Security or Substitute: The Liquidated Damages Test under Indian Law

Liquidated damages (‘LD’) clauses are a familiar feature of commercial contracts. They represent parties’ attempt to quantify, in advance, the financial consequences of a breach. These clauses, however, do not always sit comfortably with the remedy of specific performance. A recurring question arises: where parties have quantified liquidated damages, should a court nevertheless compel specific performance?

Under Indian law, section 23 of the Specific Relief Act, 1963 (‘SRA’) addresses this question in measured terms. It provides that a contract may be specifically enforced despite an LD provision if the court is ‘satisfied that the sum was named only for the purpose of securing performance of the contract and not for the purpose of giving to the party in default an option of paying money in lieu of specific performance’. The provision, therefore, does not treat these clauses as barring equitable relief. Instead, it directs attention to the intention underlying the clause.

This issue has assumed greater importance after the Specific Relief (Amendment) Act, 2018 (‘SRA Amendment’). The SRA Amendment changes two fundamental doctrines in Indian law: first, it makes specific performance mandatory, rather than discretionary; and secondly, ‘damages being an adequate remedy’ is no longer a defence to specific performance. By shifting the statutory framework towards enforcement as a rule, the relevance of arguments based solely on the adequacy of damages is reduced. In this context, section 23 operates as a critical interpretative tool.

Courts must now consider whether the terms of the contract create a choice between performance and payment. The enquiry is no longer whether damages are sufficient in the abstract, but whether the contract itself permits performance to be replaced by payment.

Doctrinal foundation

Indian courts have consistently recognised that clauses requiring payment upon breach may perform different functions, and that those functions determine their legal consequences. Broadly, such clauses fall into three categories: (i) penalties designed to secure performance; (ii) liquidated damages clauses that estimate the loss likely to result from non-performance; and (iii) clauses under which payment may be substituted for performance.

The distinction between the first two categories and the third is critical. In the former, performance remains the primary obligation and the stipulated sum merely follows a breach. In the latter, the contract contemplates that the promisor may satisfy the bargain by paying the specified amount in lieu of performance.

This distinction was articulated by the Supreme Court of India in M. L. Devender Singh v. Syed Khaja. The Court held that the central question is whether the contract requires a particular act to be performed, or whether it allows the defaulting party to choose between performance and payment. If payment is merely a consequence of breach, specific performance may still be granted. If payment itself constitutes an agreed alternative mode of discharge, the contract is satisfied by payment and there is no basis to compel performance.

This was reaffirmed by the Supreme Court after the SRA Amendment in Kamal Kant Jain v. Surinder Singh. The agreement provided that, in the event of the seller's default, the purchaser would receive a refund of the earnest money paid by it with an equal amount as penalty for non-fulfilment of the contract. Rejecting the argument that the clause by itself excluded specific performance, the Supreme Court held that section 23 requires courts to determine whether the stipulated amount was intended to secure performance or to operate in substitution of it. The Court reiterated the traditional classification of such clauses and emphasised that only the third category, where payment is intended as an alternative to performance, would defeat a claim for specific performance.

More recently, in T.D. Vivek Kumar v. Ranbir Chaudhary, the Supreme Court further clarified the position. The agreement provided that, if the seller failed to execute the sale deed, the purchaser would be entitled to receive double the earnest money. The Court understood the clause as setting out the agreed consequence of breach in a manner that displaced the primary obligation to perform and concluded that compelling performance would be inconsistent with the contractual bargain.

Comparative perspective

Unlike Indian law following the SRA Amendment, specific performance is discretionary under English law and generally unavailable where damages are an adequate remedy. While not codifying an equivalent of Section 23, English law offers instructive parallels.

In Cavendish Square Holding BV v Makdessi, the UK Supreme Court distinguished between obligations that form part of the parties’ primary bargain and obligations that arise only upon breach. The Court, while examining these issues, noted that the availability of remedies for breach of duty is not simply a question of providing a financial substitute for performance but engages broader social and economic considerations. The Court held that a secondary obligation of payment imposing a detriment out of proportion to the innocent party’s legitimate interest in performance may constitute an unenforceable penalty.

In this context, the Court stated that the minimum condition for an order of specific performance is that the innocent party should have a legitimate interest extending beyond pecuniary compensation for the breach. Indian law post-2018 modifies this position. There is no longer any requirement to demonstrate a legitimate interest beyond monetary compensation before seeking specific performance. In effect, the statutory framework assumes that parties ordinarily have a legitimate interest in obtaining performance. Section 23, however, preserves party autonomy by allowing contracting parties to agree that payment may operate as an alternative to performance.

Although Cavendish was not directly concerned with specific performance, its reasoning is relevant. The principles underlying Cavendish resemble the enquiry mandated by section 23. Both focus on the nature and purpose of the contractual obligation. Under Indian law, the question is whether liquidated damages are merely a consequence of breach or whether they form part of the primary obligation to replace performance.

Drafting implications

The post-2018 framework places considerable weight on drafting. Clauses that merely quantify a genuine pre-estimate of loss will not, by themselves, exclude specific performance. What courts look for is a clear indication that payment was intended to be the sole or alternative remedy. As the Supreme Court observed in Kamal Kant Jain, such an election is ordinarily expressed explicitly in the contract.

Difficulties often arise where clauses are framed without sufficient precision. Provisions such as break fee, forfeiture or refund, without clarifying their purpose, tend to be read as mechanisms to secure performance.

Where parties intend to create an election to perform or to pay, that intention must be expressed with clarity. If specific performance is intended to be preserved, the contract should expressly state that liquidated damages do not limit such right. Conversely, where parties intend payment to operate as an alternative to performance, the clause should expressly identify it as being ‘in lieu of specific performance’, and that the non-defaulting party will not be entitled to compel performance after such payment is made.

Practitioners should also ensure consistency across the agreement. General provisions preserving all available remedies or broad specific performance clauses may undermine an argument that a liquidated damages clause was intended to create an alternative mode of discharge.

Akshay Sharma is a Partner at Shardul Amarchand Mangaldas & Co., New Delhi. 

Sambhav Sharma is a Senior Associate at Shardul Amarchand Mangaldas & Co., New Delhi.