Liquidated damages and penalties

1. LEGAL NOTE
DAMAGES, LIQUIDATED DAMAGES AND PENALITIES/PUNITIVE DAMAGE
Regarding Contracts of Sale and Purchase of Goods and/or Services
General Preamble
Generally all contracts of supply of goods or services will fall under certain laws of the country, so nominated,
within the contract.
In the event that a contract comes into legal existence and there are no written agreed terms pertaining to that
actual agreement then the prosecution of that agreement will be under the Common Law of the country of the
party who made the last chronological offer of sale and purchase.
Any written signed contracts should be explicit within the terms of the law as to what is the real intent and
meeting of minds of both, or more, parties to the said contract. The concept is that all contracts do fall under
the country’s Common Law and we draft clauses to be specific to govern the operation of the contract and any
occurrences, which do fall within the structure of the contract will be governed by the contract, however those
occurrences, which are not specifically addressed by the actual terms of the contract shall then be addressed
and measured by the courts in terms of Common Law and or the Statue Law (Codified Law) where applicable.
Categories
In general the Law is broken down into certain categories being, for example, Criminal law, Civil law, Law of
Restitution and so on, but under laying all these specific laws is the umbrella of Common Law of the country
under which this specific contract is governed.
Essentially, under these Statutes (i.e the categorised Laws) the clauses within such Statute will have their
basis in Common law but modified to be specific to that category and hence due to the greater use, and
therefore testing of such clauses in a court of law, said clauses will have an enriched content of precedent and
case history which would lay down the real intent of such clauses by prior use and tests in court.
Codified Law
In different countries the laws have been codified to a greater or lesser degree and therefore need to be taken
into account when deciding under which country’s law the contract will be governed.
Simply, when a country Codifies their laws they take various laws and enter them into specific Legal Statues
within the categories of their laws and so those laws become specific and more detailed to that category or
discipline (if you wish) and therefore have more case history. Those laws that remain in the general Common
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2. Law are considered as not codified. It would appear that Germany has the most codified laws compared to the
other significant countries, in actual fact China has the most codified legal system but it is so different from the
norm we are not considering it in this note.
Contract Rules
The idea behind the law of contract is purely to set the ground rules regarding the intent and meeting of minds
of both (or more parties) and inscribe these rules in writing and by signature by all the parties appended to
such a document (called a Contract or Agreement) the various parties have reached a meeting of minds and
the intention of this meeting of minds should be clear.
However, although a contract may contain many provisions, we are, here in this note, specifically addressing
the remedies that get built into the contract to protect the parties in the event something goes wrong or one
party breaches the rules of the contracts.
Contractual Breaches
Broadly speaking the intent of the parties should be to reach an equitable solution as to remedies should one
party default against the other and typically these seem to fall into various categories, namely:
1. Late deliveries
2. Defective goods or services
3. Breach of the essence of the contractual terms
4. Non conformance with the specific performance of the goods or/and contract that was agreed in the
meeting of minds and really which go to the main purpose or cause for the creation of the contract in
the first instant.
And there are various other such categories which could have various remedies including financial ones.
Contract Remedies (specifically of a financial nature)
However we wish to address the remedies regarding the breach or default of one of the parties.
The essence, regarded in the old laws of Rome, contemplated that the idea was to address these breaches or
defaults in such a manner so that the work could be completed (or continued whilst the legal breach was being
attended to) with the minimum of delay and essentially to place the parties in a financial and practical position
at the end as if there had been no default at all and in the case of a serious breach where the contract is
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3. terminated then that both parties should be, in as close a position financially, as they would have been had
they not entered the contract in the first instance.
Essentially these damages fell into three categories as detailed below:
Actual damages – i.e Known just as Damages (These damages, would by nature include consequential
and indirect damage)
Actual Damages is defined as the actual costs suffered due to the default by the other party and it is the
aggrieved party’s task to quantify and prove such damages in financial terms. This is usually quantified by the
company’s auditors as all the back up documentation is required to prove the claim.
As this process can take a long time and is also a costly exercise it is often not used in contracts, in preference
of either Liquidated damages or Penalties, since most contracting parties limit their total liabilities (See heading
Consequential and Indirect Losses) to the other party and usually the maximum liability that is conceded would
be the total value of the contract, but normally it is much lower than that limit, so it is hardly worth the costs of
determining the actual financial losses bearing in mind the absence of consequential and indirect losses.
Furthermore such determinations of actual damages are open to the court to interpret as to whether these
damages, so enumerated, are real and factual and also are usually always contested by the other party.
Liquidated Damages (which is similar to penalties)
Liquidated damages are defined as an agreed basis, written within the contract, as a simple way to gain an
equity between the parties, where one has strayed from the rules of engagement under the terms of the
contract and the other party has to accept a lesser part than it had agreed to accept and pay for, then the set
Liquidated Damage enumerated in the contract would be applied and the defaulting party must pay against
such a claim for liquidated damages. Of course in all contracts the party in default always has the right to
contest such a claim and or the quantum of such a claim and various remedies (Dispute Resolution) are
inserted into all contracts to address this contest, and if agreement is not reached between the parties then
these specific remedial procedures are followed. Under Liquidated damages there is also a notion of
consequential or/and indirect damages but these are not normally accepted since both parties insert a clause
into the contract excluding consequential or indirect damages. Also under Liquidated Damages there is the
ability to enforce the definition of the remedies, to cover certain resultant suffering of the aggrieved party, but
still provided that these apparent punitive claims remain reasonable and fair and a court will quickly decline any
claim that is unfairly punitive.
Penalties (Specifically a South African legal term)
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4. Are defined as a set amount of money, or other such instrument, that the default party shall forfeit in the event
that they default in the performance of the contract. Generally it is only in South African Law that Penalties are
recognised due to the existents of the Convention of Penalty Act of South Africa. Since most other larger
countries do not have such an Act they do not recognise the word penalty which is unfortunate since in South
African Law the Penalty Act specifies that no penalty shall be punitive in any manner what so ever. Hence with
international contracts and especially where it would be governed under another country’s law then one would
always refer to Liquidated damages and not Penalties.
However, under German law which is the most codified there is legal provision for Punitive Damages. This is
not usual in the other countries who do not subscribe to any Punitive Damages.
Consequential and Indirect Losses
A point to note firstly is that within the structures of these remedies, usually either of the parties or both the
parties can include clauses specifically designed to exclude consequential or indirect damages under all
circumstances, whilst in essence some do address these areas of damage where the defaulting party has
caused these damages by gross negligence or by acts that are premeditated and are seen as malicious acts
by the other party and at law.
However for the purposes of this note, suffice it to say, that in these days where the financial stakes are very
high, in most contracts, all parties contract out of any liability which has anything to do with any form of
consequential or indirect damages whatsoever. So for this note we will accept that consequential or indirect
damaged are excluded completely from this note as they are written out of the contract.
The concept as to Consequential Damages and Indirect Damages are complex and the line between them is a
very fine line and could be discussed at a later time.
Conclusion
In conclusion the following is the norm:
1. Where a Contract/Agreement is governed by South African Law one would write a Penalty Clause into
the contract.
2. Where a Contract/Agreement is governed by the Law of an International Country one would write a
Liquidated Damage into the contract.
The above is true, as usually no company will agree to an Actual Damage Clause, being written into a contract.
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