Last week, the U.K. Supreme Court (UKSC) changed the law on liquidated
damages clauses (LDCs), giving parties greater freedom to decide on
damages for contractual breaches. The case may cause Canadian
courts to revise the law in a similar manner and provide parties
with greater flexibility for predetermining damages in commercial
contracts — a change which many parties would welcome.
CANADIAN POSITION ON LDCs
LDCs allow parties to agree upon damages for contractual
breaches and save time and expense on litigating these claims in
The Supreme Court of Canada followed Dunlop in H.F. Clarke Limited v. Thermidaire Corp.
Ltd. and stated that "a sum will be held to be a
penalty if extravagant and unconscionable in amount in comparison
with the greatest loss that could conceivably be proved to have
followed" from a breach. The result is that Canadian courts
will not enforce an LDC where the damages stipulated by the
provision are determined not to be a genuine pre-estimate of
The lone Canadian outlier is in New Brunswick, where section
5(1) of the province's Law Reform Act states: "A party
to a contract may enforce a penalty clause or a liquidated damages
clause to the extent that it is reasonable in all of the
circumstances that the clause should be enforced." In McKeen v. The Mortgage Makers Inc. and
Libby, the New Brunswick Court of Appeal held that this
provision reverses the Canadian common law position and allows a
plaintiff at trial to establish the reasonableness of an LDC.
CHANGES TO THE U.K. LAW
The UKSC has changed the law on LDCs to focus on the interests
of the parties and the scale of damages stipulated by an LDC
relative to those interests. The test in the United Kingdom is now
whether an LDC "imposes a detriment on the contract-breaker
out of all proportion to any legitimate interest of the innocent
party in the enforcement of the primary obligation."
The result of the decision is that parties can now, subject to
the parameters of the new test, agree to damages for contractual
breaches that are greater than the losses they may actually incur
and know that the provision will likely be enforced. The new law in
the United Kingdom gives parties greater flexibility to use LDCs as
a means to encourage compliance with contractual terms based on
legitimate commercial interests.
For example, in one appeal (the UKSC decided two appeals
together), the respondent managed a parking facility and charged
customers £85 for parking longer than the free period of two
hours. The appellant argued that this fine was not a genuine
pre-estimate of loss and constituted a penalty, as neither the
respondent company nor the owner of the parking facility suffered a
financial loss for customers overstaying the free period.
Using the revised approach to LDCs, the UKSC held that both the
landowner and the respondent company had a legitimate interest in
charging overstaying motorists, and that the amount charged was not
extravagant or unconscionable taking into account the notice given
to motorists and practice around the United Kingdom.
IMPACT ON THE LAW IN CANADA
The changes to the law on LDCs in the United Kingdom may
influence Canadian courts to reform the common law in a similar
manner for commercial contracts. To date, Canadian courts have
cited Dunlop as the leading authority on LDCs and penalty
clauses. As Dunlop is no longer the leading case on LDCs
in the United Kingdom, there is now a possibility for courts to
revise the law in Canada accordingly.
Please note, this Bulletin should not be construed as legal
advice on U.K. law.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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