Penalty clauses in Colchester and throughout the UK are terms in contracts which provide for the payment of a sum of money on breach whose predominant purpose is to discourage a party from deliberately breaching its obligations under the terms of an agreement.

Whether particular contracts have penalty clauses in Colchester or anywhere else for that matter is an issue of construction based on the facts of the case at the time of entering into the contract.

The classic tests for establishing the existence of a penalty clause are laid down in the leading case of Dunlop Pneumatic Tyre Co Limited v New Garage & Motor Co Limited [1915] AC 79:

  • A clause will be construed as a penalty clause if the sum specified is “extravagant and unconscionable” in comparison with the greatest loss that could possibly have been proved as a result of the breach.
  • A clause is likely to be a penalty if the breach of contract consists of not paying a sum of money and the sum stipulated as damages is greater than the sum which ought to have been paid.
  • There is a presumption that if the same sum is stated to apply to different types of breach of contract, some of which are serious and others not, it is likely to be a penalty clause.
  • It is not a bar to the operation of a liquidated damages clause that a precise pre-estimation of loss is impossible.

If a clause specifying a sum payable on breach is characterised as a penalty clause, it will be unenforceable. However, the courts are reluctant to characterise a clause negotiated between commercial parties as a penalty: in Phillips Hong Kong Ltd v Attorney General of Hong Kong (1993) 61 BLR 49, the Privy Council approved the words of Dickson J in the Supreme Court of Canada in Elsey v J G Collins Insurance Agencies Ltd [1978] 83 DLR at p15:

“It is now evident that the power to strike down a penalty clause is a blatant interference with freedom of contract and is designed for the sole purpose of providing relief against oppression for the party having to pay the stipulated sum. It has no place where there is no oppression.”

In Euro London Appointments v Claessens International [2006] 2 Lloyds Reports 436 at 442-3, the Court of Appeal approved Colman J’s dictum in Lordsvale Finance plc v Bank of Zambia [1996] QB 752 at 762-4:

“… the jurisdiction in relation to penalty clauses is concerned not primarily with the enforcement of inoffensive liquidated damages clauses but rather with protection against the effect of penalty clauses. There would therefore seem to be no reason in principle why a contractual provision the effect of which was to increase the consideration payable under an executory contract upon the happening of a default should be struck 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.”

The courts’ readiness to uphold contractual terms which fix the level of damages for breach predisposition is even stronger in the case of commercial contracts freely entered into between parties of comparable bargaining power (Alfred McAlpine Capital Projects Ltd v Tilebox Ltd [2005] BLR 271).

Contact Andrew Douglas Wills and Legal Services today via www.andrewdouglaswills.co.uk to see how we could help you sort out contractual penalty clauses in Colchester and other locations throughout Essex.

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