Liquidated damages in a contract

By admin Nov24,2023

This article is written by Naincy Mishra. The article discusses the meaning and importance of liquidated damages in contracts and some of the famous judicial pronouncements related to it. 

It has been published by Rachit Garg.

In every contractual agreement, there exists a presumption that the parties to the contract will fulfil their part of the duties and obligations mentioned in the contract. In fact, Section 37 of the Indian Contract Act, 1872 (hereinafter referred to as the “Act”) also mentions that the parties to a contract must perform/offer to perform their respective promises, unless such performance is either dispensed with or excused under the provisions of the Act, or of any other law. However, this is not the case every time. That is why there is a need for some recourse with the parties, which can be sued by them when there is a ‘breach’ of contract. 

A breach is nowhere defined in the Act, but as per Section 39, the promisee may put an end to the contract when another party to such contract has refused to perform/has disabled himself from performing his promise in its entirety. But the story doesn’t end here. Many times, due to such non-performance/breach of contract by a party, the other party might suffer damages arising in due course of time, and thus, the Act also provides for ‘compensation’ for loss or damage to the party complaining of the breach. 

The term damages means a form of monetary compensation caused due to a breach, loss, or injury [Common Cause v. Union of India (1999) 6 SCC 667]. Importantly, it must not be confused with the word ‘damage’, which simply means a loss or injury for which a compensation is sought. In the Contract Act, the word ‘compensation’ has been used to refer to damages, and it is provided in the context of ‘liquidated’ as well as ‘unliquidated’ damages. Damages can be of following types:-

  • General Damages – arose in the normal course of events
  • Special Damages – arose under situations that were reasonably anticipated by the contracting parties while they were entering into the concerned contract. Specific proof of such damage is mandatory to be established in this case
  • Nominal Damages – granted in a case where the party has not suffered actual or substantial loss or even if it has, it can’t be calculated with mathematical accuracy
  • Substantial Damages – involves considerable amount of money for the breach of contract 
  • Speculative Damages – damages that are definitely attributable to the wrong but are uncertain in respect of their amount
  • Aggravated Damages – where the loss incurred by the plaintiff are aggravated due to the mala fide conduct of the other party
  • Liquidated and Unliquidated Damages – While the above types of damages can be understood under general classifications, the damages that have been used in the Act are categorised as ‘Liquidated’ and ‘Unliquidated’ damages which will be discussed in detail hereunder. 

In a contract, when there are stipulations relating to the payment of a certain amount in case of breach of the contract, it is called liquidated damages. Under Black’s Law Dictionary, the clause of liquidated damages is defined as “a contractual provision that ascertains in advance the measure of damages in case a party breaches the agreement.” These stipulations are those terms of the contract that deal with certain circumstances that would be deemed a breach by the parties. 

For example, non-performance due to delay, discrepancy in certain quality or quantity standards, etc. Compensation to be given becomes easy in contracts involving these damages as the amount is already ascertained by the parties mutually during the formation of the contract. 

Section 74 of the Indian Contract Act

Section 74 of the Indian Contracts Act deals with liquidated damages. As per this rule, when a sum is named in a contract payable in case of its breach, regardless of the fact whether it is a penalty or not, the aggrieved party thereby suffering from the breach is entitled to receive reasonable compensation that must not exceed the amount so mentioned in the contract. Thus, the sum constitutes the maximum limit of liability. It can be understood by looking at some illustrations below.

Illustration 1: A contracts with B that if he fails to pay B Rs. 500 on a given day, he will pay B Rs. 2000. A fails to pay B Rs. 500 on such a day. Thus, B is entitled to recover from A a compensation not exceeding Rs. 2000, as the Court would consider reasonable. 

Illustration 2: X contracts with Y to pay Rs 3000 if X practises as a surgeon within Calcutta. X practises as a surgeon in Calcutta. Y is entitled to such compensation, not exceeding Rs. 3000, as the Court would consider reasonable.

Exception to Section 74 of the Indian Contract Act

Section 74 of the Act also mentions an exception to the provision as per which if a party concludes a contract (which includes  any bail-bond, recognizance, or other instrument of the same nature) with the State or Central Government under any law or order of such government to carry out an act in the interest of the general public, then a breach of such a contract or instrument makes the party responsible for paying the entire amount as specified in the contract.

