within the control of the debtor the occurrence of which might nonetheless occur without any fault on the debtor’s part. The occurrence of such circumstances, if they constitute non-performance of a duty, will trigger a right to damages on the creditor’s part, an entitlement explained more fully in the official commentary to Article III.-3:701. The DCFR damages is, in consequence, not fault-based.218

7.  Liquidated damages: penalty clauses

Arguably, any legal system which considers itself as according a high level of respect for seriously intended contractual promises would enforce a so-called ‘penalty clause’ (stipulatio poenae), being a clause for the payment or forfeiture of a sum of money in the event of a breach of contract, regardless of any possible harsh effect which such a clause might have, so long as the clause could be said to represent the freely given consent of the contracting parties. If parties wish to provide for clauses which have an effect which others might deem harsh, this need not necessarily be any concern of the courts. Indeed, such clauses can be argued to be useful, in that they both serve as a spur to performance as well as to pre-empt unnecessary judicial investigation into the assessment of damages which may be due in the event of a breach of contract.

In practice, however, many jurisdictions will not enforce such penalty clauses in every case, for instance in cases where the penalty promised does not reflect the loss which the promisee is likely to suffer or does suffer at the time the application of the clause is triggered. Such interference in penalty clauses might conceivably be justified on a number of grounds, such as the underlying purpose of contract law (to facilitate advantageous arrangements rather than to inflict punishment), the protection of weak parties, the prevention of unconscionable conduct (or the promotion of virtuous conduct), or the requirement of good faith, among others.

In Roman law, a stipulatio poenae was enforceable. Such a clause might be of two types: the first was very much like the modern penalty clause, namely an accessory obligation that became due in the event of nonperformance of a primary obligation; the second was a peculiar usage of Roman law, and provided for penalties as a means of achieving tangentially that which could not lawfully be done directly.219 With the first type

218DCFR, Official Commentary to Art. III.-3:701, Comment C.

219For instance, while a jus quaesitum tertio was not directly enforceable by a third party, the promisee could stipulate for a penalty if performance was not rendered to the third

quite readily be undertaken by parties who are not in the least terrorised by the prospect of having to pay them and yet are … entitled to claim the protection of the court when they are called on to make good their promise’.223 The essence therefore of identifying a penalty lies in assessing whether a true pre-estimate of damages took place or not, a clause not reflecting such a true pre-estimate being just such an unenforceable penalty; where such an unenforceable penalty is identified, the party seeking recovery for any loss must instead rely upon common law damages.224

The Common law rule against penalty clauses is clearly an infringement of the sanctity of promise, but it is one which is judicially justified as necessary in order to prevent oppressive and unconscionable conduct. As was said in the Canadian Supreme Court,

the power to strike down a penalty clause is a blatant interference with freedom of contract and is designed for the sole purpose of providing relief against oppression.225

Evidently the power to strike down is a discretionary one, and requires the courts to judge sensibly whether a reasonable attempt was made to assess likely losses. To that end, the adoption of guiding principles such as those in Dunlop, and the principle that, if a genuine assessment is difficult given the uncertainty of the likely loss, a court should be slow to intervene,226 represent a wise attempt to bring some objective standards into what would otherwise run the risk of being a highly subjective, ad hominem judicial exercise.

(b)  Mixed legal systems

In Roman-Dutch law, under the influence of the canon law, a penalty was only enforceable if it was reasonable in relation to the resulting damage. Subsequently, in South African law the courts introduced the Common

223[1962] AC 600, 622.

224Scandinavian Trading Tanker Co., AB v. Flota Petrolera Ecuatoriana (‘The Scaptrade’)

[1983] 2 AC 694, 702; cf. however, the alternative view that what occurs is enforcement of the penalty clause, but only up to the amount of the actual loss suffered: Jobson v. Johnson [1989] 1 WLR 1026, 1040. This latter view would cause difficulties in application if the penalty were a patent under-valuation, however, as the actual loss suffered would exceed the penalty.

225Elsey v. J. G. Collins Insurance Agencies Ltd (1978) 83 DLR 1, 15; [1978] 2 SCR 916, 937 (opinion of the Court, delivered by Dickson J).

226Clydebank Engineering and Shipbuilding Co. Ltd v. Castaneda (1904) 7 F (HL) 77; [1905] AC 6 (a Scottish authority, applied in England also).

law position, but, when this development was strongly criticised by the Appellate Division,227 the Conventional Penalties Act was passed.228 The Act provides that a penalty clause is enforceable,229 but that if the penalty is out of proportion230 to the prejudice suffered by the innocent party, a court may reduce the penalty to a level which is equitable in the circumstances.231 The Act restored the culture of the old Roman-Dutch law, which had been founded upon Voet’s view that excessive penalties might be moderated by replacing them with a provision which was ad bonum et aequum.232 It is noteworthy that the Act talks about ‘reducing’ the amount of a penalty. This means that a party who claims that a penalty clause is out of proportion to the prejudice suffered because it is too low in ­comparison with the actual loss suffered cannot argue that the amount payable under the penalty clause should be increased (a result which can theoretically happen in Scotland, where, if a penalty clause is found not to be a genuine pre-estimate, it can be struck down and a higher sum of damages claimed at common law).

In Louisiana, §2117 of the Civil Code formerly dealt with what were referred to as ‘penal clauses’, but are now, under the replacement §2005, styled stipulated damages, though nothing of substance turns on the change of terminology. §2005 states that parties

may stipulate the damages to be recovered in case of nonperformance, defective performance, or delay in performance of an obligation.

In adding that such a stipulation ‘gives rise to a secondary obligation for the purpose of enforcing the principal one’, the provision makes clear the accessory characterisation of such clauses.

