The problem of excessive penalty clauses
(a) The dangers of conventional penalties
Conventional penalties, as may have become apparent already, are dangerous. Where there is unequal bargaining power, the creditor tends to put the economically less potent debtor under considerable pressure by stipulating penalties that, on occasion, may well exceed every reasonable or legitimate interest.
The debtor, on the other hand, often has the freedom to "take it (upon the conditions offered) or leave it" only, and therefore cannot effectively negotiate the amount of the penalty. Furthermore, as the clause does not put him under any immediate obligation but only under a conditional one, the natural confidence in his own ability to render due performance will lead the debtor to underrate its gravely detrimental nature. Thus he may find himself to be exposed, rather surprisingly, to considerable claims, going far beyond the value his performance may conceivably have had for the creditor. Such considerations raise the question whether a legal system should lend its hand to the enforcement of excessive penalty clauses.[579] Roman lawyers, loath to interfere with what the parties had agreed upon, seem to have had no qualms about such clauses. They did not object to stipulationes poenae simply because the stipulated sum was too high. Until fairly recently, the French code civil followed the same principle of giving liberal effect to penalty clauses, even where the amount in question was excessive or derisory.[580] This attitude is based on individualism and freedom of contract; Johannes Voet[581] [582] summed up the underlying policy consideration in the following words:.. ac merito regeri promissori poenae Conventionalis, ilium imputare sibi debere, quod sponte sua sibi talis imposuerit tantaeque poenae necessitatem"; the debtor has but himself to blame—had he not agreed to the clause, he would not have found himself in such a predicament. After all, we are dealing with a conventional penalty. Such an attitude, however, for the reasons mentioned above, is not acceptable under modern economic circumstances.(b) The approach of modern European legal systems
An entirely different approach has been followed by English law, where penalty clauses "stipulated as in terrorem of the offending party"75 are rejected as wholly invalid. Only where the clause is a genuine attempt to estimate the damages likely to ensue as a consequence of the breach of promise will the claim be entertained by the courts.[583] Thus, while saving the debtor from a situation where he would have had to pay what appears to be an extravagant and unconscionable amount compared with the greatest loss "that could conceivably be proved to have followed from the breach",[584] the English courts have introduced a distinction between penalties in a narrow sense and liquidated damages clauses, a distinction that has proved to be cumbersome and unsatisfactory. In each case the purpose of the clause has to be determined, and certain rules and presumptions have been laid down to aid the courts in their task. But they achieve neither certainty of the law nor equitable solutions in each individual case, and therefore have been said to "manage to get the worst of both worlds".[585] Continental codifications generally recognize the validity of conventional penalties, subject, however, to judicial discretion to reduce the amount. By way of example, we may refer to the BGB: if a penalty which is due is disproportionately high, it may be reduced to a reasonable amount by a court's decision, upon application by the debtor. As far as the determination of reasonableness is concerned, the code provides that every legitimate interest (and not only pecuniary interests) shall be taken into consideration.[586] This judicial power to modify a contractual term was clearly recognized as highly exceptional[587] and was accepted only after much toing and froing in the final draft of the BGB.[588] It was also in conflict with pandectist doctrine, which faithfully supported the liberal Roman principle of literal enforcement of penalty clauses.
(c) his commune and South African law
Nevertheless, this attitude did not always reign supreme in the course of the development of the ius commune.
There was a long, drawn-out dispute as to whether the rule in C. 7, 47 limiting the amount of damages claimable to double the value of what had been promised[589] was applicable to conventional penalties. "Haec quaestio antiquis, et neotericis multum ambagiosa est, et male discussa", as Molinaeus[590] bluntly remarks, answering this question himself in the affirmative. If the penalty is, with regard to its nature and function, a substitute for the recovery of whatever damages have arisen,[591] then its amount should also be limited in the same way as damages are: this was an oft-repeated argument of those who wanted to impose the limit of duplum upon penalty clauses.[592] Their view found legislative sanction, for instance in the Prussian Code.[593] [594] But in the long run the contrary view prevailed.08 In some places, however, and especially in the law of the Netherlands, a custom had come to be recognized that if the penalty was much larger than the actual loss suffered, it was within the competence of the court to reduce it "ad bonum et aequum"[595] [596] [597] so that Voet, while rejecting the applicability of C. 7, 47,yo could state:"Denique moribus hodiernis volunt, ingcnte poena convention! apposita, non coram poenam adjudicandam esse, sed magis arbirrio judicis earn ita oportcrc mitigari, ut ad id prope reducatur ac restringatur, quanti probabiliter actoris interesse potest."51
This was also, of course, what was transplanted to the Cape of the Good Hope, and the same principle, incidentally, is today recognized in South Africa, albeit on a statutory basis. The development leading to the enactment of the South African Conventional Penalties Act[598] is colourful, interesting and not atypical of the more recent South African legal history. While at first both the Cape Supreme Court and, especially, the Transvaal Supreme Court strove to follow the Roman-Dutch principle,[599] under the influence of Lord De Villiers and the Privy Council the English law relating to penalty clauses came to be received.[600] Thus, instead of enforcing penalties subject to a moderating jurisdiction of the court, the courts started drawing a distinction between (unenforceable) penalties and genuine estimates of damages.
A half-hearted attempt by the Appellate Division to reverse the development'1 A was rejected by the Privy Council,96 until 1950 the highest court for the Union of South Africa. Naturally, the Privy Council, which was not staffed with Roman-Dutch lawyers, did not find the South African development unacceptable at all. With the rise of the purist approach to South African law, however, the decision in Pearl Assurance Co. v. Union Government was bound to receive harsh criticism; Van den Heever JA branded it as a "blemish on our legal system which militates against good faith, trust and business morality".[601] Yet little could be done by the courts against a precedent of that calibre, and thus only the legislature was able to remedy the situation. It acted in 1962.[602] [603]7.
More on the topic The problem of excessive penalty clauses:
- Genuine conventional penalty clauses
- The functions of penalty clauses
- Non-genuine conventional penalty clauses
- Forfeiture of the penalty
- THE PENALTY
- The assessment clauses and litiscrescence
- Excursion: Constantine’s Prohibition of Forfeiture Clauses
- Most of our texts by far, concerning resolutive conditions, deal with three specific clauses, frequently appended, by way of pacta ex continent! adiecta,129 to contracts of sale.
- The problem of succession
- The Free-Rider Problem
- The problem of the second chapter