Penalty clause in contracts

In order to maintain the contractual relations stability, what happens usually is that both parties of a contract agree on setting a penalty clause that applies in the case if one contracting party breached the agreement or didn’t commit to its contractual obligations, the reasons Behind setting and drafting such clause is for the contractors to guarantee that the opposite party will commit to its obligations, as this commitment is not always guaranteed, laws and regulations allowed the parties of a contract to agree on the compensation amount one party deserves in the case of a contractual breach, jurisprudence and courts call this amount the penalty clause or the contractual compensation. In this article, the legal nature of the penalty clause will be briefly discussed in addition to the clarification of the judge’s ability to interfere in modifying the penalty clause and its drawbacks on any contract’s parties. Arabic laws adopted the idea of the penalty clause in its provisions, influenced by western laws in general and by French law in particular, the Qatari Civil Code did not define the penal clause, but merely mentioned its provisions, as the Qatari legislator stipulated in Article (265) of the Civil Code that : “If the subject of the obligation is not a sum of money, the contracting parties may estimate in advance the value of compensation in the contract or in a subsequent agreement .”

Article (266) of the Civil Code stipulates that: “The agreed compensation is not due if the debtor proves that the creditor has not been harmed. The court may reduce the compensation from what was agreed upon if the debtor proves that the estimate was greatly exaggerated, or That the obligation has been implemented in part, and any agreement to the contrary shall be null and void.

Dr. Abdul Razzaq Al-Sanhoury, defined the penalty clause as: “The compensation that the two contracting parties estimate in advance instead of leaving it to the judge in the event of the debtor’s delay in fulfilling his obligation.”

(The mediator in explaining the new civil law, commitment theory in general, part 2, i 1 year 2005, p. 56)

To conclude, the penalty clause can be defined as an agreement between the contracting parties to estimate the compensation to which the penalty clause is entitled for, as a compensation based on the damage caused by the other party not committing to its obligations  or delaying the execution of its commitment, The penalty clause may be attached to the original contract, or in a subsequent agreement before the damage occurs. The penalty clause may be included in several types of contracts, as it may be found in constructions contracts, supply contracts and manufacturing contracts. The Court of Cassation affirmed in Appeal No. 70 of 2006: “The provision in Article (59) of the old Civil Code that is applicable to the incident of the dispute, and corresponding to the text of Article (266) of the current law, is that the existence of the penal clause presumes that the assessment of compensation in it, is proportional to the damage. The creditor must be subjected to this condition, unless the debtor proves that the creditor did not suffer any harm, in such case the agreement is not due in the first place, or if the debtor proves that the assessment was greatly exaggerated, in such case the judge may reduce the agreed compensation.” Moreover and in Appeal No. 390 of 2017, the Court of Cassation decided that: “ Articles (256), (263) and (266) of the Civil Code – and according to the judiciary of this court – state that the creditor and the debtor may agree in advance in the contract on The compensation due to the first of them in the event that the second party does not fulfil its obligation or is late in its execution, and the failure of the debtor to commit to its obligation is the reason for the entitlement of compensation, and this agreement entails considering the damage as being at the discretion of the contracting parties. Its basis is proportional to the damage the party sustained, and the judge is only obligated to enforce it unless the debtor proves that the creditor was not harmed or that the assessment was greatly exaggerated, or that the obligation has been implemented partially, since in that case the judge may not judge compensation or reduce it to an appropriate extent, given that such compensation is by its nature open to dispute on the part of the debtor.

The Court of Cassation also affirmed in Appeal No. 107 of 2014 that: “It is decided – in the Court of Cassation – that the meaning of Article (266) of the Civil Code is that the existence of the penal clause presumes that the assessment of compensation is proportional to the damage ,and the judge must act upon This condition  if it is provided  and only if the debtor proves that the creditor did not suffer any damage, in such case the agreement is not due in the first place, or if the debtor proves that the assessment was greatly exaggerated, in such case the judge may reduce the agreed compensation.”

since the text of Article 265 of the Qatari Civil Code corresponds to the text of Article 223 of the Egyptian civil Law, regarding which the Kafr El-Sheikh Court of First Instance ruled in Case No. 821 of 2019 as follows:

As of the text of Article 223 of the Civil Code: “The contracting parties may determine in advance the value of compensation by stipulating it in the contract or in a subsequent agreement, and in this case, the provisions of Articles 215 to 220 shall be taken into account.” It was established in the text of Article 224 that:

1. The agreed compensation is not due if the debtor proves that the creditor did not suffer any damage.
2. The judge may reduce this compensation if the debtor proves that the estimate was greatly exaggerated or that the original obligation has been partially implemented.
3. Any agreement that violates the provisions of the previous two paragraphs shall be null and void.

According to the “court” – which depends on Articles 215/2, 216, 223, 224/2 of the Civil Code, the contracting parties may specify in advance the amount of compensation to be paid for the damage that may result from  – non-performance – of the obligations stipulated in the concluded contract. The compensation in this case is compensation based on (non-implementation) that may not be combined with the specific implementation, and they may also specify compensation for the damage for – the delay in implementation – as it is permissible to combine this compensation with the implementation in kind, because the judiciary obligating the debtor to implement his obligation does not prejudice the right of The creditor is entitled to compensation for the delay in implementation, according to Appeal No. 1859 of the 70^th judicial year.

On the occasion of Appeal No. 1859 of the  judicial year 70, the court acknowledged that: “Consensual compensation – its ruling in this is the judgment of judicial compensation – it is not permissible to judge it unless the elements of responsibility are available from error, damage and a causal relationship in accordance with the general rules, the best of the matter is that the agreement is in advance of the value of Compensation for breach of the contractual obligation – in implementation or delay – makes the damage happen at the discretion of the contracting parties, and does not require the creditor to prove it.

Lastly, It becomes clear that the penalty clause when related to a specific obligation must be adhered to in the event of a breach of the obligation, whatever the correct description of the contract that included it, and that it is decided in the Court of Cassation that when there is a penalty clause in the contract, the fulfilment of such  condition makes the damage real in the estimation of The contracting parties, but the debtor bears the burden of proving that the damage has not occurred or that the compensation is greatly exaggerated. In this case, the judge may reduce the agreed compensation. The debtor denies its occurrence, and if he succeeds in doing so, the penalty clause is refused.

Authors: Mr. Mohamed Zied Boussetta & Contributor Mr. Mohammad Mufid Ratib Qurashi