A court may only interfere in such a stipulated damages clause if the damages specified are ‘so manifestly unreasonable as to be contrary to public policy’.233 Where this test is met, the clause may be amended by the

227 See Baines Motors v. Piek 1955 (1) SA 534 (A). 228 Act 15 of 1962.

229s. 1. A penalty is defined so as to include any agreed sum (or the delivery or performance of anything) due upon breach as liquidated damages or as a penalty.

230The onus is on the debtor under the penalty clause to demonstrate that it is out of proportion. In Western Credit Bank Ltd v. Kajee 1967 (4) SA 386 (N) the phrase ‘out of proportion’ was interpreted by the court to mean ‘markedly, not infinitesimally’ out of proportion.

231 s. 3. 232 See Zimmermann, Law of Obligations, p. 109.

233CC Art. 2012. Because the unreasonableness must be ‘manifest’, stipulated damages may exceed, to some degree found reasonable by the court, the actual damages, without breaching public policy (Mobley v. Mobley 852 So 2d 1136 (La App 2nd Cir 2003).

court by a downward adjustment of the damages payable.234 The courts have had occasion to consider when a stipulated damages clause might be contrary to public policy, and have formulated the position that, in assessing public policy, it is proper to consider both (i) the amount of actual loss when compared with the stipulated damages, and (ii) whether the damages stipulated were a reasonable assessment of the likely losses. In Carney v. Coles,235 for instance, Sexton J emphasised the first of these two considerations, noting that when ‘stipulated damages in a contract do not bear any reasonable relation to the actual damages suffered, courts have reduced the amount of damages recoverable’.236 On the other hand, in American Leasing Company of Monroe Inc. v. Lannon E. Miller & Son, Marvin J emphasised the second, stating that the task of the court was to ‘determine the reasonableness of the amount of stipulated damages by inquiring whether the parties attempted to approximate actual damages in confecting the stipulated damages provision of the agreement’.237 This consideration is further emphasised in official comment (c) to Article 2005, which states that a ‘stipulated damages clause is given effect if the court deems it to be a true approximation of actual damages’. The Louisiana approach is thus wider than that taken by the British courts, where judicial regard is had only to the second consideration (the reasonableness of the estimation of likely losses at the time the contract was made) and not to whether there is any discrepancy between stipulated damages and actual loss suffered. The making of a claim for stipulated damages precludes a claim for performance, unless the stipulated damages are due only for delay.238

In addition to the above accessory function of stipulated damages clauses, the Louisiana Civil Code also provides for what are styled ‘penal clauses in submission’.239 These are penalties which parties may provide for in the event of a failure to adhere to an arbitration award, such penalties being designed to encourage adherence to the award rather than the making of a further appeal (such an appeal triggering payment of the penalty by the appellant).240 This function of penalty clauses was known in Roman law.

234The wording of the codal provision would also seem theoretically to permit an upward revision of a damages clause, assuming an argument could be made out that public policy required such an uplift.

237American Leasing Company of Monroe, Inc. v. Lannon E. Miller & Son, General Contracting, Inc. 469 So. 2d 325 (La App 2nd Cir 1985).

238 CC Art. 2007. 239 CC Art. 3106.

240CC Art. 3130. The Roman usage of penalties in such circumstances was discussed above in the main text, at p. 394.

The Scottish position on stipulated damages, deriving from Dunlop Pneumatic Tyre Co. v. New Garage and Motor Co.,241 remains, for the moment,242 identical to that of the English law discussed earlier, namely that a stipulated damages clause will be enforced by a court if, and only if, it represented at the time the contract was formed a reasonable estimation of the losses likely to be suffered by the party entitled to claim under the clause. If it is struck down, it is styled a ‘penalty clause’, regardless of whether it was stated in the contract to be a liquidated damages clause and not a penalty. The reasonableness of the clause is judged at the time the contract is made. This judicial power to review damages clauses is in two senses narrower than that given to courts in Louisiana and South Africa. It is narrower, firstly, in that it is no part of the judicial consideration of the clause whether the actual loss suffered by the relevant party deviates from the stipulated amount; all that matters is whether the assessment of likely losses was carried out in a reasonable fashion. It is narrower, secondly, in that a Scottish court cannot amend a stipulated damages clause: either the clause is enforced or it is struck down entirely, the innocent party then being forced to rely on a common law damages claim. Occasionally, it may benefit the innocent party to have the clause struck down, this being so where the actual losses suffered turn out to be much greater than those predicted at the time the clause was agreed. Courts are not unaware of cynical attempts by innocent parties to have agreed damages clauses struck down simply in order to be able to claim more than was agreed, and maintain a strict assessment of the reasonableness of the clause at the time the contract was concluded.

Because only clauses which provide for payment or another performance (including forfeiture of a sum already paid) in the event of a breach of contract fall within the penalty clause rule it is possible to provide for disguised penalties, that is clauses which have a penal effect but are not tied to breach. Hence, rather than penalise a contractor for late completion of a construction project, an employer might instead specify that a

241[1915] AC 79 (HL).

242In 2010, the Scottish Government conducted a consultation exercise on whether to change the law. It proposed a new regime whereby enforceable liquidated damages clauses would no longer have to be a genuine pre-estimate of likely loss, but clauses would be unenforceable if ‘manifestly excessive’ (though in such a case, a court would be entitled to alter the terms of the clause so as to make it enforceable): see the the proposed Penalty Clauses (Scotland) Bill, included in the Scottish Government Consultation on Penalty Clauses (July 2010). These proposals are somewhat similar to the provisions of the DCFR noted in the main text below, at p. 403.