Can earnest money be forfeited without proof of loss? Section 74 after Kailash Nath

The Statutory Question

On 9 January 2015 the Supreme Court of India ordered the Delhi Development Authority to refund Rs 78,00,000 it had forfeited as earnest money on Plot No. 2-A, Bhikaji Cama Place, New Delhi. That sum was 25 per cent of a winning bid of Rs 3.12 crore made in 1982. By the time the dispute reached the Court, the DDA had re-auctioned the same plot for Rs 11.78 crore. The judgement in M/S Kailash Nath Associates v Delhi Development Authority, delivered by Justice R.F. Nariman sitting with Justice Ranjan Gogoi, turned on the reach of a single provision enacted in 1872.

Section 74 of the Indian Contract Act 1872 reads: "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."

Two riders follow. The Explanation to Section 74 states that "a stipulation for increased interest from the date of default may be a stipulation by way of penalty". The Exception preserves the full sum where a person gives a bail bond, recognizance or a bond for the performance of a public duty, and adds that a person contracting with Government does not thereby necessarily undertake any public duty. The full text sits in the statute book maintained at indiacode.nic.in.

The commercial question is sharp. A builder holds 20 per cent of your flat's basic selling price. A seller holds 10 per cent of an agreed consideration of Rs 70,00,000. A development authority holds 25 per cent of a 1982 bid. The buyer walks away. Does the phrase "whether or not actual damage or loss is proved" mean the holder simply keeps the money, or does it mean something narrower? Kailash Nath answered that question in 2015, and a bench of the same Court revisited the earnest-money corner of it on 3 February 2025.

What the Court Held

The Court allowed Kailash Nath Associates' appeal. It found, first, that there had been no breach by the bidder at all, and second, that the DDA had suffered no loss whatsoever, having realised Rs 11.78 crore on a re-auction of a plot originally bid at Rs 3.12 crore.

On the statute, the judgement is unambiguous that "damage or loss caused is a sine qua non for the applicability of the Section". The Court put the commercial logic plainly: "compensation can only be given for damage or loss suffered. If damage or loss is not suffered, the law does not provide for a windfall." A sum named in a contract is recoverable, the Court held, only where it is "a genuine pre-estimate of damages fixed by both parties and found to be such by the Court".

The Court then set out a summary of the law at paragraph 43 of the judgement. The propositions relevant to money already lying with the other side are these.

Finally, because the DDA is a public authority, the Court held its forfeiture arbitrary and therefore bad under Article 14 of the Constitution: there was no breach, and the authority had made a profit rather than suffered a loss.

Reasoning

Loss is the trigger, not an afterthought

The words "whether or not actual damage or loss is proved to have been caused thereby" had been read for decades as dispensing with proof. Kailash Nath read them far more narrowly. Paragraph 43 records that the expression relieves a party of the obligation to prove loss only "in cases where damage or loss is difficult or impossible to prove". Where loss is capable of being proved, it must be pleaded and proved in the ordinary way. On the facts, the DDA pleaded no loss and could plead none, having recovered Rs 11.78 crore against a bid of Rs 3.12 crore.

A named sum is a ceiling, not an entitlement

This is the older half of the reasoning, and it dates to 15 January 1963. In Fateh Chand v Balkishan Dass, a seller sought to keep Rs 25,000 made up of Rs 1,000 expressly described as earnest money and Rs 24,000 paid "out of the sale price". The Court permitted forfeiture of the Rs 1,000 but held the clause forfeiting the Rs 24,000 to be "manifestly a stipulation by way of penalty", recoverable only to the extent of reasonable compensation. Section 74 fixes an outer limit; it does not convert the figure into a debt.

On 19 August 1969 the same principle was applied to a security deposit in Maula Bux v Union of India. The Court held that where an amount deposited under a contract is forfeited under a stipulation in the nature of a penalty, the court may award only such sum as it considers reasonable, not exceeding the contractual figure, and that where loss is capable of proof the claimant must prove it. Kailash Nath sits squarely in that line.

