Legal Update: Penalty Clauses and Henning Berg v Blackburn Rovers Football Club and another [2013] EWHC 1070

11 June 2013

An area of law about which our clients are often unaware is that relating to penalty clauses in contracts. Often, when negotiating the terms of a contract, it is difficult to ascertain the exact amount of loss that could be suffered by a party if the other party breaches a particular clause in the agreement. Therefore, the parties will often attempt to introduce certainty by agreeing that, for example, Party A will pay Party B a fixed amount (say £1,000) if Party A breaches a clause of the agreement (for example failure to deliver goods on time).

If £1,000 is a reasonable estimate of the probable loss that will be suffered by Party B if Party A fails to deliver the goods on time then this clause will be enforceable. However, if the purpose of this clause is simply to deter Party A from failing to deliver the goods on time and it is not a reasonable pre-estimate of the loss then this clause will be a penalty clause and therefore invalid and unenforceable.

The effect of this area of law is often misunderstood, even when clients are aware of the prohibition on penalty clauses.

It is important to remember that the rule against penalties only applies where the sum becomes payable as a result of a breach of contract.

This was considered in the recent case of Henning Berg v Blackburn Rovers Football Club and another [2013] EWHC 1070. In this case, the contract between Henning Berg and Blackburn Rovers contained a clause which entitled Blackburn Rovers to terminate his contract with immediate effect on written notice and upon paying Mr Berg a payment equal to his gross salary for the remainder of the contract (which at the time was approximately two and a half years). Blackburn Rovers then attempted to avoid making this payment by stating that this was a penalty clause and is therefore invalid and they should not have to pay Mr Berg more than the amount of loss that he actually suffered.

However, as the payment to be made under this clause was not stated to be for Blackburn Rovers’ breach of contract, but was instead pursuant to their contractual right to terminate the agreement, Judge Pelling Q.C. unequivocally stated thatthe law relating to penalty clauses is entirely immaterial” and Blackburn Rovers were unsuccessful with this argument.

For further advice relating to penalty clauses or commercial agreements generally, please contact our corporate and commercial team.