Liquidated damages and penalties

Question 1

Liquidated damages clause

Answer 1

A clause which stipulates a certain sum which is to be payable on a particular breach of contract

Question 2

Why have a liquidated damages clause?

Answer 2

• can be commercially advantageous because it fixes the amount that will be due for breach without the claimant having to establish its case for damages in accordance with the principles applying to damages
• makes it clear to a party what is at stake if they fail to comply with their obligations and allows the party to then take this risk into account when determining the price for the contract
• common in the construction and technology industries where consequences of non-performance come up often e.g. delay

Question 3

Can the courts intervene?

Answer 3

• There are instances where the court will intervene.
• The courts have developed a jurisdiction to intervene to strike down a liquidated damages clause where it requires the party in breach to pay an excessive sum. This is known as the law on penalties/penalty clauses.
• If a clause is regarded as a penalty, it will be struck out by the court and the claimant will only be entitled to damages assessed the normal way

Question 4

Leading cases

Answer 4

• Prior to 2016 the leading case was Dunlop Pneumatic Tyre Co v New Garage and Motor: based on whether the clause in question was a genuine pre-estimate of loss or whether it required a payment which was extravagant and unconscionable
• The law from Dunlop has been replaced with a test derived from Cavendish Square Holdings v Talal El Makdessi

Question 5

The Makdessi test

Answer 5

• Is the clause a primary or secondary obligation? - A clause will be primary if it is part of the primary obligations in the commercial context of the contract, i.e. furthers the commercial objective of the contract. A clause will be secondary if it is an obligation triggered by breach of contract. If primary, the clause will not engage the penalty rule at all, so will be valid.
• If secondary, the clause will be a penalty if it imposes a detriment out of all proportion to any legitimate interest of the innocent party
• To determine this the Supreme Court gave two steps:
  (1) What (if any) legitimate business interest is served and protected by the clause?
  (2) Is the detriment imposed to protect that interest extravagant, exorbitant or unconscionable?
• The burden of proof is on the person alleging that the clause is a penalty.

Question 6

Example - ParkingEye Limited v Beavis

Answer 6

• charged £85 for a failure to comply with a 2 hour car park limit
• the obligation to pay this sum was a secondary obligation (was triggered by breach of the contract)
• charge was concluded not to be a penalty
• because ParkingEye had a legitimate interest in charging motorists for exceeding the 2 hour limit.
• although the charge exceeded any likely loss, ParkingEye had a responsibility to manage the car park effectively and so it was legitimate to use the charges as a means of influencing conduct

Question 7

Summary of the Makdessi decision

Answer 7

where parties have negotiated a contract, on a level playing field and with the assistance of professional advisers, it will be hard for the party paying liquidated damages to challenge the validity of those provisions on the basis that they are a penalty.

Question 8

Classification of terms of a contract

Answer 8

Positive term - requires a party to do something

Negative term - requires a party not to do something

Question 9

Specific performance

Answer 9

Issued by the court to the defendant, requiring it to carry out its obligations under a positive term of the contract
- breaching a court order for specific performance has more serious consequences than breaching a contract: it can be treated as contempt of court and lead to imprisonment

Question 10

Prohibitory injunction

Answer 10

A court order restraining a party from breaching a negative term.
- can also be punished as contempt of court

Question 11

When will specific performance/prohibitory injunction be available?

Answer 11

• will not be granted if damages are an appropriate and adequate remedy
• to prove that damages are inadequate, it must be proved that the subject matter of the contract is unique or irreplaceable, or that an award of damages would be ineffective as adequate compensation
• e.g. specific performance might be an appropriate remedy in cases of breach for a contract for the sale/lease of land because land is usually unique

Question 12

What type of remedy are specific performance and prohibitory injunctions?

Answer 12

Equitable remedies so discretionary; the court can consider all relevant circumstances and there are no clear criteria

Equitable principles also apply: the court will take into account the conduct of the claimant (‘he who comes to equity must come with clean hands’) and the action must be brought with reasonable promptness as ‘delay defeats equities’

Question 13

Further principles applying to specific performance (but they are not rules - equitable!)

Answer 13

(a) Specific performance will not be awarded where it would cause undue hardship on the defendant
(b) A promise given for no consideration is not specifically enforceable, even if made as a deed
(c) Specific performance will not be awarded for breaches of contracts of employment
- For other contracts involving services, specific performance will not be awarded if there has been a breakdown of trust and confidence or if the court would need to consider subjective opinions
(d) Specific performance will not be awarded for a breach of an obligation to perform a series of acts which would need the constant supervision of the court (so building contracts are specifically enforceable only in certain special circumstances)
(e) Specific performance will not be awarded for breach of contract which is not binding on both parties e.g. minors’ voidable contracts

Question 14

Further principles applying to prohibitory injunctions

Answer 14

• the court has power to decide the extent of any prohibitory injunction, and may limit an injunction to what the court considers reasonable in all the circumstances
• prohibitory injunctions are granted only where ‘just and convenient’ (s 37 Senior Courts Act 1982)

Question 15

Substance not form

Answer 15

• the court will look at the substance of the proposed remedy when deciding whether it would amount to a prohibitory injunction or specific performance
• e.g. Sky Petroleum Ltd v VIP Petroleum Ltd: defendant agreed to supply petrol to the claimant for a set period of time. The claimant sought an injunction preventing the defendant from terminating. Although the requested injunction appeared to be in ‘negative’ terms, the effect of the injunction would be to require the defendant to supply petrol, so in substance is an order for specific performance.