Repayment clause or unenforceable penalty clause?

Contracts and compromise agreements often contain provisions for the payment or repayment of money. For example, an employment contract can provide for the repayment of training course fees where an employee leaves his employment before a specified period after his employer has paid for the training course.

In relation to compromise agreements, it is usual to include a repayment clause, providing for repayment of all sums paid to an employee where there is a breach of the compromise agreement post signing and after payment of the settlement sum. Such repayment clauses are common but rarely tested in the Courts.

Enforceable?

Whether a repayment clause is enforceable will depend on whether it is viewed by the Tribunal as a penalty clause. Penalty clauses are unenforceable, and repayment clauses in a contract or compromise agreement should be carefully worded. Case law provides that a repayment clause is more likely than not to amount to a penalty clause if:

the purpose of the provision is to intimate, pressurise or penalise the employee who is in breach
the sum to be repaid is “extravagant and unconscionable”
the sum to be repaid bears no relevance to the greatest loss or likely damages that the employer could suffer from the employee’s breach
there is a single sum payable for a number of breaches, some which may result in serious damage and others in only minor loss to the employer.

Case update

In the recent case of CMC –v- Zhang, the Court of Appeal considered whether a repayment clause in a settlement agreement was a penalty. In settlement of a commercial dispute, Zhang agreed to refrain from:

making threats of violence to any officer or employee of CMC or their families
harassing employees
making derogatory or unfavourable communication about or in connection with CMC.

The settlement agreement provided that any breach by Zhang would result in him repaying a sum equal to the entire settlement sum ($40,000).

Zhang allegedly continued to harass employees and “made a thorough nuisance of himself”. CMC issued proceedings for the recovery of the settlement sum because he had breached the terms of the settlement agreement.

A default judgement was entered in the sum of $40,000 (together with $1,000 damages and costs). Zhang argued that the repayment clause was a penalty. The Court of Appeal agreed and decided that the repayment provision was a penalty clause. The provision was unenforceable because the damages flowing from the statement made by Zhang were not in line with the $40,000 to be repaid.

In this case, the repayment sum was excessive. No attempt had been made by CMC to tailor the sum which was payable to the different circumstances in which the agreement could be breached. CMC made no genuine attempt to estimate its potential loss, so the clause was a deterrent to breach. The provision related to payment of an extravagant or unconscionable sum of money in events, which could be very minor breaches of the agreement.

Compromise Agreements

Given the decision in Zhang, it is clear that best practice requires employers to quantify the value of the employee’s existing claims and top this up with an additional sum to reflect other potential claims, which they also agree to waive.

If the employee makes a potential claim, which he agreed to waive in the compromise agreement, the repayment provisions should be limited to the value of those potential claims, and not stipulate repayment of the entire settlement sum. Where an employee issues existing and potential claims, the repayment provisions should be drafted to allow the employer to set off any compensation subsequently awarded by a tribunal against the settlement sum. This will demonstrate to the Tribunal that the repayment provision was not simply a deterrent and is a genuine estimate of the employer’s losses.

It is more difficult to enforce a repayment clause where the employee has breached other terms of the compromise agreement, such as those relating to confidentiality or derogatory comments about the employer. It is difficult for employers to quantify their losses in relation to such breaches.