Penalty clauses and liquidated damages: traps for the unwary

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Liquidated damages (LDs) clauses stipulate that a certain specified sum of money will be payable by one (‘guilty’) party to the other (‘innocent’) party, where there has been a particular breach of contract.

LDs are a useful contracting tool in commercial agreements, but there is a danger that, if they are not considered properly or drafted correctly, they may be construed as a ‘penalty clause’, and therefore unenforceable under English law. The recent judgment in E-Nik Ltd v Department for Communities and Local Government has reignited the debate about ‘take or pay’ clauses by confirming that such provisions could also fall foul of the rule against penalties.

LDs are often payable where there is a delay in delivery or completion of a particular service, or where a service fails to meet certain specified targets. LDs bring a greater degree of certainty than relying on the contract law rules regarding claiming general damages – you know how much you can recover (or how much you will pay) if a certain type of breach occurs…

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