Liquidated Damages vs. Penalty: Are Causation and Loss Required?
Liquidated Damages v. Penalty
Are Causation and Loss Really Required?,
Pooja Sharma*
In a contract, the parties may name a sum to be payable in the event of breach. If such sum is a genuine pre estimate of loss it is termed liquidated damages, and if it bears no reflection on the loss suffered, it is termed a penalty. Courts are reluctant to enforce penalty clauses and in such cases the sum stipulated is normally reduced. It has been perceptively observed by Fansworth that in comparison to the bargaining power which parties enjoy in negotiating their substantive contractual rights and duties, their power to bargain over their remedial rights is surprisingly limited. They are not at liberty to name an extravagant sum having no relation to the breach, for fear of it being construed as a penalty. It is interesting to contrast this with the law relating to consideration. A man may sell his car for a handful of marbles, and the law cares not, as long as he is satisfied. Yet the law would give no peace to a man who claims ten thousand rupees for failure to deliver a handful of marbles, branding such a clause penal.
The Position in England
It is stated in a standard work that the specification of damages by the parties does not exclude the rule that damages for loss are expected to compensate for actual loss suffered. The major distinction between English and Indian law upon the point is that under English law, penalties are irrecoverable. In case of a penal clause, damages will be assessed in the usual way, and the plaintiff may even recover a sum greater than the stipulated amount.
In discerning the true nature of the contract and the compensation payable, the court must have regard to the terms and inherent circumstances at the time of the making of the contract and not at the time the breach occurred. The terms used by the parties are not conclusive and the court is not bound by their phraseology. If a term is stated to be a penalty but turns out to be a
Are Causation and Loss Really Required?,
Pooja Sharma*
In a contract, the parties may name a sum to be payable in the event of breach. If such sum is a genuine pre estimate of loss it is termed liquidated damages, and if it bears no reflection on the loss suffered, it is termed a penalty. Courts are reluctant to enforce penalty clauses and in such cases the sum stipulated is normally reduced. It has been perceptively observed by Fansworth that in comparison to the bargaining power which parties enjoy in negotiating their substantive contractual rights and duties, their power to bargain over their remedial rights is surprisingly limited. They are not at liberty to name an extravagant sum having no relation to the breach, for fear of it being construed as a penalty. It is interesting to contrast this with the law relating to consideration. A man may sell his car for a handful of marbles, and the law cares not, as long as he is satisfied. Yet the law would give no peace to a man who claims ten thousand rupees for failure to deliver a handful of marbles, branding such a clause penal.
The Position in England
It is stated in a standard work that the specification of damages by the parties does not exclude the rule that damages for loss are expected to compensate for actual loss suffered. The major distinction between English and Indian law upon the point is that under English law, penalties are irrecoverable. In case of a penal clause, damages will be assessed in the usual way, and the plaintiff may even recover a sum greater than the stipulated amount.
In discerning the true nature of the contract and the compensation payable, the court must have regard to the terms and inherent circumstances at the time of the making of the contract and not at the time the breach occurred. The terms used by the parties are not conclusive and the court is not bound by their phraseology. If a term is stated to be a penalty but turns out to be a