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It may seem like a good idea to insert into a contract a clause to the effect that X must do Y by a certain date and if they do not, they have to pay £100 for every day that they are in default. However, are such clauses enforceable?

The scenario outlined above is a primary obligation (X must do Y) and the liability to pay damages for each day X fails to comply with its obligation is a secondary obligation. But is the payment of the £100 a day enforceable or is it a penalty? The authoritative decision is the decision of the Supreme Court in Cavendish Square v El Makdessi / ParkingEye Ltd v Beavis where the court held:

“The true test is whether the impugned provision is a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation. The innocent party can have no proper interest in simply punishing the defaulter. His interest is in performance or in some appropriate alternative to performance. In the case of a straightforward damages clause, that interest will rarely extend beyond compensation for the breach, and we therefore expect that Lord Dunedin’s four tests [in Dunlop] would usually be perfectly adequate to determine its validity. But compensation is not necessarily the only legitimate interest that the innocent party may have in the performance of the defaulter’s primary obligations.”

Generally the obligation to pay, if it is no greater than a genuine estimate of the loss that would arise from the failure / breach, will be enforceable, particularly if the parties were commercial parties of equal bargaining power who came to an express agreement to provide for liquidated damages.

However, what if the amount payable is not a genuine estimate of loss?

Lord Dunedin’s four tests are as follows:

  • A clause may be penal if it is extravagant in amount by comparison to the maximum possible loss from the breach.
  • A clause may be penal if the breach of contract consists only of not paying a sum of money, and the amount stipulated as damages is greater than the sum that ought to have been paid if damages had been assessed at common law
  • A clause may be penal when a single lump sum is made payable by way of compensation, on the occurrence of one or more events, some of which may cause serious and others “trifling” damage.
  • A clause is not a penalty merely because a precise pre-estimation of loss is impossible.

Even if the obligation to pay is a penalty, all may not be lost. The consequence of a clause providing for penal liquidated damages is that the clause remains in the contract, and that damages are to be calculated by reference to the normal approach to assessment of damages for breach of contract. It does not necessarily mean that the clause is removed from the contract (Jobson v Johnson [1989])

This blog was written by:  Michael Stewart

DISCLAIMER: Please note that this post sets out the general position under the general law. It should not be acted upon in any specific circumstances without taking specific legal advice as to those circumstances. Also, it should not be relied upon, acted upon or treated as a substitute for specific advice relevant to particular circumstances. If you do require specific advice please contact us for assistance.