Michaelmas Term [2015] UKSC 67 On appeal from: [2013] EWCA Civ 1539 and [2015] EWCA Civ 402

JUDGMENT
Cavendish Square Holding BV (Appellant) v Talal
El Makdessi (Respondent)
ParkingEye Limited (Respondent) v Beavis
(Appellant)
before
Lord Neuberger, President
Lord Mance
Lord Clarke
Lord Sumption
Lord Carnwath
Lord Toulson
Lord Hodge
JUDGMENT GIVEN ON
4 November 2015
Heard on 21, 22 and 23 July 2015
Appellant (Cavendish
Square Holding BV)
Respondent (Talal El
Makdessi)
Joanna Smith QC Michael Bloch QC
Richard Leiper Camilla Bingham QC
James McCreath
Edwin Peel
(Instructed by Squire
Patton Boggs (UK) LLP
)
(Instructed by Clifford
Chance LLP
)
Appellant (Beavis)
Respondent (ParkingEye
Limited)
John de Waal QC Jonathan Kirk QC
David Lewis David Altaras
Ryan Hocking Thomas Samuels
(Instructed by Harcus
Sinclair
)
(Instructed by Cubism
Law
)
Intervener (Consumers

Association)
Christopher Butcher QC
(Instructed by Consumers

Association In
-House
Lawyers
)
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LORD NEUBERGER AND LORD SUMPTION: (with whom Lord
Carnwath agrees)
1. These two appeals raise an issue which has not been considered by the
Supreme Court or by the House of Lords for a century, namely the principles
underlying the law relating to contractual penalty clauses, or, as we will call it, the
penalty rule. The first appeal, Cavendish Square Holding BV v Talal El Makdessi,
raises the issue in relation to two clauses in a substantial commercial contract. The
second appeal, ParkingEye Ltd v Beavis, raises the issue at a consumer level, and it
also raises a separate issue under the Unfair Terms in Consumer Contracts
Regulations 1999 (SI 1999/2083) (“the 1999 Regulations”).
2. We shall start by addressing the law on the penalty rule generally, and will
then discuss the two appeals in turn.
The law in relation to penalties
3. The penalty rule in England is an ancient, haphazardly constructed edifice
which has not weathered well, and which in the opinion of some should simply be
demolished, and in the opinion of others should be reconstructed and extended. For
many years, the courts have struggled to apply standard tests formulated more than
a century ago for relatively simple transactions to altogether more complex
situations. The application of the rule is often adventitious. The test for
distinguishing penal from other principles is unclear. As early as 1801, in Astley v
Weldon (1801) 2 Bos & Pul 346, 350 Lord Eldon confessed himself, not for the first
time, “much embarrassed in ascertaining the principle on which [the rule was]
founded”. Eighty years later, in Wallis v Smith (1882) 21 Ch D 243, 256, Sir George
Jessel MR, not a judge noted for confessing ignorance, observed that “The ground
of that doctrine I do not know”. In 1966 Diplock LJ, not a judge given to recognising
defeat, declared that he could “make no attempt, where so many others have failed,
to rationalise this common law rule”: Robophone Facilities Ltd v Blank [1966] 1
WLR 1428, 1446. The task is no easier today. But unless the rule is to be abolished
or substantially extended, its application to any but the clearest cases requires some
underlying principle to be identified.
Equitable origins
4. The penalty rule originated in the equitable jurisdiction to relieve from
defeasible bonds. These were promises under seal to pay a specified sum of money,
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subject to a proviso that they should cease to have effect on the satisfaction of a
condition, usually performance of some other (“primary”) obligation. By the
beginning of the 16th century, the practice had grown up of taking defeasible bonds
to secure the performance obligations sounding in damages. This enabled the holder
of the bond to bring his action in debt, which made it unnecessary for him to prove
his loss and made it possible to stipulate for substantially more than his loss. The
common law enforced the bonds according to their letter. But equity regarded the
real intention of the parties as being that the bond should stand as security only, and
restrained its enforcement at common law on terms that the debtor paid damages,
interest and costs. The classic statement of this approach is that of Lord Thurlow LC
in Sloman v Walter (1783) 1 Bro CC 418, 419:
“… where a penalty is inserted merely to secure the enjoyment
of a collateral object, the enjoyment of the object is considered
as the principal intent of the deed, and the penalty only as
accessional, and, therefore, only to secure the damage really
incurred …”
5. The essential conditions for the exercise of the jurisdiction were (i) that the
penal provision was intended as a security for the recovery of the true amount of a
debt or damages, and (ii) that that objective could be achieved by restraining
proceedings on the bond in the courts of common law, on terms that the defendant
paid damages. As Lord Macclesfield observed in Peachy v Duke of Somerset (1720)
1 Strange 447, 453:
“The true ground of relief against penalties is from the original
intent of the case, where the penalty is designed only to secure
money, and the court gives him all that he expected or desired:
but it is quite otherwise in the present case. These penalties or
forfeitures were never intended by way of compensation, for
there can be none.”
This last reservation remained an important feature of the equitable jurisdiction to
relieve. As Baggallay LJ put it in Protector Endowment Loan and Annuity Company
v Grice (1880) 5 QBD 592, 595, “where the intent is not simply to secure a sum of
money, or the enjoyment of a collateral object, equity does not relieve”.
The common law rule
6. The process by which the equitable rule was adopted by the common law is
traced by Professor Simpson in his article The penal bond with conditional
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defeasance (1966) 82 LQR 392, 418-419. Towards the end of the 17th century, the
courts of common law tentatively began to stay proceedings on a penal bond to
secure a debt, unless the plaintiff was willing to accept a tender of the money,
together with interest and costs. The rule was regularised and extended by two
statutes of 1696 and 1705. Section 8 of the Administration of Justice Act 1696 (8 &
9 Will 3 c 11) is a prolix provision whose effect was that the plaintiff suing in the
common law courts on a defeasible bond to secure the performance of covenants
(not just debts) was permitted to plead the breaches and have his actual damages
assessed. Judgment was entered on the bond, but execution was stayed upon
payment of the assessed damages. The Administration of Justice Act 1705 (4 & 5
Anne c 16) allowed the defendant in an action on the bond to pay the amount of the
actual loss, together with interest and costs, into court, and rely on the payment as a
defence. These statutes were originally framed as facilities for plaintiffs suing on
bonds. But by the end of the 18th century the common law courts had begun to treat
the statutory procedures as mandatory, requiring damages to be pleaded and proved
and staying all further proceedings on the bond: see Roles v Rosewell (1794) 5 TR
538, Hardy v Bern (1794) 5 TR 636. The effect of this legislation was thus to make
it unnecessary to proceed separately in chancery for relief from the penalty and in
the courts of common law for the true loss. As a result, the equitable jurisdiction
was rarely invoked, and the further development of the penalty rule was entirely the
work of the courts of common law.
7. It developed, however, on wholly different lines. The equitable jurisdiction
to relieve from penalties had been closely associated with the jurisdiction to relieve
from forfeitures which developed at the same time. Both were directed to contractual
provisions which on their face created primary obligations, but which during the
17th and 18th centuries the courts of equity treated as secondary obligations on the
ground that the real intention was that they should stand as a mere security for
performance. The court then intervened to grant relief from the rigours of the
secondary obligation in order to secure performance in another, less penal or (in
modern language) more proportionate, way. In contrast, the penalty rule as it was
developed by the common law courts in the course of the 19th and 20th centuries
proceeded on the basis that although penalties were secondary obligations, the
parties meant what they said. They intended the provision to be applied according
to the letter with a view to penalising breach. The law relieved the contract-breaker
of the consequences not because the objective could be secured in another way but
because the objective was contrary to public policy and should not therefore be given
effect at all. The difference in approach to penalties of the courts of equity and the
common law courts is in many ways a classic example of the contrast between the
flexible if sometimes unpredictable approach of equity and the clear if relatively
strict approach of the common law.
8. With the gradual decline of the use of penal defeasible bonds, the common
law on penalties was developed almost entirely in the context of damages clauses –
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ie clauses which provided for payment of a specified sum in place of common law
damages. Because they were a contractual substitute for common law damages, they
could not in any meaningful sense be regarded as a mere security for their payment.
If the agreed sum was a penalty, it was treated as unenforceable. Starting with the
decisions in Astley in 1801 and Kemble v Farren (1829) 6 Bing 141, the common
law courts introduced the now familiar distinction between a provision for the
payment of a sum representing a genuine pre-estimate of damages and a penalty
clause in which the sum was out of all proportion to any damages liable to be
suffered. By the middle of the 19th century, this rule was well established. In Betts
v Burch (1859) 4 H & N 506, 509, Martin B regretted that he was “bound by the
cases” and prevented from holding that “parties are at liberty to enter into any
bargain they please” so that “if they have made an improvident bargain they must
take the consequences”. But Bramwell B (at p 511) appeared to have no such
reservations.
9. The distinction between a clause providing for a genuine pre-estimate of
damages and a penalty clause has remained fundamental to the modern law, as it is
currently understood. The question whether a damages clause is a penalty falls to be
decided as a matter of construction, therefore as at the time that it is agreed: Public
Works Comr v Hills [1906] AC 368, 376; Webster v Bosanquet [1912] AC 394;
Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79, at
pp 86-87 (Lord Dunedin); and Cooden Engineering Co Ltd v Stanford [1953] 1 QB
86, 94 (Somervell LJ). This is because it depends on the character of the provision,
not on the circumstances in which it falls to be enforced. It is a species of agreement
which the common law considers to be by its nature contrary to the policy of the
law. One consequence of this is that relief from the effects of a penalty is, as
Hoffmann LJ put it in Else (1982) Ltd v Parkland Holdings Ltd [1994] 1 BCLC 130,
144, “mechanical in effect and involves no exercise of discretion at all.” Another is
that the penalty clause is wholly unenforceable: Clydebank Engineering &
Shipbuilding Co Ltd v Don Jose Ramos Yzquierdo y Castaneda [1905] AC 6, 9, 10
(Lord Halsbury LC); Gilbert-Ash (Northern) Ltd v Modern Engineering (Bristol)
Ltd [1974] AC 689, 698 (Lord Reid), 703 (Lord Morris of Borth-y-Gest) and 723-
724 (Lord Salmon); Scandinavian Trading Tanker Co AB v Flota Petrolera
Ecuatoriana (The “Scaptrade”) [1983] 2 AC 694, 702 (Lord Diplock); AMEV-UDC
Finance Ltd v Austin (1986) 162 CLR 170, 191-193 (Mason and Wilson JJ).
Deprived of the benefit of the provision, the innocent party is left to his remedy in
damages under the general law. As Lord Diplock put it in The “Scaptrade” at p 702:
“The classic form of penalty clause is one which provides that
upon breach of a primary obligation under the contract a
secondary obligation shall arise on the part of the party in
breach to pay to the other party a sum of money which does not
represent a genuine pre-estimate of any loss likely to be
sustained by him as the result of the breach of primary
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obligation but is substantially in excess of that sum. The classic
form of relief against such a penalty clause has been to refuse
to give effect to it, but to award the common law measure of
damages for the breach of primary obligation instead.”
10. Equity, on the other hand, relieves against forfeitures “where the primary
object of the bargain is to secure a stated result which can effectively be attained
when the matter comes before the court, and where the forfeiture provision is added
by way of security for the production of that result”: Shiloh Spinners Ltd v Harding
[1973] AC 691, 723 (Lord Wilberforce). As Lord Wilberforce said at p 722, the
paradigm cases are the jurisdiction to relieve from a right of re-entry in a lease of
land and the mortgagor’s equity of redemption (and the associated equitable right to
redeem) in relation to mortgages. Save in relation to non-payment of rent, the power
to grant relief from forfeiture to lessees is now contained in section 146 of the Law
of Property Act 1925, and probably exclusively so (see Official Custodian for
Charities v Parway Estates Departments Ltd [1985] Ch 151). Relief for mortgagors
through the equitable right to redeem is (save in relation to most residential
properties) largely still based on judge-made law. However, neither by statute nor
on general principles of equity is a lessor’s right of re-entry or a mortgagee’s right
of sale or foreclosure treated as being by its nature contrary to the policy of the law.
What equity (and, where it applies, statute) typically considers to be contrary to the
policy of the law is the enforcement of such rights in circumstances where their
purpose, namely the performance of the obligations in the lease or the mortgage, can
be achieved in other ways – normally by late substantive compliance and payment
of appropriate compensation. The forfeiture or foreclosure/power of sale is therefore
enforceable, equity intervening only to impose terms. These will generally require
the lessee or mortgagor to rectify the breach and make good any loss suffered by the
lessor or mortgagee. If the lessee or mortgagee cannot or will not do so, the forfeiture
will be unconditionally enforced – although perhaps not invariably (see per Lord
Templeman in Associated British Ports v CH Bailey plc [1990] 2 AC 703, 707-708
in the context of section 146, and, more generally, the judgments in Cukurova
Finance International Ltd v Alfa Telecom Turkey Ltd (No 3) [2013] UKPC 20,
[2015] 2 WLR 875).
11. The penalty rule as it has been developed by the judges gives rise to two
questions, both of which have a considerable bearing on the questions which arise
on these appeals. In what circumstances is the rule engaged at all? And what makes
a contractual provision penal?
In what circumstances is the penalty rule engaged?
12. In England, it has always been considered that a provision could not be a
penalty unless it provided an exorbitant alternative to common law damages. This
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meant that it had to be a provision operating upon a breach of contract. In Moss
Empires Ltd v Olympia (Liverpool) Ltd [1939] AC 544, this was taken for granted
by Lord Atkin (p 551) and Lord Porter (p 558). As a matter of authority the question
is settled in England by the decision of the House of Lords in Export Credits
Guarantee Department v Universal Oil Products Co [1983] 1 WLR 399 (“ECGD”).
Lord Roskill, with whom the rest of the committee agreed, said at p 403:
“[P]erhaps the main purpose, of the law relating to penalty
clauses is to prevent a plaintiff recovering a sum of money in
respect of a breach of contract committed by a defendant which
bears little or no relationship to the loss actually suffered by the
plaintiff as a result of the breach by the defendant. But it is not
and never has been for the courts to relieve a party from the
consequences of what may in the event prove to be an onerous
or possibly even a commercially imprudent bargain.”
As Lord Hodge points out in his judgment, the Scottish authorities are to the same
effect.
13. This principle is worth restating at the outset of any analysis of the penalty
rule, because it explains much about the way in which it has developed. There is a
fundamental difference between a jurisdiction to review the fairness of a contractual
obligation and a jurisdiction to regulate the remedy for its breach. Leaving aside
challenges going to the reality of consent, such as those based on fraud, duress or
undue influence, the courts do not review the fairness of men’s bargains either at
law or in equity. The penalty rule regulates only the remedies available for breach
of a party’s primary obligations, not the primary obligations themselves. This was
not a new concept in 1983, when ECGD was decided. It had been the foundation of
the equitable jurisdiction, which depended on the treatment of penal defeasible
bonds as secondary obligations or, as Lord Thurlow LC put it in 1783 in Sloman as
“collateral” or “accessional” to the primary obligation. And it provided the whole
basis of the classic distinction made at law between a penalty and a genuine preestimate of loss, the former being essentially a way of punishing the contract-breaker
rather than compensating the innocent party for his breach. We shall return to that
distinction below.
14. This means that in some cases the application of the penalty rule may depend
on how the relevant obligation is framed in the instrument, ie whether as a
conditional primary obligation or a secondary obligation providing a contractual
alternative to damages at law. Thus, where a contract contains an obligation on one
party to perform an act, and also provides that, if he does not perform it, he will pay
the other party a specified sum of money, the obligation to pay the specified sum is
a secondary obligation which is capable of being a penalty; but if the contract does
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not impose (expressly or impliedly) an obligation to perform the act, but simply
provides that, if one party does not perform, he will pay the other party a specified
sum, the obligation to pay the specified sum is a conditional primary obligation and
cannot be a penalty.
15. However, the capricious consequences of this state of affairs are mitigated by
the fact that, as the equitable jurisdiction shows, the classification of terms for the
purpose of the penalty rule depends on the substance of the term and not on its form
or on the label which the parties have chosen to attach to it. As Lord Radcliffe said
in Campbell Discount Co Ltd v Bridge [1962] AC 600, 622, “[t]he intention of the
parties themselves”, by which he clearly meant the intention as expressed in the
agreement, “is never conclusive and may be overruled or ignored if the court
considers that even its clear expression does not represent ‘the real nature of the
transaction’ or what ‘in truth’ it is taken to be” (and cf per Lord Templeman in Street
v Mountford [1985] AC 809, 819). This aspect of the equitable jurisdiction was
inherited by the courts of common law, and has been firmly established since the
earliest common law cases.
16. Payment of a sum of money is the classic obligation under a penalty clause
and, in almost every reported case involving a damages clause, the provision
stipulates for the payment of money. However, it seems to us that there is no reason
why an obligation to transfer assets (either for nothing or at an undervalue) should
not be capable of constituting a penalty. While the penalty rule may be somewhat
artificial, it would heighten its artificiality to no evident purpose if it were otherwise.
Similarly, the fact that a sum is paid over by one party to the other party as a deposit,
in the sense of some sort of surety for the first party’s contractual performance, does
not prevent the sum being a penalty, if the second party in due course forfeits the
deposit in accordance with the contractual terms, following the first party’s breach
of contract – see the Privy Council decisions in Public Works Comr v Hills [1906]
AC 368, 375-376, and Workers Trust & Merchant Bank Ltd v Dojap Investments
Ltd [1993] AC 573. By contrast, in Else (1982) at p 146, Hoffmann LJ, citing
Stockloser v Johnson [1954] 1 QB 476 in support, said that, unlike a case where
“money has been deposited as security for due performance of [a] party’s
obligation”, “retention of instalments which have been paid under contract so as to
become the absolute property of the vendor does not fall within the penalty rule”,
although, he added that it was “subject … to the jurisdiction for relief against
forfeiture”.
17. The relationship between penalty clauses and forfeiture clauses is not entirely
easy. Given that they had the same origin in equity, but that the law on penalties was
then developed through common law while the law on forfeitures was not, this is
unsurprising. Some things appear to be clear. Where a proprietary interest or a
“proprietary or possessory right” (such as a patent or a lease) is granted or
transferred subject to revocation or determination on breach, the clause providing
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for determination or revocation is a forfeiture and cannot be a penalty, and, while it
is enforceable, relief from forfeiture may be granted: see BICC plc v Burndy Corpn
[1985] Ch 232, 246-247 and 252 (Dillon LJ) and The “Scaptrade”, pp 701-703,
(Lord Diplock). But this does not mean that relief from forfeiture is unavailable in
cases not involving land – see Cukurova Finance International Ltd v Alfa Telecom
Turkey Ltd (No 2) [2013] UKPC 2, [2015] 2 WLR 875, especially at paras 92-97,
and the cases cited there.
18. What is less clear is whether a provision is capable of being both a penalty
clause and a forfeiture clause. It is inappropriate to consider that issue in any detail
in this judgment, as we have heard very little argument on forfeitures –
unsurprisingly because in neither appeal has it been alleged that any provision in
issue is a forfeiture from which relief could be granted. But it is right to mention the
possibility that, in some circumstances, a provision could, at least potentially, be a
penalty clause as well as a forfeiture clause. We see the force of the arguments to
that effect advanced by Lord Mance and Lord Hodge in their judgments.
What makes a contractual provision penal?
19. As we have already observed, until relatively recently this question was
answered almost entirely by reference to straightforward liquidated damages
clauses. It was in that context that the House of Lords sought to restate the law in
two seminal decisions at the beginning of the 20th century, Clydebank in 1904 and
Dunlop in 1915.
20. Clydebank was a Scottish appeal about a shipbuilding contract with a
provision (described as a “penalty”) for the payment of £500 per week for delayed
delivery. The provision was held to be a valid liquidated damages clause, not a
penalty. Lord Halsbury (p 10) said that the distinction between the two depended on
“whether it is, what I think gave the jurisdiction to the courts in
both countries to interfere at all in an agreement between the
parties, unconscionable and extravagant, and one which no
court ought to allow to be enforced.”
Lord Halsbury declined to lay down any “abstract rule” for determining what was
unconscionable or extravagant, saying only that it must depend on “the nature of the
transaction – the thing to be done, the loss likely to accrue to the person who is
endeavouring to enforce the performance of the contract, and so forth”. Lord
Halsbury’s formulation has proved influential, and the two other members of the
Appellate Committee both delivered concurring judgments agreeing with it. It is,
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however, worth drawing attention to an observation of Lord Robertson (pp 19-20)
which points to the principle underlying the contrasting expressions “liquidated
damages” and “penalty”:
“Now, all such agreements, whether the thing be called penalty
or be called liquidate damage, are in intention and effect what
Professor Bell calls ‘instruments of restraint’, and in that sense
penal. But the clear presence of this does not in the least degree
invalidate the stipulation. The question remains, had the
respondents no interest to protect by that clause, or was that
interest palpably incommensurate with the sums agreed on? It
seems to me that to put this question, in the present instance, is
to answer it.”
21. Dunlop arose out of a contract for the supply of tyres, covers and tubes by a
manufacturer to a garage. The contract contained a number of terms designed to
protect the manufacturer’s brand, including prohibitions on tampering with the
marks, restrictions on the unauthorised export or exhibition of the goods, and on
resales to unapproved persons. There was also a resale price maintenance clause,
which would now be unlawful but was a legitimate restriction of competition
according to the notions prevailing in 1914. It was this clause which the purchaser
had broken. The contract provided for the payment of £5 for every tyre, cover or
tube sold in breach of any provision of the agreement. Once again, the provision was
held to be a valid liquidated damages clause. In his speech, Lord Dunedin formulated
four tests “which, if applicable to the case under consideration, may prove helpful,
or even conclusive” (p 87). They were (a) that the provision would be penal if “the
sum stipulated for is extravagant and unconscionable in amount in comparison with
the greatest loss that could conceivably be proved to have followed from the
breach”; (b) that the provision would be penal if the breach consisted only in the
non-payment of money and it provided for the payment of a larger sum; (c) that
there was “a presumption (but no more)” that it would be penal if it was payable in
a number of events of varying gravity; and (d) that it would not be treated as penal
by reason only of the impossibility of precisely pre-estimating the true loss.
22. Lord Dunedin’s speech in Dunlop achieved the status of a quasi-statutory
code in the subsequent case-law. Some of the many decisions on the validity of
damages clauses are little more than a detailed exegesis or application of his four
tests with a view to discovering whether the clause in issue can be brought within
one or more of them. In our view, this is unfortunate. In the first place, Lord Dunedin
proposed his four tests not as rules but only as considerations which might prove
helpful or even conclusive “if applicable to the case under consideration”. He did
not suggest that they were applicable to every case in which the law of penalties was
engaged. Second, as Lord Dunedin himself acknowledged, the essential question
was whether the clause impugned was “unconscionable” or “extravagant”. The four
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tests are a useful tool for deciding whether these expressions can properly be applied
to simple damages clauses in standard contracts. But they are not easily applied to
more complex cases. To deal with those, it is necessary to consider the rationale of
the penalty rule at a more fundamental level. What is it that makes a provision for
the consequences of breach “unconscionable”? And by comparison with what is a
penalty clause said to be “extravagant”? Third, none of the other three Law Lords
expressly agreed with Lord Dunedin’s reasoning, and the four tests do not all feature
in any of their speeches. Indeed, it appears that, in his analysis at pp 101-102, Lord
Parmoor may have taken a more restrictive view of what constituted a penalty than
did Lord Dunedin. More generally, the other members of the Appellate Committee
gave their own reasons for concurring in the result, and they also repay
consideration. For present purposes, the most instructive is that of Lord Atkinson,
who approached the matter on an altogether broader basis.
