On 4th November 2015,
judgements were made in the Supreme Court that have clarified the law on
penalties in contracts. The decisions on two cases mark the first authoritative
final appeal court decisions in 100 years that comprehensively address and
amend the law surrounding contract penalties.
Most contracts, especially
contracts of a commercial nature, feature clauses known as ‘liquidated damages’
clauses. In some cases, contract law will dictate that these clauses may amount
to penalties. If this happens and a liquidated damages clause is deemed by a
court to be a penalty, then it cannot be enforceable. It has therefore always
been vital to make sure that clauses in contracts cannot be construed as penalties.
The Cases
In the first case, Cavendish
Square Holding BV v Talal El Makdessi (The Group), the owners of The Group
agreed to sell a share to Cavendish. The terms of the agreement provided that
Mr Makdessi, one of the owners of The Group, was required to refrain from
competing activities for several years and failure to comply would mean that he
would no longer be entitled to two of the payments still due, and that he could
be required to sell his remaining holding to Cavendish, for a sum ignoring any
value for goodwill. The case went to trial due to Mr Makdessi having breached
the restrictive covenants, however he alleged that the clauses constituted
penalties and were therefore unenforceable.
The second case was ParkingEye v
Beavis. ParkingEye was the manager of a retail park car park. Notices placed
around the car park stated that exceeding the two hour free parking limit would
lead to a charge of £85. Mr Beavis had exceed the limit by almost an hour, but
refused to pay the charge, arguing that it was unenforceable and unfair under
the Unfair Contract Terms in Consumer Contracts Regulations 1999.
Penalties, or not Penalties?
In both cases, however, the
clauses were held to not be penalties.
Previously, the penalty rule was said to have become, in the words of
Lord Sumption, “an
ancient, haphazardly constructed edifice which has not weathered well”. The
Supreme Court had to consider various options, including the abolition of the
rule, or its extension to make it more widely applicable. Instead, it reformulated
the test for a penalty, which now stands as: “Whether the impugned provision
is a secondary obligation which imposes a detriment on the contract-breaker out
of all proportion to any legitimate interest of the innocent party in the
enforcement of the primary obligation.”
It is now much clearer to work out whether a clause
counts as a penalty, which should spell good news for businesses entering into
contracts.
