The argument that a liquidated damages clause amounts to an unenforceable penalty is sometimes used in disputes by the debtor to avoid payment. In one case in 2013, the argument failed because the payment was not made on breach. It provides a useful reminder on the definition of a penalty clause.
Henning Berg v Blackburn Rovers  EWHC 1070 (Ch)
Berg was employed as the club manager for Blackburn Rovers football club. The employment contract provided for a fixed term of three years, which was terminable by Blackburn Rovers for convenience, but subject to the payment of Berg’s salary for the remainder of the fixed term. The payment provision was described in the contract as a compensation payment and as liquidated damages.
Berg’s employment was terminated after 6 months. He claimed GBP 2.25 million in salary for the remaining 18 months. Blackburn Rovers refused to pay on the basis that the provision was unenforceable as a penalty.
The court held that the clause was not capable of being a penalty because the payment did not become due as a result of a breach of contract. A penalty clause has, as its aim, the deterrence of a breach of contract by imposing a high amount of damages which are disproportionate to the loss suffered on breach. In this case, Blackburn Rovers was entitled to terminate the contract.
- Be careful in the use of terminology in relation to payments on termination. Consider whether a breach of contract is required to trigger payment – if not, use terms such as ‘early termination payment’ instead.