In the case of Henning Berg v Blackburn Rovers Football Club, the High Court determined that a contractual payment due as compensation on early termination of a fixed term contract was enforceable.

Blackburn Rovers terminated the three year fixed term contract of their manager, Henning Berg, in December 2012, after just 57 days in the job. There was a contractual provision in Mr Berg's contract giving Blackburn the express right to terminate early, provided that the Club paid Mr Berg a sum equal to his gross basic salary for the unexpired balance of the fixed period as "liquidated damages" – totalling £2.25 million. The Club initially admitted liability and agreed to pay Mr Berg the remainder of the contract, but later sought to argue that the contractual provision was a so-called penalty clause (a pre-determined amount disproportionate to the financial loss likely to be suffered on a breach of contract) and that it was therefore unenforceable. The reason for raising this argument was that if the clause was deemed to be a penalty, payment under it could not be enforced by Mr Berg, who would only be entitled to damages for breach of contract under normal contractual principles (meaning he would be required to mitigate his loss, i.e. limiting his entitlement to damages by requiring him to find alternative employment).

It is established law that payments due on an event, such as the exercise of an express right to terminate a fixed term contract early, which is not a breach, cannot be invalidated as penalties. Applying existing law, the High Court found that because the payment to Mr Berg was due on the occurrence of an event other than a breach of contract, the relevant clause was valid. The agreement expressly granted Blackburn the right to terminate the fixed term early. As such, termination in accordance with it could not be a breach, and thus could not engage the law on penalties.

In summary

A contractual payment on early termination will not be a penalty and will therefore be enforceable. Penalty clauses can only apply in circumstances where the trigger for payment is a breach of contract.

In practice

When drafting or negotiating service agreements and contracts of employment, to increase certainty and reduce the risk of a penalty argument being raised, avoid describing non-breach payments as "liquidated damages". Damages are only relevant where there has been a breach of contract. For employers looking to limit the payments to be made on termination, it is better to expressly provide for a reduction in the contract, rather than later trying to rely on a penalty argument.