Penalties in agreements are a common clause, especially in typical contracts of works (appalt) or where the parties agree on a specific performance, especially when such performance is assigned a due date.
The law allows the imposition of penalties but seeks to create a fair balance in the sense that they remain in check to reflect the obligation in question and the monetary value. Indeed, obligations with a penalty clause are regulated by 1118 et seq of the Civil Code.
By definition, and according to law, “a penalty clause is a clause whereby a person, for the purpose of securing the fulfilment of an agreement, binds himself to something in case of non-fulfilment”.
The intention of having such clauses is to safeguard oneself that what is being agreed upon is effectively honoured. It creates a deterrent to any potential non-fulfilment of an obligation. One may also assimilate these to future pre-liquidated damages, which are triggered in cases of default. In fact, the letter of the law states that penalties represent a compensatory amount in connection to the damage that is sustained as a result of default.
Furthermore, the law stipulates that a penalty clause would be null if it results that the principal obligation agreed is also null. However, the nullity of a penalty clause does not bring about the nullity of the principal obligation (the agreement).
Notwithstanding the imposition of a penalty, a contracting party may always sue for the performance of an obligation, but he cannot sue for both performance and for the payment of the penalty imposed unless such penalty shall have been agreed upon in event of delays.
But what if, for one reason or another, the obligation agreed cannot be executed? The law foresaw this instance and provides that the penalty is immediately incurred as soon that the obligation can be feasibly executed (and naturally if the performance is still not honoured) – unless another agreement’s conditions regulate the triggering of the penalties. In other cases, the penalty is triggered once the debtor is put in default – usually through the issuance of an explanatory judicial letter, which is addressed to the defaulting party, which letter ought to explain the contravention that would have been committed by the defaulting party.
Penalties can be mitigated by the court in two specific scenarios (article 1122, of the Civil Code). The first being in cases where the performer executes in part the obligation assumed by him and the counter-party accepts, without any complaints, the executed acts. The second instance is similar to the first – in cases of partial executions – and the court considers that what has been performed has been performed correctly. However – and as usual when it comes to the law – this instance is subject to an underlying exception.
Should the defaulting party, a priori – in the agreement itself – waive his rights to have the penalty mitigated or abated, the penalty remains the same, notwithstanding any partial compliance. But past judgments sought to ‘water down’ the legal effects of this provision. It has been held that, even in the presence of such a waiver, judicial bodies are allowed to measure the fairness or otherwise of the imposed penalty.
A recent judgment, delivered by the Small Claims Tribunal, bearing the names of ‘Cauchi vs Seychell’, presided over by Kevin Camilleri Xuereb, studiously discussed the principles of penalty clauses.
The facts related to an agreement that was entered into between the plaintiff and the respondent, wherein the respondent undertook to repair a rubble wall within a time frame that was set out in the same said agreement. An imposition of a penalty was entered, with the penalty as contingent upon the event of delay.
The nullity of a penalty clause does not bring about the nullity of the principal obligation
The respondent did not manage to execute the repair works by the agreed deadline date. The claimant sought to seek payment of the agreed penalties, which were set out at €10 per day of delay.
The defendant contested the claim, mainly on grounds that the delay was caused by circumstances that he could not predict and had no control over. He also demanded penalty mitigation, in terms of article 1122 (highlighted above) of chapter 16.
The tribunal, while citing numerous case law, explained in detail the legal and jurisprudential features of penalty clauses, in light of the claim, and the pleas at hand.
In its explanation, the tribunal held that the spirit of a penalty clause has a twofold function: a) it caps and quantifies the damages (financially), and b) it liquidates a priori the damage that can potentially ensue, on grounds of default as set out by the agreement in question.
This judgment also highlighted the very fine line (and the fundamental difference) that exists between a mere penalty clause and an earnest (kapparra). Both concepts are made of ‘similar’ features, as in the case of earnest, a typical ‘penalty clause’ that would be triggered in cases of default is always existent.
But their legal effects differ from one another. In cases of earnest, the contravener cannot be sued for performance but, in turn, he will end up paying the ‘penalty’ imposed. Penalty clauses offer alternatives – one may opt to sue for performance or demand the penalty.
In continuance of this explanation, the tribunal explained that (unlike contractual damages lawsuits), when it comes to penalty enforcement cases, the quantum sum of the damage need not be proven; this is because the formulation – the quantum (the financial penalty) – would have already been set out a priori in the agreement between the parties. In the ‘ordinary’ cases of contractual damages – where no penalty clause is set out – the claimant needs to evidence the sum that represents the damage (by for instance exhibiting receipts for tasks/works that had to be undertaken to rectify the damage ensued).
In this case, the defendant failed to bring up evidence, and after considering the evidence that was submitted by the plaintiff, the tribunal found default on the respondent’s part and consequently ordered the payment of penalties as agreed between the parties in question.
Finally, the tribunal rejected the penalty mitigation demand as it deemed it to be fair in light of the contractual obligations at hand.
Mary Rose Micallef is an associate at Azzopardi, Borg & Associates Advocates.