Let us first see the provisions of Contract Act,1872
OF THE CONSEQUENCES OF BREACH OF CONTRACT
- Compensation for loss or damage caused by breach of contract.—When a contract has been broken, the party who suffers by such breach is entitled to receive, from the party who has broken the contract, compensation for any loss or damage caused to him thereby, which naturally arose in the usual course of things from such breach, or which the parties knew, when they made the contract, to be likely to result from the breach of it.Such compensation is not to be given for any remote and indirect loss or damage sustained by reason of the breach.
Compensation for failure to discharge obligation resembling those created by contract.—When an obligation resembling those created by contract has been incurred and has not been discharged, any person injured by the failure to discharge it is entitled to receive the same compensation from the party in default, as if such person had contracted to discharge it and had broken his contract.
Explanation.—In estimating the loss or damage arising from a breach of contract, the means which existed of remedying the inconvenience caused by the non-performance of the contract must be taken into account.
- Compensation for breach of contract where penalty stipulated for.—[When 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.
Explanation.—A stipulation for increased interest from the date of default may be a stipulation by way of penalty.]
Exception.—When any person enters into any bail-bond, recognizance or other instrument of the same nature, or, under the provisions of any law, or under the orders of the [Central Government] or of any [State Government], gives any bond for the performance of any public duty or act in which the public are interested, he shall be liable, upon breach of the condition of any such instrument, to pay the whole sum mentioned therein.
Explanation.—A person who enters into a contract with Government does not necessarily thereby undertake any public duty, or promise to do an act in which the public are interested.
- Party rightfully rescinding contract, entitled to compensation.—A person who rightfully rescinds a contract is entitled to compensation for any damage which he has sustained through the non-fulfilment of the contract
Judgments and Interpretation and instances before the Court.
In Satish Batra vs Sudhir Rawal Supreme Court dealt with this question.
“Whether the seller is entitled to forfeit the earnest money deposit where the sale of an immovable property falls through by reason of the fault or failure of the purchaser.?”
An Agreement for Sale of property for a total consideration of Rs. 70,00,000/- to be paid on or before 5.3.2006 and, towards earnest money, an amount of Rs. 4,00,000/- was paid on 29th November,2005 and another Rs. 3,00,000/- on 30th November,2005, that means, altogether Rs. 7,00,000/- was paid, being 10% of the total sale consideration. The purchaser, however, could not pay the balance amount of Rs.63,00,000/- before 5th March, 2006, consequently, the sale deed could not be executed. Seller, therefore, did not return the earnest money to the purchaser.
Consequently, the purchaser, as plaintiff, instituted a suit before the Additional District Judge, Delhi for recovery of Rs. 7,00,000/- from the seller-defendant of the earnest money paid by him. Defendant contested the suit stating that, as per the agreement, he is entitled to forfeit the amount of earnest money, if there was a failure on the part of the purchaser-plaintiff in paying the balance amount of Rs. 63,00,000/-.
The trial Court dismissed the suit holding that the defendant is entitled to retain the amount of earnest money since the plaintiff had failed to pay the balance amount of Rs. 63,00,000/- before 5th March,2006.Aggrieved by the judgment of the Additional District Judge, Delhi, plaintiff took up the matter in appeal before the High Court of Delhi. The High Court relied on the judgment of this Court in Fateh Chand v. Balkishan Dass AIR 1963 SC 1405, took the view that the seller is entitled to forfeit only a nominal amount and not the entire amount of Rs. 7,00,000/. The High Court further held that the seller can forfeit an amount of Rs. 50,000/- out of the amount of Rs. 7,00,000/- and he is bound to refund the balance amount of Rs. 6,50,000/- to the purchaser. To this extent, a decree was also passed in favour of purchaser against the seller. It was also held that the purchaser is also entitled to interest @ 12% per annum from 29th November,2005 till the amount is paid.
Aggrieved by the said judgment of the High Court, the seller has come up with this appeal. The only question is whether the seller is entitled to retain the entire amount of Rs. 7,00,000/- received towards earnest money or not. The fact that the purchaser was at fault in not paying the balance consideration of Rs. 63,00,000/- is also not disputed. The question whether the seller can retain the entire amount of earnest money depends upon the terms of the agreement.
Relevant clause of the Agreement for Sale dated 29th November,2005 is extracted hereunder for easy reference:
“(e) If the prospective purchaser fail to fulfill the above condition. The transaction shall stand cancelled and earnest money will be forfeited. In case I fail to complete the transaction as stipulated above. The purchaser will get the DOUBLE amount of the earnest money. In the both condition, DEALER will get 4% Commission from the faulty party”
It was observed that, the clause, therefore, stipulates that if the purchaser fails to fulfill the conditions mentioned in the agreement, the transaction shall stand cancelled and earnest money will be forfeited. On the other hand, if the seller fails to complete the transaction, the purchaser would get double the amount of earnest money. Undisputedly the purchaser failed to perform his part of the contract, then the question is whether the seller can forfeit the entire earnest money.
