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Liquidated Damages and Penalty Clauses by Halson, Roger (8th March 2018)

1 The Historical Origins of the ‘Penalty’ Rule

From: Liquidated Damages and Penalty Clauses

Roger Halson

Subject(s):
Damages and contract — Liquidated or agreed damages — Penalty clauses and damages

(p. 1) The Historical Origins of the ‘Penalty’ Rule

A.  General

1.01  The penalty doctrine has recently been subject to extensive review in the highest appellate courts of two major common law jurisdictions: by the Supreme Court of the United Kingdom in the conjoined appeals in Cavendish Square Holding BV v Makdessi, ParkingEye Ltd v Beavis (Consumers’ Association Intervening)1 and by the High Court of Australia in Andrews v Australia and New Zealand Banking Group Ltd.2 Many contrasts of form and substance may be drawn between these key decisions. The decision of the UK Supreme Court was, with 315 paragraphs, the longest judgment of that court in 2015,3 whereas that of the High Court of Australia was under twenty pages long. The length of the report in Cavendish Square Holding BV v Makdessi was perhaps inevitable as it represented a century’s reflection after the last review of the penalty doctrine by the House of Lords in 1915,4 expressed by seven, instead of the more usual five,5 (p. 2) voices in the UK’s highest appellate court.6 Indeed, three of the seven justices assigned to hear the appeals had previously acted as the chair, or a member, of the UK’s Law Commissions responsible for keeping the law of the UK under review.7 In Cavendish Square Holding BV v Makdessi,8 an important limit upon the penalty jurisdiction was reaffirmed, namely that a clause will only be reviewed as a potential penalty9 if the clause requires a party to make a payment (or incur some other detriment) upon the breach of a contractual obligation owed by the contemplated payer to the contemplated payee.10 Prior to 2012, the law on this point was the same in Australia.11 A ‘radical departure’12 from the previous law occurred in Australia in Andrews v Australia and New Zealand Banking Group Ltd,13 where prior ‘restrictions upon the penalty doctrine’ were rejected and it was held that the penalty jurisdiction could apply to render a contractual term unenforceable ‘[i]n the absence of a contractual breach’.14 The divergence between the two jurisdictions is brought into focus by an examination of Office of Fair Trading v Abbey National plc,15 a UK case with substantially the same facts as Andrews, concerning the enforceability of terms in banks’ contracts with customers levying charges for any ‘unauthorised’ borrowing. At first instance, Andrew Smith J16 (p. 3) had held that most of the charges in issue were incapable of being penalties because they were not sums payable upon the payor’s breach of contract.17 Consequently, the common law of penalties was not discussed when the case reached the Supreme Court, although it was the essential background to the case because virtually all the contracts used by the banks were drafted so that so-called unauthorised overdrafts did not involve a breach of any obligation on the part of the customer in order to avoid review as potential penalties. In the Cavendish case, Lords Neuberger and Sumption note that the case for abolishing the penalty rule, which the Supreme Court in that case rejected, ‘depends heavily on anomalies …’18 such as that it is, as illustrated in the Abbey case, easily avoided by skilful drafting.19

1.02  Notwithstanding the formal and substantive differences between the decision of the Australian High Court in Andrews and the UK Supreme Court in the Cavendish case, there were methodological similarities. In Andrews, the High Court ‘engaged in a detailed historical examination’; indeed, the reasoning in Andrews was characterised in Cavendish as ‘entirely historical’.20 The importance of a complete historical perspective was emphasised by the High Court of Australia when it said that:21 ‘[a]n understanding of the penalty doctrine requires more than a brief backward glance’. Similarly, in Cavendish, all the justices examined the historical origins of the control of penalty clauses.22 For some time, ascertaining the test for distinguishing penal, from other, clauses has been a challenge for the most able of judges. In 1801, Lord Eldon CJ said that he was ‘much embarrassed in ascertaining the principle upon which [the penalty rule] was founded’.23 Eighty years later, Lord Jessel MR, ‘not a judge noted (p. 4) for confessing ignorance’,24 admitted simply that ‘[t]he origin of that doctrine [the penalty rule] I do not know’.25 Similar frustration has been expressed by American judges: ‘What construction should be placed on contracts [containing stipulated damages provisions] is a question that has long vexed and perplexed the courts in this country and of England’26 and ‘[N]o branch of the law is involved in more obscurity by contradictory decisions than whether a sum specified … will be treated as liquidated damages or a penalty’.27 The same sentiments and frustrations were expressed most recently in the Cavendish case by Lords Neuberger and Sumption when they noted that examination of the history of the penalty rule in England revealed that it is ‘[a]n ancient, haphazardly constructed edifice which has not weathered well …’.28

1.03  There is therefore agreement between the senior appellate tribunals in two major common law jurisdictions upon the importance of a historical perspective,29 but both propose subtly different historical analyses to justify very different conclusions about the ambit of the modern common law jurisdiction to set aside so-called penalties. This disagreement, together with the judicial frustrations recorded in the last paragraph, render necessary an investigation of the history of the control of penalty clauses back to its earliest origins to gain a thorough understanding of the modern doctrine.

(p. 5) B.  Early History Prior to 1600

1.04  Many historical accounts of the law of contract begin with the emergence of the writ of assumpsit around the beginning of the seventeenth century.30 Assumpsit has its origins as a tort action. At common law if the defendant carelessly left an obstruction on a road which caused an injury to the plaintiff’s horse, the latter’s remedy would be in ‘trespass on the case’ (later abbreviated to ‘case’ only). In such cases, no allegation of an undertaking was needed: the gist of the wrong was the defendant’s carelessness. Assumpsit was first introduced in cases such as Bukton v Tounesende,31 better known as The Humber Ferryman’s Case, where, as a result of overloading, the plaintiff’s horse was lost overboard. The plaintiff alleged that the defendant received the horse (and, later, undertook, assumpsit, to carry it safely). Notwithstanding the early origins ‘it was not until the sixteenth [century] that [assumpsit] achieved any great prominence as a remedy for broken agreements and not until the seventeenth that it became the regular common law contractual action’.32 For this reason, the law of contract has been described as a ‘late developer’.33

1.05  This impression that the history of the law of contract began with the rise of action of assumpsit has been criticised as ‘radically mistaken’.34 Promises were routinely enforced before this time by different means including the use of so-called penal bonds. A penal bond was originally a sealed instrument, which expressed a (p. 6) promise to pay a sum of money alongside a provision to the effect that this undertaking was ‘null and void’ if the promisor tendered the performance required under the contract. Thus, the conditional penal bond has been said to operate in ‘a peculiarly topsy turvy way’:35 what we may choose to characterise as the underlying contractual promise is not imposed as a duty; rather, its performance, at a formal level, is only relevant as a defence to an action in debt to enforce the penalty. This aspect is explored further below at para 1.20 but the original and practical importance of the action in debt should be noted where ‘far and away the majority of actions brought in the common law courts in medieval times were actions of debt sur obligation36 and it is significant that this prevalence continues today.37

1.06  Historical accounts of the penalty rule often, like those of the wider law of contract, begin in the seventeenth century38 in the case of the penalty rule with the relief granted in equity in respect of penal bonds. However, like the general law of contract, its earlier origins are important in order to understand its present form. For this reason, this section will explore the very earliest manifestations of the penalty jurisdiction. Early Roman39 law40 recognised the concept of a stipulatio poenae,41 agreed sums payable upon the breach of an (p. 7) obligation,42 in most cases not providing for the payment of a fixed sum but rather a multiple (ie double, triple, etc) of the object of the contract.43 The stipulatio poenae44 was acknowledged to have a coercive function to persuade the debtor to perform.

1.07  Interestingly, this notion of the penalty acting in terrorem, ie in a coercive fashion, became a part of the formal definition of a penalty at common law propounded by Lord Dunedin in Dunlop Pneumatic Tyre Co v New Garage and Motor Co,45 which was the leading case on the penalty rule in the UK prior to the Cavendish case: ‘The essence of a penalty is a payment of money stipulated as in terrorem of the offending part’. It took a surprising time46 before it was generally recognised that the in terrorem47 requirement in fact added nothing to the definition of a penalty.48

1.08  Classical Roman law was ‘rediscovered’ in continental Europe at the end of the eleventh century in Italy, with attention focused upon the sixth century (p. 8) Corpus Iuris Civilis compiled by Emperor Justinian. This formed the basis of law teaching at newly established universities throughout Europe, including England. It was the ‘reinvigorated study of Roman law in the twelfth century [that] animated the introduction of penalty clauses into England’.49 Indeed, a reference has been found to a lecture in England on Roman law in the late twelfth century or early thirteenth century, which recommended the use of a penalty clause where damages would be uncertain.50 Bracton51 also acknowledged the advantage of a penalty in relieving the parties from the difficulty of proving, and the court of the necessity of assessing, what later became known as unliquidated damages. These observations anticipate by almost 800 years arguments to support the enforcement of penalties that have been made in the last fifty years. In Philips Hong Kong v Attorney-General of Hong Kong,52 Lord Woolf acknowledged the advantage to the promisor of being able to calculate in advance the amount of damages he would have to pay in the event of his breach and to the promisee of being aware in advance of his likely recovery in the event of breach.53 Furthermore, modern courts have recognised that, after a breach has occurred, these clauses save legal costs because the court will not be required to assess as unliquidated damages the losses of the promisee54 and thereby avoid ‘difficulty, uncertainty, delay and expense’.55 Perhaps unsurprisingly,56 these arguments were endorsed enthusiastically57 in the Cavendish case:58

There is beyond doubt real benefit in parties being able to agree the consequences of a breach of contract, particularly where there would be difficulty in ascertaining the sum in damages which was appropriate to compensate the innocent party for loss caused by the breach. Parties save on transaction costs where they can avoid expensive litigation on the consequences of breach of contract.

(p. 9) 1.09  In England the earliest records of cases to enforce penalties related to actions brought in the 1220s. These were ecclesiastical actions involving marriage contracts and the sale of tithes.59 At that time, both the ecclesiastical courts and the Court of Chancery might be approached by petitioners seeking redress for breach of contract. As the majority of medieval lord chancellors were also ecclesiastics, it might be expected that they would follow the practices of the church courts.60 The Court of Chancery, which was latterly engaged with administering relief from penal bonds61 unfortunately did not keep systematic and full records until 1543 or 1544, ‘an astonishingly late date’.62 The earlier records therefore do not extend beyond recording that the action was brought and so do not indicate how the penalty was regarded and treated. In the 1260s and 1270s, there were ‘sporadic’ cases in the King’s court seeking a penalty which, by the late 1280s became ‘a fairly steady though small, flow of cases’.63 Actions to enforce a penalty took one of two forms: the plaintiff would either sue for breach of covenant and claim the amount of the penalty as damages64 or, more frequently, use a writ of debt to claim the penalty.65 The more common usage mirrors the modern action to enforce a stipulated damages clause which is an action in debt.66

1.10  After its ‘rediscovery’ in Italy, Roman law spread across continental Europe combining with pre-existing, mostly customary law. One effect of this assimilation, together with the influence of medieval canon lawyers who recognised that breaking any promise, including those outside the hitherto enforceable categories, was wrongful, was the emergence of a more general notion that any voluntary agreement can constitute a binding contract.67 By the 1600s, this revised version (p. 10) of Roman law had become the default law applicable across mainland Europe unless overridden by local custom or statutes.

