Private Law Theory

Introduction:
The rules that apply to liquidated damages partially diverge between the common law and civil law tradition. In the United States, a distinction arises between a “proper” liquidated damages clause and a penalty clause. A provision determining the amount of damages that must be awarded in the event of breach is considered a “liquidated damages provision” and is enforceable under two conditions: (1) the actual damages at the time of contracting were difficult to estimate; and (2) the amount fixed in the provision is a reasonable estimate of the actual loss. When these two conditions do not hold, the clause is considered a penalty clause and is void. Richard Posner has described this distinction as “a major unexplained puzzle in the economic theory of the common law.” Scholars who make use of rational choice theory find this doctrine inefficient and unjustified, although their position is warranted because of their respect for the common law efficiency hypothesis. This common law treatment of penalty clauses reveals that US courts do not fully share the idea that humans are perfectly rational decision makers …

Enrico Baffi, Efficient Penalty Causes with Debiasing: Lessons from Cognitive Psychology. 47 Valparaiso University Law Review 111 (2014).

First posted 2014-05-07 18:25:03