To what extent is the penalty clause legitimate in contracts?

The penalty clause is an agreement between contracting parties on the amount of compensation due to the creditor if the debtor breaches his obligations. It is a modern term that was not known to early Muslim jurists. Contemporary scholars have divided it into two types:

1. That which is stipulated for non-performance or delay in performance: This type is permissible and valid, based on the principle of permissibility of transactions and conditions unless there is evidence prohibiting them, as stated in Sahih al-Bukhari from Ibn Sirin regarding the story of the man who stipulated a condition on the hirer, and as ruled by various fatwa bodies and committees.

2. That which is stipulated for delay in debt repayment: This type is impermissible by scholarly consensus, because it is considered clear usury, whether the committed item is of the same kind as the debt or not. The view that permits a penalty clause to compensate for damages resulting from a wealthy debtor's procrastination is rejected by the apparent meanings of texts, such as the hadith: "The procrastination of the wealthy makes his punishment and honor permissible," where scholars interpreted "punishment" as imprisonment only.