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Topic 18- Remedies Penalty Clauses (Introduction (Sometimes parties to…
Topic 18- Remedies
Penalty Clauses
Introduction
Sometimes parties to contract may decide to agree what damages should be payable in event that either of them fails to undertake heir contractual obligations
Such clauses may by defined as
a clause which, without commercial justification, provides for payment or forfeiture of a sum of money, or transfer or property by one party to the other party, in the event of breach of contract, the clause being designed to secure performance of the contract rather than compensate the payee for the loss occasioned through the breach
Courts often suspicious of such clauses
Particularly where the damages payable are wholly disproportionate to the injury that would be caused by the breach
Liquidated damages clause
The courts will consider such a clause to be valid if the amount the parties have set is a genuine estimate of the damages that would result from a breach of contract
Penalty clause
However, if a clause is inserted that is set at a deliberately high amount in order to deter a party from breaching the contract, this will be deemed to be a penalty clause
Will be unenforceable by the courts
Question of construction
The question as to whether or not a clause constitutes a liquidated damages clause or penalty clause is a matter of construction
BUT it would appear the greater the amount stated in the clause, the less likely it will be that it will be enforced
Name given
Toomey v Murphy:
Whether the clause is a penalty clause or a liquidated damages clause depends on the intention of the parties at the date of the agreement
Thus evidence of the name given to the clause will be indicative
Test
Dunlop Pneumatic Tyre Co v New Garage & Motor
a) The sum will be held to be a penalty if the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach
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Durkan New Homes v Minister for the Environment
Held; a clause in the contract of sale which required the vendor to pay damages, on an ascending scale,, of €20,000-50,000, per week between the proposed closing ate and the actual transfer
Deemed to be a penalty clause
b) The sum will be a penalty if the breach consists only in paying a sum of money, he sume stipulated being
greater than the sum which ought to have been paid
O'Donnell and Co v Truck and Machinery Sales
: court held that the formula for failing to pay under a contract should be
the fixed sum payable under the contract
plus commercial rates of interest
Anything more would be considered penal
e.g. Contract with obligations to pay 100, but provides for payment of 1000 for breach= penalty clause
c) There is
presumption
that a clause is penal when
a single lump sum is payable on the occurrence of one or more or all of several events
the events occasioning varying degrees of loss
CMC Group v Zhang:
Facts: Z settled claim brought against D
Settlement provided if Z continued to harass CMC staff a sum of 40,000 would be payable
Held: This was deemed to be a penalty clause as it could be broken any number of ways
e.g. sending of a solicitor's letter
Schiesser International v Gallagher:
Facts: D was sent to Germany to train as a textile cutter
Agreed that if he left the employment of the P before the expiration of 3 years of returning from Germany he would be required to reimburse P for his training and travelling expenses
Held; Clause struck down as penal as it applied the same amount payable regardless of whether the D had left one day after the training or one day before the expiration of the period
d) If the consequences of the breach are difficult to estimate in financial terms this, far from being an obstacle to the validity of the clause, will point in favour of upholding it, the courts taking the view that it is better for the parties themselves to estimate the damages that will result
The courts will favour genuine efforts by the parties to 'guesstimate' the costs of the losses which arise from the breach
Clauses of this type will not necessarily be struck down
Friel: Where damages are difficult to determine, he court is more likely to accept the pre-agreed view of the parties in the matter
Thus because striking down such clause goes against general principle that commercial agreements should be upheld , the courts can look at the agreement in its entirety in order to determine whether it is commercially justifiable
Tkachuk Farms v Le Blanc Auction Service
: In order to deal with sellers 'puffing up' bids in auction sales a clause was inserted into contract which required offender to pay compensation of 14% of a fixed commission
Held: this was a calculation made in good faith to settle litigation
Dominant Purpose Commercial teset
Notwithstanding four stage test laid down in
Dunlop
: Courts will look beneath agreement in order to test whether the clause is commercially justifiable
Lordsville Finance v Bank of Zambia
Jurisdiction re penalty clauses concerned not with inoffensive liquidated damages clauses but rather with the protection against the effect of penalty clauses
Seem to be no reason in principle why a contractual provision the effect of which was to increase the consideration payable under an executor contract upon the happening of a default should be struct down as a penalty
if the increase could in the circumstances be explained as commercially justifiable, provided always that its dominant purpose was not to deter the other party from breach
Dominant purpose commercial test
If the courts find a purpose for the clause
Other than oppressive conduct or
A deterrent to inhibit breach
The courts may uphold the clause
Parking Eve v Beavis:
Used in stead of 4 tests
Facts: A standard provision in a retail park advised that shoppers who park their cars that overstay the max parking period would have to pay £85 parking charge
Held: Charge was not imposed to provide a genuine pre-estimate of the loss that will be occasioned by a breach but it nevertheless has two legitimate functions
The efficient use of parking spaces for the benefit of retail outlets by deterring commuters and other long stay users
To help to finance the parking facilities that were otherwise free to compliant users
Held: UK SC- Penalties rule was engaged but he charge was not a penalty
charge neither extravagant nor unconscionable having reard to the level of charges imposed by local authorities for overstaying in car parks on public land
Cavendish Square Holding v EI Makdessi:
UK
- Recent confirmation that the issue of commercial justification is the guiding principle re whether a clause is a penalty clause or a liquidated damages clause
Facts: Clause in a share purchase agreement which bound seller not to engage in competing activities adversely impacting on the value of the shareholding acquired from the seller, upon pain of not being able to recover outstanding payments due
Held: Not to involve a penalty
Majority judgement avoided references to 'penal, 'unconscionable' or 'extravagant' stating that
- The true test= whether the impugned provision is a secondary obligation which imposes a detriment on the contract breaker out of all proportion to any legitimate interest in the enforcement of the primary obligation
The innocent party can have no proper interest in simply punishing the defaulter
His interest is in performance or in some appropriate alternative to performance
Exception: Acceleration Clauses
O'Donnell and co v Truck and Machinery Sales Ltd
SC IE:
Held: Where a breach involves the payment of a fixed sum, the damages payable will be that sum plus any commercial interest rates
If the contract provides for a sum in excess of the latter amount, then it will constitute a penalty clause
However, an acceleration clause does not infringe this rule
- These clauses operate specifically where a debtor must repay a sum of money in installments, the entire balance will become immediately due
Use of such clause will be well policed
UDT Ltd v Patterson:
Facts: p loaned D £900 which was to be repaid with interest in 36 monthly installments
A term of the agreement stated that upon default, the whole amount would be payable with interest at a rate of 10% per annum
Issue; when D defaulted after paying just one installment, P instituted proceedings for £1,137.50- £900 minus one installment plus 10% per annum over 36 month period
Held: Clause in question was penal
Angelic star
: An acceleration clause contained in a shipbuilding contract required the purchaser, in the event of defaulting on paying installments to repay the entire loan immediately together with all other moneys due
Held: Such a clause could be interpreted as being a penalty clause if view in the longer term, but stated that under the circumstances it merely referred to money due at the time of the default