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How Courts Differentiate Between Penalty Clauses and Liquidated Damages in Zambia

The liquidated damages clause and penalty clause are common provisions of contracts. 1 They
address what is to happen after the breach of contract. 2 Breach of contract comes about when
one of the parties without lawful cause refuses or fails to fulfil their obligation under the
contract or infringes on the rights of the other party under the contract according to Spancrete
Zambia Limited v. Zesco Limited.3 Essentially, a liquidated damages clause is the section of a
contract where both parties agree and approximate the genuine precise damages to be received
by an innocent party to cover the losses that will be incurred if the other party breaches the
contract.4 It is legal under the law and thus enforceable by the court based on the intentions of
the parties according to Mobill Oil Zambia limited v Patel, 5: National Airports Corporation
Limited V Reggie Ephraim Zimba And Savior Konie.6 On the other hand, a penalty clause is a
section of a contract that is meant to deter either party from breaching the contract and the
terms are fixed without consideration of the actual loss to be incurred aiming strictly to stand
as punishment.7 it is unlawful and serves as a deterrence to breach thus, unenforceable by the
court as laid down in National Airports Corporation Limited V Reggie Ephraim Zimba And
Savior Konie,8 and Zambia State Insurance Corporation Limited and Attorney General v
Alisand Singogo.9 The need to differentiate penalty clauses from liquidated damages clauses
inevitably arises as the liquidated damages clause sometimes can be declared a penalty clause
and ruled out. A penalty clause can also be adopted as liquidated damages and enforced. 10 To
do this, the courts rely on several factors to distinguish between liquidated damages and
penalties. This writing with aid of relevant authorities will highlight some of these factors.

The first factor is how reasonable or unreasonable a sum of damages is to be received by


a party to cover the losses that will be incurred if there is a breach of contract. if the sum
of damages is reasonable as compared to the great loss that could be incurred, then the party in

1
Singh, “Difference between penalty and liquidated damages – relevance of liquidated damages clause in
commercial contracts”, 2020
2
ibid
3
Spancrete Zambia Limited v. Zesco Limited, Appeal No.53 of 2018
4
Gibbs Wright Litigation Lawyers, “Liquidated damages and penalties”, 2020
5
Mobil Oil Zambia Limited v Patel (S.C.Z. Judgment 2 of 1988)
6
National Airports Corporation Limited V Reggie Ephraim Zimba And Savior Konie SCZ Judgment No. 34 Of
2000)
7
Law365 ‘Penalty Clauses vs. Liquidated Damages Clauses-Explained’, 2021
8
National Airports Corporation Limited V Reggie Ephraim Zimba And Savior Konie SCZ Judgment No. 34 Of
2000)
9
Zambia State Insurance Corporation Limited and Attorney General v Alisand Singogo Appeal No. 02 of 2007
10
ibid
breached pays the other party liquidated damages as enforced by the court,11 However, if the
sum of liquidated damages in the contract “is extravagant and unconscionable compared to
greatest loss that could conceivably be proved to have followed from the breach” according to
the rule set in Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd (thereafter now
referred to as Dunlop case),12 that emanated from Lord Halsbury’s illustration in Clydebank
Engineering and Shipping Building Co v Don Jose Ramos Yzquierdo Y Castandeda,13 then it is
a penalty and it cannot be enforceable by a court. This factor is also established as a primary
conclusion in ONGC v. Saw Pipes,14 that “liquidated damages should be regarded as
reasonable compensation, while penalties should not.” 15

The second factor is the certainty and uncertainty of the nature of a breach and the losses
it brings about. As laid down in Kemble v Farren,16 If the terms that are “breached have an
uncertain nature and amount” then it is liquidated damage but if a breach occurs and it can be
certainly assessed on the losses it brings about, a big amount of liquidated damages is
considered a penalty. This factor was also included in the Dunlop case and it is phrased as
follows “The clause will be penal if the breach entails not paying a sum of money and the
amount to be paid as damages exceeds the sum which ought to have been paid”

The third factor is the various case of a breach that is different in magnitude or nature . If
a sum of damages is payable in these breaches, then it is presumed to be a penalty. This
principle was applied in Elphinstone v Monland Iron and Coal Co.17 it was phrased as “There
is a presumption (but no more) that a provision is a 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.”

The fourth factor is the possibility to carry out a precise pre-estimation over a sum that is
being treated as a penalty to ascertain whether or not it can be liquidated damage. this
was established by Lord Dunedin in the Dunlop case. This principle is also recognized in
Webster v Bosanquet,18 where it was held that the phrasing used to describe a sum does not

11
Gibbs Wright Litigation Lawyers, “Liquidated damages and penalties”, 2020
12
Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd [1914] UKHL 1 (1 July 1914) AC 79
13
Engineering and Shipping building Co v Don Jose Ramos Yzquierdo Y Castandeda [1914] AC 6, 74 LJPC 1,
[1904-7] All ER Rep 251
14
ONGC v. Saw Pipes (2003) 5 SCC 705
15
Gupta, ‘Liquidated Damages v. Penalty: Are Causation and Loss Really Required’
16
Kemble v Farren 1829 6 Bing. 141, 130 Eng. Rep. 1234. pg. 163
17
Elphinstone v Monland Iron and Coal Co (1886) 13 R. (H.L.) 98
18
Webster v Bosanquet [1912] A.C. 394, PC (Cey)
matter and should not stop a court from assessing if they can enforce a sum or not after a pre-
estimation focus.

In conclusion, identifying liquidated damages and penalties by a court is very critical in


extenuating justice for parties in the contract after the breach of the contract by one party. And
the above-discussed factors make it possible for a court to easily accomplish this in the quest to
restore the injured party to the position, they would have been in had the breach not occurred.

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