The Commercial Advantages of Agreed Remedies Essay

This essay will examine the advantages and disadvantages of liquidated damages, deposits and forfeiture of property as agreed remedies. It will be argued that courts should give effect to agreed remedies unless there are sound justifications to do otherwise. I will analyse the way the court has regulated agreed remedies and submit that the law lacks an overarching coherent principle and contains areas of incoherency. It will be concluded that the advantages of agreed remedies outweigh its disadvantages especially in a commercial context, but that does not mean the court should invariably give effect to them.

There are many types of agreed remedies and three will be discussed in this essay. Firstly, a liquidated damages clause is an agreement to pay a fix sum of money when the contract is breached.1 Secondly, a deposit is a sum of money paid in advance as an earnest of future performance which is forfeited if the contract is breached by the depositor.2 Thirdly, forfeiture of proprietary interests is the loss of right to use a property and the property may be repossessed.3

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The commercial advantages of an agreed remedy clause are manifold.4 Agreed remedies clause reduces uncertainties about level of compensation when a breach occurs; if the remedy is a liquidated sum, applicant can apply through a quicker court procedure for debt due; agreed remedy enables parties to allocate their risks in advance; it may circumvent difficulties in proving speculative losses in court, which may otherwise fail for want of proof; it (e.g. distribution of property right clause) provides incentive to complete obligations and reduces likelihood of breach; and it may facilitate settlements. Hence, it appears that there are extensive commercial advantages to enforcing agreed remedies.

The main justification for enforcement of agreed remedies clause is freedom of contract.5 Parties should be allowed to choice their terms and the court should enforce whatever the parties have agreed; thereby protecting parties’ individual autonomy.6 Since preserving freedom of contract is an essential function of contract law and judicial control over agreed remedies may cause uncertainties and inefficiency,7 deviation form enforcement should be justified. I will examine the circumstances when the court refuses to enforce an agreed remedy before analysing the justifications for deviation from enforcement.

The court may not give effect to a liquidated damages clause which is held to be a penalty clause. The test for whether an agreed sum of compensation is enforceable or not is set out in Dunlop Tyre:8 the sum must be a genuine pre-estimate of loss at the time the contract is formed. If the amount is above such a level, then the court would rule it to be a penalty clause and unenforceable. The difficulty of foreseeability of loss is acknowledged by the court as a liquidated damages clause is enforceable as long as the pre-estimation is genuine; there is no need for it to be accurate. Without such an approach, a strict rule against over-compensation would render liquidated damages clause very likely to be invalidated9 Collins refers to the court’s approach as “risk-averaging” since the court allows for a certain degree of leeway which enables the parties to set an amount representing an average of probable losses resulting from different breached of the same contract.10

Liquidated damages clause is regulated because it may be open to abuse in two ways: firstly, a clause may impose an unjustifiably high amount of compensation to induce a party to perform its obligations. The pressure to perform may be criticised for invading one’s individual freedom.11 However, it is questionable that in a commercial context whether the argument that there is undue pressure is applicable where contracts are carefully negotiated and parties are generally aware of their rights and obligations.12 In fact, it could be argued that by invalidating an agreed remedy, the court would disrupt the balance of benefits decided by the parties, who would have taken the potential inducement of performance into account when negotiating the contract.13 Hence the prevention of inducement of obligations is not a strong justification for judicial control of penalty clause in a commercial context.

Secondly, the penalty clause may be unfair and over-compensate the injured parties in relation to the actual loss. If the aim of a remedy is corrective justice,14 invalidating penalty clauses may be justified because parties should not be allowed to set a higher amount of compensation than the actual loss. Collins has proposed that the court’s approach is one of fairness which “compares the agreed remedy with the ordinary measure of damages”,15 qualified by allowance of foreseeability issues concerning the consequence of breach at the time the contract was formed.16 This justification of avoiding over-compensation based on fairness and corrective justice would be applicable in a commercial context.17

Similarly to excessive liquidated damages clauses, unreasonable deposit is also regulated by courts. A deposit has to be at a reasonable amount, with reference to the custom of the trade.18 Applying Collin’s analysis of fairness to courts’ exercise of jurisdiction to invalidate unreasonable deposits, there seems to be two problems. Firstly, fairness is not the standard which the courts employ. Because deposit only has to be set at a reasonable rate with reference to customs of trade, the amount of justifiable deposit may be unrelated to the actual loss suffered by the injured party.19 Therefore, it seems the at the court is concerned with commercial reasonableness rather than fairness.

Secondly, fairness is a vague concept which does not explain how the court decided to use the reasonable test. For example, the court could have tested deposits according to the actual loss suffered and still claimed the standard to be based on consideration of fairness. No justification is provided by the courts as to the difference in standards for testing deposits and penalty clauses. A possible explanation may be that courts have developed responsively to different types of agreed remedies in an ad hoc manner and consequently, there are no overarching coherent principles or uniformity of standards for testing the fairness of deposits and penalty clauses.

In relation to forfeiture of property, it is also regulated and courts may grant a relief from forfeiture so that property is not repossessed. Relief would normally be granted if the rights confer a proprietary interest; proprietary interest is added to contract as security for performance; and time is not of the essence.20 The main problem with granting a relief is it only applies to certain proprietary or possessory interest.21 In Sport International22, relief was not granted for a contractual licence for use of trademark; Whereas in BICC,23 relief was grant for joint proprietary interests in patent rights.

