Contractor Doctor: Can my agency charge a £5,000 penalty for early termination?

I’m four years into a five-year contract with a UK agency. I’ve recently been offered a new contract that better suits my personal circumstances, and so gave the agency a month’s notice.

However, the agency has come back to me saying that I have a three month notice period and that if I fail to work the full three months, I am in breach of contract. They also say there is a penalty clause that will require me to pay the agency £5,000 for the breach.

Is a penalty clause in my agency contract legal?

Thanks

Lou

Contractor Doctor says:

“Assuming the contract is governed by English law, this penalty clause would not be enforceable,” explains Roger Sinclair of contractor legal specialist Egos. “Under English law, a contractual provision which places a party in terrorem will generally amount to an unlawful penalty, and so be unenforceable.”

According to Sinclair, that legal term means to intimidate, or frighten, a party to a contract into complying, and runs counter to general principles of contract law.

“The agency has offered no basis on which the amount of the penalty might reasonably be justified,” continues Sinclair, “so a court would be unlikely to enforce clause because it has the appearance of being a penalty, which would unjustly enrich the agency; it would not be a genuine assessment of the innocent party’s loss.”

This penalty does not qualify as damages – it is a bonus

“When one party to a contract is in breach, the injured party can expect damages to put them into the position that they would have been, in had the breach not occurred,” says Sinclair. “But a penalty clause such as the one affecting contractor Lou clearly does not fall into this category.”

As Sinclair explains, if the agency attempted to enforce the penalty clause in Lou’s contract in court, they would probably not succeed: “The agency has provided no basis for the amount of the penalty and it seems to me that it would, in the eyes of a court, appear as if the agency was seeking a bonus from the breach of contract, which is not allowable under English law.

“As the contract is worded, the penalty of £5,000 remains the same no matter how much or little notice the contractor gives,” he adds, “which distances the provision from being capable of being a genuine attempt to pre-assess of the agency’s damages.”

There is nothing wrong with the three-month termination clause, nor with the agency seeking damages for breach of contract, but the courts won’t allow the party seeking damages to secure a bonus as a result of the breach.

A genuine assessment of loss can be enforced

Contractual provisions which are intended, in the event of a breach by one party, to give the other a sum which can reasonably be regarded as a genuine attempt to pre-assess the loss that party might suffer can be enforced, says Sinclair: “If the parties enter into a contract and there is a clause providing for payment of a sum which is genuine pre-estimate of loss in the event of a breach, then that clause can be enforced.

Contractors concerned about a penalty clause in their client or agency contract should seek professional advice to determine whether it is likely to be enforceable, should a breach occur

Roger Sinclair, Egos

“In Lou’s case, if the agency had said in this provision ‘our margin is £100 per day, and for each day you fail to work of the notice period you will pay us £100’ then that would probably be enforceable, because the basis for it is a genuine pre-assessment of the loss the agency would be likely to suffer in the event of early termination and breach of contract.”

Similarly, if the agency has provided some other simple and realistic formula to calculate its losses in the event of a breach, then that could would be upheld by a court, and the contractor would have to pay.

“The courts are frequently asked to determine whether a clause providing for payment from one party to the other in the event of breach is an unlawful penalty, or a genuine pre-assessment of loss,” says Sinclair. “Contractors concerned about a penalty clause in their client or agency contract should seek professional advice to determine whether it is likely to be enforceable, should a breach occur. If it appears the provision is an attempt to intimidate them into not breaching the contract, then it may well be unenforceable.”

Good luck with your contracting!

Contractor Doctor

Published: Wednesday, August 24, 2011

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