Business Agreements: The Limits of the Penal Clause

Article #2009-3, by Me Gilles Thibault on Dimanche, octobre 11th, 2009
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Business agreements often include a penal clause. This provision establishes a set amount or computation method for an amount to be paid by one of the parties to the other in the event that it fails to comply with one of its obligations pursuant to the contract. For instance, the non-compliance with a deadline in a supply agreement or with a non-competition undertaking in a share purchase agreement often triggers a right to claim a penalty from the defaulting party the details of which are usually found in a penal clause. The practical reason for this clause is that it allows the creditor of the obligation to circumvent the need to prove the damages suffered due to such breach by establishing, in advance, an amount or computation method for an amount to be paid as reparation. Although these provisions are acceptable under Quebec laws, they are governed by specific rules which limit their impact, such as the reasonability requirement for the agreed-upon penalty. A recent decision of the Superior Court illustrates this reasonability requirement in the Agence Maître Boucher inc. c. Robert1 ruling.

Facts

Agence Maître Boucher inc. (hereinafter referred to as « Agence ») is a personnel placement agency which is specialized in the field of butchery. In the course of its activities, it executes contracts with butchers, which contracts contain, among others, a non-competition provision. Martin Lessard (hereinafter referred to as « Lessard ») is a butcher working for Agence.

In May 2003, Lessard is sent by Agence to work with a client, Les Entreprises Raphaël Picard Ltée, which operates an IGA grocery store in St-Amable. Lessard works for Agence at this client’s location until October 2004. At this date, Lessard stops working for Agence, but continues to work at IGA St-Amable.

The contract between Lessard and Agence includes a non-competition provision and a penal clause. The relevant portion of the non-competition provision reads as follows:

expressly, for the duration of this agreement and for a period of one (1) year from the end of this agreement, not to, directly or indirectly, offer his services to or participate in another business offering its services to the clients of AGENCY and in general, not to sollicit any client of AGENCY or lead any person to terminate its business relationship with AGENCY.

(our translation)

The penal clause reads as follows:

The employee or service provider of the AGENCY agrees that if he is in default of this undertaking [...] he shall pay to AGENCY, upon request of the latter, a sum of TWO HUNDRED DOLLARS ($200) by day of infringement as penalty, without prejudice to any other remedy of AGENCY[.]

(our translation)

The amount of penalty is eventually increased to five hundred dollars ($500.00) per day in a subsequent update to the service agreement.

Contention of the Parties

Agence claims from Lessard, the defendant, an amount of one hundred and twenty thousand dollars ($120,000.00) pursuant to a penal clause establishing a penalty equal to five hundred dollars ($500.00) for each day during which Lessard failed to comply with the non-competition undertaking provided by the service agreement entered into by the parties.

Lessard defends himself by claiming that he dealt with Mr. Pothier, ex-officer of Agence and founder of Gesco JFP inc., who told Lessard that he would handle any issue with Agence.

Ruling

The evidence shows that Lessard did fail to comply with the non-competition undertaking. However, the judge severely limits the scope of the penal clause, ordering Lessard to only pay the amount of three thousand dollars ($3,000.00) to Agence.

The judge bases his ruling on sections 1622 and 1623 of the Civil Code of Québec which read as follows:

1622. A penal clause is one by which the parties assess the anticipated damages by stipulating that the debtor will suffer a penalty if he fails to perform his obligation.

A creditor has the right to avail himself of a penal clause instead of enforcing, in cases which admit of it, the specific performance of the obligation; but in no case may he exact both the performance and the penalty, unless the penalty has been stipulated for mere delay in the performance of the obligation.

1623. A creditor who avails himself of a penal clause is entitled to the amount of the stipulated penalty without having to prove the injury he has suffered.

However, the amount of the stipulated penalty may be reduced if the creditor has benefited from partial performance of the obligation or if the clause is abusive.

The judge states that these provisions are intended to allow for compensation of damages and to dissuade non-compliance with contracts. However, penal clauses must not be abusive. In other words, dissuasion is not a justification to claim excessive amounts. The qualification of a penal clause as abusive is the principal limit to the scope of such a provision.

The abusive nature of a provision depends on its purpose and on its scope, in the context of the obligation it is intended to secure.

In this case, the judge rules that an amount of five hundred dollars ($500.00) per day is abusive, as the defendant earns fourteen dollars and fifteen cents ($14.50) an hour. In addition, the evidence shows that the damages suffered by Agence are equal to eight thousand one hundred and fifty-eight dollars and fifty-one cents ($8,158.51), of which only a part was caused by the defendant. Under the circumstances, it is obvious that by claiming an amount of one hundred twenty thousand dollars ($120,000.00) from the defendant, Agence wishes to punish him and make him an example for its other subcontractors, and not only to compensate the loss it suffered. Consequently, the judge reduces the amount of the claim to three thousand dollars ($3,000.00).

Discussion

From this ruling, we can infer that the amount provided in a penal clause must remain realistic when compared to the damages really suffered by the party benefiting from said provision. The penal clause frees a party from the obligation to prove damages, but it doesn’t prevent the other party from demonstrating that the amount claimed is abusive.

In addition, if the penalty amount is set too high, there is a incentive for the party subject to the provision to contest the claim in court, which creates an additional cost for the beneficiary of the provision. Consequently, it is also to the latter’s advantage to set a more reasonable amount, and to reserve the right to eventually claim an additional amount if necessary.

Finally, it is important to mention that in this case, the judge raised on his own initiative the issue of the reasonability of the penal clause. This reinforces the need to ensure that the provision is reasonable, as the amount within may be reduced even if the other party does not consider such provision to be abusive or if it forgets to raise the unreasonability argument.

For more information on non-competition and penal provisions, please register to our courses on business contracts.



  1. 2009 QCCS 1120
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