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Contract Law

Prologue
This note discusses contracts from an Indian legal perspective (the Indian Contract Act
1872 - "ICA1872") with a focus on cross border transactions. Some aspects within the
contract that may be relevant to the parties involved are also discussed. In cross-border
transactions, local customs and usages should be noted as it forms inter alia the intent of
the parties to a contract. Besides, many terms and conditions in a cross-border contract
may be severely affected by other existing laws in force.

Joint Ventures
A "joint venture" is a specie of contract as well as a form of partnership. Under the Indian
Partnership Act 1932, a "partnership" is defined as the relation between persons who have
agreed to share the profit of a business carried on by all or any of them acting for all. The
powers, rights, duties and liabilities of the parties to a joint venture are mostly governed
by contract. There do not appear to be any specific legal definition of a joint venture.
However, the legal nature of "joint venture" may be extrapolated to include a legal entity
in the nature of a partnership inter se individuals or incorporated entities engaged in the
undertaking of a transaction for mutual profit.

The New Industrial Policy of India recognises the nature of joint ventures between
overseas party(ies) and Indian parties as financial or technical. A shareholders agreement
is a form of joint venture. The joint venture company, if separately incorporated, is
normally included as a party to the contract as a confirming party. The joint venture
company is a separate legal entity and may not be bound by those terms of the contract if
the provisions relating to it have not been incorporated in its articles of association.

Governing Law & Jurisdiction


Conflict of Laws

In cross-border transactions, where a contract is the subject matter of more than one
jurisdiction by virtue of performance or litigation, the law governing the contract would
be relevant. There appears to be no provision in the ICA1872 regarding the place where a
contract is made. It is preferable to clearly state the governing law of the contract.
According to case law, the place where the contract is concluded, being a part of cause of
action, determines the jurisdiction of the court in a case arising out of a contract. In
deciding the governing law / jurisdiction of the contract, the following aspects would be
relevant:

Place of contracting and law chosen or intended by the parties;


If the law is chosen, limits on the scope of choice of the parties;
If no law is chosen, the governing law of the contract, the place of contracting or
reference to actual or presumed intention or objective localising factors.

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Some of the other issues that govern the implied choice of law are - nature of transaction,
place of performance, style and terminology, language, currency, nature and location of
subject matter of the contract, place of residence / domicile / business of the parties.

It may be noted that other statutes such as agreements under the Arbitration and
Conciliation Act 1996 would bear different treatment.

Enforceability & Procedural Aspects


Several elements need to be fulfilled for enforceability of a contract in India. Natural
persons, legally recognised entities such as registered firms, companies and statutory
bodies can be parties to a contract. Therefore, the qualification of the parties need to be
ensured before signing or commencement of execution of a contract. Subject to the
exceptions contained in the ICA1872, consideration as defined therein is an essential
requirement.

Though the ICA1872 recognises oral contracts, a contract in writing obviates onus of
proof of clear and satisfactory evidence on formation and contents, conclusion, and effect
of terms of the contract to an extent. It is always preferable to enter into a contract in
writing. Contracts via electronic media may be considered to be in written form. Pending
clarity in this sphere of law, implementation of other factors such as digital signatures,
confirmation hard copies and other tangible matter would ensure enforceability.

Certain Indian statutes or provisions therein such as the Arbitration and Conciliation Act
1996 (ACA1996), the Companies Act 1956 (CA1956), the intellectual property laws,
the Income Tax Act 1961 and the Transfer of Property Act 1882 (TPA1882) require
contracts to be in writing.

The ICA1872 does not stipulate any procedural requirements for enforceability. Other
laws of India in force prescribe the procedural requirements such as attestation and
registration. Some aspects are discussed hereinbelow:

Parties: If natural persons, include particulars relating to qualifications under the


ICA1872 such as capacity to contract, forms of identification, age and address. Essential
incorporation particulars of legally recognised entities as well as authority and power to
do so.
Stamp Duty: The relevant statute dealing with stamp duty relating to documents in India
is the Indian Stamp Act 1899 and the related State laws. Though an instrument not duly
stamped is not invalid, it is incapable of being used as evidence until it is properly
stamped.
Registration: The relevant statute dealing with registration of documents in India is the
Registration Act 1908. Contracts relating to transfer of property or intellectual property
have to be registered.

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Franchise laws in India

Today, India is one of the biggest emerging markets for various goods and services,
ranging from bare necessities to expensive luxuries. Until 1991 due to the archaic Foreign
Exchange Regulation Act, 1973 (FERA), almost all sectors of goods and services relating
to the consumer markets in India were secure from the grasp of foreign investors. After
the repeal of FERA and the coming into force of the Foreign Exchange Management Act,
1999 (FEMA), foreign investors found their passage into India with rules for entry
becoming far more favourable. Today, a convenient medium of entry by foreign
companies into the Indian market is franchising. Franchising also exists as a successful
business module for local companies in India within various sectors.

The United States of America stands at the forefront of the franchise boom. Today, the
legal environment in the United States is highly conducive to the healthy growth and
evolution of franchising. With more than 50% of total retail businesses in the United
States, 45% in Canada and 26% in Australia choosing a franchise model for expansion
the impact of franchising on retail industries across the globe is considerable. To foster
the rapid and sustained growth that this channel brings it is critical that laws to regulate
the franchising business exist.

However, there are no laws enacted solely for the purpose of regulating the growing
business of franchising in India, even though many nations across the world have enacted
such laws. The result is that when franchisors enter India they are governed by a number
of different statutes and codes rather than a single comprehensive enactment.

