Damages Cannot Be Awarded Based Solely On A Penalty Clause In Agreement Without Proving That Reasonable Damages Were Incurred: Delhi HC

The Delhi High Court held that damages could not be awarded only on the ground that the Collaboration Agreement had stipulated a penalty clause unless it was established that reasonable damages were suffered by the party claiming such damages.

The Court set aside the impugned award and order, wherein the Appellants were granted damages based on a penalty clause in the Agreement, and the Single Judge also upheld the decision. The Court emphasized that clause 7 of the collaboration agreement cannot be the sole reason for granting damages without the party establishing evidence of actual damages.

The Bench comprising Justice Vibhu Bakhru and Justice Amit Mahajan noted, “Damages could not be awarded on the ground that the Collaboration Agreement had stipulated the same unless it was established that the same are reasonable damages and the same were suffered by the Owners. Admittedly, the Owners had not led any evidence to establish the damages suffered by them. It is also not their case that the damages suffered by them were incapable of being proved”.

Advocate Gurmehar S. Sistani appeared for the Appellant, and Advocate Kunal Seth appeared for the Respondent.

The award pertained to a disagreement between the property owners (Appellants) and the Builder (Respondent) over a three-story property. The Respondent was given a year to complete construction with a penalty of ₹10,000 per day for delays. Disputes arose, and the Appellants terminated the agreement. The Respondent filed a petition under Section 9 of the Arbitration and Conciliation Act (AC Act), and the Respondent was awarded a refund of the money paid to the Appellants and the reconstruction costs of ₹36,92,400/-. The Tribunal also awarded damages of ₹72,00,000/- to the Appellants for breach of the Collaboration Agreement. The Court upheld the damages award but modified the calculation of damages to reflect a rate of ₹10,000/- per day, limited to 14 months. However, the Court held that the award must be upheld as the Appellants had not challenged the impugned award.

A set of Cross-Appeals were filed challenging the order passed by the Single Judge of the High Court. The Respondents also filed an appeal challenging the arbitral award passed by a sole arbitrator wherein the claims made by the Appellants were allowed.

According to the Court, the damages awarded by the Arbitral Tribunal were reduced by the Single Judge. However, the Court noted that the Single Judge acknowledged that the counterclaim award should be upheld, as the owners did not contest it but still made a separate observation. The Arbitral Tribunal ruled that the builder must refund a specific amount, which was included in the overall award in favor of the builder against the counterclaim. The Court held that the scope of Section 34 of the AC Act only allows for setting aside an arbitral award if specific grounds set out in the same section are established. The Court asserted that the Single Judge's decision substituted that of the Arbitral Tribunal, which is not permitted under the AC Act.

The Court observed that the clause clearly stated that a penalty of ₹10,000/- per day must be paid. Even if it is assumed that the clause refers to liquidated damages, the Owners were still required to prove that they suffered such damages before they could be awarded.

To plead and establish damages, the Court reiterated the need for three essential elements. Firstly, there must be a breach of the contract by the counterparty. Secondly, the party complaining about the breach must have suffered an injury directly from the counterparty's breach. Lastly, the injury sustained must be proximate and directly caused by the breach committed.

“It is material to note that the Owners had not made any categorical averments that the delay had resulted in them suffering any damages. There is no averment that the Owner’s incurred costs, which were higher than the value of the second floor of the reconstructed building. 44. Absent any pleadings that the owners had suffered damages or incurred loss on account of the delay in construction of the work, a claim of damages would not be sustainable. In addition, as noted above, admittedly there is no evidence or material on record to establish that the owners had suffered any loss or the quantum of such loss. The owners have simply relied on Clause 7 of the Collaboration Agreement”, the Bench noted.

Accordingly, the Court disposed of the Appeals and set aside the impugned order and the impugned award.

Cause Title: Sudershan Kumar Bhayana (Deceased) Thr LRS v Vinod Seth (Deceased) Thr LRS

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