Contract Law

Dunlop Pneumatic Tyre Co. Ltd. v. New Garage & Motor Co. Ltd.

[1915] AC 79

Facts

Dunlop sold tyres through dealers under a price-maintenance arrangement.
New Garage agreed:
not to sell below Dunlop’s listed prices;
not to supply unauthorised dealers;
to pay £5 for each tyre sold in breach.
New Garage sold tyres below the agreed price.
Dunlop claimed the stipulated £5 per tyre.
New Garage argued that the amount was an unenforceable penalty rather than genuine liquidated damages.

Lord Dunedin identified important indicators:
A clause is penal where the stipulated sum is extravagant and unconscionable compared with the greatest conceivable loss.
A clause is likely penal where one large sum is payable for breaches of very different seriousness.
A clause may be a penalty where it requires payment greater than the sum simply left unpaid.
Difficulty in precisely estimating loss supports, rather than defeats, a liquidated-damages clause.
Labels chosen by the parties are relevant but not conclusive.

Dunlop’s loss from underpricing extended beyond the difference on one sale.
Discounting could:
damage the wider dealer network;
reduce brand value;
undermine price discipline;
produce losses difficult to quantify.
The agreed £5 amount was not shown to be extravagant compared with the possible commercial harm.
Although the exact loss from each discounted sale could not be calculated in advance, that uncertainty justified a genuine pre-estimate.
The provision was therefore compensatory rather than oppressive.
The clause was not designed merely to frighten the dealer into performance.
It protected a legitimate and measurable commercial interest.

The House of Lords upheld the £5 clause as liquidated damages.
Use this case for: a genuine pre-estimate of difficult-to-measure loss is enforceable; an extravagant deterrent is a penalty.