This section is from the book "Popular Law Library Vol7 Equity Jurisprudence, Trusts, Equity Pleading", by Albert H. Putney. Also available from Amazon: Popular Law-Dictionary.
Liquidated damages are damages whose amount is determined in advance of the breach, by the terms of the contract. Whether the sum stipulated in a contract is a penalty or liquidated damages, will be determined by the real intention of the parties and the nature of the transaction, rather than by the name given to the sum to be paid, by the wording of the contract.
1 Peachy vs. Duke of Somerset, 1
Strange, 447. 2 Sloman vs. Waltter, 1 Brown Ch., 418.
3 Smith vs. Bergengren, 153 Mass., 690. 4 Walsh vs. Curtis, 76 N. W., 52.
The securing by a larger sum of money of the payment of a smaller one will always be considered a penalty.5 Although a note may be made to pay a higher rate of interest after maturity, a provision that in case of failure to pay when due the maker shall pay a higher rate from the date of the note, creates a penalty. In Krutz vs. Robbins,6 the Court said:
"The plaintiff in the action sought to recover interest on the note from its date at the rate of 12 per cent per annum, compounded semi-annually, in accordance with the stipulation in the mortgage above set forth. The court, however, awarded him but 7 per cent, interest on the note, computed semi-annually from date to maturity, and thereafter at the rate of 12 per cent. per annum. Interest was also allowed on each coupon at the rate of 12 per cent, per annum from maturity, as therein specified. The amount recovered is $866.33 less than plaintiff conceives himself entitled to, and hence this appeal. The trial court, it will be seen, based its decision as to the rate of interest on the stipulation in the note itself in regard thereto; but appellant contends that the ruling was erroneous, for the reason that it gave no effect whatever to the stipulation in the mortgage providing for interest on the principal note, at the rate of 12 per cent. per annum from its date in case of default. He claims that that provision was part of the contract between the parties, and that inasmuch as it is not contrary to law or public policy, and is not immoral, it should be enforced as made. On the other hand the respondents insist that the provision in the mortgage for a higher rate of interest in case of default of payment of the principal or interest specified in the note is in the nature of a penalty, and unenforceable in equity. If this provision is a penalty, there can be no doubt that it is unenforceable, for it is a universal rule in equity never to enforce either a penalty or a foreclosure. 2 Story, Eq. Jur., Sec. 1319. But what is a penalty, and what is liquidated damages in a given case, it is not always easy to determine. As the question is one of intention, no single rule can be laid down which will furnish a certain and satisfactory criterion for all cases. In most cases many circumstances must be considered in order to ascertain the real intention of the parties. The courts, however, have deduced from the authorities certain general rules, 'each having more or less weight, according to the peculiar circumstances of each case.' Among these rules is one which is almost universally recognized and acted on, and which is that, where the payment of a smaller sum is secured by an agreement to pay a larger sum, the larger sum will be held a penalty, and not liquidated damages. Keeble vs. Keeble, 85 Ala., 552; 5 South, 149, and cases cited; 1 Pom., Eq. Jur., Sec. 441; Adams, Eq., page 108; 2 Pars., Notes and B., pages 413-414; Seton vs. Slade, 7 Ves., 265; 3 Bl. Comm., 432; Holies vs. Wyse, 2 Ver., 289; Strode vs. Parker, Id., 316; Orr vs. Churchill, 1 H. Bl, 227; Bonafous vs. Rybot, 3 Burrows, 1370; Parker vs. Butcher, L. R., 3 Eq., 762; Tiernan vs. Hinman, 16 I11., 400; Watts vs. Watts, 11 Mo., 547; Mason vs. Callendar, 2 Minn., 350 (Gil., 302); Richardson vs. Campbell, 34 Neb., 181; 51 N. W., 753; Waller vs. Long, 6 Munf., 71.
5 Morrill vs. Weeks, 70 N. H., 178; Gay Mfg. Co. vs. Camp, 65 Fed., 794.
6 12 Wash 7; 40 Pac, 415.
"In Alexander vs. Troutman, 1 Kelly, 469, this is said to be the settled doctrine. If this case, therefore, falls within the rule stated, the provision in the mortgage for an increased rate of interest in case of default in the payment of principal or specified interest is in the nature of a penalty, and the trial court was right in refusing to enforce it. While, in construing contracts, due weight will be given to the language used, still courts of equity will not be absolutely controlled by the words employed, when the enforcement of such contract will cause an unconscionable hardship or otherwise work an injustice. Keeble vs. Keeble, supra. A penalty has been defined to be an agreement to pay a greater sum to secure the payment of a less sum (Henry vs. Thompson, Minor, Ala., 209), and it seems to us that this case clearly falls within that definition and the rule above stated. The additional rate of interest is essentially a penalty, although not designated as such. It could not have been intended as compensation for the use of the principal before maturity, for the reason that 7 per cent. interest was agreed on as the rate of compensation. It could not have been intended as compensation for failure to pay the interest when due, because it is neither porportioned to the amount of interest nor to the length of time the debtor is in default. The provision for 5 per cent. extra interest may therefore be considered as a provision to secure the prompt payment of 7 per cent. interest on the principal debt, and also taxes, insurance, and principal when due."
If the sum to be paid is the same in case of any breach of the contract, whether great or small, it will be construed as a penalty.7
"Where an agreement is for the performance or non-performance of only one act, and there is no adequate means of ascertaining' the precise damage which may result from a violation, the parties may, if they please, by a separate clause of the contract, fix upon the amount of compensation payable by the defaulting party in case of a breach; and a stipulation inserted for such purpose will be treated as one for 'liquidated damages,' unless the intent be clear that it was designed to be only a penalty." 8
7 East Moline Plow Co. vs. Weir Plow Co., 95 Fed., 250; Kem-ble vs. Farren, 6 Bing., 141.
In the case of a penalty the party bound has not the right to elect to pay the penalty and not to perform the contract;9 but the rule is the opposite in the case of liquidated damages.10