The distinction between the two cases is unjustified because it lacks consideration of practical commercial implications, where the two interests were both intended to allow another party to use a form of intellectual property.24 In an age where intellectual property rights are seen as valuable assets, relief granted may be significant to a business’s viability,25 especially if creditor only wishes the property to be a security.26 Collins argues that courts should consider whether debtor has a real commercial interest in keeping possession and whether forfeiture clause was merely a security against payment for granting relief.27 Such considerations would ensure that the interests of the debtor and creditor would be properly balanced. Relief from forfeiture may be said to be based on a conception of fairness which enable both parties to achieve their benefits, without unduly favouring one party and therefore the nature of the interests should be immaterial.

To conclude, it has been demonstrated that there are many advantages of allowing agreed remedies to be enforced. The main justification for enforcing agreed remedies is freedom of contract. However, commercial advantages of agreed remedies must be balanced by consideration of fairness and the need to prevent abuse. Currently, the court is able to invalidate penalty clauses and unreasonable deposits, and grant relief form forfeiture. But regulation of agreed remedies has not developed any overarching coherent principles and there remains some incoherent areas of law. In sum, the advantages of agreed remedies may outweigh its disadvantages, but that does not mean the court should invariably give effect to them.

References:

1 Hugh Collins, The Law of Contract, pp.367-8; see Dunlop Tyre v. New Garage [1915] AC 79

2 Hugh Collins, The Law of Contract, p.381; see e.g. Workers Trust ; Merchant Bank Ltd v Dojap Investments Ltd [1993] A.C. 573

3 Hugh Collins, The Law of Contract, pp.385-6; see e.g. The Scaptrade [1983] 2 AC 694, HL

4 Hugh Collins, The Law of Contract, pp.364-367

5 Hugh Collins, The Law of Contract, pp.365-366

6 Smith, ‘Substantive Fairness’ (1996) 112 LQR 138, 145

7 The jurisdiction of the court to control penalty clauses has been criticised on economic grounds by Rea, ‘Efficiency Implication of Penalties and Liquidated Damages’ (1984) 13 JLS 147. Although penalty clauses which induces performance may deter an efficient breach and bring about other economic costs such as over-insurance for promisee and exposure of risks to the promisor, Rea has argued that the party would charge a higher price if it risks a penalty clause being invalidated. In this case, the cost of the contract would be higher for both parties. Hence, invalidating a penalty clause would be economically inefficient.

8 Dunlop Tyre v. New Garage [1915] AC 79, Lord Dunedin

9 Hugh Collins, The Law of Contract, p.375

10 Hugh Collins, The Law of Contract, p.375

11 Hugh Collins, The Law of Contract, p.377

12 Hugh Collins, The Law of Contract, p.377

13 Rea, ‘Efficiency Implication of Penalties and Liquidated Damages’ (1984) 13 JLS 147, pp. 152-153

14 Collins, ‘Fairness in Agreed Remedies’, in Willett, Aspects of Fairness in Contract (Blackstone, 1996), Chapter 5, at p.105

15 Hugh Collins, The Law of Contract, p.368

16 Although it may still be argued that the aim of judicial control is not corrective justice because courts permits a clause as long as it is a genuine pre-estimate of loss, instead of a sum which refers to the actual loss suffered. If corrective justice is the main reason for judicial control, the court should be allowed to modify contracts to reduce the liquidated damages to the loss suffered whenever the amount contracted is more than the actual loss suffered, instead of invalidating clauses for not being a genuine pre-estimate. Compare civil law approaches which seem to accord more closely with the concept of corrective justice.

17 See Beckham v Drake 9 E.R. 1213 where the court invalidated the penalty clause and awarding ordinary damages with accurate assessment of fair measure of compensation for loss.

18 Workers Trust ; Merchant Bank Ltd v Dojap Investments Ltd [1993] A.C. 573

19 See e.g. Union Eagle Ltd. v. Golden Achievements Ltd. [1997] 2 All ER 215 or Hyundai Shipbuilding and Heavy Industries Ltd. v. Papadopoulos [1980] 1 WLR 1129

20 See Dillon LJ in BICC plc v Burndy Corp [1985] Ch 232, CA; see also On Demand Information plc v Michael Gerson (Finance) plc [2002] UKHL 13

21 The Scaptrade [1983] 2 AC 694, HL, where the court concluded that a contract for services does not qualify for relief from forfeiture.

22 Sport International Bussum v. Inter-Footwear Ltd [1984] 1 WLR 776

23 BICC plc v Burndy Corp [1985] Ch 232, CA

24 Hugh Collins, The Law of Contract, p.387

25 Smith, ‘Relief Against Forfeiture: A Restatement’ [2001] CL 178, p. 194; See for example, in Sport International, the business was ruined because of a delay in arranging a bank guarantee, but the payment for using the trademark was still satisfied and the plaintiff was not affected.

26 Smith, ‘Relief Against Forfeiture: A Restatement’ [2001] CL 178, p.186

27 Hugh Collins, The Law of Contract, pp.387-8