The Penalty Clause Bias

Abstract

Common law and civil law do not seem to agree on the function of punitive liquidated damages. Whereas penalty clauses are seen as a way of enriching contract law in France and the Netherlands, they are forbidden in the United States. Belgian law has its own hybrid approach to penalty clauses.

This article looks to the past, the present and the future role that penalty clauses (could) play in American contract law, by comparing the American situation with that of France, the Netherlands, Belgium, and the harmonization efforts in private law (such as the Draft Common Frame of Reference). It promotes an understanding of the different visions in common and civil law. While recognizing the risks inherent to penalty clauses, the article puts forward that these risks can be better tackled by allowing a judge to reduce excessive or abusive penalty clauses – a power judges already have when dealing with excessive covenants not to compete, or when confronted with excessive punitive damages. It finds support for this statement in law and economics, the nature of contract law and the theory of punitive damages.