Penalties, Liquidated Damages and Penal Clauses in Commercial Contracts: A Comparative

Study of English and Continental Law

Author(s): Peter Benjamin
Source: The International and Comparative Law Quarterly, Vol. 9, No. 4, (Oct., 1960), pp. 600-
627
Published by: Cambridge University Press on behalf of the British Institute of International
and Comparative Law
Stable URL: http://www.jstor.org/stable/756335
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 PENALTIES, LIQUIDATED DAMAGES AND PENAL
CLAUSES IN COMMERCIAL CONTRACTS:
A COMPARATIVE STUDY OF ENGLISH AND
CONTINENTAL LAW

By
PETER BENJAMIN *

THE insertion in a commercial contract of a clause providing for

the payment of a specific or ascertainable sum of money on the
failure of a party to perform or comply with one of the contractual
obligations, such as the failure to deliver or to remove goods within
the contractual time-limit, or non-compliance with a restriction on
user or resale, to mention but two contingencies in which recourse
is sometimes had to this form of clause, gives rise to a number of
important questions, both from the point of view of substantive
law and from that of procedure. Amongst these questions are the
effect of the clause where the actual damage suffered is greater or
less than the sum of money specified. The effect where there is in
fact no damage at all, and lastly its effect with regard to the burden
of proof.
Notwithstanding the importance of the above problem from the
point of view of present-day international commercial contracts,
the literature on the subject from the comparative aspect, as
opposed to monographs on a particular legal system, is not
plentiful.1 This scarcity has led the writer of this article to attempt
to compare the positions under English and Continental law.
* Assistant
Legal Adviser, United Nations Economic Commission for Europe.
The views expressed in this article are, however, the writer's personal views
and should not be interpreted as those of the Organisation.
See however two papers read to the Academly of Comparative Law: Esser,
Les clauses penales en droit civil et leur appreciation par les tribunaux, Mem.
Acad. Inte. Droit Comp., Rome, 1955, III, p. 475 (dealing with German lan);
Veaux, Les clauses penales dans les contrats de droit prive et leur respect
par les tribunaux, Etudes de droit contemporain de l'Institut de Droit Com-
pare de I'Universite de Paris, II, p. 25 (dealing with French law). See also
Marsh, " Penal clauses in contracts," Journal of Comparative Legislation,
3rd series, 1950, Part III, p. 66 (dealing with English, French and German
law); Facio, "Nature juridique de la clause penale dans les droits fran9ais
et latino-americain," Revue internationale de droit compare, 1949, p. 315;
Grabe, Contractual penal clauses in Soviet law, Moscow, 1950; Secretan,
Etude sur la clause pdnale en droit suisse, Lausanne, 1917.
600
OCT. 1960] Penal Clauses in Commercial Contracts 601

Before embarking on this comparative study, an apology is

made for the use of the adjective " Continental " as a matter of
convenience, for after examining the position under English law it
is proposed to examine certain, rather than all, Continental legal
systems, namely the French, the German and the Soviet. The
reason for this selection is not only the material impossibility of
doing otherwise in a study of this nature, but because the four
legal systems that have been selected would appear to be the most
divergent and interesting in their approach to the subject-matter
of this study.
This brings us to another question which at first sight is one of
terminology but which in reality is one of substance, namely the
use of the terms " penalty " and " liquidated damages " in the
common law to refer to the nature of the clauses specified at the
outset of this article, and the use of the term " penal clauses " in
Continental law to refer to the same subject-matter. On analysis
it will be seen that much of the apparent confusion and doctrinal
divergencies that exist on this question in all Continental legal
systems arises from the fact that " penal clauses " have a hybrid
nature, being used both to guarantee the performance of a particu-
lar contractual obligation, and in order to provide a pre-estimate
of the damage likely to flow from the particular breach of contract
in question. The fact that under certain legal systems greater
emphasis is laid upon the aspect of sanction in a penal clause (i.e.,
in Austrian, German, Swiss and Soviet law), whereas in others it is
the aspect of an evaluation of damages that predominates (i.e., in
French law as in Belgian and Italian law), should not mislead one
into disregarding the fact that both the element of sanction and
that of damages are present in these legal systems. This confusion
is, however, to a great extent absent in English law, largely due to
the distinction drawn between these two separate functions of the
clauses in question.
Another factor of considerable interest in the subject-matter of
this study will be found in the use that is sometimes made of
similar reasoning to achieve divergent results, or the fact that simi-
lar results are often obtained by different reasoning. Thus, as will
be seen below, the sanction aspect of penal stipulations in early
Roman law prevented their alteration by the judge, whereas in
English law and in French law it is the aspect of evaluation of
damages made by the parties that prevents judicial interference
respectively with a clause for the payment of liquidated damages,
and a penal clause. It would be unwise at the outset to anticipate
the conclusions to be found at the end of this study, but it might
perhaps be not altogether out of place to underline the fact that
602 International and Comparative Law Quarterly [VOL. 9

the attitude in any legal system towards liquidated damages,

penalties, or penal clauses, reflects public policy and as such varies
not only from country to country, but also within the same country
at different periods of time.
It is proposed, therefore, to examine first of all the position
under English law with regard to penalties and liquidated damages
in commercial contracts, and to follow this examination by a brief
outline of the history of modern Continental law on the subject of
penal clauses (which, as will be seen, has no direct bearing on
English law), before embarking on an account of the respective
positions of French, German and Soviet law regarding these
clauses. Finally, it is hoped to be able to draw conclusions as to
the relative utility in practice of inserting a clause regarded as
providing for a penalty or liquidated damages in English law, or
regarded as penal under Continental law.

I. ENGLISH LAW
Under English law where a contract provides that should one of
the parties fail to perform or to comply with a particular contrac-
tual obligation, such party shall pay to the other either a specific
sum of money (e.g., ?x) or an ascertainable sum of money (e.g.,
10 per cent. of the purchase price), it is a question of construction
whether the clause in question will be regarded as providing for the
payment of liquidated damages or a penalty. The distinction is
capital, for the legal effect of each of these two forms of clause is
different.
It was stated in an early case 2 by Lopes J. that " the distinc-
tion between penalties and liquidated damages depends on the
intention of the parties to be gathered from the whole of the
contract. If the intention is to secure performance of the contract
by the imposition of a fine or penalty, then the sum specified is a
penalty, but if on the other hand the intention is to assess the
damages for breach of the contract, it is liquidated damages."
The fact that the parties have used the expression " penalty "
or that of "liquidated damages " is by no means conclusive, for
under English law the court still has to ascertain whether or not
the parties have genuinely attempted to assess the damages.3
In order to determine whether the sum stipulated is a penalty
or liquidated damages certain rules have been laid down by the
courts. In the leading case of Dunlop Pneumatic Tyre Co., Ltd. v.

2 Law v. Redditch Local Board [1892] 1 Q.B. 127, at p. 132.

3 ClydebankEngineering and Shipbuilding Co. v. Don Jose Ramos Yzquierdo
y Castaneda[1905] A.C. 6, at p. 9.
OCT. 1960] Penal Clauses in Commercial Contracts 603

New Garage and Motor Co., Ltd.,4 Lord Dunedin stated these
rules to be as follows:
" (a) It will be held to be a penalty if the sum stipulated for is
extravagant and unconscionable in amount in comparison
with the greatest possible loss that could conceivably be
proved to have followed from the breach.
(b) It will be held to be a penalty if the breach consists only in
not paying a sum of money, and the sum stipulated is a
sum greater than the sum which ought to have been
paid ....
(c) There is a presumption (but no more) that it is a penalty
when a single lump sum is made payable by way of com-
pensation on the occurrence of one or more or all of
several events, some of which may occasion serious and
others but trifling damage.
(d) It is no obstacle to the sum stipulated being a genuine
pre-estimate of damage, that the consequences of the
breach are such as to make precise pre-estimation almost
an impossibility. On the contrary, that is just the situa-
tion when it is probable that pre-estimated damage was
the true bargain between the parties."
The importance of the distinction just referred to is that when
the amount stipulated for is construed as providing for liquidated
damages it is payable in full whether the damage suffered be
greater or lesser, or even non-existent.5
This attitude of English law with regard to liquidated damages is
extremely liberal, for the clause providing for liquidated damages
is sacrosanct, and provided that the contract in which it is inserted
is valid, and provided that the circumstances giving rise to pay-
ment have in fact arisen, the courts will neither increase nor
decrease the amount agreed upon, for such an alteration of the
parties' contract would be an unwarranted interference with the
freedom of contract.6 As will be seen below, this attitude is very
close to that of French law with regard to penal clauses and is in
opposition to that of German and Soviet law.
Quite different is the position where the clause is construed as
providing for the payment of a penalty, for in such a case the
legal effect is that, since a penalty so designed is a mere security
for the performance of the contract, the promisee is adequately
indemnified if he recovers his actual loss, and he is regarded as

4 [1915] A.C. 79, at p. 87 et seq.

