Enabling Penalties and Missing the Goal: Rethinking Nepal’s Erroneous Jurisprudence and Practice Concerning Liquidated Damages, and its Application in the Nepalese Public Procurement Regime

Abstract

Liquidated damages are damages that are pre-determined by the parties to a contract before any actual damage takes place. Liquidated damage clauses act as limitation-of-liability clauses in contracts and serve a significant commercial purpose. However, if such clauses are not regulated, they can lead to potential misuse. For example, when excessively high and unconscionable liquidated damages clauses are imposed, such clauses ought to be classified as unenforceable penalties. It is in this regard that various jurisdictions had, early on, adopted a compensatory-penal dichotomy (rule against penalties) wherein compensatory liquidated damages clauses (based on a genuine pre-estimate of loss) were enforced and penal liquidated damages clauses were not. However, the rule against penalties, as developed in Nepal, requires liquidated damages to be compared against actual damages (rather than against a genuine pre-estimate of loss), thus creating an erroneous ‘actual damages-penalty’ dichotomy. Despite the existence of such a rule against penalties in Nepal (although erroneous in nature), Nepalese courts and arbitration tribunals, while adjudicating over liquidated damages clauses, ignore the rule against penalties and the probable penalty aspect of such clauses, and solely focus on the attributability of the damages suffered. Therefore, the existing Nepalese practice concerning liquidated damages is more erroneous than the existing Nepalese jurisprudence against penalties. The article refers to various foreign judgements and criticizes the practice concerning liquidated damages and the jurisprudence concerning penalties in Nepal and recommends the correct practice and jurisprudence that can be adopted. Since liquidated damages clauses are largely observed in Nepalese public procurement contracts and construction contracts, this article specifically highlights the error in the application of such jurisprudence and practice under various circumstances that arise during the enforcement of such agreements.