Liquidated damages

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Liquidated damages, also referred to as liquidated and ascertained damages (LADs), [1] are damages whose amount the parties designate during the formation of a contract [2] for the injured party to collect as compensation upon a specific breach (e.g., late performance). [3] This is most applicable where the damages are intangible.

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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). [4]

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, 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, [5] [6] [7] in which case it is referred to as a penal or penalty clause. [8] One reason for this is that the enforcement of the term would, in effect, require an equitable order of specific performance. However, courts sitting in equity will seek to achieve a fair result and will not enforce a term that will lead to the unjust enrichment of the enforcing party.[ citation needed ]

For a liquidated damages clause to be upheld, two conditions must be met.

  1. The amount of the damages identified must roughly approximate the damages likely to fall upon the party seeking the benefit of the term [8] as assessed at the time when the agreement of contract was entered into. [9]
  2. 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. [10]

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. [11] [12]

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, 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). [13]

Uniform Commercial Code

In the United States, Section 2-718(1) of the Uniform Commercial Code provides that, in contracts for the sale of goods: [14]

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.[ citation needed ]

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 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. [9]

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 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 ) that terms in bank account contracts were not capable of being penal, bar those applicable to NatWest Bank customers between 2001 and 2003. [15] 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. [13]

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. [16] 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). [17] 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. [18] 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

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. [19]

Article 420-1 of the Civil Code of Japan provides an even firmer basis to uphold contractual penalties: [20]

  1. 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.
  2. The liquidated damages shall not preclude the demand for performance or the exercise of the cancellation right.
  3. Any penalty is presumed to constitute liquidated damages.

In the U.S. state of Louisiana, which follows a civil law system, liquidated damages are referred to as "stipulated damages". [21] Prior to 1 January 1985, Louisiana law used the term “penal clause” under former article 2117 of the Civil Code. [22] 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. [23] 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". [24]

Islamic law

Islamic law prohibits gharar (uncertainty) in contracts, and liquidated damages provisions are a favored mechanism to overcome uncertainty regarding contractual damages. [25]

Related Research Articles

At common law, damages are a remedy in the form of a monetary award to be paid to a claimant as compensation for loss or injury. To warrant the award, the claimant must show that a breach of duty has caused foreseeable loss. To be recognised at law, the loss must involve damage to property, or mental or physical injury; pure economic loss is rarely recognised for the award of damages.

<span class="mw-page-title-main">Indemnity</span> Type of contractual obligation

In contract law, an indemnity is a contractual obligation of one party to compensate the loss incurred by another party due to the relevant acts of the indemnitor or any other party. The duty to indemnify is usually, but not always, coextensive with the contractual duty to "hold harmless" or "save harmless". In contrast, a "guarantee" is an obligation of one party to another party to perform the promise of a relevant other party if that other party defaults.

Punitive damages, or exemplary damages, are damages assessed in order to punish the defendant for outrageous conduct and/or to reform or deter the defendant and others from engaging in conduct similar to that which formed the basis of the lawsuit. Although the purpose of punitive damages is not to compensate the plaintiff, the plaintiff will receive all or some of the punitive damages in award.

This aims to be a complete list of the articles on real estate.

A legal remedy, also referred to as judicial relief or a judicial remedy, is the means with which a court of law, usually in the exercise of civil law jurisdiction, enforces a right, imposes a penalty, or makes another court order to impose its will in order to compensate for the harm of a wrongful act inflicted upon an individual.

Resale price maintenance (RPM) or, occasionally, retail price maintenance is the practice whereby a manufacturer and its distributors agree that the distributors will sell the manufacturer's product at certain prices, at or above a price floor or at or below a price ceiling. If a reseller refuses to maintain prices, either openly or covertly, the manufacturer may stop doing business with it. Resale price maintenance is illegal in many jurisdictions.

A civil penalty or civil fine is a financial penalty imposed by a government agency as restitution for wrongdoing. The wrongdoing is typically defined by a codification of legislation, regulations, and decrees. The civil fine is not considered to be a criminal punishment, because it is primarily sought in order to compensate the state for harm done to it, rather than to punish the wrongful conduct. As such, a civil penalty, in itself, will not carry jail time or other legal penalties. For example, if a person were to dump toxic waste in a state park, the state would have the same right to seek to recover the cost of cleaning up the mess as would a private landowner, and to bring the complaint to a court of law, if necessary.

