Penalty clause must be applied according to the principles of equity

The Magistrates Court in Gozo decided that a penalty clause in a contract of works could not be applied in full once the owner of the property locked out the contractor. 

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Malcolm Mifsud
1 May 2015, 8:00am
This was decided by Magistrate Joanne Vella Cuschieri on 17 April, 2015 in the case Dr Isabella Borg -v- M.P.J. Limited.

In her lawsuit Borg claimed that she had purchased a property in Xaghra, Gozo in July 2004, but in June 2004 she had engaged MPJ Limited to carry out a number of works in that property. Another contract of works was signed between the two in July 2004, according to which the works had to be finalised by the end of September 2004, failing which the company would suffer a penalty of Lm10 per day until the works were completed.

An architect’s report of 16 April, 2006 in another case decided upon on 30 November, 2012 in Joe Spiteri noe -v- Dr Isabella Borg held that the works were not completed. In a counter claim in this first case, Borg asked the court to declare that the works were incomplete or else not done according to professional standards.

The court had agreed with Borg, which judgement was not appealed. Borg claimed that she had a right to be paid the penalty mentioned in the contract of works until 30 January, 2013. She therefore asked the court to rule that the defendant company failed to fulfil its obligations and therefore, to be liable to Lm10 for each day from 1 October, 2004 to 11 February, 2013. 

The defendant company pleaded that the delay was due to constant changes to the plans and that Borg managed to fight with all the workers and sub-contractor working on site.

Magistrate Cuschieri examined the facts of the case and noticed that there was consensus that the company did not manage to finish on time. She made reference to another judgement concerning this particular contract of works, wherein the company was ordered to carry out remedial works in the Xaghra property.

The magistrate also examined the agreement signed by the parties where the company had to complete the works by 30 September, 2004 and was to be paid Lm4,500, however, if the company delayed then it had to pay Lm10 per day until the works were completed. 

Since the previous case, which decided that the works were not completed on time, the court had its hands bound and had to limit its decision as to whether the company had to pay Lm10 per day.

The Court quoted from Article 1120 of the Civil Code, which reads:

(1) The penalty represents the compensation for the damage which the creditor sustains by the non-performance of the principal obligation.

(2) The creditor may sue for the performance of the principal obligation instead of demanding the penalty incurred by the debtor.

(3) He cannot demand both the principal thing and the penalty, unless the penalty shall have been stipulated in consideration of mere delay.

The Article 1122 states:

(1) It shall not be lawful for the court to abate or mitigate the penalty except in the following cases:

(a) if the debtor has performed the obligation in part, and the creditor has expressly accepted the part so performed;

(b) if the debtor has performed the obligation in part, and the part so performed, having regard to the particular circumstances of the creditor, is manifestly useful to the latter. In any such case, however, an abatement cannot be made if the debtor, in undertaking to pay the penalty, has expressly waived his right to any abatement or if the penalty has been stipulated in consideration of mere delay.

The court also quoted from a previous judgement, Marie Debono -v- Saviour Cassar of 7 October, 1997 where the Court of Appeal held that penalties constitute a pre-liquidation of damages, which may exceed the price of the contract between the parties. The damages should not be reduced to match the profit. Furthermore it is the defendant who has to prove that he/she is exonerated from his/her contractual obligations. 

From these articles of law it transpires that penalty clauses are compensation for damages due to non-performance of a contract. The creditor has the option to ask for the performance of the obligations of the contract instead of the penalty. Both performance and penalty may not be asked for. 

The court held that these articles of the Civil Code of Art 993 of the same Code bind parties of contracts to act in good faith and as a fact this also equates to equity in the practical and moral sense.

The Court pointed out that if one had to apply the penalty of Lm10 per day for 3,037 days the company would have to pay €70,743 which exceeds by far the value of the work. The court took in consideration a letter produced as evidence which was written by the plaintiff on 10 March, 2005 in which Borg instructed the company to stop works immediately.

The company’s representative testified that he followed the instructions and understood that the contract was being terminated. This letter did not mention that it was being written without prejudice to her rights to claim payment of a penalty, therefore any claim for payment of penalties after 10 March, 2005 is in bad faith, since it renounced her right from that date.

The court then moved to uphold the plaintiff’s request for payment of penalty but limited it to €3,749.69

Malcolm Mifsud, Partner, Mifsud & Mifsud Advocates

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Malcolm Mifsud is a partner at Mifsud & Associates.