Red Card for a Penalty?

  • Commercial Litigation

Construction lawyers are extremely familiar with contractual penalty clauses.

Recently however contractual law and the issue of penalties in particular has again come under the judicial microscope in two reported cases:-

Iman-Sadeque-v-Bluebay Asset Management (Services) Limited [2012] EWHC 3511 (QB) and Cavendish Square Holdings BV and another-v-El Makdessi [2012] EWHC 3582 (Comm)

It is important to appreciate the difference between a liquidated damages clause and a penalty clause.

The question is whether the liquidated damages clause is a genuine pre-estimate of loss.

The courts will also examine the commercial justification for the clause in question, even though the courts always have a desire to allow the parties the freedom to contract with each other; appreciating as they do the sanctity of a bargain struck between two parties.

In addition the court will consider whether the predominant function of the clause is to deter a breach of contract rather than provide for the payment of compensation.

If the raison d’être is to deter breaches of contract, then it may be penal. If on the other hand, the intention is to provide compensation it may not be penal even if the amount has the effect of encouraging performance of the contract.

Whoever is drafting your contract or terms of business should be aware that the courts will consider these points carefully, so it is important to instruct business and commercial lawyers who truly understand the importance of such clauses.

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The information and any commentary on the law contained in this article is provided free of charge for information purposes only.

No responsibility for its accuracy and correctness, or for any consequences of relying on it, is assumed by any member or employee of Summit Law LLP. The information and commentary does not and is not intended to amount to legal advice and is not intended to be relied upon.

You are strongly advised to obtain advice from a Solicitor about your specific case or matter and not to rely on the information or comments in this article.