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Simple English definitions for legal terms
penalty clause
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A quick definition of penalty clause:
A penalty clause is a part of a contract that says if someone breaks the contract, they have to pay a lot of money that is not fair. It's like a punishment instead of a reasonable amount of money for the harm caused by breaking the contract. Penalty clauses are not allowed because they are too harsh. For example, if someone rents an apartment and the contract says they have to pay $750 a day if they stay longer than they are supposed to, that is not fair and is a penalty clause. The law says that contracts can have a fair amount of money that someone has to pay if they break the contract, but not too much.
A more thorough explanation:
A penalty clause is a part of a contract that imposes damages that are unreasonably high and represent a punishment for breach, rather than a reasonable forecast of damages for the harm that is caused by the breach. These clauses allow parties to agree to their respective damages liability if they later breach. However, courts do not enforce penalty clauses.
For example, if a landlord leases an apartment to a tenant for $1000 a month and the lease provides that if a tenant holds over, the tenant must pay $750 per day, then this would be considered a penalty clause and be invalid because the damages for holding over are excessive.
Another example could be a contract between a company and a vendor. The contract states that if the vendor is late in delivering the goods, they must pay the company $10,000 per day. This would also be considered a penalty clause and be invalid because the damages are excessive and do not represent a reasonable forecast of damages for the harm caused by the breach.
These examples illustrate how penalty clauses are unenforceable because they do not represent a reasonable forecast of damages for the harm caused by the breach. Instead, they are seen as a punishment for breaching the contract.