A public authority cannot profit from a forfeiture

The third strand is constitutional rather than contractual, and it is the strand most often overstated. The Court did not hold that every forfeiture by every party offends Article 14. It held that this forfeiture, by this public authority, on these facts, was arbitrary, because the bidder had not breached and the authority had gained. The Court reiterated that bodies of the State must act "fairly, justly and reasonably" in their contractual dealings. That reasoning is available against a development authority or a public-sector allottee; it is not directly available against a private seller.

The earnest-money line, from Fateh Chand to Godrej Projects

Kailash Nath brought earnest money within Section 74. It did not abolish forfeiture of earnest money, and it is important not to read it as having done so. The test for what even counts as earnest money was laid down on 28 October 1969 in Shree Hanuman Cotton Mills v Tata Air-Craft Ltd, where a deposit of Rs 2,50,000 against a Rs 10,00,000 contract for aero-scrap was in issue. Five conditions must be satisfied: the sum must be given at the moment the contract is concluded; it must represent a guarantee that the contract will be fulfilled; it must form part of the purchase price if the transaction goes through; it is forfeited if the transaction falls through by the purchaser's default; and absent a contrary term, the seller may forfeit it on the buyer's default.

In Satish Batra v Sudhir Rawal, reported at (2013) 1 SCC 345, a buyer had paid 10 per cent of a Rs 70,00,000 consideration in November 2005 and failed to pay the balance by March 2006. The Court held a seller justified in retaining a sum as earnest money where the contractual terms are clear and explicit, while repeating that a payment made as part payment of price, and not intended as earnest, cannot be forfeited.

Then came Godrej Projects Development Limited v Anil Karlekar, 2025 INSC 143, decided on 3 February 2025 by Justice B.R. Gavai and Justice S.V.N. Bhatti. The builder-buyer agreement treated 20 per cent of the basic selling price as earnest money. The buyer, who had booked in 2014, declined possession in 2017 citing a market decline. The National Consumer Disputes Redressal Commission reduced the forfeiture to 10 per cent of the basic selling price and awarded interest at 6 per cent per annum. The Supreme Court upheld the 10 per cent forfeiture, set aside the interest, and directed a refund of Rs 12,02,955 within six weeks.

The Court's formulation matters for anyone reading Kailash Nath in isolation: where forfeiture of earnest money is reasonable it does not amount to imposing a penalty and so does not fall within Section 74, but where the forfeiture is in the nature of a penalty, Section 74 applies. The Court also treated a one-sided clause between parties of unequal bargaining power as an unfair trade practice, following the approach taken in Pioneer Urban Land and Infrastructure Ltd v Govindan Raghavan in 2019.

Practical Takeaways

If you are the buyer whose deposit has been forfeited

• Establish first whether the sum is earnest money at all. Apply the five conditions from Shree Hanuman Cotton Mills, decided 28 October 1969. Money paid in instalments after the contract was concluded, or described in the agreement as part payment of price, is closer to the Rs 24,000 in Fateh Chand than to the Rs 1,000.
• Check the percentage. In Godrej Projects, decided 3 February 2025, a contractual 20 per cent was cut to 10 per cent. A demand materially above 10 per cent of consideration invites scrutiny on reasonableness.
• Ask what the counterparty actually lost. Kailash Nath turned on the DDA having re-auctioned at Rs 11.78 crore against a bid of Rs 3.12 crore. If the seller resold at the same price or higher within a short period, that fact is central.
• Model the number before you argue about it. The stamp duty calculator and the real estate ROI calculator will tell you what the transaction actually cost you and what the counterparty plausibly gained.

If you are the seller or allottee holding the money

• Draft the figure as a genuine pre-estimate and be able to say how it was arrived at. Kailash Nath requires a pre-estimate "fixed by both parties and found to be such by the Court", not a percentage inserted unilaterally.
• Keep evidence of actual loss: carrying costs, the price achieved on resale, the interval before resale. Paragraph 43 of Kailash Nath permits proof to be dispensed with only where loss is difficult or impossible to prove.
• If you are a public authority or a public-sector body, assume Article 14 applies to the forfeiture decision itself, as it did to the DDA in the 9 January 2015 judgement.

