Liquidated damages, also referred to as liquidated and ascertained damages (LADs), are damages whose amount the parties designate during the formation of a
contract
A contract is a legally enforceable agreement between two or more parties that creates, defines, and governs mutual rights and obligations between them. A contract typically involves the transfer of goods, services, money, or a promise to tran ...
for the injured party to collect as compensation upon a specific breach (e.g., late performance).
This is most applicable where the damages are intangible, such as a failure by the contractor on a public project to fulfill minority business subcontracting quotas.
An average of the likely costs which may be incurred in dealing with a breach may be used. Authority for the proposition that averaging is the appropriate approach may be taken from the case of ''English Hop Growers v Dering'', 2 KB 174, CA (1928).
When damages are not predetermined/assessed in advance, then the amount recoverable is said to be "at large" (to be agreed or determined by a court or tribunal in the event of breach).
The purpose of a liquidated damages clause is to increase certainty and avoid the legal costs of determining actual damages later if the contract is breached. Thus, they are most appropriate when (a) the parties can agree in advance on reasonable compensation for breach, but (b) the court would have a difficult time determining fair compensation at the time of breach. Under the common law, liquidated damages may not be set so high that they are penalty clauses rather than fair compensation.
Common law
Generally, at
common law
In law, common law (also known as judicial precedent, judge-made law, or case law) is the body of law created by judges and similar quasi-judicial tribunals by virtue of being stated in written opinions."The common law is not a brooding omnipresen ...
, a liquidated damages clause will not be enforced if its purpose is to punish the party in breach rather than to compensate the injured party,
[.][.] in which case it is referred to as a
penal or penalty clause.
One reason for this is that the enforcement of the term would, in effect, require an equitable order of
specific performance
Specific performance is an equitable remedy in the law of contract, whereby a court issues an order requiring a party to perform a specific act, such as to complete performance of the contract. It is typically available in the sale of land law, ...
. However, courts sitting in
equity
Equity may refer to:
Finance, accounting and ownership
* Equity (finance), ownership of assets that have liabilities attached to them
** Stock, equity based on original contributions of cash or other value to a business
** Home equity, the dif ...
will seek to achieve a fair result and will not enforce a term that will lead to the
unjust enrichment
In laws of equity, unjust enrichment occurs when one person is enriched at the expense of another in circumstances that the law sees as unjust. Where an individual is unjustly enriched, the law imposes an obligation upon the recipient to make res ...
of the enforcing party.
For a liquidated damages clause to be upheld, two conditions must be met.
# The amount of the damages identified must roughly approximate the damages likely to fall upon the party seeking the benefit of the term
as assessed at the time when the agreement of contract was entered into.
[Deane, J.]
Liquidated damages clause unenforceable?
Gannons Solicitors, accessed 5 March 2021
# The damages must be sufficiently uncertain at the time the contract is made that such a clause will likely save both parties the future difficulty of estimating damages.
Damages that are sufficiently uncertain may be referred to as unliquidated damages, and may be so categorized because they are not mathematically calculable or are subject to a
contingency.
Contracts in the
NEC3 family use the term 'low service damages' (optional clause X.17) and generally include a Low Service Damages Schedule.
Contracts under common law require there to have been some attempt to create an equal or reasonably proportionate quota between the damages made and the actual loss. Parties must not lose sight of the principal compensation and they must keep the time of execution and the difficulty of the calculations in mind when drafting the contract.
;Example
Anna Abbot agrees to lease a store-front to Bob Benson, from which Benson intends to sell jewellery. If Abbot breaches the contract by refusing to lease the store-front at the appointed time, it will be difficult to determine what profits Benson will have lost because the success of newly created small businesses is highly uncertain. This, therefore, would be an appropriate circumstance for Benson to insist upon a liquidated damages clause in case Abbot fails to perform.
The definition and scope extended
In
Australia
Australia, officially the Commonwealth of Australia, is a Sovereign state, sovereign country comprising the mainland of the Australia (continent), Australian continent, the island of Tasmania, and numerous List of islands of Australia, sma ...
, the definition of liquidated damages applies to the situations where upon the failure of a primary stipulation, imposes a detriment to the first party or a benefit to the second party by a secondary stipulation collateral to the primary stipulation (i.e. it does not have to be a breach).