23. Lord Atkinson pointed (pp 90-91) to the critical importance to Dunlop of the
protection of their brand, reputation and goodwill, and their authorised distribution
network. Against this background, he observed (pp 91-92):
“It has been urged that as the sum of £5 becomes payable on
the sale of even one tube at a shilling less than the listed price,
and as it was impossible that the appellant company should lose
that sum on such a transaction, the sum fixed must be a penalty.
In the sense of direct and immediate loss the appellants lose
nothing by such a sale. It is the agent or dealer who loses by
selling at a price less than that at which he buys, but the
appellants have to look at their trade in globo, and to prevent
the setting up, in reference to all their goods anywhere and
everywhere, a system of injurious undercutting. The object of
the appellants in making this agreement, if the substance and
reality of the thing and the real nature of the transaction be
looked at, would appear to be a single one, namely, to prevent
the disorganization of their trading system and the consequent
injury to their trade in many directions. The means of effecting
this is by keeping up their price to the public to the level of their
price list, this last being secured by contracting that a sum of
£5 shall be paid for every one of the three classes of articles
named sold or offered for sale at prices below those named on
the list. The very fact that this sum is to be paid if a tyre cover
or tube be merely offered for sale, though not sold, shows that
it was the consequential injury to their trade due to undercutting
that they had in view. They had an obvious interest to prevent
this undercutting, and on the evidence it would appear to me
impossible to say that that interest was incommensurate with
the sum agreed to be paid.”
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Lord Atkinson went on to draw an analogy, which has particular resonance in the
Cavendish appeal, with a clause dealing with damages for breach of a restrictive
covenant on the canvassing of business by a former employee. In this context, he
said (pp 92-93):
“It is, I think, quite misleading to concentrate one’s attention
upon the particular act or acts by which, in such cases as this,
the rivalry in trade is set up, and the repute acquired by the
former employee that he works cheaper and charges less than
his old master, and to lose sight of the risk to the latter that old
customers, once tempted to leave him, may never return to deal
with him, or that business that might otherwise have come to
him may be captured by his rival. The consequential injuries to
the trader’s business arising from each breach by the employee
of his covenant cannot be measured by the direct loss in a
monetary point of view on the particular transaction
constituting the breach.”
Lord Atkinson was making substantially the same point as Lord Robertson had made
in Clydebank. The question was: what was the nature and extent of the innocent
party’s interest in the performance of the relevant obligation. That interest was not
necessarily limited to the mere recovery of compensation for the breach. Lord
Atkinson considered that the underlying purpose of the resale price maintenance
clause gave Dunlop a wider interest in enforcing the damages clause than pecuniary
compensation. £5 per item was not incommensurate with that interest even if it was
incommensurate with the loss occasioned by the wrongful sale of a single item.
24. Although the other members of the Appellate Committee did not express
themselves in the same terms as Lord Atkinson, their approach was entirely
consistent with his. Lord Parker at p 97 said that “whether the sum agreed to be paid
on the breach is really a penalty must depend on the circumstances of each particular
case”, and at p 99, echoing Lord Atkinson’s fuller treatment of the point, as just set
out, he described the damage which would result from any breach as “consist[ing]
in the disturbance or derangement of the system of distribution by means of which
[Dunlop’s] goods reach the ultimate consumer”. In their speeches, Lord Dunedin (p
87), Lord Parker (p 98) and Lord Parmoor (p 103) ultimately were content to rest
their decision that the £5 was not a penalty on the ground that an exact pre-estimate
of loss was impossible, whereas, in the passages quoted above, Lord Atkinson
analysed why that was so. It seems clear that the actual result of the case was
strongly influenced by Lord Atkinson’s reasoning. The clause was upheld although,
on the face of it, it failed all but the last of Lord Dunedin’s tests. The £5 per item
applied to breaches of very variable significance and it was impossible to relate the
loss attributable to the sale of that item. It was justifiable only by reference to the
wider interests identified by Lord Atkinson.
Page 13
25. The great majority of cases decided in England since Dunlop have concerned
more or less standard damages clauses in consumer contracts, and Lord Dunedin’s
four tests have proved perfectly adequate for dealing with those. More recently,
however, the courts have returned to the possibility of a broader test in less
straightforward cases, in the context of the supposed “commercial justification” for
clauses which might otherwise be regarded as penal. An early example is the
decision of the House of Lords in The “Scaptrade”, where at p 702, Lord Diplock,
with whom the rest of the Appellate Committee agreed, observed that a right to
withdraw a time-chartered vessel for non-payment of advance hire was not a penalty
because its commercial purpose was to create a fund from which the cost of
providing the chartered service could be funded.
26. In Lordsvale Finance plc v Bank of Zambia [1996] QB 752, Colman J was
concerned with a common form provision in a syndicated loan agreement for interest
to be payable at a higher rate during any period when the borrower was in default.
There was authority that such provisions were penal: Lady Holles v Wyse (1693) 2
Vern 289; Strode v Parker (1694) 2 Vern 316, Wallingford v Mutual Society (1880)
5 App Cas 685, 702 (Lord Hatherley). But Colman J held that the clause was valid
because its predominant purpose was not to deter default but to reflect the greater
credit risk associated with a borrower in default. At pp 763-764, he observed that a
provision for the payment of money upon breach could not be categorised as a
penalty simply because it was not a genuine pre-estimate of damages, saying that
there would seem to be:
“no reason in principle why a contractual provision the effect
of which was to increase the consideration payable under an
executory contract upon the happening of a default should be
struck down as a penalty if the increase could in the
circumstances be explained as commercially justifiable,
provided always that its dominant purpose was not to deter the
other party from breach.”
27. Colman J’s approach was approved by Mance LJ, delivering the leading
judgment in the Court of Appeal in Cine Bes Filmcilik ve Yapimcilik v United
International Pictures [2004] 1 CLC 401, para 13. A similar view was taken by
Arden LJ in Murray v Leisureplay plc [2005] IRLR 946, para 54, where she posed
the question
“Has the party who seeks to establish that the clause is a penalty
shown that the amount payable under the clause was imposed
in terrorem, or that it does not constitute a genuine pre-estimate
of loss for the purposes of the Dunlop case, and, if he has shown
the latter, is there some other reason which justifies the
Page 14
discrepancy between [the amount payable under the clause and
the amount payable by way of damages in common law]?”
(emphasis added).
She considered that the clause in question had advantages for both sides, and pointed
out that no evidence had been adduced to show that the clause lacked commercial
justification: see paras 70-76. But Buxton LJ put the matter on a wider basis for
which Clarke LJ (para 105) expressed a preference. He referred to the speech of
Lord Atkinson in Dunlop and suggested that the ratio of the actual decision in that
case had been that “an explanation of the clause in commercial rather than deterrent
terms was available”. All three members of the court endorsed the approach of
Colman J in Lordsvale and Mance LJ in Cine Bes.
28. Colman J in Lordsvale and Arden LJ in Murray were inclined to rationalise
the introduction of commercial justification as part of the test, by treating it as
evidence that the impugned clause was not intended to deter. Later decisions in
which a commercial rationale has been held inconsistent with the application of the
penalty rule, have tended to follow that approach: see, for example, Euro London
Appointments Ltd v Claessens International Ltd [2006] 2 Lloyd’s Rep 436, General
Trading Company (Holdings) Ltd v Richmond Corpn Ltd [2008] 2 Lloyd’s Rep 475.
It had the advantage of enabling them to reconcile the concept of commercial
justification with Lord Dunedin’s four tests. But we have some misgivings about it.
The assumption that a provision cannot have a deterrent purpose if there is a
commercial justification, seems to us to be questionable. By the same token, we
agree with Lord Radcliffe’s observations in Campbell Discount at p 622, where he
said:
“… I do not myself think that it helps to identify a penalty, to
describe it as in the nature of a threat ‘to be enforced in
terrorem’ (to use Lord Halsbury’s phrase in Elphinstone v
Monkland Iron & Coal Co Ltd (1886) 11 App Cas 332, 348). I
do not find that that description adds anything of substance to
the idea conveyed by the word ‘penalty’ itself, and it obscures
the fact that penalties may quite readily be undertaken by
parties who are not in the least terrorised by the prospect of
having to pay them and yet are, as I understand it, entitled to
claim the protection of the court when they are called upon to
make good their promises.”
Moreover, the penal character of a clause depends on its purpose, which is ordinarily
an inference from its effect. As we have already explained, this is a question of
construction, to which evidence of the commercial background is of course relevant
in the ordinary way. But, for the same reason, the answer cannot depend on evidence
Page 15
of actual intention: see Chartbrook Ltd v Persimmon Homes Ltd [2009] AC 1101,
paras 28-47 (Lord Hoffmann). However, while we have misgivings about some
aspects of their reasoning, these aspects are peripheral to the essential point which
Colman J and Buxton LJ were making, and we consider that their emphasis on
justification provides a valuable insight into the real basis of the penalty rule. It is
the same insight as that of Lord Robertson in Clydebank and Lord Atkinson in
Dunlop. A damages clause may properly be justified by some other consideration
than the desire to recover compensation for a breach. This must depend on whether
the innocent party has a legitimate interest in performance extending beyond the
prospect of pecuniary compensation flowing directly from the breach in question.
29. The availability of remedies for a breach of duty is not simply a question of
providing a financial substitute for performance. It engages broader social and
economic considerations, one of which is that the law will not generally make a
remedy available to a party, the adverse impact of which on the defaulter
significantly exceeds any legitimate interest of the innocent party. In the famous
case of White & Carter (Councils) Ltd v McGregor [1962] AC 413, Lord Reid
observed, at p 431:
“It may well be that, if it can be shown that a person has no
legitimate interest, financial or otherwise, in performing the
contract rather than claiming damages, he ought not to be
allowed to saddle the other party with an additional burden with
no benefit to himself. If a party has no interest to enforce a
stipulation, he cannot in general enforce it: so it might be said
that, if a party has no interest to insist on a particular remedy,
he ought not to be allowed to insist on it. And, just as a party is
not allowed to enforce a penalty, so he ought not to be allowed
to penalise the other party by taking one course when another
is equally advantageous to him. … Here the respondent did not
set out to prove that the appellants had no legitimate interest in
completing the contract and claiming the contract price rather
than claiming damages. … Parliament has on many occasions
relieved parties from certain kinds of improvident or
oppressive contracts, but the common law can only do that in
very limited circumstances.”
In White & Carter the innocent party was entitled to ignore the repudiation of the
contract-breaker and proceed to perform, claiming his remuneration in debt rather
than limiting himself to damages, notwithstanding that this course might be a great
deal more expensive for the contract-breaker. This, according to Lord Reid (p 431),
was because the contract-breaker “did not set out to prove that the appellants had no
legitimate interest in completing the contract and claiming the contract price rather
than claiming damages”.
Page 16
30. More generally, the attitude of the courts, reflecting that of the Court of
Chancery, is that specific performance of contractual obligations should ordinarily
be refused where damages would be an adequate remedy. This is because the
minimum condition for an order of specific performance is that the innocent party
should have a legitimate interest extending beyond pecuniary compensation for the
breach. The paradigm case is the purchase of land or certain chattels such as ships,
which the law recognises as unique. Because of their uniqueness the purchaser’s
interest extends beyond the mere award of damages as a substitute for performance.
As Lord Hoffmann put it in addressing a very similar issue “the purpose of the law
of contract is not to punish wrongdoing but to satisfy the expectations of the party
entitled to performance”: Co-operative Insurance Society Ltd v Argyll Stores
(Holdings) Ltd [1998] AC 1, 15.
31. In our opinion, the law relating to penalties has become the prisoner of
artificial categorisation, itself the result of unsatisfactory distinctions: between a
penalty and genuine pre-estimate of loss, and between a genuine pre-estimate of loss
and a deterrent. These distinctions originate in an over-literal reading of Lord
Dunedin’s four tests and a tendency to treat them as almost immutable rules of
general application which exhaust the field. In Legione v Hateley (1983) 152 CLR
406, 445, Mason and Deane JJ defined a penalty as follows:
“A penalty, as its name suggests, is in the nature of a
punishment for non-observance of a contractual stipulation; it
consists of the imposition of an additional or different liability
upon breach of the contractual stipulation …”
All definition is treacherous as applied to such a protean concept. This one can fairly
be said to be too wide in the sense that it appears to be apt to cover many provisions
which would not be penalties (for example most, if not all, forfeiture clauses).
However, in so far as it refers to “punishment” and “an additional or different
liability” as opposed to “in terrorem” and “genuine pre-estimate of loss”, this
definition seems to us to get closer to the concept of a penalty than any other
definition we have seen. The real question when a contractual provision is
challenged as a penalty is whether it is penal, not whether it is a pre-estimate of loss.
These are not natural opposites or mutually exclusive categories. A damages clause
may be neither or both. The fact that the clause is not a pre-estimate of loss does not
therefore, at any rate without more, mean that it is penal. To describe it as a deterrent
(or, to use the Latin equivalent, in terrorem) does not add anything. A deterrent
provision in a contract is simply one species of provision designed to influence the
conduct of the party potentially affected. It is no different in this respect from a
contractual inducement. Neither is it inherently penal or contrary to the policy of the
law. The question whether it is enforceable should depend on whether the means by
which the contracting party’s conduct is to be influenced are “unconscionable” or
Page 17
(which will usually amount to the same thing) “extravagant” by reference to some
norm.
32. The true test is 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.
The innocent party can have no proper interest in simply punishing the defaulter.
His interest is in performance or in some appropriate alternative to performance. In
the case of a straightforward damages clause, that interest will rarely extend beyond
compensation for the breach, and we therefore expect that Lord Dunedin’s four tests
would usually be perfectly adequate to determine its validity. But compensation is
not necessarily the only legitimate interest that the innocent party may have in the
performance of the defaulter’s primary obligations. This was recognised in the early
days of the penalty rule, when it was still the creature of equity, and is reflected in
Lord Macclesfield’s observation in Peachy (quoted in para 5 above) about the
application of the penalty rule to provisions which were “never intended by way of
compensation”, for which equity would not relieve. It was reflected in the result in
Dunlop. And it is recognised in the more recent decisions about commercial
justification. And, as Lord Hodge shows, it is the principle underlying the Scottish
authorities.
33. The penalty rule is an interference with freedom of contract. It undermines
the certainty which parties are entitled to expect of the law. Diplock LJ was neither
the first nor the last to observe that “The court should not be astute to descry a
‘penalty clause’”: Robophone at p 1447. As Lord Woolf said, speaking for the Privy
Council in Philips Hong Kong Ltd v Attorney General of Hong Kong (1993) 61 BLR
41, 59, “the court has to be careful not to set too stringent a standard and bear in
mind that what the parties have agreed should normally be upheld”, not least because
“[a]ny other approach will lead to undesirable uncertainty especially in commercial
contracts”.
34. Although the penalty rule originates in the concern of the courts to prevent
exploitation in an age when credit was scarce and borrowers were particularly
vulnerable, the modern rule is substantive, not procedural. It does not normally
depend for its operation on a finding that advantage was taken of one party. As Lord
Wright MR observed in Imperial Tobacco Company (of Great Britain) and Ireland
v Parslay [1936] 2 All ER 515, 523:
“A millionaire may enter into a contract in which he is to pay
liquidated damages, or a poor man may enter into a similar
contract with a millionaire, but in each case the question is
exactly the same, namely, whether the sum stipulated as
damages for the breach was exorbitant or extravagant …”
Page 18
35. But for all that, the circumstances in which the contract was made are not
entirely irrelevant. In a negotiated contract between properly advised parties of
comparable bargaining power, the strong initial presumption must be that the parties
themselves are the best judges of what is legitimate in a provision dealing with the
consequences of breach. In that connection, it is worth noting that in Philips Hong
Kong at pp 57-59, Lord Woolf specifically referred to the possibility of taking into
account the fact that “one of the parties to the contract is able to dominate the other
as to the choice of the terms of a contract” when deciding whether a damages clause
was a penalty. In doing so, he reflected the view expressed by Mason and Wilson JJ
in AMEV-UDC at p 194 that the courts were thereby able to “strike a balance
between the competing interests of freedom of contract and protection of weak
contracting parties” (citing Atiyah, The Rise and Fall of Freedom of Contract
(1979), Chapter 22). However, Lord Woolf was rightly at pains to point out that this
did not mean that the courts could thereby adopt “some broader discretionary
approach”. The notion that the bargaining position of the parties may be relevant is
also supported by Lord Browne-Wilkinson giving the judgment of the Privy Council
in Workers Bank. At p 580, he rejected the notion that “the test of reasonableness
[could] depend upon the practice of one class of vendor, which exercises
considerable financial muscle” as it would allow such people “to evade the law
against penalties by adopting practices of their own”. In his judgment, he decided
that, in contracts for sale of land, a clause providing for a forfeitable deposit of 10%
of the purchase price was valid, although it was an anomalous exception to the
penalty rule. However, he held that the clause providing for a forfeitable 25%
deposit in that case was invalid because “in Jamaica, the customary deposit has been
10%” and “[a] vendor who seeks to obtain a larger amount by way of forfeitable
deposit must show special circumstances which justify such a deposit”, which the
appellant vendor in that case failed to do.
Should the penalty rule be abrogated?
36. The primary case of Miss Smith QC, who appeared for Cavendish in the first
appeal, was that the penalty rule should now be regarded as antiquated, anomalous
and unnecessary, especially in the light of the growing importance of statutory
regulation in this field. It is the creation of the judges, and, she argued, the judges
should now take the opportunity to abolish it. There is a case to be made for taking
this course. It was expounded with considerable forensic skill by Miss Smith, and
has some powerful academic support: see Sarah Worthington, Common Law Values:
the Role of Party Autonomy in Private Law, in The Common Law of Obligations:
Divergence and Unity (ed A Robertson and M Tilbury (2015)), pp 18-26. We rather
doubt that the courts would have invented the rule today if their predecessors had
not done so three centuries ago. But this is not the way in which English law
develops, and we do not consider that judicial abolition would be a proper course
for this court to take.
Page 19
37. The first point to be made is that the penalty rule is not only a long-standing
principle of English law, but is common to almost all major systems of law, at any
rate in the western world. It has existed in England since the 16th century and can
be traced back to the same period in Scotland: McBryde, The Law of Contract in
Scotland, 3rd ed (2007), paras 22-148. The researches of counsel have shown that it
has been adopted with some variants in all common law jurisdictions, including
those of the United States. A corresponding rule was derived from Roman law by
Pothier, Traité des Obligations, No 346, which is to be found in the Civil Codes of
France (article 1152), Germany (for non-commercial contracts only) (sections 343,
348), Switzerland (article 163.3), Belgium (article 1231) and Italy (article 1384). It
is included in influential attempts to codify the law of contracts internationally,
including the Unidroit Principles of International Commercial Contracts (2010)
(article 7.4.13), and the UNCITRAL Uniform Rules on Contract Clauses for an
Agreed Sum Due upon Failure of Performance (article 6). In January 1978 the
Committee of Ministers of the Council of Europe recommended a number of
common principles relating to penal clauses, including (article 7) that a stipulated
sum payable on breach “may be reduced by the court when it is manifestly
excessive”.
38. It is true that statutory regulation, which hardly existed at the time that the
penalty rule was developed, is now a significant feature of the law of contract. In
England, the landmark legislation was the Unfair Contract Terms Act 1977. For
most purposes, the Act was superseded by the Unfair Terms in Consumer Contracts
Regulations 1994 (SI 1994/3159), which was in turn replaced by the 1999
Regulations, both of which give effect to European Directives. The 1999
Regulations contain an “indicative and non-exhaustive list of the terms which may
be regarded as unfair”, including terms which have the object or effect of “requiring
any consumer who fails to fulfil his obligation to pay a disproportionately high sum
in compensation”. Nonetheless, statutory regulation is very far from covering the
whole field. Penalty clauses are controlled by the 1999 Regulations, but the
Regulations apply only to consumer contracts and the control of unfair terms under
regulations 3 and 5 is limited to those which have not been individually negotiated.
There are major areas, notably non-consumer contracts, which are not regulated by
statute. Some of those who enter into such contracts, for example professionals and
small businesses, may share many of the characteristics of consumers which are
thought to make the latter worthy of legal protection. The English Law Commission
considered penalty clauses in 1975 (Working Paper No 61, Penalty Clauses and
Forfeiture of Monies Paid, April 1975), at a time when there was no relevant
statutory regulation, and the Scottish Law Commission reported on them in May
1999 (Report No 171). Neither of these Reports recommended abolition of the rule.
On the contrary, both recommended legislation which would have expanded its
scope.
Page 20
39. Further, although there are justified criticisms that can be made of the penalty
rule, it is consistent with other well-established principles which have been
developed by judges (albeit mostly in the Chancery courts) and which involve the
court in declining to give full force to contractual provisions, such as relief from
forfeiture, the equity of redemption, and refusal to grant specific performance, as
discussed in paras 10-11 and 29-30 above. Finally, the case for abolishing the rule
depends heavily on anomalies in the operation of the law as it has traditionally been
understood. Many, though not all of these are better addressed (i) by a realistic
appraisal of the substance of contractual provisions operating upon breach, and (ii)
by taking a more principled approach to the interests that may properly be protected
by the terms of the parties’ agreement.
Should the penalty rule be extended?
40. In the course of his cogent submissions, Mr Bloch QC, who appeared for Mr
Makdessi on the first appeal, suggested that, as an alternative to confirming or
abrogating the penalty rule, this court could extend it, so that it applied more
generally. As he pointed out, this was the course taken by the High Court of
Australia, and it would have the advantage of rendering the penalty rule less
formalistic in its application, and, which may be putting the point in a different way,
less capable of avoidance by ingenious drafting.
41. This step has recently been taken in Australia. Until recently, the law in
Australia was the same as it is in England: see IAC Leasing Ltd v Humphrey (1972)
126 CLR 131, 143 (Walsh J); O’Dea v Allstates Leasing System (WA) Pty Ltd (1983)
152 CLR 359, 390 (Brennan J); AMEV-UDC at p 184 (Mason and Wilson JJ, citing
ECGD among other authorities), 211 (Dawson J); Ringrow Pty Ltd v BP Australia
Pty Ltd (2005) 224 CLR 656, 662. However, a radical departure from the previous
understanding of the law occurred with the decision of the High Court of Australia
in Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205.
The background to this case was very similar to that in Office of Fair Trading v
Abbey National plc [2010] 1 AC 696. It concerned the application of the penalty rule
to contractual bank charges payable when the bank bounced a cheque or allowed the
customer to draw in excess of his available funds or agreed overdraft limit. These
might in a loose sense be regarded as banking irregularities, but they did not involve
any breach of contract on the part of the customer. On that ground Andrew Smith J
had held in the Abbey National case that the charges were incapable of being
penalties: [2008] 2 All ER (Comm) 625, paras 295-299 (the point was not appealed).
