The traditional doctrine of penalties
1 Traditionally, the doctrine of penalties has been thought to apply only where an innocent party terminated a contract for the other party’s breach and then sought to rely upon a clause requiring the payment of a specified sum. Thus, in Ringrow Pty Ltd v BP Australia Pty Ltd (2005) 224 CLR 656, Gleeson CJ, Gummow, Kirby, Hayne, Callinan and Heydon JJ said:
“10 The law of penalties, in its standard application, is attracted where a contract stipulates that on breach the contract-breaker will pay an agreed sum which exceeds what can be regarded as a genuine pre-estimate of the damage likely to be caused by the breach.
11 The starting point for the appellant was the following passage in Lord Dunedin’s speech in Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd:
‘2. The essence of a penalty is a payment of money stipulated as in terrorem of the offending party; the essence of liquidated damages is a genuine covenanted pre-estimate of damage …
3. The question whether a sum stipulated is penalty or liquidated damages is a question of construction to be decided upon the terms and inherent circumstances of each particular contract, judged of as at the time of the making of the contract, not as at the time of the breach … read more