- Compact Contract
Liquidated damages payable on termination not unenforceable penalty
04 March 2021
The law around unenforceable penalty clauses is well-known but the question of how to apply it in practice is notoriously tricky. The court has recently looked at this issue again in De Havilland v Spicejet.
The Indian airline Spicejet agreed to purchase aircraft from the Canadian manufacturer De Havilland. Spicejet failed to pay some of the pre-delivery payments due under the purchase agreement and then failed to take delivery of some of the aircraft. De Havilland served notice terminating the agreement and claiming liquidated damages payable on termination.
There were a number of issues between the parties but I have focused on whether the liquidated damages provision was an unenforceable penalty. The court held, in no uncertain terms, that the liquidated damages clause was a genuine pre-estimate of loss and therefore not an irrecoverable penalty. In doing so, it set out some helpful points to keep in mind when considering this issue.
- The onus is upon the party asserting that the clause is unenforceable. Spicejet was fighting an uphill battle here since it had expressly acknowledged in the purchase agreement that the liquidated damages clause did not constitute a penalty (and it had had plenty of opportunities for advice before doing so).
- There is a strong presumption in favour of the agreed provision. This was particularly so in this case where both parties were represented at the time by sophisticated and experienced lawyers and were themselves substantial commercial operators with a long-standing relationship and comparable bargaining power. It was also initially asserted (though not ultimately decided) that liquidated damages or forfeited deposit clauses are frequently used in the aviation industry.
- The question is one of construction at the time the agreement was entered into. As a result, the factual matrix is limited. This was important in this case because it meant the question of whether the clause was a penalty was appropriate for summary judgment (notwithstanding Spicejet’s arguments to the contrary).
- When the Court is assessing whether the pre-estimate of loss is exorbitant or extravagant, it does not need detailed evidence as to actual loss suffered since the whole purpose of a liquidated damages clause is to avoid the expense and time incurred in calculating the actual extent of loss and doing the calculation to justify the pre-estimate destroys the point.
- Even if the clause is an unenforceable penalty, the claimant can still fall back on a claim for damages under the common law.