5 See Wallis v. Smith (1882) 21 Ch.D. 243.
6 On the principle of freedom of contract in English law see the
judgment of
Jessel M.R. in Printing and Numerical Registering Co. v. Sampson (1875)
L.R. 19 Eq. 462, at p. 465 cited below.
604 International and Comparative Law Quarterly [VOL. 9

acting unconscionably if he attempts to recover a sum of money

which, although fixed by the contract, is disproportionate to the
amount of damage suffered.7 Therefore, where the damage suffered
is less than the amount of the penalty the claimant can only
recover the actual amount of damage suffered.8 This proposition
answers half of the problem only, for where the actual damage is
more than the amount of the penalty the authorities are not quite
as clear, although it would seem that the claimant can disregard
the penalty and sue for the actual damage 9 unless the clause is
construed as a limitation of liability.10
One of the characteristics of a clause construed as providing for
the payment of liquidated damages is that it shifts the burden of
proof, for the claimant is not required to prove damage. The
position is totally different, however, where the clause is construed
as providing for the payment of a penalty, for in such a case the
claimant must prove damage.1l
It will be seen below that this peculiarly English distinction
between penalties and liquidated damages 12 avoids the endless
theoretical discussions that abound in Continental legal literature
on the nature of penal clauses. An examination of case law will
show, moreover, that in practice, in cases of doubt, the courts have
tended to construe the relevant clauses as providing for the pay-
ment of liquidated damages rather than for the payment of penal-
ties, even though these clauses may sometimes not only constitute
an attempt to assess the loss likely to ensue from a breach of
contract, but also endeavour to insure against a breach of the
contract itself. The reason would appear to be that in all cases
in which the courts have to interpret clauses providing for the
payment of a particular sum of money on default, the courts have
hesitated between the traditional dislike of equity for penal clauses
(mentioned below) and the abhorrence of English courts to inter-
ference with the freedom of contract, which would appear to be
stronger than the dislike of penal clauses. This reluctance was
admirably put by Jessel M.R. in Printing and Numerical Register-
13: " You have this
ing Co. v. Sampson paramount public policy
to consider-that you are not lightly to interfere with this freedom

7 Watts, Watts & Co., Ltd. v. Mitsui & Co., Ltd. [1917] A.C. 227 (H.L.).
s Wilbeam v. Ashton (1807) 1 Camp. 78.
9 See Wall v, RederiaktiebolagetLuggude [1915] 3 K.B. 66; Watts, Watts A
Co., Ltd. v. Mitsui & Co., Ltd. (above); and dicta of Lord Mansfield in
Lowe v. Peers (1768) 4 Burr. 2225, at p. 2228. The above question was
moreoverIiot regardedas decidedby the House of Lords in CelluloseAcetate
Silk Co., Ltd. v. Widnes Foundry (1925) Ltd. [1933] A.C. 20.
10 See Watts, Watts & Co., Ltd. v. Mitsui & Co., Ltd., above.
11 R. v. London Guaranteeand AccidentCo., Ltd. (1920)2 W.W.R. 85, at p. 88.
12 Which is applied inter alia in both Scots law and in South African law.
13 (1875)L.R. 19 Eq. 462, at p. 465.
OCT. 1960] Penal Clauses in Commercial Contracts 605

of contract." It is not without interest to compare this affirmation

of the sanctity of contracts with the provisions of article 1134 14 of
the French Civil Code examined below.
As the next section of this article will deal with the historical
background to modern Continental law on the subject of penalties,
which cannot be shown to have had any direct bearing on English
law, it would perhaps not be altogether inappropriate to mention
briefly before leaving this account of English law the historical
origin of the English distinction between penalties and liquidated
damages.
The distinction between penalties and liquidated damages would
appear to be an historical accident, and, like many a rule of
English law, it owes its origin to the conflicts of jurisdiction
between the courts of equity and the common law courts. One of
the peculiarities of the common law is the use which is made of
historical accidents in order to create a thoroughly workable system
of law.15
At common law no distinction was originally made between
penalties and liquidated damages and the common law courts
regularly enforced what we nowadays regard as penalties. In
equity, however, the position was different, for the Chancellor
intervened to grant relief in certain cases. It would appear that
during the fifteenth century 16 the courts of equity granted relief
in the case of common money bonds 17 where fraud was involved,
where default in payment was justified, and whenever payment
with interest was tendered. This intervention by the courts of
equity was subsequently extended to cover cases in which bonds
were given not only to secure payment of a specific sum of money
on a given date, but in which they were to secure or prevent the
performance of some act. As to the principles applied to determine
equitable relief in the case of penalties, it would appear that, at
any rate from the latter part of the eighteenth century,18 the courts
of equity reduced penalties which they regarded as oppressive and

14 " Les conventionsdlgalement formees tiennent lieu de loi a ceux qui les ont
faites."
15 In the Hamlyn lectures of 1951, Professor Lawson underlines the fact that
where English law seems to go wrong it is nearly always due to excess of
logic: cf. The Rational Strength of English Law, p. 70.
'1 Cf. Marsh, op. cit. p. 69.
17 i.e., a bond entered into in order to secure the payment of a
given sum of
money with interest, coupled with an undertakingto pay a greater specified
sum of money if payment is not made on the agreed date.
1s As late as the middle of the eighteenth century there are reportedcases in
which the courts of equity refused to examine the amount stipulated in the
parties' contract and in which they refused to intervene although the clauses
in question would undoubtedlybe regardedas in terroremtoday. Cf. Roy v.
Duke of Beaufort (1741) 2 Atk. 190.
606 International and Comparative Law Quarterly [VOL. 9

unconscionable 19 because it was regarded as contrary to natural

justice to have contractual clauses that were in terrorem.
Mention was made above of the fact that at common law no
distinction was drawn between penalties and liquidated damages.
In the seventeenth century, however, this situation changed, for
the common law courts, traditionally jealous of the courts of
equity, acquired jurisdiction over penalties by means of the
Administration of Justice Acts, 1696,20 and 1705.21 The latter Act
provided that the debtor on a bond could plead as a defence that
he had by the time of the action paid the debt and interest; and
that he might pay the principal, interest and costs into court and
obtain a discharge by judgment.
The result of the passing of the above statutes was that, not-
withstanding the fact that the jurisdiction of the courts of equity
over penalties lingered on until the Supreme Court of Judicature
Acts, 1873-1875, at common law, whenever the claimant sued to
recover a fixed or ascertainable sum of money as being payable by
the respondent on breach of contract, the court had to determine
whether or no such sum of money was a penal sum within the
meaning of the statute. Where the sum of money was regarded as
penal, the claimant was only entitled to recover the actual loss he
had suffered and which he had to prove. Where the sum of money
was not regarded as a penal sum, the courts were bound to award
the claimant the amount agreed upon in full, neither more nor
less,22 and without his having to prove any damage.

