Introduction 

• This is a landmark judgment relating to forfeiture of earnest money and the applicability of Section 74 of Indian Contract Act, 1872 to it. 
• The Judgment was delivered by a 3 judge bench consisting of Justice JC Shah, Justice V Ramaswami and Justice AN Grover.  

Facts 

• Maula Bux (plaintiff) entered into two contracts with the Government of India in 1947: 
  • Contract for supplying potatoes with a security deposit of Rs. 10,000. 
  • Contract for supplying poultry, eggs, and fish with a security deposit of Rs. 8,500. 
• The plaintiff persistently defaulted in supplying the agreed commodities regularly and fully. 
• The Government of India rescinded both contracts and forfeited the security deposits. 
• Maula Bux sued the Union of India seeking the return of Rs. 20,000 (the total security deposits) along with interest at 6% per annum. 
• The Trial Court held that although the Government was justified in rescinding the contracts, it could not forfeit the deposits as there was no proof of actual loss. The suit was decreed in favor of the plaintiff. 
• The High Court modified the decree, awarding Rs. 416.25 with 3% interest, reasoning that the forfeited deposits could be considered reasonable compensation despite the absence of evidence of actual loss. 
• Maula Bux appealed with special leave to the Supreme Court, challenging the High Court’s decision. 

Issues Involved  

• Whether the Government of India in this case can forfeit the amount of deposit? 

Observation  

• The Court in this case cited the case of Fateh Chand v. Balkishan Dass (1964) wherein it was held that in all cases where there is a stipulation in the nature of penalty for forfeiture of amount deposited in terms of the agreement, the Court has jurisdiction only to award the sum which is reasonable and does not exceed the amount specified that is liable to be forfeited. 
• The Court held in this case that forfeiture of earnest money if reasonable does not fall within Section 74 of Indian Contract Act, 1872 (ICA). 
• However, if the forfeiture is in the nature of penalty, Section 74 of ICA will apply. 
• The Court further observed that where the party in breach has undertaken to pay a sum of money or to forfeit a sum of money which he has already paid to the party complaining of a breach the undertaking is of the nature of penalty. 
• Further, with regard to compensation that can be awarded the Court observed that: 
  • In case of a breach in some cases it may be impossible for the Court to assess the compensation from breach, whereas in other cases it may be calculated in accordance with established rules. 
  • Where the Court is unable to assess the compensation, the sum named by the parties if it be regarded as a genuine preestimate may be taken into consideration as the measure of reasonable compensation, but not if the sum named is in the nature of a penalty. 
  • Where loss in terms of money can be determined, the party claiming compensation must prove the loss suffered by him. 
• The Court held that in the present case the Government of India could have comfortably proved the rates at which the commodities were later bought by the Government. However, the evidence for the same was not led by the Government of India. 
• The Court finally held that plaintiff was guilty of breach of contract and considerable inconvenience was caused to the military authorities due to that. 
• Hence, the Court held that the fairest order is that each party bear it’s own cost. 

Conclusion 

• This is the landmark judgment which lays an important principle that if the forfeiture of earnest money is reasonable it will not fall under Section 74 of the ICA.