Penalties in Contracts
The basic principle of Australian contract law is freedom of
contract. However, like freedom in general, freedom of contract is
subject to limitations.
One such limitation is that a provision in a contract that seeks
to impose a penalty on a contracting party, is not enforceable.
What is a penalty?
In its basic form, a penalty is a requirement in a contract
whereby one party, who breaches a certain clause in the contract,
is obliged to pay a sum of money to the party who is not in breach.
The courts have historically taken the view that if the amount to
be paid to the innocent party bears no relationship to, or is much
greater than, or is out of all proportion to, the damage or loss
suffered by the innocent party, the obligation to make the payment
will be regarded as a penalty and, as such, not be enforceable.