Franchise Laws across the Globe

There are many countries which have developed comprehensive legislation to cover
franchising in their respective dominions. At the federal level in the United States, the
Federal Trade Commission s Rules on Disclosure Requirements and Prohibitions
Concerning Franchising and Business Opportunity Ventures (1979) regulate the
information a franchisor is required to supply the prospective franchisee in order to
enable the franchisee to make an informed decision on the prospects of venturing into the
business. The North American Security Administration Association (NASSA) has
adopted a Uniform Franchise Offering Circular (UFOC) which delineates the information
required to be disclosed to a prospective franchisee. Disclosure requirements under
franchising are well-defined in the USA.

In 2000, the Ontario Legislature in Canada adopted the Arthur Wishart Act which deals
comprehensively with disclosure requirements as well as important aspects of the
franchisee-franchisor relationship such as fair dealing by each party to a franchise
agreement as regards its performance and enforcement, and the right of action for
damages for breach of the duty of fair dealing.

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In the United Kingdom, there exists no operative franchise-related legislation. However
different aspects are governed by norms laid down by the British Franchise Association
(BFA), the regulatory body of the franchise industry in the United Kingdom. These
include a code of ethical conduct, disciplinary procedure, complaints procedure and
appeals procedure.

The Australian government has adopted a mandatory code of conduct and has also
modified the Trade Practice Act 1974 to provide for franchising. The new code imposes
comprehensive disclosure requirements and provides for mandatory mediation of
franchising disputes and minimum standards for franchise agreements including, inter
alia, a cooling period, refrain from seeking from a franchisee a general release liability,
disclosing material facts and refrain from unreasonably withholding consent to transfer of
the business.

In April 2002, the Japan Fair Trade Commission (JFTC), the competition authority of
Japan, published new guidelines on franchising. These guidelines contain three parts - a
general description of franchising, provisions for the disclosure of necessary information
(such as details of the assistance to be offered to franchisees, the nature, amount and
conditions of repayment, if any, of the fee to be paid at the time of entering into a
franchise agreement, etc.) at the time of the offer of a franchise and a part on vertical
restraints between a franchisor and its franchisees. Under the guidelines, the failure to
provide necessary information shall constitute deceptive customer inducement, which is
considered an unfair trade practice.

On 31 December 2004 the Ministry of Commerce of the Peoples Republic of China


promulgated the Measures for the Regulation of Commercial Franchises which became
the sole legal framework for franchising in China. The measures became operative on 1
February 2005 and provide detailed regulations for franchising, comprising of 42 articles
over nine chapters covering a wide span of areas from the franchise agreement to
disclosure requirements, special rules for foreign invested enterprises and legal liabilities.

Need for a Franchise Law in India

A healthy legal environment is of great importance for franchising and should include
provisions pertaining to all areas that fall within the ambit of franchising. This includes,
inter alia, commercial law relating to contracts and joint ventures and intellectual
property law for protection of trade marks and know-how. Franchise arrangements are
subject to an array of laws and regulations in addition to those regulating commercial
contracts and intellectual property rights. There are no specific laws governing
franchising in India. As a result a franchise agreement may be governed by different laws.

Primarily a franchise agreement is a contract between the franchisor and the franchisee.
The first law which comes into the picture is the Contract Act 1872 which governs
contracts in India. A franchise agreement will be governed by the Indian Contract Act,
1872 and the Specific Relief Act, 1963 which provides for both specific enforcement of
covenants in a contract and remedies in the form of damages for breach of contract. If a

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party to the franchise agreement commits a breach of contract, the aggrieved party has
the option to initiate a suit for specific performance in Indian courts and apply for relief
in the form of a temporary or permanent injunction, which may be granted at the
discretion of the court considering the balance of convenience and the interests of justice.
An order granting or rejecting an injunction may be appealed by an aggrieved party.

Laws relating to taxation, property laws, insurance law and labour laws also apply to
franchise transactions. Additionally, laws and regulations applying to specific sectors of
goods and services will also apply depending on the franchised.

The following are the reasons why a comprehensive franchise law is required in India:

Application of Multiple Legislation

A well-defined legal structure is indispensable for the effective functioning of any


business operation. The international business environment demands a well-defined
suitable legislation that is complete in all respects. The lack of a comprehensive
legislation on franchising in India leads to the applicability of multiple laws to a franchise
transaction.

This poses the following problems:


Complexities: Parties to a contract normally prefer agreements with a simple approach
and encompassing all the required law procedures and rules required to be complied with.
However the application of different laws to one agreement makes it complex to decide
various issues arising from the agreement.
Ambiguities: Due to the necessary application of multiple legislation, ambiguities are
created as to certain issues. For example, a franchisor would imagine that a certain issue
is the franchisees responsibility under one law, whereas the franchisee would think the
opposite based on a different law.
Time-Consuming: Referring to multiple laws consumes a lot of time at the initial stages
of a transaction as well as other points of time when the agreement is sought to be
enforced. This proves to be detrimental to the smooth functioning of franchising
operations in India and also makes time-bound operations involving new enterprises
difficult.
Absence of Disclosure Requirements
Countries with specific franchising legislation make it imperative for parties to a
franchise agreement to disclose certain factual information pertaining to the business of
the parties. This ensures transparency and facilitates an informed decision. A franchisor
should be required, by law, to make certain disclosure to the prospective franchisee
wherein he is supposed to reveal detailed information regarding himself, his litigation and
bankruptcy history, his financial position, the facilities he offers etc. In India, in the
absence of effective disclosure norms, a prospective franchisee is rendered helpless as the
franchisor is under no statutory obligations to make disclosures.
In the absence of a specific statute governing the franchise agreement, the franchisor
refrains from providing any information that is likely to prejudice or make a franchisee
reconsider the business proposition of the franchisor. The lack of proper disclosure

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requirements provides a golden opportunity to a franchisor to abuse his position of
importance as he is virtually under no statutory obligation to make the requisite
disclosure.

