Understanding the differences between “liquidated damages” and damages

The “liquidated damages” clauses and the “penalty clause” as a “penalty clause”. Comparison between Spanish law and English law.

In English law, the purpose of liquidated damages” is to increase security and avoid the legal costs of determining actual damages later if the contract is breached. Therefore, they are most appropriate where (a) the parties can agree in advance to reasonable compensation for the breach, but (b) the court would have difficulty determining fair compensation at the time of the breach. Under common law, this compensation cannot be so large that it constitutes a penalty clause rather than just compensation. Penalty clauses (whose purpose is solely to punish a breach) will not be valid under English law.

On the other hand, in Spanish law, there are normally three ways to compensate a victim: restitution, reparation for damages and compensation for damages. Compensation for damages can be caused by consequential damage or lost profits (articles 1101, 1106, 1107, 1902… of the Spanish Civil Code).

However, the “liquidated damages“ and the “penalty clause” clauses must be assimilated to the penalty clause and no to compensation for damages (different legal figures in Spanish law). A “penalty clause” in Spanish legislation is a clause that can be agreed in contracts, whereby the payment of a certain compensation is agreed in advance in case of breach of contract by any of the parties. Therefore, the amount owed is already agreed upon when the default is committed. It is an accessory obligation whose objective is to ensure compliance with the main obligation. Therefore, if the main obligation is not met, the penalty clause is activated.

Consequently, it replaces compensation for damages when nothing has been expressly agreed in the contract in this regard, without the need to prove the breach (the parties have previously assessed the damages caused by said breach). Its regulation is found in articles 1152-1155, Section 6 (“Obligations with penalty clause”) of Chapter III (“Various kinds of obligations”) of Book IV (“Obligations and contracts”) of the Spanish Civil Code. In addition, the key to knowing if a “penalty clause” should be assimilated to the “liquidated damages” or the English “penalty clause” is the amount of the damages and if these they are reasonable. Spanish law allows the parties to set the amount they consider convenient, even if it is much higher than the foreseeable damages derived from a hypothetical breach.

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Brief introduction to English contract law

A party breaches the contract (According to Treitel (2011. Paragraph 17-049), “a breach of contract is committed when, without legitimate excuse, a party fails to or refuses to perform what is owed to it under the contract, or performs it defectively, or becomes incapable of performing it.”) if you have not done what you agreed to do (or have done something you agreed not to do). to do), or does what he had agreed to do but falls short of what he agreed to do, or prevents himself from doing, or refuses to do, what he had agreed to.

If a party “fails to perform”, or alternatively clearly, unequivocally and unconditionally refuses to perform the contract before the time stipulated for performance, this is known as an “anticipated breach,” which entitles the innocent party to choose between terminating performance of the contract or “affirming” the contract and continuing to perform its obligations. In any case, you can resort to other remedies (for example, damages).

A party is not in breach if it has a “legal excuse”. This is a limited exception, but may include: (i) acts or omissions permitted in the contract; (ii) the breach of the other party (but only if the obligation of the first party is “dependent” on the obligation that has been breached by the other party, and not if it is “independent”): or (iii) (in to the extent applicable under English law) frustration, illegality, mistake (common or unilateral) or duress.

Consequences of breaching a contract

For the rest, the consequences of a breach of contract in English law depend on whether the breach is of a term that is classified in English law as (i) a condition (promissory), (ii) a guarantee or (iii) an unnamed term. A condition is a term that is classified as such (i) by law, (ii) by the courts (generally because it goes to the root of the contract) or (iii) by the parties themselves. A contractual term that is not a condition will be a warranty (a term generally less fundamental to the contract than a condition) or an “unnamed term,” which falls between a condition and a warranty.

Failure to comply with a condition entitles the innocent party to terminate the contract, as well as to claim damages for losses suffered. On the other hand, the breach of a guarantee only entitles the innocent party to claim damages. The breach of an “unnamed clause” may give the innocent party the right to terminate the contract, in addition to the right to claim damages, but this will depend on the degree of importance of the breach, which will be determined based on the nature of the breach and of its consequences.

Types of damages

The most common remedy for breach of contract in English law is damages. This is, the amount of money awarded to the injured and winning party in a lawsuit.

We could broadly classify the types of damages into the following categories:

• Compensation for damages. Intended to compensate the plaintiff for the loss, injury or damage.
  • General damages. To compensate the plaintiff for the non-monetary aspects of the specific damage suffered (for example, loss of consortium, loss of reputation, loss of mental or physical capacity…).
  • Special damages. To compensate the plaintiff for quantifiable monetary losses suffered by the plaintiff (for example, the cost of replacing damaged goods).
    • Incidental and consequential losses. It is about the cost of “putting things in order” and also about lost profits.
    • Breach of contractual obligation (ex contract).
      • “Reliance measure”. When it is not possible or desirable to compensate the victim in this way, a court may award monetary damages intended to restore the injured party to the financial position it was in at the time the contract was entered into.
      • “Liquidated damages” and “penalty”. They will be explained later.
    • Breach of non-contractual obligation (ex delicto).
  • Legal compensation for damages. Amount stipulated in the law instead of being calculated based on the degree of damage to the plaintiff.
  • Nominal damages. Small damages that are awarded to demonstrate that the loss or damage suffered is of a technical nature and not real.
  • Punitive damages (non-compensatory). They are granted not to indemnify the plaintiff, but rather to reform or discourage the defendant and similar persons from following a course of action such as that which injured the plaintiff. They are only awarded in special cases where the conduct was egregiously insidious and exceeds the amount of compensatory damages, such as intent or intent.
  • Restitution compensation for damages. By which the defendant is forced to renounce the benefits obtained by the civil offense through restitution.

Conclusion

The importance of knowing the difference between the legal remedies for a breach of contract under English law (termination and/or damages) and under Spanish law (performance of contract, termination and compensation for damages) is essential. It must be taken into account that the liquidated damages“ (if their amount is reasonable) or the “penalty clause” (if it is much higher than the foreseeable damages) are not considered in Spain “damages”, but an accessory obligation called “penalty clause”, which replaces the general compensation unless otherwise expressly agreed in the contract (art. 1152 Spanish Civil Code).

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