International Construction Law Review
THE DOCTRINE OF PENALTIES AND THE “ABSURD PARADOX”: DOES IT REALLY MATTER IN 2003?1
HAMISH LAL2
B Eng, BA (Oxon), Ph D Solicitor, Freshfields Bruckhaus Deringer, London
INTRODUCTION
It is of the essence of the doctrine of penalties that the sum specified is payable upon breach of contract. It is therefore generally accepted that a provision calling for the payment of money by one party on the occurrence of a specified event, rather than upon a breach by that party, cannot be a penalty (the “principle”). However, in many construction-related agreements, for example in project finance agreements and property development agreements, clauses often give one party to the contract an option of terminating on the payment of an additional sum or make express provision for the payment of a specified sum on the occurrence of a specified event (where that event does not involve a breach of contract by the payer).3
The correctness of the view that the doctrine of penalties has no application to a clause which provides for the payment of an agreed sum on the happening of a specified event other than a breach of contract has been affirmed by the House of Lords in Export Credits Guarantee Department Ltd
v. Universal Oil Products Co
.4
Earlier, in Bridge
v. Campbell Discount Co Ltd
5
Lord Denning rejected the notion that the doctrine of penalties was confined solely to sums stipulated to be paid for breach of contract.6
He said that strict adherence to this rule led to an “absurd paradox” because it would grant relief to a man who breaks his contract but would penalise the man who keeps it. Lord Denning stated:
“The jurisdiction of equity is confined, they say, to relief against penalties for breach of contract and does not extend further. Applied to this case it means this: If Bridge, after a few weeks, finds himself unable to keep up the instalments and, being a conscientious
1 A paper based on the second prize entry in the Hudson Prize Competition 2002 presented to the Society of Construction Law in London on 6 May 2003. The author is grateful to the Society of Construction Law (http://www.scl.org).
2 Hamish Lal, B Eng, BA (Oxon), Ph D is a solicitor in the Construction and Engineering Group at Freshfields Bruckhaus Deringer.
3 Such clauses are not common in “pure” construction contracts because there is usually an express contractual obligation on the contractor to reach practical completion by a specified date.
4 Export Credits Guarantee Department
v. Universal Oil Products Co
[1983] 1 WLR 399, [1983] 2 Lloyd’s Rep 152, [1983] 2 All ER 205 (HL).
5 Bridge
v. Campbell Discount Co Ltd
[1962] AC 600.
6 See [1962] AC 600 at pp. 629–631. For Lord Denning this was simply absurd and he called attention to equity’s practice in earlier times of granting relief against penalties for non-performance of a condition in circumstances where, he suggested, the obligor gave no covenant to perform the condition.
[2003
The International Construction Law Review
506