Applicability of Laws of other Countries


Normally, the absence of franchise laws enables foreign franchisors to make the laws of
their own country applicable to the agreements entered into with the franchisees in India.
The same is the case with franchisors who enter into franchising agreements with
franchisees from other countries. This proves to be an additional burden on the parties,
particularly the franchisee.

Lack of Proper Format for Franchising Agreements


Due to lack of a specific format, franchisors from other countries draft agreements which
are in the same format as is approved or followed in their countries. Such agreements are
made to suit the specific environment of their respective countries and hence are not
suitable for Indian environment.

Liability of Parties Uncertain


Due to the lack of specific legislation, the liability of either party is either determined by
the agreements entered into between them or on the basis of general prevailing law. The
liability clause is different in different countries, and this leads to a great discrepancy
among the courts which try such disputes on liabilities.

The Central Government is currently considering a franchise law aimed at fast resolution
of disputes; the proposal is expected to be placed before a sub-committee of the National
Development Council. The aforesaid problems surrounding franchising in India
necessitate the enactment of a specific legislation pertaining to franchising in India and
providing for the gamut of activities that franchising encompasses. A special franchise
law would greatly accelerate dispute resolutions and fortify the Indian retail industry.

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Case Law and franchising

Entrepreneurs who have chosen franchising as a tool for marketing their products and
services are increasingly becoming aware that their survival depends on the consumers
who buy their products. Franchising affords entrepreneurs a chance to build commercial
infrastructure and develop domestically oriented businesses in an efficient and profitable
manner. However, a deviation on their part from statutory provisions regulating the
franchise arrangement or well-established commercial practices may result in them being
dragged into a court of law which could result not only in heavy pecuniary losses but also
in intangible losses in the form of bad publicity for the franchise brand and loss of
consumers. This article proposes to analyse the impact of recent caselaw on the growth
and development of franchising and the often complex relationship between a franchisor
and a franchisee.

A franchisor who makes a decision to franchise his business in India, should ideally
indulge in course-correction i.e. observing and learning from mistakes made by
franchisors in various aspects of the franchise business not only in India but also in other
countries, the predominantly United States of America, as it is the birthplace of
franchising. Verdicts pronounced in important cases under Indian and US jurisdiction
provide indispensable lessons to prospective franchisors and franchisees. Disputes often
arise from provisions of the franchise agreement, which define and govern the franchise
relationship and delineate the rights and the obligations of both the franchisor and the
franchisee. As observed from judgments delivered in the Indian jurisdiction, certain
covenants commonly form a bone of contention between the franchisor and the
franchisee. They are outlined as follows:

Confidentiality and Non-Compete: Ordinarily, franchise agreements contain a clause


regarding confidentiality in relation to know-how and other forms of intellectual property
and the franchisor will have legal recourse in cases where:

an employee comes into possession of a trade secret, know-how and confidential


information in the normal course of business and either carelessly or deliberately passes
off the information in the normal course of business, as was the case in V.V. Sivaram and
Ors v. Foseco India Limited 2006 (1) Kar LJ 386;
an unauthorised person incites such an employee to provide him with such information,
as in Electrosteel Castings Ltd. v. Saw Pipes Ltd. and Ors. 2005(1) CHN 612; or
under a license for the use of know-how, a licensee in breach of condition, either
expressed in an agreement or implied from the conduct, to maintain secrecy in respect of
such know-how fails to do so, as in Gujarat Bottling Co. Ltd. and Ors. v. Coca Cola Co.
and Ors 1995(5) SCC 545.
Non-competition clauses are those which oblige the franchisor or master franchisee not to
operate a competing franchise within a certain radius or for a period after the termination
of the franchise agreement. The enforceability of such clause varies widely and depends
on its reasonableness. It was observed by Honble Supreme Court in the case of Gujarat
Bottling Co. Ltd. and others v. Coca Cola Company and Ors. that:

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There is a growing trend to regulate distribution of goods and services through franchise
agreements providing for grant of franchise by the franchisor on certain terms and
conditions to the franchisee. Such agreements often incorporate a condition that the
franchisee shall not deal with competing goods. Such a condition restricting the right of
the franchisee to deal with competing goods is for facilitating the distribution of the
goods of the franchisor and it cannot be regarded as in restraint of trade.

The conclusion that may be drawn from the above judgement is that although non-
compete clauses in franchise agreements are not seen as being in restrain of trade, they
should not be excessively harsh or unreasonable. Great care should, therefore, be taken in
drafting a restrictive or negative covenant; if the same is very onerous to a single party,
the court may refuse to enforce it in its entirety. Protection of confidentiality and post-
term restriction on competition are issues that the franchisor must consider very carefully
before finalising the form of a franchise agreement.

