WHERE the parties to a contract agree that in the event of a breach, the contract breaker will pay the other a specified sum of money, the sum fixed may be classified by the courts either as a penalty (which is irrecoverable) or as liquidated damages (which are recoverable).

The provision will be enforceable if the sum specified represents a genuine attempt to estimate in advance the loss the claimant would be likely to suffer in the event of a breach. It is enforceable irrespective of the loss actually suffered.

The purpose of the parties fixing the sum is to facilitate the recovery of damages without the difficulty and expense of proving actual damage.

The question of whether a sum stipulated in a contract is a penalty or liquidated damages is a question of law and is to be assessed by reference to the economic conditions at the time the contract was made, not at the time of the breach.

The courts have traditionally shown a reluctance to find that a clause is a penalty, particularly in the case of commercial contracts freely entered into between parties of comparable bargaining power.

The Court of Appeal affirmed this approach in the case of Taiwan Scot Co Ltd v The Masters Golf Company Limited.

Taiwan supplied golf clubs to Masters for resale in the UK. A dispute arose regarding the quality of the product and an agreement was entered into under which Masters was to make certain payments to Taiwan with a contractual interest rate of 15 per cent for late payment. Masters made smaller payments than agreed and Taiwan sued for the balance plus interest.

In the High Court, Taiwan was awarded the balance, but was denied the contractual rate of interest on the grounds that the rate was unreasonably high and a penalty.

Masters appealed the award and Taiwan cross appealed the interest decision.

The Court of Appeal dismissed the appeal and allowed the cross appeal, holding that the court of first instance had been entitled to find that Masters was due to pay the balance under the contract.

The court also held that 15 per cent was not exorbitant at the time the agreement was entered into.

This case suggests that commercial parties of comparable bargaining power may be able to enforce higher contractual rates of interest than are commonly included in commercial contracts.

■ David Wilson is a partner and specialist in company law at BHP Law. For more information, contact him on 0191-221-0898.