Liquidated damages should be distinguished from penalty clauses.
Liquidated damages are a reasonable estimate of the amount which would
be needed to put right a defect, and are agreed by the parties. These have
some merit in that they save time if a breach arises, they enable parties to
make an informed decision whether to continue or to breach, and they help
parties to make insurance estimates. A penalty clause is seen as a kind of
threat within a contract and will not be upheld by the court.
Unliquidated damages are intended to compensate the victim and it would
be reasonable to assume that there is an assessment of loss and that this is
the amount to be awarded. However, the court has a large role to play in
assessment, and a fair amount of discretion. Although the basic principle of
awarding damages is purely to compensate, the exact measure can also be
used to express disapproval or to have a deterrent effect (although it could
be questioned whether this should be the role of the criminal law).
Unliquidated damages can be divided into:
- substantial damages (a normal claim reflecting the loss as accurately as
possible) - nominal damages (a minimum amount, acknowledging merely that a
party has won) - exemplary damages (an unusually large amount, representing more than
the actual loss, awarded to show the court’s disapproval of the party at
fault – these are not awarded very often).
Basis of assessment
The normal basis for awarding damages in contract is for loss of bargain,
sometimes known as an expectation basis. The aim is restitutio in
integrum, and this is best explained in the words of Parke B in Robinson v
Harman (1848):
226 Contract law
Dunlop Pneumatic Tyres v New Garage (1915)
Some principles emerged from this case, perhaps the most important
being that:- the use of the words ‘penalty clause’ or ‘liquidated damages’ is not
conclusive, as it is for the courts to decide within which of these
categories a terms falls - an obligation to pay an amount of money which is ‘extravagant and
unconscionable’ compared to the value of the contract may be an
indication that a clause is a penalty clause.