Intellectual Property Rights:


Protection of IPR is of vital importance to any franchisor in India because its violation
may result in the gradual erosion of the saleability of the franchisors products. The Trade
Marks Act, 1999 provides for the registration and better protection of trademarks and for
the prevention of use of fraudulent marks on merchandise. It was observed by the Court
in VivekanandaEnglishAcademy and Ors. v. Amoha Education Pvt. Ltd. and Anr. that
many franchisees continue using the trademark, technical know-how and other
confidential information of the franchisor even after the termination of the franchise
agreement; a franchisor should in such situation take advantage of the remedies which are
available in India under the statute in relation to trademark and copyright which are
particularly effective against the infringement and trafficking in trademark.

An aggrieved franchisor has recourse to three courses of action against the violation of
his trade marks: (a) seeking an injunction, (b) action for passing off, (c) criminal action.

In the case of Teju Singh v. Shanta Devi AIR 1973 AP 51, it was stated that infringement
of a trademark gives the proprietor of the registered trademark a statutory remedy. It was
stated that a registered trademark is considered infringed by if a person who not being the
registered proprietor of the trademark or a registered user thereof using by way of
permitted use, uses in the course of a trade, a mark which is identical with or deceptively
similar to the trademark in relation to any goods and in such manner as to render the use
of the mark likely to be taken as being used as the trademark. However, it should be
borne in mind that the license to use a trademark does not amount to an assignment of
trademark and therefore the original proprietor does not divest high right, interest or title
in the mark through the license, as held in the case of Caprihans (India) (P) Ltd. v.
Registrar of T.N (1976) 80 CWN 222.

In order to prevent the franchisee from taking undue advantage of the goodwill generated
by the franchise brand, the franchisor must not only make suitable provision in the
franchise agreement but also take immediate legal action against the erring franchisee so
as to set a precedent for all prospective franchisees.

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Consumer Rights: A consumer of products or services offered by a franchise may seek a
remedy under the provisions of the Consumer Protection Act, 1986. It was observed in
cases filed against Kentucky Fried Chicken and McDonalds in India and the US that the
franchisor of a fast food chain has a lot to learn from the large number of lawsuits filed
against fast food franchises in the past. Consumer complaints originate due to attitude of
complacency of the franchisor. A lawsuit was filed against KFC in Texas for allegedly
serving sandwiches containing baby cockroaches. Once a brand name is established,
franchisors often take their consumers for granted and fail to adhere to required standards
of hygiene that ought to be maintained in any food franchise. In Penelope Baim Block,
Brij. M. Sharma, Lisa M. Bertini, Vandana Makker, Bala M. Krishna, TYC Gerhardt and
Jeffrey Zimmerman, et al v. McDonalds Corporation 01 CH 9137, consumers were
misled about the actual ingredients used in the preparation of products. McDonalds was
ordered to pay damages to the tune of $ 10 million, and was also asked to issue an
apology.

The question which often arises is should the franchisee alone be held liable or also the
franchisor? It was seen in the US case of Kerl v. Rasmussen Inc., Wis. Ct. App. No. 02-
1273 2003 that the degree of control which the franchisor exercises over the franchisee
forms the basis of the franchisors liability in any legal action. The more control, the
more legal risk. It was stated that although franchisees operate as separate businesses,
plaintiffs often look to the deepest pockets when developing a claim, which means that
franchisors are frequent targets in lawsuits. In nearly every case, liability hinges on how
much control the franchisor holds over its franchisee. A franchise has an independent
nature, but a franchisor must by necessity retain some control over the use of its names,
goods or services.

The provisions of all applicable laws should be adequately complied with at every stage
commencing from entering into a franchise agreement to finally setting up the franchise
business and carrying on the day-to-day operations. A deviation or complacency at any
stage may prove fatal. Restrictive covenants in a franchise agreement should not be
unduly onerous; immediate legal action should be taken in case of infringement of any
trademark of the franchisor. Adequate provision should also be made in the franchise
agreement to prevent the franchisee from misusing the intellectual property of the
franchisor. Consumer issues may have substantial impact on the development of the
franchise brand and they should be attended to promptly. Further, the franchisor-
franchisee liability should be well-defined in the agreement itself so that there is no room
for any ambiguity at a later stage. The obvious inference that can be drawn from the
above-mentioned cases is that although franchising is certainly one of the most
innovative ways of promoting a brand, one simply cannot afford to overlook the legal
principles which are primarily responsible for shaping, delineating and defining the
commercial relationship within the broad framework of international business relations.

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A brief note on breach of service agreements
Mallikarjuna C.N.

Human Resources Managers often insist on surety from new recruits by having them
execute a bond stating that in case they commit a breach of the agreement, they will have
to pay to the employer the damages as may be agreed upon. Generally the agreements
stipulate that the appointee shall not leave the organization for a prescribed period
especially when the employer trains the employee at his cost. The purpose behind such
agreements is that the employers who spend money and impart training to their
employees should get some benefit from the employees.

Experience however shows that several employees execute the bond but break the same
within a short period and leave employment. Disputes arise about the legality of the
conditions of employment. The agreements are questioned on the grounds of public
policy. Disputes also arise about the quantum of damages, which an employer can
recover, from the employee in breach. Here are some notable cases of breach of service
agreements wherein the Courts have laid broad principles for recovery of damages.