If you are financing the purchase

• A forfeited deposit is dead capital while the dispute runs. Before committing 10 to 25 per cent of consideration as earnest money, run the numbers on the home loan EMI calculator and the rent versus buy calculator so the deposit is sized to what you can afford to have locked up.
• A refund ordered without interest, as in Godrej Projects on 3 February 2025, is a real loss in present-value terms. The concept is explained at net present value, and stamp duty and collateral cover the other costs that do not come back.

Where to complain

• For a flat booking or other consumer transaction, the National Consumer Helpline on 1915 and the e-Daakhil portal at edaakhil.nic.in are the official routes. Godrej Projects itself came up from the National Consumer Disputes Redressal Commission.
• For a grievance against a bank or a regulated lender connected to the transaction, the Reserve Bank of India's complaint portal at cms.rbi.org.in and its awareness site sachet.rbi.org.in are the official channels.
• If the transaction involved online fraud rather than a contractual dispute, report it at cybercrime.gov.in or on 1930.

Readers following the contract-law thread may also want our explainer on setting aside an arbitral award for patent illegality and, on property paperwork, why a general power of attorney does not convey title.

FAQ

Does Kailash Nath mean earnest money can never be forfeited without proof of loss?

No. The 9 January 2015 judgement holds that damage or loss is a sine qua non for Section 74 and that Section 74 applies to forfeiture of earnest money. But on 3 February 2025 in Godrej Projects, 2025 INSC 143, the Court held that where forfeiture of earnest money is reasonable it does not amount to a penalty and therefore does not attract Section 74 at all. Section 74 bites where the forfeiture is penal in nature or excessive in amount.

What is the difference between earnest money and part payment?

Shree Hanuman Cotton Mills, decided 28 October 1969, requires that earnest money be given at the moment the contract is concluded, operate as a guarantee of performance, and form part of the price if the sale completes. Fateh Chand in 1963 drew the line precisely: the Rs 1,000 labelled earnest was forfeitable, while the Rs 24,000 described as paid out of the sale price was not and the clause forfeiting it was a penalty.

Is 10 per cent the legal ceiling for forfeiture?

There is no statutory percentage. Section 74 of the Indian Contract Act 1872 speaks only of reasonable compensation not exceeding the sum named. In practice 10 per cent of consideration has been treated as reasonable in a residential sale, as in Satish Batra at (2013) 1 SCC 345 and in the outcome upheld in Godrej Projects on 3 February 2025, where a contractual 20 per cent was reduced to 10 per cent.

Did Kailash Nath overrule Fateh Chand or Maula Bux?

No. It followed them. The 2015 judgement records that forfeiture of earnest money on the facts of Fateh Chand was conceded by the appellant, and that the deposits in Maula Bux were not earnest money at all. Kailash Nath's contribution was to hold that Section 74 applies uniformly to sums payable on breach, so earnest money is not carved out of the statute.

Does it matter that the other side was a government body?

It can be decisive. Because the Delhi Development Authority is a public authority, the Court applied Article 14 and held the forfeiture arbitrary given that there was no breach and the DDA had re-auctioned at Rs 11.78 crore against a Rs 3.12 crore bid. Against a private seller the argument rests on Section 74 and reasonableness alone, without the constitutional overlay.

If a refund is ordered, do I get interest?

Not automatically. In Godrej Projects the National Consumer Disputes Redressal Commission awarded 6 per cent per annum, and on 3 February 2025 the Supreme Court set that interest aside while upholding the 10 per cent forfeiture, directing a refund of Rs 12,02,955 within six weeks. Interest depends on the facts and on the forum's assessment of conduct.

What should I check in the agreement before paying a deposit?

Check whether the sum is described as earnest money or as part payment, what percentage of consideration it represents, whether the clause is reciprocal or applies only to your default, and whether the counterparty must account for its actual loss. Godrej Projects on 3 February 2025 treated a one-sided clause between parties of unequal bargaining power as an unfair trade practice, following the 2019 decision in Pioneer Urban Land and Infrastructure Ltd v Govindan Raghavan.