What are parameters for interpretation of forfeiture Clause in a Contract?

 The right to forfeit has, ordinarily, to be balanced against the rule against unjust enrichment. Merely because there is a forfeiture clause does not imply that the entire amount deposited has to be forfeited. The forfeiture clause, like an earnest money deposit clause or a liquidated damages clause, has to be regarded as a genuine pre-estimate of the loss that may have been incurred, but when a forfeiture clause does not indicate an amount but provides that the entire amount tendered would be forfeited, it may not be permissible to forfeit, say 99% of the payment made for the default in depositing the balance 1%. Thus, the quantum that can be forfeited will depend on the extent of the loss or damage suffered by the party not in breach and this is, essentially, a question of fact that has to be adjudicated by an appropriate forum. The High Court, in exercise of the jurisdiction under Article 226 of the Constitution, is not such forum.

In the High Court of Madras

(Before Sanjib Banerjee, C.J. and Senthilkumar Ramamoorthy, J.)

Rubina   Vs   Authorised Officer, Axis Bank Limited 

W.P. No. 19042 of 2020

Decided on July 2, 2021

Citation: 2021 SCC OnLine Mad 2349

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Whether earnest money can be forfeited even if there is no forfeiture clause in contract?

 Reading of Section 74 would go to show that in order to forfeit the sum deposited by the contracting party as "earnest money" or "security" for the due performance of the contract, it is necessary that the contract must contain a stipulation of forfeiture. In other words, a right to forfeit being a contractual right and penal in nature, the parties to a contract must agree to stipulate a term in the contract in that behalf. A fortiori, if there is no stipulation in the contract of forfeiture, there is no such right available to the party to forfeit the sum.

IN THE SUPREME COURT OF INDIA

Civil Appeal No. 7665 of 2009

Decided On: 25.10.2017

 Suresh Kumar Wadhwa Vs.  State of M.P. and Ors.

Hon'ble Judges/Coram:

R.K. Agrawal and Abhay Manohar Sapre, JJ.

Citation:(2017) 16 SCC757

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Whether forfeiture clause in void agreement can enforced?

Under Section 74 of the Act, however, the parties to the agreement stipulate either a particular amount which is to be paid in case of breach or an amount may be mentioned to be paid 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, to receive from the party who has committed the breach of contract, compensation not exceeding the amount mentioned in the agreement or the penalty stipulated therein. But this Section also contemplates a valid and binding agreement between the parties. Since the stipulation for forfeiture of the earnest money is part of the contract, it is necessary for the enforcement of that stipulation, that the contract between the parties is valid. If the forfeiture clause is contained in an agreement which is void on account of the fact that the parties were not ad-idem and were suffering from mistake of fact in respect of a matter which was essential to the contract, it cannot be enforced as the agreement itself is void under Section 20 of the Contract Act. A void agreement cannot be split up. None of the parties to the agreement can be permitted to seek enforcement of a part only of the contract through a court of law. If the agreement is void, all its terms are void and none of the terms, except in certain known exceptions, specially where the clause is treated to constitute a separate and independent agreement, severable from the main agreement can be enforced separately and independently.

Since, in the instance case, it has been found as a fact by the below that the agreement in question was void from its inception as the parties suffered from mutual mistake with regard to the area and price of the plots of land agreed to be sold, the forfeiture clause would, for that reason, be also void and, therefore, the petitioner could not legally forfeit the amount and seek the enforcement of forfeiture clause, even by way of defence, in a suit instituted for Specific Performance by the respondent.

Supreme Court of India

Sri Tarsem Singh vs Sri Sukhminder Singh on 2 February, 1998

Bench: S. Saghir Ahmad, M. Jagannadha Rao

          Citation; AIR 1998 SC1400

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Whether earnest money can be forfeited even in absence of proof of damage?

Mr. Palaniswami strenuously contended that as the amount is in the nature of earnest money, it could be forfeited notwithstanding the absence of proof of damage. Reliance was placed upon a decision of our High Court in Natesa Aiyar v. Appavu Padayachi (ILR 38 Mad 78): (AIR1915 Mad 896) (FB). Apart from the fact that we have our own doubts whether, in the light of the later pronouncements of the Supreme Court, the ratio of the above decision would still be applicable to the facts of this stage that the parties expressly stipulated that what was paid under Ex.B-2 was not earnest money but advance. It is reasonable also to characterise this amount as advance since it bears a very great proportion to the totality of the consideration as well. Generally earnest money forms a small proportion or ratio to the consideration which is agreed to be the consideration to be passed by one to the other under a contract of sale. Having regard to the fact that the amount of Rs. 10,000/- was paid, treated and nomenclatures as advance under Ex.B-2, we are unable to agree with Mr. Palaniswami that the amount paid should be treated automatically as earnest money. Again in the absence of pleading that the defendants have suffered damage to the tune of Rs. 10,000/- the plea that the entire amount paid by the plaintiff cannot be demanded and the defendants are not under an obligation to refund it is an extreme contention. We searched in vain for proof of any such sufferance of damage and in fact Mr. Palaniswami was called upon to refer to such a plea or a statement in the witness box by the witnesses examined on the side of the defendants. He was unable to refer to any specific statement by the defendants or by the witness examined on their side. It was in those circumstances that Sethuraman. J., said that without reference to any actual damage, the amount referred to in the agreement cannot be forfeited, because it would be in the nature of penalty. Proof of actual damage is a sine qua non to seek damage. The Supreme Court noticed the inequity in a case where an automatic forfeiture is sought for by a defendant and their conclusion is based upon the principle that nobody can unjustly enrich himself.