The question raised is no more res integra. In (Kunwar) Chiranjit Singh v. Har Swarup AIR 1926 P.C. 1, it has been held that the earnest money is part of the purchase price when the transaction goes forward and it is forfeited when the transaction falls through, by reason of the fault or failure of the purchaser. In Fateh Chand (supra), this Court was interpreting the conditions of an agreement dated 21st March,1949. By that agreement, the plaintiff contracted to sell his rights in the land and the building to Seth Fateh Chand (defendant). It was recited in the agreement that the plaintiff agreed to sell the building together with pattadari rights appertaining to the land admeasuring 2433 sq. yards for Rs. 1,12,500/- and that Rs. 1,000/- was paid to him as earnest money at the time of the execution of the agreement. The conditions of the agreement were as follows:
.(1) I, the executant, shall deliver the actual possession, i.e. complete vacant possession of kothi (bungalow) to the vendee on the 30th March, 1949, and the vendee shall have to give another cheque for Rs. 24,000/- to me, out of the sale price.
(2) Then the vendee shall have to get the sale (deed) registered by the 1st of June, 1949. If, on account of any reason, the vendee fails to get the said sale-deed registered by June, 1949, then this sum of Rs. 25,000/- (twenty-five thousand) mentioned above shall be deemed to be forfeited and the agreement cancelled. Moreover, the vendee shall have to deliver back the complete vacant possession of the kothi (bungalow) to me, the executant. If due to certain reason, any delay takes place on my part in the registration of the sale-deed, by the 1st June 1949, then I, the executant, shall be liable to pay a further sum of Rs. 25,000/- as damages,apart from the aforesaid sum of Rs. 25,000/- to the vendee, and the bargain shall be deemed to be cancelled..Plaintiff, on 25th March,.1949, received Rs. 24,000/- and delivered possession of the building and the land in his occupation to the defendant.
Alleging that the agreement was rescinded because the defendant committed default in performing the agreement and the sum of Rs. 25,000/- paid by the defendant stood forfeited.
Plaintiff instituted a suit. The defendant resisted the claim contending inter alia that the plaintiff having committed breach of the contract could not forfeit the amount of Rs. 25,000/- received by him. The matter ultimately came to this Court. This Court considered as to whether the plaintiff could forfeit the amount. Noticing that the defendant had conceded that the plaintiff was entitled to forfeit the amount which was paid as earnest money, the Court held as follows:
.The contract provided for forfeiture of Rs. 25,000/- consisting of Rs. 1000/-paid as earnest money and Rs. 24,000/- paid as part of the purchase price. The defendant has conceded that the plaintiff was entitled to forfeit the amount of Rs. 1,000/- which was paid as earnest money. We cannot however agree with the High Court that 10 per cent of the price may be regarded as reasonable compensation in relation to the value of the contract as a whole, as that in our opinion is assessed on arbitrary assumption. The plaintiff failed to prove the loss suffered by him in consequence of the breach of the contract committed by the defendant, and we are unable to find any principle on which compensation equal to ten percent of the agreed price could be awarded to the plaintiff. The plaintiff has been allowed Rs. 1,000/- which was the earnest money as part of the damages. Besides he had use of the remaining sum of Rs. 24,000/-, and we can rightly presume that he must have been deriving advantage from that amount throughout this period. In the absence therefore of any proof of damage arising from the breach of the contract we are of opinion that the amount of Rs. 1,000/- (earnest money) which has been forfeited, and the advantage that the plaintiff must have derived from the possession of the remaining sum of Rs. 24,000/-during all this period would be sufficient compensation to him. It may be added that the plaintiff has separately claimed mesne profits for being kept out of possession for which he has got a decree and therefore the fact that the plaintiff was out of possession cannot be taken into account in determining damages for this purpose. The decree passed by the High Court awarding Rs. 11,250/- as damages to the plaintiff must therefore be set aside..
It was observed that, the High Court has completely misunderstood the dictum laid down in the above mentioned judgment and came to a wrong conclusion of law for more than one reason, which will be more evident when we scan through the subsequent judgments of this Court.
In Shree Hanuman Cotton Mills and Others v. Tata Air Craft Limited 1969 (3) SCC 522, this Court elaborately discussed the principles which emerged from the expression earnest money.
Supreme Court, considering the scope of the term earnest, laid down certain principles, which are as follows:
(1) It must be given at the moment at which the contract is concluded.
(2) It represents a guarantee that the contract will be fulfilled or, in other words, earnest is given to bind the contract.
(3) It is part of the purchase price when the transaction is carried out.
(4) It is forfeited when the transaction falls through by reason of the default or failure of the purchaser.
(5) Unless there is anything to the contrary in the terms of the contract, on default committed by the buyer, the seller is entitled to forfeit the earnest..
In Delhi Development Authority v. Grihstrapana Cooperative Group Housing Society Ltd.1995 Supp (1) SCC 751, Supreme Court following the judgment of the Privy Council in Har Swaroop and Shree Hanuman Cotton Mil ls (supra), held that the forfeiture of the earnest money was legal.
