W10: Unfair contract terms
Thursday, 27 August 2020
13:44
A. PENALTIES
Penalties - v - Liquidated Damages
Parties attempt to regulate by clauses in contract what is payable in damages
for breach.
Damages is an illiquid sum
To remove uncertainty of predicting the quantum of damages, the parties may
insert a clause in their contract stipulating that a fixed sum will be payable on
breach.
1)Traditionally, the courts would only enforce such a clause if it was a genuine
pre-estimate of loss (liquidate damages; money that is fixed in account and
presently payable); parties agree there shall be damages and set out formula
for calculation.
2) parties agree no damages or small token damages payable; (Exclusion
clauses/Exemption clauses/ limitation clauses)
Enforceable liquidated damages clause 'genuine covenanted pre-estimate' of
the damage flowing from breach. Clauses fixing money to be paid
purpose of such a clause; to provide other party incentive to perform; too
much of incentive runs risk of becoming stipulation in terrorem.
If the clause penalised or was intended to pressurise the party in breach then it would
be treated as invalid and not enforceable (penalty clause)
Damages claim in general illiquid unless liquidated by judge; delay
(construction). However if allow complete freedom to contract then outcome
may be unequal; penalty clauses
Freedom of parties to introduce such a clause into their contract long been
restricted by law on penalties, lord hodge "the rule against penalties is a rule
of contract law based on public policy. … courts will not enforce a stipulation
for punishment for breach of contract
Leading case on this distinction until October 2015:
Dunlop Pneumatic Tyre Co v New Garage & Motor Co [1915] AC 79 (per Lord
Dunedin)
To be a liquidated damages clause: clause had to be parties reasonable pre-estimate
of the loss likely to be suffered as a result of the breach of contract. If not liquidated
damages clause then it is a penalty clause.
“The question whether a sum stipulated is penalty or liquidated damages is a question
of construction to be decided upon the terms and inherent circumstances of each
particular contract, judged of as at the time of the making of the contract, not as at the
time of the breach.
To assist this task of construction, various tests have been suggested, which if
applicable to the case under consideration may prove helpful, or even conclusive.
Such are:
It will be held to be a penalty if the sum stipulated for is extravagant and
unconscionable in amount in comparison with the greatest loss that could
conceivably proved to have followed from the breach.
It will be held to be a penalty if the breach consists only in not paying a sum of
money, and the sum stipulated is a sum greater than the sum which ought to
have been paid. …
There is a presumption (but no more) that it is penalty when a single lump sum
is made payable by way of compensation, on the occurrence of one or more or
, all of several events, some of which may occasion serious and others but
trifling damage.
unenforceable penalty 'a payment of money stipulated as in terrorem of the
offending party' 'A stipulated sum 'extravagant and unconscionable in amount
compared to loss that could be proved to follow from breach'. Contract terms held to
be illegal and unenforceable because contrary to public policy
If such parties negotiate an agreed damages regime, why should the courts
be empowered to intervene
Ignoring the actual loss beneath that a clause may be recoverable which is
disproportionate
Controls did not reach far enough and were relatively easily evaded
When a contract contains a penalty clause which operates on the occurrence
of an event other than breach, eg if a party exercises an option to terminate
the contract, clause is not subject to any scrutiny at all
No controls against a clause operating on breach which required the contract
breaker to transfer something other than money to the other party or
allowed the other party to withhold a performance.
Design her clause appropriately and the clause would escape judicial
scrutiny
Forfeiture clause: sums already paid under a contract. The law of penalties
only applies to sums to be paid after the breach
Accelerated payment clause: terminate a contract early becomes liable to
make all or some of the other payments still due under the contract
Bonus arrangements: clause provides for bonuses payable on 'early'
completion
'lane rental' arrangements: contractor pays a rental for each of the contract;
quicker the work is done, the less the charges to be offset against the
payments due to the contractor for the construction
On the other hand:
It is no obstacle to the sum stipulated being a genuine pre-estimate of damage,
that the consequences of the breach are such as to make precise pre-
estimation almost an impossibility. On the contrary, that is just the situation
when it is probable that pre-estimated damage was the true bargain between
the parties.”
And see:
Clydebank Engineering Co v Castaneda (1904) 7 F (HL) 77; 12 SLT 498; [1905]
AC 6 (the Spanish Navy case – an e.g. of (d) above)
But see now the seven-judge decision of the UK Supreme Court in *Cavendish Square
Holding BV v El Makdessi; ParkingEye Ltd v Beavis [2015] UKSC 67, [2016] AC 1172,
[2015] 3 WLR 1373:
If a clause provides for payments or sanctions of breach of contract, then it will be
basically enforceable. Clause must seek to protect legitimate interests of innocent party
in order to be valid.
“22. Lord Dunedin’s speech in Dunlop achieved the status of a quasi-statutory
code in the subsequent case-law. Some of the many decisions on the validity of
damages clauses are little more than a detailed exegesis or application of his
four tests with a view to discovering whether the clause in issue can be brought
within one or more of them. In our view, this is unfortunate. In the first place, Lord
Dunedin proposed his four tests not as rules but only as considerations which
might prove helpful or even conclusive “if applicable to the case under
consideration”. He did not suggest that they were applicable to every case in
which the law of penalties was engaged. Second, as Lord Dunedin himself
acknowledged, the essential question was whether the clause impugned was
“unconscionable” or “extravagant”. The four tests are a useful tool for deciding
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