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Dunlop Pneumatic Tyre Company v New Garage & Motor co [1915] AC 79 House of Lords

The claimant, Dunlop, manufactured tyres and distributed them to retailers for resale. The contract between Dunlop and New Garage contained a clause preventing New garage from selling the tyres below list price. In the event that they were in breach the contract specified that 5/. would be payable for each tyre sold below the list price. The defendants sold some tyres below the list price and the claimant brought an action for damages based on the amount specified in the contract. The defendant argued that the relevant clause was a penalty clause and thus unenforceable. The trial judge held it was a liquidated damages clause and awarded the claimant 5/. per tyre. The Court of Appeal reversed this holding that the clause was a penalty clause and awarded the claimant 2/. per tyre representing the actual loss suffered. The claimant appealed to the House of Lords.

Held:

The clause was a liquidated damages clause not a penalty clause.

Lord Dunedin set out the differences between a liquidated damages clause and a penalty clause:

1. Though the parties to a contract who use the words "penalty" or "liquidated damages" may prima facie be supposed to mean what they say, yet the expression used is not conclusive. The Court must find out whether the payment stipulated is in truth a penalty or liquidated damages. This doctrine may be said to be found passim in nearly every case.

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 (Clydebank Engineering and Shipbuilding Co. v. Don Jose Ramos Yzquierdo y Castaneda)

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 (Public Works Commissioner v. Hills and Webster v. Bosanquet)

4. To assist this task of construction various tests have been suggested, which if applicable to the case under consideration may prove helpful, or even conclusive. Such are:

( a ) It will be held to be penalty if the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach. (Illustration given by Lord Halsbury in Clydebank Case)

( b ) It will be held to be a penalty if the breach consists only in not paying a sum of money, and the sum stipulated is a sum greater than the sum which ought to have been paid (Kemble v. Farren)This though one of the most ancient instances is truly a corollary to the last test. Whether it had its historical origin in the doctrine of the common law that when A. promised to pay B. a sum of money on a certain day and did not do so, B. could only recover the sum with, in certain cases, interest, but could never recover further damages for non-timeous payment, or whether it was a survival of the time when equity reformed unconscionable bargains merely because they were unconscionable, - a subject which much exercised Jessel M.R. in Wallis v. Smith

( c ) There is a presumption (but no more) that it is penalty when "a single lump sum is made payable by way of compensation, on the occurrence of one or more or all of several events, some of which may occasion serious and others but trifling damage" (Lord Watson in Lord Elphinstone v. Monkland Iron and Coal Co)

On the other hand:

( d ) It is no obstacle to the sum stipulated being a genuine pre-estimate of damage, that the consequences of the breach are such

as to make precise pre-estimation almost an impossibility. On the contrary, that is just the situation when it is probable that pre-estimated damage was the true bargain between the parties ( Clydebank Case, Lord Halsbury; Webster v. Bosanquet, Lord Mersey).
 
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