Difference Between Liquidated Damages and Penalty

Liquidated Damages vs Penalty

These days it has become common to includ terms like liquidated damages and penalty in contracts beforehand to avoid possible losses in case of breach of contract by a party. Though, payment of a sum of money may be stipulated in a contract, the payment of money is actually decided by a jury that has to decide whether this payment is in the nature of a penalty or is liquidated damages. In case or instances, where actual damages can be easily ascertained, it is allowed as compensation to the aggrieved party, but where it is difficult to ascertain the extent of damages, jury often decides in favor of a reasonable compensation. There are similarities between liquidated damages and penalty yet are sufficiently different from one another to warrant highlighting these differences.

It is the responsibility of the aggrieved party to prove the extent of damages suffered by him to be able to get a penalty from the other party. In English law, there is a distinction between penalty and liquidated damages, which is necessary to mention here. You must have heard million dollar cases of compensation that bear no resemblance to the extent of damages and yet are accepted in courts of law. Sometimes, the amount of money demanded as compensation or penalty seems too high and almost absurd. This is the point that clearly separates penalty from liquidated damages. When the amount of compensation is fixed and is a fair assessment of damages sustained by the victim, it is said to be liquidated damages. On the other hand, if the amount of money demanded as compensation is extravagant and has no regard to the extent of damage to the victim, it is said to be a penalty. It is punitive in nature and the main intention is to frighten the aggressor to prevent him from committing a breach in future.