Document Type : Original Article
Authors
1
PhD. Candidate, Faculty of Law, Shahid Beheshti University, Tehran, Iran Corresponding Author Email: vfmlawyer@gmail.com
2
Assistant Professor, Faculty of Law, Shahid Beheshti University, Tehran, Iran
Abstract
In contractual agreements, parties commonly include a liquidated damages clause, under which a predetermined amount is to be paid in the event of a breach. Liquidated damages represents the parties’ mutual agreement to ensure the performance of obligations. One of its advantages is that in order to claim damages, there is no need to prove actual harm or establish causality between the wrongful act and the resulting damage. Such features encourage the parties to include this clause and make it a popular tool in contracts, especially in cases where there is a possibility of breach of obligation or the impossibility of proving actual damages in practice. However, it is necessary to question whether the absolute and unconditional enforcement of this clause is always logical, fair and economical. Article 230 of the Civil Code states: “If it is stipulated in a contract that in case of breach the breaching party shall pay a certain sum as compensation, the judge may not award more or less than that amount.” In other words, the amount agreed upon between the parties (liquidated damages) is recognized as the final and enforceable damages and the court cannot adjust or change it. According to the aforementioned article, the arbitrator or judge is obliged to use the same amount as the criterion and refrain from violating the provisions of the contractual clause. However, in some cases, the absolute implementation of this rule in practice may lead to unfair and unjust results, especially when the economic, social, or even personal circumstances of one of the parties have changed after the conclusion of the contract. In contrast, in common law systems such as England, an excessive penalty clause is not enforceable. English courts do not automatically accept the parties’ agreement; if the stipulated amount significantly exceeds the estimated actual loss, the clause is considered a penalty clause and declared unenforceable. In English law, the principle is that of actual and reasonable compensation for damages, not punishment for the breaching party. Therefore, judges distinguish between a “reasonable lump sum” and a “penalty clause” and consider a penal clause to be valid only if it is justified in economic and equitable terms. In other words, penalty clauses are not enforceable in English law unless they are reasonably related to anticipated loss, rather than merely designed to punish or intimidate the breaching party. In law and economics literature, the classical view is that the penalty clause hinders the efficiency of the market and contracts. Classical economists believe that after the conclusion of the contract, conditions may arise in which the performance of the obligation is more costly for the obligor than its benefit. In such scenarios, breaching the contract while paying fair compensation - known as efficient breach- can yield better results for all parties and society. However, excessive penalty clauses distort this mechanism by reducing the incentive to pursue economically beneficial breaches. They also hinder optimal resource reallocation and may force performance in situations where breach would be more efficient outcome for the society. However, recent analyses in economic law indicate that a penalty clause is not necessarily always detrimental to efficiency and may even be beneficial in some cases. From this perspective, a clear fixed amount for breach can operate as a pre-arranged option that enhances transparency and predictability in contractual relationships. In this case, the parties know from the outset what amount they will receive in the event of a breach and can better adjust their economic decisions. Some studies show that a penalty clause can also facilitate efficient breach; on the one hand, the need to file a lawsuit in court to determine the amount of damage is reduced from this perspective and, on the other hand, as a deterrent, it forces the obligor to pursue long-term interests and perform obligations on time. Such a clause can also be considered an alternative to an insurance contract. Despite the aforementioned benefits, an exorbitant penalty clause should not be enforced unconditionally. The contemporary approach of legal scholars is that a penalty clause must have a “reasonable economic role” in the contract. If the opposite is proven (i.e. if it is found that the parties imposed the onerous condition solely as a punishment or unfair pressure), its implementation is unacceptable. It is also necessary to distinguish between the terms of supplementary contracts and contracts concluded through fair negotiation. In summary, it can be acknowledged that although the obligation is a useful tool for ensuring the performance of contractual obligations, the absolute implementation of an excessive penalty clause does not necessarily lead to justice and economic efficiency. From the perspective of modern economic law, a penalty clause can be constructive when it is applied in the contract with a clear economic purpose; otherwise, it should be viewed with greater consideration and, in necessary cases, the possibility of adjusting the clause should be provided. Accordingly, it seems necessary to revise article 230 of the Iranian Civil Code so that in the cases of excess and unfairness, the court can adjust the amount of the penalty clause and reduce its unfair consequences, without questioning the principle of partis' autonomy in the entire contract.
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