AI Overview...

Forfeiture of Earnest Money in Contracts: A Comprehensive Legal Guide

Disclaimer: This blog post provides general information based on judicial precedents and is not intended as legal advice. Legal situations vary, and you should consult a qualified lawyer for advice specific to your circumstances.

In business transactions, property deals, and government tenders, earnest money serves as a security deposit to demonstrate a party's serious intent to perform the contract. But what happens when a party backs out? Can the other side legally forfeit the earnest money? This is a common question in forfeiture of earnest money in contract disputes, governed primarily by the Indian Contract Act, 1872, especially Section 74.

This guide breaks down the legal principles, key Supreme Court rulings, and practical considerations to help you navigate these issues.

What is Earnest Money?

Earnest money (also called earnest deposit or EMD) is a sum paid by one party (usually the buyer or bidder) to bind the contract. It acts as:
- A token of good faith.
- Security against breach.
- Part-payment adjustable towards the final price if the deal proceeds.

Earnest is something given by Promisee to Promisor to mark conclusiveness of contract – This is quite apart from price – It may also avail as a part payment if contract goes through – But even so it would not lose its character as earnest, if in fact and in truth it was intended as mere evidence of bargain. Authorised Officer, Central Bank Of India VS Shanmugavelu - 2024 2 Supreme 92

Unlike a mere advance payment, earnest money is typically forfeitable upon breach, but only under specific conditions.

When Can Earnest Money Be Forfeited?

Forfeiture is not automatic. Courts scrutinize contracts closely. Here's when it's generally permissible:

1. Clear Contractual Terms

The contract must explicitly state that the deposit is earnest money and forfeitable on breach.

The law is, therefore, clear that to justify the forfeiture of advance money being part of earnest money the terms of the contract should be clear and explicit. National Insurance Co. LTD. VS Swaran Singh - 2004 1 Supreme 243 K. R. Suresh VS R. Poornima - 2025 4 Supreme 609

• In property sales, 5-10% of the sale price is common and often upheld if reasonable. Forfeiture of earnest money under a contract for sale of property - Movable or immovable - If the amount is reasonable, does not fall within Section 74. Authorised Officer, Central Bank Of India VS Shanmugavelu - 2024 2 Supreme 92

2. Proven Breach by the Depositor

Forfeiture requires a breach by the party paying earnest money, such as:
- Withdrawing a tender before acceptance (in some cases).
- Failing to pay balance amount in auctions.
- Defaulting on time-bound obligations.

In tenders and auctions, forfeiture is common if the bidder resiles. The NIT stipulated that tenderers who resile before the validity period shall be liable for forfeiture of EMD. Food Corporation Of India, Rep. By The Chairman Cum Managing Director VS M. Pul Enterprise Proprietorship Concern Of Sri Muhilum Pul - 2023 Supreme(Gau) 733

3. No Need for Actual Loss Proof in Some Cases

Traditionally, earnest money forfeiture doesn't always require proving actual damages if the amount is a genuine pre-estimate and reasonable.

The forfeiture of earnest money under a contract for the sale of property does not fall within the ambit of Section 74 of the Indian Contract Act. DHARAM CHAND SONI VS SUNIL RANJAN CHAKRABARTY - 1981 Supreme(Cal) 27

However, post Kailash Nath Associates v. DDA (2015), courts increasingly demand proof of loss even for earnest money under Section 74.

Section 74 of the Indian Contract Act: Key to Forfeiture

Section 74 limits compensation to reasonable damages for breach, abolishing penalties.

• Applies to forfeiture: Section 74 will apply to cases of forfeiture of earnest money under a contract. K. R. Suresh VS R. Poornima - 2025 4 Supreme 609 P.S.T. Engineering Construction vs HSCC (India) Limited - 2025 Supreme(Mad) 2545


• Reasonable amount only: Forfeiture beyond actual loss is invalid. Forfeiture of earnest money must be reasonable, just, and based on actual loss suffered. Atibir Industries Company Limited VS Central Coalfields Limited - 2023 Supreme(Jhk) 1228


• Burden on claimant: The party forfeiting must prove loss; otherwise, refund with interest may be ordered.

