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Useful Resources

Contracts - liquidated damages and Penalties

Watch out, this is an area that can really come back to bite – whether it’s your clause or if it’s being asserted against you.

What is a Penalty clause?

A penalty clause is one that sets a harsh monetary punishment for the breach of a contract term, or failure to uphold contractual obligations.

 

According to the court, a clause is a penalty if it requests the payment of an amount that is “extravagant” and “unconscionable” in light of the most significant loss that the breach could have caused.

What is a liquidated damages clause?

Well obviously it’s one that’s not a penalty clause right?

 

A liquidated damages clause provides a predetermined amount of money that must be paid as damages for failure to perform an obligation under a contract. The amount of the liquidated damages is supposed to be the parties’ best estimate at the time they sign the contract of the damages that would be caused by a breach.

Common scenarios where a clause may be a penalty are:

  • A business entering a fixed term contract with another party and requiring payment of an early termination fee;

  • A company providing services at a set time and issuing a fee for cancelling or rescheduling an appointment;

  • A party charging a fee for the other party’s failure to fulfil a particular task;

  • Liquidated damages in construction; and

  • Liquidated damages in leasing contracts.

Key Considerations When Drafting Commercial Contracts

In drafting your commercial contracts, there are a few things to consider. These include:

 

  • The amount the other party is to pay. When determining this amount, take into consideration whether it reflects your actual costs for rectifying the breach of the contract;

  • The wording of your contract. Where you want to include an obligation for another party to pay a fee, always state that the amount is a genuine pre-estimate of the loss you will suffer as a result of a breach of the contract;

  • The bargaining position of each party. Here the court will consider each party’s bargaining power and will consider the amount that the other party is required to pay and how “oppressive” it may be and how the clause might advantage or disadvantage them; and

  • The possibility that the clause may be a threat. It If it is a threat, it is likely that the clause will be a penalty.

​What now?

So you think I just gave you all the answers?

 

Unfortunately it’s a lot more complicated. And always remember the adage she who has herself as a lawyer is a fool’. There’s a reason for that wise adage.

 

Call me now – I will help you draft your clauses – and always remember -  spend a dollar now, and avoid spending $10 later.

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