Liquidated Damages in Contracts: s.74 and CPWD Clause 2

By Khanal Group · Contracts and site work · Updated 25 October 2026 · Not legal or tax advice

What liquidated damages are

Liquidated damages (LD) are a sum the parties fix in the contract, at the time of signing, as the compensation payable if one of them breaches it. In works and supply contracts the breach is almost always delay: the contractor does not finish by the completion date, or misses a milestone. Instead of proving the owner's actual loss after the event, the contract names a rate, usually a percentage of the contract value for each day, week or month of delay, with a ceiling.

Government contracts call it by different names. CPWD's General Conditions of Contract use compensation for delay (clause 2). Supply contracts under the General Financial Rules and GeM use liquidated damages. Private contracts sometimes call it a penalty, which matters less than people think in Indian law, for the reason below.

LD and penalty under the Indian Contract Act 1872

English law draws a sharp line between a genuine pre-estimate of loss, which is enforced, and a penalty, which is not. Indian law does not. Two sections of the Indian Contract Act 1872 apply:

Section 73 gives the injured party compensation for loss or damage that naturally arose in the usual course of things from the breach, or that the parties knew, when they made the contract, was likely to result from it. Remote and indirect loss is not covered.
Section 74 applies where the contract names a sum to be paid on breach, or contains any other stipulation by way of penalty. The injured party is entitled, whether or not actual damage or loss is proved, to reasonable compensation not exceeding the amount so named.

So under s.74 the figure in the contract is a ceiling, not an automatic entitlement, whether the clause calls it LD or penalty. The Supreme Court has read this together with s.73. In ONGC v Saw Pipes (2003) it upheld LD where the amount was a genuine pre-estimate and loss was hard to prove. In Kailash Nath Associates v DDA (2015) it held that where loss can be proved, it must be, and that reasonable compensation under s.74 cannot be awarded where no loss at all was caused. The practical reading most lawyers take: where the owner's loss from delay is hard to measure, as with most public works, a reasonable pre-agreed rate is usually upheld; where there is clearly no loss, LD may be cut down or refused. Take advice on any disputed deduction.

Point	General damages (s.73)	Named sum, LD or penalty (s.74)
Amount	Actual loss that naturally arises from the breach	Reasonable compensation, up to the sum named
Proof of loss	Must be proved	Not always needed, but the courts expect proof where loss can be proved
Label in the contract	Not relevant	Not decisive: "penalty" and "LD" are treated alike
Ceiling	None beyond the rules on remoteness	The named sum or the contract cap

Compensation for delay in CPWD contracts: clause 2

Clause 2 of the CPWD General Conditions of Contract 2023 applies if the contractor fails to maintain the required progress in terms of clause 5, or fails to complete the work and clear the site by the contract date or the justified extended date. The authority named in Schedule F decides the compensation, on the accepted tendered value, for every completed day or month that progress stays behind or the work stays incomplete.

Rate: a maximum of 1% per month of delay, computed on a per-day basis, based on the quantum of damage suffered because of the contractor's delay. The text makes 1% a maximum, not a fixed figure, and links it to the damage, which follows the s.74 approach.
Cap: the total compensation for delay cannot exceed 10% of the accepted tendered value.
Extensions: extensions under clause 5.5 (delay on the contractor's account) do not stop clause 2 running; time added under clauses 12 (deviations) and 15 (suspension) is taken into account.
No waiver: if the authority does not decide compensation during the work, it can still levy it if the work stays incomplete on the final justified extended date.
Set-off: the CPWD Works Manual 2022 (para 5.16.1) says clause 2 must be operated by following due procedure and proper application of mind, and that notice to adjust or set off compensation from the contractor's dues is given by the Engineer-in-Charge.

Older CPWD editions and many state PWD, railway and PSU contracts use different rates and caps. Always read the clause in your own agreement and its Schedule F: the edition that applies is the one the tender was issued under.

How extension of time changes LD

LD runs from the completion date, so the completion date itself is the real argument. Under CPWD clause 5:

Delay from events in clause 5.2 (force majeure, abnormally bad weather, serious fire damage, strikes or local commotion, delay by other contractors engaged by the department, or similar causes beyond the contractor's control) gives an extension of time but no damages.
Delay caused by the department under clause 5.3 (late site handover, late drawings, late decisions) gives a fair and reasonable extension and keeps the contractor's other remedies open.
Delay on the contractor's own account may be covered by an extension under clause 5.5, but compensation under clause 2 is levied for that period.