[.]
Uniform Commercial Code
In the United States, Section 2-718(1) of the
Uniform Commercial Code
The Uniform Commercial Code (UCC), first published in 1952, is one of a number of Uniform Acts that have been established as law with the goal of harmonizing the laws of sales and other commercial transactions across the United States through UC ...
provides that, in contracts for the sale of goods:
Damages for breach by either party may be liquidated in the agreement but only at an amount which is reasonable in the light of the anticipated or actual harm caused by the breach, the difficulties of proof of loss, and the inconvenience or nonfeasibility of otherwise obtaining an adequate remedy. A term fixing unreasonably large liquidated damages is void as a penalty.
This largely mirrors the common law rule, which applies to other types of contracts under the law of most US states.
Case law
In the case of construction contracts, courts have occasionally refused to enforce liquidated damages provisions, choosing to follow the
doctrine of concurrent delay when both parties have contributed to the overall delay of the project.
In the 2015 case of Unaoil Ltd v Leighton Offshore PTE Ltd., a Memorandum of Understanding (MoU) between the two parties detailed plans for Leighton to
sub-contract
A subcontractor is an individual or (in many cases) a business that signs a contract to perform part or all of the obligations of another's contract.
Put simply the role of a subcontractor is to execute the job they are hired by the contractor ...
work to Unaoil if they won a bid for a construction and engineering contract. The MoU included an agreement on liquidated damages. The MoU was amended on two occasions after it had been agreed, including an amendment to the amount to be paid to Unaoil. The court found that although the liquidated damages clause may have been based on a genuine pre-estimate of loss at the time the MoU was agreed, it had not been reviewed or amended at the times when the agreement was amended and therefore was unenforceable. The ruling means that when a contract is being amended, particularly if the amendment is relevant to the value of the contract, any liquidated damages clauses should be reviewed and amended if necessary.
The law applied to bank and credit card charges
United Kingdom
UK bank and credit card customers were being charged as much as £39 for a single transaction taking them over their credit limit. Consumers argued these charges were well beyond the cost of sending a computerised letter.
In 2007 the
Office of Fair Trading
The Office of Fair Trading (OFT) was a non-ministerial government department of the United Kingdom, established by the Fair Trading Act 1973, which enforced both consumer protection and competition law, acting as the United Kingdom's economic ...
investigated the charges being imposed on customers of credit card companies. In its report, the OFT claimed these charges were unlawful under UK law as they amounted to a penalty. It said it would be prepared to investigate any charge over £12, though this was not intended to indicate that £12 is a fair and acceptable charge. The OFT said it would be up to a court to determine such an amount based on the established legal precedent that the only recoverable cost would be actual costs incurred.
The credit card companies did not produce evidence of their actual costs to the OFT, instead insisting their charges are in line with clear policy and information provided to customers.
Receipt of liquidated damages and intimately linked with the purpose of the profit-making apparatus, is a capital receipt. The amount received by the assessee towards compensation for sterilization of the profit earning source is not in the ordinary course of business. Hence, it is a capital receipt in the hands of the assessee.
In 2009 the Supreme Court ruled (''see
Office of Fair Trading v Abbey National plc
is a judicial decision of the United Kingdom Supreme Court relating to bank charges in the United Kingdom, with reference to the situation where a bank account holder goes into unplanned overdraft.
When a bank customer uses an unplanned overdra ...
'') that terms in bank account contracts were not capable of being penal, bar those applicable to NatWest Bank customers between 2001 and 2003. The court ruled that the charges were a charge for a service, and not a penalty for damages for breaching a contract term.
Australia
In 2012, the High Court of Australia allowed an appeal against findings of the Federal Court of Australia that 'exception fees' imposed by the ANZ Bank could not constitute an unenforceable penalty. The High Court found that fees were not incapable of being characterised as penalties merely because they were not charged upon breach of contract.
Conversely, in 2014, the federal court (Gordon J) described $35 late payment fees by ANZ Banking Group to customers who failed to make their monthly minimum credit card repayment as being “extravagant, exorbitant and unconscionable” and ordered for these fees to be reimbursed. ANZ appealed.
