The practical implications of the new penalties law

The Supreme Court has devised a new test for whether or not a clause is a penalty, namely whether the agreed consequences of a breach are out of all proportion to the innocent party’s legitimate interest in the enforcement of the clause that has been breached.

Key points of interest include:

• contracting parties now have greater freedom to agree on the consequences of a breach of contract;
• a clause may be enforceable even if it is not a genuine pre-estimate of the innocent party's loss or if it is designed to deter a breach of contract; and
• the rules on penalties only apply to clauses which stipulate the consequences of a breach of contract, meaning that it may be possible to "draft round" them.

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