Where the parties to a commercial agreement are concerned about the consequences of a specific breach of contract, they may agree to include
a provision in the contract which stipulates how much one party will pay the other party if the party is in fact in breach. This type of provision is known as a “liquidated damages clause”, and is a useful way of dealing with the consequences of a breach of contract without the parties having to try to negotiate the amount of damages to be paid after the breach has occurred (or having a court do so). But English law provides that, in order for a liquidated damages clause to be enforceable, the amount of the liquidated damages must be a genuine pre-estimate of the loss which the aggrieved party would expect to suffer. If it does not meet this test, the amount of the liquidated damages will be deemed to constitute a “penalty”, and as such the relevant clause will be unenforceable. In other words, the amount of the liquidated damages must be compensatory, rather than penal (or operate as a deterrent).
Henning Berg v Blackburn Rovers Football Club
In December 2012, Blackburn Rovers FC terminated the 3-year fixed term contract of their manager, Henning Berg, after just 57 days. Mr Berg’s contract provided that Blackburn Rovers was entitled to terminate Mr Berg’s contract, provided that they paid Mr Berg his gross basic salary for the remainder of the 3-year term, amounting to £2.25 million. Given the subject matter of this Update, it will come as no surprise that that Blackburn Rover decided to challenge Mr Berg’s entitlement to the £2.25 million as being a penalty, arguing that Mr Berg should only be entitled to damages for breach of contract under normal contractual principles, which would include a duty for Mr Berg to mitigate his losses. In other words, Mr Berg should be obliged to try to secure alternative employment for the remainder of the 3-year term, and the amount of damages payable by Blackburn Rovers should be reduced by the earnings from such employment.
The High Court said, however, that the law against penalty clauses was “entirely immaterial” in these circumstances, because Mr Berg’s entitlement to the £2.25 million resulted from Blackburn Rovers’ exercise of its contractual right to terminate, not as a result of a breach of contract.
The Berg case confirms that the law against penalties is only relevant in relation to contractual clauses which specify the amount payable on a particular breach of contract, and does not apply where one party is required to pay a specific amount on the exercise of contractual right, eg the right to terminate.
Note 1:  EWHC 1070 (Ch) (29 April 2013)