Liquidated Damages and the Doctrine of Penalties: Rethinking the War on Terrorem

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Matthew Bell

May 2011

A paper based on the joint second prize entry in the Hudson Prize essay competition 2010 presenting to a meeting of the Society of Construction Law in London on 26th May 2011

The underlying premise of the paper is that, where commercial parties have freely agreed, within a binding contract, to a regime for liquidated damages (LDs) which is expressed in terms sufficiently certain to be enforced, the law should uphold its enforcement. The modern approach places a high barrier in the path of a party seeking to overturn an LDs provision on the basis that it is penal. However, the jurisprudential foundations of the penalty doctrine remain and the law maintains a prohibition upon parties using LDs provisions to enforce performance by placing the other in fear - terrorem - of breach. Matthew Bell argues that this prohibition has outlived its usefulness. He describes the commercial impetus for the use of LDs provisions in construction contracts; he outlines the history and current state of the law relating to deterrence within the penalty doctrine; he offers a critique of the current law and proposes an alternative formulation of the doctrine of penalties based upon whether the allegedly penal component serves a purpose other than the proper performance of the contract.

A. Introduction - B. The commercial impetus for LDs in construction contracting - LDs as a risk mitigation measure - Challenges to enforceability - C. Evolution of the doctrine of penalties - Pre-Dunlop history - The Dunlop test - Current approaches to the deterrence element - D. Satisfactory outcomes built on unsatisfactory foundations? - E. Conclusion: back to the future? - Considerations underpinning a revised formulation - A return to the collateral purpose test?

Matthew Bell is a Lecturer and Co-Director of Studies for Construction Law at the Melbourne Law School, University of Melbourne, Australia.

Text 17 pages.

Paper number: 
May 2011, printed/online, 340k

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