1.11  In England, ‘the underlying structure of contractual liability’ had been established before the end of the thirteenth century and ‘remained fundamentally the same’, through the next two successive centuries prior to the rise of the writ of assumpsit.68 The major change during this period was a fragmentation of available remedies.69 In other respects as well, the rules of the common law which were dominated by procedural matters had become so ‘bafflingly complex’ that ‘even getting one’s opponent into court was no simple matter’.70 Against this backdrop the enforcement of penalties continued unabated. Indeed, it has been suggested that in England the judicial enforcement of penalties became more rigorous in the 1350s after the time of the Black Death.71 This is attributed to the relaxation of an earlier concern that the enforcement of penalties might offend rules against usury and the influence of more sophisticated business practices.72 A different survey73 of the available cases acknowledges this trend but suggests that English judges had continuously followed Roman law and continental practice and routinely enforced penalties,74 without being unduly restrained by the prohibition on usury,75 absent any but a tangential reference to Roman law and practice.76

C.  Later History 1600–1915

1.12  It has already been seen that several features and debates in the modern law of penalties have their origins in the earliest history of penalties. Notwithstanding this, the trend is to begin a historical account of the modern penalty doctrine around 1600. Such studies suggest that the jurisdiction to control penalty clauses would appear to have had a simple beginning in the relief granted by courts of equity from the enforcement of penal bonds. The emergence of this equitable relief will now be explored.

(p. 11) 1.13  The enforcement of a simple bond was ‘almost irresistible’ at common law.77 This attitude is portrayed and satirised in Shakespeare’s The Merchant of Venice.78 Shylock, a sophisticated lender, when negotiating a loan with Antonio, an experienced merchant, proposes ‘a pound of flesh’ as a bond in the event of Antonio’s failure to repay.79 When Bassanio, for whose benefit the loan was taken out, implores his friend not to agree to Shylock’s terms (‘you shall not seal such a bond for me’) Antonio brushes away these concerns, confident that the penalty will not be exacted (‘Why, fear not, man I will not forfeit it’).80 When Antonio is unable to repay he is of course saved from his fate by the skilful advocacy of Portia81 who insists that although ‘A pound of that same merchant’s flesh is thine … This bond does give thee here no jot of blood’ and threatens Shylock with ruinous consequences if any of Antonio’s blood is spilt. Thus, Antonio was saved.82

1.14  In the absence of a ‘Portia’ the only defences available at common law to a debt other than an acknowledgment of satisfaction in a sealed document were a similarly sealed acquittance or plea of non est factum (it is not my deed), where forgery could be proved. Other facts such as payment at a different time or place to that specified, fraud infecting the underlying transaction, the failure of the contemplated consideration or the impossibility of performance were inadmissible to defeat the bond at common law.83 A bond subject to a condition was (p. 12) always treated a little differently. The two elements of a conditional penal bond have been described;84 a promise to pay a stated sum, subject to a condition that if the main obligation is fulfilled by a particular time the promise to pay the stated sum would be void. Defences to the bond included:85 the performance of the condition which could be proved other than under seal;86 and, later, a debtor was excused from payment if the other party refused to accept payment of the bond at the originally appointed time and place87 or at a different place if that variance was the choice of the creditor.88

1.15  The very limited exceptions at common law to the enforcement of penal bonds produced ‘tough law’ often summarised by the oft-cited remark, then and now, that it is not the courts’ business to rewrite private contracts.89 In equity, however, a different rule prevailed, most dramatically recorded by Lord Mansfield in Wyllie v Wilkes,90 who observed that at the time of Henry VIII (reign 1509–1547), Sir Thomas More:

[s]ummoned [the common law judges] … to a conference concerning the granting relief at law after the forfeiture of bonds, upon payment of principal, interest, and costs; and when they said they could not relieve against the penalty, he swore by the body of God, he would grant an injunction.

1.16  Although the jurisdiction seems to have arisen from the earlier relief when successive Chancellors started to grant against forfeitures of all types of bonds91 the first case where Chancery gave relief from a penal bond may have been (p. 13) Barrantyne v Jackett in 1553.92 Henderson charts the increased frequency of equitable intervention noting that by the mid-sixteenth century equitable intervention was taking place ‘quite frequently’ and by the 1590s had become ‘almost routine’93 when justified by factors beyond an unequal exchange. This latter point is illustrated by Chamberlayn v Iseham94 in 1557, where enforcement of a bond to pay £400, defeasible if £13 6s 8d was paid by a particular time was restrained by injunction but not on the single ground that there was a gross disproportion between the penal sum and the underlying debt despite the fact that the penalty was ‘very commonly fixed at [only] twice the sum lent’.95 Rather, the court chose to emphasise exceptional factors: that the debtor was in the service of the Crown on the day appointed for payment and that he had paid £13 6s 8d to the court to be held for the other party. Writing at the beginning of the seventeenth century, Cary gives an insight into the developing width of this jurisdiction and, interestingly, its rationale:96

If a man be bound in a penalty to pay money at a day and place … and intending to pay the same, is robbed by the way; or hath intreated by some other respite at the hands of the [creditor], or cometh short of the place by any misfortune; [but] doth provide and tender the money in short time after; in these and many such like cases the Chancery will compel [the creditor] to take his principal, with some reasonable consideration of his damages, for if this was not men would do that by covenant what they now do by bond.

This valuable commentary97 again emphasises the fact that, although it was the established practice in cases of hardship to relieve bonds where the money was not paid at the appointed time, there is no hint at this time of a jurisdiction to relieve without such special circumstances being asserted and proved. Rather, this development followed a little later and, around 1675, when Lord Nottingham was Lord Chancellor, the law was summarised in Francis’ Maxims of Equity as: ‘equity suffers no advantage to be taken of a penalty or forfeiture, where compensation can be made’.98

(p. 14) 1.17  Once Chancery courts were accustomed to relieving against penalties in penal bonds, the jurisdiction was enlarged to include the setting aside of penalties in simple contracts. An early example where the court set aside as a penalty, a sum specified in advance by the parties to quantify damages in the event of the breach of such a contract, is Sir Baptiste Hixt’s Case,99 where it was agreed that any shortfall in the acreage of land sold would be compensated for at the rate of £11 per acre. Applied to the facts of the case, a shortfall of over 63 acres resulted in a sum of about £700 being due. The jury was instructed that its members should regard themselves as ‘chancellors’ and give only such damages as equity required.100

1.18  The different practices of the common law and chancery courts resulted in an inevitable tension between the two jurisdictions which Chief Justice Coke tested in the case of Courtney v Glanvill and Allen,101 where the Court of King’s Bench granted habeas corpus to release a litigant who had been imprisoned by the Court of Chancery for disobeying its order effectively to return the overpayment for a jewel that was represented to be much more valuable than it in fact was. This friction between the common law and chancery courts came to a head in The Earl of Oxford’s Case,102 where the master of Magdalen College Cambridge had leased land to Smith, which one Warren claimed was leased to him from Edward de Vere, 17th Earl of Oxford, who in turn traced his title back to a sale by the college to Queen Elizabeth 1. Chief Justice Coke held that this latter sale was void under a statute that provided that conveyances of estates by college representatives to anyone for a term other than twenty-one years (or three lives) was void, with the consequence that Warren was not entitled to eject Smith. When the case was brought to Chancery the master of Magdalene College and Smith were imprisoned for their refusal to respond. Lord Ellesmere LC granted an injunction out of the Court of Chancery preventing the enforcement of the common law order and granting to the Earl of Oxford and his successors quiet enjoyment of the land. With their conflicting orders, the two courts had reached an impasse that was referred to the Attorney General, Sir Francis Bacon, and ultimately resolved by King James I; the king effectively declaring that henceforth in any conflict between common law and equitable principles, equity would prevail.103 Intriguingly, (p. 15) both Sir Francis Bacon104 and Edward de Vere, 17th Earl of Oxford,105 have been considered as possible authors of Shakespeare’s plays, including The Merchant of Venice discussed above. The primacy of equity established in The Earl of Oxford’s Case was of course later recognised in the Judicature Acts 1873–75, which also sought to fuse courts of common law and equity. With respect to ordinary money bonds, the common law courts eventually recaptured106 their jurisdiction by replicating the principles of relief adopted by the Chancery Court.107 This was effected by granting the defendant ‘a perpetual imparlance’ (a licence to imparl, ie talk the matter over), which stayed the proceedings. Statutes passed in 1696 and 1705108 confirmed this position. Under the first, a plaintiff who sued for a penalty arising from a conditional bond was permitted to assert all breaches and consequences of the broken condition. The jury should then assess the damages thereby incurred. Judgment could then be entered for the penalty, although the plaintiff would only recover the assessed sum of damages. The second statute allowed the court to discharge a debtor who presented to the court the full principal, interest, and costs due on a money bond. Further, it formally reversed the old common law rule that payment, other than that acknowledged in a deed (of acquittance), could not be relied on as a defence to an action on a bond.109 With respect to money bonds, the common law courts ‘were travelling much the same road’ as their Chancery counterparts but ‘[t]hey took half a century longer to reach the same destination’.110

1.19  The convergence of law and equity in relation to relief from money bonds was not reflected in other areas such as the evolution of the mortgage and the development of the general relief to mortgagors recognised in the concept of the equity of redemption,111 although the reasons for this are not clear.112 Relief against the (p. 16) forfeiture of proprietary interests has also developed in an independent way. It has been suggested that its present form and restrictions may be explained historically but that it is now ‘impossible to articulate any coherent justification for this form of intervention’.113 The complex and fractured history of equitable relief has been recognised in the most recent examination of the jurisdiction to control penalty clauses in Cavendish Square Holding BV v Makdessi,114 where Lords Neuberger and Sumption acknowledged that contractual terms which on the one hand provide for the payment of a sum of money (or other valuable consideration) and those which on the other hand provide for forfeiture have ‘the same origin in equity’115 but also that ‘the [subsequent] relationship between penalty clauses and forfeiture clauses is not entirely easy’.116 Indeed, the issue of the relationship between the control of penalty clauses and the relief from forfeiture was the subject of a disagreement between the justices in Cavendish. Lords Neuberger and Sumption declined to decide whether a provision was simultaneously capable of being both a penalty and a forfeiture clause.117 Lord Mance expressly accepted that a case might ‘raise for consideration both the penalty doctrine and the power of the court to relieve against forfeiture’.118 Similarly, Lord Hodge expressly rejected the argument of counsel for Cavendish that the law of penalties should not apply to forfeiture clauses.119

1.20  Following the enactment of the statutes of 1696 and 1705, the penal bond then metamorphosed into a closer approximation to the modern form when it appeared as an agreement to pay a sum on breach of contract. This turned around the old penal bond; now the ‘penalty’ was stated as the subsidiary obligation. By 1801, it was established that the claimant had a technical election: he could bring an action in debt to recover the penalty, which recovery would be limited by the statute to the damage sustained, or he could sue in assumpsit for his actual losses.120 Therefore, in either case the result was the same: recovery for actual (p. 17) loss only.121 Inexplicably, it seems that the common law courts began to act, as of course they were bound to, consistently with the statutory provisions even though they rarely referred to them: ‘[a]s if, by some singular instinct the Courts have been right, though without referring to the statute by which they ought to have been governed’.122 Today, the action to enforce the penalty has been largely forgotten123 and the old statutes formally repealed.124

1.21  The unified jurisdiction to control so-called penalty clauses that emerged from the struggle between the courts of equity and common law was, and continues to be, at variance with the so-called principle of ‘freedom of contract’, which enshrines contractors’ rights of self-determination.125 As Patrick Atiyah noted in his magisterial survey of the intellectual history of modern contract law:126 ‘The new attitude to the autonomy of private contracts was, inevitably, difficult to reconcile with the old equitable doctrines about penalties and forfeitures’.

