This argument is also distinct from that of unconscionability although there is an element which is similar.
The law with respect to the use of a “genuine pre-estimate of liquidated damages” is well-known. It is a question to be determined on the facts of each case as to whether the requirement to pay a fixed sum, given a violation of the contracted term, is indeed just that or an unenforceable penalty. If the latter is the case, the plaintiff must prove its damages in the normal manner.
Should the sum be seen as “extravagant and unconscionable” compared to the greatest loss that could follow, it will be viewed as a penalty.
Mr. Justice Fitch in the 2011 decision of the BCSC in Super Save Disposal v Blazin Auto Ltd. And Daily Sun Investment set out this principle:
[26] The enforceability of a liquidated damages provision in an agreement engages two competing objectives: freedom of contract versus the right of the courts to intervene in a given case to relieve against an oppressive or unconscionable result flowing from enforcement of the liquidated damages term. It is well settled that the enforceability of such a term turns on whether it is a genuine pre-estimate of the expected loss that a party will sustain in the event of a breach of contract or a penalty clause so oppressive or unreasonable that equitable intervention is justified to prevent an injustice.
[27] On the authorities drawn to my attention in these appeals, the following non-exhaustive list of guiding principles can be identified.
[28] The characterization of the provision in issue is either a genuine pre-estimate of expected loss or a penalty requires a case-specific assessment: 32262 B.C. v. See-Rite Optical, 1998 ABCA 89 (CanLII), 1998 ABCA 89, at para. 15.
[29] The issue is to be decided upon the terms of the contract and “inherent circumstances” of each particular contract, Dunlop Pneumatic Tire Co. Ltd. v. New Garage and Motor Co. Ltd., [1915] A.C. 79, per Lord Dunedin at pages 86 and 87.
[30] Though the parties may use the words “liquidated damages” or “penalty” in the agreement itself, the parties’ characterization of the clause in the contract as one or the other is not conclusive: Dunlop Pneumatic Tire Co. Ltd. v. New Garage and Motor Co. Ltd., supra. Similarly, the absence of such characterizing phrases is neither fatal to the plaintiff’s claim for liquidated damages or to the defendant’s challenge that the clause at issue amounts to a penalty: Bayliss Sign Ltd. v. Advantage Holdings Ltd. (1986), 9 B.C.L.R. (2d) 230 (Co.Ct.), at p. 241. In each case, the court must make an assessment as to whether the clause is in truth a genuine pre-estimate of anticipated loss in the event of a breach, or an in terrorem clause inserted to compel performance of a contractual obligation.
[31] Judicial interference with a liquidated damages provision will be justified if enforcement of the term results in payment of a sum which is extravagant and unconscionable in comparison with the greatest loss that could conceivably be proved to have followed from the breach: 32262 B.C. v. See-Rite Optical, supra, at para. 13.
[32] Conversely, a liquidated damages provision is more likely to be enforced where the claim approximates the amount to which the claimant would otherwise have been entitled according to principles of general contract law: 32262 B.C. v. See-Rite Optical, supra, at para. 16 to 18.
The defence to the claim, as with undue influence and unconscionability, is a plea in equity.
Reference to this submission was also found in Jung v Lheidli T’enneh Indian Band in which the court stated, obiter, that the termination clause would have been unenforceable as a penalty clause:
[52] In Wrongful Dismissal, Vol. II, Davis Harris, B.A., L.L.B., the learned author, at para. 9.10, under the heading Penalty Clause, states:
In general a “penalty clause” (ie., a clause that may be fairly construed as being – interrorem rather than being a genuine pre-estimate of liquidated damages) will be held unenforceable at the instance of either party.
The principles to be used in differentiating “penalty clause” from one that contains a genuine pre-estimate of liquidated damages were set out in Dunlop Pneumatic Tyre Co. v. New Garage & Motor Co., [1915] A.C. 79, [1914] All E.R. Rep. 739, Viscount Dunedin stated that the factors to be considered include the terms and inherent circumstances of each contract, judged at the time of making. Should the amount stipulated be extravagant or unconscionable, the clause would be considered to be of a penal nature and thus unenforceable.
The employer in Maxwell v Peace Arch Hospital Society argued that the employment agreement which allowed a payment of 12 months’ severance even in the event of a voluntary cessation of employment by the plaintiff was a penalty clause.
The Supreme Court of British Columbia referenced, in the above decision, with apparent approval the decision of the Supreme Court of Ontario in Ashdown v Jumbo Video, in which the trial judge stated that the argument of a penalty clause had no place in employment law, at least in dealing with a payment in lieu of notice:
Moreover, I hold that penalty is an inappropriate concept to employment law.
In Matthewson v. Aiton Power Limited, 1 the Ontario Court of Appeal had little difficulty with the concept of an agreed notice period as a penalty, although it was not applied in this instance. 2
The rationale makes sense: in commercial contracts, it is relatively easy to pre-estimate damages, and if an amount stipulated is outrageous and unrelated to actual loss, its penalty character is evident.
In employment contracts, however, where it is difficult to know how long the employee will be unemployed, it is almost impossible to pre-estimate damages. Therefore the penalty approach is inappropriate.
In the Maxwell case, the Supreme Court of B.C. concluded that there was an inherent rational in allowing the plaintiff a payment in the event of his resignation, given pending merger discussions and the possibility that his position may have been revised.