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'Penalty' Clause in English Law: a Critical Analysis and Comparison with Jordanian Law

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'Penalty' Clause in English Law: a Critical Analysis and Comparison with Jordanian Law The 'Penalty' Clause in English Law: A Critical Analysis and Comparison with Jordanian Law Yusuf Mohammed Gassim Obeidat BA in Law! Yarmouk University! Jordan LLM in Civil Law! University of Jordan! Jordan MA in Business Law! University of Leeds! UK "Submitted in accordance with the requirements for the degree of Doctor of Philosophy" University of Leeds School of Law Centre for the Study of Business Law and Practice July 2004 "The candidate confirms that the work submitted is his own and that appropriate credit has been given where reference has been made to the work of others" "This copy has been supplied on the understanding that it is copyright material and that no quotation from the thesis may be published without proper acknowledgement" Acknowledgements Undertaking a Ph.D is a humbling experience and would not be possible without the help of others. Therefore I must acknowledge the debts which I have incurred throughout my research. Whilst the creation of this thesis is my responsibility, I would not have been able to complete it without the generous help of Professor Roger Halson. I am utterly obliged to Professor Halson for his constructive comment, support and encouragement, and it is with the utmost respect and regard that I will list him as my academic reference. I am grateful to Yarmouk University for sponsoring my research. In particular I wish to thank the Dean of the Faculty of Law, Professor Abdel Mohdi Massa'deh, and Dr. Farouq Al Zo'bi for their kind assistance and cooperation. On a .personal level my greatest debt is due to my father and mother for their continued affection, love, help and moral encouragement, which are always my constant companions. Therefore it is an honour to dedicate this worth to both of them. Thanks must also go to my sister and my seven brothers for their neat and constant support and encouragement. Special gratitude goes to my wife, Laialy, without whose assistance and tolerance the task would have been much more difficult. Her cooperation will always be appreciated. In particular, I am indebted to her for caring for and entertaining our daughter Sireen. ii Abstract This thesis discusses the penalty rule in English law. Pre-arranged provisions concerning the estimation of due damages in event of the promisor' breach are of considerable practical importance. When such provisions are enforceable they are called liquidated damages clauses. However, English law courts will not enforce these provisions where they are categorised as penalty clauses. A penalty clause is a contractual provision which provides that in the event of a breach of contract the de,faulting party shall pay to his contractual partner a sum which is unconscionable and extravagant in relation to the loss that is likely to result from breach. Despite the fact that the non-enforcement of penalties seemed to be well recognised at least by the seventeenth century the penalty rule remains elusive and controversial. This thesis tentatively suggests a New Approach which in some circumstances would involve a different solution than the application of existing law. The thesis also builds upon a comparison with Jordanian law. This thesis has been divided into SIX chapters.' The first chapter examines the historical development of penalty clauses and also introduces the New Approach. The second chapter critically examines the existing test, i.e. the sum being extravagant and unconscionable, for the invalidity of penalty clause. Chapter three considers the principle that the penalty rule is only applicable on breach and the loss to be estimated for application of this rule. The general principle under English law, which gives a court no power but to declare the invalidity of a penalty is dealt with in chapter four. The circumstance where the injured party's actual loss exceeds the stipulated sum is the object of examination in chapter five. Chapter six discusses whether the penalty rule should be applied to a provision that requires a forfeiture of money already paid taking into consideration that the only difference between a forfeiture clause and a stipulated damages clause is that under a forfeiture clause the sum is paid before breach. In the last part of this thesis a summary of the thesis including suggestions for the improvement of the current law are put forward. 111 Table of Contents ACKN"OWLEDGEMENTS ....................................................................................... II ABSTRACT .............................................................................................................. III TABLE OF CONTENTS .......................................................................................... IV TABLE OF CASES .................................................................................................... X INTRODUCTION ....................................................................................................... 1 CHAPTER ONE: HISTORICAL OUTLINE OF PENALTY CLAUSES AND THE NEW APPROACH ............................................................................................. 9 O-INTRODUCTION .................................................................................................... 9 I-PENAL BOND .......................................................................................................... 9 1: 1 WHAT IS A PENAL BOND? ....................................................................................... 9 1:2 PENAL BOND AND GENERAL RULE AGAINST USURy ............................................. 11 2-EVOLUTION OF PENALTY CLAUSE OVER CENTURIES ......................... 12 2:1 PENAL BOND IN THE FOURTEENTH CENTURy ....................................................... 12 2:2 FIFTEENTH AND SIXTEENTH CENTURy ................................................................. 13 2:3 PENAL BOND IN THE SEVENTEENTH CENTURy ..................................................... 14 2: 3: 1 The decline ofpenal bond ........................................................................... 14 2:3:2 Reception ofrule against penalties ............................................................. 15 2:3:3 Legislative Intervention ............................................................................... 17 2:4 EIGHTEENTH CENTURY ............•.............•.•................•......................................... 18 2:5 NINETEENTH CENTURY DEVELOPMENTS ............................................................. 20 2 :6 ESTABLISHMENT OF RULES THAT DISTINGUISH PENALTIES FROM LIQUIDATED DAMAGES IN THE TWENTIETH CENTURy .................................................................... 21 2.7 JORDANIAN CIVIL LA W ........................................................................................ 22 3- A NEW APPROACH ............................................................................................ 23 3.1 INTRODUCTION .................................................................................................... 23 3.2 WHAT IS THE NEW APPROACH ............................................................................ 26 3.3 EXPOSITION OF THE NEW ApPROACH .................................................................. 26 3.3.1 Enforcement ofall penalty clauses subject to courts' power ofmodification ............................................................................................................................... 26 3.3 .1.1 The actual loss, which is relevant under the New Approach ................. 28 3.3.2 Advantages ofthe New Approach ................................................................ 29 3.3.2.1 The New Approach leads to greater respect for the doctrine of freedom of contract .......................................................................................................... 30 3.3.2.2 The New Approach will give courts a power to consider the matter at the time of contracting and at breach ................................................................. 31 3.3.2.3 The New Approach will put the burden of proof on the defaulting party ifhe claims reduction ........................................................................................ 37 3.3.3 Supportfor the New Approach .................................................................... 38 IV 3.3.3.1 Historical background of penalty clause ............................................... 38 3.3.3.2 European and international developments ............................................. 39 3.3.3.3 The decision of the Jobson v Johnson case ........................................... 41 3.3.3.4 Saving trial expenses and time of the parties and courts ....................... 43 3.3.3.4 Efficient breach ...................................................................................... 44 CHAPTER TWO: WHAT IS THE TEST FOR THE INVALIDITY OF PENALTY CLAUSE? ............................................................................................... 49 O-INTRODUCTION .................................................................................................. 49 I-DEMISE TEST: PARTIES' INTENTION .......................................................... 49 1: 1 THE SUBSTANCE OF THE TEST •.•.......•..•..••.........•.•.....•....•....•......•.•............••..•.•.... 49 2-THE IMPORTANCE OF THE WORD USED BY THE PARTIES .....•.........•• 51 2: 1 THE TERMS USED ARE NOT DECISIVE •••..•...•••..•........•...............•..•..•.....•..•••.•.•...... 51 2:2 "NOT DECISIVE" DOES NOT MEAN UNIMPORTANT ...............•....................•.....•..... 53 3- THE
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