The Four Dunlop Tests

In out first entry we set out why liquidated damages clauses matter. In our last entry we saw that telling whether something is or is not a ‘penalty’ is harder than it looks. We said we would need to go back in time to look at the old but important case of Dunlop Pneumatic Tyre Co Ltd v Dunlop Motor Co Ltd [1907] A.C. 430. We need to do that because the tests set out in that case have been highly influential. However the tests are rather inflexible and this has been causing difficulty for the courts in our era.

Dunlop is an important case on the law relating to penalties. In his speech, Lord Dunedin formulated four tests which could be relied upon if they were ‘applicable to the case under consideration.’ The four tests were intended to help decide whether or not a liquidated damages clause was to be treated as a penalty clause. They were,

(a)  that the provision would be penal if “the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach”;

Explanation: so the court has to work out the damages which would be recoverable at common law and compare them with the amount awarded under the liquidated damages clause. If the difference between the two is ‘extravagant and unconscionable’ then the provision would be penal.

(b)   that the provision would be penal if the breach consisted only in the non-payment of money and it provided for the payment of a larger sum than had to be paid in the first place;

Application: Mr Beavis’ breach was to stay too long, it did not arise from a failure to pay for his parking upfront.

(c)  that there was “a presumption (but no more)” that a clause would be penal if payment was triggered by a number of events of differing importance.

Application: Mr Beavis could have stayed a few minutes or a few hours but the charge would have been the same.

(d)  that a clause would not be treated as penal simply because it was impossible to estimate the true loss in advance with any precision.

Application: ParkingEye could not tell in advance by how long any visitor might overstay.

As you can see, Dunlop was a poor fit with the facts of the ParkingEye case. The court needed to come up with a flexible formula to guide it in complex cases. We will deal with this in our next blog entry.