In the case of Amar Singh v. Gopal Singh [AIR 1931 Lahore 133], one Amar Singh was
employed under Gopal Singh, as a chauffer on monthly wages. He left the service
without notice of his own accord and he was not paid his wages for 23 days. He had
worked for only a fortnight and left service when his services were badly needed. Amar
Singh filed suit against Gopal Singh for recovery of unpaid wages. Gopal Singh claimed
damages for leaving service without notice. The dispute went up to the High Court of
Lahore. In that case, it was held that when a servant whose wages are due periodically,
leaves service without legal justification or without proper notice, he is entitled to be paid
for the portion of the time during which he served since last periodical payment and the
master would be entitled to a reasonable compensation for breach of contract. Very often,
the question of quantity of damages, which an employer may recover from the employee
who commits breach of agreement, also arises.

A student entered into a bond with the State of Mysore, which agreed to pay for his
education expenses in the U.S.A. The condition for such payment was that after finishing
his studies, he would serve the State Government for a period of not less than five years
on such salary as the Government may fix. However, if he was not given employment
within six months of his return, they should be deemed to have waived their right to
claim his services. He would then be free to seek services elsewhere. In the event of a
breach of the terms of the bond, the student would be obliged to refund all the expenses
incurred by the Government, along with interest. The student finished his studies at the
Polytechnic Institute of Brooklyn, New York in September 1949 and obtained diploma
from that Institute on June 14, 1950 and with the permission of the State stayed on in the
U.S.A. for practical training at his own expense. Before finishing his training he
returned for domestic reasons and stayed in India for 6 months and again returned to
U.S.A. to finish his training with the States permission. He finished his training and got
employed in the U.S.A, claiming waiver by the State Government. It was held by the

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Supreme Court that staying on for six months in India, after his return on account of
domestic reasons and his being permitted to return for finishing his training his training
did not indicate that he was waiting for the State to offer him appointment. [M. Sham
Singh v. State of Mysore, AIR 1972 SC 2440.]

The obligation to pay compensation or damages is a contractual obligation. The measure


of damages in contract is compensation for the consequences, which follow as a natural
and probable consequence of the breach; or in other words, which could reasonably be
foreseen. [Cook v. S., (1967) 1 AII E.R. 299, 302.]

The rule is well settled, that damages due either for breach of contract, or for tort, are
damages, which so far as money can compensate, will give the injured party reparation
for the wrongful act and for all the natural and direct consequences of the wrongful act.
In the absence of special circumstances the measure of damages cannot be the amount of
loss ultimately sustained by the injured party. [Trojan & Co. v. Nagappa Chettiaar,
(1953) S.C.R. 789. 799]. If the quantification of loss or damages is not possible, even the
party who suffered can request the Court to assess the reasonable damages provided there
is damage. [State of Kerala v. United Shippers and Dredgers, AIR 1982 Ker 281].

There is authority to the proposition that substantial damages can be claimed where a
breach is proved even though the calculation of damages is 'not only difficult but
incapable of being carried out with certainly or precision. In such cases, however, the via-
media would be to stipulate the quantum of compensation in the agreement itself. When
a contract has been broken and if a sum has been 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 by virtue
of s. 74 of the Indian Contract Act. The Indian legislature, by enacting s. 74, sought to
cut across the web of rules and presumptions under the English common law, by enacting
a uniform principle applicable to all stipulations naming amounts to be paid in case of
breach, and stipulations by way of penalty. [Fateh Chand v. Balkishan Das, AIR 1963 SC
1405].

The Supreme Court in Fateh Chands case said: Section 74 declares the law as to liability
upon breach of contract where compensation is - by agreement of parties, predetermined
or where there is a stipulation by way of penalty. But the application of the enactment is
not restricted to cases where the aggrieved party claims relief as a plaintiff. The section
does not confer a special benefit upon any party. It merely declares the law that
notwithstanding any term in the contract for determining the damages or providing for
forfeiture of any property by way of penalty, the Court will award to the party aggrieved,
only reasonable compensation not exceeding the amount named or penalty stipulated.
The same proposition has also received the support of the Supreme Court in Nareshchand
Sanyal v. Calcutta Stock Exchange Assn. Ltd., AIR 1977 SC 422, 428.

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But in an English case, the House of Lords held: a clause in an artistes agreement
suspending salary upon her failure to appear and perform does not prevent the employers
from recovering damages for breach of contract as well as suspending her salary. The
suspension of salary is not a penalty. [Gaumont British Picture Corporation v. Alexander,
(1936) 2 All E.R. 1686, 1693]. A sum which is payable in pursuance of a contractual
obligation is different from a sum payable on a breach of contractual obligation. The
former is not a penalty. [Tool Metal Co. v. Tungsten Electric Co. (1955) 2 All E.R. 657,
688.] Liquidated damages is the term used to indicate the sum, which the parties have, by
the contract assessed as the damages to be paid, whatever may be the actual damage.
[Wallis v. Smith (1882) 21 Ch.D. 243, 267]

To claim penalty or liquidated damages, the onus of proof is on the plaintiff. The plaintiff
has to prove that the amount of damages stipulated whether by way of liquidated
damages or penalty is a reasonable pre-estimate of damages and he cannot be awarded a
sum greater than the one stipulated. [George Pictures Ltd. v. Neelakandaru
Gopalakrishna, AIR 1971 Ker 271; Narasimha Rao v. Supdt. of Excise, AIR 1974 AP.
157, 167].

But where the engagement is for one full year, say from 1st April, 1908, to 31st March
1909, and the salary is fixed at so much (say Rs. 18) per month, and the servant
wrongfully leaves his employers service on 20th March, 1909, he is nevertheless entitled
to his salary for the eleven months during which he actually served his employer, less the
damages incurred by the employer by the breach, through the salary be payable under the
terms of the agreement in a lump sum of Rs. 216 at the end of the year.

