Forfeiture Clauses in Agreements Must Be Reasonable — Supreme Court reaffirms

Overview

Since 2015, by way of a series of judgments, the Supreme Court and the National Consumer Disputes Redressal Commission (NCDRC) have consistently held that forfeiture clauses in agreements should be reasonable.

In DLF Ltd. v. Bhagwanti Narula¹, Ramesh Malhotra v. Emaar Mgf Land Ltd.² and Komal Aggarwal v. Godrej Projects Development Ltd.³, the NCDRC has held that the condition of forfeiture of 20% of the basic sale price (BSP) by the buyer when he terminates a flat sale agreement, is not reasonable and 10% of the BSP is a reasonable amount which is liable to be forfeited in case of cancellation of the agreement by the buyer, if the agreement contemplates such forfeiture.

More recently, the Supreme Court, in Godrej Project Development Ltd. v. Anil Karlekar⁴ (Godrej Project judgment) analysed the validity of one-sided forfeiture clauses in apartment/flat buyer agreements and held that the amount which is forfeited by the buyer, upon cancellation of a booked flat must be reasonable. The Supreme Court in Godrej Project judgment⁵, found no reason to interfere with the view taken by the NCDRC i.e. that regardless of the terms of the contract, forfeiture of 10% of the BSP by the buyer in favour of the seller, would be reasonable when the buyer terminates the agreement and seeks refund of the amounts paid pursuant to such termination.

The Godrej Project judgment

Background

On 10-1-2014, certain individuals (buyers) had booked an apartment with Godrej Project Development Limited (Godrej) in a project named “Godrej Summit” (Project) in Section 104, Gurgaon, Haryana. On 20-6-2014, the buyers were allotted an apartment in the Project, pursuant to which an apartment buyer agreement (agreement) was executed by the parties. The BSP for the apartment was Rs 1,70,81,400.

In June 2017, Godrej completed the construction, obtained the occupancy certificate for the Project and offered possession of the apartment to the buyers. The buyers, however, sought cancellation of the allotment and further sought full refund of the entire amount paid (being Rs 51,12,310) on account of the market recession owing to which identical apartments were available to buyers at lower rates. On the other hand, Godrej claimed that, as per the terms of the agreement: (i) the buyers were entitled to a refund of Rs 4,22,845 [i.e. after forfeiting the entire earnest money paid under the agreement being 20% of the BSP (earnest money)]; and (ii) upon termination of the agreement on account of the buyers’ event of default, Godrej was entitled to forfeit the entire earnest money and other dues including interest on delayed payments as specified in the agreement.

Accordingly, the buyers filed Consumer Complaint No. 262/2018 before the NCRDC inter alia praying for Godrej to be directed to refund a sum of Rs 51,12,310 paid by the buyers, with interest @ 18% p.a.

Vide order dated 25-10-2022 (impugned order) the NCDRC found that the term of the agreement requiring forfeiture of the earnest money being 20% of the BSP, was onerous and unreasonable and directed Godrej to deduct only 10% of the BSP i.e. Rs 17,08,140 towards termination of the agreement and refund the balance amount of Rs 34,04,170 along with simple interest @ 6% p.a. from the date of each payment till the date of refund, within 3 months. Godrej challenged the impugned order before the Supreme Court.

Submissions of the parties before the Supreme Court

On behalf of Godrej it was inter alia argued that the agreement specifically provided a forfeiture clause by way of which Godrej was entitled to forfeit the entire earnest money and that the NCDRC acknowledged that upon cancellation by the buyers, Godrej was entitled to forfeit the amount as per the agreement. Hence, the NCDRC could not have concluded that the condition of forfeiture of the earnest money (being 20% of the BSP) was unreasonable.

In response thereto, the buyers inter alia relied on aforementioned judgments of the NCDRC, under which the NCDRC has uniformly held that forfeiture of 10% of the BSP is reasonable.

Analysis and findings of the Supreme Court

Forfeiture of earnest money

In Satish Batra v. Sudhir Rawal⁶, the Supreme 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 was observed that earnest money is paid when the contract is entered into, as a pledge for its due performance by the depositor to be forfeited in case of non-performance by the depositor. It was further clarified that if the payment is only made towards part-payment of the consideration and is not intended as earnest money, then the forfeiture clause will not apply. In the present case, it was held that as per the clear terms of the agreement, 20% of the BSP was intended to be used as earnest money.