II. AN HISTORICAL OUTLINE OF MODERN CONTINENTAL LAW

ON PENAL CLAUSES

The hybrid nature of penal clauses in modern Continental law,

whereby use of these clauses is made both to guarantee the per-
formance of a particular contractual obligation, and in order to
provide a pre-estimate of damage on the breach of the contractual
obligation, is a direct consequence of the fact that the purpose of
these clauses has varied throughout history. Some mention must
therefore be made of the historical background of modern Con-
tinental law, and in particular of Roman and canon law wherein
will be found not so much the source of the modern Continental
law on penal clauses as the historical origin of its confusion and
uncertainty.
19 See Sloman v. Walter (1783) 1 Bro.C.C. 418.
20 8 & 9 Will. 3, c. 11; and 4 & 5 Anne, c. 16, s. 2.
21 s. 8.
22 On the manner in which the courts of common law came to adopt the doctrines
of equity, see the judgment of Bramwell B. in Betts v. Burch (1859) 4
H. & N. 506.
OCT. 1960] Penal Clauses in Commercial Contracts 607

Although penal clauses have been traced in the laws of ancient

Greece,23 the point of departure for modern Continental law is
undoubtedly Roman law, where the purely repressive nature of
penal clauses gradually gave way in classical Roman law to penal
clauses having a hybrid nature much as they do today.
Under early Roman law, the stipulatio poenae took the form of
a single conditional obligation, wholly repressive in character, the
formula used being " Si Pamphilum non dederis, centum dare
spondes ?" 24 The importance of this form of penal stipulation was
the use that was soon made of it in Roman law so as to give a
sanction to promises that were not legally enforceable, such as
where A promised B that he would give money to X in order that
X should perform some act.
Historically, the formula just referred to formed part and parcel
of the system of " private " penalties common to all systems of
early law.25 From its purely repressive character it followed that
the penalty was payable in full even though there had been partial
performance, and even where the subject-matter had been
destroyed by reason of circumstances beyond the debtor's control.26
Even more striking was the fact that where the penalty was insuf-
ficient to cover the damage suffered, the penal stipulation did not
prevent the creditor recovering both the amount of the penalty and
damages,27 notwithstanding the fact that where the amount of the
penalty exceeded the actual damage it was nevertheless fully
recoverable, as has just been mentioned.
This early form of penal stipulation which was wholly repressive
in character gave way in time to a second kind of formula, which
Buckland called " a principal obligation followed by a penal stipu-
lation for non-performance," 28 of a hybrid nature because it was
both repressive and a means of assessing the damages for non-per-
formance. The new formula was " Pamphilum dari spondes? Si
non dederis centum dare spondes ?" 29 This new formula resulted
in the creditor having to choose between recovery of the penalty
and recovery of damages. This result was achieved by regarding
the principal obligation as extinguished once the penalty was
sought, and by invoking the exceptio doli where the creditor

23 See Maruani, La clause penale, Tunis, 1936, p. 17.

24 "If you do not transfer to me the property in Pamphilus, do vou promise
to pay me a hundred?"
25 See Savigny, Droit des obligations, 1863, French edition, II, p. 421.
26 See Fliniatx, L'evolution du concept de clause pdnale chez les canonistes du
Moyen Age, Melanges Fournier, 1929, pp. 234-235, and the authoritiescited
in notes (3) and (5) thereof.
27 See Fliniaux, op. cit. p. 235, note (6).
28 A Text-bookof RomanLaw, 2nd ed., pp. 428-429.
29 "Do you promise to transfer to me the propertyin Pamphilus? If you do
not transfer the propertyto me, do you promiseto pay me a hundred?"
608 International and Comparative Law Quarterly [VOL. 9

attempted to recover both damages and the penalty.30 There is

moreover a text in the Digest 31 that allows the creditor to sue for
damages after payment of the penalty, where the amount of the
penalty was less than the actual damage. However, there is no
evidence of the amount of the penalty being reduced where it was
greater than the amount of damage suffered, and in point of fact it
was not until the development of canon law in the thirteenth
century that this question first began to be discussed, as will be
seen below.
Any account of penal stipulations in Roman law would be
incomplete were mention not made of the fact that in classical
Roman law they appear as a means of avoiding proof of damage
much as penal clauses do today. Indeed, Justinian lays consider-
able stress on the fact that a penal stipulation avoids the necessity
for a creditor having to prove damage arising from a breach of
contract and that it also avoids the judge having to assess the
evidence regarding such damage.32
With the decline of the Western Roman Empire and the arrival
of the Dark Ages, penal stipulations (or clauses as they are now
called) abandoned their hybrid nature and became once more
wholly repressive in character, being regarded solely as a means of
securing the performance of an obligation and not as a means of
assessing the damages likely to ensue from default.33 This new use
of penal clauses enjoyed considerable favour. The great French
legal historian Glasson states, " Les Barbares ont singulierement
elargi l'application du systeme des clauses penales qu'ils avaient
empruntees aux praticiens romains. On peut dire qu'aucun con-
trat, qu'aucun acte de la vie civile . . . ne se formait sans qu'une
clause penale en garantit l'execution." 34
The use of penal clauses as a means of assessing damages was,
however, to leappear with the development of canon law in the
middle ages, and it is proposed to mention briefly the use of penal
clauses in canon law, since this legal system provides the link
between the Roman law which we have just been discussing, and
the modern Continental law which we are to examine in the subse-
quent sections of this study.

30 See Fliniaux, op cit., p. 235, note (7); Maruani, op cit., p. 33; Mauler, De la
nature de Ia clause pdnale, 1898, p. 28.
31 D. 19.1.28 held to be interpolated by Fliniaux, op cit., p. 235, note (7).
32 Institutes, III, 15, 7.
33 See Loening, Der Vertragsbruch und seine Rechtsfolgen, Strasbourg, 1876, I,
p. 534; Thevenin, Textes relatifs aux institutions privees ct publiques
aux epoques merovingiennes et carolingiennes, Paris, 1887, I, Nos. 12, 19, 21,
27, 33, 40.
34 Histoire du droit franqais et des institutions de la France, Paris, 1887-1903,
III, p. 235.
OCT. 1960] Penal Clauses in Commercial Contracts 609

One of the most curious phenomena to be observed with regard

to penal clauses is their extraordinary utility for a multitude of
different reasons in the development of any legal system. Under
Roman law, quite apart from the use that was made of penalties at
first to secure performance of obligations, and later on to assess
damages, mention was made of the utility of penal clauses to
render actionable certain obligations that were not as a matter of
strict law enforceable. Similarly, in canon law it would seem that
penal clauses first came to be used because they offered a means of
avoiding the usury laws, which were stifling economic development.
Thus instead of concluding a contract whereby A lent B 100 with
a proviso that B would pay A five per cent interest if he did not
repay A by a certain date, which would have infringed the usury
laws,35 a contract was concluded whereby A lent B 100 and B
agreed to pay the penalty of 105 if he did not repay A on the
agreed date; and on the agreed date A would sue B directly for
the penalty.
The use of penal clauses which has just been mentioned was
discussed at great length by the medieval canonists, who
attempted to establish a distinction between bona fide penal
clauses and clauses that were not bona fide.36 However, the diffi-
culties of attempting in practice to apply a purely subjective
distinction of this character soon became apparent, and although
various other attempts were made, the turning point would appear
to have been reached in the thirteenth century due to the doctrine
of interesse.37 This doctrine, which was borrowed from the civil
lawyers, permitted a distinction to be drawn between usury,
regarded as so much per cent, and interesse, or what we would
call damages today. The distinction thus drawn led to a discussion
of whether a penalty could exceed the amount of damage. In this
context certain canon lawyers proposed a further distinction
between cases where the penalty was loco interesse, that is to say
an assessment of damages, in which case it was argued that it must
not exceed the damages, and cases where the penalty was pro
conturacia, that is to say a punishment of the debtor, in which
case it could not be reduced,38 provided of course it was not used
in fraud of the usury laws.39

35 At first applied solely to the clergy, the usury laws were applied to all and
sundry in A.D. 789 by Charlemagne.
36 Fliniaux, op cit., p. 237, notes (14) and (15), refers in particular to the
writings of Bernard of Pavia, and of Robert de Courgon.
37 See Fliniaux, op cit., p. 240.
38 See William of Rennes (circ. 1254) in SummnaRaymundi, Lib. III, tit. 32,
de poenis.
39 This distinctionof courseprovidedno solution of the question as to what was
in fraud of the usury laws. In view, however, of the limited interest of this
610 International and Comparative Law Quarterly [VOL. 9

However, on the question of whether or not a judge should be

allowed to reduce the amount of the penalty where it was in excess
of the damage, opinions were divided. Hostiensis favoured such a
reduction, on the ground that as the whole object of the penal
clause was to provide a pre-estimate of damages a judge should be
allowed to reduce the amount provided for, where it was more than
the damage.40 This position is of course the exact opposite of that
taken by the common law, for as was seen above, where the effect
of the clause is to assess damages the amount thus provided for
will not be reduced by a court of law, as opposed to a clause in
terrorem which will be interfered with. The opinion of Hostiensis
was not, however, followed by Panormitanus, who refused to allow
such a reduction of a penalty, basing his arguments on the fact
that the sole object of a penal clause was not so much to assess the
damages as to avoid difficulties with regard to the burden of
proof.41
The importance of the doctrine propounded by Hostiensis,
whereby penal clauses are a means of assessing damages, and that,
as such, the sums stipulated can be reduced where they are in
excess of the damage suffered, is that this doctrine was accepted
by Dumoulin 42 and thus passed out of the realm of canon law into
the civil law. In fact until the passing of the French Civil Code,
Continental law accepted the idea of the reduction of an excessive
penalty by a court of law on the ground that the object of a penal
clause was solely to assess the damages. Pothier in fact underlines
the nature of a penal clause in these words: " La peine est com-
pensatrice des dommages et interets que le creancier souffre de
l'inexecution de l'obligation principale." 43

