Penalties

When negotiating an agreement, parties should consider whether it is appropriate to include a provision that deters a party from committing a breach by stipulating that the defaulting party shall be obliged to pay the other party a fixed sum of money, or to return assets or even forfeit instalments which have been paid or which have become due. The provision may even provide that upon withdrawal of an agreement by a party under circumstances specified therein, any other party will forfeit the right to claim restitution of its performance in accordance with the terms of the agreement, or must, notwithstanding the withdrawal, remain liable for the performance of anything thereunder, as seen in section 4 of the Conventional Penalties Act 15 of 1962 (Penalties Act).

Such provisions are classified as penalties. When an agreement contains such penalty provisions, the Penalties Act will be applicable. Section 1 of the Penalties Act empowers a competent court to enforce a penalty clause. In terms of section 2 of the Penalties Act, penalties and damages may not both be recovered by a party, and an innocent party will not be entitled to recover damages instead of the penalty, unless the agreement expressly provides otherwise. However, contracting parties must note that if a penalty provision is included and defective, or non-timeous performance is accepted, or a party is obliged to accept same, the penalty may not be recovered unless the agreement expressly stipulates that it can be recovered.

If a penalty provision is being considered, parties must ensure that it is not excessive as section 3 of the Penalties Act enables a court to reduce a penalty to one it considers equitable if it appears to the court that the penalty is not in proportion to the prejudice suffered.

Damages

Another remedy for a breach of an agreement if the inclusion of a penalty provision is not reasonable and financial loss is suffered, is a claim for damages. It is trite that a claim for damages is intended to place the innocent party in a position they would have been in had the defaulting party performed properly, as long as it can be done by way of a payment of money.

In order to claim damages, the innocent party must prove i) that a breach was committed, ii) financial or patrimonial loss was suffered, iii) there is a factual causal link between the breach committed and loss suffered (i.e the loss would not have been suffered had the breach not been committed), and iv) that the loss is not too remote a consequence of the breach (i.e whether there is a sufficiently close causal connection between the breach and loss to justify the imposition of liability while distinguishing between whether it will be general damages and special damages).

General damages are those damages which follow naturally from the type of breach and are presumed to be not too remote as they might be expected in the ordinary course. However, special damages are those damages that would not normally be expected from the breach committed but rather arise due to special circumstances. The general rule is that a party cannot be held responsible for special damages unless the following can be proved:

• the damages were actually foreseen or reasonably foreseeable when the agreement was concluded; and
• the contacting parties concluded the agreement on the basis of their knowledge of the special circumstances and therefore can be seen to have agreed that liability would arise from these specific circumstances.

The latter principle has been noted by our courts to be unreasonably strict as an agreement must be shown before liability arises. However, until Lavery & Co Ltd v Jungheinich [1931] AD 156 is overturned by our courts, the principle is considered part of South African law. We note, however, that most commercial agreements will include a limitation of liability for any loss of profit or any other indirect, special or consequential loss.

Indemnities

In addition to a penalty provision or damages claim, contracting parties may add additional protection in their agreements against financial loss by including an indemnity clause. An indemnity provides that one party will agree to bear all the costs of any loss suffered by another party which arises from, inter alia, a failure of any of the warranties or undertakings or breach of or non-compliance of any obligation.

Conclusion

Contracting parties have various mechanisms to protect against loss and have various remedies in the event of loss. A party may wish to include a penalty provision to reduce the burden of proof which would be required for a claim for damages. An indemnity may be provided in addition to either remedy as a further form of protection against financial loss. We thus recommend that contracting parties consider the nature of the commercial agreement being concluded and negotiate the most preferable remedy in order to protect themselves to the fullest extent possible.