Traditionally, the common law courts do not enforce contracts that are illegal, penal in nature, or contrary to public policy.
The courts’ disinclination to enforce contracts that are illegal is easy to understand. After all, this country is governed by the rule of law. Contracts that do not observe the laws of the land should be unenforceable. For example, illegal gambling debts are not recoverable in court.
The public policy part is a bit tricky. Since the concept of “public policy” is vague and quite subjective, the courts are generally reluctant to render a contract void or voidable on this ground. Only contracts concerning serious infringement to civil liberties will be held unenforceable on this ground. For example, restriction of the parties’ ability to marry will be rendered unenforceable, since marriage is a fundamental right to a person’s liberty.
Finally, contracts that are penal in nature (including penalty clauses) will not be enforced. This may surprise you. The rationale behind this disinclination to enforce penalty clauses is that the right to penalize individuals belongs to the sovereign, and not to individuals.
Then why are so-called “penalty clauses” still common in commercial contracts?
The answer is two-fold. First, the courts respect the individual’s freedom to engage in contracts and generally will not interfere, even if a party has entered into a lousy contract. Second, the so-called “penalty” clauses are not really penal in nature per se. Rather, they are viewed as liquidated damages for the non-compliance of the terms of the contract.
Even though “penalty” clauses of this kind are generally enforceable, I prefer to avoid referring to them as such to avoid potential confusion.
