A clause that allows a party to terminate a contract early for convenience in return for a payment is not a penalty clause. The prohibition on penalties relates only to clauses that require a party to make a payment as a result of a breach of contract. Termination for convenience payments in outsourcing and other services agreements are valid.
Blackburn Rovers Football Club had appointed Mr Berg as manager. The service contract allowed Blackburn to terminate the appointment early, on payment of the salary due for the remaining term. It chose to terminate early, and argued that the payment was a penalty and therefore invalid.
The High Court confirmed existing law: the prohibition on penalties applies only to clauses that require payments for breach. The aim of the rule is to prevent a party recovering a sum unrelated to the loss he suffers as a result of the breach. Here, the contract clearly allowed Blackburn to terminate early – there was no breach and the payment obligation was valid.
When drafting a clause requiring payment for a contractual breach, consider whether the payment can be linked to an event other than breach. To minimise the risk of a termination for convenience payment obligation being treated as a penalty, avoid using the phrase ‘liquidated damages’ – if there is no breach, there are no damages (only a debt).