Dunlop Pneumatic Tyre Company, Limited v New Garage and Motor Company, Limited (1914)

Lord Dunedin's speech is the most quoted statement in the common law of the difference between a penalty and liquidated damages. Rather than review the case law, he set out a numbered list of propositions "deducible from the decisions which rank as authoritative". Any answer on s. 74 of the Indian Contract Act that compares English law will start with them.

The case also shows the test at work on facts that look like a penalty at first sight: a flat 5l. payable for every tyre, cover or tube sold even a shilling below list price. The House of Lords held it was a genuine pre-estimate, because the real loss — damage to Dunlop's whole system of distribution — was certain in general but impossible to measure for any one sale.

• Dunlop, through an agent (Messrs. A. Pellant, Limited), made a price-maintenance agreement with New Garage. In return for discounts, New Garage agreed not to tamper with Dunlop's marks, not to sell to private customers or co-operative societies below Dunlop's current list prices, not to supply persons whom Dunlop had decided to suspend, and not to exhibit or export without Dunlop's assent.
• Clause 5 provided: "We agree to pay to the Dunlop Pneumatic Tyre Company, Ltd. the sum of 5 l. for each and every tyre, cover or tube sold or offered in breach of this agreement, as and by way of liquidated damages and not as a penalty."
• New Garage sold covers and tubes below list price. The breach was held proved at trial. On an inquiry as to damages the Master found the 5l. was liquidated damages and assessed the damages at 250l.
• The Court of Appeal (Vaughan Williams and Swinfen Eady LJJ, Kennedy LJ dissenting) held the 5l. was a penalty and gave judgment for 2l. nominal damages. Dunlop appealed.

1. Was the sum of 5l. per article payable under clause 5 a penalty or liquidated damages?
2. In particular, did the fact that one sum was payable for several kinds of breach, some possibly causing serious and others trifling damage, make it a penalty?

The appeal was allowed. The 5l. was liquidated damages. Dunlop recovered the sum found by the Master, with costs in the House and below. The House agreed with Kennedy LJ's dissent.

Lord Dunedin's propositions

1. Labels are not conclusive. Though parties who use the words "penalty" or "liquidated damages" may prima facie be taken to mean what they say, "yet the expression used is not conclusive. The Court must find out whether the payment stipulated is in truth a penalty or liquidated damages." 2. The essence of each. "The essence of a penalty is a payment of money stipulated as in terrorem of the offending party; the essence of liquidated damages is a genuine covenanted pre-estimate of damage". 3. Judged at the time of contract. It is a question of construction decided on the terms and circumstances of each contract, "judged of as at the time of the making of the contract, not as at the time of the breach". 4. Tests that may prove helpful, "or even conclusive": - (a) It is a penalty "if the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach." - (b) It is a penalty "if the breach consists only in not paying a sum of money, and the sum stipulated is a sum greater than the sum which ought to have been paid" (Kemble v Farren). - (c) "There is a presumption (but no more) that it is penalty" when a single lump sum is payable on one or more of several events, "some of which may occasion serious and others but trifling damage" (Lord Watson in Lord Elphinstone v Monkland Iron and Coal Co). - (d) On the other hand, it is no obstacle to a genuine pre-estimate "that the consequences of the breach are such as to make precise pre-estimation almost an impossibility." On the contrary, "that is just the situation when it is probable that pre-estimated damage was the true bargain between the parties".

Lord Dunedin applied the tests

• The damage Dunlop feared was "an indirect and not a direct damage". "But though damage as a whole from such a practice would be certain, yet damage from any one sale would be impossible to forecast."
• It was therefore "one of those cases where it seems quite reasonable for parties to contract that they should estimate that damage at a certain figure, and provided that figure is not extravagant there would seem no reason to suspect that it is not truly a bargain to assess damages".
• New Garage had "overpressed" Lord Watson's dictum in Elphinstone, treating as conclusive what raised only a presumption. On the different kinds of breach: "You cannot weigh such things in a chemical balance."
• Where one sum covers various breaches, "the strength of the chain must be taken at its weakest link": if the loss on one particular breach could clearly never amount to the sum, it may be a penalty. That was not this case.

Lord Atkinson

• Dunlop's evidence (Mr. Baisley) showed that undercutting would dislocate its distributing organisation, and that the loss, though possibly very serious, would be very difficult to prove. "This evidence was uncontradicted."
• A single sale might cause Dunlop no direct loss, "but the appellants have to look at their trade in globo, and to prevent the setting up, in reference to all their goods anywhere and everywhere, a system of injurious undercutting."
• The presumption in favour of a penalty is "rebutted by the very fact that the damage caused by each and every one of those events, however varying in importance, may be of such an uncertain nature that it cannot be accurately ascertained."

Lord Parker of Waddington

• He distinguished stipulations whose likely damage is the same in kind from those whose damage differs in kind. Here "the damage likely to accrue from the breach of every stipulation to which clause 5 applies is the same in kind. Such damage will in every case consist in the disturbance or derangement of the system of distribution by means of which the appellants' goods reach the ultimate consumer."
• Even where damage differs in kind, any presumption of a penalty "would be prima facie only and capable of being displaced by other considerations."

Lord Parmoor

• A sum is a penalty only if there is "an extravagant disproportion between the agreed sum and the amount of any damage capable of pre-estimate." Here, "the definite sum agreed by the parties is 5 l. , and this cannot be said to be extravagant or extortionate, having regard to the nature of the contract."
• "The parties adopted a wise and prudent course, having regard to the nature of the contract and the practical impossibility of an accurate ascertainment of damages."

Whether a sum payable on breach is a penalty or liquidated damages is a question of construction, judged at the time the contract is made, and the parties' label is not conclusive. A penalty is a sum stipulated in terrorem; liquidated damages are a genuine pre-estimate of loss. A single sum payable on several breaches raises only a presumption of a penalty, and that presumption is rebutted where the likely damage is uncertain in amount, the same in kind, and not extravagantly exceeded by the sum. Dunlop's 5l. per article, protecting its whole distribution system against undercutting, was a genuine pre-estimate and recoverable.

• Direct question: Distinguish between a penalty and liquidated damages. How does Indian law under s. 74 differ from English law? Set out Lord Dunedin's four propositions, then turn to s. 74 and the Indian cases.
• Problem question: a supply contract fixes a flat sum per unit for any breach of a resale-price clause, and the supplier can prove no loss on the particular sale. Use the case: loss to a distribution system is real but unmeasurable per sale, so the sum may be a genuine pre-estimate unless it is extravagant.
• Phrases to learn: "in terrorem"; "genuine covenanted pre-estimate of damage"; "judged of as at the time of the making of the contract, not as at the time of the breach".
• Remember the court: House of Lords, England, 1914 (reported [1915] AC 79) — persuasive in India, not binding.