1.22  Although the emphasis of successive lord chancellors varied,127 a consensus emerged in favour of the new but circumscribed power to set aside a penalty clause providing for a sum of money to be paid (or possibly other advantage conferred128) following the potential ‘payer’s’ breach of contract. Lord Eldon, upon resuming the position of lord chancellor, declined in Hill v Barclay129 to extend to breaches of other undertakings such as that to effect repairs, older rules about relief from the forfeiture of a lease for failure to pay rent. After analysing the older cases, Lord Eldon said that the court was ‘[s]urely not authorised so to deal with contracts’ because to do so would be ‘taking a prodigious liberty’.130 The jurisdiction to set aside (p. 18) a stipulated damages clause as a penalty is anomalous; it is an explicit derogation from the so-called laissez-faire approach to contracts that seek to empower parties with the maximum degree of contractual self-determination.131 In support of his thesis describing the nineteenth-century rise of contractors’ right of ‘freedom of contract’, Patrick Atiyah suggests that Lord Eldon’s remarks restricting the power to set aside contractual terms are not the product of conservatism but, rather, the embracing of ‘the spirit of the new age’.132

1.23  Lord Eldon’s successors continued this approach133 and relief from the payment of money134 was granted only in exceptional cases. An example is Kemble v Farren135 where an ‘actor’ undertook an engagement for four seasons with £1,000 payable by either side if they refuse to perform the agreement. The theatre’s action to recover £1,000136 failed on the ground that the figure did not reflect an accurate assessment of the loss that might result from a minor breach of contract. Together with Astley v Weldon,137 another case concerning an actor’s refusal to carry out the main duties under a contract, it seems that the class of exceptional cases where the jurisdiction to set aside a clause as a penalty was exercised may be described as the failure to carry out general provisions under an employment contract.138 In contrast, and in accordance with the then prevailing spirit of freedom of contract, clauses requiring the payment of a sum of money upon a payer’s failure to (p. 19) perform specific obligations under an employment contract,139 a charterer’s unauthorised detention of a ship (a so-called demurrage clause),140 the breach by a seller of a business of an undertaking not to compete with the business sold,141 and a builder’s failure to complete works on time142 have all been held to be enforceable liquidated damages clauses. Indeed, today it is an incontrovertible fact that the penalty jurisdiction is more often discussed than exercised to the extent that, in one case,143 Colman J noted that he was only referred to four cases where the relevant clause was struck down as a penalty.144

1.24  This conflict between the concept of freedom of contract and the penalty jurisdiction was noted145 in Cavendish Square Holding BV v Makdessi by Lords Neuberger and Sumption: ‘The penalty rule is an interference with freedom of contract’146 which, quoting Hoffmann LJ from an earlier case, ‘ought not to be extended’.147 However, this was exactly what the High Court of Australia did in Andrews v Australia and New Zealand Banking Group Ltd.148 The High Court built upon a subtly different historical account, which asserts that there was a distinct and subsisting equitable jurisdiction to relieve against penalties which is wider than, as opposed to co-extensive with, the common law jurisdiction and so extends to relief from obligations to pay money contingent upon events other than a breach of contract. In Cavendish, this conclusion was disapproved of as a matter of principle and of authority. The objection of principle is discussed further below.149 As to authority, Lords Neuberger and Sumption point out the asserted broad equitable jurisdiction to relieve ‘appears to have left no trace in the authorities since the fusion of law and equity in 1873’.150 The only recent (p. 20) authority151 would appear to be a case in the Court of Appeal152 that may have been wrongly decided.153

1.25  A final ‘legacy’ issue that arises from the nineteenth-century cases concerns the relevance of the parties’ intention. The difficulty arises from the discomfort felt by judges who simultaneously decline to enforce a penalty but who at a more general level are committed, by adherence to the concept of freedom of contract, to giving effect to the freely negotiated terms of a contract. If the penalty jurisdiction could in some way be rooted in the intention of the parties then this conflict would disappear. It is thought that this is the explanation for the persistence in several nineteenth-century cases of references to the intention of the parties154 and is manifested in the same cases by an over-reliance upon the formal description in the contract of the clause in question as providing for either the imposition of a penalty or the recovery of liquidated damages. In the early nineteenth century, a clause was held to be a penalty because the use of that term would not allow the courts to find that it provided for the recovery of liquidated damages155 and, in another case,156 it was noted that no case was cited where a clause described as liquidated damages was found to be a penalty. This formalistic approach was abandoned in Kemble v Farren,157 when a clause that provided for liquidated damages was held to be a penalty. Despite this decision and Baron Bramwell’s clear statement that ‘the names … are immaterial’,158 echoes of the old approach persisted159 and, indeed, survived into the twentieth century.160 It would (p. 21) appear that references to the intent of the parties endured longer in the US than in the UK. As late as 1914,161 a third requirement162 for a valid liquidated damages clause was said to be ‘an intent on the part of the parties to liquidate them in advance’. Despite the suggestion that these references are ‘fast disappearing’,163 there are continuing instances in modern cases.164

D.  Dunlop Pneumatic Tyre Co v New Garage and Motor Co (1915)

1.26  The decision in the Dunlop165 case was ‘the leading authority’166 or locus classicus167 on the law of stipulated damages for a century. The plaintiff sold tyres to the defendant who undertook inter alia168 not to sell the tyres to the public below a given price and further to pay £5 to the sellers for every tyre sold, or offered for sale, in breach of this and other undertakings. The defendant sold tyres to the public below the list price and so the plaintiff claimed payment under the contract for £5 in respect of each tyre sold. The House of Lords held that the provision for payment was not penal and so was enforceable.

1.27  Lord Dunedin’s judgment in the case contained a summary of the law, expressed as a number of rules. The Privy Council later said that these rules ‘authoritatively set out’169 proper guidance to distinguish between liquidated (p. 22) damages and penalties and Arden LJ as recently as 2005 referred to ‘the continued usefulness of the authoritative guidance given by Lord Dunedin’.170 In the Cavendish case itself, when a new approach to penalty clauses was outlined Lords Neuberger and Sumption noted that ‘Lord Dunedin’s speech in the Dunlop case achieved the status of a quasi-statutory code’, with ‘[m]any decisions … little more than a detailed exegesis or application of his … tests’.171 Now, for the most part, the Dunlop case forms part of the history of the modern jurisdiction to control penalty clauses, hence its consideration here. The qualification ‘for the most part’ is, however, necessary for two reasons. First, the Dunlop case was ‘considered’ but not overruled by the Supreme Court in the Cavendish case. While the Cavendish case proposed a different ‘true test’ to identify an unenforceable penalty clause,172 it is likely that the Dunlop case will still prove valuable with respect to many other matters. Secondly, more controversially, Lords Neuberger and Sumption (Lord Carnwath agreeing) appeared to suggest that the entire approach of Dunlop might be retained for ‘simple damages clause in standard contracts’, with the new test in Cavendish applicable ‘to more complex cases’.173 This aspect is considered further in Chapter 2.

(1)  The ‘Dunedin rules’

1.28  The rules laid down in Lord Dunedin’s speech in the Dunlop174 case were the source of the prevailing legal principles regulating stipulated damages clauses for 100 years before the Supreme Court’s decision in the Cavendish case. The rules and, where appropriate, their origins are reproduced below; a commentary then follows.

  1. (1)  Though the parties to a contract who use the words ‘penalty’ or ‘liquidated damages’ may prima facie be supposed to mean what they say, yet the expression is not conclusive. …

  2. (p. 23) (2)  The essence of a penalty is a payment of money stipulated as in terrorem of the offending part; the essence of liquidated damages is a genuine covenanted pre-estimate of damage.175

  3. (3)  The question whether a sum stipulated is a penalty or liquidated damages is a question of construction to be decided upon the terms and inherent circumstances of each particular contract, judged at the time of the making of the contact,176 not as at the time of the breach.

  4. (4)  To assist this task of construction various tests have been suggested which, if applicable to the case under consideration, may prove helpful or even conclusive. Such are:

    1. (a)  It will be held to be a penalty if the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach.177

    2. (b)  It will be held to be a penalty if the breach consists only in not paying a sum of money, and the sum stipulated is a sum greater than the sum which ought to have been paid …178

    3. (c)  There is a presumption179 (but no more) that it is a penalty when ‘a single lump sum is made payable by way of compensation, on the occurrence of one or more of several events, some of which may occasion serious and others but trifling180 damage …

    4. (d)  It is no obstacle to the sum stipulated being a genuine pre-estimate of damage, that the consequences of the breach are such as to make precise pre-estimation almost an impossibility. On the contrary, that is just the situation when it is probable that pre-estimated damage was the true bargain between the parties.’

The most important of these ‘rules’ is (2), which expressly describes ‘the essence of a penalty’ and so by implication the essence of a valid liquidated damages clause. This statement contains two definitions: a penalty and a liquidated damages (p. 24) clause and each, in turn, derives from a different source.181 However, it is to be doubted whether the definition of a penalty provides a test sufficient to identify one. Notwithstanding more modern expression,182 taken literally it appears to import a sort of mens rea requirement on the part of the person for whose benefit the clause is designed to operate. Yet the cases applying the definition do not turn on whether the beneficiary of the clause intended it to operate in a coercive way.183 Rather, the focus is upon the definition of a liquidated damages clause and a penalty is simply treated as its negative counterpart, ie a clause that provides for something in excess of a ‘genuine … pre-estimate of loss’.184 On this view, ‘a payment of money stipulated in terrorem of the offending party’ describes a conclusion of law arrived at by the application of the ‘genuine pre-estimate’ of loss test, to which it adds nothing.185

1.29  Lord Dunedin’s test posits an exhaustive twofold classification for all terms which provide for the payment of a sum of money (or other valuable benefit) on breach; they are either an unenforceable deterrent penalty or an enforceable liquidated damages clause inferred because the clause provides for the payment of a sum (or other benefit), respectively, in excess or equivalent to a genuine pre-estimate of loss. This was the interpretation of Lord Dunedin’s basic test favoured by Buxton and Clarke LJ J in Murray v Leisureplay plc,186 stating that it was ‘[i]mportant to note that the two alternatives, a deterrent penalty; or a genuine pre-estimate of loss; are indeed alternatives, with no middle ground between them’. The decision (p. 25) in Cavendish, which definitively rejected this twofold classification (‘These are not natural opposites, or mutually exclusive categories’187), was presaged by decisions from courts which, unlike the Supreme Court in Cavendish, were bound by precedent188 to follow the decision in Dunlop but who nonetheless managed to support a threefold classification of stipulated damages clauses.189

1.30  Lord Dunedin’s rule (1) is a specific application of the more general principle that the law should act upon the substance, rather than the form, of a contractual provision; ‘The court must proceed according to what is the real nature of the transaction’.190 On this view the actual expression used, be it ‘penalty’ or ‘liquidated damages’, can never alone be determinative of the proper legal classification of the term, an approach that can be traced back to Kemble v Farren.191 The contrary view, which attached too much emphasis to the ‘label’ and which found expression in some later cases,192 is probably based upon a misplaced emphasis upon the older approach discussed above, which in turn emphasised the intention of the parties.

