The Accrual of Interest on Liquidated Damages: A Judicial Scrutiny under Indian Law

Introduction

The jurisprudence surrounding liquidated damages in India, primarily governed by Section 74 of the Indian Contract Act, 1872, is a well-trodden path. However, a more nuanced and complex question arises at its intersection with the law of interest: Can interest be levied on an amount claimed as liquidated damages, and if so, from what point in time does it accrue? This inquiry delves into the fundamental nature of liquidated damages—whether they constitute a pre-determined debt upon breach or merely a claim for damages that must first be adjudicated. The answer determines the applicability of statutory provisions like the Interest Act, 1978, and the discretionary powers of courts and arbitral tribunals under the Code of Civil Procedure, 1908, and the Arbitration and Conciliation Act, 1996.

This article provides a scholarly analysis of the legal principles governing the award of interest on liquidated damages in India. It examines the critical distinction between a 'claim' and a 'debt', the crystallization of a damages claim into an adjudicated sum, and the tripartite classification of interest—pre-litigation, pendente lite, and post-award. By synthesizing landmark precedents from the Supreme Court of India and various High Courts, this analysis seeks to delineate a coherent legal framework on this intricate subject.

The Nature of Liquidated Damages: From Penalty to Reasonable Compensation

To comprehend the issue of interest, one must first appreciate the legal character of liquidated damages (LDs) in India. Section 74 of the Indian Contract Act, 1872, represents a significant departure from English common law by effacing the distinction between a 'penalty' and 'liquidated damages'. The provision mandates that upon breach of a contract with a stipulated penalty, the aggrieved party is entitled to receive "reasonable compensation not exceeding the amount so named."

The Supreme Court, in the seminal case of Fateh Chand v. Balkishan Dass (1963 AIR SC 1405), established that Section 74 applies to all stipulations for damages, ensuring that a party does not profit from a breach but is merely compensated for the loss or legal injury suffered. This principle was further refined in subsequent judgments. In Oil & Natural Gas Corporation Ltd. v. Saw Pipes Ltd. (2003 SCC 5 705), the Court held that where a contract contains a genuine pre-estimate of damages, the party claiming compensation is not required to prove the actual loss. This appeared to grant significant sanctity to LD clauses.

However, the Supreme Court in Kailash Nath Associates v. Delhi Development Authority (2015 SCC 4 136) harmonized the position. It clarified that while proof of the precise quantum of loss may be dispensed with under Section 74, the fundamental principle of compensation remains paramount. The Court held that if no legal injury or loss is suffered by the party, it is not entitled to any compensation, irrespective of the existence of an LD clause. Therefore, LDs function as a ceiling for compensation and a pre-estimate of loss, but their award is contingent upon the existence of a legal injury resulting from the breach (M/s.Concrete Products & v. Union of India, Madras High Court, 2021).

The Crystallization of a Claim: When Does a Right to Damages Become a Debt?

The core of the issue concerning interest lies in determining the moment a claim for liquidated damages transforms into an ascertained sum or a 'debt'. The Interest Act, 1978, which empowers courts to award interest, primarily applies to "any debt or damages". A debt is generally understood as a definite and ascertained sum of money. A claim for damages, by contrast, is inchoate until it is adjudicated and quantified by a competent court or tribunal.

The Supreme Court's decision in Union Of India v. Raman Iron Foundry (1974 SCC 2 231) is the locus classicus on this point. The Court was tasked with interpreting a contractual clause allowing the government to recover any "sum due" from the contractor. The government sought to appropriate funds against a claim for liquidated damages. The Court unequivocally held that a claim for damages, whether liquidated or unliquidated, does not constitute a "debt" or a "sum due" until the liability is adjudicated and a specific sum is decreed. It observed:

"Now, it is true that the damages which are claimed are liquidated damages under Clause 14, but so far as the law in India is concerned, there is no qualitative difference in the nature of the claim whether it be for liquidated damages or for unliquidated damages. Section 74 of the Indian Contract Act eliminates the somewhat elaborate refinements made under the English common law... A claim for damages for breach of contract is, therefore, not a claim for a sum presently due and payable."

This principle establishes that the mere invocation of an LD clause upon breach does not create an immediate debt. It only gives rise to a right to claim reasonable compensation, the final amount of which is subject to determination. This has profound implications for the award of pre-litigation interest.