In Andrews, the High Court of Australia disagreed. They engaged in a detailed
historical examination of the equitable origin of the rule and concluded that there
subsisted, independently of the common law rule, an equitable jurisdiction to relieve
against any sufficiently onerous provision which was conditional upon a failure to
observe some other provision, whether or not that failure was a breach of contract.
At para 10, they defined a penalty as follows:
Page 21
“In general terms, a stipulation prima facie imposes a penalty
on a party (the first party) if, as a matter of substance, it is
collateral (or accessory) to a primary stipulation in favour of a
second party and this collateral stipulation, upon the failure of
the primary stipulation, imposes upon the first party an
additional detriment, the penalty, to the benefit of the second
party. In that sense, the collateral or accessory stipulation is
described as being in the nature of a security for and in terrorem
of the satisfaction of the primary stipulation. If compensation
can be made to the second party for the prejudice suffered by
failure of the primary stipulation, the collateral stipulation and
the penalty are enforced only to the extent of that
compensation. The first party is relieved to that degree from
liability to satisfy the collateral stipulation.”
42. Any decision of the High Court of Australia has strong persuasive force in
this court. But we cannot accept that English law should take the same path, quite
apart from its inconsistency with established and unchallenged House of Lords
authority. In the first place, although the reasoning in Andrews was entirely
historical, it is not in fact consistent with the equitable rule as it developed
historically. The equitable jurisdiction to relieve from penalties arose wholly in the
context of bonds defeasible in the event of the performance of a contractual
obligation. It necessarily posited a breach of that obligation. Secondly, if there is a
distinct and still subsisting equitable jurisdiction to relieve against penalties which
is wider than the common law jurisdiction, with three possible exceptions it appears
to have left no trace in the authorities since the fusion of law and equity in 1873.
The first arguable exception is in In re Dagenham (Thames) Dock Co; Ex p Hulse
(1873) LR 8 Ch App 1022 (followed by the Privy Council in Kilmer v British
Columbia Orchard Lands Ltd [1913] AC 319), where the Court of Appeal granted
a purchaser, who had been in possession for five years and carried out
improvements, further time to pay the second and final instalment of a purchase
price on the ground that the clause requiring him to vacate and to forfeit the first
instalment for not having paid the second instalment on time, was a “penalty”.
However, James and Mellish LJJ may have been treating the clause as a forfeiture
(as they both also used that expression in their brief judgments), and in any event
they treated the purchaser in the same way as a mortgagor in possession asking for
more time to pay. Further, as Romer LJ pointed out in Stockloser at pp 497-498, the
decision could be justified by the fact that time had already been extended twice by
agreement, and in any event there was no question of the vendor being required to
repay the first instalment. The second arguable exception is no more than an
unsupported throw-away line in the judgment of Diplock LJ in Robophone at p 1446,
where he said it was “by no means clear” whether penalty clauses “are simply void”,
but, on analysis, he was dealing with a rather different point (namely that discussed
by Lord Atkin in the passage that follows). The third exception is the unsatisfactory
decision in Jobson v Johnson [1989] 1 WLR 1026, to which we shall return in paras
Page 22
84-87 below. It is relevant to add in this connection that the law of penalties has
been held to be the same in England and Scotland: Stair Memorial Encyclopaedia
of the Laws of Scotland, vol 15, paras 783-801, and see Clydebank. Yet equity,
although influential, has never been a distinct branch of Scots law. In the modern
law of both countries, the penalty rule is an aspect of the law of contract. Thirdly,
the High Court’s redefinition of a penalty is, with respect, difficult to apply to the
case to which it is supposedly directed, namely where there is no breach of contract.
It treats as a potential penalty any clause which is “in the nature of a security for and
in terrorem of the satisfaction of the primary stipulation.” By a “security” it means
a provision to secure “compensation … for the prejudice suffered by the failure of
the primary stipulation”. This analysis assumes that the “primary stipulation” is
some kind of promise, in which case its failure is necessarily a breach of that
promise. If, for example, there is no duty not to draw cheques against insufficient
funds, it is difficult to see where compensation comes into it, or how bank charges
for bouncing a cheque or allowing the customer to overdraw can be regarded as
securing a right of compensation. Finally, the High Court’s decision does not
address the major legal and commercial implications of transforming a rule for
controlling remedies for breach of contract into a jurisdiction to review the content
of the substantive obligations which the parties have agreed. Modern contracts
contain a very great variety of contingent obligations. Many of them are contingent
on the way that the parties choose to perform the contract. There are provisions for
termination upon insolvency, contractual payments due on the exercise of an option
to terminate, break-fees chargeable on the early repayment of a loan or the closing
out of futures contracts in the financial or commodity markets, provisions for
variable payments dependent on the standard or speed of performance and “take or
pay” provisions in long-term oil and gas purchase contracts, to take only some of
the more familiar types of clause. The potential assimilation of all of these to clauses
imposing penal remedies for breach of contract would represent the expansion of
the courts’ supervisory jurisdiction into a new territory of uncertain boundaries,
which has hitherto been treated as wholly governed by mutual agreement.
43. We would accept that the application of the penalty rule can still turn on
questions of drafting, even where a realistic approach is taken to the substance of
the transaction and not just its form. But we agree with what Hoffmann LJ said in
Else (1982) at p 145, namely that, while it is true that the question whether the
penalty rule applies may sometimes turn on “somewhat formal distinction[s]”, this
can be justified by the fact that the rule “being an inroad upon freedom of contract
which is inflexible … ought not to be extended”, at least by judicial, as opposed to
legislative, decision-making.
Page 23
The first appeal: Cavendish v El Makdessi
The factual and procedural history
44. Mr Makdessi founded a group of companies (“the Group”) which by 2008
had become the largest advertising and marketing communications group in the
Middle East, and operated through a network of around 20 companies with more
than 30 offices in over 15 countries. At that time, Mr Makdessi was one of the most
influential Lebanese business leaders, his name was closely identified with the
business of the Group, and he had very strong relationships with its clients and senior
employees.
45. In 2008, the holding company of the Group was Team Y & R Holdings Hong
Kong Ltd (“the Company”). The Company had 1,000 issued shares, which were
owned by Mr Makdessi and Mr Joseph Ghossoub, with the exception of 126 shares
which were held by Young & Rubicam International Group BV (“Y & RIG”), a
company in the WPP group of companies (“WPP”), the world’s largest market
communications services group.
46. By an agreement of 28 February 2008 (“the Agreement”) Mr Makdessi and
Mr Ghossoub (described as “the Sellers”) agreed to sell to Y & RIG (described as
“the Purchaser”) 474 shares (described as “the Sale Shares”) in the Company. Y &
RIG then transferred those shares to Cavendish Square Holdings BV (“Cavendish”),
another WPP company, and by a novation agreement of 29 February 2008,
Cavendish was substituted for Y & RIG as a party to the Agreement. Thus
Cavendish came to hold 60% of the Company while the Sellers retained 40%. For
present purposes, Y & RIG can be ignored and the Purchaser can be treated as
Cavendish.
47. The Agreement had been the subject of extensive negotiations over six
months, and both sides were represented by highly experienced and respected
commercial lawyers: Allen & Overy acting for Cavendish, and Lewis Silkin for the
Sellers, Mr Makdessi and Mr Ghossoub.
48. By clause 3.1, the price payable by Cavendish “[i]n consideration of the sale
of the Sale Shares and the obligations of the Sellers herein” (and which was to be
apportioned 53.88% to Mr Makdessi and 46.12% to Mr Ghossoub) was to be paid
by Cavendish in the following way:
i) A “Completion Payment” of US$34m to be paid on completion of the
Agreement;
Page 24
ii) A “Second Payment” of US$31.5m to be paid into escrow on
completion, and to be released in four instalments, as restructuring of the
Group companies took effect;
iii) An “Interim Payment”, to be paid 30 days after agreement of the group
operating profits (“OPAT”) for 2007-2009, and to be the amount by which
the product of eight, 0.474 and the average annual OPAT 2007-2009
exceeded US$63m (being the sum of the earlier payments less US$ 2.5m
representing interest);
iv) A “Final Payment”, to be paid 30 days after agreement of the OPAT
for 2007-2011, and to be the amount by which the product of a figure between
seven and ten (depending on the level of profit), 0.474 and the annual average
annual OPAT for 2009-2011 exceeded the aggregate of US$63m and the
Interim Payment.
Clause 6 contained provisions relating to the “calculation of OPAT and payment of
the consideration”.
49. Clause 3.2 of the Agreement provided that, if the Interim Payment and/or the
Final Payment turned out to be a negative figure, it or they should be treated as zero,
but there was to be no claw back of the earlier payments. Clause 3.3 of the
Agreement provided that the maximum of all payments would be US$147.5m. By
clause 9.1 of, and paragraph 2.15(c) of Schedule 7 to, the Agreement, the Sellers
warranted that the Net Asset Value (“NAV”) of the Company at 31 December 2007
was just over US$69.74m.
50. Clause 15 contained a put option which entitled each of the Sellers to require
Cavendish, by a Notice served at any time between 1 January and 31 March in 2011
or any subsequent year (in the case of Mr Makdessi) and any time between 1 January
and 31 March in 2017 or in any subsequent year (in the case of Mr Ghossoub), to
buy all their remaining shares in the Company. The price payable on the exercise of
this option was (subject to a cap of US$75m in the case of each Seller) to be the
relevant seller’s proportion of a sum eight times the average OPAT for a reference
period of seven years (the year in which the notice was served, the previous year
and the two subsequent years). It was to be payable by instalments.
51. Clause 11 was concerned with the “protection of goodwill”. Clause 11.1
provided as follows:
Page 25
“11.1. Each Seller recognises the importance of the goodwill of
the Group to [Cavendish] and the WPP Group which is
reflected in the price to be paid by the Purchaser for the Sale
Shares. Accordingly, each Seller commits as set out in this
clause 11 to ensure that the interest of each of [Cavendish] and
the WPP Group in that goodwill is properly protected.”
52. Clause 11.2 provided that, in Mr Makdessi’s case, until two years after he
ceased to hold any shares in the Company or the date of the final instalment of any
payment under clause 15, and in Mr Ghossoub’s case, until two years after he ceased
employment with the Company, the Sellers would not (a) carry on, or be engaged
or interested in “Restricted Activities” (ie the provision of goods or services which
competed with the Group companies) in “Prohibited Areas” (ie in countries in which
any of the Group companies carried on business); (b) solicit or accept orders,
enquiries or business in respect of Restricted Activities in the Prohibited Areas; (c)
divert orders, enquiries or business from any Group company; or (d) employ or
solicit any senior employee or consultant of any Group company.
53. Clause 11.7 started by recording that Cavendish “recognises the importance
of the goodwill of the Group to the Sellers and to the value of the Interim Payment
and the Final Payment”. It then contained a covenant by Cavendish that neither it
nor any other WPP company would “without the Sellers’ prior written consent other
than within the Group companies, trade in any of the [23 identified] countries …
using [specified] names [including ‘Adrenalin’]”.
54. Under clause 7.5, Messrs El Makdessi and Ghossoub agreed that, within four
months of completion, they would dispose of any shares in Carat Middle East Sarl
(“Carat”), and procure the termination of a joint venture agreement which another
Carat company had entered into with a member of the Aegis group of companies.
Carat describes itself on its website as “the world’s leading independent media
planning and buying specialist … [o]wned by global media group Aegis Group plc
… [with] more than 5,000 people in 70 countries worldwide”. It is a competitor of
WPP, including Cavendish and the Company.
55. The two provisions of central relevance for present purposes were included
in clause 5, which was headed “Default”. Clauses 5.1 and 5.6 provided:
“5.1 If a Seller becomes a Defaulting Shareholder [which is
defined as including ‘a Seller who is in breach of clause 11.2’]
he shall not be entitled to receive the Interim Payment and/or
the Final Payment which would other than for his having
become a Defaulting Shareholder have been paid to him and
Page 26
[Cavendish]’s obligations to make such payment shall cease.

5.6. Each Seller hereby grants an option to [Cavendish]
pursuant to which, in the event that such Seller becomes a
Defaulting Shareholder, [Cavendish] may require such Seller
to sell to [Cavendish] all … of the Shares held by that Seller
(the Defaulting Shareholder Shares). [Cavendish] shall buy and
such Seller shall sell … the Defaulting Shareholder Shares…
within 30 days of receipt by such Seller of a notice from
[Cavendish] exercising such option in consideration for the
payment by [Cavendish] to such Seller of the Defaulting
Shareholder Option Price [defined as ‘an amount equal to the
[NAV] on the date that the relevant Seller becomes a
Defaulting Shareholder multiplied by [the percentage which
represents the proportion of the total shares the relevant Seller
holds].”
56. Mr Ghossoub signed an agreement by which he agreed to remain an
employee and director of the Company. During the negotiations, Mr Makdessi had
made it clear that he did not wish to remain an employee. However, he signed an
agreement, by which he became a non-executive director of the Company (as well
as other companies in the Group) and non-executive chairman, for an initial term of
18 months which was renewable. Under this he agreed to certain specific obligations
by way of ongoing support of the Company.
57. Mr Makdessi resigned as non-executive chairman of the Company in April
2009. On 1 July 2009, at the Company’s request, he resigned as non-executive
director of all companies in the Group, save the Company itself. He was removed
from the board of the Company on 27 April 2011, after the commencement of these
proceedings.
58. Mr Makdessi has been paid his share of the first two payments stipulated by
clause 3.1, namely the Completion Payment and the Second Payment, together with
some additional interest. However, he has not yet been paid the remaining payments
under clause 3.1, namely the Interim Payment or the Final Payment, or any part
thereof. His remaining shares represent just over 21.5% of the whole issued share
capital of the Company.
59. By December 2010, Cavendish and the Company concluded that Mr
Makdessi had acted in breach of his duties to the Company as a director and in
breach of his obligations to Cavendish under clause 11.2 of the Agreement. On 13
Page 27
December 2010 Cavendish gave notice of the exercise of its Call Option under
clause 5.6.
60. In December 2010, these proceedings were commenced against Mr
Makdessi, with Cavendish suing for breach of the Agreement, and the Company
suing for breach of fiduciary duty. Their re-amended particulars allege that in breach
of his fiduciary duties and the restrictive covenants Mr Makdessi had throughout
2008 and 2009 in Lebanon and Saudi Arabia (both of which were within the
Prohibited Area), in breach of clause 11.2, engaged in Restricted Activities, solicited
clients and employees away from Group companies and accepted orders in respect
of Restricted Activities.
61. The essence of the complaints was that Mr Makdessi had (i) continued to
provide services to Carat, including assisting it to generate business, diverting
business to it and soliciting clients and diverting their business to it; and (ii) set up
rival advertising agencies in Lebanon and Saudi Arabia with “Adrenalin” in their
name and that those agencies had poached or tried to poach a number of the
Company’s customers and employees.
62. Mr Makdessi subsequently admitted that from February 2008 he had had an
ongoing, unpaid involvement in the affairs of Carat pending the appointment of a
replacement CEO and that such involvement placed him in breach of fiduciary duty
to the Company with effect from 1 July 2008, and that, if the covenants in clause
11.2 were valid and enforceable (as they have been held to be) his involvement in
the affairs of Carat rendered him a Defaulting Shareholder within the meaning of
the Agreement. The Company’s claim for breach of fiduciary duty was settled by its
acceptance of a payment into court made by Mr Makdessi in the sum of
US$500,000. Cavendish claimed to have suffered loss and damage in the form of a
loss of value of its shareholding in the Company, but it subsequently accepted that
such loss was irrecoverable as it was merely “reflective” of the loss which could be
claimed, indeed had been claimed, by the Company.
63. More importantly for present purposes, Cavendish claimed that Mr
Makdessi’s admissions of breach of fiduciary duty demonstrated that he was in
breach of clause 11.2 in relation to (at least) his continued involvement in Carat.
Cavendish accordingly sought a declaration that he was a Defaulting Shareholder,
was not entitled to the Interim Payment or the Final Payment as a result of clause
5.1, and was obliged, as of the date 30 days after the service of its notice exercising
the Call Option, namely 14 January 2011, to sell to Cavendish all his shares in the
Company at the Defaulting Shareholder Option Price, and it sought specific
performance of the latter obligation.
Page 28
64. The case was tried by Burton J and the appeal was heard in the Court of
Appeal by Patten, Tomlinson and Christopher Clarke LJJ. The issue at both stages
was the same, namely whether clauses 5.1 and 5.6 were valid and enforceable as
Cavendish contended, or whether as Mr Makdessi argued they both were void and
unenforceable because they constituted penalties. The courts below were naturally
constrained by the perceived need to fit any analysis into the framework set by Lord
Dunedin’s four principles. Burton J felt able to escape those constraints, and
concluded that the two provisions were valid and enforceable. However, Christopher
Clarke LJ, giving the leading judgment in the Court of Appeal, held that the two
provisions were unenforceable penalties under the penalty rule as traditionally
understood. No short summary can do justice to Christopher Clarke LJ’s thoughtful
and careful analysis, but essentially he felt unable to uphold Burton J’s decision
because he felt bound by the traditional explanation of the rule as being directed
against deterrent clauses as such: see [2012] EWHC 3582 (Comm) and [2013]
EWCA Civ 1539 respectively. Cavendish now appeals to this court.
The implications of the Agreement
65. Clause 5 deals with the obligations of a “Defaulting Shareholder”. So far as
Mr Makdessi was concerned, that meant a Seller in breach of the restrictive
covenants at clause 11.2. In the case of Mr Ghossoub, who remained an employee
of the Company, it meant a Seller who was either in breach of the restrictive
covenants or else had been summarily dismissed on any of a number of specified
grounds, all of them serious and potentially discreditable to the Company.
66. The background to clause 5 is of some importance. Burton J found that the
Agreement was negotiated in detail over a considerable period by parties dealing on
equal terms with professional assistance of a high order. Cavendish was acquiring
47.4% of the Company so as to bring its holding up to 60%. It is common ground
that a large proportion of the purchase price represented goodwill. The NAV
(without goodwill) of the Company was warranted by the Sellers at over US$69.7m
as at 31 December 2007, whereas the maximum consideration for 47.4% of the
Company, including the profit-related element, was US$147.5m, implying a
maximum value of more than US$300m for the whole Group. Clause 11.1 recorded
the Sellers’ recognition that the restrictive covenants reflected the importance of the
goodwill, and Burton J found that its value was heavily dependent on the continuing
loyalty of Mr Makdessi and Mr Ghossoub. Subject to various options, they retained
a 40% shareholding between them and were expected to maintain their connection
with the business for a minimum period, Mr Ghossoub as an employee and director,
and Mr Makdessi as a non-executive director and chairman. The following summary
in the agreed Statement of Facts and Issues is based on the unchallenged evidence
given at the trial:
Page 29
“The structure of the Agreement was typical of acquisition
agreements in the marketing sector. As in this case, the vendor
is typically the founder or operator of the business, and has
important relationships with clients and key staff. If they decide
to turn against the business, its success can be significantly
affected, and provisions are therefore included to protect the
value of the investment, and in particular the value of the
goodwill represented by the vendor’s existing personal
relationships. The respondent fell into that category; the
importance of personal relationships with clients is even
stronger in the Middle East than the UK, and he had very strong
relationships with clients and senior employees, and he was
such a well known figure that if he acted against the Group, it
would inevitably cause it to lose value.”
67. Clause 3.1 provided that the first two instalments of the purchase price
amounted to US$65.5m, which would be received by the Sellers in any event. The
effect of clause 5.1 was that in the event that a Seller acted in breach of the restrictive
covenants, he would not be entitled to receive the last two instalments of the
purchase price, the Interim Payment and the Final Payment, both of which were
calculated by reference to the audited consolidated profit of the Company for years
after completion of the Agreement (2007-2009 for the Interim Payment, and 2007-
2011 for the Final Payment). The result of Cavendish’s exercise of its rights under
clause 5.1 according to its terms was to reduce the consideration for the Defaulting
Shareholder’s shares from his proportion of the maximum of US$147.5m to his
proportion of US$65.5m. In Mr Makdessi’s case, he would receive up to
US$44,181,600 less.
68. Under clause 15, the Sellers had a put option to require Cavendish to buy
their remaining shareholdings, which in Mr Makdessi’s case was first exercisable
during the first three months of 2011. The provisions determining the option price
have been summarised in para 50 above. It was a multiple of average audited
consolidated profit over a reference period, a formula which would reflect the value
of goodwill. The effect of clause 5.6 was that if before the exercise of the clause 15
put option a Seller was in breach of the restrictive covenants, Cavendish acquired
an option to acquire his retained shareholding at a lower price, namely the relevant
proportion of the net asset value at the time of the default. The result of Cavendish’s
implementation of clause 5.6, according to its terms, was that insofar as, at the date
of default, Mr Makdessi’s shareholding had a value attributable to goodwill, he
would not receive it and would not be able to exercise the clause 15 put option in
2011.
Page 30
Was clause 5.1 contrary to the penalty rule?
69. Clause 5.1 disentitles a Defaulting Shareholder from receiving money which
would otherwise have been due to him as his proportion of the price of the
transferred shares. If this constitutes a forfeiture, it would appear that, at least on the
current state of the authorities, there would be no jurisdiction to relieve against it,
because a contractual right to be paid money is not a proprietary or possessory
interest in property: The “Scaptrade” and BICC (see para 17 above). But there is
some, albeit rather unsatisfactory, authority that such a clause may be a penalty.
70. Gilbert-Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd [1974] AC
689 concerned a provision in a building subcontract entitling the contractor to
“suspend or withhold” the payment of money due to the subcontractor upon any
breach of contract. Four members of the Appellate Committee accepted, obiter, a
concession by counsel that this was a penalty: see p 698 (Lord Reid), pp 703-704
(Lord Morris of Borth-y-Gest), p 711 (Viscount Dilhorne), pp 723-724 (Lord
Salmon). This was because it allowed the contractor to withhold all sums due, and
not just the estimated damages flowing from the sub-contractor’s breach. The result
was to put intolerable pressures on the latter’s cash-flow which was calculated to
force him into submission.
71. The only other English decision directly in point is Socony Mobil Oil Co Inc
v West of England Ship Owners Mutual Insurance Association Ltd (The “Padre
Island”) [1987] 2 Lloyd’s Rep 529 (Saville J), [1989] 1 Lloyd’s Rep 239 (CA);
[1991] 2 AC 1, a case notable for the multiplicity of arguments and the diversity of
judicial opinions. It was a claim under the Third Parties (Rights Against Insurers)
Act 1930 by cargo claimants who had obtained judgment for damages against an
insolvent ship owner entered with the defendant P & I Club. Saville J dismissed the
claim on the ground that under the standard “pay to be paid” clause in the rules
recovery from the club was conditional on the ship owner having first paid the
judgment creditor. Since this had not happened there was no claim to be transferred
under the 1930 Act. The Court of Appeal allowed the appeal on this point. They
were wrong to do so, as the House of Lords subsequently held. But on the footing
that the “pay to be paid” clause did not bar the claim, the Court of Appeal went on
to consider an alternative argument on behalf of the club, based on a provision in its
rules that cover should retrospectively cease upon the insured’s failure to pay a call.