Though actual damage has not been proved, the sum stipulated in the contract towards
liquidated damages can be recovered by the employer for the breach committed by the
employee. [P. Nagarajan v. Southern Structurals Ltd., 1996 (2) LLN 810.

In Fertiliser and Chemical Travancore Ltd. v. Ajay Kumar and others, 1990 LLR 711, the
employer selected three trainees who then signed a bond that they would obtain two years
training in the Company and after the training they will put in at least five years service
in the company. In case of a breach of these conditions by the trainees, Rs.10,000/- was to
be paid as reasonable compensation for the damages likely to be incurred by the
employer. But the trainees resigned after five months.

The employer filed a suit for recovery of damages on the basis of the bond executed by
the employees. The trial court dismissed the suit holding that the work done by the
trainees during the period of training would sufficiently compensate the management.
However, their Lordships at the High Court of Kerala observed that though the selection
of trainees was for absorption into training, the employer was not bound to appoint them
on permanent service. But a trainee, who accepts the selection and joins training after
entering into bond, binds himself to undergo the training and then accept regular
appointment, if offered, for a minimum period of five years. The process of selection
itself involves time, energy and expenses for the employer. This is the case of training

12
also. Over and above other expenses during training, each trainee gets Rs.800/- per month
for the first year and Rs.850/- per month for the next year from the employer.

The employer will definitely incur loss when a trainee breaks the conditions of the bond
and walks off. The employer is deprived of the expected service of a competent person,
for which fresh selection and training may become necessary. Breach of bond by the
trainee is, therefore an aspect involving damages to the employer. Only the question of
the quantum of the damage then remains to be decided.

The Court also observed that s. 73 the Indian Contract Act provides for compensation for
failure to discharge obligation resembling those created by contract. When a contact is
broken, what is recoverable is only the loss or damage caused, which naturally arose in
the usual course of things from the breach or which the parties knew, when they made the
contract, to be likely to result from the breach of it. Section 74 of the Indian Contract Act
providing compensation for breach of contact where penalty stipulated for is to be read
along with s. 73 as s. 74 is only supplementary to s. 73 irrespective of the amount
stipulated in the contract. Whether it is liquidated damage or by way of penalty, the party
complaining of breach is entitled to get reasonable compensation and the amount
stipulated could be taken as the outer limit.

Another case is Toshnial Brothers (Pvt.) Ltd. v. E. Eswarprasad & Ors., 1997 LLR 500
decided by the Madras High Court. In this case, an employee who was engaged as Sale
Engineer committed a breach of the undertaking when he left the services of the plaintiff
after serving for 14 months only as against the contracted period of three years. When the
case reached the High Court, the High Court of Madras held that in such a case, it
becomes unnecessary for the employer to prove separately any post-breach damages. On
the other hand, it would suffice to substantiate the fact that the concerned employee was
the beneficiary of special favour or concession or training at the cost and expense wholly
or in part of the employer and there had been a beach of the undertaking by the
beneficiary of the same. In such cases, the breach would per se constitute the required
legal injury resulting to the employer, out of the breach or violation by the employees.
The High Court, also clarified that while awarding damages as stipulated, the statutory
exception for mitigating the quantum of damages will have no bearing.

13
NATIONAL CONSUMER DISPUTES REDRESSAL COMMISSION

NEW DELHI

REVISION PETITION NO. 986 OF 1995


(From the order dated 15.9.1995 in Appeal No. A.P. No.693/1995 of the State
Commission, Tamil Nadu)

M/s. New India Assurance Co. Ltd. Petitioner

Versus

K.A. Abdul Hameed Respondent

AND

REVISION PETITION NO. 338 OF 1998


(From the order dated 5.11.1997 in Appeal No.225/1995 of the State Commission,
Haryana, Chandigarh)

M/s. New India Assurance Co. Ltd. Petitioner

Versus

K.L.Gupta Respondent

14
BEFORE :

HONBLE MR. JUSTICE M.B.SHAH, PRESIDENT.

DR. P.D.SHENOY, MEMBER.

For the Petitioner : Mr. Sunil Kapoor, Advocate.

For the Respondent : Mr. Anand, Advocate.

(Amicus Curiae)

DATE: 19th April, 2005

O R D E R

M.B.SHAH, J. PRESIDENT.

Question involved in these Revision Petitions is with regard to the effect of


addition of subsection (b) to Section 28 of the Indian Contract Act, 1972 , in the year
1997.

The question arises in view of the following condition of the insurance policy.

It is also hereby further expressly agreed and declared that if the


Company shall disclaim liability to the insured for any claim hereunder and such claim
shall not, within twelve calendar months from the date of such disclaimer have been
made the subject matter of a suit in a court of law, then the claim shall for all purposes be
deemed to have been abandoned and shall not thereafter be recoverable hereunder.

15
Learned counsel for the Insurance Company, contended that as the complaint
was not filed within the period of 12 months of the repudiation of the claim, the
complaint was not maintainable. In R.P.No.338 of 1998 the Insurance Company
repudiated the claim of the insured on 31st March, 1993 and the complaint was filed
before the District Forum, Gurgaon, on 12th January, 1995, i.e. beyond the period of 12
months.

Prima facie, it appears that the aforesaid condition in the insurance policy
would be void in view of Section 28(b).