When the stipulated amount is more than actual damage 

When the stipulated amount of compensation is more than the loss/damage occurred to the aggrieved party, the issue arises as to whether such an amount is reasonable or enforceable. In Fateh Chand v. Balkishan Das, AIR 1963 SC 1405, the Apex Court, while discussing the meaning of liquidated damages, stated that if a genuine pre-estimate of damages is made by the contracting parties at the time of entering into a contract and the stipulated amount is not extravagant or unconscionable, then it would be considered valid and enforceable as liquidated damages. This is because a significantly higher stipulated amount than the actual damage caused could indicate that the clause is operating as a penalty rather than a means of compensation.

Explanation to Section 74 states that a stipulation in the contract for an increased interest from the date of the default may be a stipulation by way of penalty. In such a case, the court might refuse to enforce the clause as mentioned in the contract. 

In case the stipulated amount of compensation is more than the loss/damage occurred to the aggrieved party, the concept of waiver or forfeiture might come into existence. In Chuni Lal Mehta & Sons v. Century Spinning and Manufacturing Co., AIR 1962 SC 1314, it was observed that where the parties to the contract have deliberately specified the amount of liquidated damages, there can’t be a presumption that simultaneously, they intended to allow the plaintiff to give a go-by to the sum so specified and claim instead an amount that was not ascertained/ascertainable at the date of the breach.

Calculation of liquidated damages

Mere presence of a clause of liquidated damages and pre-determined sum to be awarded doesn’t actually make the story easy. The court also takes into consideration factors such as reasonability of the sum, mitigation of losses, and other facts and circumstances in order  to compensate the aggrieved party adequately as he would have been in the case of performance of the contract and not to put him in any profitable position as a result of breach of the contract.

In order to claim liquidated damages, the following conditions need to be fulfilled:- 

Existence of a valid contract

The first and foremost condition is that there must be a valid contract between the parties concerned. A valid contract is one where there is free consent of the parties and involves valid consideration. Basically, the contract must fulfil all the conditions of a valid contract under the Indian Contract Act 1872, i.e., valid offer and acceptance, competent parties, intention of the parties to create a legal obligation, valid consideration, lawful object, etc. 

Breach of contract

Secondly, the contract must be breached by any of the contracting parties. This  essentially means that there must be contravention of any terms of the contract. In other words, if there is no breach, there cannot be any argument for damages. Moreover, the plaintiff does not need to show that actual damage has been caused to him due to the breach. However, the court surely takes into consideration the degree of loss/damage suffered in certain cases. 

In Maula Bux v. Union of India (1969) 2 SCC 554, the Hon’ble Apex Court held that where the court is unable to assess the compensation to be given, the sum named by the contracting parties may be taken into consideration as the measure of reasonable compensation if it is regarded as a genuine pre-estimate, but not if the sum so named is in the nature of a penalty. Where the loss in terms of money can be ascertained, the party claiming compensation must prove the loss suffered by him. In State of Kerala v. M/s United Shippers and Dredgers Ltd., AIR 1982 Ker, it was held that there cannot be an award of any compensation if there is no legal injury to the party.

Clause of Liquidated Damages

Such a breach must be mentioned in the contract and secured against a stipulated amount of compensation. 

Reasonable relationship with the Actual Damage

The compensation sought through the clause of liquidated damages must be reasonable to make it enforceable. Unconscionable and extravagant agreements are generally struck down by the courts. The courts thus have the discretion to reduce the amount of damages to what appears to be reasonable in the circumstances. In Kailash Nath v. Delhi Development Authority (2015) 4 SCC 136, the Apex Court ruled that the plaintiff can recover the damages only to the extent of the claim being reasonable compensation for the damage caused to him, and he cannot claim the entire sum laid down as liquidated damages in the contract. As per Section 74, the amount mentioned as liquidated damages reflects the upper limit beyond which the party can’t claim damages. 

In ONGC v. Saw Pipes Ltd. (2003), the Supreme Court held that if there is no proof or an honest estimate by the claimant (party seeking damages), the court must award compensation that is less than the stipulated liquidated damages in the contract, and it must be based on a reasonable assessment of the consequences of the breach of such a contract.

It must be noted that in Indian law, unlike English law, the court does not reject the amount if it appears unreasonably high. It may either accept it or reduce it to what appears reasonable. 

