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New precedent on the position of contractual penalty in the distinction between direct and indirect damage set by the Supreme Court

New precedent on the position of contractual penalty in the distinction between direct and indirect damage set by the Supreme Court

Dispute Resolution
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The Finnish Supreme Court rendered its judgment in KKO:2014:61 on September 2, 2014, setting a new precedent for distinguishing direct and indirect damage in the sale of movable property.

The decision concerned a case in which a construction firm had ordered doors for its contract location from a construction products firm. The delivery of the doors was delayed because of the construction products firm, and, as a result, the construction firm was obliged under its piecework agreement with the buyer to pay a penalty for delay to the buyer. The construction firm sought a ruling for the court confirming the construction products firm’s liability to reimburse the construction firm in the amount of the penalty for late delivery of the doors. According to the general terms and conditions of sale of the Finnish Hardware Association (Rasi terms), which are applied to the sale of doors, a seller is not liable for the indirect damage caused by delay. Thus, the Supreme Court had to evaluate if the penalty for delay paid by the construction firm to the buyer was indirect damage as defined in the general terms and conditions, for which the construction products firm would not be liable to compensate to the construction firm.

The general terms and conditions were no help to the interpretation of the question because the term “indirect damage” is not defined in the general terms. The parties to the dispute had neither otherwise agreed on the possible consequences of a breach of contract, nor had they referred to trade customs or practice according to which the directness or indirectness of damage should be evaluated. Thus, the Supreme Court concluded that an interpretation of the standard terms should begin at the ordinary meaning of indirect damage. The interpretation of the terms can thus rely on the classification of the damages according to the Finnish Sale of Goods Act.

According to the legislative materials of the Sale of Goods Act, the recoveries paid by the buyer because of a breach of contract by the seller are direct damages. However, only damages the buyer has been obliged to pay to its contractual counterparty as direct damage are to be reimbursed as direct damages. According to the legislative materials, a contractual penalty paid by the buyer to its contractual counterparty because of a delay by the seller usually needs to be regarded as indirect damage. This classification presented in the legislative materials of the Sale of Goods Act has been criticized in the legal literature. Commentators have remarked that the different positions of a compensation for damage paid to a third party and a contractual penalty cannot be completely justified.

The Supreme Court concluded in its evaluation that in this case the penalty for delay belongs to the category of indirect damage. The Supreme Court based its decision especially on the fact that according to its view, the damage most commonly arising from a delay is lost profit, which, according to the Sale of Goods Act, must be regarded as indirect damage. The Supreme Court reasoned that in the relationship between the seller and the buyer there is no reason to regard as direct a damage that is indirect in the contractual relationship between a buyer and a third party. In addition, the Supreme Court didn’t consider it reasonable to demand the parties to present a specification of the damages that the penalty for delay actually pertained to. The Supreme Court further justified its decision by the fact that the existence of a clause concerning a penalty for delay in a contract between a buyer and a third party and specifically the amount of the contractual penalty caused by it to the buyer are often harder to predict for the seller than consequences based on the law. Even a delay in delivery of minor value may in the relationship between a buyer and a third party lead to a penalty for delay, which is multiple times greater than the original purchase price.

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