Penalty Clauses Who has to Prove the Penalty

A recent Scottish case has confirmed that the burden of proving whether or not a contractual clause is a penalty falls on the contractor where he wishes to challenge the clause.  In Hill v. Stewart Milne Group and Gladedale (Northern) Limited, the developer had entered into an agreement with the contractors relating to the installation of a sewage system and the connection of the same to the developer’s intended site.  The contractors were to use all reasonable endeavours to ensure that the sewage system was completed by a longstop date.  Unfortunately, the works were not completed in time and the developer wanted to claim the £5,000.00 per month provided for under the agreement until the sewage system was finally commissioned.  The contractors tried to counter this by saying that the monthly sum was a penalty and could not therefore be enforceable.  The Court decided that it was for the developer to show that the clause was enforceable, in other words, that the monthly sum was indeed a genuine pre-estimate of loss and damage.  As the developer had not adduced any sufficient evidence to establish this, it could not succeed. 

In the appeal by the developer, however, the contractors took the point that the question of whether the clause was or was not a penalty could not arise where there was no breach of contract.  In fact, in this case, the developer had not pleaded a case in breach of contract.  In response, the developer argued that the agreement provided for payment of the monthly sum where the works had not been completed by the longstop date regardless of whether or not the contractors were in breach of contract. 

The Appeal Court disagreed with the lower Court on the question of whose duty it was to show that the clause was a genuine pre-estimate of damage.  While it was clear that the developer could have led evidence on the point, the burden of proof undoubtedly lay on the contractors, not the developer.  The Appeal Court also indicated that the lower Court had erred in finding that the real reason for the developer’s intended sale of the site had not been due to the failure to complete the sewage system, but rather to do with the market conditions.  It was quite clear that the contractors had not produced evidence to confirm that the monthly sum was a penalty rather than a genuine pre-estimate of damage.  It was also suggested that the lower Court had erred in appearing to find that it was necessary to establish that actual losses caused by the failure to complete the works in time were of the same sort or type that the pre-estimate was there to quantify. 

For further advice and assistance in relation to construction law or construction dispute resolution, please speak to Iain MacLauchlan, Employed Barrister and Associate in the Dispute Resolution Department on 01484 519999.

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