Companies dealing with personal protective equipment and masks had a busy pace during this pandemic period. As a result, I have found an opportunity to work, participate in the meetings and issue contracts with companies dealing with personal protective equipment and masks.
I have witnessed difficulties during the course of building the process on the urgent needs, doubts between the parties, issuing and execution of the agreement under the effects of the regulatory rules of the public authorities.
During this process, almost all of the companies I have been providing consultation services demand many penalty clauses within the frame of their agreements.
Then I realized that they do not know about the penalty conditions of the companies dealing with international trade although I have tried to meet those demands, what the liquidated damage is and whether those regulations are subjected to any kind of restriction and that they can be frustrated in case they rely on the articles under those agreements if there is any kind of dispute.
By taking the foregoing issues into consideration, I will make some short and enlightening explanations related to the penalty clauses and liquidated damage here.
The issue of regulating the contractual penalty conditions is used as an important instrument in order for the parties to fulfil their obligations related to their debts for issuing/preparing the international commercial agreements.
Penalty Clause indicates the payment of a price as a penal sanction since the party violating the agreement did not fulfil its obligation.
There are 3 types of penalty clauses in general:
- Alternative Penalty Clause: The fulfilment of the actual debt or penalty clause instead of the actual debt.
- Cumulation Penalty Clause: The fulfilment of both actual debt and penalty clause.
- Special Penalty Clauses: Payment of a pre-determined amount.
Liquidated damage indicates the pre-determination of a damage incurred as a result of a violation by one of the parties as a lump sum on a price. This liquidated damage should not be higher than the actual damage.
In case those two concepts are confused when issuing an international commercial agreement, then those clauses have a potential to be invalid. In other words, it is debateable how the application of those clauses added on the international commercial agreement can be guaranteed.
This issue arises from the contradictory application between two legal grounds effective in the world. There are difference in the validity of the penalty clauses between the Civil Law (Continental Europe) and Common Law (United Kingdom and USA). For the countries subjected to the Common Law legal system has not executed the penalty clause demands of the “common law” for years based on the decision of the Dunlop Pneumatic Tyre Co. V. New Garage & Motor Co. Ltd. The judges of this legal ground perceive the penal clauses as ignoring the certainty expected from the law and as intervention to the freedom of the agreement. In other words, those clauses are not deemed effective in the Common Law (Anglo-American) legal system and they interfere in the execution of them. The penalty clauses which are only found extreme within the frame of the Civil Law (Continental Europe) are mitigated with the intervention of the courts. However; related to the liquidated damage for instance, the courts of New York are generally considers the clauses on the liquidated damages effective within the reasonable criteria (However, the execution of the penalty clauses is not possible). The same perspective applies for the British Law. The Continental Europe, especially Germany and France have the same mitigation application for the extreme penalty clauses.
It is obvious that the international instruments are insufficient related to those issues.
This issue was regulated obviously in the CISG. However; in case of a dispute when this clause is more or less predictable than the damages, there are opinions indicating that it is necessary to interpret them in accordance with the Article 7 of the CISG instead of the applicable law for the agreement. There are open-ended interpretation indicating that the national laws are applied within the frame of the rules and applications of the international commercial law.
The Unitroit Principles (7.4.13) evaluated the penalties and liquidated damages under the same clause.
Consequently, the problematic issue have made the different methods for the applications to be preferred. When issuing the international commercial agreements, I recommend you to take this issue especially into consideration.