvt.) Limited v. Messrs Orix Leasing Pakistan Limited) 2004 CLD 984 Lahore (Messrs Ravians Paper and Board Industries Limited v. Messrs Taj Company Limited) 2003 MLD 314 Lahore (Punjab Provincial Cooperative Bank, Lahore v. Fazal-ur-Rehmard 2001 MLD 1955 Lahore (Allied Bank of Pakistan Limited, Faisalabad v. Messrs Asisha Garments) PLD 2000 Karachi 246 (Askari Commercial Bank Limited v. Pakland Cement) 1995 SCMR 1431 (Sandoz Limited v. Federation of Pakistan) 1991 SCMR 1436 (Messrs Khanzada Muhammad Abdul Haq Khan Khattak and Co. v. WAPDA) 1989 CLC 636 Karachi (Messrs Ghulam Muhammad Dossal Engineering Limited v. Zafar Iqbal 1988 CLC 1555 Karachi (Messrs International Civil Engineers v. Karachi Shipyard and Engineering Works) 1986 MLD 754 Karachi (Attaullah Zia v. Pakistan Industrial Development Corporation) PLD 1985 Karachi 71 (Industrial Development Bank of Pakistan v. Messrs Han Dossa Ltd.) PLD 1971 SC 743 (Syed Sibte Raza v. Habib Bank Ltd.) PLD 1969 SC 80 (Province of West Pakistan v. Messrs Mistri Patel and Co.) PLD 1961 (W.P.) Karachi 305 (Major Aziz Ahmed Mohammad v. Manzoor Ahmed Sahi) PLD 1953 Lahore 400 (Cantonment Board, Sialkot v. Sheikh Nazir Ahmad) Dunlop Pneumatic Tyre Co Ltd v. New Garage Co. Ltd. [1915] AC 79 (House of Lords) A guide to liquidated damages clauses, November 2009, http: / / www.steptoe.corn/ publications-6445. Html Lordsdale Finance PLC v Bank of Zambia [1996] QB 752 at p 762G Euro London Appointments Ltd. v Claessens International Ltd. [2006] EWCA Civ 385.