Services/Operations Deductions and the Penalty Rule in the operation of long-term contracts

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Clawbacks and deductions: computation v. compensation

Clawbacks or deductions are part of a complex pricing mechanism. That raises a very interesting question about the way that those computations play in relation to the rule against penalties.

The rule against penalties is of course familiar in the construction context.

Common law will treat as void and unenforceable a provision which prescribes consequences for breach where those consequences, per the supreme court in Cavendish Square case, are out of all proportion to the legitimate commercial interest which those clauses serve.

You may have a contract which provides an obligation, and you may have another provision which provides a secondary obligation, which tells you what happens in the event of a breach.

Much ink has been spilled in the construction arena in the context of liquidated damages and how those play in relation to the rule against penalties, but you will struggle to find any learning about clawbacks and deductions which are part of a pricing formula play.

What you have got to look at in that situation is what is the real purpose and intent of the provision?

The supreme court in the Cavendish Square case made clear that the law against penalties only applies to the secondary obligations, a provision whose purpose is to prescribe the consequences of breach of a primary obligation. It doesn’t have any application to a primary obligation, such as the basic definition of the services that have got to be provided, and the basic definition of the consideration of the price that the authority has to provide for those services.

So, what happens if a provision that’s being complained about is fundamentally part of a complex pricing formula, even though it may be in the form of a clawback deduction?

Well, this seems to be immune from the application of the law against penalties, as it is part of the primary obligations under the contract, and it is not fundamentally a provision prescribing consequences of breach, even if a deduction that can be made in relation to the pricing formula could also bite on a breach of contract.

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How can Barton Legal help?

At Barton Legal we have extensive experience in all the standard contract forms, including JCT as well as NEC, IChemE, and FIDIC.

We believe that an increased understanding of contractual terms and the roles and responsibilities of all parties ensures a successful conclusion to a project, which is why we always use plain English and ensure you understand and can apply the terms of your contract.

Our aim is to reduce legal gobbledegook and increase collaboration between parties to increase the prospects of completing your project on time and on budget.

We place great emphasis in the early stages of the contract on understanding and preparing thoroughly, in order to avoid costly disputes later.

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