As stated in the provision itself, “whether or not actual damage or loss is proved to have been caused” due to the breach of contract is not necessary. Therefore, generally, the plaintiff does not need to show that actual damage has been caused in the scenario for him to seek damages. But the damages sought must not be exorbitant or unreasonably high by taking advantage of the ‘upper limit’ as stipulated in the contract. In that case, it would be treated as a penalty, and the court shall assess the extent of the loss/damage caused to the aggrieved party and shall award a reasonable compensation to it, as held in Fateh Chand’s case (supra). In this case, it was said that giving compensation is to make good the loss, and thus, there can be no compensation when there is no loss. Thus, while showing that there has been some loss due to breach would be a prerequisite to claiming damages, it is not necessary to prove the extent of it strictly. 

Liquidated damages where no loss is caused or loss is not proven

As already stated, where there is no loss or injury, there cannot be a question of damages. Thus, while the court has stated in Fateh Chand and Maula Bux that the aggrieved party would be awarded some reasonable damages owing to the breach of contract even if actual loss was not proven, he surely has to show that there has been some loss or injury incurred to him due to such a breach. In Union of India v. Motor & General Sales Ltd. (2019), there was a delay in providing delivery of certain goods, and the issue involved was whether such a delay in the performance of a promise would attract the provisions of Section 74 of the Act. The Bombay High Court in this case refused to give any reasonable compensation to the claimant as they were unable to “prove” the loss incurred by them.
In Haryana Telecom Ltd. v. Union of India AIR 2006 Delhi 339, when the contractor delayed in supplying the cables and the Government had to procure the same from other sources but ultimately got it at cheaper rates, it was held by the Delhi High Court that there can be no damages for breach as there was no loss caused.

The following advantages can be laid down for having a clause for liquidated damages in a contract:-

  • Ensures transparency and certainty 

In every contract, the most important thing is to ensure transparency between the parties in order to make them clearly aware of their part of the obligations to be fulfilled as well as to prevent any future conflicts. By mutually deciding the events of breach and the specified amount to be compensated in such a case, the certainty increases with respect to the same and, hence, saves the time of the parties as well as the courts.

  • Security of the plaintiff against a breach 

By laying down the situations that the parties can reasonably foresee and ensuring that they are secured for any loss or injury that occurs to them in case of non-performance of the contract as decided, the importance of stipulating liquidated damages becomes all the more important in the contractual transactions. 

  • Promotes fulfilment of obligations under the contract 

The clause of liquidated damages will promote the fulfilment of the mutual obligations of the contracting parties as it increases their accountability. This would cast a mandatory and deterrent effect on the parties against non-fulfillment/performance of their obligations. 

  • Protects defendant against any arbitrary claims for a breach of contract 

This not only helps the parties make a genuine and reasonable claim that the other party cannot refuse, but it also assists the court in determining the claims when a case is instituted before it. Moreover, since it signifies the upper limit within which the court can grant reasonable compensation, it also protects the defendant from any arbitrary claim by the plaintiff in order to gain undue advantage of the clause. 

Forfeiture of earnest money 

The term forfeiture generally means loss or giving up something as a penalty for wrongdoing. In the contractual agreements, parties usually set up a clause regarding forfeiture of the money (for example, earnest money in the case of sale deeds or security amounts in other cases) if the contract is broken in the future due to their fault or failure. The amount involved is the money paid to confirm the contract. The courts in India upheld the validity of such a forfeiture in cases of failure to perform the party’s obligations. For example, due to a delay in the completion of the work, as in the case of Mountain Movers v. State of HP (2008).

In Fateh Chand, the court observed that the expression “contract containing any other stipulation by way of penalty” is comprehensively applicable to every covenant involving a penalty, irrespective of whether it is for payment on breach of contract of money/delivery of property in the future or for a forfeiture of the right to money/other property already delivered. Therefore, in all the cases where there is a stipulation in the nature of a penalty for forfeiture of an amount deposited pursuant to the terms of the contract, the court has jurisdiction to award such a sum only as it considers reasonable, but it must not exceed the amount specified in the contract as liable to be forfeited.

Other relevant cases in this respect

1. When the contract is frustrated 

As per Section 56 of the Act, if the party knows or is likely to know with reasonable diligence that the act (to be performed under the contract) per se is impossible or unlawful to be done, then such a contract becomes void and the aggrieved party cannot, for the non-performance of such an act, seek damages/forfeiture of any advance paid from the other party. In Thiriveedhi Channaiah v. Gudipudi Venkata Subba Rao, AIR 2007 SC 2439, it was held that since the performance of the agreement had become impossible, the forfeiture of the advance paid would be improper. In this case, the deed of sale of land could not be completed due to a government notification for the acquisition of the said land.