III. FRENCHLAW
Mention has been made of the fact that prior to the enactment of
the French Civil Code of 1804, the prevailing view in Continental
law with regard to penal clauses, reflected in the writings of
Dumoulin and Pothier, was that these clauses were a means of
assessing damage, and that as such they were liable to attract
judicial intervention where the penalty exceeded the damage. As
will be seen below, French law accepts the first of these two

question to the subject of penalties it is not proposed to mention various

other distinctions that were made as to what was or was not contrary to the
usury laws.
40 Summa, De sententia,
quis sit effectus (f? 179 r?).
41 Com. in decret, ad. c. 4 (dilecti), X De arbitris (I, 43) No. 14, 1586 edition.
42 Tractatus contractsum usurarum ct redituum, Paris, 1681, II,
p. 10 (of Op.
omm. No. 25).
43 Traite des obligations, Paris-Orleans, 1763, I, No. 342, p. 417.
OCT. 1960] Penal Clauses in Commercial Contracts 611

propositions but rejects the second. Moreover, even with regard

to the proposition that penal clauses are a means of assessing
damages, its importance is such in French law that it tends to
obscure the hybrid nature of these clauses, and whether their
object be genuinely to assess the damages, or to compel an econom-
ically weaker party to perform an obligation, the consequences are
invariably the same. In other words, in practice penal clauses are
always construed in French law as providing for what the common
lawyer would call liquidated damages, notwithstanding their hybrid
nature both from a theoretical and from a practical point of view.
Two articles of the Civil Code, Articles 1229 and 1152, lay down
the basic position taken by French law, and as such must be
examined closely.
Article 1229 in its first section reproduces practically word for
word the statement of Pothier referred to above, by providing:
"La clause penale est la compensation des dommages et interets
que le creancier souffre de l'inexecution de l'obligation principale."
Article 1152, on the other hand, entirely rejects the doctrine that
because a penal clause assesses damages it can be the subject of
judicial intervention, which was, as has been mentioned, the
prevailing doctrine both in canon law and thereafter in Continental
law. This article in fact introduces a startling innovation by
providing: " Lorsque la convention porte que celui qui manquera
de l'executer payera une certaine somme a titre de dommages-
interets, il ne peut etre alloue a l'autre partie une somme plus
forte, ni moindre."
The premises on which these two articles are based are, first,
that penal clauses are solely a means of assessing damages, and
secondly that it would be an unwarranted intervention with the
parties' contract for a court of law to modify in any way the
damages that have been agreed, for such intervention would
infringe the rule pacta sunt servanda, which plays a particularly
important role in the French law of contract and which will be
found in the first section of Article 1134 of the Civil Code.44
It is not without interest to note that when the Civil Code was
drafted there were partisans of the hybrid nature of penal
clauses,45 and the legislative section of the Tribunate even went so
far as to distinguish between cases where the penal clause provided
for the payment of liquidated damages and no judicial interven-
tion was desirable, and cases where the penal clause provided for

44 " Les conventions legalement formees tiennent lieu de Ioi a ceux qui les ont
faites."
45 See e.g., the opinion of the Tribunal of Montpellier cited in Fenet, Recueil
cowiplet des Travaux preparatoires du code civil, Paris. 1827-28, IV, p. 443.
612 International and Comparative Law Quarterly [VOL. 9

the payment of a penalty, which should be subject to judicial

control.46 This distinction was not, however, adopted.
The question whether or not a court of law should be
empowered to modify a penal clause was the subject of a heated
discussion, summed up by Bigot-Preameneu before the Conseil
d'Etat 47 in the following terms:
"On disait, d'un cote, que les contrats devant etre executes
de bonne foi, il etait juste de reduire la somme a laquelle les
parties avaient fixe les dommages-interets; que le debiteur n'a
consenti a en elever la fixation beaucoup au dela de la juste
proportion que parce qu'il s'est persuade qu'il pourrait remplir
ses engagements, et qu'il ne serait pas expose a la peine de
l'inexecution; que s'il eut prevu les obstacles qui l'ont arrete,
il ne se serait pas soumis a des dommages-interets si consider-
ables, qu'enfin les principes etaient ceux de la jurisprudence
actuelle.
On disait, d'un autre cote, que les parties sont les
appreciateurs les plus surs du dommage qui peut resulter de
l'inexecution d'un engagement; qu'ainsi leur volonte doit
etre respcctee; que si l'on accorde au juge le droit de diminuer
les dommages-interets qu'elles ont fixes, il faut done aussi leur
donner le pouvoir de les augmenter lorsque les circonstances
portent la perte du creancier au dela de ce qui avait ete
prevu. ...
" Au milieu de ces difficultes, la section s'est arretee a une
regle simple; elle a pense que quand les parties ont fixe elles-
memes le taux des dommages-interets, leur prevoyance ne
devait pas demeurer sans effet, et qu'il fallait respecter leurs
conventions, d'autant plus que, dans d'autres contrats, on ne
corrige pas les stipulations que les circonstances rendent
ensuite excessives. . . "
At the outset of this study, stress was laid on the fact that
where penal clauses are involved different results are sometimes
obtained by similar reasoning. This is particularly true of the
mode of dealing with penal clauses under French law. For having
analysed these clauses as the compensation in respect of damage
suffered from non-performance, as does Article 1229 of the Civil
Code, it would have been equally logical to conclude that where the
damage is less than the penalty the amount stipulated for should
be reduced-the solution favoured by classical Roman law, canon
law, and in fact by Dumoulin and Pothier. Instead we find that

46 See the commentary on the future article 1152 (art. 53, section 3, Chap. 2,
tit. 3, Liv. 3 of the " Projet de Code civil."
47 See Fenet, op. oit., XIII, Proces verbal de la seance du 11 brumaire.
OCT. 1960] Penal Clauses in Commercial Contracts 613

French law invokes the notion of the sanctity of contract to pre-

vent any such interference, much as English law relies upon the
freedom of contract to prevent interference by a court of law with
liquidated damages. The real reason behind the attitude of French
law would therefore not appear to be based upon a logical analysis
of the nature of penal clauses, but rather upon the fact that it is
not in the interest of public policy to interfere with a bargain freely
entered into solely on the ground of the inadequate appreciation
by the parties of the amount of damage likely to ensue from a
breach of contract. This public policy is, moreover, such that the
notion of the sanctity of contract is still invoked irrespective of
whether the penal clause is designed to assess damages, to secure
performance of a contractual obligation or to prevent its breach,48
whether the parties are equals from the point of view of their
economic power,49 whether the terminology used be " clause
" forfaits d'indemnite," " or even
penale," penalites,"
" amendes,' 50 and whether or not the damage be greater than the
sum stipulated.
Notwithstanding doctrinal criticism,51 the French courts have
been remarkably faithful to the rule laid down in Article 1152 of
the Civil Code in their refusal to alter the amounts stipulated in
penal clauses,52 and have constantly disregarded arguments
founded on natural justice and " equite." 53
Where commercial contracts are involved,54 there are in French
law three exceptions to the rule contained in Article 1152; namely
where there is part performance, where there is " dol " or " faute
lourde," 55 and lastly where a penal clause is used to avoid legal