The judgment creditor’s answer to this argument was that the provision was
unenforceable as a penalty. Saville J had held (i) that this last question did not arise
because on the facts the retrospective cesser clause would not have applied anyway,
but (ii) that the penalty rule was not engaged because it applied only to provisions
which required the contract-breaker to pay money. The Court of Appeal upheld him
on (i), as a result of which (ii) did not arise. But Stuart-Smith LJ considered point
(ii), obiter. He thought, on the basis of Gilbert-Ash, that the penalty rule could apply
to a provision disentitling the contract-breaker from receiving a sum of money. He
Page 31
could “see no distinction between withholding or disentitling a person to a sum of
money which is due to him and requiring him to pay a sum of money” (p 262).
O’Connor LJ said (p 265) that if the point had arisen he would have been of the same
view as Stuart-Smith LJ. Bingham LJ disagreed, and would have held that the
penalty rule was not engaged.
72. These two cases thus provide some support for the contention that clause 5.1
is capable of engaging the penalty rule. On the other hand, it has been held that a
clause which renders instalments irrecoverable by a defaulting purchaser is a
forfeiture but not a penalty: see Else (1982) and Stockloser, cited in para 16 above.
If that is so, then there is a powerful argument for saying that a clause which renders
instalments of payment irrecoverable by a defaulting vendor should, by the same
token, not be a penalty, but at best a forfeiture.
73. We are, however, prepared to assume, without deciding, that a contractual
provision may in some circumstances be a penalty if it disentitles the contractbreaker from receiving a sum of money which would otherwise have been due to
him. But even on that assumption, it will not always be a penalty. That must depend
on the nature of the right of which the contract-breaker is being deprived and the
basis on which he is being deprived of it. The provision thought to be penal in
Gilbert-Ash was a good example of a secondary provision operating upon a breach
of the subcontractor’s primary obligations. It authorised the contractor to withhold
all remuneration due to the subcontractor if the latter had committed any breach of
contract until the contractor’s claim had been resolved. It was a security, albeit an
exorbitant one, for the contractor’s claim. The retrospective cesser clause in the
West of England Club’s rules in The “Padre Island” was very different. It forfeited
an accrued right to indemnity permanently. Clauses of this kind are potentially
harsher than those which operate simply as a security. But they may define the
primary obligations of the parties, in which case the penalty rule will not apply to
them. It is not a proper function of the penalty rule to empower the courts to review
the fairness of the parties’ primary obligations, such as the consideration promised
for a given standard of performance. For example, the consideration due to one party
may be variable according to one or more contingencies, including the contingency
of his breach of the contract. There is no reason in principle why a contract should
not provide for a party to earn his remuneration, or part of it, by performing his
obligations. If as a result his remuneration is reduced upon his non-performance,
there is no reason to regard that outcome as penal. Suppose that a contract of
insurance provided that it should be cancelled ab initio if the insured failed to pay
the premium within three months of inception. The effect would be to forfeit any
claim upon a casualty occurring in the first three months but it would be difficult to
regard the provision as penal on that account. One reason why Bingham LJ
disagreed with Stuart-Smith LJ was that he considered the retrospective cesser
clause to be no different. “I do not myself think it unreasonable”, he said (p 254),
“that a member should lose his cover in respect of a period for which he fails to pay
Page 32
his premium.” He may well have been right to analyse the clause in that way, but it
is a fair criticism of Stuart-Smith LJ’s approach that he did not consider this aspect
of the matter at all.
74. Where, against this background, does clause 5.1 stand? It is plainly not a
liquidated damages clause. It is not concerned with regulating the measure of
compensation for breach of the restrictive covenants. It is not a contractual
alternative to damages at law. Indeed in principle a claim for common law damages
remains open in addition, if any could be proved. The clause is in reality a price
adjustment clause. Although the occasion for its operation is a breach of contract, it
is in no sense a secondary provision. The consideration fixed by clause 3.1 is said to
be payable “[i]n consideration of the sale of the Sale Shares and the obligations of
the Sellers herein”. Those obligations of the Sellers herein include the restrictive
covenants. Clause 5.1 belongs with clauses 3 and 6, among the provisions which
determine Cavendish’s primary obligations, ie those which fix the price, the manner
in which the price is calculated and the conditions on which different parts of the
price are payable. Its effect is that the Sellers earn the consideration for their shares
not only by transferring them to Cavendish, but by observing the restrictive
covenants. As Burton J said at para 59 of his judgment, “[t]he juxtaposition on the
one hand of substantial delayed payment for goodwill and on the other hand a series
of covenants which is intended to safeguard and protect that goodwill is of particular
significance”.
75. Although clause 5.1 has no relationship, even approximate, with the measure
of loss attributable to the breach, Cavendish had a legitimate interest in the
observance of the restrictive covenants which extended beyond the recovery of that
loss. It had an interest in measuring the price of the business to its value. The
goodwill of this business was critical to its value to Cavendish, and the loyalty of
Mr Makdessi and Mr Ghossoub was critical to the goodwill. The fact that some
breaches of the restrictive covenants would cause very little in the way of
recoverable loss to Cavendish is therefore beside the point. As Burton J graphically
observed in para 43 of his judgment, once Cavendish could no longer trust the
Sellers to observe the restrictive covenants, “the wolf was in the fold”. Loyalty is
indivisible. Its absence in a business like this introduces a very significant business
risk whose impact cannot be measured simply by reference to the known and
provable consequences of particular breaches. It is clear that this business was worth
considerably less to Cavendish if that risk existed than if it did not. How much less?
There are no juridical standards by which to answer that question satisfactorily. We
cannot know what Cavendish would have paid without the assurance of the Sellers’
loyalty, even assuming that they would have bought the business at all. We cannot
know whether the basic price or the maximum price fixed by clause 3.1 would have
been the same if they were not adjustable in the event of breach of the restrictive
covenants. We cannot know what other provisions of the agreement would have
been different, or what additional provisions would have been included on that
Page 33
hypothesis. These are matters for negotiation, not forensic assessment (save in the
rare cases where the contract or the law requires it). They were matters for the
parties, who were, on both sides, sophisticated, successful and experienced
commercial people bargaining on equal terms over a long period with expert legal
advice and were the best judges of the degree to which each of them should
recognise the proper commercial interests of the other.
76. We have already drawn attention to the fact that damages are in principle
recoverable in addition to the price reduction achieved by clause 5.1. In this case,
the Company recovered US$500,000 from Mr Makdessi. Cavendish has abandoned
any claim of their own for damages, because any loss of theirs would simply reflect
the Company’s loss. But it would not always be so. There are hypotheses, for
example that the restrictive covenants had been broken after he ceased to be a
director, in which Cavendish’s loss by his breach of the restrictive covenants would
not have been reflective and might in principle have been recovered in addition to
the reduction of the price under clause 5.1. Does any of this matter? We do not think
so. Clause 5.1 is not concerned with the measure of compensation for the breach. It
cannot be regarded as penal simply because damages are recoverable in addition.
The real question is whether any damages have been suffered on account of the
breach in circumstances where the price has been adjusted downwards on account
of the same breach. As between Mr Makdessi and the Company, the right of
Cavendish to a price reduction cannot affect the measure or recoverability of the
Company’s loss. It is res inter alios acta. It is an open question whether the right to
a price reduction would go to abate any loss recoverable by Cavendish themselves
if they had suffered any. We do not propose to resolve it on this appeal: the issue
does not arise and was not argued. It is enough to note that if Cavendish’s loss is not
abated, that would be because the law regards Cavendish as having suffered it
notwithstanding its right to the reduction. That can hardly make clause 5.1 a penalty.
77. We do not doubt that price adjustment clauses are open to abuse, and if clause
5.1 were a disguised punishment for the Sellers’ breach, it would make no difference
that it was expressed as part of the formula for determining the consideration. But
before a court can reach that conclusion, it must have some reason to do so. In this
case, there is none. On the contrary, all the considerations summarised above point
the other way.
78. We conclude, in agreement with Burton J, that clause 5.1 was not a penalty.
Was clause 5.6 contrary to the penalty rule?
79. Clause 5.6 gives rise to more difficult questions, but the analysis is essentially
the same.
Page 34
80. The purpose of requiring a Defaulting Shareholder to sell his retained shares
was to sever the connection between the Company and a major shareholder if he
were to compete against it (and also, in the case of Mr Ghossoub, if he were to be
dismissed for discreditable conduct). The severance of the connection is completed
by clause 14.2, which provides that upon ceasing to be a shareholder he will no
longer be entitled to a seat on the board or to appoint a nominee in his place. In itself,
this is not said to be objectionable. The objection is to the formula which excludes
the value of goodwill from the calculation of the price. It is not and could not be
suggested that the exclusion of goodwill serves to compensate for the estimated loss
attributable to the breach. Any recoverable damages for the breach of the restrictive
covenants will be recoverable on top of the forced sale of the Defaulting
Shareholder’s retained shares. Indeed, the effect of excluding the value of goodwill
is to achieve what Mr Bloch called a “reverse sliding scale”. The more trivial the
effect of the breach on the value of the goodwill, the greater will be the Defaulting
Shareholder’s loss in being deprived of any goodwill element in the price.
81. The logic of the price formula for the sale of the retained shares under clause
5.6 is similar to that of the price adjustment achieved by clause 5.1 for the sale of
the transferred shares. It reflects the reduced price which Cavendish was prepared
to pay for the acquisition of the business in circumstances where it could not count
on the loyalty of Mr Makdessi and/or Mr Ghossoub. We have dealt with this point
in the context of clause 5.1. It also reflects the fact that with the severance of the
connection between the Defaulting Shareholder and the Company, no goodwill will
in future be attributable to his role in the business. Indeed, the assumption must be
that a Seller in breach of the restrictive covenants may be actively engaged in
undermining the goodwill attributable to his former role in the business. It is true
that the severance of the connection between a Defaulting Shareholder and the
Group will not necessarily destroy the whole of the goodwill of the business which
was sold to Cavendish, especially if the other Seller remains loyal. But so far as the
Group is able to retain some or all of the goodwill built up by the Defaulting
Shareholder in the past, that will presumably be due to the efforts of others.
82. In our view, the same legitimate interest which justifies clause 5.1 justifies
clause 5.6 also. It was an interest in matching the price of the retained shares to the
value that the Sellers were contributing to the business. There is a perfectly
respectable commercial case for saying that Cavendish should not be required to pay
the value of goodwill in circumstances where the Defaulting Shareholder’s efforts
and connections are no longer available to the Company, and indeed are being
deployed to the benefit of the Company’s competitors, and where goodwill going
forward would be attributable to the efforts and connections of others. It seems likely
that clause 5.6 was expected to influence the conduct of the Sellers after Cavendish’s
acquisition of control in a way that would benefit the Company’s business and its
proprietors during the period when they were yoked together. To that extent it may
be described as a deterrent. But that is only objectionable if it is penal, ie if the object
Page 35
was to punish. But the price formula in clause 5.6 had a legitimate function which
had nothing to do with punishment and everything to do with achieving Cavendish’s
commercial objective in acquiring the business. And, like clause 5.1, it was part of
a carefully constructed contract which had been the subject of detailed negotiations
over many months between two sophisticated commercial parties, dealing with each
other on an equal basis with specialist, experienced and expert legal advice.
83. More fundamentally, a contractual provision conferring an option to acquire
shares, not by way of compensation for a breach of contract but for distinct
commercial reasons, belongs as it seems to us among the parties’ primary
obligations, even if the occasion for its operation is a breach of contract. This may
be tested by asking how the penalty rule could be applied to it without making a new
contract for the parties. The Court of Appeal simply treated clause 5.6 as
unenforceable, and declared that Mr Makdessi was not obliged to sell his shares
whether at the specified price or at all. That cannot be right, since the severance of
the shareholding connection was in itself entirely legitimate, and indeed
commercially sensible. If the option to acquire the retained shares is to stand, the
price formula cannot be excised without substituting something else. Yet there is no
juridical basis on which a different pricing formula can be imposed. There is no fallback position at common law, as there is in the case of a damages clause.
84. Mr Bloch argued that this difficulty can be surmounted by granting Mr
Makdessi a remedy corresponding to the one ordered by the Court of Appeal in
Jobson v Johnson. We do not accept this. Jobson arose out of a contract for the sale
of a substantial shareholding in a football club for a consideration payable by
instalments. The contract provided that in the event of default in the payment of any
instalment, the purchaser would be obliged to transfer the shareholding back to the
vendors at a price which was said to represent a substantial undervalue. This was a
forfeiture. The purchaser would have been entitled to relief in equity if he had been
in a position to pay, albeit late. The purchaser had in fact counterclaimed for such
relief, but the counterclaim had been struck out on account of his failure to comply
with his disclosure obligations. That left only a contention, advanced by way of
defence, that the obligation to transfer back the shares was also a penalty. As briefly
discussed in para 17 above, that may or may not have been an argument which was
open to him, and it is unnecessary to decide that issue on this appeal. The Court of
Appeal accepted the argument and held that the penalty rule could apply not only to
an obligation to pay money upon a breach of contract, but also to an obligation to
transfer assets in that event. This gives rise to no difficulty at least in principle, in a
case where the court could simply decline to enforce the penalty, leaving the
innocent party to his ordinary remedies at law. That was the position in Jobson,
because the Court of Appeal construed the share transfer clause as a purely
secondary obligation which was intended simply to secure the payment of the price:
see pp 1031-1032, 1037 (Dillon LJ), pp 1043-1044, 1045 (Nicholls LJ). On that
basis, Mr Johnson could in theory have been left to obtain judgment for the amount
Page 36
of the outstanding instalments and if necessary levy execution against the shares.
However, we are bound to observe that this would appear to be a somewhat peculiar
outcome. If the purchaser had been able to argue that he was entitled to relief from
forfeiture, the court would presumably have dealt with his case on that basis and
would not have considered the penalty argument at all. Accordingly, on the Court
of Appeal’s reasoning, as a result of his default in giving disclosure, he was able to
achieve a better result than he would have done if he had given disclosure and been
able to seek relief from forfeiture.
85. In terms of achieving a fair commercial result, it is perhaps understandable
that the Court of Appeal took the course that they did. Rather than applying the wellestablished principles relating to penalties, they invoked the authorities on relief
from forfeiture, which Mr Johnson had been prevented from claiming, and applied
them to the penalty rule. They held that in equity a penalty was enforceable pro
tanto, or on what Nicholls LJ called a “scaled down” basis, ie only to the extent of
any actual loss suffered by the breach. The court achieved this by offering the vendor
the choice of (i) taking an order for specific performance of the retransfer,
conditional upon its being ascertained that this would not overcompensate him for
the non-payment of the outstanding instalments, or (ii) taking an order for the sale
of the shares by the court, the outstanding instalment and interest to be paid to him
out of the proceeds and the balance to be paid to the defaulting purchaser. A
somewhat similar approach was later taken by the High Court of Australia in
Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205,
which also adopted the concept of partial enforcement.
86. The difficulty about this approach was pointed out by Mason and Wilson JJ
in the High Court of Australia in AMEV-UDC at pp 192-193:
“At least since the advent of the Judicature system a penalty
provision has been regarded as unenforceable or, perhaps void,
ab initio: Citicorp Australia Ltd v Hendry (1985) 4 NSWLR 1.
In all that time it has been thought that no action could be
brought on such a clause, no doubt because the courts should
not lend their aid to the enforcement in any way of a provision
which is oppressive. However, this is not the only reason why
the courts would refuse to lend their aid. In the majority of
cases involving penalties, the courts, if called upon to assist in
partial enforcement of the kind suggested by the appellant,
would be required to undertake an unfamiliar role. They would
need to rewrite the clause so as to permit the plaintiff to recover
the loss he has actually sustained. Penalty clauses are not,
generally speaking, so expressed as to entitle the plaintiff to
recover his actual loss. Instead they prescribe the payment of a
sum which is exorbitant or a sum to be ascertained by reference
Page 37
to a formula which is not an acceptable pre-estimate of damage.
In either case the court, if it were to enforce the clause, would
be performing a function very different from that which it
undertakes when it severs or reads down an unenforceable
covenant, such as a covenant in restraint of trade. In the
ultimate analysis, in whatever form it be expressed, the
appellant’s argument amounts to an invitation to the court to
develop a new law of compensation, distinct from common law
damages, which would govern the entitlement of plaintiffs who
insist on the inclusion of penalty clauses in their contracts.”
87. Even if the course taken by the Court of Appeal in Jobson had been right, it
would not be available to Mr Makdessi because clause 5.6 cannot sensibly be
analysed as a mere security for the performance of the restrictive covenants. But in
our opinion the analysis of Mason and Wilson JJ was correct, and so far as it related
to the form of relief, Jobson was wrongly decided. In the first place, the treatment
of a penalty clause as partly enforceable, although supported by some turns of phrase
in old cases concerned with other issues, is contrary to consistent modern authority.
So, with respect, is the treatment of its enforcement as discretionary according to
the circumstances at the time of the breach. If, as the authorities show, the penal
consequences of a contractual provision fall to be determined as at the time of the
agreement, and a provision found to be a penalty is unenforceable, it is impossible
to see how it can be enforceable on terms. Secondly, the Court of Appeal accepted
that the court could not rewrite the parties’ contract by specifically enforcing the
retransfer of the shares to the vendors at a higher price or enforcing the retransfer of
some only of the shares: see p 1037 (Dillon LJ), p 1042 (Nicholls LJ). Yet that is in
reality what they did, by refusing to enforce the retransfer unless the vendor agreed
to vary its effect. Third, the Court of Appeal interpreted the provision for the
retransfer of the shares as a “security” for the payment of the outstanding
instalments. They placed the word “security” in inverted commas because the
obligation was purely personal. But the Court of Appeal’s order treated it as if it was
an equitable mortgage of the shares, which it manifestly was not. It appears to us
that the Court of Appeal were, as a matter of legal analysis, treating the clause in
question as a forfeiture and not a penalty, and granting relief from forfeiture on
appropriate terms, although in doing so they purported to be treating it as a penalty
clause, because they were constrained to do so in the light of the pleadings. So far
as the relief granted in Jobson is concerned, the decision was entirely orthodox if it
is treated as a forfeiture case, but it was wrong in principle if it is treated as a penalty
case.
88. The Court of Appeal in this case thought clauses 5.1 and 5.6 should both be
treated in the same way when it came to applying the penalty rule, and we take the
same view, but, in agreement with Burton J at first instance, we consider that neither
clause is avoided by the penalty rule.
Page 38
The second appeal: ParkingEye v Beavis
The factual and procedural history
89. British Airways Pension Fund (“the Fund”) owns the Riverside Retail Park
in Chelmsford. The Fund leases sites on the Retail Park to various multiple retailers,
but retains overall control of the site. There is a car park located at the Retail Park,
and, on 25 August 2011, the Fund entered into a contract with ParkingEye Ltd in
respect of management services at that car park.
90. At all material times since then, ParkingEye has displayed about 20 signs at
the entrance to the car park and at frequent intervals throughout it. The signs are
large, prominent and legible, so that any reasonable user of the car park would be
aware of their existence and nature, and would have a fair opportunity to read them
if he or she wished to do so.
91. The upper 80% or so of the signs are worded and laid out substantially as
follows (mostly in black print on an orange background):
“ParkingEye
car park management
2 hour max stay
Customer only car park
4 hour maximum stay for Fitness Centre Members
Failure to comply with the following
will result in a Parking Charge of £85
 Parking limited to 2 hours (no return within 1 hour)
 Park only within marked bays
 Blue badge holders only in marked bays”.
Below this main part of the signs in small, but legible black print on the same orange
background is the following information:
“ParkingEye Ltd is solely engaged to provide a traffic space
maximisation scheme. We are not responsible for the car park
surface, other motor vehicles, damage or loss to or from motor
vehicles or user’s safety. The parking regulations for this car
Page 39
park apply 24 hours a day, all year round, irrespective of the
site opening hours. Parking is at the absolute discretion of the
site. By parking within the car park, motorists agree to comply
with the car park regulations. Should a motorist fail to comply
with the car park regulations, the motorist accepts that they are
liable to pay a Parking Charge and that their name and address
will be requested from the DVLA.
Parking charge Information: A reduction of the Parking Charge
is available for a period, as detailed in the Parking Charge
Notice. The reduced amount payable will not exceed £75, and
the overall amount will not exceed £150 prior to any court
action, after which additional costs will be incurred.”
Below that information, in somewhat larger print are the words: “This car park is
private property”. At the very bottom of the signs on a black background is
ParkingEye’s name, telephone number and address in orange, and a drawing of a
padlock, a drawing of a surveillance camera with the words “car park monitored by
ANPR systems” in small letters underneath, and two logos recording that
ParkingEye was a member of the British Parking Association (“BPA”) and that it
was a BPA “approved operator”.
92. At 2.29 on the afternoon of 15 April 2013, Mr Beavis drove his motor car
into the car park and parked it there. He did not leave until two hours 56 minutes
later, thereby overstaying the two-hour limit by nearly an hour. ParkingEye obtained
Mr Beavis’s name and address from the Driver and Vehicle Licensing Agency
(“DVLA”), and sent him a standard “First Parking Charge Notice” which demanded
that he pay the £85 charge within 28 days, but stated that, if he paid within 14 days,
the charge would be reduced to £50. The Notice also informed him of an appeals
procedure. Mr Beavis ignored this demand, as well as a subsequent standard form
reminder notice and warning letter. ParkingEye then began proceedings in the
County Court to recover the £85 alleged to be due. A claim of this size would
normally have been dealt with by a District Judge under the small claims procedure,
but it was recognised that the case raised some points of principle which were likely
to affect many other similar claims, so it was heard by the Designated Civil Judge
for East Anglia.
93. Before Judge Moloney QC and before the Court of Appeal, Mr Beavis raised
two arguments as to why he should not have to pay the £85 charge, namely that it
was (i) unenforceable at common law because it is a penalty, and/or (ii) unfair and
therefore unenforceable by virtue of the 1999 Regulations. The Court of Appeal
(Moore-Bick and Patten LJJ and Sir Timothy Lloyd) upheld Judge Moloney QC’s
Page 40
decision rejecting each of his arguments – see [2015] EWCA Civ 402. Mr Beavis
now appeals to this court, maintaining both his arguments.
Introductory
94. It was common ground before the Court of Appeal, and is common ground
in this court, that on the facts which we have just summarised there was a contract
between Mr Beavis and ParkingEye. Mr Beavis had a contractual licence to park his
car in the retail park on the terms of the notice posted at the entrance, which he
accepted by entering the site. Those terms were that he would stay for not more than
two hours, that he would park only within the marked bays, that he would not park
in bays reserved for blue badge holders, and that on breach of any of those terms he
would pay £85. Moore-Bick LJ in the Court of Appeal was inclined to doubt this
analysis, and at one stage so were we. But, on reflection, we think that it is correct.
The £85 is described in the notice as a “parking charge”, but no one suggests that
that label is conclusive. In our view it was not, as a matter of contractual analysis, a
charge for the right to park, nor was it a charge for the right to overstay the two-hour
limit. Not only is the £85 payable upon certain breaches which may occur within the
two-hour free parking period, but there is no fixed period of time for which the
motorist is permitted to stay after the two hours have expired, for which the £85
could be regarded as consideration. The licence having been terminated under its
terms after two hours, the presence of the car would have constituted a trespass from
that point on. In the circumstances, the £85 can only be regarded as a charge for
contravening the terms of the contractual licence.
