Contracts Law. Penal damages can be best described as quantitatively excessive liquidated damages and are therefore invalid and not enforceable. Although liquidated damages are a prior calculation of the expectation loss under the contract they can also sometimes be used to penalize a party for breaking a clause that causes more harm than the loss suffered by the innocent party. Many clauses that constitute penal are expressed in liquidated damages clauses, but courts consider them excessive and invalid.
Conceptually, the judicial approach to penal damage is important because it is one of few instances of judicial paternalism within contract law. Two parties may not agree to a contract that includes a penalty clause unless they do so genuinely and uncoerced. A person who wants to quit smoking can’t agree to a contract that would see them being fined $100 for each puff they inhale. This figure doesn’t represent the loss of expectation.
For example, in Montz v. Theard, 818 So.2d 181 (La. 2002), the court held that the forfeiture provision in a real estate purchase agreement, under which the purchaser would forfeit $8,000 down payment, all installment payments paid, and all funds expended for taxes and improvements in the event the purchaser defaulted on the purchase agreement, was unenforceable as contrary to established public policy prohibiting punitive or penal damages for breach of contract.
Domestic Linen Supply & Laundry Co. v. Kenwood Dealer Group, Inc., 672 N.E.2d 184 (Oh. 1996):
“[T]he Ohio Supreme Court has set forth the test for determining whether a liquidated damages clause is enforceable, as follows: Where the parties have agreed on the amount of damages, ascertained by estimation and adjustment, and have expressed this agreement in clear and unambiguous terms, the amount so fixed should be treated as liquidated damages and not as a penalty, if the damages would be (1) uncertain as to amount and difficult of proof, and if (2) the contract as a whole is not so manifestly unconscionable, unreasonable, and disproportionate in amount as to justify the conclusion that it does not express the true intention of the parties, and if (3) the contract is consistent with the conclusion that it was the intention of the parties that damages in the amount stated should follow the breach thereof. To determine whether the sum stipulated in the contract is liquidated damages or a penalty, a court will construe the contract by its four corners in the light of the situation of the parties at the time of the execution of the contract.”
Bennett v. Les Schwab Tire Centers, 48 Or. App. 909 (1980):
“The test in Oregon for determining whether or not a liquidated damages provision is penal in nature is [as follows]: (1) An agreement, made in advance of breach, fixing the damages therefor, is not enforceable as a contract and does not affect the damages recoverable for the breach, unless the amount so fixed is a reasonable forecast of just compensation for the harm that is caused by the breach.”