1.31  Whether or not a term is a genuine pre-estimate of loss falls, according to Lord Dunedin’s rule (3), to be judged at the time of contracting. In the US this approach has been characterised as a ‘single look’ approach193 because its logical conclusion is that where a forecast is reasonable when the contract was made, the forecast loss may be recovered even if no actual loss ensues.194 In any case, it is clear that the (p. 26) mere assertion that the clause was a genuine pre-estimate of loss will not be sufficient to satisfy the test.195

1.32  In Rule 4(a), Lord Dunedin proposed a comparison between the sum stipulated and the greatest loss that could be expected to follow from breach, which we will call ‘the disproportion principle’. The application of the disproportion principle was illustrated with an example put by the Earl of Halsbury in Clydebank Engineering and Shipbuilding Co Ltd v Don Jose Ramos Yzquierdo Y Castaneda:196

For instance, if you agreed to build a house in a year, and agreed that if you did not build the house for £50, you were to pay a million of money as a penalty, the extravagance of that would be at once apparent.

It is suggested that this illustration is not a good one. The disproportion principle stated by Lord Dunedin in Dunlop invites a comparison between the sum stipulated and the loss197 that could flow from breach and was applied in this way many times;; Earl Halsbury’s example compares the sum stipulated with the contract price. The contract price of course may bear no direct relationship to the amount of damage that might be caused if the contract is breached. For example, in one celebrated contract case198 the defendant undertook to provide security patrols at the plaintiff’s factory at a cost of only 26p per visit but the damage to the claimant’s factory caused by a negligent patrol amounted to £615,000.

1.33  Lord Dunedin proposed a subsidiary test which was said to arise from a simple application of the disproportion principle. Under Rule 4(b) a clause will not be held to be a penalty where the breach of contract asserted is the failure to pay a sum of (p. 27) money and the sum stipulated is greater than the one which ought to have been paid. This principle may be closely related to the principle of long standing that the failure to pay money should not result in a liability to pay substantial damages.199 However, the abandonment in Sempra Metals v Inland Revenue Commissioners200 of the associated principle that the non-payment of money attracted only nominal damages or at least none beyond simple interest, may have a corresponding effect upon that stated by Lord Dunedin.201

1.34  Lord Dunedin’s rule 4(c) addresses the situation where a single sum is payable on several events of varying seriousness. The presumption that such a provision is a penalty acts upon the intuition that the same sum specified as liquidated damages in respect of many different breaches is unlikely to be a genuine pre-estimate of the loss flowing from each. The facts and decision in Dunlop itself suggest that the presumption must have been intended to apply with some latitude as the respondents undertook twenty-seven distinct obligations202 in respect of which liquidated damages of £5 for each infraction were payable under a clause that was upheld. The presumption against enforceability was, according to Lord Atkinson in Dunlop, rebutted because the damage caused by each separate breach would be ‘of such an uncertain nature that it cannot be accurately ascertained’.203 From this statement it appears that rule 4(c) is intended to operate in conjunction with Lord Dunedin’s final rule 4(d), which recognises that liquidated damages clauses may be enforceable when the loss they are created to compensate for might be almost impossible to calculate. Indeed, rule 4(d) expressly acknowledges that these are the very circumstances when parties may wish to include such provisions in their contracts.

1.35  In the Dunlop case, Lord Parker said that a clause which sought to average different magnitudes of damage that might result from breach would be enforceable:204

Supposing it was recited in the agreement that the parties had estimated the probable damage from a breach of one stipulation at from 5l. to 15l. and the probable damage from breach of another stipulation at from 2l. to 12l., and had agreed on a sum of 8l.205 as a reasonable sum to be paid on the breach of either stipulation, (p. 28) I cannot think that the Court would refuse to give effect to the bargain between the parties.

In contrast a clause that stipulated the recovery of a sum on money which might be a fair reflection of likely loss if the obligation undertaken is breached in the most serious way, but which could also be breached in less serious ways, will be invalid.

1.36  The decision in Dunlop did not address two major issues. First, the clause in question in Dunlop provided for the payments of money by the party in breach and so the question did not arise as to whether the principles laid down in respect of penalty payments should apply mutatis mutandis to terms obliging the party in breach to do or suffer something other than being required to pay a sum of money. There existed a scintilla of authority predating the Dunlop case to support this view,206 which may perhaps be taken to be implicitly approved in that case.207 It is surprising how long it has taken for this extension to be unequivocally recognised.208 Secondly, the Dunlop was a decision that required payments to be made to Dunlop if New Garage Co did certain acts ‘in breach of the agreement’. The House of Lords was therefore also not required to consider whether the penalty jurisdiction extended to payments conditional on events other than a breach of contract by the payer. The discussion in Dunlop is confined to its facts, ie a clause requiring a payment to be made upon the breach of a contractual obligation owed by the contemplated payer to the contemplated payee. There was no challenge in the case to this limit upon the ambit of the penalty jurisdiction. Challenges to this limitation came after the decision in Dunlop and so are discussed later.209

Footnotes:

1  [2015] 3 UKSC 67, [2015] 3 WLR 1373.

2  [2012] HCA 30.

3  The second longest was R (Keyu) v Secretary of State for Foreign and Commonwealth Affairs [2015] UKSC 69, [2015] All ER (D) 223 (Nov), a ‘mere’ 313 paragraphs (concluding that there was no legal requirement to hold an enquiry into the 1948 killing of 24 persons by British soldiers operating in Malaya). For further interesting statistics see Brice Dickson, ‘Reigning Supreme, Inside the Supreme Court’ (2016) 166 New Law Journal 19.

4  In Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Company Ltd [1915] AC 79.

5  In 2015, the Supreme Court delivered judgments in seventy-nine cases, of which sixty-five (or 85%) were heard by five justices, only thirteen were heard by seven, and one case, dealing with costs, was heard by a bench of three.

6  Since its establishment in 2009, the UK Supreme Court has generally followed the practice of the appellate body it replaced, the judicial committee of the House of Lords, and sat with five judges. When cases involve more wide-ranging issues such as the Cavendish case 7 justices might sit: ‘A larger panel … was needed if the court was to depart from the decision of the House of Lords in Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Company Ltd (n 4), which Cavendish had asked it to do when it applied for permission [to appeal]’. See the discussion by Lord David Hope, formerly Deputy President of the UK Supreme Court in ‘The Law of Penalties: A Wasted Opportunity?’ (2016) 33 Journal of Contract Law 1, 10.

7  And also to consider and report upon any proposals for reform which are referred to in them: see Law Commissions Act 1965, s 6.

8  See Cavendish Square Holding BV v Makdessi (n 1).

9  ibid [12], where Lords Neuberger and Sumption expressed this question as to the applicability of the penalty jurisdiction by asking ‘[i]s the penalty rule engaged?’, repeating but not acknowledging the language used in Andrews v Australia and New Zealand Banking Group Ltd (n 2) [15]–[16]. In contrast, Lord Mance in Cavendish Square Holding BV v Makdessi (n 1) asked whether the penalty rule had been ‘triggered’ or whether it is ‘potentially applicable’ at, respectively, [171] and [193].

10  Affirming the rule laid down in Export Credits Guarantee Dept v Universal Oil Products Co [1983] 1 WLR 399 (a contract, part of a scheme to finance the construction of an oil refinery, contained a clause under which the defendant builder was to make a payment to the claimant if and when the defendant was in breach of contract of contractual obligations owed to a consortium of Newfoundland companies. Held: penalty rule was not applicable because the sum to be paid was not payable upon the breach of any contractual obligation owed by the contemplated payer (defendant) to the contemplated payee (claimant); rather, it was payable upon the breach of a contractual obligation owed by the defendant to the consortium).

11  AMEV-UDC Finance Ltd v Austin [1986] HCA 63, 162 CLR 170 and Ringrow Pty Ltd B P Australia Pty Ltd (2005) 224 CLR 656.

12  Cavendish Square Holding BV v Makdessi (n 1) [41] (Lords Neuberger and Sumption).

13  [2012] HCA 30.

14  ibid [78].

15  [2009] UKSC 6, [2010] 1 AC 696.

16  There were three cases: Office of Fair Trading v Abbey National Plc [2008] EWHC 875 (Comm), [2008] 2 All ER (Comm) 625 at [449]; Office of Fair Trading v Abbey National Plc [2008] EWHC 2325 (Comm), [2009] 1 All ER (Comm) 717 at [131] (although inviting further submissions from counsel with regard to some terms); and Office of Fair Trading v Abbey National Plc [2009] EWHC 36 (Comm) at [33].

17  The case arose after a formal investigation by the Office of Fair Trading (OFT) into charges levied by leading banks in respect of so-called unauthorised overdrafts. The OFT sought a declaration under the Unfair Terms in Consumer Contracts Regulations 1999 (SI 1999/2083) (now repealed and re-enacted with some changes by the Consumer Rights Act 2015, s 64(1)) that these standard terms and charges were ‘unfair’ and so not binding on the customer. The banks succeeded before the Supreme Court [2009] UKSC 6, [2010] 1 AC 696 on the ground that the fees levied were part of the consideration paid by customers for the banking services they received. This meant that they were not subject to challenge under the Regulations (so long as they were expressed in ‘plain intelligible language’).

18  See Cavendish Square Holding BV v Makdessi (n 1) [39].

19  ibid: ‘[i]n some cases the application of the penalty rule may depend on how the relevant obligation is framed in the instrument’ at [14] (Lords Neuberger and Sumption) repeated at [43]; ‘It is true that clever drafting may create incongruities in particular cases’ at [130] (Lord Mance); and ‘The rule may also be criticised because it can be circumvented by careful drafting’ at [258] (Lord Hodge).

20  Cavendish Square Holding BV v Makdessi (n 1) [41] and [42] (Lords Neuberger and Sumption, respectively), Lord Carnwath agreeing.

21  Andrews v Australia and New Zealand Banking Group Ltd (n 2) [14].

22  See especially the discussions of Lords Neuberger and Sumption (Lord Carnwath agreeing) at [6]–[11] and Lord Hodge at [250]–[255], discussing the origins of the penalty jurisdiction in Scotland.

23  Astley v Weldon (1801) 2 Bos & P 346 at 350.

24  Cavendish Square Holding BV v Makdessi (n 1) [3].

25  Wallis v Smith (1882) 21 Ch D 243 at 256.

26  Sanders & Ables v Carter 91 Ga 450, 451, 17 SE 345, 345–6 (1893).

27  Giesecke v Cullerton 280 Ill 510, 513, 117 NE 777, 778 (1917). See further J B Coopersmith, ‘Refocusing Liquidated Damages Law for Real Estate Contracts: Returning to the Historical Roots of the Penalty Doctrine’ (1990) 39 Emory LJ 267.