2. Existence of force majeure event

Force majeure is an event that is outside human control and thus relieves the parties from performing their respective obligations under the contract. The Indian Contracts Act doesn’t explicitly mention the term ‘force majeure’ but it is implicit in Section 32 of the Act, as per which, if an uncertain event becomes impossible, the contract contingent on such an event becomes void. Thus, damages cannot be given in cases involving force majeure because the breach due to non-performance is outside the control of the parties. However, such should not become an easy excuse for the parties, as was seen often during COVID times. In Standard Retail Pvt. Ltd. v. M/s G. S. Global Corp. & Ors. (2020), it was held that mere hardship to perform obligations of the contract cannot be covered under the definition of impossibility to avoid relief under the force majeure clause.

3. Waiver of the breach

In case of a breach of a contract, the aggrieved party has the option to affirm such breach and claim damages or to waive the breach and continue with the contract. If the party waives the breach, he loses his right to claim any damages, even if the clause for damages exists in the contract. In a recent judgement by the Supreme Court in Welspun Specialty Solutions Limited v. ONGC (2021), it was held that ONGC was not entitled to recover the liquidated damages as they had waived their imposition while granting the first two extensions.

4. Aggrieved party himself at fault

There may be circumstances in which the aggrieved party may himself be at fault for leading the other party to breach the contract. In such a case, it would be difficult to claim damages from the breaching party, as it was he who put the other party in such a position. 

While the damages are clearly stipulated in the contract in the case of liquidated damages, the court comes up with an ascertainment of the compensation in cases where there aren’t any stipulations relating to the damages for breach of contract, and this is known as ‘unliquidated damages’. Thus, the unliquidated damages would be considered to be given in two cases. First, when the parties have not mentioned any terms for compensation in case of breach of contract; and second, when there is breach of contract due to any unforeseen circumstances about which the parties might not have thought but the damages should definitely be provided. 

Section 73 of the Act deals with  unliquidated damages, wherein the amount for compensation is decided as such to make good the loss or damage naturally arising in the usual course of business or which the parties knew to be likely to result from a breach at the time of making the contract. Therefore, the damages are awarded by the courts based on an assessment of the injury/loss caused to the party against whom the breach has occurred.

Moreover, there is no need to show actual loss or damage caused in the case of liquidated damages, but on the other hand, the plaintiff must necessarily prove the loss due to the breach of contract in the case of unliquidated damages. Therefore, loss or damage is important here, and there must be a reasonable connection between the breach and the damage caused.

Serial No. Basis of Difference Liquidated Damages Unliquidated Damages
1. Provision  Governed by Section 74 of the Indian Contract Act, 1872. Governed by Section 73 of the Indian Contract Act, 1872.
2. Definition A pre-estimated amount of damages specified in the contract and payable in case of its breach. Damages that are determined by a court as compensation for actual losses suffered due to a breach.
3. Enforcement Can be enforced even if actual damage/loss has not occurred. However, the amount sought should be genuine and not exorbitant. Can be enforced only when actual losses are proved and on their basis 
4. Certainty Since it is already stipulated, it provides certainty about the compensation to be sought. Causes uncertainty as the estimates are not known 
5. Settlement Can be settled within the parties themselves, as the amount stipulated is already mutually decided between the parties. Might lead to legal proceedings, and the courts will ascertain the actual losses and appropriate compensation.
6. Examples Construction contracts, lease agreements, and commercial contracts etc. Applicable to various contracts where actual losses can be proven, such as sales of goods or services.

Section 74 of the Act also provides for a penalty to be received by the party who has suffered the loss/damage due to the breach of contract by the other party. While the liquidated damages are payable as a pre-ascertained amount of compensation for the loss, the penalty is generally disproportionate to or higher than the loss that could result from the breach of the contract. For example, A borrows from B Rs. 200 and gives him a bond for Rs. 500 payable in ten yearly instalments of Rs. 50, with the stipulation that the whole shall become due in default of payment of any instalment. This can be said as a stipulation by way of penalty. 

