Penalty Clauses in Canadian Contract Law

By Veel, Paul-Erik | University of Toronto Faculty of Law Review, Spring 2008 | Go to article overview

Penalty Clauses in Canadian Contract Law


Veel, Paul-Erik, University of Toronto Faculty of Law Review


 
I    INTRODUCTION 
 
II   THE EVOLUTION OF THE LAW OF STIPULATED DAMAGES CLAUSES 
     IN CANADA 
 
Dunlop and the Traditional Doctrine 
Elsley and the Emergence of an Oppression-Based Doctrine 
 
III  COMPARING DUNLOP AND ELSLEY: A NORMATIVE ANALYSIS OF 
     COMPETING APPROACHES 
 
Stipulated Damages as a Mechanism for Increasing Contractual Certainty 
Stipulated Damages as a Mechanism for Avoiding Under-Compensation 
The Signaling Function of Supra-Compensatory Stipulated Damages 
Freedom of Contract and Bargaining Failures in Stipulated Damages 
Inefficient Behaviour and Supra-Compensatory Stipulated Damages 
 
IV   A REFORMULATED TEST FOR THE ENFORCEABILITY OF STIPULATED 
     DAMAGES CLAUSES 
 
V    CONCLUSION 

Abstract

This article critically examines the current state of the law of penalty clauses in Canada. First, while many commentators regard the law of penalty clauses as being relatively settled, this article tracks the development of two competing lines of authority. This article contends that lower courts' decisions across Canada have been split between (1) the traditional standard regarding the non-enforceability of true penalty clauses, which stems from the House of Lords' decision in Dunlop Pneumatic Tyre Co. Ltd. v. New Garage and Motor Co. Ltd., and (2) a more recent oppression-based standard under which courts have been increasingly reluctant to strike down supra-compensatory penalty clauses, which has emerged from the Supreme Court of Canada's decision in J.G. Collins Insurance Agencies Ltd. v. Elsley Estate. Second, this article examines whether the recent authority in favour of greater enforceability of penalty clauses is a positive change in the law of penalty clauses. While many authors have argued in favour of greater enforceability of penalty clauses, this article argues that there are policy reasons in favour of the traditional position of stricter scrutiny of penalty clauses. Taking these policy considerations into account, this article proposes a reformulated test of the enforceability of such clauses based on Dunlop.

Resume

Cet article examine d'une maniere critique l'etat present de la loi sur les clauses de penalite au Canada. Premierement, bien que plusieurs commentateurs considerent la loi sur les clauses de penalite comme etant relativement etablie, cet article trace le developpement de deux types d'autorites qui sont en competition. Cet article suggere que les decisions des tribunaux inferieurs a travers le Canada sont divisees entre (1) le standard traditionnel de non validite des clauses de penalites veritables, qui derive de la decision de la Chambre des Lords dans l' arret Dunlop Pneumatic Tyre Co. Ltd. v. New Garage and Motor Co. Ltd., et (2) un plus recent standard d'oppression sous lequel les tribunaux ont ete de plus en plus reticents a invalider des clauses de penalites supra compensatoires, standard qui emergea de la decision de la Court Supreme du Canada dans l'arret J.G. Collins Insurance Agencies Ltd. v. Elsley Estate. Deuxiemement, cet article ce penche sur les autorites recentes en faveur d'une plus grande applicabilite des clauses de penalite et se demande si elles constituent un developpement positif a la loi sur les clauses de penalite. Bien que plusieurs auteurs se prononcent en faveur d'une plus grande applicabilite des clauses de penalite, cet article suggere qu'il existe des raisons politiques en faveur de la position traditionnelle d'examen plus minutieux des clauses de penalite. Prenant en compte ces considerations politiques, cet article propose un test reformule, base sur l'arret Dunlop, sur l' applicabilite de ces clauses.

I INTRODUCTION

Canadian contract law and the British contract law from which it developed have generally tended to support the ability of individuals to enter into contracts on their own terms. One notable exception to this general principle of freedom of contract has been the scrutiny with which courts have treated certain contractual arrangements specifying in advance the damages which will flow from a breach of contract. …

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