95. Schemes of this kind (including a significant discount on prompt payment
after the first demand) are common in the United Kingdom. Some are operated by
private landowners, some by parking management companies like ParkingEye, and
some by local authorities. They are subject to a measure of indirect regulation. Under
section 54 of the Protection of Freedoms Act 2012, parked cars may not be
immobilised or towed away by a private operator, but section 56 and Schedule 4
provide for the recovery of parking charges. Where a motorist becomes liable by
contract for a “sum in the nature of a fee or charge” or in tort for a “sum in the nature
of damages”, there is a right under certain conditions to recover it: Schedule 4,
paragraph 4. One of those conditions is that the keeper’s details must have been
supplied by the Secretary of State in response to an application for the information:
ibid, para 11. The Secretary of State’s functions in relation to the provision of this
information are performed by the DVLA. Under article 27(1)(e) of the Road
Vehicles (Registration and Licensing) Regulations 2002 (SI 2002/2742), the
Secretary of State is empowered to make available particulars in the vehicle register
to anyone who “has reasonable cause for wanting the particulars to be made
available to him”. Since 2007, the policy of the Secretary of State has been to
disclose the information for parking enforcement purposes only to members of an
accredited trade association. The criteria for accreditation were stated in Parliament
Page 41
to include the existence of “a clear and enforced code of conduct (for example
relating to conduct, parking charge signage, charge levels, appeals procedure,
approval of ticket wording and appropriate pursuit of penalties” (Hansard (HC
Debates), 24 July 2006, col 95WS).
96. As at April 2013, there was only one relevant accredited trade association,
the BPA, to which reference was made on the Notice, and to which ParkingEye still
belongs. The BPA Code of Practice is a detailed code of regulation governing signs,
charges and enforcement procedures. Clause 13 deals with grace periods. Clause
13.4 provides:
“13.4 You should allow the driver a reasonable period to leave
the private car park after the parking contract has ended, before
you take enforcement action.”
Clause 19 provides:
“19.5 If the parking charge that the driver is being asked to pay
is for a breach of contract or act of trespass, this charge must
be based on the genuine pre-estimate of loss that you suffer.
We would not expect this amount to be more than £100. If the
charge is more than this, operators must be able to justify the
amount in advance.
19.6 If your parking charge is based on a contractually agreed
sum, that charge cannot be punitive or unreasonable. If it is
more than the recommended amount in 19.5 and is not justified
in advance, it could lead to an investigation by the Office of
Fair Trading.”
The maximum of £100 recommended by the BPA may be compared with the
penalties charged by local authorities, which are regulated by statute. The Civil
Enforcement of Parking Contraventions (Guidelines on Levels of Charges)
(England) Order 2007 (SI 2007/3487) lays down guidelines for the level of penalties
outside Greater London. For “higher level contraventions” (essentially unauthorised
on-street parking), the recommended penalty is capped at £70 and for other
contraventions at £50. The corresponding figures for Greater London are £130 and
£80.
Page 42
Parking charges and the penalty rule
97. ParkingEye concedes that the £85 is payable upon a breach of contract, and
that it is not a pre-estimate of damages. As it was not the owner of the car park,
ParkingEye could not recover damages, unless it was in possession, in which case it
may be able to recover a small amount of damages for trespass. This is because it
lost nothing by the unauthorised use resulting from Mr Beavis overstaying. On the
contrary, at least if the £85 is payable, it gains by the unauthorised use, since its
revenues are wholly derived from the charges for breach of the terms. The notice at
the entrance describes ParkingEye as being engaged to provide a “traffic space
maximisation scheme”, which is an exact description of its function. In the agreed
Statement of Facts and Issues, the parties state that “the predominant purpose of the
parking charge was to deter motorists from overstaying”, and that the landowner’s
objectives include the following:
“a. The need to provide parking spaces for their commercial
tenants’ prospective customers;
b. The desirability of that parking being free so as to attract
customers;
c. The need to ensure a reasonable turnover of that parking
so as to increase the potential number of such customers;
d. The related need to prevent ‘misuse’ of the parking for
purposes unconnected with the tenants’ business, for example
by commuters going to work or shoppers going to off-park
premises; and
e. The desirability of running that parking scheme at no
cost, or ideally some profit, to themselves.”
98. Against this background, it can be seen that the £85 charge had two main
objects. One was to manage the efficient use of parking space in the interests of the
retail outlets, and of the users of those outlets who wish to find spaces in which to
park their cars. This was to be achieved by deterring commuters or other long-stay
motorists from occupying parking spaces for long periods or engaging in other
inconsiderate parking practices, thereby reducing the space available to other
members of the public, in particular the customers of the retail outlets. The other
purpose was to provide an income stream to enable ParkingEye to meet the costs of
operating the scheme and make a profit from its services, without which those
Page 43
services would not be available. These two objectives appear to us to be perfectly
reasonable in themselves. Subject to the penalty rule and the Regulations, the
imposition of a charge to deter overstayers is a reasonable mode of achieving them.
Indeed, once it is resolved to allow up to two hours free parking, it is difficult to see
how else those objectives could be achieved.
99. In our opinion, while the penalty rule is plainly engaged, the £85 charge is
not a penalty. The reason is that although ParkingEye was not liable to suffer loss
as a result of overstaying motorists, it had a legitimate interest in charging them
which extended beyond the recovery of any loss. The scheme in operation here (and
in many similar car parks) is that the landowner authorises ParkingEye to control
access to the car park and to impose the agreed charges, with a view to managing
the car park in the interests of the retail outlets, their customers and the public at
large. That is an interest of the landowners because (i) they receive a fee from
ParkingEye for the right to operate the scheme, and (ii) they lease sites on the retail
park to various retailers, for whom the availability of customer parking was a
valuable facility. It is an interest of ParkingEye, because it sells its services as the
managers of such schemes and meets the costs of doing so from charges for breach
of the terms (and if the scheme was run directly by the landowners, the analysis
would be no different). As we have pointed out, deterrence is not penal if there is a
legitimate interest in influencing the conduct of the contracting party which is not
satisfied by the mere right to recover damages for breach of contract. Mr Butcher
QC, who appeared for the Consumers’ Association (interveners), submitted that
because ParkingEye was the contracting party its interest was the only one which
could count. For the reason which we have given, ParkingEye had a sufficient
interest even if that submission be correct. But in our opinion it is not correct. The
penal character of this scheme cannot depend on whether the landowner operates it
himself or employs a contractor like ParkingEye to operate it. The motorist would
not know or care what if any interest the operator has in the land, or what relationship
it has with the landowner if it has no interest. This conclusion is reinforced when
one bears in mind that the question whether a contractual provision is a penalty turns
on the construction of the contract, which cannot normally turn on facts not recorded
in the contract unless they are known, or could reasonably be known, to both parties.
100. None of this means that ParkingEye could charge overstayers whatever it
liked. It could not charge a sum which would be out of all proportion to its interest
or that of the landowner for whom it is providing the service. But there is no reason
to suppose that £85 is out of all proportion to its interests. The trial judge, Judge
Moloney QC, found that the £85 charge was neither extravagant nor unconscionable
having regard to the level of charges imposed by local authorities for overstaying in
car parks on public land. The Court of Appeal agreed and so do we. It is higher than
the penalty that a motorist would have had to pay for overstaying in an on-street
parking space or a local authority car park. But a local authority would not
necessarily allow two hours of free parking, and in any event the difference is not
Page 44
substantial. The charge is less than the maximum above which members of the BPA
must justify their charges under their code of practice. The charge is prominently
displayed in large letters at the entrance to the car park and at frequent intervals
within it. The mere fact that many motorists regularly use the car park knowing of
the charge is some evidence of its reasonableness. They are not constrained to use
this car park as opposed to other parking facilities provided by local authorities,
Network Rail, commercial car park contractors or other private landowners. They
must regard the risk of having to pay £85 for overstaying as an acceptable price for
the convenience of parking there. The observations of Lord Browne-Wilkinson in
Workers Bank at p 580 referred to in para 35 above are in point. While not
necessarily conclusive, the fact that ParkingEye’s payment structure in its car parks
(free for two hours and then a relatively substantial sum for overstaying) and the
actual level of charge for overstaying (£85) are common in the UK provides support
for the proposition that the charge in question is not a penalty. No other evidence
was furnished by Mr Beavis to show that the charge was excessive.
101. We conclude, in agreement with the courts below, that the charge imposed
on Mr Beavis was not a penalty.
Parking charges and the Unfair Terms in Consumer Contracts Regulations
1999
102. The 1999 Regulations subject the terms of consumer contracts to a fairness
test. An unfair term is not binding on a consumer: regulation 8(1). The fairness test
is not applicable to all terms in consumer contracts. It does not apply to certain core
terms, namely those which define the “main subject matter of the contract” nor to
the adequacy of the price or remuneration for the goods or services supplied:
regulation 6(2). But it follows from the fact that the £85 charge is a charge for acting
in breach of the primary terms that it is not excluded from the fairness test under
either of these heads. The issue is therefore whether the test is satisfied.
103. Under regulation 5(1), a contractual term which has not been individually
negotiated
“shall be regarded as unfair if, contrary to the requirement of
good faith, it causes a significant imbalance in the parties’
rights and obligations arising under the contract, to the
detriment of the consumer.”
Regulation 6(1) provides that
Page 45
“the unfairness of a contractual term shall be assessed, taking
into account the nature of the goods or services for which the
contract was concluded and by referring, at the time of
conclusion of the contract, to all the circumstances attending
the conclusion of the contract and to all the other terms of the
contract or of another contract on which it is dependent.”
An “indicative and non-exhaustive” list of terms which “may” be regarded as unfair
by this test is contained in Schedule 2. This includes at paragraph 1(e) a term
“requiring any consumer who fails to fulfil his obligation to pay a disproportionately
high sum in compensation”.
104. In our opinion, the same considerations which show that the £85 charge is
not a penalty, demonstrate that it is not unfair for the purpose of the Regulations.
105. The reason is that although it arguably falls within the illustrative description
of potentially unfair terms at paragraph 1(e) of Schedule 2 to the Regulations, it is
not within the basic test for unfairness in regulations 5(1) and 6(1). The Regulations
give effect to Council Directive 93/13/EEC on unfair terms in consumer contracts,
and these rather opaque provisions are lifted word for word from articles 3 and 4 of
the Directive. The effect of the Regulations was considered by the House of Lords
in Director General of Fair Trading v First National Bank plc [2001] 1 AC 481.
But it is sufficient now to refer to Aziz v Caixa d’Estalvis de Catalunya, Tarragona
i Manresa (Case C-415/11) [2013] 3 CMLR 89, which is the leading case on the
topic in the Court of Justice of the European Union. Aziz was a reference from a
Spanish court seeking guidance on the criteria for determining the fairness of three
provisions in a loan agreement. They provided for (i) the acceleration of the
repayment schedule in the event of the borrower’s default, (ii) the charging of
default interest, and (iii) the unilateral certification by the lender of the amount due
for the purpose of legal proceedings. The judgment of the Court of Justice is
authority for the following propositions:
1) The test of “significant imbalance” and “good faith” in article 3 of the
Directive (regulation 5(1) of the 1999 Regulations) “merely defines in
a general way the factors that render unfair a contractual term that has
not been individually negotiated” (para 67). A significant element of
judgment is left to the national court, to exercise in the light of the
circumstances of each case.
2) The question whether there is a “significant imbalance in the parties’
rights” depends mainly on whether the consumer is being deprived of
an advantage which he would enjoy under national law in the absence
Page 46
of the contractual provision (paras 68, 75). In other words, this element
of the test is concerned with provisions derogating from the legal
position of the consumer under national law.
3) However, a provision derogating from the legal position of the
consumer under national law will not necessarily be treated as unfair.
The imbalance must arise “contrary to the requirements of good faith”.
That will depend on “whether the seller or supplier, dealing fairly and
equitably with the consumer, could reasonably assume that the
consumer would have agreed to such a term in individual contract
negotiations” (para 69).
4) The national court is required by article 4 of the Directive (regulation
6(1) of the 1999 Regulations) to take account of, among other things,
the nature of the goods or services supplied under the contract. This
includes the significance, purpose and practical effect of the term in
question, and whether it is “appropriate for securing the attainment of
the objectives pursued by it in the member state concerned and does
not go beyond what is necessary to achieve them” (paras 71-74). In
the case of a provision whose operation is conditional upon the
consumer’s breach of another term of the contract, it is necessary to
assess the importance of the latter term in the contractual relationship.
106. In its judgment, the Court of Justice drew heavily on the opinion of Advocate
General Kokott, specifically endorsing her analysis at a number of points. That
analysis, which is in the nature of things more expansive than the court’s, repays
careful study. In the Advocate General’s view, the requirement that the “significant
imbalance” should be contrary to good faith was included in order to limit the
Directive’s inroads into the principle of freedom of contract. “[I]t is recognised,”
she said, “that in many cases parties have a legitimate interest in organising their
contractual relations in a manner which derogates from the [rules of national law]”
(para AG73). In determining whether the seller could reasonably assume that the
consumer would have agreed to the relevant term in a negotiation, it is important to
consider a number of matters. These include
“whether such contractual terms are common, that is to say they
are used regularly in legal relations in similar contracts, or are
surprising, whether there is an objective reason for the term and
whether, despite the shift in the contractual balance in favour
of the user of the term in relation to the substance of the term
in question, the consumer is not left without protection” (para
AG75).
Page 47
Advocate General Kokott returned to the question of legitimate interest when
addressing default interest. She observed that a provision requiring the payment
upon default of a sum exceeding the damage caused, may be justified if it serves to
encourage compliance with the borrower’s obligations:
“If default interest is intended merely as flat-rate compensation
for damage caused by default, a default interest rate will be
substantially excessive if it is much higher than the accepted
actual damage caused by default. It is clear, however, that a
high default interest rate motivates the debtor not to default on
his contractual obligations and to rectify quickly any default
which has already occurred. If default interest under national
law is intended to encourage observance of the agreement and
thus the maintenance of payment behaviour, it should be
regarded as unfair only if it is much higher than is necessary to
achieve that aim” (para AG87).
Finally, the Advocate General observes that the impact of a term alleged to be unfair
must be examined broadly and from both sides. Provisions favouring the lender may
indirectly serve the interest of the borrower also, for example by making loans more
readily available (para AG94).
107. In our opinion the term imposing the £85 charge was not unfair. The term
does not exclude any right which the consumer may be said to enjoy under the
general law or by statute. But it may fairly be said that in the absence of agreement
on the charge, Mr Beavis would not have been liable to ParkingEye. He would have
been liable to the landowner in tort for trespass, but that liability would have been
limited to the occupation value of the parking space. To that extent there was an
imbalance in the parties’ rights. But it did not arise “contrary to the requirement of
good faith”, because ParkingEye and the landlord to whom ParkingEye was
providing the service had a legitimate interest in imposing a liability on Mr Beavis
in excess of the damages that would have been recoverable at common law.
ParkingEye had an interest in inducing him to observe the two-hour limit in order to
enable customers of the retail outlets and other members of the public to use the
available parking space. To echo the observations of the Advocate General at para
AG94 of her opinion, charging overstayers £85 underpinned a business model which
enabled members of the public to park free of charge for two hours. This was
fundamental to the contractual relationship created by Mr Beavis’s acceptance of
the terms of the notice, whose whole object was the efficient management of the car
park. It was an interest of exactly the kind envisaged by the Advocate General at
para AG87 of her opinion and by the Court of Justice at para 74 of the judgment.
There is no reason to regard the amount of the charge as any higher than was
necessary to achieve that objective.
Page 48
108. Could ParkingEye, “dealing fairly and equitably with the consumer, …
reasonably assume that the consumer would have agreed to such a term in individual
contract negotiations”? The concept of a negotiated agreement to enter a car park is
somewhat artificial, but it is perfectly workable provided that one bears in mind that
the test, as Advocate General Kokott pointed out in Aziz at para AG75, is objective.
The question is not whether Mr Beavis himself would in fact have agreed to the term
imposing the £85 charge in a negotiation, but whether a reasonable motorist in his
position would have done so. In our view a reasonable motorist would have agreed.
In the first place, motorists generally and Mr Beavis in particular did accept it. In
the case of non-negotiated standard terms that would not ordinarily be entitled to
much weight. But although the terms, like all standard contracts, were presented to
motorists on a take it or leave it basis, they could not have been briefer, simpler or
more prominently proclaimed. If you park here and stay more than two hours, you
will pay £85. Motorists could hardly avoid reading the notice and were under no
pressure to accept its terms.
109. Objectively, they had every reason to do so. They were being allowed two
hours of free parking. In return they had to accept the risk of being charged £85 if
they overstayed. Overstaying penalties are, as we have mentioned, both a normal
feature of parking contracts on public and on private land, and important for the
efficient management of the space in the interests of the general body of users and
the neighbouring outlets which they may frequent. They are beneficial not just to
ParkingEye, the landowner and the retail outlets, but to the motorists themselves,
because they make parking space available to them which might otherwise be
clogged up with commuters and other long-stay users. The amount of the charge
was not exorbitant in comparison to the general level of penalties imposed for
parking infractions. Nor is there any reason to think that it was higher than necessary
to ensure considerate use by motorists of the available space. And, while we accept
Mr Butcher’s submission that the fact that the £85 charge is broadly comparable to
charges levied by local authorities for parking in public car parks is not enough to
show that it was levied in good faith, it is nonetheless a factor which assists
ParkingEye in that connection. The risk of having to pay it was wholly under the
motorist’s own control. All that he needed was a watch. In our opinion, a
hypothetical reasonable motorist would have agreed to objectively reasonable terms,
and these terms are objectively reasonable.
110. It is right to mention three further arguments which were raised by Mr de
Waal QC on behalf of Mr Beavis to support his case that the £85 charge was unfair,
and which we have not so far specifically addressed.
111. First, Mr de Waal relied on the fact that it was payable by a motorist who
overstayed even by a minute. The Consumers’ Association expanded on this point
by observing that there are many reasons why a motorist may overstay, some of
which may be due to unforeseen circumstances. We cannot accept this.
Page 49
ParkingEye’s business model could have had a graduated charge for overstayers
based on how long they overstayed, but the fact that it did not do so does not render
it unfair. Even if it had done, it would presumably have involved a specific sum for
each hour or part of an hour, in which case the same complaint could be made. More
fundamentally, as we have explained, the £85 charge for overstayers was not a
payment for being permitted to park after the two hours had expired: it was a sum
imposed for staying for more than two hours. The notion of a single sum between
£50 and £100 for overstaying even by a minute, appears to be a very common
practice, in that it is adopted by many, probably the majority of, public and private
car park operators. As for the suggestion that the overstay may have arisen from
unforeseen circumstances, we find it hard to regard that as relevant. The object of
the £85 charge is simply to influence the behaviour of motorists by causing them to
leave within two hours. It is reasonable that the risk of exceeding it should rest with
the motorist, who is in a position to organise his time as he sees fit. There are many
circumstances in life when the only way of being on time is to allow for contingency
and arrive early. This is accepted by every motorist who uses metered on-street
parking while shopping. The legal basis on which he is made liable for overstaying
penalties is of course different in that case. It is statutory and not contractual. But
the underlying rationale and justification is precisely the same, namely to ration
scarce parking space. It is right to add that, as communicated to any overstayer from
whom the charge is demanded, ParkingEye has an appeals procedure, and the BPA
Code of Practice provides at paragraph 13.4 for a reasonable grace period after the
expiry of the fixed parking period. The appeals procedure provides a degree of
protection for any overstayer, who would be able to cite any special circumstances
as a reason for avoiding the charge. And, while the Code of Practice is not a
contractual document, it is in practice binding on the operator since its existence and
observance is a condition of his ability to obtain details of the registered keeper from
the DVLA. In assessing the fairness of a term, it cannot be right to ignore the
regulatory framework which determines how and in what circumstances it may be
enforced.
112. The second argument which should be mentioned is that the £85 charge for
overstayers “takes advantage of the consumer’s requirement to park in that particular
place to shop or visit a particular location”. If this car park is unusually attractively
located for shoppers and others, the evidence shows that the £85 charge has not been
fixed at a particularly high level to reflect that fact. Further, as Mr Kirk QC pointed
out on behalf of ParkingEye, it is equally true that the consumer gets the benefit of
free parking in that unusually attractively located car park for two hours, and, save
in unusual circumstances, it is entirely within his or her control whether the twohour limit is exceeded. And if the consumer considers that the circumstances are
unusual, he or she can invoke the appeals procedure.
113. Finally, Mr de Waal submitted that it was unfair to make the minority who
contravene the parking rules bear the whole cost of running the car park. In our view,
Page 50
if the £85 charge is itself such as a reasonable motorist would accept, the mere
imbalance between the position of those who comply and those who do not cannot
possibly make the charge unfair. It arises only because both categories are allowed
two hours of free parking, and because the great majority of users of the car park
(more than 99.5%, we were told) observe the rules.
114. Accordingly, we agree with the courts below that the £85 charge in this case
does not infringe the 1999 Regulations.
Conclusion on the two appeals
115. For these reasons, we would allow the appeal in Cavendish v El Makdessi
and dismiss the appeal in ParkingEye v Beavis, and we would declare that none of
the terms impugned on the two appeals contravenes the penalty rule, and that the
charge in issue in ParkingEye v Beavis does not infringe the 1999 Regulations.
LORD MANCE:
Introduction
116. These two appeals raise wide-ranging and difficult questions about the
current law governing contractual penalties. The cases lie at opposite ends of a
financial spectrum. In the first, the appellant, Cavendish Square Holding BV
(“Cavendish”), is part of the world’s leading marketing communications group
(“WPP”), while the respondent, Mr Talal El Makdessi, was co-founder and coowner with Mr Joseph Ghossoub of the Middle East’s largest advertising and
marketing communications group (“the Group”). Prior to 2008 WPP held 12.6% of
the shares of the Group. In 2008 Mr El Makdessi and Mr Ghoussoub agreed to sell
to Cavendish a further 47.4% of the Group’s shares (in the form of an interest in
Team Y & R Holdings Hong Kong Ltd (“Team”), a holding company set up to
facilitate the transaction).
117. The transaction was effected by a sale and purchase agreement dated 28
February 2008, whereby Mr El Makdessi and Mr Ghoussoub agreed to make the
47.4% shareholding available in the ratio of 53.88% to 46.12%. The price was
payable in stages: US$65.5m (Mr El Makdessi’s share being 53.88%) was payable
on completion of the sale and Group reorganisation. Thereafter, there were to be
Interim and Final Payments derived from a multiple of the Group’s audited
consolidated operating profit (“OPAT”) between respectively 2007 and 2009 and
2007 and 2011. Clause 11.2 was a clause prohibiting Mr El Makdessi from various
competitive or potentially competitive activity. Clauses 5.1 and 5.6 provided that, if
Page 51
he breached clause 11.2, he would not be entitled to receive the Interim and/or Final
Payments, and could be required to sell Cavendish the rest of his shares at a
“Defaulting Shareholder Option Price”, based on asset value and so ignoring any
goodwill value. Mr El Makdessi also became non-executive chair of Team with a
service agreement binding him to remain in position for at least 18 months.
