“Relaxing penalties”? Sounds like an oxymoron

Did you know?

The Hong Kong courts are now relaxing the legal test on what is a “penalty” to allow a wider range of agreed damages in commercial contracts.

Why does this matter to you?

It is notoriously difficult and time consuming (not to mention costly!) to assess damages for breach of contract which must be proved by the innocent party. Therefore, it is common for contracting parties to want to agree a specific sum of damages in relation to a certain breach of contract ahead of time in the contract. However, if the sum agreed is determined to be a penalty, then it will be unenforceable.

The main issue under the “old” position in law was the requirement to stipulate a “genuine pre-estimate of damages” – if this requirement (among others) was met, then the remedy would not be a penalty, and would be enforceable. As mentioned, trying to calculate a genuine pre-estimate of damages is notoriously difficult (certainly any precise pre-estimation is almost impossible) as one would have to project what the breach (and therefore the damages) may be, and there is the risk that the estimated sum may be too much leading to the agreed amount being a penalty and therefore unenforceable, or too little and not covering the actual damages. This requirement was also often applied too rigidly, and ultimately arguably interfered with the freedom of contract.

However, a recent case in the Supreme Court of England & Wales changed the test for determining whether a remedy amounts to a penalty – and the Hong Kong courts have been applying this new test.

The test is a more “relaxed” way of determining penalties, as it now revolves around determining whether the non-defaulting party has a legitimate interest which the remedy seeks to protect, and whether the remedy sought is exorbitant or unconscionable for the protection of that legitimate interest. This means that contracting parties now have more freedom to agree on a specific sum of damages (or alternative remedies) for certain breaches of contract, where the predominant purpose of the remedy can be to act as a deterrent against a certain breach.

Of course, there are still rules (what court wouldn’t leave any more rules to follow?), and contracting parties must still take precautions to ensure the remedy agreed is not determined to be a penalty and so unenforceable.

So do you want to deter a contracting party from breaching your agreement or to ensure that if there is a breach, you would not have to go through the uncertainty, time and costs to prove your damages (but still worry your agreed remedy may be determined to be a penalty)? Contact us and we will be happy to help you come up with a solution depending on your specific circumstances!

How can Deacons help?

Deacons offers a wide range of services and advice in relation to commercial IP matters. These include:

• Drafting/reviewing commercial/IT/IP agreements (including assignments, licences, development agreements, distribution agreements, manufacturing agreements, non-disclosure agreements, services agreements, etc.)
• Advising on the IP aspects of corporate transactions (including IP due diligence in business acquisitions and stock exchange listings)
• Advising on general commercial IP matters such as software (development, maintenance, and licensing), e-commerce, and personal data (including general privacy matters, privacy policy documents and terms of business)

If you have any questions or concerns about your commercial IP contracts/practices, or would like any further information, please contact us at: charmaine.koo@deacons.com or david.swain@deacons.com.