Understanding the penal conditions in contracts
We hear a lot about the nightmares of the penal conditions in the contracts and their heavy burden on the contractors, but will they remain nightmares if used correctly?
The penalty clause is defined as an agreement between the contractors to assess the compensation to which the person is entitled for the damage caused if the other party fails their commitments.
It is often noted that these penal conditions are often found in contracts that relate to the performance of a task such as construction, and are usually used to motivate the party likely to fail to complete the tasks entrusted to them.
I will now outline the main points that the public should be aware of the penalty clause.
The clause is considered an arbitrary estimate submitted for compensation and it can be a monetary sum, an act, or even an omission.
Originally, the penalty clause is associated with the original contract and maybe in a subsequent agreement before the damage occurs. Therefore, it is not intended in itself, but it is there for a specific purpose, which is to get the contractor to fulfill his obligation as mentioned earlier.
In this case, the penalty clause is similar to bail, mortgages and other insurances, and of course, it follows that the invalidity of the original obligation invalidates the subordinate obligation pursuant to the idea that the subordinate follows the original, but the invalidity of the penal clause in return does not result in the invalidity of the original obligation.
Furthermore, it is important to note that the penalty clause may be stipulated in all financial contracts except those in which the original obligation is a debt. This is because it is considered explicit usury, which is prohibited by Shariah. For example, the penalty clause may not be included in an installment sale because the debtor could be late in paying the remaining installments, whether due to insolvency or procrastination.
But, instead of this penalty clause, the affected party has the right in such contracts to claim litigation fees as well as compensation for the actual loss of benefit.
Moreover, for the contracts involving this type of condition, the compensable damage shall be deemed to include actual financial damage, the actual loss suffered by the injured party and the loss of certain gain.
But what about the application of this condition in the case of a greater force that prevents the performance of the goal of the contract? In this case, the penalty clause shall not be applied if the party subjected to this clause proves that the breach of the contract was due to a reason beyond his control.
But when resorting to the court, how is this penalty clause applied when claimed?
The judiciary may proceed to rule on the condition agreed upon between the parties as an expression of their agreement and their free will at the time of contracting. However, it also has the right to modify the amount of this condition according to the rule of no harm.
If, after the breach of execution, it is found that the amount of damage suffered by the affected party is equal to the amount of the penalty clause, the judge will rule without any increase or decrease.
On the other hand, if it is found that the amount of the penal condition exceeds the damage inflicted substantially, the judge may reduce it to cover the actual damage.
But what if the penalty clause is found to be less than the amount of the actual damage? In most cases, the judge may not increase the amount of the penal requirement because responsibility has already been determined.
This was a simple and general overview of the penal clause, but of course, caution must be exercised before signing any contract it contains as it is essentially linked to the objectives and purposes of each contract. And it should also be pointed out that the cases of the application of the penalty condition vary according to legislation and concepts.
Dimah Talal Alsharif is a Saudi legal consultant, head of the health law department at the law firm of Majed Garoub and a member of the International Association of Lawyers. Twitter: @dimah_alsharif