Penalty Clause in UK Law

And the more difficult it is likely to be to prove and assess the loss which a party will suffer in the event of a breach, the greater the advantages to both parties of fixing by the terms of the contract itself an easily ascertainable sun to be paid in that event. The Court should not be astute to descry a "penalty clause" in every provision of a contract which stipulates a sum to be payable "by one party to the other in the event of a breach by the former.

The real question when a contractual provision is challenged as a penalty is whether it is penal, not whether it is a pre-estimate of loss. These are not natural opposites or mutually exclusive categories. The question whether it is enforceable should depend on whether the means by which the contracting party's conduct is to be influenced are "unconscionable" or (which will usually amount to the same thing) "extravagant" by reference to some norm.

The true test is whether the impugned provision is a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party 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.

My Lords, one purpose, perhaps the main purpose, of the law relating to penalty clauses is to prevent a plaintiff recovering a sum of money in respect of a breach of contract committed by a defendant which bears little or no relationship to the loss actually suffered by the plaintiff as a result of the breach by the defendant.

He did not terminate under clause 10 and I cannot see therefore how there is any ground for saying the agreement to terminate which in fact took place gave this finance house any right to the sum of £709 If there was no agreed termination then I think that the finance house must be taken to have repossessed the goods under clause 8 as they were entitled to do since the hirer was in arrears with the first instalment As I have already stated this would give the finance house no right to collect any part of what would than clearly be a penalty under clause 11.

It has been held to apply to a clause entitling the innocent party to the retransfer of property which had previously been transferred to the contract breaker ( Jobson v Johnson [1989] 1 WLR 1026), and (see Workers Trust and Merchant Bank Ltd v Dojap Investments Ltd [1993] AC 573) to a clause which requires a contract breaker to forfeit a deposit or sum of money due or to become due to the other party in the event of breach.

In principle, a transaction must be just as objectionable and unconscionable in the eyes of equity if it requires a transfer of property by way of penalty on a default in paying money as if it requires a payment of an extra, or excessive, sum of money. In each case the clause ought to be unenforceable in equity in so far as it is a penalty clause.