§ 776. Provisions for penalty are invalid in any contract. The principles first developed in actions upon bonds were subsequently extended to all contracts and applied by courts of law as well as by courts of equity.28 The difficulty which has vexed modern courts, and which has caused much litigation, is to distinguish between a provision for a penalty and one for liquidated damages. Though difficulties frequently arise in the application of the principle distinguishing one from the other, and though the statements in the cases have not always been clear, the fundamental basis of the distinction at least is evident. A penalty is a sum named, which is disproportionate to the damage which could have been anticipated from breach of the contract, and which is agreed upon in order to enforce performance of the main purpose of the contract by the compulsion of this very disproportion. It is held in terrorem over the promisor to deter him from breaking his promise. Liquidated damage, on the other hand, is a sum fixed as an estimate made by the parties at the time when the contract is entered into, of the extent of the injury which a breach of the contract will cause. 29 A provision for a penalty is, therefore, necessarily invalid, though the fact that parties do or do not call a provision a penalty is not conclusive of its character.30 A provision for a forfeiture, on the other hand, though not favored by the law, is not necessarily invalid. The nature of a contract may make a provision for a specific forfeiture in case of a breach only a legitimate agreement for liquidated damages;31 28 The leading case is Astley v. Weldon, 2 B. & P. 346. The contract there involved bound the defendant to perform at the plaintiff's theatre, and provided that if either of the parties broke the contract, he should pay the other £200. The provision was held to be penal and not recoverable. 29 "Compensation for damages sustained is the legitimate object of such provisions, and where that object is lost sight of and a penalty imposed they will not be given effect by the courts. Equity will enjoin the enforcement of inequitable and unjust provisions of this nature and courts of law will refuse to enforce them." 30 See infra, § 778. 31 In Stennick v. Jones, 252 Fed. 345, 352, 164 C. C. A. 269, the court said: "There are also many decisions where the measure of damages for the breach of a contract by a vendor being ascer tainable without difficulty, forfeiture will not be enforced. But these equitable doctrines do not override the principle that parties may make a contract to run for years, and of a character where, actual damages being and even though what is forfeited by one who breaks a contract is disproportionate to the damage suffered by the injured party, if the latter has already acquired the forfeiture by the partial performance of the contract he is in many cases not deprived of any part of it or of its value.32 §777. How far the question of penalty or liquidated damages is one of construction. It is commonly said in the cases that the decision of the question whether a certain provision is penal or not, is one of construction; 33 yet it is evident that the question is at least not wholly one of construction. If the matter were fully summed up by saying that the duty of the courts is "to give effect to the plainly expressed will of the contracting parties," 34 the recovery of penalties would generally if not universally be allowed. To be sure, in the case of a bond, it is no doubt generally understood to-day that the penalty is not intended or expected to be enforced; that performance of the condition is the purpose which the parties have exclusively in mind; but this is not the meaning of the language of the bond, and indeed is not only in direct contradition of plain language but in contradiction of what was undoubtedly the intention of the parties when equity first gave relief. There can be no doubt that our forefathers when they provided in a bond that a penalty should be paid if a certain condition were not performed, meant exactly what they said; and even to-day though this may no longer be true in regard to bonds, there can be no doubt that in other penal contracts it is generally the clearly expressed will of the parties that the penalty shall be paid if uncertain of estimation, there may be and Motor Co., [1915] A. C. 79, provision for a forfeiture or transfer of ownership in case of a substantial breach, which the courts, after inquiry will enforce. Edmunds v. Spanish R. P. & P. Co., 206 Fed. 92." 