This article has been written by Prabhanshu Sharma pursuing Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution and edited by Shashwat Kaushik. In this article, we are going to discuss the concept of penalties under English law, their objectives, enforceability, and impact on contractual relationships between parties.
This article has been published by Sneha Mahawar.
Table of Contents
Introduction
Contract law under English jurisdiction provides a sturdy framework to make sure that agreements and contracts between the parties are enforced as per law. When a party or parties to the contract default in discharge of duties and liabilities, penalties and remedies under English contract law come to the rescue of the other party or parties that have been at the receiving end of such default.
One such remedy is the “concept of penalty” under English contract law, which plays a vital role in shaping the consequences of contractual non-adherence. The provisions of the penalty deter the parties from non-performance of the contract and make sure that the terms and conditions of the contract are legally complied with.
A penalty in English contract law is said to be a provision that deters the opposite party from default and punishes the opposite party in the event of a breach of contract.
Objectives of penalty provisions
The primary goal of inserting penalty provisions in English contract law is to deter breaches of contract by creating a financial constraint for non-performance of contract. These provisions provide a tool of security to the party that is victimised by the breach of contract.
The primary purposes of inserting penalty provisions are to create a financial disincentive for the party that may breach the contract, protect the legitimate interests of innocent parties, ensure certainty of consequences in the event of non-performance of contractual obligations, and encourage parties to meet their contractual obligations.
Enforceability of penalty provisions
Historically, penalty provisions were considered void under English contract law as they were an unfair obstruction to the freedom of parties to the contract. Generally, penalty provisions in English contract law are unenforceable and if any clause is found to be a penalty, then it would be unenforceable. The English courts were of the view that punitive provisions that impose an excessive financial burden on the party who breaches the contract.
In disharmony with other jurisdictions, English contract law does not recognise punitive or special damages to the party victimised by the breach of contract. The clauses in the contract, if found to appear as penalties against the other party, shall not be enforceable under English contract law by courts or otherwise.
The leading cases of Cavendish Square Holdings BV vs. Talal El Makkdesi (2015) and ParkingEye Ltd. vs. Beavis (2015) have shed light on the enforceability of penalty clauses.
The Cavendish Square case
In this case, the Supreme Court marked two principles for the enforceability of penalty clauses:
- The legitimate interest principle: A clause will not be considered a penalty if it safeguards the legitimate interest of the innocent party and is not excessive concerning the consequences of the breach.
- Proportionality: The penalty must be proportionally equal to the breach, keeping in view the loss suffered by the innocent party.
In this case, the Supreme Court of the UK held that a clause providing for a considerable reduction in the purchase price of shares upon breach of a non-compete clause is not a penalty but predetermined damages for the losses suffered.
The ParkingEye case
In the ParkingEye case, the Supreme Court of the UK reaffirmed the principles established in the Cavendish Square case. Although the Court this time expanded the application of principles outside the realm of commercial contracts. In this case, the Lordships held that a parking charge imposed on a vehicle for overstaying and exceeding the free parking time was not a penalty but a reasonable tool to manage parking spaces and hence it is enforceable.
The above-mentioned cases have established principles to determine the enforceability of penalty provisions. Based on the above set principles, English courts determine whether the penalty is proportionate to the breach and whether it protects the genuine and legitimate interests of the innocent parties.
Remedies and penalties
To understand the enforceability of contracts, it is important to understand certain remedies and penalty provisions that have been provided in English contract law, which are the following: –
Liquidated damages
According to English law, liquidated damages are a predetermined amount of money that a party that is at fault for breaching the contract has to pay to the innocent party. The purpose of inserting a clause for liquidated damages is to specify a particular amount of money to be paid to the innocent party in the event of a breach of contract and avoid the need for the innocent party to prove the actual amount of damages they suffered due to the fault of the breaching party.
For example, you have hired a private contractor to construct a house for you and in the contract, you have inserted a clause that “if the construction is not completed before the deadline agreed upon, then in that case the contractor has to pay you damages at the rate of 500 pounds per day”, If the construction is completed ten days after such a deadline, then the contractor is liable to pay you 5000 pounds as damages.
