Penalty clauses in Property Contracts

If you wish to include a penalty clause in a property deal, it is critical you ensure any penalty sum due is proportionate to the loss incurred.

In a recent case involving Halton Borough Council (Halton BC), the High Court ruled that a penalty clause requiring a developer to pay £240,000 to Halton BC was not enforceable. The penalty was due if the developer had not started developing the site within three years of purchasing the land. The reason was that the penalty payment was not in proportion to the loss incurred by Halton Borough Council by the breach. The judge stated that the penalty payment was “extravagant, exorbitant and unconscionable and therefore unenforceable”.

In all contractual situations, it is crucial that the financial penalties in any penalty provisions are proportional to their practical usefulness. The judge found that the penalty clause in question was excessive because the extensive terms of the original 2011 transfer from Halton BC to the developer meant that the covenant added very little surplus value, especially as “it only required commencement of development, instead of completion”.

Moreover, in this case, Halton BC also had overage provisions in place following the completion of the project which meant that once any development was completed, they would have been entitled to additional payment. This ‘win-win’ situation was used by the judge to further demonstrate the exorbitance of the penalty and, consequently, should be avoided by those drafting contracts.

Clearly, what is a proportionate level to set any penalty payment will vary in each case according to each particular set of circumstances. This makes it hard to set a precise sum. However, we would recommend that if you are considering incorporating a penalty provision in a property contract, you get independent advice from a valuer or surveyor to try and assess what actual impact on values any breach may create. This should reduce the risk that any such payment will be unenforceable.

For any specific queries, please call our Real Estate team today on 0113 207 0000.