Dunlop Pneumatic Tyre Co Ltd v Selfridge [1915] AC 847

KEY POINTS

• Liquidated damages are predetermined amounts in a contract to cover specific breaches, often used to avoid complex damage assessments.

  • A penalty is a punitive sum meant to deter breach rather than compensate for loss. Courts generally uphold liquidated damages but disfavor penalties.

  • When a breach occurs, courts often decide if a liquidated damages clause is valid or if it constitutes a penalty.

  • They assess whether the amount is a reasonable estimate of anticipated harm or an unfairly high sum meant to punish.

• Liquidated damages aim to compensate for breach-related losses and are considered valid if reasonable. Penalties, however, are excessive or coercive amounts, making them unenforceable. The distinction lies in whether the stipulated amount reflects a fair estimate of harm.

• A clause that requires the same payment for breaches of varying severity raises suspicion of a penalty. Courts may scrutinize such clauses to determine if they are punitive or genuinely reflective of the expected loss.

• If it's difficult to pre-estimate damages, a liquidated damages clause can still be valid if it represents a genuine attempt to predict losses. Courts may consider whether the parties tried to establish a fair pre-estimate of harm despite the inherent uncertainty.

FACTS

• In this case, a contract between parties included a clause specifying that if one party breached the contract, they would pay a predetermined sum "by way of damages and not as a penalty."

  • While such wording indicates intent, courts still examine whether this sum is actually a penalty or true liquidated damages.

  • A penalty is generally designed to deter or punish, while liquidated damages aim to be a fair pre-estimate of the loss from a breach. Courts decide this based on the contract's terms and the context when the contract was made, not at the time of the breach.

  • A sum is likely to be a penalty if it's excessive compared to potential losses, or if it's more than the amount due under the contract.

    • A presumption of a penalty exists if a single sum is payable for different breaches, some of which cause major harm and others minor.

    • However, this presumption can be rebutted if the actual damages for those events are unpredictable.

• In this scenario, retail dealers agreed to sell only the goods of a wholesale manufacturer, with a 5-pound payment for each item sold in violation of the agreement, labeled as "liquidated damages, not a penalty."

• The court had to decide whether this clause represents a genuine pre-estimate of damage or serves as a deterrent.

JUDGEMENT

• The court held that although the breach of contract by selling one type of article might have caused more damage to the manufacturer than another, the provision in question had to be interpreted as referring to a single obligation to maintain prices generally, rather than as payment for the non-performance of multiple obligations of differing importance.

• Considering the circumstances of the case and the contract's construction, the provision regarding damages was found to be neither unreasonable, unconscionable, nor extravagant.

  • Consequently, the stipulation was deemed to be for liquidated damages, and the retailers were held liable to pay the specified sum for each breach of the contract they had committed

COMMENTARY

• A clause requiring the same payment for breaches of varying severity often raises a presumption of a penalty, as it could be deemed coercive.

  • However, this presumption can be rebutted if damages from those breaches are inherently uncertain, indicating a genuine attempt to pre-estimate losses.

• In a given case, a contract between parties included a clause stating that if one party breached, they would pay a predetermined sum "by way of damages and not as a penalty."

  • The court examined whether this clause represented liquidated damages or a penalty.

• The final judgment found that although selling one type of item might cause more damage than another, the provision was designed to maintain prices generally, not to penalize varying breaches.

  • The court concluded that the stipulated damages were reasonable and not extravagant, deeming them as liquidated damages.

  • As a result, the retailers were liable to pay the specified sum for each contract breach they committed.

ORIGINAL ANALYSIS

• Dunlop sold goods to Dew on the condition that Dew wouldn’t sue below the list price and would ensure that anyone to whom they sold the goods would not sell below the list price.

• S bought from Dew and sold below the list price, but the court refused Dunlop an injunction against S since:

  1. Dunlop was not a party to the agreement between S and Dew, and so couldn’t impose or enforce terms on their agreement, and

  2. Dunlop had not given consideration in return for S’s promise as to selling price. 

Viscount Haldane

• There are certain fundamental principles of contract law: “only a person who is a party to a contract can sue on it” and consideration is another. 

Lord Atkinson

• In the absence of consideration, this is a nudum pactum 

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