A penalty clause is a clause in a contract which mandates financial forfeiture in the event that one party breaches the contract. Penalty clauses are specifically designed to penalize, going above basic compensation for losses which might occur as a result of breach of contract. People may refer to the funds mandated in the penalty clause as “penal damages,” distinguishing them from other types of damages which can also be written into legal contracts.
If a caveat in a contract is clearly a penalty cause, it may not be enforceable in court. The court will not mandate someone to pay a penalty which is unrelated to the specifics of the contract, or which is deemed excessive. “Excessive” can be defined by standard practice with similar contracts, and by the specifics of the situation. A lawyer who has experience with contract law can review the terms of a contract to determine whether or not they are reasonable, and provide advice about rewriting or reformulating to make the terms fair. A lawyer can also provide advice on inserting a penalty clause if the parties to the contract feel that it is necessary.
This contrasts with damages such as liquidated damages, which are intended as compensation in the event that there is a breach of contract. For example, someone writing a contract to sell a house can write in liquidated damages, with the buyer forfeiting some funds in the event that the contract is broken, while the seller may be forced to compensate with payments of rent or similar damages in the event that they back out of the contract. This is intended to create a mechanism for recovering compensation after the contract is breached.
When writing up and looking at a contract agreement, it is important to fully understand the terms, and to question anything which seems odd or unfamiliar. While a penalty clause may not be enforceable in court, people may not be ready or willing to take it to court, and they should consider whether or not they are willing to pay the stated penalty if they decide to cancel the contract.
The idea behind inserting liquidated damages and other types of clauses into contracts is to make sure that there is a clear consequence for breaking the contract, so that people understand the seriousness of the agreement they are making. These stipulations are also designed to make sure that people are more likely to fulfill the contract. A penalty clause takes this one step further, creating potential punishment as a consequence for a breach.
