The Supreme Court has ruled that forfeiting earnest money in a contract is permissible, provided it is not excessive to the extent of constituting a penalty under Section 74 of the Indian Contract Act, 1872.
The case involved a dispute between flat purchasers and a builder over the forfeiture of 20% of the basic sale price (BSP) after the purchasers canceled their booking. While the builder defended the forfeiture based on the Apartment Buyer Agreement (ABA), the purchasers argued that the amount was arbitrary and should be capped at 10%.
The National Consumer Disputes Redressal Commission (NCDRC) sided with the purchasers, limiting the forfeiture to 10% and ordering the refund of the remaining amount with 6% annual interest. The builder then appealed to the Supreme Court.
In its judgment, the Court upheld the NCDRC’s decision, stating that while forfeiting earnest money is legally valid, it must not be excessive or punitive. The ruling emphasized that courts have the authority to reduce such amounts if they qualify as penalties under Section 74. The Court referenced previous rulings, including Maula Bux v. Union of India (1969) and Satish Batra v. Sudhir Rawal (2013), to reinforce the principle that reasonable forfeiture is not a penalty.
However, while affirming the 10% forfeiture limit, the Supreme Court overturned the interest on the refunded amount, concluding that the NCDRC was not justified in awarding it.
The ruling clarifies the legal boundaries of earnest money forfeiture, ensuring fairness while maintaining contractual obligations.