Section 28 is as under:

28. Agreements in restraint of legal proceedings, void. Every agreement

(a) by which any party thereto is restricted absolutely from enforcing his rights under
or in respect of any contract, by the usual legal proceedings in the ordinary tribunals, or
which limits the time within which he may thus enforce his rights; or

(b) which extinguishes the rights of any party thereto, or discharges any party thereto,
from any liability, under or in respect of any contract on the expiry of a specified period
so as to restrict any party from enforcing his rights,

is void to that extent.

However, it is contended that:

(a) this condition was part of the contract which had taken place in 1992,
the claim was repudiated in 1993 and the complaint was filed in 1995 when Clause (b) of
Section 28(b) of the Act was not in existence.

(b) Similar condition came up for interpretation before the Apex Court in the case of
Petitioner and the Court has upheld such condition.

16
Learned Counsel for the Petitioner has referred to the three Judge Bench
decision of the Supreme Court in National Insurance Co. Ltd. Vs. Sujir Ganesh Nayak &
Co. & Anr., (1997) 4 SCC 366. In this decision the Supreme Court upheld the
contention of the Insurance Company and observed:

14. Sahai, J. [(in Food Corporation of India Vs. New India Assurance Co. Ltd., (1994) 3
SCC 324)] who wrote a separate but concurring judgment extracted the clause of the
Fidelity Insurance Guarantee (which we have extracted earlier) and then posed the
question: What does it mean? What is the impact of Section 28 of the Contract Act on
such a clause? Pointing out that the said Section 28 was a departure from the English law
(there is no such statutory bar in English law) the learned Judge observes that: (SCC
p.330, para 3)

... Even though the phraseology of Section 28 is explicit and strikes at the very root by
declaring any agreement curtailing the normal statutory period of limitation to be void the
courts have been influenced by the distinction drawn by English Courts in extinction of
right by agreement and curtailment of limitation.

Referring to the language of the various terms of the agreement, the learned Judge holds
in paragraph 8 thus: (SCC p.335)

From the agreement it is clear that it does not contain any clause which could be said to
be contrary to Section 28 of the Contract Act nor it imposes any restriction to file a suit
within six months from the date of determination of the contract as claimed by the
company and held by the High Court. What was agreed was that the appellant would not
have any right under this bond after the expiry of six months from the date of the
termination of the contract. This cannot be construed as curtailing the normal period of
limitation provided for filing of the suit. If it is construed so it may run the risk of being
violative of Section 28 of the Contract Act. It only puts embargo on the right of the
appellant to make its claim known not later than six months from the date of termination
of contract. It is in keeping with the principle which has been explained in English
decisions and by our own court that the insurance companies should not be kept in dark
for long and they must be apprised of their liabilities immediately both for facility and
certainty. The High Court erroneously construed it as giving up the right of enforceability
of its claim after six months.

15. From the case law referred to above the legal position that emerges is that an
agreement which in effect seeks to curtail the period of limitation and prescribes a shorter
period than that prescribed by law would be void as offending Section 28 of the Contract
Act. That is because such an agreement would seek to restrict the party from enforcing
his right in Court after the period prescribed under the agreement expires even though the
period prescribed by law for the enforcement of his right has yet not expired. But there
could be agreements which do not seek to curtail the time for enforcement of the right but
which provides for the forfeiture or waiver of the right itself if no action is commenced

17
within the period stipulated by the agreement. Such a clause in the agreement would not
fall within the mischief of Section 28 of the Contract Act. To put it differently,
curtailment of the period of limitation is not permissible in view of Section 28 but
extinction of the right itself unless exercised with a specified time is permissible and
can be enforced. If the policy of insurance provides that if a claim is made and rejected
and no action is commenced within the time stated in the policy, the benefits flowing
from the policy shall stand extinguished and any subsequent action would be time-
barred. Such a clause would fall outside the scope of Section 28 of the Contract Act.
This, in brief, seems to be the settled legal position. We may now apply it to the facts of
this case.

In our view, the Supreme Court declared the law as under:

Curtailment of the period of limitation is not permissible in view of Section


28 but, extinction of right itself unless exercised within a specified time is permissible
and can be enforced.

Legislature thought the aforesaid approach may be sound in theory but in


practice it causes serious hardship and might even be abused, and it harms the interest of
a consumer dealing with big corporations and causes serious hardships to those who are
economically disadvantaged. Hence, Clause (b) of Section 28 was added. This is made
clear by the Statement of Objects and Reasons for substituting Section 28. The same are
as under:

The Law Commission of India has recommended in its 97th report that Section 28 of the
Indian Contract Act, 1872 may be amended so that the anomalous situation created by the
existing section may be rectified. It has been held by the courts that the said section 28
shall invalidate only a clause in any agreement which restricts any party thereto from
enforcing his rights absolutely or which limits the time within which he may enforce his
rights. The courts have, however, held that this section shall not come into operation
when the contractual term spells out an extinction of the right of a party to sue or spells
out the discharge of a party from all liability in respect of the claim. What is thus hit by
Section 28 is an agreement relinquishing the remedy only, i.e. where the time limit
specified in the agreement is shorter than the period of limitation provided by law. A
distinction is assumed to exist between remedy and right and this distinction is the basis
of the present position under which a clause barring a remedy is void, but a clause
extinguishing the rights is valid. This approach may be sound in theory but, in practice, it
causes serious hardship and might even be abused.

18
.2. it is felt that section 28 of the Indian Contract Act, 1872 should be amended as it
harms the interests of the consumer dealing with big corporations and causes serious
hardship to those who are economically disadvantaged.