Another example can be given in the form of an explanation in the provision itself that a stipulation for increased interest from the date of default may be a stipulation by way of penalty. E.g., X gives Y a bond for the repayment of Rs. 2000 with interest at 15 per cent at the end of 10 months, with a stipulation that interest shall be payable at the rate of 70 percent in case of default from the date of such default. This is also a stipulation by way of a penalty, and Y is only entitled to recover from X such compensation as the Court would consider reasonable.

Discussing the difference between liquidated damages and a penalty, the Apex Court in BSNL v. Reliance Communication Ltd. (2011) 1 SCC 394 observed that to treat a provision of a contract as a penalty is a matter of construction, and it has to be resolved by asking whether the predominant contractual function of the provision, at the time of formation of the contract was to deter a party from breaking the contract or to compensate the innocent party for a breach. It can also be determined by considering the stipulated sum. That is, if it bears a reasonable correlation to anticipated loss, it would be construed as a liquidated damages clause and, if not, then as a penalty clause [M/s 3I Infotech Limited v. Tamil Nadu E-Government Agency, 2019 SCC Online Mad 33295]. Thus, the alleged penalty clause must pass muster as a genuine pre-estimate of loss.

The Court in Fateh Chand v. Balkishan Das, AIR 1963 SC 1405, has held that statutorily under Section 74, the duty of the courts is only to award reasonable compensation and not to enforce the penalty clause. The expression ‘stipulation by way of penalty’ used in the provision only applies where a sum is named as ‘penalty’ to be paid in the future for a breach,and not to cases where a sum is already paid and thus liable to be forfeited by a term in the contract. 

It can therefore be said that the question whether a particular stipulation shall operate as a penalty would be answered by the court while considering a variety of factors such as intent of the contracting parties, the character of the transaction concerned, consequential injury to the plaintiff, etc.

Serial No. Basis of Difference Liquidated Damages Penalty
1. Definition A pre-estimated amount of compensation specified in the contract and payable in case of its breach A kind of specified sum in the contract which acts as a punishment for a breach
2. Purpose To ascertain and compensate for actual losses suffered due to a breach of the contract To deter the other party from committing a breach by imposing a punitive cost.
3. Enforceability If they are genuine pre-estimates of damage, they are enforceable and held valid by the courts These are generally non-enforceable by the courts as they are considered punitive in character
4. Calculation of damages Generally, based on a reasonable estimate of the actual damages that are likely to occur from the breach Usually, the amount is arbitrary and is not based on a genuine estimate of damages
5. Modification of the amount by the court If the amount appears high and disproportionate to the actual damages caused, the court can reduce it The court would always avoid putting unreasonable penalties on the defaulting party, so requisite modifications are generally executed

Bharat Sanchar Nigam Ltd. v. Motorola India Ltd., 2009 (2) SCC 337 


In the case of Bharat Sanchar Nigam Ltd. v. Motorola India Ltd. (2009), parties entered into an agreement by way of bidding that included the terms for the payment and the schedule for delivery of the goods. It also provided for liquidated damages in the event of failure on the part of the respondent to meet the delivery schedule. Later, the appellant invoked the clause of liquidated damages due to a delay in the purchase of goods. 


Whether the liability of the respondent to pay the Liquidated Damages and the entitlement of the other party to collect the same from the respondent are excepted matters for the purposes of the concerned clause in the contract?


The Apex Court held that the question of holding a person liable for Liquidated Damages and the question of assessing the amount payable by way of Liquidated Damages are entirely different. While fixing the liability is primary, the quantification of the amount that is provided for is secondary. The court held that quantification of liquidated damages could be an exception, as argued by the appellant, but there has to be a delay in the first place for the levying of the liquidated damages. Therefore, it cannot be treated as an excepted matter because it does not provide for any adjudicatory process for a decision on a question, dispute, or difference, which is the condition precedent to the stage of quantification of the damages.

Sir Chuni Lal Mehta & Sons v. Century Spinning and Manufacturing Co., AIR 1962 SC 1314 


This case revolved around a contract for the sale of goods in a managing agency agreement wherein the respondent wrongfully terminated the agreement before the stipulated period could end, and therefore, the appellants filed a suit for the recovery of damages for a breach of contract based on the stipulated amount in the agreement. 


The issue was regarding the calculation and validity of damages for the breach of contract.