In 2015, the full court overturned Justice Gordon’s first instance judgment that credit card late payment fees charged by ANZ to its customers constituted penalties at law and equity (and were therefore largely unenforceable). The decision otherwise upholds Justice Gordon's findings that honour, dishonour and overlimit fees charged by ANZ were not penalties, unconscionable or unfair. While the decision is very fact specific, it represented a major setback for other class actions based on penalties. Paciocco appealed to the High Court.
The last chapter of the bank fees saga took place in July 2016 where the High Court dismissed the appeal for leave and held that the full court was correct to characterise the loss provision costs, regulatory capital costs and collection costs as affecting the legitimate interests of the Bank.
[ ] The Court asserted that the fact that those categories of costs could not be recovered in an action for damages did not alter that conclusion. Further, neither the fact that the late payment fees were not genuine pre-estimates of damage nor the fact that the amounts charged were disproportionate to the actual loss suffered by itself rendered the late payment fees penalties
High Court
Other legal systems
Civil law
Civil law systems generally impose less severe restrictions on liquidated damages. For example, Article 1226 of the
French Civil Code provides for ''clause pénale'', a variant of liquidated damages which combines compensatory and coercive elements. Judges may adjust excessive contract penalties, but such clauses are not generally void as a matter of French law.
Article 420-1 of the
Civil Code of Japan
The law of Japan refers to legal system in Japan, which is primarily based on legal codes and statutes, with precedents also playing an important role. Japan has a civil law legal system with six legal codes, which were greatly influenced by Ger ...
provides an even firmer basis to uphold contractual penalties:
# The parties may agree on the amount of the liquidated damages with respect to the failure to perform the obligation. In such case, the court may not increase or decrease the amount thereof.
# The liquidated damages shall not preclude the demand for performance or the exercise of the cancellation right.
# Any penalty is presumed to constitute liquidated damages.
In the U.S. state of
Louisiana
Louisiana , group=pronunciation (French: ''La Louisiane'') is a state in the Deep South and South Central regions of the United States. It is the 20th-smallest by area and the 25th most populous of the 50 U.S. states. Louisiana is borde ...
, which follows a civil law system, liquidated damages are referred to as "stipulated damages". Prior to 1 January 1985, Louisiana law used the term “penal clause” under former article 2117 of the
Civil Code
A civil code is a codification of private law relating to property, family, and obligations.
A jurisdiction that has a civil code generally also has a code of civil procedure. In some jurisdictions with a civil code, a number of the core ar ...
. Stipulated damages create a secondary obligation for the purpose of enforcing the principal obligation. The aggrieved party may demand either the stipulated damages or performance of the principal obligation, but may not demand both except for delay. Stipulated damages may not be modified by the court (and will therefore be enforced) "unless they are so manifestly unreasonable as to be contrary to public policy".
Islamic law
Islamic law
Sharia (; ar, شريعة, sharīʿa ) is a body of religious law that forms a part of the Islamic tradition. It is derived from the religious precepts of Islam and is based on the sacred scriptures of Islam, particularly the Quran and the ...
prohibits ''
gharar
''Gharar'' ( ar, غرر) literally means uncertainty, hazard, chance or risk. It is a negative element in ''mu'amalat'' ''fiqh'' (transactional Islamic jurisprudence), like '' riba'' (usury) and '' maysir'' (gambling).
One Islamic dictionary (''A ...
'' (uncertainty) in contracts, and liquidated damages provisions are a favored mechanism to overcome uncertainty regarding contractual damages.
References
See also
{{cite BAILII , litigants=Cavendish Square Holding BV v Talal El Makdessi , year=2015 , court=UKSC , num=67 , courtname=auto
*
Unspecified claim
An unspecified claim is a tort claim "where the amount to be awarded is left to the Court to determine."
Examples of unspecified claims are unspecified damages for personal injuries, such as from a motor vehicle accident (MVA) or medical malpracti ...
*
Penal bond
A penal bond is a written instrument executed between an obligor and an obligee designed to secure the performance of a legal obligation through the '' in terrorem'' effect of the threat of a penalty for nonperformance.
Types of bonds
At its s ...
Contract law
Facilities engineering
Judicial remedies