The issue of excessive penalty clauses in commercial contracts: How did the court reduce the compensation?

The issue of excessive penalty clauses in commercial contracts: How did the court reduce the compensation?

Penalty clause cases are among the most frequent before commercial courts in Saudi Arabia, especially when one party claims substantial sums after contract termination. In this high-profile case, a lawyer successfully proved that the agreed-upon penalty clause was excessive compared to the actual damages, resulting in a significant reduction. The court based its decision on legal principles stipulating that the determining factor is the actual damages, not the amount stipulated in the contract.

Case facts

The case arose between a project owner and a contracting company with whom he had a contract to carry out construction work. The contract was terminated before the work was completed, and the company demanded that the project owner pay a penalty clause of 20% of the contract value, a substantial sum considering the stage the work had reached.

Project owner's defense

The lawyer presented several arguments proving that the penalty clause was unfair and disproportionate to the actual damage.

1. The company has only completed a small percentage of the project.
2. The delay did not significantly affect the project's timeline.
3. The value of the penalty clause is much greater than the actual amount of damage.
4. Submitting engineering and technical reports that prove this

Defense of the contracting company

The company maintained that the penalty clause was part of the contract terms and binding on both parties, and that it should be applied as is without modification.

The court's approach to dealing with the penalty clause

The court based its decision on the statutory rule contained in the Civil Transactions Law, which stipulates that compensation must be commensurate with the actual damage.

1. The penalty clause is not binding if it is excessive.
2. The judge may reduce it to a limit equal to the extent of the damage.
3. The affected party can prove that the amount is unfair.

The ruling issued

After examining the technical and financial evidence, the court ruled as follows:

1. Significant reduction in the penalty clause
2. The project owner is not obligated to pay the full amount specified in the contract.
3. Actual compensation is based on the project's completion phases.

This ruling sent a clear message that a penalty clause does not necessarily imply an absolute obligation if it is unreasonable or disproportionate.

The importance of this case

This case has become an important reference because it illustrates the following principles.

1. The judge has discretionary power to modify the penalty clause.
2. The important thing is the actual extent of the damage, not the amount written in the contract.
3. The affected party can avoid hefty sums if they provide valid technical evidence.
4. Legal consultations before entering into a contract can prevent many future disputes.

Summary

This case underscores that fairness for contracting parties is not achieved simply by drafting strict clauses in the contract, but rather by ensuring justice that takes into account the nature of the work and the actual extent of the harm. It also demonstrates the lawyer's skill in shifting the course of the case through technical evidence and systematic arguments.