The Penalties Rule and Compensation

Abstract

According to the penalties rule, agreed damages clauses that grossly over-compensate the promisee for breach of contract are invalid and unenforceable. This chapter argues that the ‘promise theory’ has struggled to explain how the rule is justified, because promissory logic seems to require that such clauses be enforced. It is only by rejecting the idea that promise plays a special role in contract law that an explanation comes into view. The penalties rule, like undue influence, is a ‘composite’ doctrine, that is, it involves and is justified by the interaction of a multiplicity of moral concerns. The main normative concerns in this context are promise and the compensation principle. This combination explains puzzles such as why penalty clauses are not enforced but, in contrast, liquidated damages clauses are, and why breach of contract is a condition for the application of the penalties jurisdiction.