An application for extension must be made in writing within fourteen days of the event, on the prescribed form. That is why the hindrance record matters: see extension of time and the hindrance register.

Worked example

Illustrative figures, CPWD-style clause 2 at the maximum rate:

ABC Infra Private Limited's accepted tendered value: ₹2,00,00,000. Stipulated completion: 31 March. Actual completion: 30 June, 91 days late.
The department accepts that 30 days of the delay were caused by late drawings (clause 5.3), and grants an extension to 30 April. The remaining 61 days are on the contractor's account.
Maximum rate: 1% per month of ₹2,00,00,000 = ₹2,00,000 a month. Taking a 30-day month for the per-day basis, that is about ₹6,667 a day. Your contract or the department's practice decides the day count.
Maximum compensation for 61 days: ₹6,667 × 61 = about ₹4,06,700.
Cap: 10% of ₹2,00,00,000 = ₹20,00,000. The figure is under the cap.

Step	Figure
Total delay	91 days
Less: justified extension (department's delay)	30 days
Delay on contractor's account	61 days
Maximum rate per day (1% a month ÷ 30)	₹6,667
Maximum compensation	₹4,06,700
Cap at 10% of tendered value	₹20,00,000

The authority can decide a lower figure if the damage suffered was lower; 1% is the ceiling. Without the extension, the maximum would have been about ₹6,06,700 for 91 days. Run your own figures in the liquidated damages calculator.

Tax treatment, briefly

CBIC Circular 178/10/2022-GST (3 August 2022) says that liquidated damages for delay are compensation for a breach of contract, not consideration for a separate supply of "tolerating an act", so GST is generally not payable on the LD itself. Whether the LD deduction also reduces the value of the contractor's works contract supply depends on how the contract and the invoices treat it; confirm with your CA. For income-tax TDS, the deductor deducts on the amount credited or paid under s.393 [194C]; whether TDS is computed before or after the LD deduction depends on how the bill is credited in the deductor's books. The RA bill deductions calculator shows LD as an "other deduction" on the bill.

What to check when LD is levied

Which edition of the conditions applies, the rate, the base (tendered value, or the value of the delayed part) and the cap.
Whether all extension applications were made in time, and whether each was decided.
Whether the department's own delays (site, drawings, decisions, payments) were netted off.
Whether the levy was decided by the authority named in Schedule F, with a notice.
Whether the amount was set off from this contract's bills, the security deposit or another contract, and whether the contract allows that.

K-Projects records hindrances and hours lost in the daily progress report and shows days behind on each project, which gives you the dated record an extension application needs.

Common questions

Is there a difference between liquidated damages and a penalty in India?

Not in the way English law draws it. Section 74 of the Indian Contract Act 1872 treats a named sum and a penalty stipulation alike: the injured party gets reasonable compensation not exceeding the amount named. The label in the contract does not decide the amount.

What is the rate of compensation for delay in CPWD contracts?

Under clause 2 of the CPWD General Conditions of Contract 2023, a maximum of 1% per month of delay, computed per day and based on the damage suffered, on the accepted tendered value. The total cannot exceed 10% of the accepted tendered value. Older editions and other departments use their own rates.

Does the owner have to prove loss before deducting LD?

Section 74 says compensation is payable whether or not actual loss is proved, but the Supreme Court in Kailash Nath Associates v DDA (2015) held that where loss can be proved it must be, and that nothing is payable where no loss was caused. Where loss is hard to measure, as with most public works, a reasonable pre-agreed rate is usually upheld.

Does an extension of time stop liquidated damages?

An extension for events beyond the contractor's control, or for the department's own delays, moves the date from which LD runs. Under CPWD clause 5.5, an extension for delay on the contractor's own account is granted with compensation under clause 2 for that period.

Is GST payable on liquidated damages?

CBIC Circular 178/10/2022-GST says liquidated damages paid as compensation for breach are not consideration for a supply, so GST is generally not payable on them. The circular leaves room for the facts of each case, so confirm with your CA.

Liquidated damages and compensation for delay in works contracts