Godrej Projects: Did the SC Miss to State Something – on Forfeiture of Earnest Money?

Saji Koduvath, Advocate, Kottayam.

Abstract

  • Sec. 74 lays down two (enforceable) classes –
    • 1. a sum named (or fixed or pre-estimated) as damages to be paid in case of breach; and,
    • 2. any other stipulation by way of penalty.
  • Three restraints are discussed in Section 74.  
    • 1. A ‘reasonable compensation’ alone will be entitled to by the claimant.
    • 2. The claimant is entitled compensation, ‘whether or not actual damage or loss is proved’.
    • 3. It must be reasonable compensation ‘not exceeding the amount so named’.
  • The following (apparently antithetical) words in this Section  (ex-facie, out of ‘ill-drafting’) Triggered Controversies.
    • (1) “reasonable compensation”
    • (2) ‘whether or not actual damage or loss is proved’ and
    • (3) “not exceeding the amount so named”.
  • The following are the divergent views –
    • 1. Earnest money (nominal sum , e. g. a shilling) can be forfeited but in dealing with the rest of the amount which was not admittedly earnest money Section 74 shall apply (Maula Bux v. Union of India, AIR 1970 SC 1955; 1969-2 SCC 554).
    • 2. The court has to adjudge in every case reasonable compensation. Because, liability for damages is a matter for the civil court, and a party to an agreement cannot be an arbiter in its own cause (Union of India v. Raman Iron Foundry, AIR 1974 SC 1265: (1974) 2 SCC 231).
    • 3. Earnest sum (i.e. pre-estimated damages) can be forfeited directly, if breach from other side (Satish Batra v. Sudhir Rawal, (2013) 1 SCC 345).
    • 4. If breach alleged by a party is DENIED by the other, adjudication (is) necessary. If breach is admitted, injured party can forfeit, without aid of court (State of Karnataka v. Rameswara Rice Mill, (1987) 2 SCC 160).
    • 5. Onus to prove that the same was ‘penal’ in nature squarely lies on the party seeking refund of the same. Failure to discharge such burden would treat any pre-estimated amount stipulated in the contract as a ‘genuine pre-estimate of loss’ (ONGC Ltd. v. Saw Pipes Ltd., (2003) 5 SCC 705).

Part I

Legal Background of Godrej Projects Development Limited v. Anil Karlekar (2025 INSC 143, Feb. 3, 2025)

What is Earnest-Money?

In law of contracts, earnest-money is the amount paid as advance in sale of a property and forms part of the purchase price when the transaction goes forward; and liable to be forfeited by the seller, in case the sale is failed owing to the fault of the purchaser (Shree Hanuman Cotton Mills v. Tata Aircraft Limited, 1970 (3) SCR 127).

In Maula Bux v. Union of India, AIR 1970 SC 1955; 1969-2 SCC 554, it is shown that the earnest money is a ‘nominal sum’. It is stated as under:

  • “According to Earl Jowitt in “The Dictionary of English Law” at P 689: “Giving an earnest or earnest-money is a mode of signifying assent to a contract of sale or the like by giving to the vendor a nominal sum (e. g. a shilling) as a token that the parties are in earnest or have made up their minds.”

In Authorised Officer, Central Bank of India v. Shanmugavelu, AIR 2024 SC 962; 2024-6 SCC 641, it is pointed out as under:

  • “83. The difference between an earnest or deposit and an advance part payment of price is now well established in law. Earnest is something given by the Promisee to the Promisor to mark the conclusiveness of the contract. This is quite apart from the price. It may also avail as a part payment if the contract goes through. …. Earnest need not be money but may be some gift or token given. It denotes a thing of value usually a coin of the realm given by the Promisor to indicate that the bargain is concluded between them and as tangible proof that he means business. Vide Howe vs. Smith, (1884) 27 Ch.D. 89.”

Section 74 of the Indian Contract Act holds the field.

Sec. 74 Says as to ‘Reasonable Compensation’

A genuine ‘pre-estimated damages’ (on breach) had been accepted in law of contracts, under the English Common Law. But, a penalty had not been enforced by common law courts, as it was a stipulation in terrorem.

Sec. 74 mandates that the contractual terms as to damages, should subserve the edicts under this Section.

