Since 1915, English law has distinguished between penalties (which are unenforceable) and ‘liquidated damages’ (which are enforceable) by the criterion of whether the amount agreed to be payable is extravagant and unconscionable in comparison to a genuine pre-estimate of the loss. Recent cases have suggested that a clause may also be valid, though it was not a genuine pre-estimate of the loss, if it had a commercial justification and was not merely aimed at deterring breach or even if it was aimed at deterring breach, provided that there was a broader social interest in ensuring compliance with the contract. The latest cases have been appealed to the Supreme Court. In one, the appellants argued that the doctrine of penalty clauses should be abolished or at least dis-applied when the parties ‘met on a level playing field’. But total abolition would leave unsophisticated businesses unprotected and partial disapplication would be difficult without developed criteria to determine when the doctrine should apply. More promising approaches may be to exempt clauses that form the ‘core’ of the contract or to ask what the commercial purpose of the provision is and whether its effects are proportionate to that purpose. It might be difficult, however, to determine what types of clause should fall within such a control, and it may be that the Supreme Court will decide to deal only with clauses that are triggered by a breach and to consider the legitimacy of clauses that have a commercial purpose other than compensation and including deterrence, provided that the effects of the clause are not extravagant and unconscionable.
Hugh Beale, ‘Penalty Clauses in English Law’. European Review of Private Law Volume 24 (2016).