Liquidated Damages

In Cavendish Square Holding BV v Talal El Makdessi [2015] UKSC 67, the Supreme Court restated the test for distinguishing an enforceable liquidated damages clause from an unenforceable penalty. The older approach, associated with Lord Dunedin's four tests in Dunlop Pneumatic Tyre Co v New Garage, asked whether the specified sum was a genuine pre-estimate of loss, treating a sum that was out of all proportion to any damages liable to be suffered as the hallmark of a penalty. The Supreme Court held that this test, while still useful for straightforward damages clauses in standard contracts, was not adequate for more complex commercial bargains, and reformulated the underlying question: the true test is whether the impugned provision is a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation. Compensation for loss remains the paramount legitimate interest, but the Court recognised that a party can have other legitimate commercial interests that justify a clause going beyond a bare pre-estimate of loss.

The consequence of a clause being classified as a penalty rather than a legitimate liquidated damages provision has not changed: if the agreed sum was a penalty, it was treated as unenforceable, and the innocent party is left to prove and recover its actual loss under the ordinary rules of damages instead. The Cavendish appeal itself was decided alongside a second appeal, ParkingEye Ltd v Beavis, concerning a parking charge at consumer level, illustrating that the same penalty rule — and the same 'legitimate interest' test — applies across both substantial commercial contracts and everyday consumer agreements, even though what counts as a legitimate interest, and what detriment is proportionate to it, will differ sharply between the two contexts.