48 e.g., where penal clauses are used by trade associationsto compel observance
of their rules. See Civ. 27 juin 1944, S. 1944.1.143.
49 This fact is deploredby Carbonnier,Droit Civil, 1959, II, p. 543, who draws
attention to the fact that where the parties are not on the same footing of
equality, recoursemust be had to legal theories of a general nature such as
abuse of rights, or " fraude i la loi," if it is desired to protect the weaker
party.
50 See Planiol, Ripert et Boulanger, Traite elementaire de droit civil, 4th ed.,
II, par. 752; Colin, Capitant et Julliot de la Morandiere, Traite de droit
civil, 1959, II, par. 918.
51 See Carbonnier,op. cit., p. 543; Planiol, Ripert et Boulanger, op. cit., par.
867.
52 See Req. Nov. 11, 1940, D.A. 1941.26; Civ. 8 mai 1933, D.H. 1933.3.95; Civ.
14 fev. 1866, D.P. 1866.1.85; Douai 25 fev. 1954, D. 1954.579.
53 See: Civ. 23 mai 1940, D.H. 1940.161.
54 Other exceptions exist, however, in fields that are outside the scope of this
study. Thus, there has been legislative interventionagainst the abusive use
of penal clauses between master and servant (see, e.g., the Code du Travail,
Livre I, Article 22(b), forbiddingpenal clauses in workshopregulations; the
Code du Travail, Livre I, Art. 22(o), forbiddingthe use of penal clauses by
employerswith regard to commercialtravellers).
55 It is not proposed to translate these terms, as there is no exact equivalent in
English law. An approximatetranslation would. however, be to use the
respectiveterms " fraud" and " gross misconduct."
 614 International and Comparative Law Quarterly [VOL. 9

liability in cases where the law prevents such an avoidance of

liability by means of clauses of non-responsibility. It is proposed
to consider these three exceptions before attempting to assess the
effect of penal clauses in practice under French law.
The first exception to the rule contained in Article 1152, unlike
the other two exceptions, is expressly laid down by the Civil Code
itself, for Article 1231 allows a judge to modify the amount stipu-
lated in a penal clause where there is part performance. The
underlying premise for Article 1231 is usually said to be the
presumed intent of the parties that their contractual assessment of
damages be altered where in fact the actual damage is reduced due
to part performance.56 This is a somewhat dubious argument, in
view of the refusal of the courts to reduce the contractual assess-
ment of damages in cases where, independently of the doctrine
of part performance, the actual damage is less than the sum
stipulated.
In practice moreover, Article 1231 is of extremely limited appli-
cation, for the courts have refused to apply its provisions where the
object of the penalty is to prevent delay in performance as opposed
to performance itself (which is of course one of the most common
uses of penal clauses in practice !).57 In addition, Article 1231 has
not been applied where part performance is quite incompatible with
the contract.58 Finally, mention must be made of the tendency of
the courts to discover a presumed intent in the parties' contract to
disregard the provisions of Article 1231 and thus to conserve the
draconian rigidity with which penal clauses are applied in French
law.59
The second exception to the rule in Article 1152 is entirely the
result of judicial construction, for the French courts have persis-
tently disregarded the sum stipulated in a penal clause where the
actual damage is greater by reason of the debtors " dol " or " faute
lourde "60 on the ground that it is contrary to public policy to
allow a debtor to benefit by his " dol " or " faute lourde." 61
The last exception to the rule in Article 1152 is that the courts
will inquire into the adequacy of a sum stipulated in a penal
clause in cases where the law excludes the contractual avoidance of

56 See Colin, Capitant et Julliot de la Morandiere, op. cit., par. 919.

57 See Civ. 4 juin 1860, D.P. 1860.1.257.
58 See Civ. 3 fev. 1937, D.H. 1938, Somm. 11.
59 See Colin. Capitant et Julliot de la Morandiere, op. cit., par. 919, Vaux, op.
cit., p. 33.
60 Civ. 29 juin 1948, D.1948.435; Req. 27 novembre 1934, D.H. 1935.51; Civ. 15
mars 1876, 5.1877.1.337. Also Cor. 7 juin 1952, D.1952.651.
61 In these cases the provisionsof Article 1150 are invoked which provide: " Le
debiteurn'est tenu que des dommageset interets qui ont ete prevus ou qu'on
a pu prevoirlors du contrat, lorsquece n'est point par son dol que l'obligation
n'est point executee."
OCT. 1960] Penal Clauses in Commercial Contracts 615

liability. An illustration 62 of such intervention by the courts will

be found in contracts for the carriage of goods,63 for the Commer-
cial Code forbids clauses of non-responsibility for loss and damage
in the case of the carriage of goods by land.64 In such cases, the
insertion of a very low figure as penalty would obviously provide a
means for drafting a clause of non-responsibility in the form of a
penal clause.
We have been considering at length what exceptions there are
to the rule contained in Article 1152 of the Civil Code, and it is now
proposed to examine the effect in practice where a commercial
contract contains a penal clause and none of these exceptions is
applicable.
The importance of the assimilation of penal clauses and dam-
ages is that penal clauses are enforceable solely where damages
can be awarded by a court of law. It follows that a penal clause
will not be enforceable where the contract of which it forms part is
void,65 or where the contract has been performed.66 It is therefore
necessary for the creditor suing on a penal clause solely, to prove
the existence of the contract containing the penal clause, that it
has been freely accepted by the debtor, and that the clause has
actually come into operation by reason of the circumstances in
which it is to apply.67
The assimilation of penal clauses and damages is not however
carried to its logical conclusion, for as has been repeatedly men-
tioned, Article 1152 of the Civil Code prevents a judge modifying
the stipulated penalty where the actual damage is less than the
latter. It has constantly been held that where the creditor seeks to
enforce a penal clause he is not required to prove either the amount
of damage he has suffered, or in fact any damage at all,68 since, to
use the language of the Cour de Cassation " L'indemnite fixee a
forfait par une clause penale est en principe invariable et arbi-
traire." 69 Therefore, where the damage suffered is less or equal to
the penalty, penal clauses are extremely useful in practice.

62 Another illustration of this intervention will be found in contracts between

master and servant. See Planiol & Ripert, Traite pratique de droit civil
franqais, 2nd ed., VII, p. 202, note (1), and the authorities there cited.
63 See Mazeaud, Traite theoriqueet pratique de la responsabilitdcivile, 4th
ed.,
III, par. 2628, and the authoritiesthere cited.
64 Article 103 as modified
by the Law of March 17, 1905.
65 See Art. 1226 of the Civil Code.
66 See Arts. 1229 al. 2, and 1231 of the Civil Code.
67 The creditor must, however, prove that he has
given formal notice to the
debtor to comply with the obligation secured by the penal clause. See Art.
1230 of the Civil Code.
68 Civ. 17 janvier 1906, D.1906.1.262; Req. 8 juillet 1873, D.P.1874.1.56. See
also Mazeaud, op. cit., III, p. 765, and the other authorities there cited.
69 Civ. 14 fev. 1866, D.P.1866.1.85.
 616 International and Comparative Law Quarterly [VOL. 9

However, where the damage flowing from non-performance

exceeds the amount stipulated in the penal clause, the latter will
constitute an inadequate remedy, apart from the fact that it shifts
the burden of proof, since Article 1152 of the Civil Code prevents a
creditor obtaining more than the amount stipulated in a penal
clause by suing on it.70 Moreover, in such a case the exact position
of the creditor in practice is doubtful, due to the provisions of
Articles 1228 and 1229 al.2 of the Civil Code which enable the
creditor to disregard the penal clause and to sue for performance
if he so desires.
Article 1228 provides: " Le creancier, au lieu de demander la
peine stipulee contre le debiteur qui est en demeure, peut pour-
suivre l'obligation principale." The corollary of this provision will
be found in the second section of Article 1229, which states that the
creditor has a choice between demanding performance and suing on
the penal clause save where the purpose of the latter is to cover
delayed performance, in which case the creditor can both sue on
the penal clause and require performance.71
The operation in practice of Articles 1228 and 1229 al.2 is far
from clear and the question may well be put: what is meant by
securing performance (l'execution de l'obligation principale)?
Mazeaud, commenting on these articles, states that in French law
the innocent party is always entitled to obtain a " condemnation
en nature " (judgment in kind) which in contract is the perfor-
mance of the contract itself.72 This statement however sheds but
little light on the problem, which may well be illustrated by two
practical examples.
The first example is a price maintenance agreement in a con-
tract of sale accompanied by a penal clause for non-performance.
A sells B 2,000 electric fans and B agrees that he will not
resell individual fans below 500 francs and that if he does so he
will pay A the penalty of 100 francs in respect of each fan sold
in derogation of the agreement. B sells fans in breach of the
agreement at 200 francs each. It is certain that if A relies on
the penal clause he will only recover 100 francs per fan. What if A
invokes Article 1228 ? It is clear that he can go to court and obtain
an injunction which will be accompanied by fines (astreintes) to
prevent further breaches of the contract, but can A invoke Article
70 Secretan, op. cit., p. 97, states it is generally agreed that the parties to a
contractcan providein a penal clause for the recoveryof additionaldamages
where the penalty is insufficient. However, he cites no authority for his
assertion, which does not appear to be in conformity with practice. The
point moreoveris not dealt with by such leading authorities as Planiol and
Ripert or Mazeaud.
71 "I1 ne peut demanderen meme temps le principalet la prime, a moins qu'elle
n'ait stipulee pour le simple retard." 72 Op. cit., III, par. 2637.
OCT. 1960] Penal Clauses in Commercial Contracts 617

1228 and argue that the " condemnation en nature " 73 is the
difference between the contract price and 200 ? The position is
very doubtful and it would seem to be an extremely easy way of
avoiding the sacrosanct nature of penal clauses in French law
were one to obtain damages by means of Article 1228.
The second example is a prohibition on resale in a commercial
contract also accompanied by a penal clause. A in France sells to
B in Belgium goods which are not to be re-exported into France or
any other country. The contract contains a penal clause. Assum-
ing that the contract is governed by French law, can A invoke the
provisions of Article 1228 and thus sue for damages arguing that
the " condemnation en nature " is B's profit ?

