Penalty Clauses and Why They Are Unenforceable
An Ontario court recently refused to award damages after a real estate agent resigned from a brokerage before the end of his agreement, finding the clause to be a penalty clause and therefore unenforceable.
The plaintiff was a real estate agent who began his own brokerage in 2012. As part of his brokerage, he began what he described as a mentoring, training and marketing program. As part of the program, he recruited “up-and-coming” real estate agents who would contract with him to receive hands-on training in real estate sales.
In May 2012, the defendant, who was a newly licensed real estate agent, began a position with the plaintiff’s new brokerage. He joined the plaintiff’s team in large part due to the training and mentorship offered which he believed would help him build and advance a career in real estate. The two men entered into an agreement. Under the agreement the defendant was an independent contractor and committed himself to the plaintiff for a period of not less than two years.
In July 2012, the defendant asked for, and was approved for, taking time off at the end of August. However, two days into this time off, the plaintiff suspended the defendantalleging that he had breached the plaintiff’s policy regarding vacation coverage along with other things.The suspension was lifted in or about early September 2012. The defendant submitted his resignation on September 12, 2012. The same day, he became a registered agent with another brokerage.
The plaintiff sued the defendant seeking damages in the amount of $15,000, invoking clause 11 of the agreement, which read:
“I agree to commit a minimum of 24 MONTHS. Should this agreement be terminated prior to the 2 YEAR anniversary all current projects and clients become property of the [plaintiff] Team. If you terminate your membership within 2 YEARS your payment for training is agreed as follows:
▪ Leaving the team within 6 months of joining $20,000 (Twenty-thousand dollars) willbe payable on the release
▪ Leaving the team between 6 months and 1 year of joining $15,000 (Fifteen thousand dollars) will be payable on release
▪ Leaving the team between 1 year and 2 years of joining $10,000 (Ten thousand dollars) will be payable upon release.”
The defendant argued that the plaintiff had repudiated the agreement when, without notice, he suspended him while he was on vacation. Additionally, the defendant contended that clause 11 of the agreement was a “penalty clause” and therefore unenforceable in law.
The issues were set out as follows:
- Did the plaintiff repudiate the agreement when he suspended the defendant, without pay for an indefinite period, without notice to him?
- Was clause 11 of the agreement a penalty clause and therefore unenforceable?
Regarding the first issue, the court simply stated that the suspension did not repudiate the entire agreement.
However, the court determined that clause 11 of the agreement was a penalty clause, which was meant to “penalize” the defendant in the event that he might consider an early departure from the brokerage and, in effect, act as an indirect attempt to keep the defendant bound to the plaintiff’s brokerage.
The court explained that such penalty clauses are unenforceable; however, if the clause is found to instead be a genuine pre-estimate of the damages in the event of a breach, it will be enforceable, citing a previous decisions that stated:
“I must compare the quantum of damages provided in the contract with the greatest potential loss that might have been reasonably contemplated by the parties at the time of contracting. If the quantum of damages provided for in the contract is extravagant,excessive, having regard to the greatest potential loss reasonably contemplated by the parties, it will be classified as a penalty and unenforceable.”
The court agreed with previous decisions that clause 11 in this contract was a penalty clause due to the fact that there was little or no evidence with respect to the methodology to quantify the calculation of damages or any meaningful evidence adduced through which the court could determine the reasonableness of damages or how the quantum for damages was prescribed.
The court found that there was no evidence from the plaintiff to form the basis of its assessment of the reasonableness of the quantum set out in clause 11 of the agreement or how the plaintiff actually arrived at the $15,000 amount, despite the plaintiff’s testimony citing certain incurred fees. Therefore, the penalty clause was not enforceable.
Additionally, the court disapproved of the training program, stating:
“Bluntly put – the court was not impressed with the Plaintiff’s training program. It appeared lacking in depth and quality and was really nothing what the Plaintiff made it out to be or the Defendant bargained for.”
However, the court did find that the plaintiff was entitled to some liquidated damages, in the form of costs and expenses incurred by the plaintiff over the eight-month period.
As a result, the court awarded the plaintiff $3,600 in damages.
The Kitchener-Waterloo employment lawyers at Petker Campbell Postnikoff have many years of experience advising non-unionized employees and employers on a variety of workplace issues including termination and wrongful dismissal. Our team will walk you through the details of your dispute, advise you on your rights, responsibilities and obligations, and help you understand your options. If your dispute cannot be settled through negotiation, we can represent you through mediation and the court process.
We represent clients throughout southern Ontario, including the communities of Cambridge, Guelph, Elmira, Brantford, Fergus, Elora and the surrounding area. Call 519-886-1204 or contact us online for a consultation.