A penalty is just one element of the consideration for a contract. The party received something of value because it was willing to take the risk of having the penalty imposed upon it. Courts do not, in general, inquire into the adequacy of the consideration for a contract; yet if it is possible to characterize an element of a contract as a penalty, the court will scrutinize the adequacy of that element of the consideration more carefully.

The judicial hostility to penalties goes too far. Society would, I am quite certain, be better off if it adopted a more accommodating approach to liquidated damages and resisted the temptation to eliminate the right to terminate a relationship at will (if the initial contract allows for such terminations). There has been considerable effort to protect both employees and franchisees from such terminations, and courts have become more sympathetic to these efforts in recent years. Some of the hostility is undoubtedly due to a lack of appreciation of the mutual benefits to parties of arranging their affairs so that one could impose costs on the other. Nonetheless, I suspect that more than ignorance is involved.

It seems clear that the acceptability of certain penalties is culturally dependent. Society will simply not enforce certain penalties because that society perceives them to be wrong. You cannot contractually agree that in the event of breach you will become the other party's slave. At least you can't in twentieth-century America. It seems reasonable to take these social attitudes as given “tastes.” That is not to say that economic analysis will be useless in generating propositions about these attitudes. It is probably true that “morality” is income elastic.