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Paying the Penalty - The Supreme Court and the law on penalties

04-December-2015
04-December-2015 17:23
in Contract
by Christopher Loxton

On 4 November 2015, the Supreme Court changed the rule on penalties, whilst hearing the appeals of Cavendish Square Holding BV v Talal El Makdessi and ParkingEye Limited v Beavis [2015] UKSC 67. The traditional “genuine pre-estimate of loss” test was rejected. It was held that the proper test is whether the clause is out of all proportion to the innocent party's legitimate interest in enforcing the other party's obligations under the contract. If so, it will be penal and therefore unenforceable.

 

The Makdessi Litigation

 

Makdessi concerned provisions of a share purchase and shareholders’ agreement. If Mr Makdessi was in breach of certain non-compete restrictions, he lost certain entitlements. Upon breach, a call option was triggered, allowing Cavendish to buy his remaining shares at a price based on net asset value, with no provision for goodwill.

 

The High Court held the provisions therein were not penalties. The Court of Appeal reversed this decision. Their Lordships were not persuaded that the provisions were a genuine pre-estimate of loss. They held that the purpose of the provisions were a deterrent, rather than compensatory, with no sufficient commercial justification. That meant they were unconscionable and therefore penal. Cavendish was granted permission to appeal to the Supreme Court.

 

The Supreme Court held that the relevant provisions were not penalties. The pertinent reason was that the clauses "had nothing to do with punishment and everything to do with achieving Cavendish's commercial objective in acquiring the business". The parties, who were "sophisticated, successful and experienced commercial people bargaining on equal terms over a long period with expert legal advice", were the best judges of how their commercial interests should be reflected in the agreement.

 

The ParkingEye Litigation

 

ParkingEye charged Mr Beavis £85 for overstaying a two-hour permitted period of free parking at a retail park in Chelmsford.

 

The High Court held that this was not a penalty. The Court of Appeal agreed. Although it was not a genuine pre-estimate of loss and was aimed at deterring motorists, their Lordships held that it was justifiable commercially. The "dominant purpose of deterrence" need not be akin to unconscionability. Mr Beavis was granted permission to appeal to the Supreme Court.

 

The Supreme Court also held that the £85 charge was not penal because it was not out of all proportion to ParkingEye's legitimate interest. The purpose of the charge was to manage the efficiency of the car park by deterring motorists occupying spaces for long periods. It also was not lost on their Lordships, ParkingEye’s need for an income stream to run a viable business and to make a profit. This, in their view, was reasonable and the method in achieving it by fines for over stayers, was also reasonable.

 

Both judgments acknowledge that the law has been lacking in commercial reality. In Makdessi, the court was content to respect the parties’ commercial position at the outset. It seems no longer tolerable that that the court can protect one from making a bad bargain, after the event. Similarly, ParkingEye’s commercial viability was also respected. It is clear that businesses as profit centres, are in existence to make a profit. Clauses promoting this, but short of the unconscionable are now protected by the law. It will be intriguing to observe how the courts differentiate the commercially viable from the extravagant and unconscionable.

© 2015 Chambers of Lawrence Power, 4 King’s Bench Walk, Temple, London, EC4Y 7DL. Tel: 020 7822 8822. www.4kbw.net  email jr@4kbw.net