In this view of the matter, it is apparent that the aforesaid clause (b) is a
declaratory enactment. It declares that such term would be void and that was the intention
of the Legislature.

The law with regard to declaratory enactment is settled.

In Central Bank of India and Ors. Vs. Their Workmen, etc. , AIR 1960 SC
12 the Apex Court has approved the following law from Craies : Statute Law, 7th Edition,
p.58.

The Court observed:

What is a declaratory Act? The following observations (in Craies on Statute Law, 5th
Edition, pp.56-57) are apposite:

For modern purposes a declaratory Act may be defined as an Act to remove doubts
existing as to the common law, or the meaning or effect of any statute. Such Acts are
usually held to be retrospective. The usual reason for passing a declaratory Act is to set
aside what Parliament deems to have been a judicial error, whether in the statement of the
common law or in the interpretation of statutes. Usually, if not invariably, such an Act
contains a preamble, and also the word declared as well as the word enacted.

Further, in Shri Chaman Singh & Anr. Vs. Srimathi Jaikaur (1969) 2 SCC
429, the Court has observed that:

It is well settled that if a statute is curative or merely declares the previous


law retroactive operation would be more rightly ascribed to it than the legislation which
may prejudicially affect past rights and transactions.

19
In view of the aforesaid law, no further reference is required to various
judgments sought to be relied upon by the learned amicus curiae.

Considering the law as declared and amended, it is to be held that the


condition which extinguishes the right of the Complainant to approach the Court or
Forum within a specified time as per the contract is void and cannot be enforced. The
law declares such condition to be void and in such a situation it is not necessary for us to
discuss the difference between void and voidable.

Hence, it would not be possible to uphold the contention raised by the


Insurance Company and arrive at the conclusion merely on the condition stated above
that as the claim was repudiated before one year of the filing of the complaint, the
complainants rights are extinguished and therefore the complaint is barred.

With this background, we would narrate brief facts chequered facts in


Revision Petition No.986 of 1995.

The Complainant, owner of a Mahindra Van, which was insured with the
New India Assurance Co. Ltd. for the period 31.8.1990 and 30.8.1991. The van met with
an accident on 23.10.1990; FIR was lodged; a sum of Rs.37,436/- was claimed from the
Insurance Company; that claim was repudiated. Hence the Complainant preferred O.P.
No.178 of 1993 before the District Forum, Nagapattinam. By order dated 5.7.1994 the
complaint was partly allowed and the Insurance Company was directed to pay a sum of
Rs.21,773/- with interest at the rate of 18% p.a. and also to pay Rs.7,500/- towards
mental agony and Rs.500/- towards cost of litigation. Against that order, the Insurance
Company preferred Appeal No.A.P. No. 693 of 1995 before the State Consumer Disputes
Redressal Commission, Tamil Nadu. In that appeal the only contention raised was with
regard to the condition of the insurance policy which provides that the complaint filed
after one year from the date of repudiation was not maintainable. That contention was
negatived and the appeal was dismissed by judgment and order dated 28.9.1995.

Against that order the Petitioner preferred Revision Petition No.196 of 1995
before this Commission. That was summarily dismissed. Hence, the Insurance Company
preferred Special Leave Petition No.5769 of 1999 before the Apex Court and the Apex
Court remitted this matter to his Commission for being decided afresh in accordance with
law, by observing that this was not a fit case for summary disposal.

20
Facts of Revision Petition No.338 of 1998:

The Complainant was owner of a jeep insured for a sum of Rs.2,22,000/- for
the period from 7.4.1992 to 6.4.1993. The vehicle met with an accident on 8.7.1992; FIR
was registered on the same day; report to that effect was sent to the Insurance Company;
a surveyor was appointed who assessed the loss at Rs.38,000/-; the Complainant claimed
Rs.1 lakh; despite the report of the surveyor, the Insurance Company failed to settle the
claim; the Complainant visited the office of the Insurance Company on various occasions,
ultimately, the claim was repudiated on the ground that the driver of the vehicle was not
possessing any valid driving licence. It was the contention of the Complainant that the
driver of the vehicle was having valid driving licence. His licence was revalidated by the
licensing authority, Gurgaon of the M.A.C.T. claim arising out of the said accident. The
licensing clerk proved the validity of the licence. So the claim was repudiated without
any basis. The Insurance Company mainly objected the complaint on the ground that it
was barred in view of the condition mentioned above. That was negatived by the District
Forum after referring to various judgments. Finally, the District Forum by order dated
28.4.1995 awarded Rs.25,526/- as compensation payable by the Insurance Company.

Against that order First Appeal No.255 of 1995 was filed before the State
Consumer Disputes Redressal Commission, Haryana, Chandigarh. That appeal was
dismissed by order dated 5th November, 1997. Thereafter Revision Petition No.338 of
1998 was filed before this Commission which was dismissed. The Insurance Company
preferred Civil Appeal 5769 of 1997 before the Supreme Court. That appeal was allowed
by the Apex Court and the matter was remitted to this Commission.

In these revision petitions no other point is involved except with regard to


the condition quoted above. Hence, there is no substance in these revision petitions and
are dismissed. The Insurance Company shall pay costs of Rs.5,000/- in each case. The
amount shall be deposited with the NCDRC Bar Association Legal Aid Fund.

We appreciate the hard work done and assistance rendered by the amicus
curiae.

J.

(M.B.SHAH)

PRESIDENT

21

(P.D.SHENOY)

MEMBER

22