Madras High Court

Marimuthu Gounder vs Ramaswamy Gounder And Ors. on 11 September, 1978

Equivalent citations: AIR 1979 Mad 189, (1979) 1 MLJ 343

Bench: T R Rao, Ramanujam

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When earnest amount can be forfeited?

 Furthermore, it is to be noted that in this particular contract there was a specific condition of the sale by auction that the deposit was to be forfeited in case of default by the purchaser and we think that such a clause is not unreasonable and must be given effect to. Our own High Court Rules regarding the sale by the Sheriff's office (Rule 391) specifically allow a deposit to be forfeited and the mere fact that the word "may" is used in that Rule cannot be taken to mean that only such sum out of the deposit can be forfeited as the Court may think proper as damages following the failure of the buyer to complete the sale.

Bombay High Court

Dinanath Damodar Kale vs Malvi, Mody, Ranchhoddas And Co. on 18 September, 1929

Equivalent citations: (1930) 32 BOMLR 272

Bench: N Kemp, Kt., Murphy

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Whether void agreement can be split up?

Under Section 74 of the Act, however, the parties to the agreement stipulate either a particular amount which is to be paid in case of breach or an amount may be mentioned to be paid 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, to receive from the party who has committed the breach of contract, compensation not exceeding the amount mentioned in the agreement or the penalty stipulated therein. But this Section also contemplates a valid and binding agreement between the parties. Since the stipulation for forfeiture of the earnest money is part of the contract, it is necessary for the enforcement of that stipulation, that the contract between the parties is valid. If the forfeiture clause is contained in an agreement which is void on account of the fact that the parties were not ad-idem and were suffering from mistake of fact in respect of a matter which was essential to the contract, it cannot be enforced as the agreement itself is void under Section 20 of the Contract Act. A void agreement cannot be split up. None of the parties to the agreement can be permitted to seek enforcement of a part only of the contract through a court of law. If the agreement is void, all its terms are void and none of the terms, except in certain known exceptions, specially where the clause is treated to constitute a separate and independent agreement, severable from the main agreement can be enforced separately and independently.

Supreme Court of India

Sri Tarsem Singh vs Sri Sukhminder Singh on 2 February, 1998

Bench: S. Saghir Ahmad, M. Jagannadha Rao
Citation: AIR1998SC1400, 1998(2)ALLMR(SC)528, 

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When forfeiture clause contained in agreement of sell becomes void?

Learned counsel for the petitioner has contended that Lower Appellate Court or the High Court were not justified in passing a decree for the refund of Rs. 77,000/- which was paid as earnest money to the petitioner as there was a specific stipulation in the agreement for sale that if the respondent did not perform his part of the contract and did not obtain the sale deed after paying the balance amount of sale consideration within the time specified in the agreement, the earnest money would stand forfeited. It is contended that since the respondent did not offer the balance amount of sale consideration and did not obtain the sale deed in terms of the agreement, the amount of earnest money was rightly forfeited and a decree for its refund could not have been legally passed.

Learned counsel for the petitioner has invited our attention to Section 73 and 74 of the Contract Act which, in our opinion, are of no aid to the petitioner.

Section 73 stipulated a valid and binding contract between the parties. It deals with one of the remedies available for the breach of contract. It is provided that where a party sustains a loss on account of breach of contract, he is entitled to receive, from the party who has broken the contract, compensation for such loss or damage.

Under Section 74 of the Act, however, the parties to the agreement stipulate either a particular amount which is to be paid in case of breach or an amount may be mentioned to be paid 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, to receive from the party who has committed the breach of contract, compensation not exceeding the amount mentioned in the agreement or the penalty stipulated therein. But this Section also contemplates a valid and binding agreement between the parties. Since the stipulation for forfeiture of the earnest money is part of the contract, it is necessary for the enforcement of that stipulation, that the contract between the parties is valid. If the forfeiture clause is contained in an agreement which is void on account of the fact that the parties were not ad-idem and were suffering from mistake of fact in respect of a matter which was essential to the contract, it cannot be enforced as the agreement itself is void under Section 20 of the Contract Act. A void agreement cannot be split up. None of the parties to the agreement can be permitted to seek enforcement of a part only of the contract through a court of law. If the agreement is void, all its terms are void and none of the terms, except in certain known exceptions, specially where the clause is treated to constitute a separate and independent agreement, severable from the main agreement can be enforced separately and independently.

Since, in the instance case, it has been found as a fact by the below that the agreement in question was void from its inception as the parties suffered from mutual mistake with regard to the area and price of the plots of land agreed to be sold, the forfeiture clause would, for that reason, be also void and, therefore, the petitioner could not legally forfeit the amount and seek the enforcement of forfeiture clause, even by way of defence, in a suit instituted for Specific Performance by the respondent.

Supreme Court of India

Sri Tarsem Singh vs Sri Sukhminder Singh on 2 February, 1998

Bench: S. Saghir Ahmad, M. Jagannadha Rao
Citation: AIR1998SC1400, 1998(2)ALLMR(SC)528, 

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