IV. GERMAN LAW

Like other systems of Continental law, German law does not recog-
nise the English distinction between liquidated damages and
penalties, and penal clauses are sometimes used to serve the pur-
poses of the one, sometimes those of the other, but more often of
both. However, the absence of this distinction does not have the
same dire consequences as in French law, for German law does not
recognise the principle of the immutability of penal clauses, at any
rate in so far as the Civil Code (BGB) is concerned, although this
principle exists to a limited extent in the Commercial Code (HGB).
In fact, in a general manner, the German law on the subject of
penal clauses follows the position which had been reached in Conti-
nental law at the dawn of the French Civil Code, reflected in the
writings of Dumoulin, Pothier, and the late canonists, which has
been referred to in Section II above, and arguments on the sanctity
of contract do not play the same role as in French law.
In the " motives " of the BGB, the hybrid nature of penal
clauses is laid down in unequivocal terms, for the purpose of these
clauses is stated to be twofold: first, to serve as a means of con-
straint, and secondly to secure damages for the creditor.74
Before examining the legal effect of penal clauses in German
law, mention should be made of their widespread use in practice
for a large variety of purposes, including cases where it would be
particularly difficult to prove damage, such as in cases of restric-
tions on competition, where these clauses operate as a veritable
sword of Damocles.75

73 This formula so beloved by French

lawyers is, however, not used in the Civil
Code.
74 ?420, which states moreover that this hybrid nature of
penal clauses is in
conformity with the general principles of modern law.
75 Esser, op. cit., p. 475, also mentions the widespread use of penal clauses by
trade associations, and in contracts by theatrical impresarios.
 618 International and Comparative Law Quarterly [VOL. 9

Mention has been made of the fact that, where penal clauses are
concerned, the principle of the sanctity of contract does not have
the same importance in German law as it does in French law.
Notwithstanding the hybrid character of penal clauses, German
law attaches great attention to the element of sanction prevalent in
these clauses, and judicial intervention is in fact possible both
where the damage exceeds the penalty and where the damage does
not do so.
Where the damage exceeds the penalty the creditor is in a
particularly favourable position under German law, for Article 340
of the BGB treats the penal clause as merely laying down a mini-
mum rate for damages, and thereby allows the creditor suing on a
penal clause to recover such excess damage as he may be able to
prove. The same article however excludes a creditor both claiming
performance of the contractual obligation and suing on the penal
clause, save where the penalty is designed to cover delayed per-
formance. Notwithstanding this provision it is possible in practice
to sue both for performance of the contractual obligation and for
payment of the penalty, for the courts have held that the provi-
sions of Article 340 can be excluded by agreement, and they have
been particularly ready to infer such an agreement where the
penalty is designed to compel performance of an obligation as
opposed to refraining from doing some act.76
Where the damage is less than the penalty, Article 343 of the
BGB,77 following the precedent of the Austrian Civil Code of
1811,78 allows a court of law to reduce the penalty in cases where
it is found to be disproportionately high. Article 343 is however
of limited interest where most commercial transactions are
involved,79 due to its application being expressly excluded by the
Commercial Code,8"and for this reason it is not proposed to dwell
on the application of Article 343 in practice.81

76 See RGZ 70, 441; 112, 336.

77 The provisionsof this article, unlike those of Art. 340, cannot be excludedby
agreement.
78 Art. 1336 II. This principle is also applied inter alia in Swiss law; see Art.
163 of the Code des obligations.
79 The Commercial Code applies to professional merchants and their professional
acts, see Art. I of the HGB. On the exact scope of these provisions see
Cohn, in the Manzualof German. Lawl 1950, I, pp. 212 et seq., and the refer-
ences there cited. Dr. Cohn in particular draws attention to the fact that
certain rules of the HGB, including the exclusion of Art. 343 of the BGB,
apply only to that person on whose side a contract is a commercial one.
Thus, where the debtor is a merchant within the meaning of the HGB, its
provisions will apply, but not where he is not a merchant.
so Art. 348.
81 A full account will be found in Esser, op. cit., pp. 475 et seq.
OCT. 1960] Penal Clauses in Commercial Contracts 619

Quite apart from the provisions of Article 343 of the BGB, there
are in German law two other cases in which judicial intervention
may be invoked by a debtor to relieve him of the consequences of
having entered into a valid contract 82 containing a penal clause,
and unlike the provisions of Article 343 of the BGB these cases are
not affected by the provisions of the Commercial Code. Thus
where a penal clause offends against the principle of die guten
Sitten (good morals) 83 laid down in Article 138 of the BGB, the
clause will be set aside by the courts. Similarly, the courts will
also set aside a penal clause if it offends the principle of Treu und
Glauben (good faith) in the interpretation of contracts to be found
in Article 157 of the BGB.
In practice, the German courts have made great use of the
principle of Treu und Glauben to reject penal clauses, and it has
been said that they never let an opportunity pass of intervening in
the debtor's favour.84 In justifying their intervention on the Treu
und Glauben principle, the courts have taken into account the
purpose of the penal clause and whether the breach of contract is
such that the enforcement of the penal clause is justified.85 Simi-
larly, the courts have examined the validity of penal clauses,
taking into account whether the penalty is fair having regard to
the circumstances existing and the quid pro quo received by the
debtor when he consented to the clause.86 Other factors that have
been taken into account include whether the parties intended to
apply the penalty to successive breaches of contract,87 and whether
the penal clause is to cover innocent breaches of contract as
opposed to cases where there has been wilful misconduct by the
debtor.88 In fact the higher the penalty, the greater will be found
the tendency to construe the penal clause as applying only where
there has been wilful misconduct.89 Finally, mention must be made
that in certain cases the courts have regarded the suing on a penal
clause as an abuse of rights, contrary to Article 226 of the BGB, or

82 As in all other legal systems a prerequisitefor the enforceabilityof a penal

clause is that the contract in which it is inserted is itself valid. However,
the limitation of actions with regard to the contract has been held not to
affect an action on the penal clause. See RGZ 114, 332.
83 The Reichsgericht has defined the term " good morals " as " not contravening
the sense of decency of every person who possesses understanding for what is
just and equitable." See on this question Cohn, op. cit., p. 46, and the
references there cited.
84 See Esser, op. cit.,
p. 482. Dr. Cohn, op. cit., I, p. 62, draws an analogy
between the Treu unodGlauben principle in German law and equity in English
law.
85 See RG JW 1920, 137; RG DJZ 1911, 537; RGZ 152, 261.
86 See RGZ 96, 174; RG JW 1921, 1528.
87 There will be found in
practice a marked hesitation to apply a penal clause
to successive breaches of contract. See RGZ 147, 229.
88 See RGZ 95, 200.
89 See RGZ 79, 40.
620 International and Comparative Law Quarterly [VOL. 9

as an infraction of the requirement of Treu und Glauben in the

performance of obligations as laid down in Article 242 of the
BGB.90
Notwithstanding the frequency of the circumstances justifying
judicial intervention for the purpose of modifying or setting aside
penal clauses, and the heterogenous nature of these circumstances,
it is apparent that penal clauses enjoy great popularity in Ger-
many. This popularity can be ascribed to two distinct factors.
The first is that, as in French law, the burden of proof is shifted by
means of a penal clause from the creditor to the debtor, and the
creditor is solely required to prove the existence of the circum-
stances giving rise to the penal clause's operation.91 The second
factor is that creditors find these clauses attractive because they
are not precluded thereby in German law from claiming any addi-
tional damage that they may be able to prove.

