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Penal damages are liquidated damages which exceed reasonable compensatory damages, making them invalid under common law. While liquidated damage clauses set a pre-agreed value on the expected loss to one party if the other party were to breach the contract, penal damages go further and seek to penalise the breaching party beyond the reasonable losses from the breach. Many clauses which are found to be penal are expressed as liquidated damages clauses but have been seen by courts as excessive and thus invalid.
The judicial approach to penal damages is conceptually important as it is one of the few examples of judicial paternalism in contract law. Even if two parties genuinely and without coercion wish to consent to a contract which includes a penal clause, they are unable to. So, for example, a person wishing to give up smoking cannot contract with a third party to be fined $100 each time they smoke as this figure does not represent the expectation loss of the contract.
A wholesale review of the English law rule against penalty clauses (as opposed to penal damages) was conducted by the UK Supreme Court in the 2015 judgment in Cavendish Square Holding BV v Talal El Makdessi
As distinguished from other types of damages
Penal damages are to be distinguished from punitive damages, which are awarded in certain types of tort actions for actions which caused harm to the plaintiff. Penal damages are also different from treble damages, which are generally set by statute for certain violations of competition law and related laws.
- Esanda Finance Corporation Ltd v Plessnig  HCA 7, (1989) 166 CLR 131, High Court (Australia).
- Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd  UKHL 1 at , House of Lords (UK).
- Cavendish Square Holding BV v Talal El Makdessi  UKSC 67, Supreme Court (UK), a case joined with ParkingEye Ltd v Beavis for the purposes of the Supreme Court judgment.
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