<span class="mw-page-title-main">Unconscionability</span> Doctrine in contract law

Unconscionability is a doctrine in contract law that describes terms that are so extremely unjust, or overwhelmingly one-sided in favor of the party who has the superior bargaining power, that they are contrary to good conscience. Typically, an unconscionable contract is held to be unenforceable because no reasonable or informed person would otherwise agree to it. The perpetrator of the conduct is not allowed to benefit, because the consideration offered is lacking, or is so obviously inadequate, that to enforce the contract would be unfair to the party seeking to escape the contract.

<span class="mw-page-title-main">Penal damages</span>

Penal damages are liquidated damages which exceed reasonable compensatory damages, making them invalid under common law. While liquidated damage clauses set a pre-agreed value on the expected loss to one party if the other party were to breach the contract, penal damages go further and seek to penalise the breaching party beyond the reasonable losses from the breach. Many clauses which are found to be penal are expressed as liquidated damages clauses but have been seen by courts as excessive and thus invalid.

Misleading or deceptive conduct is a doctrine of Australian law.

<span class="mw-page-title-main">Expectation damages</span>

Expectation damages are damages recoverable from a breach of contract by the non-breaching party. An award of expectation damages protects the injured party's interest in realising the value of the expectancy that was created by the promise of the other party. Thus, the impact of the breach on the promisee is to be effectively "undone" with the award of expectation damages.

<span class="mw-page-title-main">Efficient breach</span>

In legal theory, particularly in law and economics, efficient breach is a voluntary breach of contract and payment of damages by a party who concludes that they would incur greater economic loss by performing under the contract.

The UK default charges controversy was an issue in consumer law, relating to the level of fees charged by banks and credit card companies for late or dishonoured payments, exceeding credit limits, etc.

Reliance damages is the measure of compensation given to a person who suffered an economic harm for acting in reliance on a party who failed to fulfill their obligation. If the injured party could go back in time, they should be indifferent to entering into the contract that would be breached and receiving the reliance damages as opposed to not entering into any contract with the breaching party. The injured party should be put in a substantially similar situation position as they would have been had the contract not been entered into. This is different from expectation damages, where the injured party should be indifferent between the fulfillment of the contract and never having entered into the contract.

<i>Office of Fair Trading v Abbey National plc</i>

Office of Fair Trading v Abbey National plc and Others[2009] UKSC 6is 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.

<span class="mw-page-title-main">Contract</span> Legally binding document establishing rights and duties between parties

A contract is an agreement that specifies certain legally enforceable rights and obligations pertaining to two or more mutually agreeing parties. A contract typically involves the transfer of goods, services, money, or a promise to transfer any of those at a future date, and the activities and intentions of the parties entering into a contract may be referred to as contracting. In the event of a breach of contract, the injured party may seek judicial remedies such as damages or rescission. A binding agreement between actors in international law is known as a treaty.

A take-or-pay contract is a rule structuring negotiations between companies and their suppliers. With this kind of contract, the company either takes the product from the supplier or pays the supplier a penalty. For any product the company takes, they agree to pay the supplier a certain price, say $50 per ton. Furthermore, up to an agreed-upon ceiling, the company is required to pay the supplier even for products they do not take. This "penalty" price is lower, say $40 a ton.

<i>Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd</i> English contract law case

Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd[1914] UKHL 1 is an English contract law case, concerning the extent to which damages may be sought for failure to perform of a contract when a sum is fixed in a contract. It held that only if a sum is of an unconscionable amount will it be considered penal and unenforceable. The legal standing of this case has been superseded by the Supreme Court's 2015 ruling in the combined cases of Cavendish Square Holding BV v Talal El Makdessi and ParkingEye Ltd v Beavis.

<span class="mw-page-title-main">Penalties in English law</span>

Penalties in English law are contractual terms which are not enforceable in the courts because of their penal character. Since at least 1720 it has been accepted as a matter of English contract law that if a provision in a contract constitutes a penalty, then that provision is unenforceable by the parties. However, the test for what constitutes a penalty has evolved over time. The Supreme Court most recently restated the law in relation to contractual penalties in the co-joined appeals of Cavendish Square Holding BV v Talal El Makdessi, and ParkingEye Ltd v Beavis.

<i>Cavendish Square Holding BV v Talal El Makdessi</i> English contract law case

Cavendish Square Holding BV v Talal El Makdessi[2015] UKSC 67, together with its companion case ParkingEye Ltd v Beavis, are English contract law cases concerning the validity of penalty clauses and the application of the Unfair Terms in Consumer Contracts Directive. The UK Supreme Court ruled on both cases together on 4 November 2015, updating the established legal rule on penalty clauses and replacing the test of whether or not a disputed clause is "a genuine pre-estimate of loss" with a test asking whether it imposed a proportionate detriment in relation to any "legitimate interest" of the innocent party.

