Difference between penalty and liquidated damages

Liquidated damages is a concept that often results in confusion when used in continental law. This article aims at clarifying the difference between liquidated damages and penalty, and to advise on the correct terminology in situations when a delay or non-performance is penalized under the civil law.

Liquidated damages is a common law term which means that the parties agree on a sum to be paid if a party fails to fulfill an obligation. It also means that if the concept of liquidated damages is applied, then the defaulting party must pay this sum, the entire amount preset as liquidated damages without assessing what the actual amount of damages was. It, also means, of course, that the preset amount of the liquidated damages is payable if the actual amount of the damages exceeded the amount of liquidated damages. Now, this is the point of law that you need to be aware of, and compare it with the rules applicable to your jurisdiction when you use the term "liquidated damages".

In the event your law allows the payment of damages in excess of the amount preset in the contract, it is, in fact, not liquidated damages, but something else.

What else? Some of the international law firms operating in civil law jurisdictions use the term "penalty", or even "contractual penalty". How about this term? Sounds good, it perfectly describes the penalizing function of this amount, but there is one point you should not forget. Penalty is unenforceable in common law jurisdictions. The parties are not permitted to penalize each other in a contract since penalty is typically assessed by the court.

What is the conclusion? You can use either term depending on the
1) context,
2) the applicable law and
3) the intent of the contracting parties.

We hope this entry was useful. Should you have any further questions regarding this matter, feel free to ask in the comments section.

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