Section 74 of the Indian Contract Act reads as under:

  • S. 74: “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.”

Section 74 lays down two (enforceable) classes –

  • 1. a sum named (or fixed or pre-estimated) as damages to be paid in case of breach; and,
  • 2. any other stipulation by way of penalty.

Three restraints are discussed in Section 74.

  • 1. A ‘reasonable compensation’ alone will be entitled to by the claimant.
  • 2. The claimant is entitled compensation, ‘whether or not actual damage or loss is proved’.
  • 3. It must be reasonable compensation ‘not exceeding the amount so named’.

The following (apparently antithetical) words in this Section Triggered Controversies..

  • (1) “reasonable compensation”
  • (2) ‘whether or not actual damage or loss is proved’ and
  • (3) “not exceeding the amount so named”.

Two points of Disputes on Application of Sec. 74

They are:

  • 1. Whether Adjudication of court necessary for fixing damages (even if ‘breach’ admitted)?
  • 2. Whether the pre-estimated damages can be forfeited (by the party concerned) in case ‘breach’ is ‘admitted’ by the other party?

First View – Earnest (Nominal) can be Forfeited; Rest Not

Maula Bux (1987) and Fateh Chand (1970) – Two Earlier Decisions on Earnest Money

In Fateh Chand v. Balkishan Das AIR 1963 SC 1405, the Constitution Bench of out Apex Court observed as under:

  • “11. …. In all cases, therefore, where there is a stipulation in the nature of penalty for forfeiture of an amount deposited pursuant to the terms of contract which expressly provides for forfeiture, the court has jurisdiction to award such sum only as it considers reasonable, but not exceeding the amount specified in the contract as liable to forfeiture….
  • 15. …. The section does not confer a special benefit upon any party; it merely declares the law that notwithstanding any term in the contract predetermining 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 court has to adjudge in every case reasonable compensation to which the plaintiff is entitled from the defendant on breach of the contract. …..”

Gujrat High Court (MB Shah, J.) in State of Gujarat v. Mohanlal Motilal and Company, 1987-1 GLH 447, analysed Maula Bux v. Union of India, AIR 1970 SC 1955, and Fateh Chand v. Balkishan Das AIR 1963 SC 1405, and said as under:

  • “The Supreme Court (Maula Bux v. Union of India, AIR 1970 SC 1955) also considered the decision in Fateh Chand v. Balkishan Das AIR 1963 SC 1405 and held that the said decision recognised a principle that earnest money can be forfeited but in dealing with the rest of the amount which was not admittedly earnest money Section 74 shall apply.”
  • (But, note: Sec. 74 covers – “if a sum is named in the contract as the amount to be paid in case of such breach” (whereby, earnest is also covered by Sec. 74). It is the reason that these rulings are not consistently followed.)

Second View Damages, Only After Adjudication

Liability for damages is a matter for the civil court, and a party to an agreement cannot be an arbiter in its own cause. This proposition is followed in the following cases:

  • Bharat Sanchar Nigam Ltd. v. Motorola India Pvt. Ltd., AIR 2009 SC 357: 2009 2 SCC 337;
  • Rambal Co. v. Kerala State Science & Technology Museum, 2000 (3) Arb. LR 212;
  • Union of India v. Raman Iron Foundry, AIR 1974 SC 1265: (1974) 2 SCC 231.
  • Mohammed Kunhi v. Executive Engineer, 2001(3) KLT 733;
  • Union of India v. Tejinder Kumar Dua, 2013-200 DLT 60;
  • Tulsi Narayan Garg v. Madhya Pradesh Road Development Authority, Bhopal, 2019 SCC OnLine SC 1158.
  • Latheef v. Superintending Engineer, ILR 1993(2) Ker 426;
  • Abdul Rahiman v. Divisional Forest Officer, AIR 1989 Ker 1;

SThird View – Earnest Sum Can be Forfeited Directly, if Breach From Other Side

It is the view in Satish Batra v. Sudhir Rawal, (2013) 1 SCC 345.

Fourth View – If Breach Admitted (otherwise, not), Injured Party can Forfeit, Without aid of Court

Where a sum is named in the contract as the amount to be paid in case of breach, and the breach is admitted (or not disputed) the injured party can forfeit (by himself); and need not seek the aid of court.

