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Issues: (i) Whether damages under a liquidated damages clause could be awarded without proof of actual loss or legal injury; (ii) Whether the arbitral award awarding liquidated damages was liable to be set aside for patent illegality.
Issue (i): Whether damages under a liquidated damages clause could be awarded without proof of actual loss or legal injury.
Analysis: The dispute turned on the interplay between Sections 73 and 74 of the Indian Contract Act, 1872. Section 74 permits recovery of reasonable compensation up to the stipulated amount, but the award of compensation still presupposes some legal injury or loss. Where actual loss can be proved, proof is not dispensed with merely because the contract contains a liquidated damages clause. Only where loss is difficult or impossible to prove may a genuine pre-estimate in the contract be awarded as reasonable compensation. The record showed that no evidence was led and the arbitrator itself noted absence of documentary proof of damage suffered by either side.
Conclusion: Damages could not be awarded merely on proof of breach and contractual stipulation; proof of loss remained necessary, so the claim for liquidated damages could not stand on the material before the arbitrator.
Issue (ii): Whether the arbitral award awarding liquidated damages was liable to be set aside for patent illegality.
Analysis: The award recorded breach by the petitioner but also recorded that there was no evidence to prove damages. Even so, it granted liquidated damages by relying on the contractual clause and selective extracts of precedent, without returning a finding that the respondent suffered loss or that loss was incapable of proof. Such an approach ignored the settled requirement that compensation under Section 74 must be linked to legal injury and reasonable compensation. An award based on no evidence or ignoring vital evidence is perverse and falls within patent illegality under Section 34 of the Arbitration and Conciliation Act, 1996.
Conclusion: The award was liable to be set aside for patent illegality.
Final Conclusion: The arbitral award could not be sustained because it granted liquidated damages without proof of loss or a legally supportable finding of reasonable compensation, and it was therefore interfered with in the Section 34 proceedings.
Ratio Decidendi: A contractual liquidated damages clause does not dispense with the requirement of proving legal injury or loss where such loss is capable of proof; compensation can be awarded only as reasonable compensation and an award granting damages without that foundation is vulnerable to challenge as patent illegality.
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