A penalty clause enables a creditor to claim a stipulated penalty without having to prove the injury suffered. In construction contracts, these clauses typically set the damages for project delays in advance.

However, the court retains the power to review and reduce penalties that prove to be abusive. The decision in EBC inc. c. Ville de Montréal, 2026 QCCS 855, illustrates the exercise of this judicial power, which is part of a broader effort to balance freedom of contract with the requirement to act in good faith.

The decision offers an important reminder of the limits of penalty clauses in construction law and the circumstances in which a clause may be considered abusive.

Where the delays are significant, so is the penalty

In October 2017, the City of Montreal (the “City”) awarded EBC Inc. (“EBC”) a contract worth nearly $30 million to install underground wastewater pipes. The work had to be completed within 425 days, and the contract provided that a penalty of 0.1% of the contract price would be incurred for each day of delay, up to a maximum of 10%. This limit was introduced during the bidding process at the request of the bidders, including EBC.

Partway through the project, a major heave in an underground pipe halted the work, and corrective measures had to be implemented. Consequently, the project fell 193 days behind schedule, prompting the City to apply the maximum penalty of 10%, totalling $2,997,500.

In August 2022, EBC filed a lawsuit against the City, asking the court to reduce the delay penalty to zero. EBC argued that the City had wrongfully set off the amount and had been unjustly enriched, since the delays had caused only minor damage at most.

The City countered that the penalty clause had been agreed upon in the contract, that its deterrent purpose had to be upheld, and that its application was legitimate given the scale of the delays.

A legitimate clause with excessive effects

The Superior Court of Quebec (the “Court”) held that the project delays stemmed from EBC’s faulty performance of the contract, not from force majeure or any wrongdoing by the City. EBC was bound by an obligation of result with respect to meeting the contractual deadline; therefore, exceeding it constituted a fault.

In principle, even where there is fault, a penalty clause may be set aside if the creditor has suffered no injury. In this case, however, the Court found that the 193-day delay, against a 425-day schedule, inevitably caused injury to the City. The purpose of a penalty clause is to spare the creditor from having to prove the extent of the injury suffered. Therefore, the Court concluded that the existence of injury alone was enough to justify the clause’s application.

However, the Court’s analysis did not end there. Instead, the crux of the decision rested on the notion of abuse, the true basis on which the Court could reduce the amount of the penalty. The judge noted that a penalty clause may be abusive either intrinsically, meaning it is disproportionate from the moment it is formed, or in the circumstances of its application.

In this case, the Court found that the clause was not intrinsically abusive, particularly because the maximum penalty was reduced and capped following discussions with the bidders, including EBC.

Regarding the effects of the penalty, the Court recognized that a penalty clause serves a comminatory, or deterrent, function and that a penalty may legitimately exceed the actual injury suffered. However, this function must not lead to the creditor’s excessive and unjust enrichment.

Given the circumstances, the Court determined that imposing the full penalty would give the City an unfair advantage over the benefits it would have received if the contract had been completed on time. Therefore, the penalty clause was declared abusive since it permitted enrichment beyond its compensatory and deterrent role, placing EBC at an unreasonable disadvantage contrary to the requirements of good faith.

Accordingly, the Court reduced the penalty to $2,000,000 at its discretion.

Practical takeaways

The penalty clause is a legitimate and useful contractual tool for owners, particularly in public contracts, where its deterrent effect plays an essential role in enforcing contractual discipline. However, contracting parties must remain alert to potential abuses that may arise when such a clause is applied, especially when the penalty becomes an instrument of enrichment rather than a mechanism for compensation and deterrence.

When reviewing a case, the court must consider all the circumstances to determine whether the penalty should be reduced to restore the balance between the creditor’s right to full compensation and the reasonable exercise of contractual rights.

Whether you are an owner seeking to protect your rights or a contractor facing a disproportionate penalty, the lawyers in the Construction and Infrastructure team at Miller Thomson are here to advise you. Contact our team to discuss your construction contract issues.