Repayment Clauses in Compromise Agreements - are they enforceable?
Repayment clauses are frequently incorporated into compromise agreements, which are entered into in order to settle employment disputes and other agreements that parties enter into upon the settlement of litigation.
However, in a recent case, CMC Group plc v Zhang, the Court of Appeal held that a repayment clause in a settlement agreement was unenforceable. They ruled that such clauses will usually be unenforceable because they are regarded as penalty clauses.
In that case, Mr Zhang entered into an agreement with CMC Group plc for the settlement of claims he had against them, arising out of his business dealings with them. The agreement was not a compromise agreement, but it contained a clause in the following terms:
“For the avoidance of doubt, you hereby agree that any breach of this settlement and agreement will render you liable to us for the sum of US$40,000 together with a claim for reimbursement of our legal costs against you in addition to a claim for damages in relation to loss of business.”
This was held to be a penalty clause. The Court of Appeal emphasised that the test of whether or not a clause is a penalty depends on its predominant contractual function.
Where the purpose of a clause is to deter a breach of contract it will be a penalty clause and will be unenforceable. There is a presumption of penalty when a single lump sum is payable by way of compensation on the occurrence of a breach of contract regardless of the nature of that breach, which may often be trivial.
On the other hand, where the function of a clause is to compensate the losses that are likely to be suffered as a result of its breach, it will not be a penalty clause. This means that the repayment clause will be enforceable if the sum repayable is genuine pre-estimate of the loss that the innocent party is likely to suffer as a result of the breach.
The Court of Appeal held that the purpose of the clause was to deter Mr Zhang from making claims against CMC Group. It held that the sum of $40,000 was not a genuine pre-estimate of the loss that CMC Group was likely to suffer as a consequence of Mr Zhang breaching the settlement agreement, particularly when the clause stated that he would also have been liable for further damages and costs in the event of a breach.
Similar clauses are often found in compromise agreements entered into following the termination of a person’s employment.
Where a repayment clause is unenforceable, the settlement agreement itself will not be invalidated. Claims that have been compromised will still be barred. Confidentiality clauses will still be enforceable. However, if confidential information is disclosed, or there is some other breach of contract, an employer will not be able to rely on the repayment clause. It will have to prove the loss it has suffered as a result of the breach, which in some cases will be nominal.
For further information please contact: Alison Gow