Can a Penalty Clause in a Contract Be Enforced or Not

By Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a Freehold, NJ Contract Attorney

Many contracts contain language which provides that a breach will result in the offending party being assessed a stipulated amount of money, say $1,000, or, $5,000 etc. This provision is inserted instead of language which requires the non-breaching party to prove their actual economic loss.

This contract clause is called a “liquidated damages clause”. Faced with a liquidated damage clause many parties will argue the contract’s liquidated damages clause is “grossly disproportionate to the actual damages sustained by the other side and thus unenforceable as a penalty.” They argue they are entitled to a refund of any monies that are not related to an ascertainable measure of damages. Some judges reject this argument, concluding that if the terms of the contract are “clear and unambiguous…the courts must enforce those terms as written.”

New Jersey Courts have provided a clear definition to distinguish between an enforceable liquidated damages clause and an unenforceable penalty:

Liquidated damages is the sum a party to a contract agrees to pay if he or she breaks some promise, and which, having been arrived at by a good faith effort to estimate in advance the actual damage that will probably result from the breach, is legally recoverable as agreed upon damages if the breach occurs. A penalty is the sum a party agrees to pay in the event of a breach, but which is fixed, not as a pre-estimate of probable actual damages, but as a punishment, the threat of which is designed to prevent the breach.

The Supreme Court has expanded its reasoning to account for the evolution of these legal principles as applied in a variety of factual settings. The court has explained that “a stipulated damage clause ‘must constitute a reasonable forecast of the provable injury resulting from breach; otherwise, the clause will be unenforceable as a penalty and the non-breaching party will be limited to conventional damage measures.’”

To discuss your NJ Contract and Breach of Contract matter, please contact Fredrick P. Niemann, Esq. toll-free at (855) 376-5291 or email him at  Please ask us about our video conferencing consultations if you are unable to come to our office.