The
liquidated damages clause and penalty clause are common provisions of contracts. [1]
They address what is to happen after the breach of contract.[2]
Breach of contract comes about when one party without lawful cause
refuses or cannot fulfil their obligation under the contract or infringes on
the rights of the other party under the contract according to Spancrete Zambia Limited v. Zesco Limited.[3]
Essentially, a Liquidated damages clause is the section of a contract where
both parties agree and approximate the genuine precise damages to be received
by an innocent party to cover the losses that will be incurred if the other party
breaches the contract.[4] It is legal under the law and thus
enforceable by the court based on the intentions of the parties according to MobillOil Zambia limited v Patel,[5]:
National Airports Corporation Limited V Reggie Ephraim Zimba And Savior Konie.[6] On
the other hand, a Penalty clause is a section of a contract that is meant to
deter either party from breaching the contract and the terms are fixed without
consideration of the actual loss to be incurred aiming strictly to stand as
punishment.[7]
it is unlawful and serves as a deterrence to breach thus, unenforceable by the
court as laid down in National Airports Corporation Limited V Reggie EphraimZimba And Savior Konie,[8] and
Zambia State Insurance Corporation Limited and Attorney General v AlisandSingogo.[9] The need
to differentiate penalty clauses from liquidated damages clauses inevitably
arises as the liquidated damages clause sometimes can be declared a penalty
clause and ruled out. A penalty clause can also be adopted as liquidated damages
and enforced.[10]
To do this, the courts rely on several factors to distinguish between
liquidated damages and penalties. This writing with aid of relevant authorities
will highlight some of these factors.
The
first factor is how reasonable or unreasonable a sum of damages is to be
received by a party to cover the losses that will be incurred if there is a
breach of contract. if the sum of damages is reasonable as
compared to the great loss that could be incurred, then the party in breached
pays the other party liquidated damages as enforced by the court,[11]
However, if the sum of liquidated damages in the contract “is extravagant and
unconscionable compared to greatest loss that could conceivably be proved to
have followed from the breach” according to the rule set in Dunlop Pneumatic
Tyre Co Ltd v New Garage & Motor Co Ltd (thereafter now referred to as Dunlop
case),[12]
that emanated from Lord Halsbury’s illustration in ClydebankEngineering and Shipping Building Co v Don Jose Ramos Yzquierdo Y Castandeda,[13]
then it is a penalty and it cannot be enforceable by a court. This factor is
also established as a primary conclusion in ONGC v.
Saw Pipes,[14]
that “liquidated damages should be regarded as reasonable compensation, while
penalties should not.” [15]
The
second factor is the certainty and uncertainty of the nature of a breach and
the losses it brings about. As laid down in Kemble v Farren,[16]
If the terms that are “breached have an uncertain nature and amount” then it is
liquidated damage but if a breach occurs and it can be certainly assessed on
the losses it brings about, a big amount of liquidated damages is considered a
penalty. This factor was also included in the Dunlop case and it is
phrased as follows “The clause will be penal if the breach entails not paying a
sum of money and the amount to be paid as damages exceeds the sum which ought
to have been paid”
The
third factor is the various case of a breach that is different in magnitude or
nature. If a sum of damages is payable in these breaches,
then it is presumed to be a penalty. This principle was applied in Elphinstone v Monland Iron and Coal Co.[17] it was phrased as “There is a presumption (but
no more) that a provision is a penalty when a single lump sum is made payable
by way of compensation, on the occurrence of one or more or all of several
events, some of which may occasion serious and others but trifling damage.”
The
fourth factor is the possibility to carry out a precise pre-estimation over a
sum that is being treated as a penalty to find out whether it can be
liquidated damage. this was established by Lord
Dunedin in the Dunlop case. They also recognized this principle in Webster v Bosanquet,[18]
where it was held that the phrasing
used to describe a sum does not matter and should not stop a court from
assessing if they can enforce a sum or not after a pre-estimation focus.
In
conclusion, identifying liquidated damages and penalties by a
court is very critical in extenuating justice for parties in the contract after
the breach of the contract by one party. And the above-discussed factors make
it possible for courts to easily accomplish this in the quest to restore the
injured party to the position, they would have been in had the breach not
occurred.
[1] Singh,
“Difference between penalty and liquidated damages – relevance of liquidated
damages clause in commercial contracts”, 2020
[2] ibid
[3] Spancrete
Zambia Limited v. Zesco Limited, Appeal No.53 of 2018
[4] Gibbs Wright Litigation Lawyers,
“Liquidated damages and penalties”, 2020
[5]
Mobil Oil Zambia Limited v Patel (S.C.Z. Judgment 2 of 1988)
[6]
National Airports Corporation Limited V Reggie Ephraim Zimba And Savior Konie
SCZ Judgment No. 34 Of 2000)
[7] Law365
‘Penalty Clauses vs. Liquidated Damages Clauses-Explained’, 2021
[8]
National Airports Corporation Limited V Reggie Ephraim Zimba And Savior Konie
SCZ Judgment No. 34 Of 2000)
[9]
Zambia State Insurance Corporation Limited and Attorney General v Alisand
Singogo Appeal No. 02 of 2007
[10]ibid
[11]Gibbs Wright Litigation Lawyers, “Liquidated damages and
penalties”, 2020
[12] Dunlop
Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd [1914] UKHL 1 (1 July 1914) AC 79
[13] Engineering
and Shipping building Co v Don Jose Ramos Yzquierdo Y Castandeda [1914] AC 6,
74 LJPC 1, [1904-7] All ER Rep 251
[15]
Gupta, ‘Liquidated Damages v. Penalty:
Are Causation and Loss Really Required’
[16] Kemble v
Farren 1829 6 Bing. 141, 130 Eng. Rep. 1234. pg. 163
[17] Elphinstone
v Monland Iron and Coal Co (1886) 13 R. (H.L.) 98
[18] Webster v
Bosanquet [1912] A.C. 394, PC (Cey)