118. It is accepted by Mr El Makdessi that he did subsequently breach clause 11.2,
and was thereby also in breach of fiduciary duty towards Team. The present
proceedings were initiated by both Cavendish and Team. Team’s claim was settled
in October 2012 when it accepted a Part 36 payment of US$500,000 made by Mr El
Makdessi. Cavendish’s claim is for declarations that Mr El Makdessi’s breach of
clause 11.2 means that clauses 5.1 and 5.6 now have the effect stated in the previous
paragraph. Mr El Makdessi maintains that they are unenforceable penalty clauses.
119. In the second case, the appellant, Mr Beavis, was the owner and driver of a
vehicle which he parked in a retail shopping car park adjacent to Chelmsford railway
station. The owner of the retail site and car park, British Airways Pension Fund
(“BAPF”), had engaged ParkingEye Ltd, the respondent, to provide “a traffic space
maximisation scheme”. The scheme involved the erection at the entrance to and
throughout the car part of prominent notices, including the injunctions “2 hour max
stay” and “Parking limited to 2 hours”, coupled with the further notice “Failure to
comply … will result in a Parking Charge of £85”. Underneath, it also stated: “By
parking within the car park, motorists agree to comply with the car park regulations”.
Mr Beavis left his car parked for 56 minutes over a permitted two-hour period. He
maintains that the £85 charge demanded of him by ParkingEye (reducible to £50 if
he had paid within 14 days) is an unenforceable penalty. Further or alternatively, he
maintains that it is unfair and invalid within the meaning of the Unfair Terms in
Consumer Contracts Regulations 1999.
120. Cavendish succeeded before Burton J on 14 December 2012, although only
on condition that it agreed to credit Mr El Makdessi with the US$500,000 recovered
from him by Team. The Court of Appeal (Patten, Tomlinson and Christopher Clarke
LJJ), [2013] EWCA Civ 1539, over-ruled Burton J, [2012] EWHC 3582 (Comm),
on 26 November 2013, holding both clauses to be unenforceable penalties. The court
held however that the judge had had, on his view of the case, no basis to impose a
condition that Cavendish agree to credit Mr El Makdessi with the US$500,000 (and
the contrary has not been suggested before the Supreme Court). Mr Beavis has so
far failed at both instances, before Judge Moloney QC on 19 May 2014 and the
Court of Appeal (Moore-Bick and Patten LJJ and Sir Timothy Lloyd) on 23 April
2015, [2015] EWCA Civ 402. The appellants in both cases now appeal with the
permission of the Supreme Court in the case of Mr El Makdessi and of the Court of
Appeal in the case of Mr Beavis.
Page 52
Cavendish v Mr El Makdessi – facts
121. I can summarise and take the relevant terms of the sale and purchase
agreement to which Cavendish and Mr El Makdessi were parties from the agreed
Statement of Facts and Issues (“SFI”):
“10. By clause 2.1 of the Agreement, Joe and the respondent
(defined as ‘the Sellers’) agreed to sell 47.4% of the
shareholding in the Company. Clause 3 set out the
consideration for that sale, which pursuant to Schedule 1 was
to be shared between the respondent and Joe in shares of
53.88% and 46.12% respectively. The consideration, payment
of which was not expressed to be subject to any condition, was
as follows:
(1) A payment of US$34,000,000 on completion;
(2) A second payment of US$31,500,000 to be paid into
escrow on completion and released to Joe and the respondent
in accordance with clauses 3.6 to 3.12 (which in short provided
for the sum to become payable in stages as the various
restructurings provided for in the Agreement took effect).
(3) A further payment (‘the Interim Payment’) was to
become payable on its ‘Due Date’ and was to be calculated as
follows:
8 x Average 2007-2009 ‘OPAT’ x 47.4% minus
US$63,000,000
(4) A final payment (‘the Final Payment’) was to become
payable on its ‘Due Date’, and was to be calculated as follows:
‘M’ x Average 2007-2011 ‘OPAT’ x 47.4% minus
US$63,000,000 and the Interim Payment.
11. ‘OPAT’ was defined in Schedule 12 as meaning the audited
consolidated operating profit of the Group, and ‘Due Date’ was
defined as meaning 30 days after the relevant OPAT was
Page 53
agreed or determined. The figure ‘M’ in the definition of Final
Payment was a figure varying between seven and ten
depending on the growth of OPAT over the period 2007 to
2011.
12. Thus the Interim and Final Payments in essence obliged the
purchaser to make further payments to Joe and the respondent
calculated by reference to the Group’s profitability in the years
2007 to 2011.
13. Clause 3.2 provided that if the calculation of the Interim
Payment or the Final Payment resulted in a negative figure, it
was to be treated as zero and Joe and the respondent would not
be required to repay any sum already paid.
14. Clause 3.3 capped the total amount of all payments at
US$147,500,000.
15. By clause 9.1, paragraph 2.15 of Schedule 7, and Schedule
11, Joe and the respondent warranted that the net assets of the
entire Group, not just their share, as at 31 December 2007 were
US$69,744,340.
16. Under the Agreement, therefore, a substantial part of the
purchase consideration comprised goodwill:
a. The Completion and Second Payments totalled
$65.5m and were for 47.4% of the equity (47.4% of the
warranted 2007 NAV being $33,058,817);
b. At its highest (assuming no decrease in NAV)
some US$114.44m would be payable for goodwill
($147,500,000 – $33,058,817), representing 77% of the
aggregate purchase consideration.
17. Clause 11 was entitled ‘Protection of Goodwill’, and
provided that:
‘11 PROTECTION OF GOODWILL
Page 54
11.1 Each Seller recognises the importance of the
goodwill of the Group to the Purchaser and the WPP
Group which is reflected in the price to be paid by the
Purchaser for [the shares]. Accordingly, each Seller
commits as set out in this clause 11 to ensure that the
interest of each of the Purchaser and the WPP Group in
that goodwill is properly protected.’
18. Clause 11.2 then set out various restrictive covenants (‘the
Restrictive Covenants’) entered into by Joe and the respondent:
‘11.2 Until the date 24 months after the Relevant Date,
no Seller will directly or indirectly without the
Purchaser’s prior consent:
(a) carry on or be engaged, concerned, or
interested, in competition with the Group, in the
Restricted Activities within the Prohibited Area;
(b) solicit or knowingly accept any orders,
enquiries or business in respect of the Restricted
Activities in the Prohibited Area from any Client;
(c) divert away from any Group Company any
orders, enquiries or business in respect of the
Restricted Activities from any Client; or
(d) employ, solicit or entice away from or
endeavour to employ, solicit, or entice away from
any Group Company any senior employee or
consultant employed or engaged by that Group
Company.’
19. By virtue of the definitions in Schedule 12 of the
Agreement, ‘Restricted Activities’ meant the provision of
products and/or services of a competitive nature to those being
provided by the Group, ‘Prohibited Area’ meant any countries
in which the Group carried on the business of marketing
communications and ancillary services, and ‘Client’ meant any
client or potential client of the Group who had placed an order
Page 55
with the Group during the past 12 months or been in
discussions with the Group during that period.
20. As to the several covenants:-
(a) the effect of any breach of the covenant against
employing or soliciting senior employees could be less
than a breach of the covenants against competitive
activity; the respondent’s position is that it was likely,
in many circumstances, to be markedly less; and
(b) Losses attributable to breaches of the covenant
against solicitation could vary, the respondent says were
likely to vary widely, according to the nature, extent,
duration and success of the solicitation.
21. By clause 7.5, the respondent agreed that within four
months after completion he would dispose of any shares held
by him in Carat Middle East Sarl (‘Carat’) and procure that a
joint venture agreement of 19 December 2003 to which Group
Carat (Nederland) BV and Aegis International BV, on the one
hand, and the respondent, on the other, were parties, would be
terminated.
22. By the time of trial, the respondent had conceded that (if
the Restrictive Covenants were enforceable) he was in breach
thereof by reason of his ongoing, unpaid involvement in the
affairs of Carat (‘the Breach’).
23. It is the provisions providing for the consequences of
breach which are in issue in this appeal. By reason of the
Breach, the respondent became a ‘Defaulting Shareholder’
within the meaning of the definition in Schedule 12. Clause 5.1
is headed ‘DEFAULT’ and includes two relevant provisions.
24. First, clause 5.1 provides that on becoming a Defaulting
Shareholder, the respondent would not be entitled to receive the
Interim Payment or the Final Payment:
Page 56
‘If a Seller becomes a Defaulting Shareholder he shall
not be entitled to receive the Interim Payment and/or the
Final Payment which would other than for his having
become a Defaulting Shareholder have been paid to him
and the Purchaser’s obligation to make such payments
shall cease.’
25. In money terms, the effect of this provision is that in the
event of a default by the respondent, he could receive up to
$44,181,600 less than would have been the case had he not
acted in breach. If both Sellers were to default, they could lose
up to US$82m ($147.5-$65.5) between them.
26. Second, clause 5.6 grants an option over the respondent’s
remaining shares in the Group whereby in the event that he
became a Defaulting Shareholder, the appellant could require
him to sell those remaining shares:
‘Each Seller hereby grants an option to the Purchaser
pursuant to which, in the event that such Seller becomes
a Defaulting Shareholder, the Purchaser may require
such Seller to sell to the Purchaser (or its nominee) all
(and not some only) of the Shares held by that Seller (the
Defaulting Shareholder Shares). The Purchaser (or its
nominee) shall buy and such Seller shall sell with full
title guarantee the Defaulting Shareholder Shares …
within 30 days of receipt by such Seller of a notice from
the Purchaser exercising such option in consideration
for the payment by the Purchaser to such Seller of the
Defaulting Shareholder Option Price.’
27. The ‘Defaulting Shareholder Option Price’ is defined in
Schedule 12 as meaning the proportion of the Net Asset Value
of the company equal to the proportion of shares sold by the
Defaulting Shareholder, a formula which excludes the value of
goodwill. By clause 5.7, this could be satisfied either in cash or
by issuing shares in WPP, at the absolute discretion of the
appellant.
28. Clause 15.1 granted the Sellers a put option by which they
could require the appellant to purchase all their remaining
shares in the Company:
Page 57
‘Each Seller is hereby granted an option by the
Purchaser pursuant to which such Seller may, subject to
clause 15.2, by service of an Option Notice in the form
set out in Schedule 10 (the Option Notice) require the
Purchaser (or its nominee) to purchase from him all
(and not some only) of the Shares held by that Seller (the
Option Shares). The Purchaser (or its nominee) shall
buy and the Seller shall sell with full title guarantee the
Option Shares … within 30 days of receipt of the Option
Notice in consideration for the payment when due of the
price determined in accordance with clause 15.3 (the
Option Price).’
29. In money terms, the effect of clause 5.6 is that insofar as
the retained shares of a Defaulting Shareholder have, at the date
when he becomes a Defaulting Shareholder, a value which is
attributable to goodwill, he will not receive it. He will not be
able to exercise the put option otherwise available in 2011 and
subsequent years, which would give him a price, not exceeding
$75m, which reflected goodwill.
30. As of the date of the Agreement, the respondent was, and
was bound to remain, a director for at least 18 months and was
entitled to remain thereafter as long as he was a shareholder
unless Cavendish considered that his outside business interests
were likely to result in a material ongoing conflict with his
duties as a director. For so long as he did remain a director, any
breach of clause 11.2 would give rise to a cause of action for
breach of fiduciary duty to the Company.
31. The Agreement contained no provision which precluded the
Company from bringing a claim for damages for conduct
rendering the respondent a Defaulting Shareholder.
32. As with the agreement as a whole, these provisions were
subject to negotiation and amendment between the parties. …
33. The structure of the Agreement was typical of acquisition
agreements in the marketing sector. As in this case, the vendor
is typically the founder or operator of the business, and has
important relationships with clients and key staff. If they decide
to turn against the business, its success can be significantly
Page 58
affected, and provisions are therefore included to protect the
value of the investment, and in particular the value of the
goodwill represented by the vendor’s existing personal
relationships. The respondent fell into that category; the
importance of personal relationships with clients is even
stronger in the Middle East than the UK, and he had very strong
relationships with clients and senior employees, and he was
such a well known figure that if he acted against the Group, it
would inevitably cause it to lose value. …”
122. Paragraphs 25 and 29 of this agreed summary outline the effect of clauses 5.1
and 5.6 of the sale and purchase agreement, on which Cavendish relies but which
Mr El Makdessi submits to be penal and unenforceable. Since clauses 5.1 and 5.6
operate because Mr El Makdessi became a Defaulting Shareholder by reason of
breach of clause 11.2, both clauses need to be considered with reference to the
nature, scope and duration of the restrictive covenants in favour of Cavendish which
clause 11.2 contains. As para 33 of the agreed summary records, the restrictive
covenants represented very significant protections of the value of the goodwill
which Cavendish was to acquire. Clause 11.2 provides for such protection to
continue until 24 months after the “Relevant Date”. By Schedule 12:
“Relevant Date means in respect of a Seller the later of the date
of termination of his employment by the Group, the date that
he no longer holds any Shares or the date of payment of the
final instalment of the Option Price pursuant to clause 15.5(b).”
Clause 16.1 provided that:
“Save as otherwise expressly provided by this agreement no
Seller shall transfer, sell, charge, Encumber or otherwise
dispose of all or part of his interest in any Shares.”
The put option referred to in para 28 of the agreed summary was only exercisable
by Mr El Makdessi by option notice served “at any time between 1 January and 31
March in 2011 or in any subsequent year” (clause 15.2). Upon its exercise, the
Option Price was payable in two instalments, the second or final instalment being
due “within 30 days of the agreement or final determination of OPAT for N+2”
(clause 15.5(b)). OPAT means under Schedule 12 “the audited consolidated
operating profit … in any 12-month accounting period ending 31 December”. N
means “the financial year in which the Option Notice is served” (clause 15.3). N+2
thus means the year 2013, and the earliest date of full payment of any Option Price
under clause 15 would be some date in 2014, once the OPAT for N+2 was agreed
Page 59
or finally determined. That would be the (earliest) Relevant Date, assuming that Mr
El Makdessi had previously determined his employment by the Group which he was
only committed to maintain for 18 months from the date of the agreement (para 30
of the agreed summary). Under the terms of the sale and purchase agreement dated
28 February 2008, Mr El Makdessi was bound by the restrictive covenants for a
further 24 months, ie until a date in 2016, some eight years after the sale and
purchase agreement. There has been no challenge in this court to the reasonableness
of this lengthy restriction, and it underlines the importance of goodwill to the
agreement and to the buyers, Cavendish, in particular.
ParkingEye Limited v Beavis – facts
123. The signs exhibited at the entrance and throughout the car park are large,
prominent and legible. They are worded as follows (the words down to “marked
bays” all being given especial prominence):
“ParkingEye
car park management
2 hour max stay
Customer only car park
4 hour maximum stay for Fitness Centre Members
Failure to comply with the following will result in a Parking Charge of:
£85
Parking limited to 2 hours
(no return within 1 hour)
Park only within marked bays
Blue badge holders only in marked bays
ParkingEye Ltd is solely engaged to provide a traffic space
maximisation scheme. We are not responsible for the car park
surface, other motor vehicles, damage or loss to or from motor
vehicles or user’s safety. The parking regulations for this car park
apply 24 hours a day, all year round, irrespective of the site
opening hours. Parking is at the absolute discretion of the site. By
parking within the car park, motorists agree to comply with the car
park regulations. Should a motorist fail to comply with the car park
regulations, the motorist accepts that they are liable to pay a
Parking Charge and that their name and address will be requested
from the DVLA. Parking charge Information: A reduction of the
Parking Charge is available for a period, as detailed in the Parking
Charge Notice. The reduced amount payable will not exceed £75,
and the overall amount will not exceed £150 prior to any court
action, after which additional costs will be incurred.
Page 60
This car park is private property.”
124. ParkingEye operated the arrangements at the Chelmsford car park under a
“Supply Agreement for Car Park Management” made with BAPF on 25 August
2011. ParkingEye guarantees BAPF an undisclosed minimum weekly amount for
the privilege, for which it appears, in practice, to have been paying BAPF about
£1,000 per week. Neither BAPF nor ParkingEye makes any charge for parking by
motorists who comply with the two-hour maximum stay and other regulations. So
ParkingEye’s only income is from those required to pay the £85 (or reduced) charge.
ParkingEye operates a number of other car parks on a similar basis. Its annual
accounts for the year ended 31 August 2013 show an operating profit of over £1.6m,
and a net profit after tax of about £1m, on a turnover of over £14m.
125. Parking at the site is monitored by ParkingEye by automatic number plate
recognition cameras to monitor the entry into and departure of vehicles from the car
park. The cameras showed Mr Beavis’s vehicle driving into the car park at 14.29
pm on 15 April 2013 and leaving at 17.26 pm, a stay of two hours and 56 minutes.
Mr Beavis admits having been the driver. ParkingEye obtained the vehicle’s
registered keeper’s details from the DVLA, and sent a First Parking Charge Notice
which included statements to the effect that the parking charge of £85 was payable
within 28 days of the date of the notice, but would be discounted to £50 if paid
within 14 days, and that there was an appeals procedure (which did not however
include any power to grant discretionary relief). Mr Beavis did not pay or appeal,
and the present proceedings were begun against him.
The issues
126. This section of the judgment concerns the doctrine of penalties. I deal later
with the issues arising under the Unfair Terms in Consumer Contracts Regulations
1999: see paras 200-213 below. Miss Joanna Smith QC for Cavendish invites the
Supreme Court to undertake a fundamental review of the law regarding penalties. In
her submission it is outdated, incoherent and unnecessary, and should be abolished.
Alternatively, it should have no place in relation to “commercial” contracts, by
which I understand her to mean contracts at arm’s length between equally balanced
parties, like Cavendish and Mr El Makdessi. In the further alternative, she submits
that it is or should be held to be inapplicable to any clauses other than those requiring
payment of money on breach, and/or to clauses not aimed at compensating for the
breach, but for which some other valid commercial reason exists.
127. Mr Bloch QC for Mr El Makdessi resists these submissions. In his
submission, the doctrine fulfils a tried and well-established role, there is no impetus,
let alone one based on any research or review, for its abolition or restriction and it
Page 61
is, on principle and authority, applicable to the types of clause in issue in this case.
He submits that the law governing penalties enables and requires account to be taken
of the interests intended to be protected by the relevant clause – a proposition that
Miss Smith was in reply at first inclined to dispute, but after questioning and
reflection later herself endorsed. But protection of such interests is, in Mr Bloch’s
submission, subject to the over-riding control that it must not be extravagant,
oppressive or manifestly excessive. In his submission the present clauses are
precisely that, since their effect is in the case of clause 5.1 to deprive Mr El Makdessi
of part of the agreed consideration, and to do so in a way which bears no resemblance
to any loss which his breach may have caused Cavendish or the Group. On the
contrary, the smaller the loss it has caused, the larger the penalty effect, and vice
versa. As to clause 5.6, its effect is to give Cavendish a right on any default by Mr
El Makdessi to force him to part with his remaining shareholding, at a price likely
to be well below its actual value, again in circumstances where the difference in
value in no way reflects any loss which the default may have caused Cavendish or
the Group, and where the smaller the loss caused to the Group, the larger the
difference in value of which Mr El Makdessi is deprived.
128. Mr John de Waal QC for Mr Beavis, and Mr Christopher Butcher QC for the
Consumers’ Association, interveners, submit that there is a dichotomy between a
genuine pre-estimate and a deterrent clause, that the focus must be on the particular
contractual relationship in issue, and general commercial or other considerations
cannot detract from that focus or justify what would otherwise amount to a penalty.
Mr Jonathan Kirk QC for ParkingEye does not challenge the existing law of
penalties, but, like Miss Smith, submits that it is inapplicable to clauses not aimed
at compensating for the breach, but for which some other valid (not necessarily
commercial) reason exists. That, he submits, is the present case.
129. The law of penalties in this jurisdiction currently applies to contractual
clauses operating on a breach of contract by the other party to the contract: see the
statements to that effect by Lord Roskill in Export Credits Guarantee Department v
Universal Oil Products Co [1983] 1 WLR 399 at pp 402H and 404C (although the
facts of that case were quite special). This limitation has on occasion been seen as a
weakness or even as an indication of inherent fragility in the doctrine’s
underpinning. The High Court of Australia has quite recently addressed this aspect
head-on, holding that breach is not an essential aspect of the doctrine; the essential
question is whether the contract imposes a restriction from doing the particular act,
reserving a payment if it is done, or whether it confers a right to do the act in return
for payment of an equivalent: Andrews v Australia and New Zealand Banking Group
Ltd [2012] HCA 30, 247 CLR 205, Paciocco v Australia and New Zealand Banking
Group Ltd [2015] FCAFC 50, para 95.
130. The present appeals do not raise for consideration whether there should be
any such extension of the doctrine, but rather whether it should be abolished or
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restricted, in English law. For my part, if the doctrine survives in English law, I do
not see the distinction between situations of breach and non-breach as being without
rational or logical underpinning. It is true that clever drafting may create apparent
incongruities in particular cases. But in most cases parties know and reflect in their
contracts a real distinction, legal and psychological, between what, on the one hand,
a party can permissibly do and what, on the other hand, constitutes a breach and may
attract a liability to damages for – or even to an injunction to restrain – the breach. In
Mr Beavis’s appeal, Mr de Waal also suggested that ParkingEye could have
economic reasons for formulating the liability to pay £85 (or a reduced £50) as a
liability for breach, rather than as a consideration payable for parking for longer than
two hours. As a consideration, he suggested, it would have attracted VAT and
ParkingEye could furthermore have incurred liability for rates as a person in
beneficial occupation of the car park.
The concept of a penalty
131. The doctrine of penalties is commonly expressed as involving a dichotomy
between compensatory and deterrent clauses. In Robophone Facilities Ltd v Blank
[1966] 1 WLR 1428, 1446H-1447A, Diplock LJ even expressed the doctrine in
terms of a rule of public policy that did not “permit a party to a contract to recover
in an action a sum greater than the measure of damages to which he would be entitled
at common law”. All three of the early 20th century decisions of highest jurisdictions
which together constitute the origin of the modern doctrine contain dicta suggestive
of a mutually exclusive dichotomy. But all three show that there is no requirement
that the measure of damages at common law should be ascertainable – indeed that
an inability to ascertain this can justify an agreement to pay a fixed sum on breach.
In this connection, they point to a broad understanding of the interests which can
justify such an agreement. All three decisions must also be read in context, which
involved interests different from those relevant on the present appeals.
132. In the first decision, the Scottish appeal of Clydebank Engineering and
Shipbuilding Co v Don Jose Ramos Yzquierdo y Castaneda [1905] AC 6, the House
was concerned with an expressed “penalty” of £500 per week for late delivery of
four torpedo boats to the Spanish Government. The Earl of Halsbury LC
distinguished at p 10 between an agreed sum for damages and a penalty to be held
over the other party in terrorem and Lord Davey at p 15 between a clause providing
for liquidate damages or for a punishment irrespective of the damage caused. But
the Earl of Halsbury went on to stress how “extremely complex, difficult, and
expensive” any proof of damages would have been, how it would involve “before
one’s mind the whole administration of the Spanish Navy” and how “absolutely idle
and impossible [it would be] to enter into a question of that sort unless you had some
kind of agreement between the parties as to what was the real measure of damages
which ought to be applied” (pp 11-12). He also rejected out of hand submissions
that a warship has no value at all, and that, had the torpedo boats been delivered on
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time, they would have been sunk, like much else of the Spanish fleet, in the SpanishAmerican war (of 1898, after the United States intervened in support of Cuban
independence).
