Liquidated damages

A contractual clause which specifies an agreed sum as the amount to be paid in the event of a specified breach. The amount should be based on a genuine estimate of the loss such a breach would entail. Liquidated damages clauses aim to incentivise parties to discharge their obligations on time and make determination of a damages claim for breach easier.

The case of Paciocco v Australia and New Zealand Banking Group Ltd [2014] FCA 35 outlined the circumstances in which a liquidated damages clause will be enforced. The question of whether the sum stipulated is enforceable is a question of construction to be determined with reference to the terms and context of the contract at the time of formation, not at the time of breach.

A liquidated damages clause will not be enforced where close examination reveals that it is in fact a penalty clause – included to penalise the party in breach. Penalty clauses are voidable and will not be enforced by courts. The considerations for identifying penalty clauses can be found in Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79:

  • The effect of the clause as opposed to the words used
  • Whether the clause is a warning or a genuine pre-estimate of loss arising from a breach
  • The construction of the clause in the context of the rest of the contract
  • Whether the amount specified is ‘extravagant and unconscionable’
  • The breach is solely for non-payment, and the amount sought exceeds the amount owed
  • If the payment is a lump sum, whether the amount is reflective of a serious breach or a trivial breach

The High Court approved this in Ringrow Pty Ltd v BP Australia Pty Ltd [2005] HCA 71.