It was observed that where the contracting parties have knowingly specified the amount of liquidated damages in such a contract, there can’t be a presumption that, at the same time, they intended to allow the plaintiff to give a go-by to the sum specified and claim instead an amount that was not ascertained/ascertainable at the date of the breach. The court further stated that by providing for the compensation in express terms, the right to claim damages is necessarily excluded under the general law. Therefore, the seller’s claim for damages was held valid, and they were entitled to the difference between the contract price and the resale price as compensation for the buyer’s breach of contract.

Maula Bux v. Union of India (1969), 2 SCC 554


In this case, Maula Bux had entered into a contract with the Indian Government for the supply of certain goods and had deposited a certain amount of security for its due performance. It was stipulated in the contract that such an amount was to be forfeited if the appellant neglected to perform his part. Maula Bux defaulted on the supply. The government didn’t only rescind the contract but also forfeit the security deposit. 


Issue was related to the validity of such a forfeiture of the security deposit for due performance of the contract.


The Supreme Court pointed out that a case of forfeiture of earnest money was different from forfeiture of the security deposit for due performance of the contract and held that under Section 74, only a reasonable amount can be forfeited if a contract is not performed. But where, under the contractual terms, the party in breach has undertaken to pay an amount or to forfeit a sum of money that he has already paid to the party complaining of such a breach, the undertaking is in the nature of a penalty. Thus, performance of the contract could not be regarded as earnest money. 

Kailash Nath Associates v. Delhi Development Authority and Another (2015)


This case involved a public auction of land conducted by the DDA, wherein the highest bidder was required to pay a sum as earnest money, and such a sum was to be forfeited in case of default, breach, or non-compliance with any of the terms and conditions of the auction. The appellant, Kailash Naith, paid the earnest money and sought to extend the date for the rest of the payment, which was even granted, but later the land was auctioned. The appellant thus approached the Court to seek a refund of the earnest amount and the specific performance of such a contract.


Whether Section 74 of the Act can be applied to contracts demanding forfeiture of the earnest money upon a breach of the terms of the contract?


The Supreme Court held that where a contract incorporates provisions for liquidated damages, such an amount can be received in totality only if the amount of damages suffered by the aggrieved party is similar to the pre-established amount of damages. It was further observed that the compensation awarded by the court must not at any point exceed the amount mentioned in the contract in the form of liquidated damages. The court in this case held that there was no breach of contract on the appellant’s part, and thus no penalty can be imposed in order to forfeit the earnest amount under Section 74 of the Act. The law does not provide for a windfall in the case of a breach when there is no damage suffered by the parties to the contract.

In the dynamic landscape of modern business and commerce, where time and resources are of the essence, including a clause for liquidated damages contributes to the overall effectiveness of the contracts. The contracting parties can thus enter into agreements with greater confidence, knowing that the potential consequences of non-performance of the contractual obligations have been carefully contemplated and agreed upon. Such clauses promote transparency and ultimately foster trust between the parties.

However, it is important to understand the necessity of a clear and reasonable clause for  liquidated damages in the contract. The risk of such clauses being struck down or deemed unenforceable by the courts due to ambiguity or exorbitant fees further emphasises the need for thoughtful drafting. Legal practitioners and contract drafters therefore must necessarily be aware of the evolving jurisprudence relating to liquidated damages, ensuring that such clauses reflect not only the parties’ future intentions but also adhere to the legal parameters set forth by the statute and precedents.

Can I get damages for breach of contract by the other party?

Yes. Under the Contract Law (of any country), damages are provided for a breach committed by one of the contracting parties. This is done to make up the loss incurred by the aggrieved party. In the Indian Contract Act, damages can be sought under Sections 73 and 74.

Which section talks about liquidated damages in the Indian Contract Act?

Section 74 of the Act talks about liquidated damages in the Indian Contract Act of 1872.

Which section talks about unliquidated damages in the Indian Contract Act?

Section 73 of the Act talks about unliquidated damages in the Indian Contract Act of 1872.

Are damages and indemnity the same things?

No. While damages can be claimed for the actions of the parties to the contract, indemnity can be claimed for the actions of the third party even if the contract is not breached. 

Are liquidated damages and penalties the same things?

No. Liquidated damages are a genuine pre-estimate of loss incurred due to breach of contract, but penalties are generally disproportionate to the loss incurred. 

Is it mandatory to include a clause for liquidated damages in a contract?

No. It’s totally at the discretion of the parties to include such a clause in the contract. However, it is definitely recommended to have the clause in order to avoid future conflicts in case of breach of the contract and to easily make a claim and get compensation for the same.

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