Penalising the penaliser - Penalties doctrine survives assassination attempt in Supreme Court
- A blatant interference with the principle of freedom of contract or a justifiable restraint on the power of one party to a contract to impose an extortionate payment or other obligation in the event of breach?
- The status and future of the doctrine of penalties in English law has been considered by The Supreme Court in Cavendish Square Holdings v Makadessi and ParkingEye Ltd v Beavis  UKSC 67. The first concerned a commercial Agreement for the sale by the defendant of his controlling interest in his advertising and marketing company. The Agreement contained a non competition clause and provisions to the effect that on breach of this clause the Defendant would not be entitled to further payments under the Agreement and the Claimant would be entitled to an option to purchase his remaining shares at a price which disregarded goodwill. The Second case concerned a charge of £85 payable by those who stayed in the Claimant’s car park for more than 2 hours.
- In both cases the issue was whether the provisions in question constituted enforceable liquidated damages provisions or were liable to be struck down as unenforceable penal provisions.
- The Claimants in Makedessi sought to make an all out attack on the doctrine of penalties in so far as commercial Agreements between parties of equal bargaining strength and having access to proper advice were concerned. The argument in essence was that, for contracts in this category, the doctrine of penalties has no part to play and should not be used as a means to trump the contractual choices made by the parties.
- Unsurprisingly the Court did not accede to the invitation to abolish such an entrenched doctrine as that of contractual penalties, even for a specific variety of contracts. One can imagine the potential for difficult questions to arise as to whether a given contract did or did not fall within the abolished category.
- The court was also influenced by evidence that almost all major systems of law have a doctrine of contractual penalties and by the view that the doctrine did have a continuing utility in the control of oppressive clauses in situations in which there was a lacunae in terms of statutory regulation.
- The doctrine thus survives the attempted assassination. However in a nod to the Claimant’s argument and no doubt in recognition of the detracting effect that the doctrine has on the freedom to contract on such commercial terms as the parties wish, the Court established that in a negotiated contract between properly advised parties the strong initial presumption is that the parties themselves are the best judges of what is legitimate in a provision dealing with the consequences of breach.
- There is, as one might expect, little elucidation in the judgment of ‘comparable bargaining power’, nor ‘properly advised parties’. Take company A, a major supplier and distributor having the lions share in the supply of a given commodity. It negotiates a supply Agreement with company B, a much smaller enterprise and essentially reliant on supply from A for its retail customer base. The provision provides for stringent payments by B should it fail to order minimum quantities each month under the supply Agreement. B breaches the minimum order term and contests the obligation to pay as a penalty. The evidence is that the agreement was drawn up by A’s solicitors, a blue chip city firm. Whereas B was advised by a local sole practitioner.
- Were the parties of ‘comparable bargaining power’? Were they properly advised? Does the reference by The Supreme Court to ‘proper advice’ indicate that, in a given case, evidence that one of the parties has been advised to agree to a provision which reasonably skilled legal advice would have advised against, mean that this is a factor which weighs against the application of the ‘strong initial presumption’?.
- As to the practical effect and application of the newly recognised ‘strong initial presumption’, the applicable principles will, no doubt, fall to be ‘hammered out on the anvil of decided cases’ as Lord Steyn once famously put it in a different context.
- The other notable development which arises from the decision is the change of emphasise in the test to determine whether a particular provision does or does not fall foul of the rule against penalties.
- The tendency in the more recent case law has been to focus upon the motive for the inclusion of the disputed clause in the Agreement in question. A finding that the primary motive was to act as a deterrent of a party or parties to act in breach was a factor which would be indicative of a clause that was penal in nature.
- The test as formulated by the Supreme Court requires a Court to focus on the legitimacy of the interest which the party relying on a clause has in that clause being present in the Agreement and whether the liability to which it gives rise is disproportionate to that legitimate interest. The fact that a provision does not provide for a genuine pre estimate of loss or that it is deterrent does not necessarily mean it is penal.
- In both Cavendish Square and ParkingEye the Supreme Court held that the provisions in question were enforceable as having a legitimate commercial purpose. The liabilities to which they gave rise were not sufficiently disproportionate to that legitimate interest as to allow the Court to intervene. In Cavendish Square the strong initial presumption applied, the Court finding that the parties were ‘sophisticated, successful and experienced commercial people bargaining on equal terms over a long period with expert legal advice’.
- Further, 3 of the Justices (Lords Neuberger PSJ, Sumption and Carnworth) were of the view that the clauses in Makdessi were, in reality, price adjustment clauses comprising primary obligations and therefore the penalty rule was not, in any event, engaged.
- Despite the reformulation by The Supreme Court of the criteria for the assessment of a clause asserted to comprise a penalty, the outcomes of individual cases are likely to continue to be largely fact specific and thus difficult to predict. The extent of liability as against legitimacy of purpose and whether the former is disproportionate to the latter, is not amenable to an easily applied litmus test. The recognition of a strong initial presumption in favour of enforcement in cases in which it applies does sway the balance in favour of the freedom of contracting parties and away from judicial interventionism.
- The decision also indicates that careful thought will need to be given by those responsible for drafting commercial Agreements to the wordings used in provisions giving rise to a liability on the part of a party to make payment, transfer property or forfeit a deposit based on the acts of the other party.
Europa Law Editorial
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