Section 74 of ICA And Non-Compete Agreements: Examining Indian Court’s Approach

15th May, 2024 - 9:03 am Categories: News & Updates 0 Comments

INTRODUCTION

The Indian Contract Act, 1872, primarily establishes the regulations concerning liquidated damages under section 74. In essence, it states that parties may specify in the contract itself an amount that will be paid by the party in default to the other party in event of a breach of contract. The party seeking damages for the violation of contract must be entitled to a reasonable damages.

If there is a breach of contract, the liquidated damages clause provides for the payment of a predetermined amount. This blog looks at how Indian courts have interpreted the contracts’ liquidated damages clauses. In addition, it addresses the particular situation of non-compete agreements and studies legal options that either party may pursue in order to support its position,

SCOPE OF SECTION 74

The Court, in the case of FATEH CHAND V. BAL KISHAN DAS clarified that section 74 deals with damages in two categories of instances when discussing its scope:

First, whether the sum to be paid in the case of a contract violation has been predetermined.

For instance- Party A contracts with party B to pay a sum of Rs. 1,000, if he fails to pay B Rs. 500 on a given day. A fail to pay B Rs. 500 on that day. B is entitled to recover from A such compensation, not exceeding Rs. 1,000, as the Court considers reasonable.

Secondly, in cases when any additional penalty clauses may be included in the contract.

 QUANTUM OF LIQUIDATED DAMAGES

If a party properly rescinds a contract, it may be entitled to indemnification for any losses or damages resulting from non-performance under this clause.

The Supreme Court of India ruled that, in relation to the amount of liquidated damage, the parties proposed amount may be taken into consideration as a measure of reasonable compensation if it is thought to be a true pre-estimate (but not if the amount is intended to be penalized). This is true even in cases where the court is unable to evaluate the amount of compensation. However, as indirect consequential losses are not quantified in the contracts, they may also be covered by the aforementioned Supreme Court approach.

Concerning the quantity of liquidated damages, it is a well- established legal principle that in order to quantify damages in monetary terms, the party making the claim must provide evidence of the loss incurred. In addition, a significant factor in that determines damage liability is the principle of causation and the efforts made by the parties in minimizing such losses.

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In the case of MAULA BUX V. UNION OF INDIA, the Supreme Court ruled that, in cases where the court of appeals decides that compensation can be determined in conformity with established guidelines under the specific facts and circumstances, the claimant may be required to present proof of the real loss resulting from the breach.

We can say that the general rule governing a non-defaulting party’s ability to seek consequential damages is that the non-defaulting party may only recover or assert any portion of the loss resulting from the defaulting party’s infringement that was reasonably foreseeable at the time the contract was executed. The knowledge that each party possesses and shares will determine the extent of the reasonably foreseeable loss or damage, among other things.

The parties may stipulate in a contract that, in the event of a breach, no money will be paid out except for the refunds of sums paid and that the parties agree that such a stipulation is enforceable. The parties can also define unique and specific obligations for themselves, including how much damages are awarded for infringement.

NON-COMPETE CLAUSE

A non-compete clause is a provision in a contract that states, when the contract expires or is terminated, that a party shall not engage into a new agreement with any other business. These terms specify the geographic area, the market, and/or the duration that the party must wait to work with another party. These sorts of clauses typically specify how much a party will be entitled to in the event that the other party violates the same.

Currently, in a lawsuit, one of the two parties would be convicted for breaking the terms of the agreement, and the other would have to deal with the fallout. The former would undoubtedly be inclined to argue that the contract’s damages are not real in order to avoid paying any damages at all or to pay a reduced amount. The latter, however, would contend that the predetermined damages in the clause are legitimate and reasonable and would want them to remain as they are.

According to the Kailash Nath case ratio, the party that violates the contract may argue that the amount of liquidated damages is excessive and that a much smaller amount should be awarded as damages as the amount is only the ceiling limit and is not legally enforceable. The same would rely on the case’s particular facts and circumstances. One possible response is that the non-compete provision cannot, in theory, be applied because the new entity’s business model differs from the old entity’s (the entity that was violated).

Alternatively, the party that was harmed by the breach of contract and is claiming a legitimate amount of damages can support their position by first demonstrating that the non-compete agreement was a goodwill transaction and then presenting prior financial data. Given the prior entity’s goodwill in that business model, it makes sense that any new entity operating under the same model would most likely generate income equal to the consistent revenue generated by the previous entity. Liquidated damages specified in the non-compete agreement will therefore be proven to be fair and genuine and will not subject to diminution if the court is convinced that the new firm is generating the same revenue as the previous entity.

CONCLUSION

If the court believes that the agreed damages are reasonable, it will award the predetermined damages specified in the contract. If it isn’t, though, the court will step in and grant the appropriate amount of damages, using the maximum damages specified in the contract as a guideline. In light of this, should a contract be broken, the parties may first dispute whether or not the damages are justifiable and authentic. In addition, the party whose non-compete was violated may utilize its financial records to support its claim for damages under the terms of the agreement.

Author: Aniya vijayvergiya , in case of any queries please contact/write back to us via email to chhavi@khuranaandkhurana.com or at  Khurana & Khurana, Advocates and IP Attorney.