Walt, Steven --- "Penalty Clauses and Liquidated Damages" [2011] ELECD 127; in De Geest, Gerrit (ed), "Contract Law and Economics" (Edward Elgar Publishing, 2011)

Book Title: Contract Law and Economics

Editor(s): De Geest, Gerrit

Publisher: Edward Elgar Publishing

ISBN (hard cover): 9781847206008

Section: Chapter 10

Section Title: Penalty Clauses and Liquidated Damages

Author(s): Walt, Steven

Number of pages: 29

Extract:

10 Penalty clauses and liquidated damages
Steven Walt* 1




1. Introduction
The common law of contracts refuses to enforce contractual stipulations
of damages courts deem penalties. Although sometimes formulated dif-
ferently, doctrine characterizes a stipulation a `penalty' that either unrea-
sonably forecasts expected or actual damages arising from breach, or sets
damages that are easily ascertainable by a court. Damage stipulations
that either reasonably forecast expected or actual damages, or provide for
damages that are difficult to ascertain judicially, are deemed `liquidated
damages' and enforced. For most legal economists and many traditional
legal scholars, the penalty doctrine is puzzling. Contracting parties agree
to stipulate damages from breach, as they do for any other contract term,
because they anticipate that the stipulation maximizes their joint surplus.
A `performance terms' doctrine specifically regulating the performance
terms of a contract, such as risk of loss or warranty provisions, therefore is
undesirable, and contract law does not contain one. For the same reason,
a penalty doctrine specifically regulating damage stipulations also seems
undesirable.
This chapter critically surveys the recent economic literature on penalty
clauses. Almost all of this work appeared between 1977 and 1996, with
a few contributions appearing in the late 1990s. It differs from early law
and economics scholarship on penalty regulation in both method and
substance. The early work evaluated penalty regulation informally. In
contrast, much of the strictly economic recent work formally models the
effects of damages clauses on investment in performance, breach and trade
under prescribed conditions. Some of ...