V. SOVIETLAW
As in other Continental legal systems, penal clauses have a hybrid
nature in Soviet law, being used both as a sanction to guarantee the
performance of a particular contractual obligation, and as a pre-
estimate of the damage likely to flow from the particular breach
of contract in question. However, as is the case in German law,
Soviet law lays greater emphasis upon the aspect of sanction in a
penal clause than does French law. At first sight, there is yet
another analogy between Soviet and German law on the subject of
penal clauses, due to the fact that the Soviet Civil Code does not
apply the principle of the immutability of these clauses, allowing a
creditor to sue for damages where these exceed the amount stipu-
lated for, and the debtor to ask a court of law to reduce the
penalty where it is out of proportion to the actual damage suffered.
However, in practice, whereas in German law a marked ten-
dency can be discerned to protect the debtor from the consequences
of penal clauses, in Soviet law the tendency is the reverse, at any
rate with regard to contracts between government agencies,
co-operatives or other institutions forming part of Soviet economic
life. This tendency of Soviet law finds expression in the Law of
90Relevant factors include the creditor's conduct and the importanceof the
breach of contract. See RG Leipziger Zeitschrift, 1929, col. 481; RGZ 147,
233.
91 This would appearto be implicit from the wording of Articles 339 and 345 of
the BGB. Under the first of these two articles, it is providedthat the penalty
becomesdue on the debtor's default. Under the second of these two articles,
it is providedthat where the debtor contests that the penal clause has come
into operationon the groundthat he has performedhis contractualobligations
he is requiredto furnish proof of performanceunless the obligation consists
in his refrainingfrom a particularact.
OCT. 1960] Penal Clauses in Commercial Contracts 621

December 19, 1933, providing for the widespread use of penal

clauses to guarantee the performance of contracts relating to the
delivery and the supply of goods entered into by government
agencies and similar bodies, and the provisions of the Civil Code
must therefore be seen in the light of this law.
It is, therefore, proposed to examine first the provisions of the
Civil Code relating to the legal effect of penal clauses, and secondly
how these provisions have been affected by the Law of December
19, 1933.
The R.S.F.S.R. Civil Code of 1922 defines a penalty in Article
141 as: " a sum of money or other property of a pecuniary value
which one party to a contract undertakes to transfer to the other
party in the event of non-performance or inadequate performance
of the contract ". The same article, moreover, goes on to provide
that: " Where a penal clause is stipulated in a contract or is added
to a contract, the creditor shall be entitled to choose between
demanding damages for non-performance or the payment of the
penalty. Where the penalty is stipulated for delay in, or for inade-
quate, performance, the creditor shall be entitled to demand both
the performance of the contract, and either the payment of the
penalty, or the payment of damage for the delay or the inadequate
performance." In addition, the first Note to Article 141 lays
down that a creditor shall be entitled to recover both the penalty
and damages solely where legislation or the parties' contract so
provides.
It follows from the above Article of the Civil Code, that where
the damage exceeds the penalty, the creditor must choose between
suing on the penal clause and suing for damages, except where the
parties have agreed to both remedies in their contract, or where the
law expressly so provides.92 In this respect the position under
Soviet law is different from that under German law, although the
results in practice are the same. Thus where the damage exceeds
the penalty, it is possible under the latter system to sue on the
penalty and recover the excess damages by treating the penalty as
merely laying down a minimum rate of damages. Under the Soviet
Civil Code this is not in general possible,93 although a similar result
is obtained by the creditor being entitled to disregard the penal
clause and sue for damages, which he will do whenever he is in a
position to prove the damage incurred. Otherwise the creditor will
92 An example of this will be found in the decision of the Council of People's
Commissarsof September14, 1937, regarding interest on overdue payments.
See also Art. 95 of the Civil Code relating to the mortgagee'sremedies.
93 As will be seen below, where standard forms of contract are concerned,
arbitral awards, and administrative decisions adjudicating between State
trading organisations,have in practice allowed the creditorsuing on a penal
clause to recoverexcess damages.
622 International and Comparative Law Quarterly [VOL. 9

have to rely on the penal clause, since as is the case in other legal
systems a penal clause avoids the creditor having to prove the
amount of his loss.
The provisions of Article 341 differ in yet another respect from
the position under German law where it is not possible to claim
both performance of the contract and the penalty, save where the
parties have so agreed, although in practice the German courts
have been particularly ready to infer such agreement as has been
seen. Under Article 141, where the penal clause is designed to
prevent delay in performance, or where it is designed to prevent
inadequate performance (a term which in Soviet law covers a host
of contingencies such as performance effected after the contractual
date, defects as to quantity or quality etc.) the creditor can both
sue for performance and for the payment of the penalty, irrespec-
tive of there being any special agreement to this effect.
As is the case under the German Civil Code, the Soviet Civil
Code allows a court of law to reduce inordinately high penalties.
The relevant provision is Article 142 of the Civil Code which
provides:
" Where the penalty incurred is inordinately high in com-
parison with the actual damage inflicted on the creditor, the
court shall be entitled to reduce the penalty at the debtor's
request.
In so doing the court must take into consideration:
(1) The degree of performance of the contract by the
debtor;
(2) The material situation of the parties;
(4) Every interest of the creditor meriting consideration
in addition to his material interest."
The provisions of Article 142 will be seen to cover both the case
where the actual damage is less than the sum stipulated for in the
penal clause by reason of part-performance of the contract by the
debtor, as well as cases where irrespective of any part performance
the amount stipulated is found to be inordinately high in relation
to the actual damage suffered. However, the R.S.F.S.R. Supreme
Court has refused to apply the provisions of Article 142 to set aside
a penal clause where there is in fact no damage at all. In a deci-
sion of 1926, the court, criticising the position taken by certain
courts of inferior jurisdiction, has stated that such an interpreta-
tion of Article 142 fails to take into account the two distinct pur-
poses of penal clauses, which are to compensate for damage and to
guarantee performance.94 In the case in question the court went
94 R.S.F.S.R. Supreme Court, Civil Appellate Division, 1926, Civil Code (1943)
178.
OCT. 1960] Penal Clauses in Commercial Contracts 623

on to state that the setting aside of a penalty where there is no

damage would deprive the creditor of guarantees stipulated to
secure performance, would weaken the legal effects of contracts
unnecessarily, and would fail to take into account the great utility
of penalties in trade relations.
Mention has been made of the fact that the provisions of the
Civil Code on penal clauses must be seen in the light of the Law of
December 19, 1933, No. 445, concerning contracts between Govern-
ment agencies, and it is therefore proposed to examine the relevant
provisions of this law, but before so doing it is necessary to mention
briefly its background.
At the time of the enactment of the Civil Code in 1922 the new
economic order was far from crystallised, for the attempt to achieve
the new order had foundered and was replaced by a period of the
so-called New Economic Policy (N.E.P.) which sought a compro-
mise with capitalism within the country. This period ended in
1929 with the introduction of the Five-Year Plan whose aim was to
exterminate all vestiges of capitalism, and with the passing of a
large number of laws which directly or indirectly touched the Civil
Code. However, notwithstanding the fact that certain provisions
of the Code designed for private enterprise lost all significance,
these provisions were never formally repealed.95
The change in Soviet economic policy just mentioned was not
without impact on the utilisation of penal clauses,96 for one of the
prerequisites for the successful carrying out of the Five-Year Plan
was the strict observance of its discipline, and to achieve this,
numerous enactments (and in particular the Law of December 19,
1933) were passed, setting out special rules to govern contracts
between government agencies.
The Law of December 19, 1933,97 provides inter alia: that penal
clauses shall be inserted in every contract; that the penalty stipu-
lated shall differ according to the importance of each delivery of
goods and according to the degree of the contract's performance
when it is invoked; that penal clauses shall cover the case where
the goods are of defective quality; and finally, that during arbitral
proceedings arising on breach of contract the arbitrators shall be
empowered to increase the amount of the penalty stipulated where
there have been systematic breaches of contract.

