Last Updated on 30/03/2026 by Damin Murdock
Is it a Penalty Clause?
Is someone trying to hold you liable for breaching a clause which you believe may be a penalty? Many commercial contracts have clauses that stipulate compensation in the event that a contractual term or an obligation is breached.
The general rule is that if the clause is a liquidated damages clause it is enforceable and the sum set out in the clause is recoverable. If, however, if it is a penalty clause it will not be enforced beyond the actual loss of the innocent party.
A clause is potentially a penalty clause if:
- the predominant function of the clause is to deter a party from breaking the contract;
- the compensation stipulated is not a genuine pre-estimate at the time the contract was entered into;
- the sum specified is extravagant and unconscionable in comparison with the greatest loss that could have been proved to have followed from the breach;
- if the breach of contract consists only of not paying a sum of money, and the amount stipulated as compensation is greater than the sum that ought to have been paid;
- a single lump sum is made payable by way of compensation whether the occurrence of event or events that trigger the clause are serious or trifling; and
- in a sales contract, the buyer is obliged to either take delivery of a minimum quantity of product or pay a specified minimum amount.
Before paying any compensation demanded under such clauses, or signing a contract that has a penalty clause, please contact Damin Murdock at Leo Lawyers on (02) 8201 0051 or at office@leolawyers.com.au.
DISCLAIMER: This article is not to be taken as legal advice and is general in nature. If you require specific advice, please contact us.
Damin Murdock (J.D | LL.M | BACS - Finance) has over 17 years of experience as a commercial lawyer. He helps businesses navigate construction and technology law. Damin has held several big leadership roles, including serving as a director of a national law firm and the Chief Legal Officer for Lawpath.
He has personally helped more than 2,000 startups and small businesses. With over 300 five-star reviews, his clients clearly value his practical advice and simple way of explaining things. Damin has also hosted over 100 webinars that thousands of people have watched to get reliable legal help.
