Comparative Contract Damages and Penalty Provisions
Presented at Free University of Tbilisi, Georgia, Commercial Law Week May 17, 2013
Georgian Commercial Law Review Journal, Vol. 3, 2014
11 Pages Posted: 30 Nov 2016
Date Written: November 28, 2016
Uniformly foundational to every legal system is the concept of pacta sunt servanda – agreements are binding. But the precise parameters of this concept differ across legal systems based, in part, upon available remedies for contract breach. Many European legal systems, including Georgia’s Civil Code, characterize the breach of a valid obligation as wrongful, and remedies for breach may therefore be punitive. In the American legal system, however, courts and legal scholars have avoided characterizing a contract breach as wrongful, and contract remedies are limited to reimbursement of a non-breaching party’s financial loss. In addition to generally calculating damages in a way that avoids imposing a penalty, courts in the U.S. will even strike down agreed-upon liquidated damages provisions in contracts if they implicitly punish breach.
The disparity between U.S. and Georgian legal treatments of breach-penalizing contract provisions discloses an illuminating conceptual distinction. In Georgia, contract breach is considered socially and economically disruptive and costly. Private measures discouraging breach therefore create a public benefit, and the Civil Code mandates that they be generally upheld. In the U.S., alternately, contract breach is viewed as an expression of party autonomy that may even, in appropriate circumstances, create a positive externality. Contract provisions that effectively punish breach are therefore invalidated as imposing a public and private harm.
The reality of contract breach is somewhere between these two perspectives. Breach frustrates expectations and can impose costs – both tangible and intangible, and some such costs may not be reimbursed through the American approach to damage calculation. Although the American approach protects party autonomy and allows for changing economic realities, it does so at the expense of the non-breaching party. Contractual uncertainties create social costs. The U.S. legal system should reconsider whether and when contract breach is wrongful and consider expanding enforceability of liquidated damages in cases where parties have truly agreed to such terms.
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