In V. Lakshmanan v. B.R. Mangalgiri and others (1995) Suppl. (2) SCC 33, Supreme Court held as follows:
The question then is whether the respondents are entitled to forfeit the entire amount. It is seen that a specific covenant under the contract was that respondents are entitled to forfeit the money paid under the contract. So when the contract fell through by the default committed by the appellant, as part of the contract, they are entitled to forfeit the entire amount.
In Housing Urban Development Authority and another v. Kewal Krishan Goel and others (1996) 4 SCC 249, the question that came up for consideration before Supreme Court was, where a land is allotted, the allottee deposited some installments but thereafter intimated the authority about his incapacity to pay up the balance installments and requested for refund of the money paid, was the allotting authority entitled to forfeit the earnest money deposited by the allottee or could be only entitled to forfeit 10% of the total amount deposited by the allottee till the request is made?
Following the judgment in Shree Hanuman Cotton Mills (supra), Supreme Court held that the allottee having accepted the allotment and having made some payment on installments basis, then made a request to surrender the land, has committed default on his part and, therefore, the competent authority would be fully justified in forfeiting the earnest money which had been deposited and not the 10% of the amount deposited, as held by the High Court. In that case, this Court took the view that the earnest money represented the guarantee that the contract would be fulfilled.
Supreme Court, again, in Videocon Properties Ltd. v. Dr. Bhalchandra Laboratories and others (2004) 3 SCC 711, dealt with a case of sale of immovable property. The Court held that the earnest money serves two purposes of being part-payment of the purchase money and security for the performance of the contract by the party concerned. In that case, on facts, after interpreting various clauses of the agreement, the Court held as follows:
“Coming to the facts of the case, it is seen from the agreement dated 13.5.1994 entered into between parties – particularly Clause 1, which specifies more than one enumerated categories of payment to be made by the purchaser in the manner and at stages indicated therein, as consideration for the ultimate sale to be made and completed. The further fact that the sum of Rs. 38 lakhs had to be paid on the date of execution of the agreement itself, with the other remaining categories of sums being stipulated for payment at different and subsequent stages as well as execution of the sale deed by the Vendors taken together with the contents of the stipulation made in Clause 2.3, providing for the return of it, if for any reason the Vendors fail to fulfill their obligations under Clause 2, strongly supports and strengthens the claim of the appellants that the intention of the parties in the case on hand is in effect to treat the sum of Rs. 38 lakhs to be part of the prepaid purchase-money and not pure and simple earnest money deposit of the restricted sense and tenor, wholly unrelated to the purchase price as such in any manner. The mention made in the agreement or description of the same otherwise as deposit or earnest money and not merely as earnest money, inevitably leads to the inescapable conclusion that the same has to and was really meant to serve both purposes as envisaged in the decision noticed supra. In substance, it is, therefore, really a deposit or payment of advance as well and for that matter actually part payment of purchase price, only. In the teeth of the further fact situation that the sale could not be completed by execution of the sale deed in this case only due to lapses and inabilities on the part of the respondents – irrespective of bonafides or otherwise involved in such delay and lapses, the amount of rupees 33 lakhs becomes refundable by the Vendors to the purchasers as of the prepaid purchase price deposited with the Vendors. Consequently, the sum of rupees 38 lakhs to be refunded would attract the first limb or part of Section 55(6)(b) of the Transfer of Property Act itself and therefore necessarily, as held by the learned Single Judge, the defendants prima facie became liable to refund the same with interest due thereon, in terms of Clause 2.3 of the agreement Therefore, the statutory charge envisaged therein would get attracted to and encompass the whole of the sum of rupees 38 lakhs and the interest due thereon….”
In the above mentioned case, the Court also held as follows:
Further, it is not the description by words used in the agreement only that would be determinative of the character of the sum but really the intention of parties and surrounding circumstances as well, that have to be baked into and what may be called an advance may really be a deposit or earnest money and what is termed as a deposit or earnest money may ultimately turn out to be really an advance or part of purchase price. Earnest money or deposit also, thus, serves two purposes of being part payment of the purchase money and security for the performances of the contract by the party concerned, who paid it..
Law is, therefore, clear that to justify the forfeiture of advance money being part of earnest money the terms of the contract should be clear and explicit. Earnest money is paid or given at the time when the contract is entered into and, as a pledge for its due performance by the depositor to be forfeited in case of non-performance, by the depositor. There can be converse situation also that if the seller fails to perform the contract the purchaser can also get the double the amount, if it is so stipulated. It is also the law that part payment of purchase price cannot be forfeited unless it is a guarantee for the due performance of the contract. In other words, if the payment is made only towards part payment of consideration and not intended as earnest money then the forfeiture clause will not apply.
In Satish Batra ( supra) Supreme Court held that, it is amply clear that the clause extracted hereinabove was included in the contract at the moment at which the contract was entered into. It represents the guarantee that the contract would be fulfilled. In other words, earnest is given to bind the contract, which is a part of the purchase price, when the transaction is carried out and it will be forfeited when the transaction falls through by reason of the default or failure of the purchaser.