Punitive damages are liquidated damages which exceed reasonable compensatory damages, making them invalid under common law. While liquidated damage clauses set a pre-agreed value on the expected loss to one party if the other party were to breach the contract, punitive damages go further and seek to penalise the breaching party beyond the reasonable losses from the breach. Many clauses which are found to be punitive are expressed as liquidated damages clauses but have been seen by courts as excessive and thus invalid.
The judicial approach to punitive damages is conceptually important as it is one of the few examples of judicial paternalism in contract law. Even if two parties genuinely and without coercion wish to consent to a contract which includes a punitive clause, they are unable to. So, for example, a person wishing to give up smoking cannot contract with a third party to be fined $100 each time they smoke as this figure does not represent the expectation loss of the contract.