28  See Lords Neuberger and Sumption in Cavendish Square Holding BV v Makdessi (n 1), with Lord Carnwath agreeing at [3].

29  For historical sources see A W B Simpson, A History of the Common Law of Contract (Clarendon Press 1975) 118; D Ibbetson, A Historical Introduction to the Law of Obligations (Oxford University Press 2001) 150–1 and 213–4; J Edelman (ed), McGregor on Damages (20th edn, Sweet and Maxwell 2018) paras 16-003–16-007 and the more expansive account in J D Heydon, M Leeming, and P Turner, Meagher, Gummow and Lehane’s Equity: Doctrines and Remedies (5th edn, LexisNexis Butterworths 2014) Pt 4 s 7; W Loyd, ‘Penalties and Forfeitures’ (1915) 29 Harvard Law Review 117; A W B Simpson, ‘The Penal Bond with Conditional Defeasance’ (1966) 82 LQR 392; E Henderson, ‘Relief from Bonds in the English Chancery’ (1974) 18 American Journal of Legal History 298; E V Lanyon, ‘Equity and the Doctrine of Penalties’ (1996) 9 Journal of Contract Law 234; and G A Muir, ‘Stipulations for the Payment of Agreed Sums’ (1983–85) 10 Sydney Law Review 503, 503. For judicial discussions in addition to those in Cavendish Square Holding BV v Makdessi (n 1) and Andrews v Australia and New Zealand Banking Group Ltd (n 2) see Wall v Rederiaktiebolaget Luggude [1915] 3 KB 66 at 72–3 (Bailhache J); Bridge v Campbell Discount Co [1962] AC 600 at 630–1 (Lord Denning); AMEV-UDC Finance Ltd v Austin (1986) 162 CLR 170 at [35]–[40] (Gibbs CJ), at [8] (Deane J) and at [14] (Dawson J); Jobson v Johnson [1989] 1 All ER 621 at 631–2 (Nicholls LJ); and Lancore Services Ltd v Barclays Bank plc [2008] EWHC 1264 (Ch) at [97], [2008] 1 CLC 1039.

30  For an interesting review of the ‘full’ history of contract law as the effectuation of promise see Warren Swain, ‘Contract as Promise: the Role of Promising in the Law of Contract. An Historical Account’ (2013) 17(1) Edinburgh Law Review 1.

31  (1348) B & M 358. For other accounts in order of decreasing brevity see L Fuller, Contract Law (West Academic Publishing 2006) Appendix B at 1081; Ibbetson, A Historical Introduction to the Law of Obligations (n 29) at 46–8 and A Kiralfy, ‘The Humber Ferryman and the Action on the Case’ (1953) Cambridge Law Journal 421. Somewhat appropriately, this note has been typed in the author’s study overlooking the probable site of that ill-fated crossing.

32  Simpson, A History of the Common Law of Contract (n 29) 3 and see the same author in ‘The Penal Bond with Conditional Defeasance’ (n 29) at 392: ‘After a certain amount of dithering the common law courts in the early sixteenth century permitted actions to be brought for damages for breach of parole promises; in the course of the century the action for breach of promise was (according to taste) embellished or marred by the evolution of a doctrine of consideration. At the turn of the century, again after a great deal of dithering, assumpsit was allowed to take over the job previously done by the writ of debt sur contract. Thereafter the action of assumpsit is regarded as the contractual action’.

34  Simpson, ‘The Penal Bond with Conditional Defeasance’ (n 29) 392, 393. The method by which the misimpression has arisen has been exposed most eloquently by Simpson who refers to the legend of the Abominable Snowman (or My-go), which is said to protect its privacy by moving backwards with its feet facing forward thereby thwarting all attempts to follow its tracks. Simpson argues that the history of the law of contract has been written ‘in snowman fashion …working backwards while appearing to proceed chronologically forward’. The consequence of this mode of progress to ourselves, but not to the My-go is that ‘we deceive ourselves, obtaining a distorted view of the contractual scenery’.

35  ibid 411. Indeed, in the US, ‘A similar form is still in use, particularly if the promise is that of a third party, such as a surety company, that guarantees performance’ in which case the stated sum acts ‘as an upper limit of the third party’s liability’: see Allan Farnsworth, Farnsworth on Contracts (3rd edn, Wolters Kluwer 2004) para 12.18, n 6.

36  ibid 393.

37  ‘The vast majority of civil cases … are handled by the County Court. These cases are typically related to debt [and three other categories: personal injury, insolvency and repossession]’ Ministry of Justice, Court Statistics Quarterly 2014https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/321 (last accessed 23 June 2016).

38  See eg T Downes, ‘Rethinking Penalty Clauses’ in P Birks (ed), Wrongs and Remedies in the Twenty-First Century (Clarendon Press 1996); L Gullifer, ‘Agreed Remedies’ in A Burrows and E Peel (eds), Commercial Remedies: Current Issues and Problems (Oxford University Press 2003); J Edelman (ed), McGregor on Damages (n 29) para 16-003; Muir, ‘Stipulations for the Payment of Agreed Sums’ (n 29) 504.

39  P Benjamin, ‘Penalties, Liquidated Damages and Penal Clauses in Commercial Contracts: A Comparative Study of English and Continental Law’ (1960) 9 Int’l & Comp LQ 600 at 607 suggests that the origins of ‘penal clauses’ may be traced back further to ancient Greece referring to C Maruani, La clause pénale (Thesis, University of Paris 1936) 17.

40  See generally W W Buckland, B Arnold, D McNair, and F H Lawson, Roman Law and the Common Law (Cambridge University Press 1952) and A Watson, The Law of the Ancient Romans (Southern Methodist University Press 1970).

41  At the apogee of Roman civilisation in the first quarter of the first millennium, there was no general obligation to perform a contract; only certain contract types were enforceable, eg sales and leases. In these categories of contract, the parties’ consent alone was sufficient to justify enforcement. For other contracts, some formality was required, the most common being an [unqualified] stipulation, which was literally a ritual question and unqualified response acknowledging the obligation asserted: ‘Do you promise such and such’ [to] which the promisor ‘had to answer … exactly … I do promise such and such’. See J M Smits, Contract Law A Comparative Introduction (Edward Elgar Publishing 2014) 12. Latterly, a document was required to evidence the stipulation and this was most effective when recorded before a notary: see J Gordley, Foundations of Private Law Property, Tort, Contract and Unjust Enrichment (Oxford University Press 2006) 290. The qualified notion of a stipulation poenae adds to the original meaning the idea of an associated punishment and so is the derivation of the English concept of a penalty and its French equivalent, the clause pénale.

42  R Zimmermann, ‘Stipulatio Poenae’ (1987) 104 South African Law Journal 399 and R Zimmermann, The Law of Obligations, Roman Foundations of the Civilian Tradition (Oxford University Press 1996) 95–112 and 294–300; R Zimmermann and F Myburgh, ‘J C de Wet and the Conventional Penalties Act 15 of 1962’ in G Lubbe and J du Plessis (eds), A Man of Principle: The Life and Legacy of J C de Wet (1st edn, Juta Publishing 2013) ch 11.

43  See the brief discussion in P Hachem, Agreed Sums Payable upon Breach of an Obligation (Eleven International Publishing 2011) 29 (a law comparative account of its subject).

44  The stipulation has been called ‘the most important and typical creation of Roman Law’. See W Swain, ‘Contract as Promise: the Role of Promising in the Law of Contract. An Historical Account’ (2013) 17 Edinburgh Law Review 1, 5, quoting J A C Thomas, Textbook of Roman Law (North Holland 1976) 259.

45  Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Company Ltd (n 4) 86, referring to Clydebank Engineering and Shipbuilding Co v Don Jose Ramos Yzquierdo y Castaneda [1905] AC 6.

46  Especially in light of Lord Radcliffe’s important but much neglected statement that: ‘I do not myself think that it helps to identify a penalty, to describe it as in the nature of a threat “to be enforced in terrorem” … I do not find that that description adds anything of substance to the idea conveyed by the word “penalty” itself, and it obscures the fact that penalties may quite readily be undertaken by parties who are not in the least terrorised by the prospect of having to pay them and yet are, as I understand it, entitled to claim the protection of the court when they are called upon to make good their promises’. This important statement went unnoticed for many years; it was not recorded in successive editions of McGregor on Damages or Treitel’s The Law of Contract. Cf M Furmston, Cheshire, Fifoot, and Furmston’s Law of Contract (16th edn, Oxford University Press 2012) 785, n 172. More recently, it was quoted with approval in Cine Bes Filmcilik ve Yapimcilik AS v United International Pictures [2004] 1 CLC 401 and by Arden and Buxton LJJ in Murray v Leisureplay plc [2005] IRLR 946 at [47] and [109], respectively.

47  Despite the substitution of the more modern phrase ‘intended to deter’ by the Court of Appeal in El-Makdessi v Cavendish Square Holdings BV [2013] EWCA Civ 1539 at [58].

48  Taken literally, it appeared to import a sort of mens rea requirement on the part of the person for whose benefit the clause is designed to operate. However, it was never applied in this way; rather, the focus was upon the definition of a liquidated damages clause and a penalty was simply treated as its negative counterpart. Its abandonment was confirmed in Cavendish (n 1) by Lords Neuberger and Sumption, Lord Carnwath agreeing, at [28] and Lord Mance at [141] respectively. See further the discussion below at para 1.28.

49  J Biancalana, ‘Contractual Penalties in the King’s Court 1260–1360’ (2005) 64 Cambridge Law Journal 212, 216. See also J L Barton, Roman Law in England (Giuffrè 1971) 8–28 and F Pollock and F Maitland, History of English Law before the Time of Edward 1, Vol 1 (Liberty Fund 1968) 111–22.

50  F De Zulueta and P Stein, The Teaching of Roman Law in England Around 1200 (Selden Society 1990) 85.

51  G Woodbine, Bracton De Legibus et Consuetudinibus Angliae, Vol 2 (Thorne (trans), Yale University Press 1968–77) 285.

52  (1993) 61 BLR 41.

53  ibid 54 and 55 (Lord Woolf).

54  Diestal v Stevenson [1906] 2 KB 345 at 350 (Kennedy J).

55  Wise v United States, 52 Ct Cl 400, 1917 US Ct Cl LEXIS 95, 249 US 647 (1918) at 649 (Clarke J).

56  For a critical appraisal of these arguments see ch 4C and R Halson, ‘Remedies for Breach of Contract’ in M Furmston (ed), The Law of Contract (5th edn, LexisNexis 2015) para 8.106.

57  For similar academic enthusiasm see G Treitel, Remedies for Breach of Contract: A Comparative Account (Clarendon Press 1988) para 167: ‘One purpose of penalty clauses is to fix in advance the damages payable in the event of default. This is in itself a perfectly legitimate and, indeed, laudable purpose’.

58  See Lord Hodge at [259]. See also Lord Mance at [172]. Lord Toulson agreed with both these passages. For further discussion see ch 5C.

