The commercial world is largely governed by commercial contracts.

Where there is a
transaction between two parties, a contract is usually formed establishing the obligations
and the liabilities of the parties. Where parties use standard form contracts to expressly
agree on the consequences of breach, the question arises as to what extent, and should,
agreed remedies be enforceable. Some argue that parties know best whilst others argue
that court intervention is justified in protecting the weaker and more vulnerable party
from exploitation or abuse as a result of low bargaining power. There is no consistency in
the manner in which the court interferes in the determination of remedies in the event of a
breach of contract. In England, a payment clause is enforceable when it functions as a
liquidated damages clause but 'disregarded' when it is held to be a penalty clause.
However, whether there is an actual distinction between these types of remedies is
arguable

Contracts allow parties to incur reciprocal obligations and to make promises the other
party can reasonably rely on. The underlying principle of freedom of contract states that
it is the free choice of the parties whether they bind themselves, when they bind
themselves and to what they bind themselves through contracts. The non-intervention of
parliament or the judiciary removes uncertainties which may hinder contracts, thereby
allowing parties to establish reasonable expectations for future actions without fearing
being compromised by intervention. Contract law should respect party autonomy and
thus should be guided by the will of the parties and by their mutual consent; after all, they
entered into a contract for a reason. Although, in principle, freedom of contract extends
to the context of remedies, the law intervenes in some situations and thus, undermines the
principle.
Commercial contracts are generally established between two established businesses, not
weak and vulnerable individuals. Thus, there is a general assumption that the parties are
knowledgeable and have the benefits of legal advice. This means that big companies are
able to look after themselves, their rights and interests, without the protection by the
courts. By interfering in contracts between commercial parties, the courts may undermine
the commercial efficacy of the contract. Lord Woolf stressed in Philips Hong Kong that
courts should adopt a hands off approach unless the sums stipulated were obviously
extravagant or there was significant inequality of bargaining power. He emphasized the
exceptional nature of the penalty jurisdiction and that courts have always avoided
claiming that they have any general jurisdiction to rewrite the contracts. Thus, courts
should notbe too ready to find the requisite degree of disproportion lest they impinge
on the parties freedom to settle for themselves the rights and liabilities following a
breach of contract. But, as I shall argue, this is not always the case.
The broadened scope of liquidated damages is evidence that the courts are usually
reluctant compromise the principle of freedom in commercial contracts. Lord Dunedin in
Dunlop v New Garage held that the mere labeling of liquidated damages by the parties,
while relevant, is not conclusive; the court will take into account the intention of the
parties as to its purpose, whether it is genuinely to calculate loss or to punish and to deter
breach. So long as it is a genuine attempt to assess loss, the courts are likely to regard the
clause to be enforceable. Yet, the position of the law has since changed, it is held that
some clauses which are neither a penalty nor a genuine pre-estimate of loss, might still be
enforceable. It was held that commercially justifiable clauses should be enforceable
provided the dominant purpose is not to deter breach. Accordingly, a clause giving rise to
a very high level of liquidated damages may not be a penalty, as long as it is
commercially justifiable. Thus, the court is willing to uphold clauses in commercial
contracts where parties have been legally represented in negotiating the terms. It is
obvious that the court is willing to depart from the tradition principle of genuine pre-
estimate of loss and adopt a more flexible and non-traditional approach towards the
enforceability of a liquidated damages clause, in order to respect parties commercial
interests and thereby, to uphold the principle of freedom of contract.

The legal division of agreed damages clause, resulting in a separation between liquidated
damages and penalty clauses rests on the assumption that they have an explicitly divisible
nature. This analysis is problematic. In practice, the courts will not be over-zealous to
characterize a clause as oppressive or penal. There are clearly commercial benefits of
allowing the parties to know with as much certainty as possible the risks they face when
they enter into a contract and judicial intervention will be detrimental for business
dealings as it compromises predictability. There is a high threshold for clauses to be
regarded to be penal - the sum must be 'extravagant and unconscionable'
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. This protects
the principle of freedom of contract and allows commercial parties to know in advance
what risk they are taking and what happens if there is a breach, without feeling threatened
by judicial intervention.