133. Lord Davey and Lord Robertson indicated that they saw the ultimate question
as being whether the shipbuilders had shown that the clause was exorbitant,
extravagant or unconscionable to the point where it could not be regarded as
commensurate with the interest protected: see pp 16 and 20. Lord Robertson
encapsulated his view of the issue as follows:
“The question remains, had the respondents no interest to
protect by that clause, or was that interest palpably
incommensurate with the sums agreed on? It seems to me that
to put this question, in the present instance, is to answer it.
Unless injury to a state is as matter of law inexpressible in
money, Spain was or might be deeply interested in the early
delivery of these ships and deeply injured by delay.
To my thinking, Lord Moncreiff has, in two sentences,
admirably stated the case: ‘The subject-matter of the contracts,
and the purposes for which the torpedo-boat destroyers were
required, make it extremely improbable that the Spanish
Government ever intended or would have agreed that there
should be inquiry into, and detailed proof of, damage resulting
from delay in delivery. The loss sustained by a belligerent, or
an intending belligerent, owing to a contractor’s failure to
furnish timeously warships or munitions of war, does not admit
of precise proof or calculation; and it would be preposterous to
expect that conflicting evidence of naval or military experts
should be taken as to the probable effect on the suppression of
the rebellion in Cuba or on the war with America of the
defenders’ delay in completing and delivering those torpedoboat destroyers.’”
At p 19, Lord Robertson also described a penalty as a sum “merely stipulated in
terrorem [which] could not possibly have formed … a genuine pre-estimate of the
creditor’s probable or possible interest in the due performance of the principal
obligation”.
134. Lord Robertson’s last words were quoted by the Judicial Committee of the
Privy Council (which included the Lord Chancellor, Lord Davy and Lord Dunedin)
in the second decision, Public Works Comr v Hills [1906] AC 368, 375-376. The
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Board’s advice was that the clause in that case was a penalty. The clause, contained
in one railway construction contract, provided for the forfeiture, on non-completion
of the railway within the stipulated time, of whatever retention moneys were held as
a result of two separate railway construction contracts together with a further
£10,000. The “determining factor” was in the Board’s advice that the sum was not
a “definite sum, but is liable to great fluctuation in amount dependent on events not
connected with the fulfilment of this contract” (p 376).
135. The third decision is the English appeal in Dunlop Pneumatic Tyre Co Ltd v
New Garage and Motor Co Ltd [1915] AC 79. Under Dunlop’s standard terms,
distributors undertook not to sell or offer the goods to any private customers or to
any co-operative society at less than Dunlop’s current list prices, not to sell to
persons whose supplies Dunlop had decided to suspend, and not to exhibit or export
without Dunlop’s consent. The terms stipulated for payment of £5 for every tyre,
cover, or tube sold or offered in breach of such undertakings. Dunlop’s unchallenged
evidence was price cutting would indirectly damage their business as a whole (p 88).
On this basis the House held that the stipulation was not a penalty.
136. Lord Dunedin said:
“But though damage as a whole from such a practice would be
certain, yet damage from any one sale would be impossible to
forecast. It is just, therefore, one of those cases where it seems
quite reasonable for parties to contract that they should estimate
that damage at a certain figure, and provided that figure is not
extravagant there would seem no reason to suspect that it is not
truly a bargain to assess damages, but rather a penalty to be
held in terrorem.”
137. Lord Atkinson spelled the point out at pp 91-93 (italics added):
“In the sense of direct and immediate loss the appellants lose
nothing by such a sale. It is the agent or dealer who loses by
selling at a price less than that at which he buys, but the
appellants have to look at their trade in globo, and to prevent
the setting up, in reference to all their goods anywhere and
everywhere, a system of injurious undercutting. The object of
the appellants in making this agreement, if the substance and
reality of the thing and the real nature of the transaction be
looked at, would appear to be a single one, namely, to prevent
the disorganization of their trading system and the consequent
injury to their trade in many directions. The means of effecting
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this is by keeping up their price to the public to the level of their
price list, this last being secured by contracting that a sum of 5l
shall be paid for every one of the three classes of articles named
sold or offered for sale at prices below those named on the list.
The very fact that this sum is to be paid if a tyre cover or tube
be merely offered for sale, though not sold, shows that it was
the consequential injury to their trade due to undercutting that
they had in view. They had an obvious interest to prevent this
undercutting, and on the evidence it would appear to me
impossible to say that that interest was incommensurate with
the sum agreed to be paid.
Their object is akin in some respects to that which a trader has
in binding a former employee not to set up, or carry on, a rival
business within a certain area. The trader’s object is to prevent
competition, and especially to prevent his old customers whom
the employee knows from being enticed away from him. If one
takes for example the case of a plumber, the carrying on of the
trade of a plumber may mean anything from mending gas pipes
for a few pence apiece up to doing all the plumbing work of a
big hotel. If the employee should mend one hundred of such
pipes for twenty old customers at 6d apiece, for which the
employer would charge 1s apiece, could it possibly be
contended that the trader’s loss was only one hundred
sixpences, 21 10s? It is, I think, quite misleading to concentrate
one’s attention upon the particular act or acts by which, in such
cases as this, the rivalry in trade is set up, and the repute
acquired by the former employee that he works cheaper and
charges less than his old master, and to lose sight of the risk to
the latter that old customers, once tempted to leave him, may
never return to deal with him, or that business that might
otherwise have come to him may be captured by his rival. The
consequential injuries to the trader’s business arising from each
breach by the employee of his covenant cannot be measured by
the direct loss in a monetary point of view on the particular
transaction constituting the breach. An old customer may be as
effectively enticed away from him through the medium of a 10s
job done at a cheap rate as by a 50l job done at a cheap rate, or
a reputation for cheap workmanship may be acquired possibly
as effectively in one case as in the other.”
138. Lord Parker was to like effect. After concluding that the damage likely to
accrue from the breach of every stipulation to which the clause applied was the same
in kind, he said (p 99):
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“Such damage will in every case consist in the disturbance or
derangement of the system of distribution by means of which
the appellants’ goods reach the ultimate consumer.”
139. Lord Dunedin’s is the first and most cited speech in Dunlop. But Miss Smith
is right to emphasise the importance of the other speeches. The second of four main
propositions which Lord Dunedin thought deducible from authoritative decisions
was that:
“2. The essence of a penalty is a payment of money stipulated
as in terrorem of the offending party; the essence of liquidated
damages is a genuine covenanted pre-estimate of damage
(Clydebank Engineering and Shipbuilding Co v Don Jose
Ramos Yzquierdo y Castaneda [1905] AC 6).”
140. Later authority has found the phrase in terrorem to be unhelpful. Lord
Radcliffe commented in Campbell Discount Co Ltd v Bridge [1962] AC 600, 622:
“I do not find that that description adds anything of substance
to the idea conveyed by the word ‘penalty’ itself, and it
obscures the fact that penalties may quite readily be undertaken
by parties who are not in the least terrorised by the prospect of
having to pay them …”
141. Lord Radcliffe’s comment has been quoted with approval in the Court of
Appeal in Cine Bes Filmcilik ve Yapimcilik v United International Pictures [2004]
1 CLC 401 and again in Murray v Leisureplay plc [2005] EWCA Civ 963, [2005]
IRLR 946, paras 47 and 109, per Arden LJ and Buxton LJ. In Cine Bes, para 13, I
regarded as a “more accessible paraphrase of the concept of penalty” that adopted
by Colman J in Lordsvale Finance plc v Bank of Zambia [1996] QB 752, 762G.
Colman J there said that the Dunlop Pneumatic Tyre case showed that:
“whether a provision is to be treated as a penalty is a matter of
construction to be resolved by asking whether at the time the
contract was entered into the predominant contractual function
of the provision was to deter a party from breaking the contract
or to compensate the innocent party for breach. That the
contractual function is deterrent rather than compensatory can
be deduced by comparing the amount that would be payable on
breach with the loss that might be sustained if breach
occurred.”
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142. Lord Dunedin’s first and third propositions were that, while the language
used may be a prima facie indication as to whether a sum stipulated is a penalty, it
is not conclusive; the question is one of “construction” to be decided “upon the terms
and inherent circumstances of each particular contract, judged of as at the time of
[its] making”. His fourth proposition had four sub-heads, identifying various tests
which have been suggested to assist this task of construction and which “may prove
helpful, or even conclusive”. Briefly summarised, the tests were:
a. A sum is a penalty if “extravagant and unconscionable in amount in
comparison with the greatest loss that could conceivably be proved to have
followed from the breach”.
b. If the breach consists only in not paying a sum of money, a sum
stipulated as payable on the breach greater than any that ought to have been
paid will be a penalty.
c. There is a presumption (but no more) that it is penalty when “a single
lump sum is made payable by way of compensation, on the occurrence of one
or more or all of several events, some of which may occasion serious and
others but trifling damage”.
d. On the other hand, it is “no obstacle to the sum stipulated being a
genuine pre-estimate of damage, that the consequences of the breach are such
as to make precise pre-estimation almost an impossibility. On the contrary,
that is just the situation when it is probable that pre-estimated damage was
the true bargain between the parties (Clydebank Case, Lord Halsbury, at p
11)”.
143. It is clear from these three decisions that a concern can protect a system which
it operates across its whole business by imposing an undertaking on all its
counterparties to respect the system, coupled with a provision requiring payment of
an agreed sum in the event of any breach of such undertaking. The impossibility of
measuring loss from any particular breach is a reason for upholding, not for striking
down, such a provision. The qualification and safeguard is that the agreed sum must
not have been extravagant, unconscionable or incommensurate with any possible
interest in the maintenance of the system, this being for the party in breach to show.
144. In 1986 the High Court of Australia thought, when examining recent English
authority, that the underlying test of extravagance, exorbitance or unconscionability
to be derived from the Clydebank Engineering and Dunlop cases had been eroded
by decisions in which the focus had been more narrowly on a comparison between
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the agreed sum and any possible loss which could be awarded for the breach of
contract in question: AMEV-UDC Finance Ltd v Austin [1986] HCA 63, 162 CLR
170, 190. It advocated a return to the original concept. This was taken up by the
Privy Council in Philips Hong Kong Ltd v Attorney General of Hong Kong (1993)
61 BLR 41, where Lord Woolf emphasised the interest that parties have in being
able to know with a reasonable degree of certainty the extent of their liability and
the risks that they run (p 54). But both these cases accept a basic dichotomy between
penal and compensatory provisions.
145. More recent authority suggests that this dichotomy may not be exclusive and
that there may be clauses which operate on breach and which are commercially
justifiable although they fall into neither category. In short, commercial interests
may justify the imposition upon a breach of contract of a financial burden which
cannot either be related directly to loss caused by the breach or justified by reference
to the impossibility of assessing such loss.
146. In Lordsvale Finance Colman J was concerned with a loan agreement
providing that the rate of interest would increase prospectively from the time of
default in payment. He noted, at pp 763-764 (italics added):
“… the borrower in default is not the same credit risk as the
prospective borrower with whom the loan agreement was first
negotiated. Merely for the pre-existing rate of interest to
continue to accrue on the outstanding amount of the debt would
not reflect the fact that the borrower no longer has a clean
record. Given that money is more expensive for a less good
credit risk than for a good credit risk, there would in principle
seem to be no reason to deduce that a small rateable increase in
interest charged prospectively upon default would have the
dominant purpose of deterring default. That is not because
there is in any real sense a genuine pre-estimate of loss, but
because there is a good commercial reason for deducing that
deterrence of breach is not the dominant contractual purpose
of the term.
It is perfectly true that for upwards of a century the courts have
been at pains to define penalties by means of distinguishing
them for liquidated damages clauses. The question that has
always had to be addressed is therefore whether the alleged
penalty clause can pass muster as a genuine pre-estimate of
loss. That is because the payment of liquidated damages is the
most prevalent purpose for which an additional payment on
breach might be required under a contract. However, the
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jurisdiction in relation to penalty clauses is concerned not
primarily with the enforcement of inoffensive liquidated
damages clauses but rather with protection against the effect of
penalty clauses. There would therefore seem to be no reason in
principle why a contractual provision the effect of which was
to increase the consideration payable under an executory
contract upon the happening of a default should be struck down
as a penalty if the increase could in the circumstances be
explained as commercially justifiable, provided always that its
dominant purpose was not to deter the other party from
breach.”
147. In a whole series of cases across the world, courts have taken their cue from
Lordsvale and held that provisions in loan agreements for uplifting the interest rate
for the future after a default should not be regarded as penalties, save where the
uplift is evidently extravagant: see eg Hong Leuong Finance Ltd v Tan Gin Huay
[1999] 2 SLR 153, Beil v Mansell (No 2) (2006) 2 Qd R 499, PSAL Ltd v KellasSharpe [2012] QSC 31, Elberg v Fraval [2012] VSC 342, Place Concorde East Ltd
Partnership v Shelter Corp of Canada Ltd (2003) 43 BLR (3d) 54 and In re
Mandarin Container [2004] 3 HKLRD 554.
148. The rationale of these cases is that the default bears on the credit risk (and, as
Beil v Mansell identifies, may also bear on the cost of administering the loan). The
uplift is conditioned on the breach, but the breach reflects directly upon the
continuing appropriateness of the originally agreed interest terms. In substance, the
uplift amounts to a variation of the original terms. If on the other hand, it is evident
from the size of the uplift that it is in its nature a punishment for or deterrent to
breach, rather than an ordinary commercial re-rating to reflect a change in risk (or
administration cost), then it will still be disallowed as a penalty – as the actual
decisions in Hong Leuong, Beil v Mansell and Elberg v Fraval illustrate.
149. In Cine Bes the Court of Appeal was concerned, inter alia, with an agreement
settling litigation and granting a new licence on terms that, if the new licence was
subsequently terminated for breach by the licensee, the licensor would be entitled,
inter alia, to recover the costs incurred in the litigation. The court held that this was
not penal. It was an “understandable and reasonable commercial condition upon
which [the licensor] was prepared to dispose of the prior litigation and to enter into
the fresh licence” (para 33). If that licence had to be terminated for breach, there
was, in short, no reason why the settlement terms should not be revisited. In the
course of my judgment, I said (para 15):
“I have also found valuable Colman J’s further observation[s]
in Lordsvale at pp 763g-764a, which indicate that a dichotomy
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between a genuine pre-estimate of damages and a penalty does
not necessarily cover all the possibilities. There are clauses
which may operate on breach, but which fall into neither
category, and they may be commercially perfectly justifiable.”
150. In Murray v Leisureplay plc [2005] EWCA Civ 963, [2005] IRLR 946, a later
Court of Appeal (Arden, Clarke and Buxton LJJ) agreed with the approach taken in
Lordsvale and Cine Bes, with Clarke and Buxton LJJ stressing the importance of the
commercial context, even in cases where there would be no difficulty about
assessing damages (at respectively paras 105 and 118). The case concerned a clause
in a chief executive’s employment contract entitling him to payment of a year’s
gross salary in the event of wrongful termination of his employment without a year’s
notice.
151. The dicta in para 15 in Cine Bes were considered recently by the Federal
Court of Australia in Paciocco v Australia and New Zealand Banking Group Ltd
[2015] FCAFC 50, at para 99. The case concerned fees charged by banks for late
payment, for honour and over-limit payments and for non-payments. Allsop CJ
thought that any difficulties about accepting a dichotomy could be avoided by a
different analysis, which he expressed at para 103 as follows:
“The object and purpose of the doctrine of penalties is
vindicated if one considers whether the agreed sum is
commensurate with the interest protected by the bargain:
Andrews (HC) at para 75; Dunlop at pp 91-93; Clydebank at pp
15-17, 19 and 20; Public Works Comr v Hills at pp 375-376.
This is not to say that the inquiry is unconnected with
recoverable damages, but the question of extravagance and
unconscionability by reference, as Lord Dunedin said in
Dunlop, to the greatest loss that could conceivably be proved
to have followed from the breach, is to be understood as
reflecting the obligee’s interest in the due performance of the
obligation: Public Works Comr v Hills at pp 375-376. One only
needs to reflect on the facts of Dunlop and the justification for
the payment that was found to be legitimate to appreciate these
matters.”
152. In my opinion, the development of the law indicated by the authorities
discussed in paras 145 to 151 above is a sound one. It is most easily explained on
the basis that the dichotomy between the compensatory and the penal is not
exclusive. There may be interests beyond the compensatory which justify the
imposition on a party in breach of an additional financial burden. The maintenance
of a system of trade, which only functions if all trading partners adhere to it
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(Dunlop), may itself be viewed in this light; so can terms of settlement which
provide on default for payment of costs which a party was prepared to forego if the
settlement was honoured (Cine Bes); likewise, also the revision of financial terms to
match circumstances disclosed or brought about by a breach (Lordsvale and other
cases). What is necessary in each case is to consider, first, whether any (and if so
what) legitimate business interest is served and protected by the clause, and, second,
whether, assuming such an interest to exist, the provision made for the interest is
nevertheless in the circumstances extravagant, exorbitant or unconscionable. In
judging what is extravagant, exorbitant or unconscionable, I consider (despite
contrary expressions of view) that the extent to which the parties were negotiating
at arm’s length on the basis of legal advice and had every opportunity to appreciate
what they were agreeing must at least be a relevant factor.
153. The Federal Court of Australia in Paciocco (para 151 above) preferred to
maintain the dichotomy between the penal and compensatory, while at the same time
focusing on the “interest protected by the bargain” or the “interest in the due
performance of the obligation” and on whether the sum stipulated as payable on
breach is commensurate with, or extravagant or unconscionable by reference to, that
interest. Provided that “interest” protected or “in due performance” is understood
widely enough to cover an interest in renegotiating the original contractual bargain
in the light of the situation after or revealed by the breach, that formulation would
appear to lead to the same result as reached in the cases discussed in paras 145 to
151.
Can the penalty doctrine apply to clauses withholding payments?
154. In the cases so far discussed, the provision in issue required payment of
money. A number of authorities have considered whether and how far the doctrine
extends beyond provisions for payment of money. First, the penalty doctrine has
been applied to provisions not requiring the payment of money by, but authorising
the withholding of moneys otherwise due to, the party in breach. Although the point
was apparently conceded (p 693H), several members of the House accepted this in
Gilbert-Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd [1974] AC 689. The
clause there provided that, in the event that a sub-contractor failed “to comply with
any of the provisions of this sub-contract”, the contractor might “suspend or
withhold payment of any moneys due”. Lord Reid said (p 698C-F) that, read
literally, this would entitle the contractor to withhold sums far in excess of any fair
estimate of the value of his claims and was an unenforceable penalty, and Lord
Morris, Viscount Dilhorne and Lord Salmon spoke to similar effect (pp 703G, 711D
and 723H). Hunter J adopted and applied their statements in Hong Kong in the
building contract case of Hsin Chong Construction Co Ltd v Hong Kong and
Kowloon Wharf and Godown Co Ltd [1984] HKCFI 212, paras 22-23.
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155. In Firma C-Trade SA v Newcastle Protection and Indemnity Association (The
“Fanti” and The “Padre Island”) (No 2) [1989] 1 Lloyd’s Rep 239, the majority
(O’Connor and Stuart-Smith LJJ; Bingham LJ dissenting) would have held that, if
(contrary to their holding) the mutual association’s membership rules had provided
for retrospective cesser of cover on non-payment of a release call, they would have
involved an unenforceable penalty. Bingham LJ’s reasoning does not rest
unequivocally on a view that a withholding clause cannot constitute a penalty. He
invoked considerations special to membership of a mutual insurer, namely that any
loss of cover was for a period in respect of which the member was failing to pay the
premium, so casting the burden of indemnity on other members (p 254). While he
also relied on Daff v Midland Colliery Owners’ Mutual Indemnity Co Ltd (1913)
109 LT 418, the question whether a similar clause could, if retroactive, be invalid as
a penalty was not apparently addressed by anyone in that case, and it can in those
circumstances hardly suggest that the deliberate statements in Gilbert-Ash were per
incuriam.
156. In Public Works Comr v Hills the Privy Council applied the penalty doctrine
to a clause forfeiting, on a termination for non-completion of works, sums lodged
by a contractor with the Cape Agent-General as security for its performance and for
release back to it in three stages as it progressed the works. Since the sums were
only lodged by way of security and were to be returned if the works progressed, the
contractor could be seen to have a continuing interest in them, which the clause
forfeited. More recently in Workers Trust & Merchant Bank Ltd v Dojap Investments
Ltd [1993] AC 573, the Privy Council treated Public Works Comr v Hills as authority
that the doctrine applies to the forfeiture of a deposit exceeding the sum of 10% of
the contract price customarily paid in respect of the sale of land. It left open the
unresolved question discussed in Stockloser v Johnson [1954] 1 QB 476, whether
the doctrine applies, or the court has any other equitable power, to address a situation
where a party is given possession of property on terms that he will pay for property
by instalments, in default of which he will forfeit any interest in the property and the
instalments already paid. However, still more recently, Eder J in Cadogan
Petroleum Holdings Ltd v Global Process Systems LLC [2013] 2 Lloyd’s Rep 26
held the doctrine inapplicable to forfeiture of prepayments made towards the
acquisition of property in the form of two gas plants. The contract provided for a
series of such pre-payments, not all of which GPS completed making. It never
therefore acquired the gas plants, and Cadogan relied on a contractual clause
forfeiting all pre-payments which GPS had made. It appears that there may be Scots
authority to like effect: see Zemhunt (Holdings) Ltd v Control Securities [1991] Scot
CS CSIH 6, 1992 SC 58, 1992 SCLR 151, although that case itself only concerned
a 10% deposit.
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Can the penalty doctrine apply to transfers of money’s worth?
157. Second, the doctrine has been applied to provisions requiring the transfer,
upon a breach, of money “or money’s worth” in the form of property belonging to
the party in breach. In Watson v Noble (1885) 13 R 347, a ship owner sold seven
shares in a trawler to its master for £100, and agreed to hold them on trust for him,
but only for so long as he fulfil obligations as skipper which included being sober
and attentive to his duties. The master was later dismissed for alleged drunkenness,
the owner refused to transfer the shares and the master sued to recover their price.
The master succeeded on the basis that the provision for forfeiture of the shares was
an unenforceable penalty. In Jobson v Johnson [1989] 1 WLR 1026 the English
Court of Appeal reached the same conclusion, where shares in Southend United
Football Club were transferred with part of the price payable by deferred instalments
and the contract provided for their retransfer in the event of a failure to pay any
instalment for a sum equivalent only to the first instalment, however many and
whatever the value of the instalments in fact paid. Evans LJ also accepted the
application of the penalty doctrine to transfers of property in Else (1982) Ltd v
Parkland Holdings Ltd [1994] 1 BCLC 130, 138e-f.
