The penalty clause in your contracts

By Vivian Michael | Startup Contracts

You’ve likely seen a clause in a contract, perhaps a lease that says you need to pay interest if you miss a payment or pay late.

Here’s what  you need to know about penalty clauses in your contracts.

Penalty meaning

If you fail to pay an amount due under a contract you’ve signed, you may have to pay interest aka penalty.

The courts view is that the amount you are paying is a penalty if it has no relationship to, or is much greater than the actual loss.

In this case, the payment will be a penalty and unenforceable.

Penalty test

In the classic Dunlop Pneumatic Tyre case, the court came up with a penalty test.

The penalty test is met if the penalty amount is extravagant and unconscionable when compared to the biggest loss because of the breach.  

Negotiate

You can negotiate a penalty interest rate before you sign a contract.

While there’s no mandate for a certain penalty percentage or dollar amount, I recommend negotiating down any interest rate that’s higher than 10%.

Sample penalty clause

Below is a sample penalty clause to help you identify one easily.

You will likely find the interest clause tucked away under headings like these: default, termination or even general or miscellaneous.

Below is a complex sample clause. The one below is from a commercial lease.

Without prejudice to the rights powers and remedies of the lessor otherwise provided for or under the lease, the lessee will paid to the lessor interest at the rate of 12% per annum or at such other interest rate as may be set out in the reference schedule on any monies due but unpaid for 14 days by the lessee to the lessor on any account whatsoever pursuant to the lease such interest to be computed from the date for payment of monies in respect of which the interest is chargeable until payment of such a money's in full and such monies may be recovered as rent (subject to all the lessors rights in respect of unpaid rent). 

In the case above, 8% was requested instead of the 12% rate.

As always, get advice if you are in doubt or if you are unsure or if negotiations are not going well.

Got questions or comments about penalty rates? Be sure to share them below.

I wish you every success in all your ventures!


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About the Author

Vivian Michael is a lawyer and founder of Michael Law Group. Vivian's mission is to make quality business legal services accessible to Australian businesses that would otherwise DIY, rely on legacy contracts or go without.

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