Liquidated damages clauses enable the parties to a contract to fix in advance a sum of money to be paid by the defaulting party to the innocent party in the event of a breach. This avoids the expense and difficulty of having to prove the actual damage that flows from the breach. However, under English law, it has long been the position that liquidated damages clauses are only enforceable if they represent a "genuine pre-estimate of loss". Sums that go beyond compensation for such losses, or are intended to deter a breach, are characterised as penalties and are unenforceable under English law.

In a recent case between the builder and the buyer of a superyacht (Azimut-Benetti Spa (Benetti Division) v Healey [2010] EWHC 2234 (Comm.)), the High Court was asked to decide on the enforceability of a liquidated damages clause. In short, the buyer failed to make the first instalment payment for a €38m yacht and the shipbuilder exercised its contractual right to terminate and to claim from the buyer the sum of €7.6m (20% of the purchase price) in accordance with a liquidated damages clause. That same clause also contained a provision in favour of the buyer: if the buyer had made instalment payments of more than the liquidated damages amount at the time of the termination, then the shipbuilder was obliged to refund the excess.

The fact that the liquidated damages clause included provisions in favour of each of the parties, together with correspondence that disclosed the reasons why the parties had agreed to it, persuaded the court that the clause was fair and that it struck a balance between the commercial interests of the parties. The High Court also noted that each party had freely entered into the contract and had the benefit of legal representation. The High Court decided, on summary judgment, that the clause was therefore commercially justifiable and the shipbuilder was entitled to its €7.6m. This judgment may be appealed, however.

RPC's comments:

  • General considerations of "commercial fairness and balance" can be used to justify a liquidated damages clause  
  • Parties seeking to negotiate and rely on liquidated damages clauses should consider including in the contract: (a) commercial justifications for the clause; and (b) appropriate provisions in favour of the other party  
  • Correspondence concerning the relevant clause will be admissible to the extent that it reveals the reasons the clause was included  
  • Avoid using the same liquidated damages clause for a number of different breaches, some major and some minor, as this will be presumed to be a penalty  
  • The courts are apparently increasingly reluctant to interfere in freely negotiated commercial contracts, particularly where legal advice has been sought by the parties