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.
If the default which is to make a specified sum due and payable is itself the non-payment of a smaller sum of money, the question whether the contract is for a penalty or for liquidated damages depends on which sum the original debt was. If the original debt was the smaller sum, the promise to pay the larger sum in case of default is a penalty.1 The outward form of the contract does not prevent the application of this principle. The parties may stipulate that the larger sum is the real debt due, and that it is to be discharged by the payment of the smaller sum. This, however, is a penalty if the smaller sum is the real debt.2 Thus an agreement to pay rent for machines, due on the first of each month, payable by the first of the next month, with a discount of fifty per cent if paid by the fifteenth day of the first month,3 or an agreement for the sale of realty which in legal effect is a sale at eight hundred dollars, with a provision for paying ten installments of a hundred dollars each with interest, but if each payment is made punctually when due, "eight hundred dollars and its yearly interest will be accepted in full payment,"4 are each agreements for a penalty for delay. If, however, the larger sum is the real debt, and the creditor has agreed to discharge it on payment of the smaller sum in the manner stipulated in the contract, the agreement that in case of default the larger sum shall be due and payable, is not a stipulation for a penalty.5 Thus A had a life interest in an undivided third of B's property. The parties estimated the value of this at eight hundred dollars, and A released her estate in consideration of B's promise, secured by mortgage, to pay to A eight hundred dollars on a specified date, provided if B paid twenty dollars semi-annually to A on specified dates "it shall discharge the whole debt." This was held not to be a penalty.6
1 Gay Mfg. Co. v. Camp, 65 Fed. 794; 13 C. C A. 137; Smith v. Newell, 37 Fla. 147; 20 So. 249; Goodyear, etc., Co. v. Selz, 157 111. 186; 41 N. E. 625; Fisk v. Gray, 11 All. (Mass.) 132; Morrill v. Weeks, 70 N.H. 178; 46 Atl. 32; Cairnes v. Knight. 17 O. S. 68; Longworth v. Askren, 15 0. S. 370; Fitzpatrick v. Cottingham, 14 Wis. 219.
2 Chaffee v. Landers, 46 Ark. 364; 114
Moore v. Hylton, 1 Dev. Eq. (N. C.) 429; Longworth v. Askren, 15 O. S. 370.
3 Goodyear, etc., Co. v. Selz, 157 111. 186; 41 N. E. 625.
4 Longworth v. Askren, 15 O. S. 370.
5 United States Mortgage Co. v. Sperry, 138 U. S. 313; Waggoner v. Cox, 40 O. S. 539.