Demystifying contractual penalty clauses

CONTRACTS are the cornerstone of modern commercial transactions, ensuring clarity, trust and accountability between the parties involved.

AMID the delicate balance of obligations and consequences, contractual penalty clauses emerge as a noteworthy and often contested feature. These clauses, meticulously included in agreements, delineate actions to be taken in case of a breach.

We will delve into the intriguing world of contractual penalty clauses, exploring their purpose, enforceability and implications within the legal landscape.

As disputes arise and contracts are subject to interpretation, it becomes imperative to grasp the complexities and nuances associated with these clauses to navigate contractual matters effectively.

We will untangle the intricacies surrounding contractual penalty clauses, examining the current legal stance. Additionally, we will explore notable case precedents, shedding light on how courts have interpreted and applied penalty clauses, ultimately shaping their status and enforceability.

Beyond legal considerations, we will analyse the underlying rationale behind penalty clauses and their impact on contractual relationships.

Is their intent to compensate for losses suffered or to solely deter breaches? Are such clauses deemed to be coercive or fair deterrents?

These questions require careful examination to understand the true nature and implications of contractual penalty clauses. It is my hope that this article will provide readers with a deeper understanding and critical insights into this often-debated contractual feature.

What are penalty provisions?

Penalty provisions in a contract typically refer to clauses or provisions that outline the consequences or remedies for breaching the terms of the agreement.

These provisions generally specify a predetermined amount of money or other actions the breaching party must provide as compensation for their failure to fulfil their contractual obligations.

The purpose of penalty provisions in a contract is to establish predetermined consequences or sanctions in the event that one party fails to fulfil its contractual obligations.

Penalty provisions incentivise compliance and discourage breaches by imposing a negative consequence on the party that fails to meet their commitments.

There are several other purposes. These are:

1. Deterrence: Penalty provisions act as a deterrent against any potential breach of contract. By creating potential financial or other consequences, they encourage the parties to fulfil their obligations and perform the contract faithfully.

2. Compensation: In cases where a party breaches their contractual obligations, penalty provisions provide a mechanism for the innocent party to seek compensation for the damages suffered. The penalties are often designed to reflect the estimated or actual losses incurred as a result of the breach.

3. Performance assurance: The inclusion of penalty provisions can also serve to ensure the parties take their obligations seriously and perform their duties diligently. Knowing that there are potential penalties at stake can motivate parties to meet their obligations in a timely and satisfactory manner.

The Contractual Penalties Act

In Zimbabwe, the Contractual Penalties Act (hereinafter referred to as the “Act”) governs the application of penalty stipulations or clauses in contracts, including those for the sale of land by instalments.

The Act establishes guidelines and provisions that regulate the enforceability and limitations of contractual penalties within the country.

It ensures that penalty provisions are fair and reasonable, and do not exceed the bounds of legality. Therefore, it is essential for parties involved in contractual agreements, particularly those pertaining to land sales by instalments, to adhere to the provisions outlined in the Contractual Penalties Act to ensure compliance and avoid any potential legal consequences.

It is worth noting that penalty provisions should be carefully drafted to ensure they are reasonable, proportionate and not excessive.

In some jurisdictions, excessive penalties may be unenforceable or considered unlawful.

It is advisable for parties to consult legal professionals when including penalty provisions in a contract to ensure compliance with applicable laws and regulations.

What is a penalty stipulation?

The Act defines a “penalty stipulation” as a contract or provision in a contract under which a person is liable —

(a) to pay any money; or

(b) to do or perform anything; or

(c) to forfeit any money, right, benefit or thing; as a result or in respect of —

(i) an act or omission in conflict with a contractual obligation; or

(ii) the withdrawal of any person from a contract; whether the liability is expressed by way of penalty, liquidated damages or otherwise.

The most common penalty clause occurs when parties mutually agree that the party at fault will be liable to pay a predetermined amount as compensation for the breach of contract. Alternatively, if there is a contract of sale, the seller may have the right to terminate the contract due to a breach and retain the amount already paid by the buyer as damages.

According to the Act, such penalty clauses are generally enforceable; however, the court possesses extensive discretion to intervene if it deems a clause to be “disproportionate to the harm suffered by the injured party”.

In exercising their discretion, the court has the authority to reduce the penalty to a fair and just extent, order the creditor to refund either the entire or a portion of the payment made by the debtor, or provide any other remedy it deems equitable under the circumstances.

LEGAL DISCLAIMER: The material contained in this article is set out in good faith for general guidance in the spirit of raising legal awareness on topical interests that affect most people on a daily basis. They are not meant to create an attorney-client relationship or constitute a solicitation. No liability can be accepted for loss or expense incurred as a result of relying in particular circumstances on statements made in the article. Laws and regulations are complex and liable to change, and readers should check the current position with the relevant authorities before making personal arrangements.

◆ Arthur Marara is a practising attorney, author, human capital trainer, business speaker, thought leader, law lecturer, consultant, legal proctor (University of Zimbabwe), notary public and conveyancer. He is passionate about promoting legal awareness and access to justice. He writes in his personal capacity. You can follow him on social media (Facebook Attorney Arthur Marara), or WhatsApp him on +263780055152 or email attorneyarthurmarara@gmail.com