By Mwaba Phiri
Contract Law - Remedies
INTRODUCTION
In the realm of contract law, the
distinction between liquidated damages and penalties has long been a subject of
debate. While both concepts aim to compensate parties for breaches, they differ
significantly in their application and enforceability. Liquidated damages
represent a genuine attempt to estimate and quantify losses in advance
providing a fair and reasonable remedy for contractual breaches. Penalties on
the other hand are designed to punish and deter often exceeding the actual loss
suffered. The distinction between these two concepts is crucial as courts will
only enforce liquidated damages that are deemed fair and reasonable while
penalties are often struck down as unenforceable. This writing delves into the
nuances of liquidated damages and penalties exploring the key differences and
implications for contractual parties. By examining relevant case law, it is
important to analyse the legal principles and considerations that govern these
concepts.
LIQUIDATED DAMAGES
Hugh Collins defined liquidated damages as
a sum specified in a contract as the measure of damages payable in the event of
breach and are intended to be a genuine attempt to estimate the loss likely to
be suffered rather than a penalty[1].
This simply means that these are genuine pre-estimates of the loss likely to be
caused or suffered by one party if the contract is breached by the other
party.
However, the term ‘damage’ must not be
confused with ‘damages’. Damage simply refers to loss or harm suffered by a
party which can either be physical, financial or reputational. While damages
refer to the monetary compensation agreed to be paid by either of the parties
in an event of breach of a contract. Liquidated damages having laid down the
amount to be paid by either party on breach, it follows that the only dispute
will be as to the breach itself. The damages are embodied in the clause of the
contract that effectively make a genuine assessment of the losses which are
likely to be incurred due to the breach of contract. The Supreme Court in Damales
Mwansa v. Ndola Lime Company Limited[2] defined liquidated damages as damages
which have been agreed by the contracting parties in advance of any breach of
contract, these are not equivalent of compensation rather they form an
acceptable and agreed alternative to compensation. A liquidated damage
accurately reflects the position of both parties. This is evident in the case
of Cine
Bes Filmcilik Ve Yapimilick v United International pictures[3].
Where a clause in a licensing agreement for films provided for the payment by
the licensee to the licensor in the event of termination of their agreement. It
took no account of payment by the licensee for any benefits gained by the
licensor.
PENALTIES
According to the Black’s Law Dictionary[4]
the term ‘penalty’ refers to the sum of money which the obligator of a bond
undertakes to pay by way of penalty, in the event of his omitting to perform or
carry out the terms imposed. The law does not permit penalties because they
seek to put the innocent party in a far greater position than the actual
compensation they deserve. In Ford Motors Co V Armstrong5 where
a suit was brought against the defendant for breaching one of the several
covenants contained in the contract, a sum of 250 pounds was payable. The court
in this case held in majority that it was therefore a penalty since it was an
arbitrary substantial sum and made payable for various breaches differing in
kind, some of which might cause only trifling damage. The high amount of the
agreed sum in this case showed that it could not be a genuine pre-estimate of
loss.
DIFFERENCIATING PENALTIES FROM LIQUIDATED
DAMAGES
The law has developed rules for
determining the difference between penalties and liquidated damages. In Law
v. Redditch Local Board[5].
The court stated that the distinction between penalties and liquidated damages
is the intention of the parties which has to be gathered from the contract. If
the intention is to secure the performance of the contract by imposing a fine
or penalty, then that sum is known as penalty but if the intention of the
parties is to access damages for breach of contract then it is a liquidated
damages. With references to the facts of the case, the 1000 pounds to be paid
every week for the late delivery of the suits was a penalty because it appeared
to be more than a genuine pre-estimate of the loss.
Similarly, in Dunlop Pneumatic Tyre Co Ltd v
Selfridge & Co Ltd[6].
Dunlop, a manufacturing company made a contract with Dew a trade purchaser
for tyres at a discounted price on condition that they would not resell the
tyres at less than the listed price and that the reseller who wanted to buy
them from Dew had to agree not to sell at the lower price either. Dew sold the
tyres to Selfridge at the listed price and made Selfridge agree not to sell a
lower price either and that they would pay 50 pounds in damages if they
violated the agreement. Selfridge proceeded to sell the tyres below the price
he promised to sell them for. Dunlop brought an action and was successful at
trial but this was overturned by the House of Lords. It was held that Dunlop
could not claim damages from Selfridge because Dunlop had not given
consideration to Selfridge and therefore there was no contractual obligation
between them. Consequently, the stipulation was deemed to be for liquidated
damages.
In conclusion, the key takeaway is that
liquidated clauses promote efficiency in contract enforcement, while penalties
discourage breaches through intimidation. Courts will uphold liquidated damages
clauses that represent a genuine estimate of potential losses, ensuring a fair
outcome for both parties.
[1]
Collins. H, The Law of Contracts (Oxford University Press 2017) Page 541.
[2]
[2012] ZR (3) 268.
[3]
[2003] EWCA Civ 1669.
[4] Black’s Law Dictionary, 2nd
Ed. 5 [1915] 31 TLR 267.
[5] [1892] 1 QB 127 (CA).
[6]
[1915] UKHL 1, [1915] AC 847.
LEGAL AID INITIATIVE
(Access to Knowledge)
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