Getting “compensation”

Published: 21st August 2008

In a contract you can set out systems for recompense in the event of a default. Well, you can if it's a liquidated damages clause - but not if it's a penalty. So what's the difference?

The decision in Tullett Prebon Group Limited v Ghaleb El-Hajjali has given some useful reminders of the points that contracting parties should address before entering into an agreement that contains a liquidated damages clause.

The factors that were seen as helpful in finding in favour of the claimant in this case included:

• Equality of bargaining power. In particular, the fact that the parties were represented by large firms of solicitors and negotiated changes to the contract.
• Estimating the loss. The claimant was lucky that it had prepared some form of financial assessment. However, it would not be hard to prepare a calculation of the predicted losses before entering into the contract and this is generally a good idea as part of a risk assessment / due diligence exercise.
• Discuss and agree with the other side. It would be sensible to discuss these calculations with the other side and agree, as far as possible, the amount payable under the liquidated damages clause.
• Purpose of the clause. While this may be difficult in practice, the aim of the clause needs to be to compensate for breach, rather than to deter a party from breaching the agreement. In practice, this will be difficult to do if the amount is not a genuine pre-estimate of loss.