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Penalty Clauses and Claims for Damages | MDA Consulting

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Penalty Clauses and Claims for Damages

In commercial agreements parties may agree that, Should one party fail to perform in accordance with the terms of the agreement, the other party should be entitled to receive a specified penalty or measure of damages. A stipulation of this nature in an agreement is commonly referred to as a penalty clause and falls under the ambit of the Conventional Penalties Act 15 of 1962 (the Act). Section 1 of the Act provides for the enforcement of penalty stipulations or liquidated damages clauses in agreements. Section 1 provides: A stipulation, hereunder referred to as a penalty stipulation, whereby it is provided that any person shall, in respect of an act or omission in conflict with a contractual obligation, be liable to pay a sum of money or to deliver or perform anything for the benefit of any other person, hereinafter referred to as a creditor, either by way of penalty or as liquidated damages, shall, subject to the provisions of this Act, be capable of being enforced in any competent court. Broadly speaking, penalty clauses have efficiency justifications for the agreeing parties that provide a form of insurance policy for which the other party is willing to pay a premium. For example, in construction agreements, a penalty clause enables the employer to recover a specified amount of damages should the contractor delay in completing the work by the agreed practical completion date. Without the penalty clause, the non-breaching party will be forced to take inefficient precautions, such as third-party insurance, in order to insure against breach. In practice there are four common arguments in favour of penalty clauses. Firstly, they eliminate problems in the calculation and proof of damages. Secondly, they create the possibility of avoiding costly litigation as the aggrieved party can receive compensation for the breach without the need to litigate. Thirdly, they may provide some evidentiary value at trial with regard to damages. Finally, they may provide an inducement for non-defective and timely performance. Notwithstanding these advantages, penalty clauses may provide disadvantages for the non-breaching party. In general, if the non-breaching party decides to recover a penalty and the penalty is insufficient to compensate for the damages suffered, the non-breaching party cannot claim damages. This is the issue that this article will focus on.
Prohibition of accum ulation of rem edies

One of the important questions in practice is what is recoverable in terms of a penalty clause, which is dealt with in s 2(1) of the Act, which provides that: (1) A creditor shall not be entitled to recover in respect of an act or omission which is subject to a penalty stipulation, both the penalty and damages, or, except where the relevant contract expressly so provides, to recover damages in lieu of the penalty.
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Penalty Clauses and Claims for Damages | MDA Consulting

In terms of s 2(1), the non-breaching party can claim an agreed penalty in lieu of damages or the parties may agree that damages will be recoverable in lieu of the penalty. An agreement may, however, fail to provide for the recovery of damages in lieu of a penalty. This situation was dealt with in Bestway Agencies (Pty) Ltd and Another v Western Credit Bank Ltd. In Bestway the respondent sold a yacht under a hire-purchase agreement. The agreement contained penalty stipulation in respect of certain acts or omissions, providing both for a penalty and for damages, without expressly providing for the recovery of damages in lieu of the penalty. The applicants defaulted in their obligations and the respondent instituted an action in the magistrates court for the cancellation of the agreement and the return on the yacht. In the alternative, the respondent claimed for an order for payment of the value of the yacht. The magistrate granted an order for payment of the value of the yacht. On appeal, the Witwatersrand Local Division of the High Court held that the repayment of the value of the yacht was a claim for damages; furthermore, that the respondent was not entitled by virtue of section 2(1) of the Act to recover damages in lieu of the penalty. In other words, a party may claim damages only when the contract expressly reserves the right to recover damages in lieu of a penalty4. In Botha (Now Griessel) and Another v Finanscredit (Pty) Ltd5 the court accepted that, when an agreement entitles nonbreaching parties to claim damages in addition to the penalty, this includes the lesser right to claim damages in lieu of the penalty. The court held that the fact that the parties failed to stipulate the remedies in the alternative does not render the remedies unenforceable6. In De Lange v Deeb7 the agreement stated that damages were claimable in addition to the penalty. The purchaser of a house failed to pay installments on due date, the seller cancelled the sale, resold the house and claimed from the purchaser as damages, the difference between agreed price and the price realised, less the amount paid as a deposit. In addition to a forfeiture stipulation, the agreement made provision for the recovery of damages. In the magistrates court, judgment was given in the sellers favour for the amount claimed. The agreement did not specifically state that damages were in lieu of the penalty. On appeal to the Orange Free State Division of the High Court, it was agreed that the forfeiture stipulation in the agreement was a penalty stipulation in terms of section 4 of the Act. The appellants argued that, under the circumstances, a claim for damages was bad in law because it was in addition to, not in lieu of the penalty. Reliance for this argument was placed on section 2(1), which entitles a creditor to recover damages instead of a penalty except where the relevant contract expressly so provides. Smit JP stated that the use of the word expressly in section 2(1) is not so stringent that it requires the clause for the recovery of damages to be in identical words, namely, in lieu of damages. In concluding that the right to claim damages is an alternative right in terms of the Act, Smit JP said the following:

[The Act] does not deprive the creditor of his right to claim damages in respect of the act or omission which is the sub ject of the penalty stipulation b ut prescrib es that right: thus he is not entitled to recover b oth the penalty and damages. His right to recover is accordingly in the alternative he can only recover either the penalty or the damages. That means that he can only recover either the penalty in lieu of damages or damages in lieu of the penalty. But the section prescrib es this right to recover damages in lieu of the penalty still further, b y providing that he can only recover such damages where the contract expressly so provides. In my opinion the contract does so provide where it expressly reserves to the creditor the right to recover damages even where the words in lieu of the penalty are not added. This is necessarily so b ecause the only right to recover damages which the creditor has is in lieu of the penalty. The express addition of those words is of no consequence. What is necessary is that the choice to recover damages b e expressly provided for.8
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Penalty Clauses and Claims for Damages | MDA Consulting

The court held that, despite the stringent wording of sections 2(1), the seller was entitled to claim damages as she did, in lieu of penalty. Section 2(1) disentitles the non-breaching party from recovering damages as well as what is stipulated for by way of penalty.
Conclusion

In light of the above, when the parties have a penalty clause in their agreement, the right to claim damages is an alternative right to claiming a penalty. The non-breaching party cannot claim both the penalty and damages. A prudent drafter would specify that a claim for damages is in the alternative to a claim for the penalty. However, the failure to specify the remedies stand in the alternative does not necessarily deprive the non-breaching party from claiming damages, which are still recoverable where the agreement expressly reserves that right.
1 LA Dimatteo: A Theory of Efficient Penalty: Eliminating the Law of Liquidated Damages 38 Am Bus LJ 633

(2001)
2 B Kuschke: Standing Time Clauses Where Do We Stand? THRHR 2002, Bd65(4) at 638 3 1968 (3) SA 400 (T) 4 1968 (3) SA 400 (T) at 404D 5 1989 (3) SA 773 (SCA) 6 1989 (3) All SA 773 (SCA) at 796F 7 1970 (1) SA 561 (O) 8 1970 (1) SA 561 (O) at 562H-563B

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