This section is from the book "The Law Of Contracts", by William Herbert Page. Also available from Amazon: Commercial Contracts: A Practical Guide to Deals, Contracts, Agreements and Promises.
A contract for a penalty is an agreement to pay a stipulated sum in case of default, intended to coerce performance, to punish default, or to secure payment of the actual damages.1 A contract for liquidated damages is a contract by which the parties in advance of breach fix the amount of damages which will result therefrom, and agreed upon its payment.2 The place of this topic in the law of contracts is open to question. Contracts for penalties, as we shall see later, are unenforceable, and may without any impropriety be said to be void. Such contracts might therefore be discussed under the head of void contracts. On the other hand it is so well settled that if a contract is for a penalty it is void that questions are rarely raised upon this branch of the topic. The question which is commonly presented for decision is whether the contract is one for penalty or liquidated damages; and this is primarily a question of construction. Accordingly, this subject is discussed in connection with construction. This topic might also be considered in connection with breach and damages. Questions thereunder can necessarily arise only when a breach exists or is alleged. The determination of this question is also decisive of the question whether the parties are limited by and entitled to the amount stipulated for by the contract, or whether they are driven to the proof of actual damages and are governed by the rules which control the measure of damages.
1 United States v. Cutajar, 67 Fed. 530; Gillilan v. Rollins, 41 Neb. 540; 59 N. W. 893.
2 Monmouth Park Association v.
Iron Works, 55 N. J. L. 132; 39 Am. St. Rep. 626; sub nomine Wal-lis Iron Works v. Park Association, 19 L. R. A. 456; 26 Atl. 140.