Penalty Clauses and Liquidated Damages
UVA Law Faculty Affiliations
This paper briefly assesses defenses of the law of liquidated damages based on experimental evidence adduced by behavioral law and economics (BLE). It identifies three sorts of inference BLE frequently relies upon: a weak inference of rule design, a modest inference to limited application, and a strong inference to general application. BLE's lack of a unified and coherent theory of rational choice does not mean that its unconfirmed predictions are unsupportable. However, needed support must come indirectly, from defensible inferences drawn from experimental results. Because the defensible inferences from the results BLE relies on are limited to a restricted range of choice environments, they cannot support a broad legal rule that is to apply in most cases. Two consequences follow for the regulation of liquidated damages clauses. First, the inferences cannot support a rule of penalty regulation. At most, they justify exceptions that allow judicial oversight of liquidated damages clauses in particular circumstances. Because BLE's defensible inferences have a restricted range, they cannot themselves undermine the general presumption favoring the contracting parties' choice of value-maximizing terms. Second, the inferences cannot undermine arguments for limiting penalty regulation that do not rely on the processing of information. Arguments from measurement error resulting from restricted access to information about damages, such as Goetz and Scotts', are unaffected by findings of systemic cognitive failure in information processing.