The Framework for Awarding Interest on Liquidated Damages

The award of interest can be analyzed across three distinct periods: pre-litigation, pendente lite (during the proceedings), and post-award/post-decree.

1. Pre-Litigation and Pre-Arbitration Interest

Given the rule in Raman Iron Foundry, claiming pre-litigation interest on LDs under the Interest Act, 1978, is fraught with difficulty. Since the claim is not for a 'debt' or an ascertained sum until adjudication, the statutory basis for awarding such interest is weak. The only clear exception is where the contract itself explicitly provides for the payment of interest on the LD amount from the date of breach. In the absence of such a contractual stipulation, a claim for pre-litigation interest on LDs is generally untenable.

2. Pendente Lite Interest

The position regarding pendente lite interest is markedly different, as it falls within the discretionary domain of the adjudicating body. Section 31(7)(a) of the Arbitration and Conciliation Act, 1996, grants an arbitral tribunal broad powers to award interest:

"Unless otherwise agreed by the parties, where and in so far as an arbitral award is for the payment of money, the arbitral tribunal may include in the sum for which the award is made interest, at such rate as it deems reasonable, on the whole or any part of the money, for the whole or any part of theperiod between the date on which the cause of action arose and the date on which the award is made."

The "cause of action" for a claim of liquidated damages arises on the date of the breach of contract. Therefore, an arbitral tribunal has the statutory discretion to award interest on the amount of LDs it ultimately finds payable, calculated from the date of breach until the date of the award. This power is not contingent on the claim being a 'debt' at the time of breach. The Madras High Court in TAQA Neyveli Power v. NLC India Limited (2023) affirmed this discretionary power, noting that an arbitrator can grant interest on a claim of liquidated damages, though it is not bound to do so. The court also observed that such a claim for interest should ideally be preceded by a written notice. The rate of interest must, however, be reasonable, as emphasized in cases like State Of Rajasthan And Another v. Ferro Concrete Construction Private Limited (2009 SCC 12 1).

3. Post-Award and Post-Decree Interest

Once an award or decree is passed granting a specific sum as liquidated damages, that sum crystallizes into a formal debt. The award of post-award interest is governed by Section 31(7)(b) of the 1996 Act, which provides that a sum directed to be paid by an award shall, unless the award directs otherwise, carry interest at a rate two per cent higher than the current rate of interest prevalent on the date of award, from the date of the award to the date of payment.

A pertinent question is whether this post-award interest is simple or compound. The Supreme Court in Hyder Consulting (Uk) Limited v. Governor, State Of Orissa (2015 SCC 2 189) clarified this. While dealing with the question of compound interest, the Court held that the "sum" mentioned in Section 31(7) refers to the principal amount awarded. Therefore, post-award interest is to be calculated on the principal amount of liquidated damages awarded by the tribunal, and not on any pre-award or pendente lite interest component, unless the contract or the award expressly provides for compounding. This ensures that the liability does not escalate unreasonably post-adjudication.

Conclusion

The law on awarding interest on liquidated damages in India is a tapestry woven from contractual autonomy, statutory provisions, and judicial interpretation. The legal framework can be distilled into a set of core principles. First, a claim for liquidated damages under Section 74 of the Contract Act is a claim for reasonable compensation for a legal injury and does not constitute an ascertained 'debt' upon the mere occurrence of a breach (Raman Iron Foundry; Kailash Nath). Second, consequently, pre-litigation interest is generally not awardable on LDs unless contractually stipulated. Third, courts and arbitral tribunals possess wide discretionary powers to award pendente lite interest on the amount of LDs ultimately found due, calculated from the date the cause of action arose (Section 31(7)(a), Arbitration Act, 1996). Finally, once adjudicated, the awarded sum of LDs becomes a judgment debt and carries post-award interest as a statutory mandate to ensure prompt payment.

This structured approach balances the rights of the aggrieved party to be compensated for the wrongful withholding of money against the principle that a claim for damages must first be validated through an adjudicatory process. It ensures that while LD clauses provide a convenient measure for damages, they do not automatically create an interest-bearing debt, thereby preserving the fundamental distinction between a claim and an adjudicated right.