Can I include a penalty clause in a business contract in Ontario?

Ontario courts distinguish between two types of clauses that set a fixed sum for breach of contract: liquidated damages clauses and penalty clauses. A liquidated damages clause is one where the amount is a genuine pre-estimate of the loss the injured party would suffer — courts will uphold these. A penalty clause, on the other hand, is designed primarily to punish rather than compensate, and Ontario courts have historically refused to enforce the punitive portion.

Practically, this means you can include a clause specifying a set dollar amount for late delivery, missed milestones, or other breaches, but the amount should be proportionate to the foreseeable harm at the time the contract was signed. Courts look at whether it was a reasonable estimate, not whether it turns out to be accurate.

Canadian courts have moved toward a more flexible approach in recent years, but the safest drafting practice is still to tie the fixed amount to a genuine estimate of anticipated loss and document the reasoning. If your business relies on these clauses to protect revenue, a lawyer can help you draft language that is more likely to withstand challenge.