  • State of Karnataka v. Rameswara Rice Mill, (1987) 2 SCC 160
  • Kaikkara Construction Company v. State Of Kerala, (2022) 1 Ker HC 541
  • Abdul Rahiman v. Divisional Forest Officer, 1988 (2) Ker LT 290

In other words, if breach alleged by a party is DENIED by the other, adjudication (is) necessary.

  • State of Kerala v M.K. Jose, (2015) 9 SCC 433,
  • JG Engineers Private Limited v. Union of India, AIR 2011 SC 2477: (2011) 5 SCC 758,
  • State of Karnataka v. Rameshwara Rice Mills, Thirthahalli, AIR 1987 SC 1359,
  • Build Tech India Ltd. v. State of Kerala, 2000 (2) Ker LJ 142 (breach – not admitted).

Fifth View – Onus to Prove ‘Penal’ lies on the Party Seeking Refund

Referring ONGC Ltd. v. Saw Pipes Ltd., (2003) 5 SCC 705, it is held in Desh Raj v. Rohtash Singh, 2023 AIR SC 163; 2023-3 SCC 714, as under:

  • “35. …. Hence, in a scenario where the contractual terms clearly provide the factum of the pre estimate amount being in the nature of ‘earnest money’, the onus to prove that the same was ‘penal’ in nature squarely lies on the party seeking refund of the same. Failure to discharge such burden would treat any pre-estimated amount stipulated in the contract as a ‘genuine pre-estimate of loss’.”

Two Divergent Decisions Holds the Field- Satish Batra (2013) and Kailash Nath (2015)

The divergent views are the following –

  • 1. The words ‘whether or not actual damage or loss is proved’ are to be given effect. Thereby, the entire “earnest” money could be forfeited by seller, of his own, in case the buyer breaches the contract. 
  • 2. The implication of the word ‘reasonable’ is that the compensation is a matter always left to be determined by the appropriate court of law or other legal forum. Even if the parties to the contract have pre-estimated the damages, the injured party cannot appropriate the pre-estimated damages, of his own and the reasonable compensation or damages was always subject to,or depended upon, the judicial determination.

Injured party can appropriate the pre-estimated damages, of his own

It is held in Satish Batra v. Sudhir Rawal (2013 (1) SCC 345) as under:

  • “15. The 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 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.
  • 16. When we examine the clauses in the instant case, 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. There is no other clause that militates against the clauses extracted in the agreement dated 29-11-2011.
  • 17. We are, therefore, of the view that the seller was justified in forfeiting the amount of Rs 7,00,000 as per the relevant clause, since the earnest money was primarily a security for the due performance of the agreement and, consequently, the seller is entitled to forfeit the entire deposit. The High Court has, therefore, committed an error in reversing the judgment of the trial court.”

Kailash Nath v. DD Authority, (2015) 4 SCC 136) took an Opposite View

In Kailash Nath (2015), the Supreme Court categorically held in para 43 as under:

  • “43. On a conspectus of the above authorities, the law on compensation for breach of contract under Section 74 can be stated to be as follows:-
  • Where a sum is named in a contract as a liquidated amount payable by way of damages, the party complaining of a breach can receive as reasonable compensation such liquidated amount only if it is a genuine pre-estimate of damages fixed by both parties and found to be such by the Court. In other cases, where a sum is named in a contract as a liquidated amount payable by way of damages, only reasonable compensation can be awarded not exceeding the amount so stated. Similarly, in cases where the amount fixed is in the nature of penalty, only reasonable compensation can be awarded not exceeding the penalty so stated. In both cases, the liquidated amount or penalty is the upper limit beyond which the Court cannot grant reasonable compensation.
  • Reasonable compensation will be fixed on well known principles that are applicable to the law of contract, which are to be found inter alia in Section 73 of the Contract Act.
  • Since Section 74 awards reasonable compensation for damage or loss caused by a breach of contract, damage or loss caused is a sine qua non for the applicability of the Section.
  • The Section applies whether a person is a plaintiff or a defendant in a suit.
  • The sum spoken of may already be paid or be payable in future.
  • The expression “whether or not actual damage or loss is proved to have been caused thereby” means that where it is possible to prove actual damage or loss, such proof is not dispensed with. It is only in cases where damage or loss is difficult or impossible to prove that the liquidated amount named in the contract, if a genuine pre-estimate of damage or loss, can be awarded.
  • Section 74 will apply to cases of forfeiture of earnest money under a contract. Where, however, forfeiture takes place under the terms and conditions of a public auction before agreement is reached, Section 74 would have no application.”

