A clause in a contract which provides for payment of a sum of money on breach of the contract may be unenforceable if it is a penalty clause.
How do you know if a clause is a penalty clause?
The traditional test is to ask whether the amount payable on a breach is a genuine pre-estimate of the loss the innocent party may incur in the event of a breach. If it is not, the clause is a penalty and so unenforceable.
The UK Supreme Court recently introduced a new test. It said
that a clause will be a penalty clause if it imposes a detriment on
the contract-breaker out of all proportion to any legitimate
interest of the innocent party in the enforcement of the primary
obligation under the contract.
As it stands, the traditional test is the test applicable in Ireland. However, if this matter comes before the Irish courts, the recent decision of the UK Supreme Court might persuade the Irish courts to adopt the new UK approach.
This article contains a general summary of developments and is not a complete or definitive statement of the law. Specific legal advice should be obtained where appropriate.