Article submitted by Aishwarya Deshpande
- Introduction:
Liability means legal responsibility for one’s acts or omissions. Parties in commercial contracts to mitigate their risk carve out a “limitation of liability clause” to limit their liability to a particular pre-estimated fixed sum of the amount. The Contract Act 1872 allows the parties to legally agree to restrict their obligation under the contract. However, the enforceability of exclusion or limitation of liability clauses is not absolute and cannot be applied arbitrarily; it is determined by the facts of the case.
The Contract Act of 1872 recognizes the concept of liquidated damages, where a fixed sum is specified in the contract to be paid in case of a breach. In these situations, the party seeking compensation for the breach may be entitled to a fair amount, as long as the specified sum is a genuine pre-estimate of the actual damages agreed upon by both parties, rather than a penalty. Indian courts have also ruled that, although a person may disregard a law created for their own benefit, rights resulting from the law cannot be waived if it contains a public interest or policy component because that becomes a matter of public policy or interest.
Section 74 of the Contract Act 1872 primarily talks about compensation for breach if the penalty is stipulated. In this section, liquidated damages are provided by way of a “fixed sum named in contract” or “penalty”. The basic principle that must be followed in section 74 of the Act, where exclusion clauses are carved out like the “penalty” stipulated in a contract then the compensation should be reasonable not exceeding the amount that is stipulated in the agreement as stated in Fateh Chand vs. Balkrishan Das.[1] Furthermore, the limitation of liability clause is structured as a “fixed sum contract” rather than a penalty.[2]
- Judicial Precedents on Limitation of Liability:
In 1986, the Supreme Court of India established the principle in the case of Central Inland Water Transport Corporation v. Brojo Nath Ganguly Brojo Nath Ganguly [3], that the courts may not impose an unreasonable clause in a contract entered into between parties who do not have equal bargaining power, as they are void from being opposed to public policy. However, the court ruled that this principle does not apply where the parties’ bargaining power is equal or nearly equal. This implies that when a more powerful party fully excludes its liability in the event of a breach of the agreement, it takes unfair advantage of the weaker party’s interests. Such an exclusionary clause may be deemed unenforceable by the Courts.
However, in the case of Carl Estate Private Limited & Anr. vs. Jagdish J.N. Counte[4], it was observed that, the liquidated damages or penalty, a party faced with the breach of contract, is now entitled to only reasonable compensation, subject to the limit of the amount stipulated in the contract itself. It is not necessary now for a party claiming compensation to prove the extent of loss or damage suffered and obtain compensation on that basis. The section only allows for the awarding of reasonable compensation.
Similarly, in the case of Bharathi Knitting Company v. DHL Worldwide Express Courier Division of Airfreight Ltd.[5], the Supreme Court of India was dealing with a clause, which limited the liability of a courier company in case of any loss or damage to a shipment, in the terms and conditions printed on a consignment note for shipment of a package. The Supreme Court of India upheld the decision of the National Consumer Disputes Redressal Commission, which limited the amount awarded to the consignor for deficiency of service, to the amount specified in the limitation of liability clause. The court held that parties who execute documents containing contractual terms are generally bound by the terms of the contract. It rejected the argument that, there was no consensus ad idem between the parties regarding the limitation of liability, based on the National Commission’s factual finding that the consignor had signed the consignment note.
Further in the case of A.S Motors (P) Ltd. Vs. Union of India[6], it was held that the damages awarded cannot exceed the sum so named in the contract it shall be a ceiling amount and similarly the Supreme Court observed in Surjit Kaur vs. Nauata Singh[7], observed that in a contract fixing a compensation amount must be given effect to and any award less than the amount stipulated must be accompanied with reasons. In a recent case of Mahanagar Telephone Nigam Ltd. (MTNL) vs. Tata Communications Ltd.[8], It was held that when liquidated damages are specified in the contract, the amount stated is final, and no higher amount can be awarded.
The scope of the clause limiting or excluding liability, as well as any exceptions outlined therein, must be strictly adhered Simplex Infrastructure v. Siemens Limited[9], it was observed that the issue of whether contractual clauses can disentitle a person from claiming damages, which he is otherwise entitled to claim under law i.e. whether parties can contract out of Section 73 of the Contract Act. The limitation of liability clause cannot be enforced and declared void if the clauses are unconscionable and where parties are in unequal bargaining positions.
In this case, Ramnath International Construction (P) Limited v. Union of India [10], the court examined a clause in a government construction contract that precluded the contractor from claiming compensation, even though the works were delayed and the completion time was extended due to specific circumstances beyond the contractor’s control. The court was confronted with two conflicting Supreme Court rulings interpreting the same clause. In the first ruling, the Supreme Court held that the clause would bar the contractor from receiving damages, in addition to the extension of time for completion, due to the delay. In the second ruling, the Supreme Court determined that while the clause prevented the department (the relevant authority of the employer) from granting damages, it did not prevent an arbitrator from awarding damages, which were otherwise due to the contractor as a result of the employer’s breach of contract.[11]
In addition to the abovementioned cases, there are also judicial precedents where the courts have struck down the limitation of liability in a contract because it is unreasonable, discriminatory or against public policy as per Konkan Railway Corp Ltd. vs. Oriental Contrustion Co. Ltd.[12] provided they are fair to the other party and is not against public policy.
- Conclusion:
Therefore, the limitation of liability clause is enforceable when they align with statutory principles, such as Section 74 of the Indian Contract Act, 1872, and judicial precedents, provided they represent reasonable compensation and are not penalties. Courts uphold such clauses if they are fair, and reasonable, and do not exploit weaker parties, as seen in the abovementioned cases. However, unconscionable or discriminatory clauses that violate public policy may be struck down. Indian Contract Act 1872 underscores the importance of ensuring that compensation for breach, when stipulated as liquidated damages or a penalty, remains reasonable and not excessive. It is clear that, the amount specified in a contract for breach should not exceed a fair and just sum, with the understanding that liquidated damages are intended to be a fixed sum rather than an arbitrary penalty. Moreover, limitation of liability clauses in contracts are valid, provided they are not unreasonable or unconscionable, particularly in cases where there is an imbalance of bargaining power between the parties. Courts have consistently held that, such clauses cannot be enforced if they are deemed to exploit the weaker party, as they would be contrary to public policy. Ultimately, while parties are allowed to define the extent of damages or liability in their agreements, these clauses must always align with principles of fairness and reasonableness to be enforceable.
[1] AIR 1963 SC 1405.
[2] Maya Devi vs. Lalta Prasad (2015) 5 SCC 588.
[3] AIR 1986 SC 1571.
[4] (2005) SCC OnLine Bom 282
[5] (1996) 4 SCC 704.
[6] (2013) 10 SCC 114.
[7] (2000) 7 SCC 379.
[8] 2019 SCC online SC 278.
[9] ILR (2010) II Delhi 699.
[10] (2007) 2 SCC 453.
[11] (2009) 10 SCC 354.
[12] 2013 SCC Online Bom 238.
