Penalty clauses in contracts allow for a party to charge extra money if the other party fails to follow the terms of the contract, such as a late payment or failure to pay. They are common in loan agreements and provide a pre-determined penalty amount. Unlike liquidated damages clauses, the purpose of penalty clauses is to punish a party for its actions.
Example: Joanna received a loan from her bank for $10,000. In the loan agreement, Joanna agreed to pay an additional $500 for every month that her payments were late. When her 2nd payment was three months late, she had to pay the bank $1,500 in addition to any payments she would normally have to make.
Sample – Loan Agreement:
There shall also be imposed upon Borrower a 2% penalty for any late payment computed upon the amount of any principal and accrued interest whose payment to Lender is overdue under this loan agreement and for which Lender has delivered of $500 upon the first day of each month and Borrower fails to make timely payment of said amount, Borrower (after receipt of a default notice from Lender) shall be liable to Lender for a penalty of $10 (i.e. $500 x 2%) and, to cure the default, the Borrower must pay to Lender the overdue Loan Balance of $500, interest upon the overdue Loan Balance, and a penalty of $10.