Originally from World Arbitration and Mediation Review, (WAMR)

I. INTRODUCTION

The topic of penalty clauses (or “liquidated damages” in a different formulation) has particular relevance in international law and, more particularly, in international arbitration.  Indeed, one can hardly deny the international character of the issue at stake.  In international trade and, more particularly, cross-border transactions and major projects, the crucial importance of contractual provisions to the effect of limiting and/or excluding liability, on the one hand, and to set forth the amounts due in case of breach of the contract, on the other, is of undeniable relevance.  I dare to say that these contractual stipulations are one of the core subjects of any international agreement.

Parties need to control their contractual risk and be set free from any particularity arising from local laws and jurisprudence that may inflate damages in case of a non-performance or breach of contract.  On the other hand, parties also need to fix the amount that would be due in such contractual pathological cases to avoid discussing the actual damages suffered (evidence of which is always hard to establish). 

Additionally, often times it is the case that the parties need “incentives” to fulfill their obligations and to deter non-performance.  However, there are some jurisdictions where the limitation or exclusion of liability clauses and forfaitaire liability clauses (clauses either fixing the damages via a “liquidated damages” clause or by providing a “penalty”) are questioned, if not altogether prohibited.  Those legal obstacles may often be tackled by providing a law that does not raise questions as to its validity and enforceability, coupled with arbitration agreements that prevent parties from resorting to local state courts, which may well have divergent views.

Be that as it may, the fact is that the operation of the invalidity or non-enforceability of such clauses may occur in a subsequent phase of the process when an award creditor seeks to obtain the recognition and enforcement of such award. Indeed, the jurisdiction where the recognition and enforcement of the award is sought may well consider these clauses as violating its international public policy. 

Against this backdrop, in this article, I will try to address the issue of penalty clauses in international arbitration.  First, I will provide a broad overview of the concept, underlying interests, and kinds of penalty clauses (II).  I will then present an overview of the legal framework in many jurisdictions, including both civil law and common law perspectives, alongside a few specific Latin American jurisdictions (III).  Then, I will move to consider whether or not legal rules in international law, and general principles of law, apply in this regard (IV); what the state of affairs is in international arbitration case law (V); and whether or not one can draw any conclusions from general principles of law (VI).  I will subsequently address the issue of public policy and the impact it may have on international arbitral awards (VII).