Liquidated Damages Under UAE Law and Other Legal Systems – Civil Law
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Liquidated Damages Although not present in all contracts, there will be occasions when liquidated damages are mentioned in contracts and provide the necessary assurance and security. The advantages of this type of clause are numerous, but also certain disadvantages. The method of awarding damages also differs around the world depending on the type of legal system in place in a jurisdiction and nation.
Common law and civil law nations have different ideas on this subject. In this article, we will examine the concept of liquidated damages to summarize the implications in a few jurisdictions.
Common law jurisdictions
Common law was first introduced to England at the King’s Court after the Norman Conquest around the 11th century. The system spread around the world and throughout the British Empire. Many of these nations still adopt the common law legal system to this day to varying degrees.
Case law has a significant influence in court cases through the concept of binding priority. In addition, judges play an active role in the development and evolution of the legal system throughout the country. All this is possible because it is not codified.
Under the common law, liquidated damages are subject to scrutiny. Often liquidated damages will not be awarded if they are present in the contract as a form of punishment. The reason is that one party cannot take advantage of the other by introducing a clause that would probably occur. Often a party with more power in a situation such as a business could abuse an ordinary individual in this way. However, liquidated damages are not simply ignored; this acts more as a warning than anything else.
There are two crucial aspects of the clause that must be analyzed and conditions are required before it can be upheld. These are as follows:-
- The damage value must reflect the damage caused;
- The act mentioned in the clause need not be a certainty. If its realization is certain or highly probable, the clause is considered as one party benefiting from the other.
A particular case from the United Kingdom, England, was that of Office of Fair Trading v Abbey National plc and others UKSC 6. In this case, a problem arose when a person wanted to obtain an overdraft from his bank. Certain charges were imposed on the individual, and the Office of Fair Trading (OFT) wished to examine the fairness of the charges.
A decision was issued by the Supreme Court in which it was stated that a banking entity would not be able to impose sanctions on its customers in its contracts. However, in this particular case, the “fine” could be seen more as a charge for a service than a punishment for the customer. This fact therefore made the accusation fair.
Another UK case that had a similar outcome was that of Cavendish Square Holding BV v Talal El Makdessi  UKSC 67; this is leading contract case law in the country. In the deal, a deal was struck between the two parties in which Cavendish would buy a significant stake in a leading marketing company in the Middle East. The contract between them had two specific clauses which stated the following:
- If certain clauses of the contract were violated, Mr. Makdessi would no longer be required to collect the last two promised payments;
- Mr Makdessi would also be likely to sell his remaining shares at a rate well below their actual value and the value agreed for the original shares.
A breach occurred, although Mr. Makdessi said in his defense that the clauses were unfair and served as a punishment. If the court found that this was the case, the clauses would not hold. However, in the final judgment of the Court of Appeal (the Supreme Court in this case), ruled that the clauses were not sanctions. They did not conflict with the EU Directive, Directive 93/13/EEC on unfair terms in consumer contracts.
While the EU consists of a number of nations that do not use the common law system, the law still applies in the UK and also in EU countries.
The United States is also a common law nation and its key regulation in this regard is the Uniform Commercial Code. This code was first published in 1952 and has been adopted nationwide in whole or in part depending on specific jurisdictions. Section 2-781(1) states that liquidated damages are permitted in sales contracts as long as the value of the liquidated damages is fair. They must have a value similar to the actual damage that occurs. In addition, it must be unforeseeable damage.
Overall, these are largely the same as the UK approach.
Civil law systems
The other predominant legal system in the world and perhaps the more common of the two. Civil law was the Roman legal system and was used throughout their empire for the purpose of unifying the people under a singular method of judgment. Today, it is found in its purest form all over the European continent, and further afield it is either used or modified in various ways.
This system is codified and is therefore not limited by previous case law. Statues are used by judges to identify issues and come to conclusions.
In general, civil law countries are much more open to the concept of damages. These are seen as adding certainty to a contract and taking into account different eventualities. One of the best examples of this is found in the French Civil Code. This code was established in 1804.
Article 1226 of the code concerns the penalty clause which is a form of damages. These can be used to ensure specific performance of the parties to the contract. While it often ensures performance, another use is to provide compensation in the event of a breach.
These clauses are generally accepted in France and other civil law jurisdictions. However, in cases of excessive penalties, a court may order that the fines be reduced. In accordance with article 1230 of the code, the party must know the clause and the specific penalty in the event of breach.
The United Arab Emirates is another civil law jurisdiction and holds much the same position as France. The Civil Transactions Act (Federal Act Number 5 of 1985) considers this under Section 390. Here it is stated that parties to a contract can predetermine compensation for breach. However, paragraph 2 states that a judge may order a party to vary the amount to a reasonable level if deemed necessary and there may be no clause in the contract to counter this.
The clause is widely used in construction contracts, which makes them all the more useful in the United Arab Emirates, which is known for its considerable real estate and construction sectors.
Japan is following suit in this regard, although it also goes further. Under Article 420-1 of the Japanese Civil Code, three specific points are raised. These are:
- The parties can agree on penalties in the event of breach of contract. These cannot receive any adjustment, either an increase or a decrease, from the courts;
- The clause does not prevent either party from demanding more in the event of a problem not mentioned in the contract, nor does it prevent the right to terminate the contract;
- All penalties mentioned in a contract are considered damages.
In a way, the Japanese system is quite the opposite of the common law idea, and it even goes beyond many other civil law jurisdictions.
The concept of liquidated damages is treated differently depending on a nation’s legal system. There are a few constants in most countries, regardless, which include the idea of fairness and the protection of parties’ interests. However, the common law system found in the UK and US is generally not the most friendly when it comes to any form of penalty clause in a contract due to the potential issues that can arise. These include abuse of power by those in the most powerful position.
Japan is the most extreme in its support for the idea of liquidated damages, as even the court cannot impose changes to these contract terms. Nobody can tell if the system is good or bad. Both sides have their pros and cons. Given the differences between the two types of legal systems, each argument has its merits.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.