Exceptions Where Section 74 Doesn't Apply Strictly

• Statutory auctions (e.g., SARFAESI Act Rule 9(5)): Forfeiture of 25% EMD is statutory, not penal. Legislature through Rule 9(5) of SARFAESI Rules, has made conscious departure from general law by statutorily providing for forfeiture. Authorised Officer, Central Bank Of India VS Shanmugavelu - 2024 2 Supreme 92


• Pre-contract withdrawal: No forfeiture if no concluded contract exists. Forfeiture of Earnest Money Deposit is permissible only when a concluded contract has come into being and not prior thereto. S. R. S. Infra Project Pvt. Ltd. , Gwalior VS Gwalior Development Authority, Gwalior - 2010 Supreme(MP) 83

Landmark Supreme Court Rulings

1. National Highways Authority v. Ganga Enterprises (2003) Oil & Natural Gas Corporation LTD. VS SAW Pipes LTD. - 2003 3 Supreme 449

• Held: Arbitral awards allowing unreasonable forfeiture can be set aside under Arbitration Act Section 34 if against contract terms or patently illegal.


• Key quote: If the award is contrary to the substantive provisions of law or the provisions of the Arbitration and Conciliation Act, 1996 or against the terms of the contract.

2. Maula Bux v. Union of India (1969)

• Forfeiture upheld only if genuine pre-estimate; otherwise, limited to actual loss.

3. Kailash Nath Associates v. DDA (2015)

• Reiterated: Even earnest money requires loss proof. Forfeiture of earnest money is permissible when the contract is breached by the buyer, however, unless loss is shown, forfeiture of additional amounts beyond earnest money would be contrary to Section 74. RAGHBIR SINGH AND OTHERS Vs LALIT AND OTHERS - 2026 Supreme(Online)(P&H) 110

4. SARFAESI Auction Cases Authorised Officer, Central Bank Of India VS Shanmugavelu - 2024 2 Supreme 92

• Banks can forfeit 25% EMD without proving loss due to statutory override.

Special Contexts: Tenders, Auctions, and Property

Government Tenders

• Forfeiture valid for material non-disclosure or resiling. Forfeiture of earnest money is valid before contract execution if tenderer provides false information. Gaikhonlung Panmei VS The Food Corporation of India Through The Chairman And Managing Director - 2023 Supreme(Manipur) 17


• No notice needed if terms are clear. The Chairman, T. N. Electricity Board and Another VS G. J. Fernandez - 2000 Supreme(Mad) 919

Property Sales

• Buyer default: Seller retains if reasonable (e.g., 10%).


• Seller default: Buyer gets refund + damages.

E-Auctions (e.g., Coal Blocks)

• Strict: Forfeiture for payment via wrong account or non-payment. Atibir Industries Company Limited VS Central Coalfields Limited - 2023 Supreme(Jhk) 1228

When Forfeiture is Invalid

• No breach or no concluded contract.


• Unreasonable amount (e.g., 25% when only 5% loss).


• One-sided contracts (consumer protection angle). Agreement is one-sided and totally tilted in favour of Developer. Godrej Projects Development Limited VS Anil Karlekar - 2025 3 Supreme 5


• Force majeure or no fault of depositor.

Remedy: Approach court for refund under Section 73/74, often with 6-12% interest.

Key Takeaways

• Always read terms: Ensure forfeiture clauses are explicit.


• Document loss: Parties forfeiting must prove actual damages in court.


• Seek alternatives: In suits for specific performance, plead for earnest refund explicitly. Unless plaintiff specifically seeks refund of earnest money... no such relief can be granted. Desh Raj VS Rohtash Singh - 2022 Supreme(SC) 1244


• Tender tip: Disclose all facts truthfully to avoid automatic forfeiture.

| Scenario | Forfeiture Likely? | Key Consideration |
|----------|-------------------|-------------------|
| Buyer withdraws post-acceptance | Yes | Prove breach & reasonable loss National Insurance Co. LTD. VS Swaran Singh - 2004 1 Supreme 243 |
| Tender withdrawn pre-acceptance | No | No contract formed Shillong Municipal Board VS Latiplang Kharkongor - 2005 Supreme(Gau) 262 |
| False info in bid | Yes | Material suppression P.S.T. Engineering Construction vs HSCC (India) Limited - 2025 Supreme(Mad) 2545 |
| Statutory auction default | Yes | Rule 9(5) SARFAESI Authorised Officer, Central Bank Of India VS Shanmugavelu - 2024 2 Supreme 92 |

Conclusion

Forfeiture of earnest money in contract balances securing performance with fairness. While contracts often allow it, Section 74 ensures it's not punitive. Courts protect against abuse, especially in tenders and sales, but uphold clear terms where loss is shown.

If facing forfeiture, gather evidence of no breach or excessiveness. For drafting contracts, include precise clauses to withstand scrutiny.

Stay informed—legal interpretations evolve. For personalized guidance, consult a contract law expert.

Last updated: Based on precedents up to 2023.