This must be the shipping/damages season. After a case dealing with reliance damages (blogged here), we also have a case that has reviewed the status of liquidated damages clauses: Azimut-Benetti SpA v. Healey  EWHC 2234 (Comm).
A liquidated damage is legal jargon for a loss or expense that can be costed. If the value of the loss was not known or unascertained, it would be an unliquidated damage. A liquidated damages clause sets out to define what damages will be paid to an innocent party if the other (defaulting) party breaches the contract.
The offending clause was contained in a Yacht Construction Contract dated 25 September 2008. This was for the construction of no ordinary yacht, but was for a white 60 metre luxury yacht from the Benetti builders in Italy for a price of €38 million (the picture above, by VP, shows a comparable 62 metre yacht in the Benetti shipyard. For pictures of the luxurious interior of similar yacht, the Bistango, go to http://www.bistango.net/). The liquidated damages clause stated:
Upon lawful termination of this Contract by the Builder it will be entitled to retain out of the payments made by the Buyer and/or recover from the Buyer an amount equal to 20% of the Contract Price by way of liquidated damages as compensation for its estimated loss (including agreed loss of profit) and subject to that retention the Builder will promptly return the balance of sums received from the Buyer together with the Buyer’s Supplies if not yet installed in the Yacht.
The Buyer did not pay the first instalment, 10% of the Contract Price, on the due date of 17 October 2008. The Builder then sought to enforce a guarantee given by Mr Healey under which he had guaranteed the Buyer’s obligations under the agreement. If he were able to show that the liquidated damages clause was in some way unenforceable against the Buyer, then he would have no obligation of the Buyer to guarantee. To do this Mr Healey needed to succeed in a claim that the clause was in fact a penalty. Under English contract law penalty clauses are unenforceable. As this is the law, there is often an argument between parties in a contract breach dispute about whether any given clause is an unenforceable penalty or an enforceable liquidated damages clause. The classic test was first set out by Lord Dunedin in a House of Lords case, Dunlop Pneumatic Tyre Co Limited v. New Garage and Motor Co  AC 79 (at 86-87):
The question whether a sum stipulated is a penalty or liquidated damages is….to be….judged of as at the time of the making of the contract, not as at the time of the breach… It will be held to be a penalty if the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach.
This led to the common formulation in liquidated damages clauses that the pre-determined amount payable by the defaulting party was a “genuine pre-estimate of the innocent party’s loss.” So what about this case, where clause 16.3 appears to give the Builder 20% of the Contract Price as a result of its failure to pay the first instalment of only 10%? Mr Healey’ counsel argued, as you would expect, that the parties cannot have assumed in these circumstances that the liquidated damages of 20% of the Contract Price was a genuine pre-estimate of loss. Counsel for the shipbuilders noted that the clause said more than just “pay 20%”; it also required the builder to return the balance promptly and any ships’ fittings or other Supplies that had not installed.
After a little argument and an examination of a complex email trail, the judge Mr Justice Blair was satisfied that the agreement had been entered into properly and with the assistance of appropriate legal advice. Neither party could therefore claim that it did not know what it was doing. In such circumstances, Blair J noted that English courts will normally uphold the commercial agreement of the parties. The clause was commercially justifiable and had a compensatory purpose. It was not a deterrent, which would have rendered it objectionable and a penalty. The Court seems to have been particularly persuaded that the obligation for prompt repayment under the clause of any balance was an important feature. Blair J re-emphasised that a court must exercise caution before striking down a commercially justified clause; what the parties have agreed should normally be upheld (applying Philips Hong Kong Ltd v Attorney General of Hong Kong  61 BLR 41).