95 See Gsovski, Soviet Civil Law, Michigan, 1948, I, pp. 5 et seq.

96 The whole subject of the impact of Soviet economic
policy on the utilisation
of penal clauses is admirablydealt with by Grabe,op. cit.
97 This law, originally enacted to cover contractsto be concluded
during 1934, is
still in force by virtue of subsequent enactments. See, e.g., USSR Laws
1934, No. 435; 1935, No. 27; 1938, No. 302; 1939, Nos. 617 and 618; and
1942, No. 191.
624 International and Comparative Law Quarterly [VOL. 9

The above law has had a far-reaching effect on the whole of

Soviet commercial law, for the provisions relating to penal clauses
have been rigorously applied in the different standard forms of
contract drawn up by the various administrations concerned.
These standard forms of contract contain different rates of penal-
ties for different breaches of contract, such as the failure to deliver
on time, the failure to pay on time, and the delivery of defective
goods. In addition, in certain cases, both minimum and maximum
rates of penalties are laid down, and in others, an ascending scale of
penalties for each day of default is used.
The standard contracts just mentioned have given rise to a host
of arbitral awards in which the effect of inserting a penal clause in
a contract differs in three respects from the effect where a standard
form of contract is not used and where the position is covered
wholly by the provisions of Articles 141 and 142 of the Civil Code
cited above.
The first difference that will be noted is that whereas in general
under the provision of Article 141 the creditor cannot claim both
the penalty and damages, where the various standard contracts in
question have been used, this is possible. Thus, the creditor who
has sued on the penalty will be able subsequently to claim damages
if he finds that his loss in fact exceeds the amount of the penalty.
In this case, however, the creditor will have to prove the excess
damage.
Secondly, whatever be the purpose of the penalty the creditor
has invariably been allowed to require performance in addition to
the payment of the penalty and/or damages.
Lastly, the arbitral awards in question have in certain cases
increased penalties but have never applied Article 142 of the Civil
Code to reduce penalties.
Notwithstanding the fact that the standard forms of contract
just referred to were drawn up for the purpose of internal trade in
the USSR, from the point of view of international trade their legal
effect with regard to penal clauses cannot be ignored where these
standard forms of contract have been utilised by Soviet Govern-
ment agencies in their trade with foreign countries.
Before concluding this account of Soviet law, mention should
be made of the fact that the provisions on penal clauses to be
found in the above standard forms of contract have been utilised
in the various bilateral trade agreements concluded by the Soviet
Union with the countries of Eastern Europe. Moreover in 1958,98

98 See Berman, " Unification of contract clauses in trade between member-

countries of the Council for Mutual Economic Aid" (1958) I.C.L.Q., p. 659.
OCT. 1960] Penal Clauses in Commercial Contracts 625

following the precedent established by the United Nations Eco-

nomic Commission for Europe,99 the countries of Eastern Europe,
members of the Council for Mutual Economic Aid, drew up various
standard forms of contract for international (e.g., Eastern Euro-
pean) trade, and these standard contracts contain penal clauses
inspired by the Soviet Law of December 19, 1933, unlike the
various ECE General Conditions which were drawn up for trade
between all the countries of Europe, and which do not generally
make use of penalties as opposed to clauses providing for the pay-
ment of liquidated damages due to the inherent uncertainties
attached to such clauses in international trade.

VI. CONCLUSIONS
In endeavouring to assess the advantage in practice of inserting in
a commercial contract a clause providing for the payment of a
penalty, a clause providing for the payment of liquidated damages,
or a penal clause, as the case may be, it is imperative to distinguish
between the utility of these clauses from the point of view of
substantive law, and their utility from the point of view of proce-
dure, for the latter will be found to be greater than the former. It
is therefore proposed to attempt to draw conclusions first of all
from the former aspect of the subject-matter of this study, that is
to say with the utility of these clauses from the point of view of
their substantive legal effect. Secondly, the procedural utility of
these clauses will be considered.

(a) Substantive law

Inasmuch as the substantive legal effect of penal clauses in
Continental law is concerned, and to a certain extent that of clauses
providing for the payment of a penalty or liquidated damages in
English law, it would appear from the above sections of this study
that the prima facie attraction of these clauses is somewhat
tempered by the degree of uncertainty that surrounds their exact
legal effect, which degree is accentuated where international com-
mercial contracts are involved as opposed to contracts which do
not contain a foreign element.

99 e.g., General Conditions for the supply of plant and machinery for export
Nos. 188 and 574 (UN sales numbers ME/188 bis/53 and ME/574/55);
General Conditions for the supply and erection of plant and machinery for
import and export Nos. 188A and 574A (UN sales numbers 1957.II.E/Mim.3
and 1957.II.E/Mim.4); General Conditions for export and import of sawn
softwood (UN sales number ME/410/56); General Conditions for the export
and import of solid fuels (UN sales number 1959.II.E/Mim.1); General
Conditions for the international sale of citrus fruit (UN sales number
1958.II.E/Mim.12); c.i.f. and f.o.b. contracts (maritime) for the sale of
cereals, Nos. 1A-5A, and 1B-5B inclusive (UN sales numbers
1957.II.E/Mim.21).
626 International and Comparative Law Quarterly [VOL. 9

The obscurity surrounding the precise legal effect of the clauses

under consideration would appear to result primarily from the fact
that the attitude of any given legal system towards them depends
upon considerations of public policy, which may be somewhat
elusive ! Moreover, when account is taken of the fact that public
policy with regard to these clauses not only varies within a country
over a given period of history (see, e.g., in Section I above, the
account of the changing attitude of the common law courts in
England, and in Section V above, the various attitudes taken by
the Soviet courts at different periods of Soviet legal history), but
also from country to country, it is little wonder that from the point
of view of international commercial contracts there is uncertainty
as to the legal effect of the clauses in question.
The fact that the public policy of any given legal system
towards the above clauses is made up of a welter of conflicting
principles, means that the rules that are evolved reflect this conflict
and are not precise. Thus in English law, as we have seen, the
courts are constantly faced with the problem of reconciling the
principle of the freedom of contract with that of the avoidance of
undue pressure in a contract by means of a penal clause. Simi-
larly, in French law, as has been mentioned above, there is the
problem of reconciling the sanctity of contract and the doctrine of
the immutability of penal clauses with the refusal to allow a person
to profit by his dol or faute lourde or with the possibility of varying
penal clauses where there has been part performance, and in Ger-
man law the conflict between the rigid principles of the Commercial
Code and the Treu und Glauben principle. Finally, one should
mention the difference between the principles set out in the Soviet
Civil Code with regard to penal clauses and those contained in the
Law of December 19, 1933.
From the preceding sections of this study it would appear that
the uncertain effect of the above clauses is greater in Continental
law than it is in English law due to the fact that the latter system
of law fully recognises the heterogenous character of the purposes
served by these clauses, and goes on to differentiate between their
damage aspect and their sanction aspect, in the distinction that is
drawn between the legal effects of clauses providing for the
payment of liquidated damages, and of clauses providing for the
payment of penalties.
The distinction between the legal consequences of each of these
two forms of clause is capital if one is to reduce the difficulties
surrounding their precise legal effect. The fact that French, Ger-
man and Soviet law recognise the hybrid nature of penal clauses
but nevertheless refuse to differentiate between the legal effect of a
OCT. 1960] Penal Clauses in Commercial Contracts 627

penal clause where its primary purpose is to assess damages and

where its primary purpose is to secure performance, means that in
practice each system allows one of these two facets of penal clauses
to dominate its legal thinking on the subject. The resultant effect
is that the rules applicable to penal clauses in French, German and
Soviet law are designed to apply to one of these two facets alone
(i.e., the damage aspect in French law, and the sanction aspect in
German and Soviet law).
The practical consequence of this mode of legal thinking is the
extreme complexity of French, German or Soviet law on the
subject of penal clauses, for starting from the principle that penal
clauses are or are not subject to modification, each system has
grafted on the rule it has adopted a whole series of exceptions that
give rise to considerable uncertainty in practice. In this context it
is perhaps not out of place to recall the obscurity that exists with
regard to Articles 1228 and 1229 al.2 of the French Civil Code,
enabling a creditor to disregard the penal clause and sue for
performance of the contractual obligation, or with regard to the
precise impact on German commercial law of the principles of die
guten Sitten and of Treu und Glauben.
To conclude this account of the substantive legal effects on
international commercial transactions of the clauses under con-
sideration, it is respectfully submitted that these clauses, which
appear so attractive at first sight, are a deadly weapon, due to
the confusion and uncertainty engendered thereby in commercial
relations.

(b) Procedure
Apart from the case where English law regards the above
variety of clause as providing for the payment of a penalty, there
is a distinct advantage to be obtained from these clauses in the
realm of procedure, for as has been seen above, in all the legal
systems considered, the burden of proof is shifted from debtor to
creditor by a penal clause, or a clause for the payment of liquidated
damages. This procedural advantage would therefore seem to be
the sole major asset that these clauses have, and the question may
well be put whether this asset is a sufficient counterbalance to their
uncertainty from the point of view of substantive law.

I.C.L.Q.--9 33