English lawyers turn towards liquidated damages for delay. These involve the pre-determination, at the time the contract is entered into, of the loss which a delay would cause. However, these ascertained damages must be based on a genuine estimate of the likely loss and not amount to a penalty.

French lawyers rely upon “clauses pénales”, which also involve a pre-determined amount to be paid out in the event of delay but which, as their name suggests, are punitive in nature.

In this post, we consider the distinction between “clauses pénales” and liquidated damages and whether they are reconcilable.

Conceptual distinction

Under English law, for a liquidated damages clause to be enforceable, its purpose must be to compensate the innocent party for breach of the contract, not to deter the other party from breaching it. The amount in question should be a genuine pre-estimate of loss as perceived at the time the contract was entered into. A clause whose purpose is to deter, or which sets an extravagant or unconscionable level of damages in comparison with the greatest loss which could be proved to have followed the occurrence of a particular breach, is likely to be struck out by an English judge on the basis that it amounts to a penalty. In this case, the party attempting to rely upon such provision would have to prove its loss.

The French Civil Code defines a “clause pénale” as “… a clause by which a person, in order to ensure performance of an agreement, binds himself to something in case of non-performance” (Article 1226) and “… a compensation for the damages which the creditor suffers from the non-performance of the principal obligation” (Article 1229). A provision classified as a “clause pénale” explicitly encompasses a combination of both coercive and compensatory elements. Therefore, the mere punitive nature of such a clause will not make it unenforceable.

In France, the philosophical considerations behind the 1804 Civil Code, in particular the belief in freedom of contract, meant that the “clause pénale” remained outside the control of French judges until 1975. By that date, however, tension raised by parties’ differing bargaining powers and contract disequilibrium necessitated a change in the law. Since then, the “clause pénale” has been subject to the possible control of French judges under Article 1152 of the Code. If the amount in a “clause pénale” is “obviously excessive” or “ridiculously low”, the judge may decide to adjust it, in line with certain guidelines. Unlike in England, however, an excessively onerous “clause pénale” will not be struck out.

Notwithstanding their common compensatory and pre-determined nature, liquidated damages and “clauses pénales” thus appear incompatible, since the hybrid character of the latter conflicts with the “no penalty” approach of the former.

Practical implications

Even though English law does not allow a liquidated damages clause if it is in fact a “penalty” clause, in practice there have only been a handful of English cases striking out liquidated damages as penalties. English courts are unwilling to interfere with the parties’ bargain in this respect, especially in a commercial context, when it is clear that the clause was freely negotiated.

Whilst “clauses pénales” are binding and enforceable in France, the risk of abuse is limited by the possible intervention of the judiciary to reduce or increase the amount in question.

Just as in England, a French judge must consider the existence or otherwise of a coercive (deterrent) element by looking at the intention of the parties when the contract was concluded. However, the French judge will do it not to determine whether the clause should be struck out but to establish whether it amounts to a “clause pénale” and, as such, falls under his control. If the clause lacks either the compensatory or the coercive element, the French judge will not have discretion to reduce or increase the amount in question.

Both French and English judges and arbitrators are cautious about interfering with liquidated damages and “clauses pénales” but the guidelines and criteria they have adopted differ in significant ways.

In particular, French judges may take into account the difference between the amount fixed in the clause and the actual loss suffered, a difference which is not directly relevant in England. In fact, English courts have consistently held that the comparison should be between the amount fixed in the provision and the loss as could reasonably be anticipated at the time the contract was entered into.

Conclusion

Although in principle the prohibition of penalty clauses under English law appears irreconcilable with the enforceability of “clause pénales” under French law, judges and arbitrators face similar tensions both in England and France between the risk of abuse and necessary judicial intervention on one hand and freedom of contract and legal certainty on the other.

By Joanne Clarke and Gauthier Vannieuwenhuyse for Salans and Cecile Tangy for Pinsent Masons

For several years, there has been a debate among scholars on the classification of certain provisions of the 1975 Law as mandatory within the context of international subcontracting. This Law allows, amongst other things, a subcontractor to initiate legal proceedings directly against the employer, should the main contractor fail to pay monies due by virtue of the subcontract.

The legal basis for the mandatory application of this Law is Article 7 of the Rome Convention on the law applicable to contractual obligations which provides that

when applying under this Convention the law of a country, effect may be given to the mandatory rules of the law of another country with which the situation has a close connection, if and in so far as, under the law of the latter country, those rules must be applied whatever the law applicable to the contract. In considering whether to give effect to these mandatory rules, regard shall be had to their nature and purpose and to the consequences of their application or non-application.

While the first civil chamber of the Court of cassation held, in its judgment dated January 23, 2007 (Cour de cassation, civ. 1, 23 January 2007, Bull. Civ. 2007, n°33) that the Law did not qualify as a mandatory rule, the joint chambers of the Court of cassation held, several months later, in its judgment dated November 30, 2007 (op. cit.), that regarding the construction of a building in France, the provisions of the 1975 Law which protect the subcontractor, are mandatory within the meaning of the Rome Convention. Because this jurisprudence has subsequently been confirmed by several judgments of the Court of cassation, it has to be considered a real trend.

This trend has at least two significant implications.

First, even if the contractual relationship between the parties is international, the provisions which protect the subcontractor under the 1975 Law will be applicable, if the construction works take place on French territory. For instance, the Court of cassation had to deal, in a judgment dated January 30, 2008 (op. cit.), with the following situation: the employer, a company registered in Belgium, entered into a contract with a German company. This contract provided for delivery of certain products and the erection of machines in France. The contract was governed by Swiss law. The contractor entered into a Subcontracting agreement with another German company, which itself entered into several Subcontracting agreements with three German companies. All the Subcontracting agreements were governed by German law. A French company intervened as the employer’s representative. Therefore, the only criteria which led to the mandatory application of the provisions regarding the direct action of the subcontractor under the 1975 Law was the location of the works in France.

Contracting parties should therefore be aware that their choice of governing law may be overridden by the mandatory laws of some jurisdictions. In France, the mandatory rules contained in the 1975 Law will be applied as soon as the works take place in France, regardless of the governing law of the contract or the nationality of the parties.

Second, the transformation of the 1975 Law into a mandatory rule could be considered as the first step of a more general trend towards the protection of one of the contracting parties in an international construction contract. It is possible that certain other provisions and principles of French construction law which are also aimed at protecting parties to a construction contract – such as the presumption of liability of the builder of the works or the guarantee by the building owner of payment of sums owed to the contractor when they exceed a certain threshold– might in the future be considered mandatory.

Your thoughts and comments on other implications of the recognition of new mandatory rules and on the existence of such a trend in other jurisdictions are welcomed.

By Joanne Clarke and Gauthier Vannieuwenhuyse