Agreed Damages Clauses - Back to the Future?
Journal of Contract Law, Vol. 22, No. 2, pp. 189-198, 2006
11 Pages Posted: 31 Jul 2007
If characterised as a liquidated damages clause, an agreed damages provision is valid and enforceable. But the provision will be invalid and unenforceable if properly characterised as a penalty. The characterisation of an agreed damages provision must be made as a matter of law not fact, and the intention expressed by the parties is therefore not conclusive.
The locus classicus of the principles regulating the characterisation process is, of course, Lord Dunedin's speech in Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd. Under those principles the essential issue is whether the parties arrived at a genuine pre-estimate of the loss likely to be suffered on breach of the provision to which the clause relates. In Socony Mobil Oil Co Inc v West of England Ship Owners Mutual Insurance Association Ltd (The Padre Island) (No 2), Bingham LJ suggested that the principles stated in Dunlop "have been the subject of remarkably little judicial development". Arguably, however, that is a matter of focus or perspective. Thus, in AMEV-UDC Finance Ltd v Austin Mason and Wilson JJ appear to have thought otherwise. Focusing on the chattel lease and hire-purchase cases, they clearly detected a movement from the general requirement of genuineness emphasised in Dunlop to something akin to a requirement of substantial accuracy, at least in relation to an agreed damages provision applicable on termination of such a contract.
In its recent decision in Ringrow Pty Ltd v BP Australia Pty Ltd, the High Court of Australia approved the notion that an agreed sum is is a penalty if the amount stipulated is, in the circumstances 'out of all proportion' to, or 'significantly greater' than the damage likely to be suffered as a result of breach. Moreover, the High Court appears to have treated the 'out of all proportion' test as having general application. Although that is, indeed, a return to Dunlop, it would be naive to suggest that the High Court intended the test to be applied in all cases.
Keywords: Contract law, damages, liquidated damages, penalties, good faith
JEL Classification: K12, K10
Suggested Citation: Suggested Citation