12 See infra, §§ 790, 791, 14731477. "See for instance Sun Printing & Publishing Association v. Moore, 183 U. S. 642, 662, 46 L. Ed. 366; Dunlop Pneumatic Tyre Co. v. New Garage 87. 34 As said in Sun Printing & Publishing Assoc. v. Moore, 183 U. S. 642, 662, 46 L. Ed. 366. Cf. Wise v. United States, (U. S. Oct. Term 1918), 39 Sup. Ct. 303, where the court upholds the provision because it is a "genuine pre-estimate," and Northwestern Terra Cotta Co. v. Caldwell, 234 Fed. 491, 148 C. C. A. 257; In re Liberty Doll Co., Inc., 242 Fed. 695. the main agreement is not performed, and their expressed will represents their actual intention if that is of any importance. Therefore, the first step towards a clear understanding of the matter is to recognize that the determination of whether a particular provision is penal or merely provides for liquidated damages only, does not depend on the natural meaning of the language used by the parties. The legal effect of an instrument depends on rules of law which sometimes contradict the meaning of the instrument and the intention of the parties.35 Probably all that most courts mean-at any rate all that can be defended-is to say that the validity of the stipulation is to be "judged of as at the time of the making of the contract, not as at the time of the breach," 36 and this is undoubtedly true. 37 The question whether a sum is liquidated damages or a penalty, also, is not a question of the law of damages. It is a question of the legal validity of a stipulation in a contract. If the contract which the parties have made is enforceable according to its terms, no troublesome problem of damages is presented; the real problem is whether the bargain of the parties is enforceable or not. § 778. Intention of the parties. It is not unnatural that the question under consideration should be ordinarily classified as one of construction because it is very commonly said that whether a stipulation involves a penalty or liquidated damages depends wholly or largely upon the intention of the parties. As shown in the preceding section, the statement is misleading. Where intention of the parties is spoken of in the law of contracts it normally means their expressed intention that something shall or shall not be done. 35 See criticism of the use of the terminology which ascribes to construction or interpretation all legal effects which the law gives to a writing, supra, § 601. This, however, is a question of terminology, and when, e. g., Smith, J., says in Northwestern Terra Cotta Co. v. Caldwell, 234 Fed. 491, 496, 148 C. C. A. 257, that the question is one of "construction rather than interpretation" he is taking the same view as that suggested in the text. 36 Dunlop Pneumatic Tyre Co. v. New Garage Motor Co., [1915] A. C. 79, 87. 37 Learned v. Holbrook, 87 Oreg. 576, 170 Pac. 530, 171 Pac. 222. In every case, either of penalty or of liquidated damages, the parties have manifested a clear intention that the sum stated in the contract shall be paid in the contingency which has occurred. If their intention is to be given effect, every penalty will be enforced. If, however, by intention of the parties is meant their intention that the particular provision in question shall be liquidated damages or shall be a penalty, it should be observed that most people who make contracts know nothing about these terms, nor what they connote. If they do know that there is a distinction made by the law, the surest way of indicating that they mean one or the other is to call it by its appropriate name; and when contracts are drawn by lawyers the sum stipulated for is usually called liquidated damages, but courts rightly pay little attention to the name given to a sum payable in terms on breach of a contract. Calling a sum to be paid under a contract liquidated or stipulated damages, will not prevent the court from treating it as a penalty.38 Nor will the use of the word "forfeit" 39 " 40 or "penalty" prevent the court in a proper case from regarding as liquidated damages a