Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd [1914] UKHL 1

ON 1 JULY 1914, the House of Lords delivered Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd [1915] AC 79; [1914] UKHL 1 (1 July 1914).

http://www.bailii.org/uk/cases/UKHL/1914/1.html

Liquidated sum clauses are valid and enforceable under contract law; penalty clauses are not. A liquidated sum is a genuine estimate of the losses from a breach; a penalty frightens or deters a party from breach.

A court will construe a clause to be a penalty if:

It is extravagant or unconscionable.
It is greater than the money payable for a breach for failure to pay money.

A court will presume a clause to be a penalty if it is for a single lump sum payable in the occurrence of one or multiple events, some of which may only warrant minimal damages.

A court will presume a clause to be liquidated if the consequences of a breach are hard or impossible to estimate as it is probable that the pre-estimated damage was the true bargain between the parties.