Wednesday, June 15, 2016

Liquidated Damages vs Penalty Clauses in Oman

Readers may be aware that, in common law jurisdictions, a liquidated damages clause may be void as a penalty if the amount payable under such a clause does not represent a genuine pre-estimate of the actual damages for breach of contract. Article 267 of the Civil Code (RD 29/2013) in effect provides something similar. The Article provides:

  1. If the subject matter of obligation is not a sum of money, the contracting parties may determine the amount of compensation in advance by making a provision of same in the contract or in a subsequent agreement.
  2. In all cases, the court may, upon the application of either of the parties, amend such agreement to make the compensation equal to the damage, and any agreement to the contrary shall be null and void.
A previous edition of our Client Alert included an article titled “Liquidated Damages for Delay in Construction Contracts in Oman.” In that article, we stated that in a later article we would review in more detail the practical application by the Omani courts of Article 267 of the Civil Code.

In common law jurisdictions, a strict differentiation is made between “liquidated damages” clauses and “penalty” clauses. Under common law, penalty clauses are void and unenforceable. However, promises to pay a stipulated sum in the event of a breach of contract may be valid if they represent a genuine pre-estimate of the actual damages. Accordingly, in common law jurisdictions, there are often disputes as to whether a liquidated damages clause is actually a penalty clause.

Typically in Civil Code jurisdictions, no formal distinction is made between liquidated damages clauses and penalty clauses. However, particularly recently, there is a more common approach developing in some Civil Code countries to distinguish between liquidated damages clauses (that are used to estimate damages in case of non-performance, based on the concept that there has been an actual harm) and penalty clauses that are used to establish a penalty to be paid in case of non-performance, with the intent to encourage performance.

Oman follows many other Civil Code jurisdictions in currently not making a formal distinction between liquidated damages and penalty clauses. Omani courts are known to use both terms interchangeably.

In practice, Omani jurisprudence adopts the position that the contract is the law which governs the parties, and the terms of a contract must be applied as they are. If a contractual breach results in direct, actual and foreseeable loss, meaning that the loss is a natural result of the non-performance or delay in performance, and the aggrieved party was unable to mitigate his losses, and there was no impossibility of performance or force majeure, and a causal link is established between the loss and the breach, the aggrieved party will be entitled to compensation. If the obligation under the contract is for payment of a monetary amount, then the compensation will be the specified amount.

There is no robust, formal principle of precedent in Oman and the courts of Oman have indicated that they do not consider themselves necessarily bound by their previous decisions. Nevertheless, the courts of Oman, if directed to previous decisions, are likely to take note of those decisions. Accordingly, and based on previous Omani Supreme Court judgments, where the parties stipulate a specific compensation clause in the contract, whether it is a liquidated damages or penalty clause, the court will generally adhere to it in respect of calculating the amount payable as compensation only. However, Article 267 specifically permits the courts to re-open liquidated damages and penalty clauses, and award damages commensurate with what they consider the value of the actual damage incurred. Consequently, the mere inclusion of a liquidated damages clause does not automatically result in the compensation being payable.