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An arbitrary pre-arranged sum that becomes payable if one party breaches a contract or undertaking. It is usually expressly stated in a penalty clause of the contract. Unlike liquidated damages, a penalty will be disregarded by the courts and treated as being void. Liquidated damages will generally be treated as a penalty if the amount payable is extravagant and unconscionable compared with the maximum loss that could result from the breach. However, use of the terms ‘penalty’ or ‘liquidated damages’ is inconclusive as the legal position depends on the interpretation by the courts of the clause in which they appear.

Subjects: Accounting — Financial Institutions and Services.

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