LIQUIDATED DAMAGES IN A CONTRACT

A large manufacturing company has begun a project to increase the size of their premises. The procurement team has estimated that if the main supplier fails to complete the project on schedule it will incur cost and losses of $20,000 per day for every day there is a delay

Which is the best way to put this as a clause in a contract with the supplier? Liquidated damages, that’s how.

What are liquidated damages in a contract?

At times the parties to a contract may agree, during the formation of a contract that in the event of a breach, the damages shall be a fixed sum or shall be calculated in a specific manner. Such kind of damages is referred to as liquidated damages, that is, the monetary compensation amount that has been specifically agreed to by the parties privy to the contract.

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If the parties do not have such a clause in their contract then what will happen in case of a breach is unliquidated damages. This means how much one is compensated will be left for the courts to decide. The thing to note about liquidated damages is that one only pays what they agreed to, assuming the damages are legit.

For instance

Cellulose acetate Silk Co v. Widnes Foundry (1933)

W agreed to erect a plant for C by certain date, and also agreed to pay £20 for every week they took beyond that date. They were 30 weeks late, and C claimed £5,850, which was their actual loss from the delay.

HELD: W had only agreed to pay £20 a week for delay and were not liable for more.

Liquidated damages and penalties

When a contact states that, on a breach, a fixed amount of money is to be paid by the responsible party, the question is whether this amount is a penalty or liquidated damages. The need to distinguish these two is important because if it is a penalty then actual damages suffered can be claimed, while if it is liquidated damages the sum fixed can be recovered.

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The rules for distinguishing a penalty from liquidated damages are:

#1 the fact that you have used the word “penalty” or “liquidated damages” in a contract is not conclusive. Courts will have to decide should there be an issue

#2 the idea behind penalty is the payment of money stipulated as in terrorem (in terror, threat) of the offending party. This is to say, the intent is to compel the performance of the contract by providing something by way of punishment if the contract is not performed. This differs from liquidated damage, which is a genuine pre-estimate of the loss.

#3 if the amount stipulated is bigger than the greatest loss that could be conceivably proved to have followed from the breach, then the amount is liquidated damages.

For instance:

Lamdon Trust Ltd v Hurrell (1955)

Under a hire purchase agreement in respect of a motor car the purchase price was £558, H paid a deposit and four instalments amounting to £ 302, but failed to pay the fifth instalment. L terminated the agreement, retook possession of the car and sold it for £270. L claimed £122 under a clause making H liable to pay in respect of “depreciation” a sum sufficient to bring his total payments up to £425 which was approximately three-quarters of the purchase price.

HELD: the sum of £425 was not a genuine pre-estimate of damage but was an extravagant and extortionate sum held in terrorem over the head of the hirer. It was a penalty and as such not recoverable

#4 if the breach is as a result of not paying a given amount by a given time, and the fixed amount you are to pay in the event of this breach is greater than the actual amount you did not pay, then the fixed amount is a penalty.

For example:

John agrees to pay Cate £425 on June 1, and, if he fails to make the payment at the stipulated time, he is to pay £500 as liquidated damages. The extra £75 will be a penalty and irrecoverable.

# 5 when a single sum is made payable on the occurrence of one or more of several events, some of which may occasion serious and others trifling damage, there is a presumption (but no more) that the sum is a penalty

Example

Kemble v Farren (1829)

Farren agreed to act at Kemble’s theatre and to conform to all the regulations of the theatre. Each party agreed on breach by either of them of the agreement to pay £1,000 as liquidated damages. Farren broke the contract, and the jury assessed the damages at £750.

HELD: the £1,000 was a penalty because it was payable even if Farren had broken any of the smallest regulations of the theatre, and Kemble could only recover £750.

#6 A clause providing that in case of actual loss suffered by another party, another party shall indemnify the first-named party for the loss is not a penalty clause