In Satish Batra v. Sudhir Rawal (2013 (1) SCC 345) our Apex Court had (first) taken an extreme-view that the claimant can enforce the compensation clause  ‘of his own’ and it could be forfeited.  In Kailash Nath v. Delhi Development Authority, (2015) 4 SCC 136, the Supreme Court took the (second)  extreme-view  that no amount, even a nominal sum, could be forfeited as earnest money by the seller ‘of his own’ ; he has to approach the civil court.

(Note: It had already been pointed out that that the acceptable legal position lies midway between the two differing views.)

Part II

Godrej Projects Development Limited v. Anil Karlekar

At the outset it may be pointed out – the aforestated controversy remains unanswered by this decision also. And it may be added – without addressing the controversy the Apex Court applied both principles (laid down in both the cases Satish Batra v. Sudhir Rawal and   Kailash Nath v. Delhi Development Authority) without analysing and deciphering the principles thereto.

Facts in Brief

  • It is a case from National Consumer Disputes Redressal Commission.
  • The Complainant before the Consumer Commission had booked an apartment in the opposite-party, (Godrej) Projects.
  • He paid Rs. 51,12,310/-. An Agreement was entered into between the parties.
  • It was stipulated that 20% of the Basic Sale Price (BSP) would be ‘earnest money’.
  • It could be forfeited in case of fault by the buyer.
  • Godrej thereafter gave/offered possession to the Complainant.
  • The Complainant refused to take possession.

The Supreme Court stated as regards the conduct of the Opposite Party as under:

  • “It is thus clear that the Respondents had cancelled the deal since there was recession in the market. Not only that, but the NCDRC has specifically observed as under:
  • “Hence, the action of the OPs in cancelling the apartment and forfeiting the amount as per terms and conditions of the application form and/or the BBA cannot be faulted with. However, the condition of forfeiture of 20% of BSP, being the earnest money liable for forfeiture in case of cancellation appears unreasonable. It will be in the interest of  justice and fair play to both sides, if OPs are allowed to deduct only 10% of the BSP as earnest money i.e. Rs.17,08,140/- and refund the balance amount to the complainants.”

Courts Can Strike Down Unfair And Unreasonable Contracts

The Supreme Court referred to Central Inland Water Transport Corporation Limited and Another vs Brojo Nath Ganguly (AIR 1986 SC 1571, 1986 (3) SCC 156). It held that courts can strike down unfair and unreasonable contracts, especially when parties have unequal bargaining power.

The Court also referred to Pioneer Urban Land and Infrastructure Limited v. Govindan Raghavan, where similar one-sided clauses in an agreement were considered as an “unfair trade practice”.

The Court emphasized that forfeiture of earnest money should not be a penalty, and if it is disproportionate, then Section 74 of the Indian Contract Act, 1872 would be applicable. 

The Apex Court distinguished Satish Batra v. Sudhir Rawal

The Apex Court distinguished Satish Batra v. Sudhir Rawal and Desh Raj v. Rohtash Singh. In these cases, forfeiture of earnest money was upheld on the finding that the contracts were not ‘one-sided’ (and here, it is otherwise). 

The Apex Court (in Godrej Projects Development Limited) extracted Paras 15, 16 and 17 (quoted above) of Satish Batra and said as under:

  •  “19. This Court has held that to justify the forfeiture of advance money being part of “earnest money” the terms of the contract should be clear and explicit. It has been observed that the 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. However, this Court clarified that if the payment is made only towards part-payment of consideration and not intended as earnest money then the forfeiture clause will not apply.”

Apex Court Did Not Discern the “Extreme-Views”

From the above, it is clear that the Apex Court rushed without discerning the aforementioned “extreme-views“ as regards forfeiture by “ones own”.

The Opposite Party Godrej approached the Supreme Court claiming that the NCDRC had no reason to interfere with the terms of the contract which provided for forfeiture of 20% as earnest money. NCDRC Ordered to deduct 10% cancellation charges of the BSP (not 20% – obviously applying “reasonable” compensation), and to return the balance with 6% interest. It is definite – application of the doctrine of “reasonable” compensation (in this juncture) is the application of the principles in Kailash Nath.

