Amending a contract? Remember the law against penalties

Commercial contracts often contain what is known as a liquidated damages clause. One party may have to pay the other a pre-agreed sum for failing to meet a particular obligation in the contract. To be enforceable such a sum needs to be proportionate and a genuine pre-estimate of loss, and should not amount to a ‘penalty’.

In a recent case, the High Court had to consider a contract which had been amended to substantially reduce the price payable for services under the contract, but where the liquidated damages provision had not been reduced. The court ruled that the provision was void as a penalty and unenforceable as the sum was no longer proportionate.

This case is a useful reminder that, when varying the contract, you should think about the effect the amendment may have on the original liquidation damages provision. Is it rendered disproportionate and unenforceable? If so, the parties should also consider varying the liquidation damages clause.