One-sided clauses in apartment buyer agreements

The Supreme Court examined the provisions of the agreement and observed that the same are entirely in favour of Godrej. The Supreme Court found that the agreement provides a very meagre compensation to the buyers upon any non-compliance, a grace period of 6 months to Godrej to have the apartment ready for occupation, and other eventualities which would entitle Godrej to a further extension for handing over possession. The agreement is therefore entirely one-sided and tilted in favor of the developer.

The Supreme Court reiterated the view taken in Central Inland Water Transport Corpn. Ltd. v. Brojo Nath Ganguly⁷, under which the Supreme Court applied Article 14 of the Constitution of India and held that courts will not enforce an unfair and unreasonable contract or any unfair/unreasonable clauses therein, entered into between parties who are not equal in bargaining power.

Unfair trade practice

Further, the Supreme Court relied on its judgment in Pioneer Urban Land and Infrastructure Ltd. v. Govindan Raghavan⁸ (Pioneer Urban judgment), wherein while considering similar clauses in an apartment buyer agreement, it was held that if the clauses of the agreement reveal incongruities between the remedies available to the developer and the apartment buyer and the clauses are one-sided and unreasonable, the incorporation of such clauses constitutes an unfair trade practice under Section 2(1)(r) of the Consumer Protection Act, 1986⁹ since it adopts unfair methods and practices for the purpose of selling flats. Such clauses will not be final and binding if it shown that the apartment buyers had no option but to sign on the dotted line, on a contract framed solely by the builder/developer. The view taken by Pioneer Urban judgment¹⁰ was approved by a three-Judge Bench of the Supreme Court in Ireo Grace Realtech (P) Ltd. v. Abhishek Khanna¹¹.

The Supreme Court recognised that the aforesaid principle however would not apply in a case where the contracting parties have equal or almost equal bargaining power.

When the forfeiture of earnest money amounts to imposition of a penalty

The Supreme Court also considered its judgment in Maula Bux v. Union of India¹² (Maula Bux judgment) wherein it was held that if the forfeiture of earnest money under a contract is reasonable, then it does not fall within Section 74 of the Contract Act, 1872¹³ (Section 74) inasmuch as, such a forfeiture does not amount to the imposing of a penalty. It was further held that, however, if the forfeiture is of the nature of a penalty, then Section 74 would be applicable. It was further clarified 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 already paid to the party complaining of a breach of contract, the undertaking is of the nature of a penalty.

Relying on Maula Bux judgment¹⁴ the NCDRC has, in a series of judgments starting from Bhagwanti Narula case¹⁵ held that 10% of the BSP is a reasonable amount which is liable to be forfeited as earnest money.

Therefore, the Supreme Court partially upheld the impugned order by upholding forfeiture of 10% of the BSP, however, set aside the portion which awarded interest on the amount to be refunded by Godrej on the ground that the NCDRC was not justified in awarding such interest.

Concluding remarks

The verdict in Godrej Project judgment¹⁶ comes as a relief not just to homebuyers but all parties entering into contracts with parties having better negotiating power, as the Supreme Court has reiterated and once again held that one-sided clauses in agreements are not final and binding in cases where parties are not equal in bargaining power.

The decision is a testament to the fact that the Supreme Court of the country is cognizant of the ground reality, including the plight of homebuyers in the real estate market whereby apartment purchasers are made to sign contracts framed solely by and entirely favouring the builder/developer.

The judgment once again upholds the constitutional touchtone of fairness and equality by protecting the homebuyers from being exploited by real estate developers. The Court has balanced equities by: (i) recognising that when buyers cancel the allotment of their apartments on the ground of a market recession, whereby an identical flat would be available for a substantially lower price even in the primary market, it is quite probable that the buyers would have utilised their money for purchasing another property at a lower rate; and (ii) by denying interest on the refunded amount and recognising the volatility of the real estate market in India.

As the ruling affirms that builders/developers are entitled to enforce forfeiture clauses so long as they are reasonable and not tilted towards the builder/developer, it would be worth the while of builders/developers to hire legal experts who can assist in drafting reasonable and fair clauses in the buyer agreements going forward.