The Apex Court observed as under:

  • “38. It can be seen that this Court has held that if the forfeiture of earnest money under a contract is reasonable, then it does not fall within Section 74 of the Indian Contract Act, 1872, inasmuch as, such a forfeiture does not amount to imposing a penalty. It has further been held that, however, if the forfeiture is of the nature of penalty, then Section 74 would be applicable. This Court has further held that under the terms of the contract, if the party in breach undertook to pay a sum of money or to forfeit a sum of money which he had already paid to the party complaining of a breach of contract, the undertaking is of the nature of a penalty.”

The Supreme Court pointed out that under the Agreement, Godrej was entitled to forfeit the entire earnest money upon termination of the agreement for non-payment by the buyer. And that the NCDRC had rightly held that the Appellant was entitled to cancel the apartment and “forfeit” the amount. It appears that the NCDRC and the Apex Court proceeded (in this juncture) on the ‘principles’ in Satish Batra.

The Apex Court also looked into the “reasonableness” of the provision for compensation/ forfeiture on another independent aspect (actually it related to Sec. 23 Contract Act – says as to void nature of the contract. See: Central Inland Water Transport Corporation Limited v. Brojo Nath Ganguly, (1986) 3 SCC 156). Looking into the corresponding obligation of the developer the Court found – under the agreement, the compensation payable to the buyer in case of delay in giving possession by the developer was only meagre. Thus the agreement was one-sided.  And it was found that of forfeiture of 20% of the BSP was not ‘reasonable’ and requires reduction to 10% of the BSP. The NCDRC and the Apex Court proceeded (in this juncture) on the principles in Kailash Nath.

The Court said it as under:

  • “39. Relying on the aforesaid observations of this Court, the NCDRC, in a series of cases right from the year 2015, has held that 10% of the BSP is a reasonable amount which is liable to be forfeited as earnest money. The NCDRC has initially taken this view in the case of DLF Ltd. v. Bhagwanti Narula (supra). The said view has been followed subsequently in various judgments of the NCDRC. We see no reason to upset the view consistently taken by the NCDRC based on the judgment of this Court in the case of Maula Bux (supra).”

The Apex Court further found that the NCDRC was not justified in awarding interest on the amount to be refunded.

Conclusion

It is a simple thing – the entire difficulties have arisen out of the ‘ill-drafting’ (of Sec. 74).

As stated above, in Satish Batra v. Sudhir Rawal (2013) our Apex Court had taken an extreme-view that the claimant could enforce the compensation clause  ‘of his own’ and it could be forfeited.  In Kailash Nath v. Delhi Development Authority (2015), the Supreme Court took the (opposite) extreme-view  that no amount – even a nominal sum – could be forfeited as earnest money by the seller ‘of his own’ ; he has to approach the civil court. When one considers these matters, it stands as an “elementary” and fundamental thing that requires resolution.

The Apex Court has to consider, in a proper case, the various aspects of this matter and lay down a settled principle. Or, the Parliament has to do the needful.

Tail Piece: Who will bell the cat? How much longer must we endure this ‘volatile’ situation – leaving it to the sweet will of the courts (on this “elementary” matter)?

How to Subscribe ‘IndianLawLive’? Click here – “How to Subscribe free “

Read in this cluster (Click on the topic):

Civil Suits: Procedure & Principles

Book No, 1 – Civil Procedure Code

Principles and Procedure

PROPERTY LAW

Title, ownership and Possession

Adverse Possession

Land Laws/ Transfer of Property Acta

Land Reform Laws

Power of attorney

Evidence Act – General

Sec. 65B

Admission, Relevancy and Proof

Law on Documents

Documents – Proof and Presumption

Interpretation

Contract Act

Law on Damages

Easement

Stamp Act & Registration

Divorce/Marriage

Negotiable Instruments Act

Arbitration

Will

Book No. 2: A Handbook on Constitutional Issues

Religious issues

Book No. 3: Common Law of CLUBS and SOCIETIES in India

Book No. 4: Common Law of TRUSTS in India

Unknown's avatar

Published by sajikoduvath

Leave a Comment