59  13 CRR, No 1101, Maitland ed 2 Bracton’s Note Book, 1887 Vol 2 No 293 (1228); and 17 CRR, No 2403 (1243); 19 CRR No 543 (1249) discussed by Biancalana, ‘Contractual Penalties in the King’s Court 1260–1360’ (n 49) 216.

60  T F T Pluncknett, A Concise History of the Common Law (5th edn, Liberty Fund 2010) 627; and Sir David Hughes Parry, The Sanctity of Contracts in English Law (Stevens & Sons 1959) 7. Cf J B Ames, Select Essays in Anglo-American Legal History, Vol III (Little, Brown 1907) 309, who denies this connection: ‘It was so obviously just that one who had intentionally misled another to his detriment should make good the loss, that we need not go further afield for an explanation of the chancellor’s readiness to give a remedy … ’.

61  See ch 1C below.

62  Indeed, a further ten years passed before ‘[t]he records became informative enough to tell the historian much of what was happening’: see Henderson, ‘Relief from Bonds in the English Chancery’ (n 29).

63  ibid 217.

65  See eg CP 40/148, m.47d (T1303); see Biancalana, ‘Contractual Penalties in the King’s Court 1260–-1360’ (n 49) 218.

66  Strictly, it is one type of action for an agreed sum; the other being an action for the agreed price. The action for liquidated damages differs because it seeks to enforce a secondary obligation to pay a sum of money, ie one that arose upon the payer’s breach of contract. The action for the price is of course an action to enforce the promisee’s primary obligation to pay for the good or service.

69  ‘[R]emedies … were so fragmented that the unity of the underlying relationship forever slipped out of view’: ibid 36–7 and 87–94.

70  ibid 95.

71  R C Palmer, English Law in the Age of the Black Death (University of North Carolina Press 1993) 80.

74  ibid 222. See also at 232: ‘In fashioning rules to govern the enforcement of penalties English justices followed the rules of Roman law’.

75  ibid 232.

76  ibid 234: ‘[E]nglish judges were not following … [but] were being guided by the Roman rules’.

78  (1600). See generally L Trepanier, ‘Symposium: Contract, Friendship and Love in the Merchant of Venice’ (2014) 43 Perspectives on Political Science 204; Loyd, ‘Penalties and Forfeitures’ (n 29) 123.

79  In Act 1, scene 3.

80  Antonio’s unshakable belief that the bond would not be forfeit reflects the typical concentration of contractors upon performance rather than breach of contract which is confirmed by empirical studies of contracting behaviour: see S Macaulay, ‘Non-Contractual Relations in Business: A Preliminary Study’ (1963) 28 Am Soc Rev 45; S Macaulay, ‘The Use and Non-Use of Contracts in the Manufacturing Industry’ (1963) 9 Practical Lawyer 13; and S Macaulay; ‘Elegant Models, Empirical Pictures and the Complexities of Contract’ (1976) 11 J Law and Soc Rev 507; H Beale and A Dugdale, ‘Contracts between Businessmen: Planning and the Use of Contractual Remedies’ (1975) 2 British Journal of Law and Society 18 and several industry-specific studies by Lisa Bernstein. See L Bernstein, ‘Opting Out of the Legal System: Extra-Legal Contractual Relations in the Diamond Industry’ (1992) 21 Journal of Legal Studies 115; L Bernstein, ‘Private Commercial Law in the Cotton Industry: Creating Co-operation Through Rules, Norms and Institutions’ (2001) 99 Michigan Law Review 1724. Cognitive psychology or behavioural decision theory seeks to explain this phenomenon by reference to the manner in which contractors use information and create preferences and especially the use of ‘mental shortcuts’ or heuristics, including an ‘overconfidence’ bias which results in them downplaying future risks as typified by Antonio’s behaviour discussed above. For general overviews in the context of remedies for breach of contract see Melvin Eisenberg, ‘The Limits of Cognition and the Limits of Contract’ (1995) 47 Stanford Law Review 211 and Robert Hillman, ‘The Limits of Behavioral Decision Theory in Legal Analysis: The Case of Liquidated Damages’ (2000) 85 Cornell Law Review 717.

81  See Act 4, scene 1.

82  Loyd, ‘Penalties and Forfeitures’ (n 29) 123 suggests that the ‘[p]opularity of the story … indicates that the medieval mind was already, perhaps unconsciously, in revolt against the harshness, the excessive literalism of the law, of which the merchant’s bond was but a symbol’.

83  ibid.

84  See n 33 above.

85  Developments of these special circumstances are recognised in modern cases as exceptions to the separate rule established in Pinnel’s Case (1602) 5 Co Rep 117a that the payment of a lesser sum cannot be satisfaction for a larger debt. These exceptions include where the creditor’s action to recover the full debt when a lesser sum was, at the creditor’s request, paid at an earlier date, would have failed had it not been for a technical error in the way that the debtor chose to plead his case. The rule in Pinnel’s Case was received into the new action of assumpsit supported by consideration in Foakes v Beer (1884) 9 App Cas 605, after which it was expressed as the rule that an agreement to accept a lesser sum in satisfaction of a larger debt displayed no consideration provided by the debtor. Exceptions to this rule reflect the earlier cases eg that payment of a lesser sum at a different place chosen by the creditor was good consideration: Vanbergen v St Edmund Properties [1933] 2 KB 223. For further discussion see R Halson, The Law of Contract (2nd edn, Pearson Education 2013) 339–40.

86  Abbot of Cerle’s Case YB Mich 12 R 11 (Ames Fdn) 70 (1388).

87  Fitz Abr Dette 36, 14 H Vi (1437–38); YB 4 H Vii pl 7, fo 4 (1488).

88  Fitz Abr Dette 42, Pasch. 20 H. VI (1341–42).

89  See FA Tamplin Steamship Co v Anglo-Mexican Petroleum Co Ltd [1916] 2 AC 397, 403 (Earl Loreburn): ‘a court can and ought to examine the contract and the circumstances in which it was made, not of course to vary, but only to explain it …’ (emphasis added), quoted by Lord Radcliffe in Davis Contractors v Fareham UDC [1956] AC 696, 727. See also Joseph Constantine Ltd v Imperial Smelting [1942] AC 154, 185 (Lord Wright): ‘It is thus seen that the court is not claiming to exercise a dispensing power or to modify or alter contracts …’.

90  (1780) 2 Doug KB 519, 522–3.

91  R W Turner, The Equity of Redemption: Its Nature, History and Connection with Equitable Estates Generally (Cambridge University Press 1931) 24.

92  C78/13 case 72, Hil I Mar referred to by Henderson, ‘Relief from Bonds in the English Chancery’ (n 29) 298. The plaintiff’s late husband, John, agreed with Jeckett that if the latter gave quiet possession of jointly owned lands after John’s death, John would allow lands he solely possessed to descend to a third party and both parties entered bonds to support the agreement. Later, John sold lands worth £x,xxx but purchased land worth over ten times more, which descended to the third party. When the third party sued John’s widow on his bond, Chancery stopped the action.

93  Henderson, ‘Relief from Bonds in the English Chancery’ (n 29) 299: ‘Innumerable cases of bills for relief of bonds are to be found in the Calendars of Proceedings in Chancery in Elizabeth’s reign [1558–1603], but few in the Reports’. See Turner, The Equity of Redemption (n 91) 24, also referring at p 25 to Sir George Cary’s view that there existed ‘an established practice’ to relieve bonds in cases of hardship.

94  C 33/18 fo. 228, 29 June, 4 & % Phil & Mar (1557).

96  Cary, 1, 2.

97  According to Turner, The Equity of Redemption (n 91) 25: ‘[i]s the only early summary of the matter to be found’.

98  Ed. Princ 1728. See also D E C Yale (ed), Lord Nottingham’s ‘Manual of Chancery Practice’ and Prolegomena of Chancery and Equity 275.

99  Rolle Abr. 702, tit. Trial. See also Loyd, ‘Penalties and Forfeitures’ (n 29) 123.

100  See also Roy v Duke of Beaufort (1741) 2 Atk 190; Aylet v Dodd (1741) 2 Atk 238; Wilbeam v Ashton (1807) 1 Camp 78; Benson v Gibson (1746) 3 Atk 395; and Sloman v Walker (1784) 1 Brown Ch 418 and the discussion in A C Brightman, ‘Liquidated Damages’ (1925) 25 Columbia Law Review 277, 278.

101  (1614) Cro Jac 343. The ‘prisoner’ seemed underserving, having committed fraud.

102  (1615) 1 Reports in Chancery 1.

103  ‘[W]hen their suit deserveth to be relieved in course of equity by suit in our Court of Chancery, they should not be abandoned and exposed to perish under the rigor and extremity of our laws, we … do approve, ratifie and confirm, as well the practice of our court of chancery’. See generally David Ibbetson, ‘The Earl of Oxford’s Case (1615)’ in Charles Mitchell and Paul Mitchell, Landmark Cases in Equity (Hart Publishing 2012) ch 1.

104  The so-called Baconian theory of Shakespearean authorship was supported by Mark Twain. See Mark Twain, Is Shakespeare Dead? (Harper 1909).

105  A theory supported by the respectively inconveniently and improbably named Delia Bacon, The Philosophy of the Plays of Shakespeare Unfolded (Groombridge & Sons 1857) and J Thomas Looney, Shakespeare Identified in Edward de Vere, 17th Earl of Oxford (Kennikat Press 1920).

106  Thereby reflecting an earlier episode with regard to the enforcement, as opposed to the relief from enforcement, that ‘[m]ight have brought the whole of the law of contract under the jurisdiction of the Court of Chancery, had not the common law courts awakened in time to the necessity of providing a remedy for the breach of simple contracts’. See Parry, The Sanctity of Contracts in English Law (n 60) 7–8 and, to the same effect, see Sir William Holdsworth, History of English Law (7th edn, Sweet & Maxwell 1969) 456.

107  Lord Nottingham’s ‘Manual of Chancery Practice’ and Prolegomena of Chancery and Equity’ (n 98) 203.

108  8 & 9 Will 111 c 11, s 8 and 4 & 5 Anne c 3 ss 12 and 13.

111  ibid: ‘Although the extension of general relief to the [debtor] under a bond and the similar extension of … relief to mortgagors coincide, the evolution of the mortgage does not follow further that of the bond’.

112  ibid, suggesting that the reason for this differential development might be because, in a mortgage relationship, the thing pledged may have already been transferred as compared to the bond where the sum forfeit had not yet been paid to the creditor; under the older form of mortgage the borrower/mortgagor would convey the fee simple to the lender/mortgagee by way of security for a loan subject to a term requiring reconveyance if payment was made by a certain date. See S Worthington, Equity (2nd edn, Oxford University Press 2003) 206.

113  ibid: ‘The expanded jurisdiction seems to have retained its factual links with history but discarded its explanatory links’.

114  Cavendish (n 1).

115  ibid 17 (Lords Neuberger and Sumption). To the same effect see [160] (Lord Mance), with which passage Lord Clarke at [291] and Lord Toulson at [294] agreed.

116  ibid [17].

117  ibid [18], perhaps hinting that they think the two are mutually exclusive.

