Contract Law: Liquidated Damages vs Penalties - A Legal Analysis

This essay analyzes the concept of liquidated damages within contract law, contrasting them with penalties. It explores the enforceability of pre-determined damage clauses, referencing key case laws such as Andrews v Australia and New Zealand Banking Group Pty Ltd, Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd, and Ringrow Pty Ltd v BP Australia Pty Ltd. The essay argues against the straightforward assertion that liquidated damages are always a contractual right, highlighting instances where they may be deemed penalties and thus unenforceable, particularly when they are considered extravagant or unconscionable in relation to the actual damages suffered. It examines factors influencing the classification of liquidated damages as penalties, emphasizing the importance of proportionality and the bargaining power of the parties involved. The essay concludes that while liquidated damages can serve as a cap on general damages, their enforceability hinges on their fairness and alignment with the actual losses incurred, with the burden of proof resting on the party challenging the clause.

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Asin1Answer 2
“Where contracting parties have pre-determined the amount payable as damages in the
event of a breach of contract, this amount of damages should be payable as a contractual
right.”
A contract is the combination of offer, acceptance, consideration, legal intention and
consideration. Once a valid contract is made then the parties must comply with the terms of the
contract. One of the terms that are normally made part of the contract is the term of possible
remedies or damages. These are also called liquidated damages or the pre determined amount
that must be paid by the defaulting party to the aggrieved party in case of breach of contract.
The pre contractual remedies are the amount that is freely decided by the parties prior the
establishment of the contract. thus, these are the damages which can be claimed by the parties to
the contract in the event of the breach of contract as they are freely decided by the parties and
thus the courts must honor such clauses as they are made part of a private document and where
the clause is made part of the contract by mutual determination. The courts were willing to pay
the liquidated damage even when such damages are harsh on one party as they were decided
mutually by the contractual parties.1
So, can we conclude that “Where contracting parties have pre-determined the amount payable as
damages in the event of a breach of contract, this amount of damages should be payable as a
contractual right.”
The answer is NO.
In 2012, the High court of Australia in Andrews v Australia and New Zealand Banking Group
Pty Ltd [2012]2 has determined the situation wherein the liquidated damages which are usually
claimed by the contractual parties as rights cannot be held enforceable mainly when they are
treated as penalties.
So, the question arises as to when the liquidated damages are considered as penalties to make
them non enforceable in law.
It is submitted that when the liquidated damages which are mutually decided by the parties at the
time of the formation of the contract are found to be 'extravagant and unconscionable' when
compared from what was expected by the parties then such liquidated damages must be
considered as penalties, thereby, making them non-enforceable in law. it is held in Dunlop
Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915]3 and Ringrow Pty Ltd v BP
Australia Pty Ltd (2005)4 that when the damages of serious nature as opposed to trivial damages
then such are not liquidated, rather, the same must fall in the category of penalties which cannot
be asked by the contractual parties as a matter of right. Two important factors must be
considered in making any liquidated damages into penalties. The same are:5
i. That degree of difference that exist amid the damages that are pre determined by the
parties and the damages that are actually suffered by the aggrieved party;
ii. To consider the relationship that is shared amid the parties, that is, the presence of
barraging powers of the parties when the pre determined damages were anticipated by
the parties etc.
In the leading case of Ringrow Pty Ltd and BP Australia Pty Ltd established a contractual
relationship for the purchase of a service station. Ringrow Pty Ltd needs to buy fuel from BP
Australia Pty Ltd exclusively and this will allow BP Australia Pty Ltd to buy back the service
station if the contract is violated ( as per a collateral agreement). There was a contractual breach
1 Construction (2017)(online). Available at: http://www.constructionlawmadeeasy.com/Chapter12. Accessed on 7th October
2017.
2 Andrews v Australia and New Zealand Banking Group Pty Ltd [2012] HCA 30.
3 Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79.
4 Ringrow Pty Ltd v BP Australia Pty Ltd (2005) 222 ALR 306.
5 ibid
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on the part of Ringrow Pty Ltd as it bought and on-sold fuel from some other supplier. Because
of this actions of Ringrow Pty Ltd , the BP Australia Pty Ltd brought an action against Ringrow
Pty Ltd. it was submitted by Ringrow Pty Ltd that the pre determined damages that are made part
of the contract should not be enforced as a matter of right as they are in the form of penalties and
thus are un-enforceable in nature. it was decided by the court that the pre determined damages
that are decided by the parties are always enforceable unless and until they are out of proportion
considering the facts and situations and the loss that is actually suffered by the aggrieved party.
If the actual damages are extravagant then it amounts to penalty and is not enforceable. The onus
of proving that the liquidated damages must be considered as penalties rests on the party who is
denying the liquidated damages.
If the pre determined damages are decided by the parties represent a genuinely on their part then
the clause should not be considered as enforceable otherwise not and is held in Esanda Finance
Corporation v Plessnig (1989)6. In Andrews v Australia and New Zealand Banking Group Pty
Ltd , the high court simply submitted that if the pre determined damages cause are considered to
be enforceable only when they do not fall in the category of penalty. Just because the actual
damages are difficult to prove or are complex will not make them penalty in nature. The actual
damage suffered must be extravagant an out of proportion to make them penalty in nature and
making them not enforceable in law.
Thus, if the liquidated damages are found to be out of proportion they are penal in nature and
thus cannot be claimed a matter of right and thus is not enforceable in the court of law and the
same can be challenged by the affected party. The liquidated damages can be considered as a cap
on general damages when the clause is specifically confirmed as the only remedy for the breach
of contract.
Thus, it is not rightful in submitting that “Where contracting parties have pre-determined the
amount payable as damages in the event of a breach of contract, this amount of damages should
be payable as a contractual right.” The statement is not true if the pre determined damages are
extravagant as they then are penal in nature and is not enforceable in law.
6 Esanda Finance Corporation v Plessnig (1989) 166 CLR 131.
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Reference List
Case laws
Andrews v Australia and New Zealand Banking Group Pty Ltd [2012] HCA 30.
Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79.
Esanda Finance Corporation v Plessnig (1989) 166 CLR 131.
Ringrow Pty Ltd v BP Australia Pty Ltd (2005) 222 ALR 306.
Online Material
Construction (2017)(online). Available at: http://www.constructionlawmadeeasy.com/Chapter12.
Accessed on 7th October 2017.
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