BSA Ahmad Bin Hezeem & Associates

UAE practice on restrictive provisions and penalty clauses

UAE practice on restrictive provisions and penalty clauses

May, 2015
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It is common practice for parties entering into contractual arrangements to insert restrictive provisions constraining or limiting either of the parties’ legal or contractual rights.  Such provisions work to restrict a party from committing a certain act in the future, or oblige a party to perform a certain obligation at a predetermined time.

The objectives behind including restrictive provisions in agreements vary. For example, an employer may seek to insert a restrictive provision in an employment agreement obliging its employee to relinquish its right to work for a competitor for a period of time after the employee ends its employment.

A partnership agreement establishing a business may stipulate that the partners are restricted from setting up a similar or connected business which may compete with the existing partnership.

UAE law acknowledges the validity of restrictive provisions contained in agreements and provides the groundwork from which UAE courts are empowered to enforce such clauses and award compensation for parties having sustained losses for the breach of restrictive provisions.

The main concern regarding the inclusion of restrictive provisions in agreements is whether UAE law and practice provides for adequate protection against breach of the restrictive terms and conditions contained in agreements?

UAE law stipulates that any compensation for breach of a contractual obligation must satisfy three conditions; (1) mistake, (2) harm, and (3) the correlation between conditions (1) and (2).

The onus lies on the claimant to prove that the mistake constituted a breach of the agreement, and as a result caused the claimant to sustain harm. Once a claimant is able to prove that the first two elements transpired, the defendant in turn must disprove that the mistake and subsequent harm correlate.

The burden on the claimant to prove that a mistake committed by the defendant constituted a breach will usually be straightforward. However, the burden to prove that the effects of the mistake culminated into actual harm will prove more cumbersome on the claimant.

Case in point: an employee breaches the non-compete terms contained in its employment contract by joining a direct competitor, taking a number of clientele with whom the employee established a relationship by virtue of the employee’s tenure with its previous employer.

While in this scenario the previous employer may easily prove that the employee breached the non competition clause by joining a competitor, the previous employer would need to obtain evidence from third parties who would not necessarily wish to cooperate and offer their assistance in a litigation action. Additionally, the previous employer’s only remedy will be in the form of compensation for the harm caused by the employee’s breach which, again, the previous employer must prove.

UAE law offers various mechanisms which the courts may adopt to facilitate the process of proving damage, i.e., appointing a court expert assigned to investigate and gather evidence to be submitted in its expertise report, which will document any harm which has occurred. The courts are also empowered to hear testimony from third parties which may indicate that the harm has actually occurred.

Even with all the options available to assist claimants with the difficult task of proving the occurrence of harm, the threshold a claimant must meet in order to establish that harm had actually occurred remains cumbersome and at times unattainable.

Due to the difficulty in proving harm and the inadequacy of relevant court procedures, a viable solution is to watertight the agreement such that the restrictive terms and condition are clearly set out, and more importantly to include a penalty clause for a breach of the restrictive provisions.

Numerous Court of Cassation rulings indicate that the current trajectory of the courts is to compensate claimants according to the penalty clause set out in the agreement.  This is due to the court’s reasoning that the penalty clause establishes and quantifies the harm, and therefore the claimant need not prove the harm as it is already pre-determined at the outset of the contractual relationship. By including the penalty clause, the claimant thus circumvents any requirement to prove resultant harm, as the court now establishes the occurrence of harm as already agreed upon and captured in the agreement. The burden now shifts onto the defendant, who is now tasked with disproving that the harm, as understood in the penalty clause of the agreement, bears no correlation with the breach.

The burden on the defendant to disprove the correlation between established breach and consequent harm is no easy task, as it would require the defendant to be privy to facts or information specific to the claimant that isn’t easily ascertainable by or accessible to the defendant.

In a standard construction agreement between a developer and a contractor, a clause will often be inserted obliging the contractor to complete the works within a specific deadline, failure of which will be subject to a penalty This Site. Assuming that the deadline passes without completion, the developer may subsequently lodge its claim for compensation before the court. The developer will rely on the agreement to prove that both breach and harm have occurred. The contractor will need to refute the allegation that the breach of non-completion had harmed the developer and caused the damages in question. Ostensibly, the contractor will face difficulties establishing that the developer had not in fact suffered a loss, as any evidence the contractor would need to rely on to negate the correlation condition would need to be obtained directly from the developer.

While inserting penalty clauses to supplement restrictive provisions in agreements makes for a viable solution for claimants seeking to prove that harm resulted, contracting parties should be aware that UAE law does offer protection against abusive penalty clauses. The court may determine that a penalty clause is too abusive on a party, accordingly, UAE law grants judges the sole discretionary power to adjust the amount posited in the penalty clause or to cancel the penalty clause altogether, the rationale being to avoid prejudicing one of the contracting parties unfairly.

In conclusion, the insertion of a penalty clause for breach of a restrictive provision aims to release the claimant from having to satisfy UAE laws’ condition (2) proving the aspect of harm in a compensation claim. The harm caused by the breach is presumed to have transpired automatically as set out in the penalty clause, and the defendant is burdened with disproving that the breach and subsequent harm are interrelated.

Authored by Karam Chehade and Urwa Owais.

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