118  ibid [160], accepting that Jobson v Johnson [1989] 1 WLR 1026 was, and at [161] that BICC plc v Grundy [1985] Ch 232 was ‘assumed’ to be such a case. See further the discussion by Eder J in Cadogan Petroleum Holdings Ltd v Global Process Systems LLC [2013] EWHC 214 (Comm) at [34] ‘[a]lthough there is no doubt that the penalty principle and the court’s power to grant relief against forfeiture are often closely aligned, they are distinct and operate very differently’.

119  ibid [227] and, to similar effect, at [238]. Lord Clarke at [291] and Lord Toulson at [294] expressly agreed with the statement of Lord Hodge at [227].

120  Lowe v Peers (1768) 4 Burr 2225.

121  Astley v Weldon (n 23).

122  Betts v Burch (1859) 4 H & N 506 at 511 (Baron Bramwell).

123  ‘[t]oday … a penalty clause in a contract is, in practice, a dead letter’: Jobson v Johnson [1989] 1 All ER 621 at 632 (Nicholls LJ). To similar effect see the discussion in AMEV-UDC Finance Ltd v Austin (1986) 162 CLR 170 at [35]–[40] (Gibbs CJ), at [8] (Deane J), and at [14] (Dawson J).

124  8 & 9 Will 111 c 11, s 8 and 4 & 5 Anne c 3 SS 12 and 13 repealed respectively by SI 1957/1178, Reg 7 under powers conferred by the Supreme Court of Judicature Act 1925, s 99(1)(f), (g) and Sch 1 and the Statute Law Revision Act 1948, s 1 and Sch 1.

125  The concept of freedom of contract is not without difficulty. It is one of a cluster of concepts which the late Arthur Leff would describe as ‘an emotionally satisfying incantation’. See A Leff, ‘Unconscionability and the Code: The Emperor’s New Clause’ (1967) 115 University of Pennsylvania Law Review 485, 558–9. For a discussion of freedom of contract in the context of liquidated damages and penalties see Ian MacNeil, ‘Power of Contract and Agreed Remedies’ (1962) 47 Cornell Law Rev 495, discussed in R Halson, ‘Neglected Insights into Agreed Remedies’ in D Campbell, L Mulcahy, and S Wheeler (eds), Changing Concepts of Contract Essays in Honour of Ian MacNeil (Palgrave Macmillan 2013) 95–7.

126  P S Atiyah, The Rise and Fall of Freedom of Contract (Oxford University Press 1979) 414.

127  In 1801, Lord Eldon ‘lamented’ the jurisdiction to review penalty clauses, while simultaneously in Astley v Weldon (n 23), supporting the extension of this power to the common law courts. Lord Erskine, during his brief time as lord chancellor, supported the older authorities in Sanders v Pope (1806) 12 Ves Jun 282.

128  See the discussion below at n 206.

129  (1811) 18 Ves 56.

130  ibid 240.

131  This fact has been emphasised in many modern cases, most recently in Cavendish Square Holding BV v Makdessi, ParkingEye Ltd) [2015] 3 UKSC 67, [2015] 3 WLR 1373 at [33] (Lords Neuberger and Sumption), who said that the rule against penalties ‘is an exception to the general principle of English Law that a contract should be enforced in accordance with its terms’. See also Euro London Appointments Ltd v Claessens International Ltd [2006] EWCA Civ 385, [2006] All ER (D) 79 (Apr) at [17] (Chadwick LJ); and ‘the ordinary rule which the courts apply is that contracts should be enforced, pacta sunt servanda, unless they can be brought within that limited category of cases in which, for reasons of public policy, the court refuses to give effect to the agreement of the parties … One limited and well-known class is the … penalty’: Phillip Bernstein (Successors) Ltd v Lydiate Textiles Ltd [1962] CA Transcript 238, reported sub nom Sterling Industrial Facilities v Lydiate Textiles Ltd 106 SJ 669. See also Murray v Leisureplay plc (n 46); and McAlpine v Tilebox [2005] EWHC 281 (TCC), [2005] BLR 271 at [38] (Colman J).

133  See eg Green v Price (1845) 16 M & W 346 and Saintier v Feruson (1849) 7 CB 716.

134  Patrick Atiyah concedes that: ‘The law of mortgages was, of course, far too well settled to be affected by these changing views on freedom of contract … the rules here were so well known that the intention of the parties in an ordinary case could not be supposed to be in accordance with the literal terms of the mortgage instrument’; see Atiyah, The Rise and Fall of Freedom of Contract (n 126) 415.

135  (1829) 6 Bing 141. See also Astley v Weldon (n 23), where a contract to pay an actress her weekly salary and travel expenses further provided for her to pay £200 if she failed to abide by the contract, which incorporated all the theatre’s rules. This was held to be a penalty on the basis that the breach of the theatre’s rules already rendered the actress liable to a fine.

136  The £750 unliquidated damages awarded were left in place.

137  Together with Astley v Weldon (n 23), again concerning an actor.

138  This categorisation is supported by J Edelman (ed), McGregor on Damages (20th edn, Sweet and Maxwell 2018) para 16-063. A similar approach may have operated towards the failure to carry out general provisions under a sale or lease of land or goods. See Betts v Burch (1859) 4 H & N 506 and Magee v Lavell (1874) LR 9 CP 107.

139  A principle best represented by more recent cases such as Neil v Strathclyde Regional Council [1984] IRLR 14; Tullett & Prebon Group Ltd v Ghaleb-el-Hajjali [2008] IRLR 2060; and Murray v Leisureplay Plc [2005] IRLR 946.

140  Clauses providing for the payment by the charterer of a graduated sum for the improper detention of a ship have long been regarded as enforceable, although this old rule is more usually assumed than stated. See Aktieselskabet Reidar v Arcos [1927] 1 KB 352. Indeed, demurrage clauses were only recognised authoritatively to be a form of liquidated damages in President of India v Lips Maritime Corporation [1988] AC 395.

141  Crisdee v Bolton (1827) 3 C & P 240; Galsworthy v Strutt (1848) 1 Ex 659.

142  Re Newman (1876) 4 Ch D 724; Wallis v Smith (1882) 21 Ch D 243.

143  McAlpine v Tilebox (n 131).

144  ibid para 38.

145  Most recently by Leggatt J in MSC Mediterranean Shipping Company SA v Cottonex Anstalt [2015] EWHC 283 (Comm) [2015] 2 All ER (Comm) at [111], referring to Clarke LJ in the Court of Appeal in Cavendish (n 1) [44]: ‘The law of penalties is a blatant interference with freedom of contract’.

146  Cavendish Square Holding BV v Makdessi (n 1) [33] and Lord Hodge at [257]: ‘The rule against penalties is an exception to the general approach of the common law that parties are free to contract as they please and that the courts will enforce their agreements: pacta sunt servanda’.

147  Else (1982) Ltd v Parkland Holdings Ltd [1994] 1 BCLC 130, 145.

148  See Andrews v Australia and New Zealand Banking Group Ltd (n 2).

149  See ch 2B.

150  Cavendish Square Holding BV v Makdessi (n 1) [42].

151  ibid, where two other older comments are explained on a different basis by Lords Neuberger and Sumption.

152  Jobson v Johnson [1989] 1 WLR 1026. A substantial share in a football club was sold for a consideration payable in instalments with a provision that if the purchaser defaults on payment he must retransfer the shares at undervalue. When the purchaser defaulted on payment he was not able to claim relief under the usual relief from forfeiture principles because he had failed to comply with disclosure requirements. The Court of Appeal accepted the purchaser’s argument that the retransfer clause was penal. The usual consequence would be that the clause was not enforced but, as was pointed out in Cavendish Square Holding BV v Makdessi (n 1) at [84], this might have resulted in the purchaser being advantaged by his failure to disclose. Perhaps to avoid this consequence the Court of Appeal applied forfeiture principles to the relief from a penalty and held effectively that the penalty clause was enforceable to the extent of any loss caused by the breach and the seller was therefore offered a choice of remedies to effect this.

153  Cavendish Square Holding BV v Makdessi (n 1) [84] (Lords Neuberger and Sumption).

154  For an expression of regret that the intention of the parties was not more faithfully adhered to see Wilson v Love [1896] 1 QB 626 at 633: ‘[t]he courts made a mistake when they departed in regard to [penalty] cases from the general rule that effect ought to be given to the terms of the agreement entered into by the parties’.

155  Smith v Dickerson (1804) 3 B & P 630.

156  Reilly v Jones (1823) 1 Bing 302.

157  Kemble v Farren (n 135).

158  Sparrow v Paris (1862) 7 H & N 594 at 599.

159  Boys v Ancell (1839) 5 Bing NC 390.

160  See eg ‘[c]lause 15 should be regarded as a penalty. One excellent reason is that it is so-called, a reason which I am aware is not conclusive, but is certainly weighty’: Wall v Rederiaktiebolaget Luude [1915] 3 KB 66 at 74 (Bailhache J). Also: ‘I have no doubt that clause 13 is a penalty clause … To read it otherwise is to ignore the first word “penalty” ’ in Watts, Watts and Co Ltd v Mitsui and Co Ltd [1917] AC 227 at 246 (Lord Sumner).

161  Banta v Stamford Motor Co 92 A 665 at 667 (Conn. 1914) (Supreme Court of Errors of Connecticut).

162  The first two requirements being that: ‘(1) the amount stipulated must be a reasonable one, that is to say, not grossly disproportionate to the presumable loss or injury [and] (2) the damages to be anticipated as resulting from the breach must be uncertain in amount or difficult to prove’. In relation to these requirements, the law in the US and UK also differs in the insistence upon difficulty of proof as a requirement in (2) and the later refinement of (1) that the sum need be reasonable either in light of anticipated harm or in relation to the actual harm suffered: see Uniform Commercial Code 2-718(1).

164  Walter Implement v Focht 730 P 2d 1340 (Wash 1987): ‘Courts will look to the intention of the parties to make an accurate assessment of the clause’s purpose’; Fuqua Const Co v Pillar Dev 667 SE 2d 633 (Ga App 2008), quoting from SE Land Fund v Real Estate World 227 SE 2d 340 (Ga 1976): ‘the parties must intend to provide for damages rather than a penalty’; Erie Ins Co v Winter Constr Co 713 SE 2d 318 (SC App 2010).

165  Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Company Ltd (n 4).

166  Lansat Shipping Co Ltd v Glencore Grain BV (The Paragon) [2009] EWHC (Comm) 551 at [17] (Blair J), affirmed by the Court of Appeal at [2009] EWCA Civ 855, [2009] 2 Lloyd’s Rep 688.

167  Edgeworth Capital (Luxembourg) Sarl v Ramblas Investments BV [2015] EWHC 150 (Comm) at [61] (Hamblen J).

168  The defendant also undertook not to tamper with the defendant’s ‘marks’, not to sell to any buyer ‘suspended’ by the plaintiff, and not to exhibit or export the tyres without the plaintiff’s permission.

169  Philips Hong Kong Ltd v A-G of Hong Kong (1993) 61 BLR 41 at 56 (Lord Woolf).

170  Murray v Leisureplay plc (n 46) 44. See also McAlpine v Tilebox (n 131) [42] (Colman J): ‘Lord Dunedin[’s] … propositions … have often been cited and relied upon for the last 90 years’; and Jeancharm Ltd T/A Beaver International v Barnet Football Club Ltd [2003] EWCA Civ 58, [2003] All ER (D) 69 (Jan) at [10] (Jacob J).

