Shatilla v Feinstein [1923] Sask Prov Ct Facts: A salesman breached a no-competition agreement, which provided for payment of $10,000 “as liquidated damages, and not as penalty.”
Issues: “whether or not the sum fixed by the covenant is a penalty, or whether it is recoverable by way of liquidated damages.”
Holding: The clause (covenant) was considered to be a penalty clause and thrown out.
Reasons: The court said that, “when the damages which may arise out of a breach of a contract are in their nature uncertain, the law permits the parties to agree beforehand as to the amount to be paid in case of a breach.” Whether the agreement is a penalty clause or not will be decided on a case-by-case basis. If a fixed sum is given on the breach of a number of obligations in the contract, as was the case here, there is a presumption that this is NOT a liquidated damage clause but a penalty clause – and courts will not enforce a penalty clause. This presumption can be rebutted if it can be shown that it has been carefully thought out provided, still, that it is not “extravagant or unreasonable.” The danger lies, however, in that “the strength of the chain must be taken to its weakest link and if it can be seen clearly that the loss in one particular breach could never amount to the sum stated, then the conclusion is that the sum is a penalty may be reached.”
Basically says noncompeting clause (restrictive covenant) must be reasonable to be enforceable: aka the amount of damages the other party is required to pay upon breach must be a reasonable estimate of the losses the plaintiff would suffer. If it can be shown that the pre-estimated damage is within reason / has been carefully thought out / not “extravagant or unreasonable” it might be enforced. But it cannot be taken out of proportion from what would be a reasonably expected loss. So how can you improve these types of clauses? Make it specific to certain breaches (exclude trivial breaches) and not super general, do some market calculations (have a formula to show your work).