This clause provides clarity and predictability to the contract, as the innocent party knows the amount of damages they will receive in case of breach, and the party responsible for performance is aware of the financial disincentive they will incur if they don’t meet their obligations.
Liquidated damages clauses are not punitive in nature and they are enforceable as per English law. While inserting a liquidated damages clause in a contract, it shall be made sure that damages are genuine estimations of the damages likely to occur in case of breach, and they shall not be excessive or punitive.
Specific performance
Specific performance of a contract is a remedy available to the innocent party in an English contract in which the innocent party, with the help of court intervention, compels the breaching party to perform their obligation, which they would have done if the contract had not been breached by them.
While intervening, the court enjoys wide discretionary powers to decide whether to compel or not the other party to perform a specific performance of the contract based upon the unique facts and circumstances of the matter in concern.
Injunctions
Injunctions are court orders in which a court prohibits a party from doing certain acts or compels them to specifically perform some acts relevant to the contract between the concerned parties.
An interim injunction, as called in UK, is of two types, namely-
- Prohibitory injunction- In this type of injunction, the court orders a party to the contract to refrain from doing certain acts.
- Mandatory injunction- This is a type of injunction in which a court compels a party to perform a specific obligation relevant to the contract that exists or existed between the concerned parties.
Recession of contract
Rescission of contract is a remedy available to the innocent party when there is a fundamental breach of contract or the contract was entered into with the aid of fraudulent means and misrepresentation. It allows the innocent party to cancel the contract and be released from their obligations.
Restitution
Restitution refers to a remedy in which parties are restored to their original positions, which existed before the contract was entered into. It involves returning any benefits, profits or payments made according to the contract.
Penalty provisions vs liquidated damages
It is crucial to understand the difference between clauses of liquidated damages and clauses of penalty provisions inserted in a contract to draft contracts properly and make them legally enforceable.
While penalty provisions are punitive in nature and their purpose is to punish the party in breach, liquidated damages are a genuine, predetermined amount of money that would likely incur a loss to the innocent party in case of breach.
Impact of penalty provisions on English Contract Law
Categorically speaking, law evolves over time and legislation and decisions by courts have a long-term impact on the interpretation and application of contract law. The evolving approach to English contract law has provided parties with more flexibility in drafting contracts and agreements.
The ability to include penalty clauses that are justified and legal protects the legitimate interest of the innocent party and keeps a check on cases of breach of contract. It promotes contractual certainty and encourages parties to abide by their contractual obligations.
Conclusion
Penalty provisions under English contract law serve as a vital tool to keep the obligations of parties intact. Penalty provisions have been historically unenforceable but the Supreme Court, in its recent decisions, has taken a more nuanced approach to the enforceability of penalty clauses in contracts.
Understanding penalty provisions is vital for both crafting legally enforceable contracts and navigating potential breaches of contracts and disputes. Staying informed about the latest legal developments is vital for crafting effective and legally enforceable contracts.
According to me, the goal of inserting penalty clauses in contracts should be to safeguard the legitimate interests of the innocent party and ensure proportionality. While drafting contracts, parties must make sure to strike a balance between deterring breaches and avoiding penalty clauses that seem unenforceable. Seeking advice from an experienced legal practitioner is advised.
References
- https://blog.ipleaders.in/judicial-conservatism-specific-performance-english-contract-law-discussion/
- https://blog.ipleaders.in/why-is-contract-enforcement-necessary-in-international-contracts/
- https://uk.practicallaw.thomsonreuters.com/4-502-4584?contextData=(sc.Default)&transitionType=Default&firstPage=true
- https://www.legalbites.in/historical-evolution-of-contract-law-in-india/?infinitescroll=1
- https://www.sciencedirect.com/science/article/abs/pii/S0144818802001114
- https://legalserviceindia.com/legal/article-7393-legal-compliance-for-enforcement-of-an-international-contract.html
- https://legalcareerpath.com/what-is-contract-law/
- https://www.upcounsel.com/enforceable-contract
- https://avokaado.io/blog/enforceable-contracts/
- http://financialsafetynet.org/legal/understanding-contracts-enforceable-vs-unenforceable-agreements/3749
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