171  Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Company Ltd (n 4) [22].

172  Cavendish Square Holding BV v Makdessi (n 1) [32] (Lords Neuberger and Sumption, Lord Carnwath agreeing): ‘The true test is whether the impugned provision is a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to the legitimate interest of the innocent party in the enforcement of the primary obligation’. For the similar formulations proffered see Lord Mance at [152] and Lord Hodge at [255] (endorsed by Lord Toulson at [293]). The differences between these formulations are explored in ch 2C.

173  Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Company Ltd (n 4) [22].

174  ibid 86.

175  Referring to Clydebank Engineering and Shipbuilding Co v Don Jose Ramos Yzquierdo y Castaneda (n 45). See also his earlier judgment in Public Works Comr v Hills [1906] AC 368 at 375–6.

176  This statement appears to derive from the judgment of the Privy Council delivered by Lord Dunedin in Public Works Comr v Hills (n 175) at 375–6: ‘the circumstances must be taken as a whole, and must be viewed as at the time the bargain was made’. See also Webster v Bosanquet [1912] AC 394.

177  This statement also appears to derive from the judgment of the Privy Council delivered by Lord Dunedin in Public Works Comr v Hills (n 175) at 375–6: ‘[t]he criterion of whether a sum … is truly liquidated damages … [e]normous disparity of the sum to any conceivable loss will point one way, while the fact of the payment being in terms proportionate to the loss will point the other’.

178  Described in Dunlop (n 4) at 87 as ‘one of the most ancient instances’, obviously referring to the relief from penal bonds discussed above.

179  Previously this principle had operated as a rule of law: see Astley v Weldon (n 23).

180  Referring to Elphinstone v Monkland Iron & Coal (1886) 11 App Cas 332 at 342 (Lord Watson).

181  Penalty – Elphinstone v Monkland Iron & Coal Co (1886) 11 App Cas 332 at 348 (Lord Halsbury), repeated in Clydebank Engineering Co v Don Jose Ramos Yzquierdo y Castaneda (n 45) 10. Liquidated damages: Wallis v Smith (1882) 21 Ch D 243 at 267 (Cotton LJ).

182  In Cavendish Square Holding BV v Makdessi (n 1), the Court of Appeal suggested a more modern translation of ‘intended to deter’ El Makdessi v Cavendish Square Holdings BV [2013] EWCA Civ 1539 at [58].

183  The redundancy of the in terrorem requirement was exposed in an insightful comment by Lord Radcliffe in Bridge v Campbell Discount Co Ltd [1962] AC 600 at 622: ‘ I do not myself think that it helps to identify a penalty, to describe it as in the nature of a threat ‘to be enforced in terrorem … I do not find that that description adds anything of substance to the idea conveyed by the word “penalty” itself, and it obscures the fact that penalties may quite readily be undertaken by parties who are not in the least terrorised by the prospect of having to pay them and yet are, as I understand it, entitled to claim the protection of the court when they are called upon to make good their promises’. This neglected comment (eg it is not mentioned in J Edelman (ed), McGregor on Damages (n 29) or E Peel, Treitel on the Law of Contract (14th edn, Sweet & Maxwell 2015) was belatedly endorsed in 2015 in the Cavendish case by Lords Neuberger and Sumption and also Lord Mance at [28] and [140], respectively, and to similar effect see Lord Hodge at [248].

184  See Buxton LJ, with whom Clarke LJ agreed in Murray v Leisureplay plc (n 46) [111], stating that it was ‘[i]mportant to note that the two alternatives, a deterrent penalty; or a genuine pre-estimate of loss; are indeed alternatives, with no middle ground between them’. Their approach was rejected by Arden LJ at [15].

185  Lordsvale Finance plc v Bank of Zambia [1996] QB 752 at 762 G (Colman J), approved in Cine Bes Filmcilik VE Yapimcilik v United International Pictures (n 46); Murray v Leisureplay plc (n 46) [106] and [109] (Clarke and Buxton LJJ); and Euro London Appointments Ltd v Claessens International Ltd (n 131) [30]–[31], respectively.

186  Murray v Leisureplay plc (n 46) [111].

187  Cavendish Square Holding BV v Makdessi (n 1) at [31] (Lords Neuberger and Sumption).

188  The struggle of prior judges to depart from the ‘straightjacket [of] an over-rigourous emphasis on a dichotomy between a genuine pre-estimate of damages on the one hand and a penalty’ was referred to by Lord Hodge at [225] and described by Lords Neuberger and Sumption at [28].

189  See eg Arden LJ, the third judge in the Court of Appeal in Murray v Leisureplay plc (n 46) [15], who ‘found valuable’ an earlier suggestion by Colman J in Lordsvale Finance plc v Bank of Zambia (n 185) that ‘a dichotomy between a genuine pre-estimate of damages and a penalty does not cover all the possibilities’. To similar effect see Hodge J QC in Lancore Services Ltd v Barclays Bank Plc [2008] EWHS 1264 at [100], who said that the condition in question ‘falls outside the traditional dichotomy between a genuine pre-estimate of damages and a penalty, and that the applicable test is that of commercial justifiability’ and Blair J in Azimut-Benetti SpA v Healey [2010] EWHC 2234 (Comm), [2011] 1 Lloyd’s Rep 473 at [21]: ‘On the other hand … this does not imply that if the comparison between the amount payable on breach and the loss that might be sustained on breach discloses discrepancy, it follows that the clause is a penalty’.

190  Clydebank Engineering and Shipbuilding Co Ltd v Don Jose Ramos Yzquierdo Y Castaneda (n 45) 9 (Lord Halsbury LC).

191  Kemble v Farren (n 135).

192  See n 60. This overemphasis may be a relic of the court’s reference in several older cases to the intention of the parties as a justification for the penalty jurisdiction, eg Smith v Dickenson (1804) 3 Bos & P 630. This justification was soon discredited: see Kemble v Farren (n 135).

193  See M Eisenberg, ‘The Limits of Cognition and the Limits of Contract’ (1995) 47 Stanford Law Review 211, arguing for a ‘second look standard’ on the basis of parties’ routine and documented inattention to the possibility of breach. See further ch 4G.

194  In the US the Uniform Commercial Code (UCC) discussed above in n 162 qualifies this rule by a provision that a clause may be upheld as valid because it was reasonable in relation to the actual loss incurred even though it was not reasonable when judges at the time of contracting. UCC 2-718(1) does not expressly, but it may be argued by analogy does impliedly, suggest that a clause may be struck down as a penalty because the amount was unreasonable in relation to the actual loss suffered, even though it was not unreasonable in light of the loss that could reasonably have been anticipated. See Farnsworth, Farnsworth on Contracts (n 35) 309–10.

195  Azimut-Benetti SpA v Healey (n 189) [4].

196  [1905] AC 6 (n 45) 10.

197  Simple reference to ‘loss’ conceals an ambiguity. Is the loss referred to the full loss, which it is anticipated will flow from breach or does it refer to such proportion of that loss as would be recoverable in an action for unliquidated damages, ie which is not too remote etc? For an account of the limiting factors, ie remoteness, mitigation, and contributory negligence that might reduce the prima facie level of recovery see Halson, Contract Law (n 85) 495–504. There is authority for suggesting that a liquidated damages clause may enable a party to recover for items of loss that would be too remote to form part of an unliquidated damages award. See Robophone Facilities v Blank [1966] 3 All ER 128, [1966] 1 WLR 1428 at 1448 (CA) (Diplock LJ). This approach may have received indirect support from Clarke and Buxton LJJ at [39] in Murray v Leisureplay plc (n 46) [39], who expressly disagreed with Arden LJ’s approach, which took as its starting point for any investigation into the validity of a stipulated damages clause a comparison between the ‘amount that would be payable under the terms of the agreement and … what would have been payable if [the party] had had to bring its claim under the common law’. Cf the Law Commission’s Working Paper No 61 para 44, which suggests that it is the amount that could be recovered as unliquidated damages which should be considered. A ‘compromise’ has been proposed where limitations imposed by the doctrine of remoteness should be ignored but, in the interests of avoiding waste, those imposed by the doctrine of mitigation should be considered relevant: see Hugh Beale, Remedies for Breach of Contract (Sweet & Maxwell 1950) 57.

198  Photo Production Ltd v Securicor Transport Ltd [1980] AC 827.

199  Williams v Reynolds (1865) 6 B & S 495. The Law Commission recommended the abolition of the rule (Law Com No 88 paras 35–44) but this has not been acted on. In the face of a deliberate failure by the legislature to implement the report, the House of Lords declined to do so in President of India v La Pintada Co Navigacion SA [1985] AC 104, [1984] 2 All ER 773.

200  [2008] AC 561.

201  See further read J Edelman (ed), McGregor on Damages (n 29) para 16-043.

202  Not to sell or offer for sale where the marks had been tampered with, not to sell or offer for sale to a private individual or co-operative society below list price, not to supply black-listed individuals, and not to exhibit or export the goods without permission. This totals nine obligations undertaken in relation to three goods (tyres, covers, and tubes) producing a total of 27 undertakings.

203  Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Company Ltd (n 4) 96.

204  ibid 98–99.

205  The arithmetic, as opposed to the principle, endorsed here may be wrong as: [15 – 5] + [12–5]/ 2 = 8.5 (rather than 8) may now qualify the principle stated by Lord Dunedin.

206  Re Dagenham (Thames) Dock Co; Ex p Hulse (1873) LR 8 Ch App 1022 (purchaser in possession allowed time to make second instalment on basis that clause requiring him to vacate and forfeit the first instalment was a penalty) (followed by the Privy Council in Kilmer v British Columbia Orchard Lands Ltd [1913] AC 319); Watson v Noble (1885) 13 R 347(clause under which trawler captain dismissed for being drunk was to forfeit shares in ship if not sober and attentive held to be a penalty); Comr of Public Works v Hills [1906] AC 368 (clause forfeiting money otherwise due to a contractor held to be a penalty).

207  Although only Comr of Public Works v Hills (n 206) was cited.

208  It was recognised by the Court of Appeal in Jobson v Johnson [1989] 1 All ER 621 (clause in share sale agreement requiring retransfer of shares for £40,000 after £140,000 paid but purchaser unable to pay further instalments was void) but earlier in Australia: see Bysouth v Shire of Blackburn and Mitcham (No 2) [1928] VLR 562 (clause permitting forfeiture by council of contractor’s property in the event of latter’s breach was penal). For other reasons in Cavendish Square Holding BV v Makdessi (n 1), Lords Neuberger and Sumption considered at [42] Jobson v Johnson to be an ‘unsatisfactory decision’ and Lord Hodge at [283] thought it ‘should be overruled’. Their criticism arose not from the principle of equivalence between monetary and non-monetary benefits, which they in fact endorsed (respectively at [16], [226], and [230]) but, rather, from the nature of the remedy granted. This is explored in ch 2D(2).

209  These challenges were unequivocally rejected in Exports Credits Guarantee Dept v Universal Oil Products Co [1983] 1 WLR 399 and in the UK most recently in Cavendish Square Holding BV v Makdessi (n 1). See the lengthy discussion in ch 2B.