There is a certain paradox in the termination rules which highlights the contradictions
with the penalty rules. Court intervention is limited in termination clauses; There is no
test of fairness or reasonableness or a requirement of good faith. The rules rest on the
assumption that termination satisfies commercial efficacy. Yet, the inherent coercive
nature of termination clauses to deter breach arguably functions in the same way as
penalty clauses. The law encourages performance of contractual duties whilst dismissing
penalty clauses for doing just that. Judicial control tends to be more stringent over
penalty clauses as opposed to its more liberal attitude towards self-help termination
clauses.

The remedies of deposits and penalty clauses share a lot of common characteristics, but
the law treats them differently. As with penalty clauses, deposits seek to deter breach by
forcing the other party to perform because they would not want to forfeit their deposit.
As a general rule, a deposit will be forfeited to the payee on the default of the payer, the
loss capable of being much more than the actual loss suffered by the payee, thus
subjected to extremely harsh 'penalty'. Even the definition of a deposit reiterates its
innately coercive nature - it is a payment that acts as a guarantee that the contract shall be
performed. The only distinction between a deposit and a penalty clause seems to be that
the party in breach has already transferred his money. The harsher aspect of deposits have
been somewhat mitigated; The Law Commission No.61 provisionally concluded that the
fact that a deposit in paid in advance is not sufficient and that deposits made should be
subject to the penalty rules. But this only applies where a deposit is 'unreasonable' in
relation to the loss likely to be suffered and a deposit for the sale of land that does not

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Dunlop v New Garage
exceed 10% was considered as reasonable. A 'reasonable' deposit is thus not the same as
a genuine pre-estimate of loss. The threshold of unreasonableness is not easily satisfied
which means that deposits are usually enforceable; judicial control tends to be more
stringent over penalty clauses as opposed to forfeiture clauses, which arguably may
subject the party in breach to the very same harsh penalty.

Whilst penalty clauses are struck out automatically, exemption clauses which have
arguably the same purpose, are subject to a reasonableness test under the Unfair Contract
Terms Act 1977. Exemption clauses can be seen as the binary opposite of penalty
clauses; rather than penalizing the contract breaker for breach, it limits compensation to
the innocent party. Courts are generally reluctant to intervene and prefer to leave the
parties free to allocate the risks
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in business contracts, especially where the parties are of
comparable bargaining power and can insure against risks. A loose approach was adopted
in Photo Production v Securicor Transport, deterring interference in commercial
contracts. The courts are often reluctant to disregard exemption clauses in commercial
contracts by adopting a more flexible approach towards the reasonableness test under
UCTA; this respects parties commercial interests and thereby, to uphold the principle of
freedom of contract
It is often criticised that the English courts are too harsh by invaliding all penalty clauses
in commercial contracts and thereby undercuts the principle of freedom of contract.
Critics have compared the treatment of penalty clauses in English courts to that of
Frances, which has adopted a different approach to penalty clauses. Instead of
invalidating all punitive damages clauses, courts should only invalidate abusive clauses.
Jobson v Johnson held that the penalty clause is not simply struck out but enforced to
the extent that it does not function as a penalty. By 'scaling down' the clause and
enforcing it to the extent that it does not function as a penalty, rather than 'wholly
disregarding' it, the court is in essence 'modifying' the clause. Whilst it can be seen that
the penal element of the clause is not entirely suppressed in France, Jobson v Johnson
nevertheless is a convergence of approach between the two systems. Its hybrid character
allows it to encourage performance of contractual obligations and to act as a pre-estimate
of damages for breach of a contractual obligation.

To conclude, by interfering with commercial contracts, I argue that English law
undermines the principle of freedom of contract in the context of remedies and thus,
prevents parties from protecting their interests adequately. The interaction of the penalty
clause rules with other areas of contract law produces contradictions and inconsistencies
that are difficult to defend. The common law presents difficulties by explicitly
prohibiting a penalty clause by reason of its coercive element while at the same time
implicitly tolerating a coercive element in other clauses. The court adopts a more lenient
approach towards termination clauses and deposits but a harsher approach towards
penalty clauses and specific performance clauses. Thus, the intervention by the court in
trying to protect the interests of the parties is undermined as the remedy with the lighter
treatment i.e. deposits could replace that with the harsher treatment i.e. penalty clauses.

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Watford Electronics Ltd -v- Sanderson CFL Limited