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Can penalty clauses strengthen contract lawsuits in California?

On Behalf of | Jan 9, 2024 | Contract Disputes

A breach of contract can be very expensive for the business affected. The failure to complete a project or deliver materials could slow down an organization’s fulfillment of its own obligations. Sometimes, companies may have to idle production lines or absorb losses because they must source services or materials at the last minute for a premium price.

Executing written contracts with vendors, contractors and service providers may help diminish the likelihood of a significant breach of an agreement. If a breach occurs anyway, the business may need to take the matter to civil court. Breach of contract lawsuits can lead to compensation for damages or orders of specific performance. Companies that include penalty clauses in their contracts could both deter breaches more effectively and more fully recoup losses triggered by contract issues.

How penalty clauses work

Contracts may include terms that impose specific financial consequences or liquidated damages for a material breach of the contract. Late fees charged for delays in payment are an example. Other times, companies may have much more extensive policies that could cost the other party thousands for a contract violation.

When used appropriately, penalty clauses can serve as a powerful deterrent to contract non-performance and other violations. The business facing the contract violation could automatically demand payment based on the penalty clause and take legal action if the other party remains non-compliant and refuses to pay the penalty.

Do California courts enforce penalty clauses?

California has many employee and consumer protection laws that can affect the viability of penalty clauses in some contracts. For example, recent court rulings have raised questions about the practice of increasing interest rates on consumer lines of credit when people miss payments. Businesses could have trouble enforcing certain penalty clauses against consumers in the wake of recent rulings.

Many other penalty clauses and contracts requiring liquidated damages are still potentially valid and enforceable in the California civil courts. Those who know there are financial penalties for contract non-compliance may be less inclined to violate a contractual agreement.

Businesses that integrate the right terms into their contracts can minimize their risk of major contract defaults and can benefit from more options for recourse should one occur. In these ways, seeking legal guidance to draft custom contracts can help organizations more effectively protect against operational disruptions and losses.