sum named in a contract; though the use of words appropriate for liquidated damages 41 and especially the use of 7 S. W. 777; Seeman v. Biemann, 108 Wis. 365, 84 N. W. 490. Green v. Price, 13 M. & W. 695, 701; Betts v. Burch, 4 H. & N. 506, 511; Bignall v. Gould, 119 U. S. 495, 30 L. Ed. 491; Pacific Hardware & Steel Co. v. United States, 48 Ct. Cl. 399; Northwestern Terra Cotta Co. v. Caldwell, 234 Fed. 491, 496, 148 C. C. A. 257; Pogue v. Kaweah, etc., Co., 138 Cal. 664, 668, 72 Pac. 144; New Britain v. New Britain Telephone Co., 74 Conn. 326, 50 Atl. 881, 1015; Greenblatt v. McCall, 67 Fla. 165, 64 So. 748; Scofield v. Tompkins, 95 Ill. 190, 35 Am. Rep. 160; Ludlow Valve Mfg. Co. v. Chicago, 181 Ill. App. 388; Sanders v. McKim, 138 Ia. 122, 115 N. W. 917; Basye v. Ambrose, 28 Mo. 39; Wibaux v. Grinnell, etc., Co., 9 Mont. 154, 22 Pac. 492; Whitfield v. Levy, 35 N. J. L. 149, 155; Brownold v. Rodbell, 130 N. Y. App. Div. 371, 114 N. Y. S. 846; Eakin v. Scott, 70 Tex. 442, 444, 39 Merica v. Burget, 36 Ind. App. 453, 75 N. E. 1083; Ross v. Loescher, 152 Mich. 386, 116 N. W. 193, 125 Am. St. Rep. 418; Streeper v. Williams, 48 Pa. 450. 40 Sainter v. Ferguson, 7 C. B. 716; Parfitt v. Chambre, L. R. 15 Eq. 36; United States v. Bethlehem Steel Co., 205 U. S. 105, 120, 51 L. Ed. 731, 27 Sup. Ct. Rep. 450; Pierce v. Fuller, 8 Mass. 223, 5 Am. Dec. 102; Whitfield v. Levy, 35 N. J. L. 149, 154; Ward v. Hudson River B'g Co., 125 N. Y. 230, 26 N. E. 256; Stewart v. Turner, 67 Pa. Super. 255; Grant Marble Co. v. Marshall & Ilsley Bank, 164 Wis. 547, 165 N. W. 14. 41 Reilly v. Jones, 1 Bing. 302; Geiger v. Western Md. R., 41 Md. 4, 15; Makletzova v. Diaghileff, 227 Mass. 100, 116 N. E. 231. words appropriate for a penalty or forfeiture 42 are of some evidentiary value. "Where a sum of money fixed by the parties 'as liquidated and ascertained damages, and not a penalty or penal sum, or in the nature thereof' was held by the court to be a penalty, it seems an abuse of language to say that this was in accordance with the parties' intention." 43 It may be said, however, that though the value of these terms is unknown to most persons who are not lawyers, they know whether a stipulation was inserted for the purpose of securing performance by being held in terrorem over a promisor, and that the intention of the parties with reference to this makes the vital distinction.44 But provisions for liquidated damages are intended for security as well as provisions for penalties. When liquidated damages of $10 a day are stipulated for, if a building is not completed on time, or payment of $5,000 if a promisor fails to comply with his promise not to enter into competition with the promisee, there can be no doubt that these provisions are intended not merely as a provision for an unpleasant and unexpected contingency but also to secure the promisee in the performance of the main obligation and to make the promisor more reluctant to break it. This distinction, therefore, is at least partially fictitious. The only sense in which the intention of the parties can have any meaning in this connection, and this seems to be the meaning generally given to the phrase by the courts when the matter is analyzed by them, is an intention to name a sum that is fixed in good faith as the equivalent of the injury which will probably be caused by breach of the contract, rather than an attempt to secure performance by a provision for an excessive payment. "Intention of the parties is, however, a misleading and undesirable designation for this requirement, and the first step towards clearing the confusion 42 Van Buren v. Digges, 11 How. 461, 467, 13 L. Ed. 771; Nichols v. Haines, 98 Fed. 692, 39 C. C. A. 235; Zenor v. Pryor, 57 Ind. App. 222, 106 N. E. 746; Keinath v. Reed, 18 N. Mex. 358, 137 Pac. 841; Smith v. Wainwright, 24 Vt. 97, 102. 43 Sedgwick on Damages, § 406, referring to Kemble v. Farren, 6 Bing. 141. 44 Thus in Dubinsky v. Wells Bros. Co., 218 Mass. 232, 237, 105 N. E. 1004, Crosby, J., said: "We are of opinion that this deposit was intended by the parties to secure the performance of the contract and was not to be retained by the defendant as liquidated damages for the breach of the contract by the plaintiff." See also Westfall v. Albert, 212 Ill. 68, 72 N. E. 4. |