Facts
- Dunlop Pneumatic Tyre Co Ltd, a tire manufacturer, entered into a contract with New Garage & Motor Co Ltd, a retailer.
- The contract included a clause requiring the retailer to pay £5 per tire if tires were sold below a specified minimum price.
- New Garage & Motor Co Ltd breached this clause by selling tires below the agreed price.
- Dunlop sought to enforce the stipulated £5 per tire damages.
Issues
- Whether the £5 per tire clause in the contract was a valid liquidated damages provision or an unenforceable penalty clause.
- Whether the stipulated sum represented a genuine pre-estimate of loss caused by the breach.
- Whether it was relevant that the parties labeled the clause as "liquidated damages" or "penalty."
Decision
- The House of Lords held that the £5 per tire clause was a valid and enforceable liquidated damages provision.
- The sum was not deemed extravagant or unconscionable in relation to the loss that could result from the breach.
- The enforceability of the clause did not depend on the terminology used by the parties, but rather on its substance.
- Difficulty in estimating potential damages did not convert a genuine pre-estimate into a penalty.
Legal Principles
- A clause is a penalty if it is extravagant and unconscionable compared to the greatest loss conceivably resulting from the breach.
- An enforceable liquidated damages clause must represent a genuine pre-estimate of loss, not a punitive imposition.
- The parties’ designation of a clause as "penalty" or "liquidated damages" is not determinative; the courts examine the clause's actual effect.
- Difficulty in estimating loss does not invalidate a clause if the pre-estimate is reasonable.
Conclusion
The case established the key criteria distinguishing between liquidated damages and penalty clauses, holding that stipulated damages must reflect a genuine pre-estimate of loss rather than serve as a deterrent or punishment for breach. The judgment remains influential in contract law and the enforcement of damages provisions.