Liquidated Damages, Penalties and the Just Compensation Principle: Some Notes on an Enforcement Model and a Theory of Efficient Breach

Professor of Law, University of Virginia School of Law, A.B., 1961, Providence College; Ph.D., 1964, University of Virginia. * Professor of Law, University of Virginia School of Law; B.A., 1965, Oberlin College; J.D., 1968, William & Mary; S.J.D., 1973, University of Michigan. The authors wish to acknowledge the significant contribution of Mr. Charles G. Cofer, B.A., 1974, Duke University; J.D., 1977, University of Virginia School of Law, in the preparation of this article. Mr. Cofer is primarily responsible for the material concerning the historical background of the penalty rule and also assisted in the preparation of the footnotes. 1. See 5 W. S. HOLDSWORTH, A HISTORY OF ENGLISH LAW 293 (1924). Relief from agreed damage provisions was premised on the notion that it was against "conscience" that a person might recover damages exceeding the loss which he suffered. Undoubtedly, one underlying fear was that fraud or other unconscionable conduct was involved. 2. See text accompanying notes 21-28 infra. 3. The rationale for designating a particular liquidated damages provision a penalty has as many formulations as there are treatments of the doctrine. For a representative sampling, see 5 A. CORBIN, CONTRACTS ? 1054 (1964); G. GRISMORE, PRINCIPLES OF THE LAW OF CONTRACTS ? 234 (rev. ed. 1974); C. MCCORMICK, HANDBOOK ON THE LAW OF DAMAGES 599-608 (1935); RESTATEMENT OF CONTRACTS ? 339 (1932); 5 S. WILLISTON, A TREATISE ON THE LAW OF CONTRACTS ? 775A (3d ed. W. Jaeger 1961); Brightman, Liquidated Damages, 25 COLUM. L. REV. 277 (1925). 4. See 5 W. S. HOLDSWORTH, supra note 1, at 292-93. According to Holdsworth, the rules of equity at the mid-point of the fifteenth century were very vague. Combined with the turbulence of the country, these vague rules "gave rise to many interferences of the chancellor on the grounds of equity and conscience." Id. at 278. Such broad interferences may have been prompted by perceived defects in common law rules. Id. at 278-87. Since there were no legal rules available to relieve against unconscionable bargains, equity filled the gap. Id. at 292. 5. It was not uncommon that a debtor "for further security" would bind himself for double the amount of the actual debt. "[H]e might pay the debt, and still the creditor, armed