On the Social Optimality of Liquidated Damage Clauses: An Economic Analysis

The principle of freedom of contract rests on the premise that it is in the public interest to accord individuals broad powers to order their affairs through legally enforceable agreements that the courts will enforce without passing on their substance. Occasionally, however, a court will decide that the public interest in freedom of contract is outweighed by other considerations and will refuse to enforce the agreement or some part of it. In particular, contracting parties' power to bargain over their remedial rights is surprisingly limited. The most important restriction denies them the power to stipulate damages that are so large as to be characterized as penalties.'