References

  1. ↑ Barker, C., Construction: Law: Liquidated Ascertained Damages (LADs), published 14 August 2018, accessed 15 May 2020.
  2. ↑ Lehman, Jeffrey; Phelps, Shirelle (2005). West's Encyclopedia of American Law, Vol. 3 (2 ed.). Detroit: Thomson/Gale. p. 180. ISBN   9780787663674.
  3. ↑ Lehman, Jeffrey; Phelps, Shirelle (2005). West's Encyclopedia of American Law, Vol. 7 (2 ed.). Detroit: Thomson/Gale. p. 58. ISBN   9780787663742.
  4. ↑ Office of Fair Trading, "Calculating fair default charges in credit card contracts: A statement of the OFT's position", published April 2006, accessed 15 May 2020.
  5. ↑ Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd [1914] UKHL 1 , [1915] AC 79.
  6. ↑ Amev-Udc Finance Ltd v Austin [1986] HCA 63 , (1986) 162 CLR 170, High Court (Australia).
  7. ↑ Esanda Finance Corp v Plessnig [1989] HCA 7 , (1989) 166 CLR 131, High Court (Australia).
  8. 1 2 Goetz, Charles J.; Scott, Robert E. (1977). "Liquidated damages, penalties and the Just Compensation rule: Some notes on an enforcement model and a theory of efficient breach". Columbia Law Review. 77 (4): 554–594. doi:10.2307/1121823. JSTOR   1121823.
  9. 1 2 Deane, J., Liquidated damages clause unenforceable?, Gannons Solicitors, accessed 5 March 2021.
  10. ↑ British Institute of Facilities Management, Getting Started with the NEC3 Term Services Contract, accessed 23 June 2015.
  11. ↑ Fordham Law Review, Liquidated Damages: A Comparison of the Common Law and the Uniform Commercial Code, 1977, accessed 5 March 2021.
  12. ↑ Bailey, A. L. and Treiman, D., Defining the Limits of Liquidated Damages Clauses, published 31 December 2014.
  13. 1 2 Andrews v Australia and New Zealand Banking Group Limited [2012] HCA 30. "judgment summary" (PDF). High Court (Australia). 6 September 2012.
  14. ↑ "§ 2-718. Liquidation or Limitation of Damages; Deposits". Legal Information Institute. 2012-11-20. Retrieved 17 March 2015.
  15. ↑ "The Office of Fair Trading: OFT welcomes High Court ruling on unarranged overdraft charges". Archived from the original on 2009-01-23. Retrieved 2009-05-05.
  16. ↑ Paciocco v Australia and New Zealand Banking Group Limited [2014] FCA 35 (5 February 2014), Federal Court (Australia).
  17. ↑ Australia and New Zealand Banking Group Limited v Paciocco [2015] FCAFC 78 (5 June 2015), Federal Court (Full Court) (Australia).
  18. ↑ Paccioco v Australia and New Zealand Banking Group Limited [2016] HCA 28 "judgment summary" (PDF). High Court (Australia). 27 July 2016.
  19. ↑ Clarke, Joanne. ""Clause pénale" v. liquidated damages – any similarities?". Kluwer Construction Blog. Archived from the original on 2 April 2015. Retrieved 17 March 2015.
  20. ↑ "Civil Code" (PDF). Ministry of Justice (Japan). Retrieved 17 March 2015.
  21. ↑ Louisiana Civil Code, Article 2005: Parties may stipulate the damages to be recovered in case of nonperformance, defective performance, or delay in performance of an obligation. http://legis.la.gov/Legis/LawSearchList.aspx accessed 23 June 2015.
  22. ↑ Louisiana Court of Appeal, Second Circuit, Mary Mobley v. Gary Mobley, No. 37,364-CA "Archived copy" (PDF). Archived from the original (PDF) on 2015-06-23. Retrieved 2015-06-23.{{cite web}}: CS1 maint: archived copy as title (link)
  23. ↑ Louisiana Civil Code, Article 2007, accessed 23 June 2015.
  24. ↑ Louisiana Civil Code, Article 2012 http://legis.la.gov/Legis/Law.aspx?d=109269 accessed 23 June 2015. See also Isom, H. Chervis. "Specific Performance: The Importance of a Clear Liquidated Damage Provision". Baker Donelson. Retrieved 17 March 2015.
  25. ↑ Jobst, Andreas A.; Solé, Juan (March 2012). "Operative Principles of Islamic Derivatives – Towards a Coherent Theory" (PDF). IMF. International Monetary Fund. pp. 16, 27. Retrieved 11 November 2021.

See also

Cavendish Square Holding BV v Talal El Makdessi [2015] UKSC 67 , Supreme Court (UK)

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