158. There is substantial Australian authority in the same sense. In Bysouth v Shire
of Blackburn and Mitcham (No 2) [1928] VLR 562, Irvine CJ held at pp 574-575
with Mann and Lowe JJ agreeing at p 579 that a provision for forfeiture by the
council of its contractors’ property in and upon the works in the event of breach was
penal. In Forestry Commission of New South Wales v Stefanetto (1976) 133 CLR
507, Mason and Jacobs JJ took the same view in the High Court. In Wollondilly
Shire Council v Picton Power Lines Pty Ltd (1994) 33 NSWLR 551, 555G, the
doctrine was applied to a provision requiring the defaulting contractor to sell back
property to the council at its original sale price, with Handley JA observing that,
since equity looks to substance not form, the doctrine must apply to the transfer of
money’s worth as well as money. In Ringrow Pty Ltd v BP Australia Pty Ltd (2005)
224 CLR 656, the High Court of Australia cited Jobson v Johnson for the same
proposition in relation to a clause requiring a petrol station to be sold back to BP at
a price excluding goodwill. The argument failed on the facts, because of expert
evidence, which the trial judge accepted, that in the context of this particular station
there was no monetary value attaching to any goodwill. Finally, the High Court in
Andrews again cited Jobson v Johnson for the proposition that the doctrine applied
to the transfer of property.
159. In Else (para 157 above), the Court of Appeal was however concerned with
a contract under which the seller retained the shares agreed to be sold in Sheffield
United Football Club and the terms of which permitted the seller to retain half of
any instalments already paid in the event that the contract was terminated for failure
to pay any instalment. The court, distinguishing Jobson v Johnson as a case where
property in the shares had passed, refused to extend the penalty doctrine to cover the
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situation before it. There would have been discretion to relieve against forfeiture in
equity, but this too was refused on the ground that it was not unconscionable in the
circumstances for the seller to insist on the strict terms: the purchaser had under the
contract in fact already enjoyed two years as club chairman and the agreement was
itself a compromise to avoid argument whether the terms of the agreement which it
replaced constituted a penalty.
The relationship between the penalty doctrine and relief against forfeiture
160. Jobson v Johnson proceeds on the basis that a case may raise for
consideration both the penalty doctrine and the power of the court to relieve against
forfeiture. In my opinion, that is both logical and correct in principle under the
current law. A penalty clause imposes a sanction for breach which is extravagant to
the point where the court will in no circumstances enforce it according to its terms.
The power to relieve against forfeiture relates to clauses which do not have that
character, but which nonetheless operate on breach to deprive a party of an interest
in a manner which would not be penal. That it would not be penal is evident from
the fact that the court will only grant relief on the basis that the breach is rectified
by performance. “[I]n the ordinary course”, as the Privy Council said in Cukurova
Finance International Ltd v Alfa Telecom Turkey Ltd [2013] UKPC 20, [2015] 2
WLR 875, para 13, “relief in equity will only be granted on the basis of conditions
requiring performance, albeit late, of the contract in accordance with its terms as to
principal, interest and costs: see eg per Lord Parker of Waddington in Kreglinger v
New Patagonia Meat and Cold Storage Co Ltd [1914] AC 25, at pp 49-50 and per
Lord Wilberforce in Shiloh Spinners Ltd v Harding [1973] AC 691, at pp 722C and
723H”. The two doctrines, both originating in equity, therefore operate at different
points and with different effects. Consideration whether a clause is penal occurs
necessarily as a preliminary to considering whether it should be enforced, or whether
relief should be granted against forfeiture.
161. This same inter-relationship between the penalty doctrine and relief against
forfeiture was also assumed in BICC plc v Burndy Corpn [1985] Ch 232, where
Dillon LJ, with whom Ackner LJ agreed, considered first whether the clause was a
penalty, before moving to the issue of relief against forfeiture. The clause was a
provision in an agreement dissolving a joint relationship, whereby certain joint
patent rights would continue to be held by BICC, with Burndy paying its share of
the costs of their maintenance and processing by BICC, and with a clause providing
that, if either party failed to fulfil its obligations in that regard, the party not in default
could require an assignment of the guilty party’s interests in the joint rights. Burndy
failed to meet certain costs due, BICC claimed an assignment of Burndy’s share in
the joint rights, to which Burndy’s first response was that the clause was in the nature
of a penalty, since the value of Burndy’s share would be worth many times more
than the sums unpaid or any actual loss to BICC (pp 236H-237C). The submission
failed on the basis that it was “commercial sense” or a “sensible purpose” that a
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party failing to pay its share of the costs of processing or keeping alive a patent may
be required to give up its interest (pp 246G and 247C), and that the clause was “no
more a penalty clause than is the ordinary power of re-entry in a lease or the ordinary
provision in a patent licence to enable the patentee to determine the licence, however
valuable, in the event of non-payment of royalties” (p 247C-D). The reasoning has
some of the flavour of Bingham LJ’s observations in The Fanti about the mutuality
existing between members of a mutual insurance association. But how far the
analogies on which Dillon LJ relied are reliable in a context of forced transfer of
property is a question for another case. The position regarding re-entry under a lease
has long been regulated by statute, and a contractual licence raises different
considerations to a requirement to transfer a proprietary share in joint rights. Be that
as it may be, the case does not suggest that a forced transfer of property rights can
never attract the operation of the penalty doctrine. It turned on the existence of joint
rights, in the maintenance and processing of which both parties agreed to play their
part.
Should the penalty doctrine be abolished or restricted?
162. This being the current state of authority, I come to Cavendish’s primary and
secondary cases, that the penalty doctrine should be abolished, or, that failing, that
it should be restricted to non-commercial cases or to cases involving payment of
money. I am unable to accept either proposition. As to abolition, there would have
to be shown the strongest reasons for so radical a reversal of jurisprudence which
goes back over a century in its current definition and much longer in its antecedents.
It has long been recognised that the situations in which the doctrine may and may
not apply can involve making distinctions which can appear narrow and which
follow lines which can be difficult to define. But that has never hitherto been
regarded as a reason for abandoning the whole doctrine, which in its core exists to
restrain exorbitant or unconscionable consequences following from breach. In 1966
Diplock LJ, after referring in Robophone to the public policy behind the rule in the
passage which I have already quoted (para 131 above), said that “in these days when
so often one party cannot satisfy his contractual hunger à la carte but only at the
table d’hôte of a standard printed contract, it has certainly not outlived its
usefulness”.
163. In 1975 the Law Commission in its Working Paper No 61, Penalty Clauses
and Forfeiture of Monies Paid, far from suggesting abolition proposed that the
doctrine should be expanded, along lines now accepted in Australia by Andrews, to
cover any situation where the object of the disputed contractual obligation is to
secure the act or result which is the true result of the contract (pp 18-19). In 1999,
the Scottish Law Commission in its Report on Penalty Clauses (Scot Law Com No
171) recommended that there should continue to be judicial control over contractual
penalties, whatever form they take – whether payment of money or forfeiture of
money or transfer or forfeiture of property. It suggested as the criterion for such
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control whether the penalty was “manifestly excessive” in all the circumstances
when the contract was entered into. It further recommended a test of substance for
determining whether a clause was a penalty and an extension along the same lines
as the English Law Commission recommended in 1975. Cavendish’s submission
that this court should abolish or rewrite radically the penalty doctrine is made
without the benefit of the sort of research into the consequences and merits of such
a step, which the Law Commission or Parliament would undertake before venturing
upon it.
164. There is therefore an unpromising background to Cavendish’s submission
that the doctrine should be either abolished or restricted. Further, the Scottish Law
Commission pointed out (para 1.8) that there has been a general convergence of
approaches in European civil codes and soft law proposals towards a recognition of
the utility and desirability of judicial control of disproportionately, excessively,
manifestly or grossly high or unreasonable penalties. The Council of Europe’s
Resolution 78(3) of 20 January 1978 on Penal Clauses in Civil Law (article 7), the
Principles of European Contract Law (article 9:509), the Uncitral Texts on
Liquidated Damages and Penalty Clauses (article 8) and the Unidroit Principles of
International Commercial Contracts (article 7.4.13) all contain provisions for such
control along such lines.
165. I note in parenthesis that many national European legal systems already
appear to contain similar provisions, even if only introduced legislatively as appears
to be the case in France by laws of 9 July 1975 and 11 October 1985 amending
article 1152 of the Code civil (and reversing the effect of the Cour de cassation
decision in Paris frères c Dame Juillard Civ 14 February 1866). Germany in
contrast takes a broad view of the interests which may be protected by a clause
imposing a financial liability on breach (Vertragsstrafe), including among them not
merely compensation, but also deterrence. But in non-business cases, the court has
the power to reduce any penalty to an appropriate level under BGB (the Civil Code),
section 343. However, HGB (the Commercial Code) para 248 exempts contracts
between businessmen from the scope of BGB section 343, although such contracts
appear still to be susceptible to control if they are standard form contracts (not the
case with that between Cavendish and Mr El Makdessi) or in terms so abusive as to
infringe other principles applicable generally, although only in extreme cases, such
as those governing Guten Sitten, Wucher or Treu und Glauben (BGB sections 138
and 242).
166. At the court’s request, Cavendish also included as an appendix to its case a
valuable examination of the law of, and relevant academic commentary from, other
common law countries: Australia, Canada, New York and other United States’ states
and sources, Scotland, New Zealand, Singapore and Hong Kong. It is sufficient to
say that all these countries retain a doctrine broadly on the same lines as the current
English doctrine. In both Australia and Canada, emphasis has been placed on the
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root principles of extravagance, exorbitance or unconscionability, to be found in the
Clydebank Engineering and Dunlop cases: AMEV-UDC Finance Ltd v Austin [1986]
HCA 63, 162 CLR 170 and Elsley v J G Collins Insurance Agencies Ltd [1978] 2
SCR 916 and Waddams, The Law of Damages (Nov 2014), para 8-340. In Australia,
the doctrine has been extended, as I have noted, to cover situations falling short of
breach: Andrews. In both Singapore and Hong Kong, the approach in Philips Hong
Kong has been followed. In Australia, it is established that the penalty doctrine
applies to clauses calling for the transfer of property (para 158 above) as well as to
the withholding of sums due, and there is also Hong Kong authority for the latter
(para 154 above). Waddams, The Law of Contracts, 6th ed (2010), para 461 cites
Jobson v Johnson for the proposition that it applies to clauses requiring transfer of
property at an undervalue in Canada, and there is no suggestion of disagreement on
either of these points in any other common law country. It would be odd, to say the
least, if the United Kingdom separated itself from so general a consensus.
167. It is true that, in a European Union context measures now exist which carry
some of the burden which might previously have been borne by the penalty doctrine:
the Unfair Terms in Consumer Contracts Regulations 1999, giving effect to
Directive 93/13/EEC, and the Consumer Protection from Unfair Trading
Regulations 2008, giving effect to Directive 2005/29/EC. These are confined to
consumer situations, and in the case of the former at present to contract terms which
are not individually negotiated. That limitation has disappeared, with the coming
into force of the Consumer Rights Act 2015 on 1 October 2015 to replace the Unfair
Terms in Consumer Contracts Regulations 1999, the Unfair Contract Terms Act
1977 (in relation to consumer contracts), most of the Sale of Goods Act 1979, and
the Supply of Goods and Services Act 1982 (in relation to consumer contracts). It
would be unsafe to assume that any of these measures makes or will make the
penalty doctrine redundant. The fact that Parliament has not sought to abolish or
amend the doctrine, despite their existence, is just as capable of being invoked in its
favour. In any event, the doctrine protects businesses, including small businesses,
which may well have a need for it.
168. I would reject Miss Smith’s submission that the doctrine should be limited so
as not to apply to “commercial” cases for similar reasons. There is no basis in
authority or principle for such a limitation. It would strike at an existing protection
in an area where the doctrine has been frequently invoked, including in the cases on
exorbitant uplifts of loan interest upon breach of loan agreements. The concept of a
commercial case is also undefined and obscure, in the absence of any applicable
statutory definition.
169. Miss Smith’s further submission that the doctrine should be limited by
confining unconscionability to circumstances of procedural misconduct, involving
duress, undue influence, misrepresentation, or something similar would appear
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effectively to deprive the doctrine of any role at all, and again has no basis in
authority or principle.
170. I am equally unable to accept that the doctrine should be confined to cases of
payment of money. It would be absurd to draw a rigid distinction between a
requirement to transfer money and property. It would also be absurd to draw such a
distinction between them and the withholding of moneys due. Such uncertainties as
may exist regarding the doctrine’s applicability to deposits or to clauses forfeiting
pre-payments must await decision in due course.
Application of the penalty doctrine – Cavendish
171. The relevant trigger to the operation of both clauses 5.1 and 5.6 is the
definition of “Defaulting Shareholder”, to include “a Seller who is in breach of
clause 11.2 hereof”. Clause 11.2 contains various restrictive covenants. It is common
ground (SFI para 20: para 121 above) that the breach of the covenant against
employing or soliciting senior employees could be less than a breach of the
covenants against competitive activity, and that losses from breaches of the covenant
against solicitation could vary, according to the nature, extent, duration and success
of the solicitation. Mr El Makdessi would say “markedly” less and vary “widely”.
172. Two points may be made here. First, the covenants must be seen as a package
designed to protect against activities, all of them aimed at competitive activity and
all of them likely to be conducted in a manner difficult to detect and to be, if
detected, difficult to evaluate with regard to their extent or impact. In this situation,
Lord Atkinson’s words in Dunlop appear to me to have resonance here:
“The object of the appellants in making this agreement, if the
substance and reality of the thing and the real nature of the
transaction be looked at, would appear to be a single one,
namely, to prevent the disorganization of their trading system
and the consequent injury to their trade in many directions.

It is, I think, quite misleading to concentrate one’s attention
upon the particular act or acts by which, in such cases as this,
the rivalry in trade is set up, … The consequential injuries to
the trader’s business arising from each breach by the employee
of his covenant cannot be measured by the direct loss in a
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monetary point of view on the particular transaction
constituting the breach.”
This was said in a context where Dunlop was protecting the whole of its business,
involving many actual and potential transactions with many different purchasers, by
imposing trading restrictions on every purchaser. In the present case, Cavendish is
protecting the whole of the business, of which it was to be majority shareholder,
involving many actual and potential transactions with many different customers, by
imposing a competitive restriction on the sellers from whom it was buying the
majority control. In each case, the focus should be on the overall picture, not on the
individual breaches.
173. Second, so far as it is said, obviously correctly, that breach of clause 11.2(d)
may have consequences different from those of clauses 11.2(a) to (c), the speeches
in Dunlop may be seen as open to different interpretations. On the one hand, the
situation may be argued to fall within Lord Dunedin’s fourth proposition, para (c).
On the other hand, the whole of clause 11.2 may be regarded as doing (in Lord
Atkinson’s further words at p 93) “little, if anything, more than impose a single
obligation” – here refraining from any potentially competitive activity. Lord Parker
exposed the problems in this area to particularly detailed examination at p 98, when
he described the position as
“more complicated when the stipulation, though still a single
stipulation, is capable of being broken more than once, and in
more ways than one, such as a stipulation not to solicit the
customers of a firm. A solicitation which is unsuccessful, can
give rise to only nominal damages, and even if it be successful
the actual damage may vary greatly according to the value of
the custom which is thereby directly or indirectly lost to the
firm. Still, whatever damage there is must be the same in kind
for every possible breach, and the fact that it may vary in
amount for each particular breach has never been held to raise
any presumption or inference that the sum agreed to be paid is
a penalty, at any rate in cases where the parties have referred to
it as agreed or liquidated damages.
The question becomes still more complicated where a single
sum is agreed to be paid on the breach of a number of
stipulations of varying importance. It is said that in such a case
there arises an inference or presumption against the sum in
question being in the nature of agreed damages, even though
the parties have referred to it as such. My Lords, in this respect
I think a distinction should be drawn between cases in which
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the damage likely to accrue from each stipulation is the same
in kind and cases in which the damage likely to accrue varies
in kind with each stipulation. Cases of the former class seem to
me to be completely analogous to those of a single stipulation,
which can be broken in various ways and with varying damage;
but probably it would be difficult for the court to hold that the
parties had pre-estimated the damage if they have referred to
the sum payable as a penalty.
In cases, however, of the latter class, I am inclined to think that
the prima facie presumption or inference is against the parties
having pre-estimated the damage, even though the sum payable
is referred to as agreed or liquidated damages. The damage
likely to accrue from breaches of the various stipulations being
in kind different, a separate pre-estimate in the case of each
stipulation would be necessary, and it would not be very likely
that the same result would be arrived at in respect of each kind
of damage.”
174. Applying this passage, on the assumption that clause 11.2 should be regarded
as containing, in Lord Parker’s words, “a number of stipulations of varying
importance” I would consider that the damage likely to accrue from each such
stipulation was the same in kind – being damage from competitive activity. On that
basis, Lord Parker’s approach would lead to the conclusion that there was no penal
presumption.
175. It is submitted, however, by Mr Bloch that clause 5.1 is penal for a different
reason, because of the size and haphazard nature of its potential impact in forfeiting
entitlement to receive the Interim and/or Final Payments, so far as not yet paid at the
time of its breach. Taking the size of impact, it is common ground that a substantial
part of the purchase price comprised goodwill (SFI, para 16). This is clear from the
terms of the agreement alone (especially clauses 11.1 and 11.7), but is further
confirmed by the evidence of Mr Scott for Cavendish and by the figures alone. The
net assets of the entire Group were, by the terms of the sale and purchase agreement,
warranted by Mr El Makdessi to be US$69.7m as at 31 December 2007. That
indicates that in broad terms around US$33m of the US$65.5m paid to Mr El
Makdessi and Mr Ghoussoub by way of Completion and Second Payments was seen
as attributable to the Group’s net asset value. Their total entitlement was capped
under clause 3.3 at US$147.5m. Deducting the net asset value element of the
Completion and Second Payments, the anticipated goodwill value must have been
up to US$114.5m, of which US$32.5m (about 26%) was covered by the Completion
and Second Payments, meaning that up to US$82m was anticipated to come by way
of the Interim and Final Payments, of which Mr El Makdessi’s 53.88% share would
be some US$44m. On Cavendish’s case, Mr El Makdessi’s breach of clause 11.2
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deprives him of any claim to this or any other goodwill element of the value of his
shares over and above that already covered by the Completion and Second
Payments.
176. Mr Bloch submits that this arrangement self-evidently lacks any rational
connection between the severity of the breach or of its consequences and the impact
of clause 5.1. A partial response to this submission is that there may be a connection
as a result of the timing of the Interim and/or Final Payments. Clause 5.1 will only
result in the loss of either Payment, if the breach occurs before the payment is due.
The Due Date for each such Payment is 30 days after determination of the relevant
OPAT for all financial periods to which the Payment relates. That would normally
mean at some point in the first half of 2010 in the case of the Interim Period, and in
the first half of 2012 in the case of the Final Payment. The later the breach in time,
the less its impact on the Group and the less likely that it would occur in time for
clause 5.1 to bite.
177. That, however, amounts to a very crude link, at best. And it means that clause
5.1 is only capable of operating as any form of protection for Cavendish against
breaches occurring for something over four years from the date of agreement, while
clause 11.2 is capable of continuing and being broken for a much longer period of
years (24 months after the Relevant Date, itself potentially postponed until whenever
Mr El Makdessi exercises the put option provided by clause 15).
178. Further, Mr Bloch can point to a respect in which the mechanism of clause
5.1 is likely to work in a quite opposite direction to any that would be expected: that
is, in inverse ratio to any loss caused to the Group by the breach. The earlier and
greater the breach, the more likely that Mr El Makdessi would be profiting by it at
the expense of the Group, in a way affecting the Group’s OPAT and so reducing the
Interim and Final Payments and the impact of their loss under clause 5.1. In contrast,
a small breach with small consequences for the Group at an early stage would leave
the Group’s OPAT unaffected, and would mean that clause 5.1 had the maximum
possible impact on Mr El Makdessi.
179. Cavendish’s response to such points is in essence that they focus too narrowly
on the consequences of breach. In line with Lord Atkinson’s approach in Dunlop
(paras 142 and 172 above), the focus should be not on any particular possible breach
or its timing or consequences, but on the general interest being protected, and the
question whether the protection which the parties agreed can be condemned as
unconscionable or manifestly excessive. In this connection, Miss Smith submits that
what was in substance agreed was a price formula, which reverted, understandably,
in the event of breach of clause 11.2 to a basis of valuation omitting any further
goodwill element. In this connection, Miss Smith drew attention to the provision in
clause 3.1 stating that the agreed payments were all in consideration of “the sale of
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the Sale Shares and the obligations of the Sellers herein”. However, I do not regard
that as assisting the argument. The same could be said of any obligation triggering
a penalty clause, and one might add that neither the Interim nor the Final Payment
is expressly tied to clause 11.2, although each is expressly made “subject to the
provisions of clause 6”, dealing with “Calculation of OPAT and payment of the
consideration”.
180. Cavendish’s general response nonetheless appears to me to have substantial
force. The essence of what the parties were agreeing was that goodwill was crucial,
and that there could be no further question of paying for any goodwill element of
Mr El Makdessi’s shares if he committed a breach of his non-competitive
obligations under clause 11.2. It is true that, in the circumstances existing for at least
the first 18 months after the agreement, any such breach would be actionable in
damages by Team, with the result that Cavendish’s loss would in theory be made
good and it could itself have had no contractual claim for damages because of the
rule precluding recovery of reflective loss. But after 18 months this would not
necessarily be the case, and even during the 18-month period, it is understandable
that Cavendish should no longer be prepared to pay any further goodwill element,
once competitive activity by Mr El Makdessi had cast a doubt over the current and
future value of the Group’s goodwill. As with a bank loan, so here, on a much larger
scale, it can be said that any such breach could and would change in a fundamental
respect the risk element involved in Cavendish’s purchase of a large block of shares
in the Group.
181. On this basis, the question still remains whether clause 5.1 can and should be
condemned as penal, on the grounds that it is extravagant, exorbitant or
unconscionable in its nature and impact. Not without initial hesitation, and despite
the powerful points made by Mr Bloch, I have come to the conclusion that, in this
particular agreement made deliberately and advisedly between informed and
sophisticated parties, the court should answer this question in the negative, and hold
that clause 5.1 is enforceable. Its effect was to revise the basic price calculation for
the shares which had been agreed to be sold, and, so viewed in the context of a
carefully negotiated agreement between informed and legally advised parties at
arm’s length, I do not consider it can or should be regarded as extravagant,
exorbitant or unconscionable.
182. I turn to clause 5.6. This raises somewhat different considerations. It is a
provision requiring Mr El Makdessi as the party in breach to transfer property in his
remaining shares against his will at a price based on net asset value alone. It is
explained in terms of a desire to sever all interest from someone who has breached
his contract. But it does so, first by imposing on the contract-breaker a forced
deprivation of property which was not otherwise agreed to be sold under the contract
broken, and second by doing this at a price which (unlike clause 5.1 which leaves
the contract-breaker with a substantial element of goodwill value, under the
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Completion and Second Payments) deprives him of the whole of any goodwill value
attaching to such property.
183. I accept that a forced transfer for no consideration or for a consideration
which does not reflect the value of the asset transferred may constitute a penalty
within the scope of the penalty doctrine. But clause 5.6 must be viewed in nature
and impact as a composite whole as well as in context. It operates as an element in
a mechanism provided by clauses 5 and 11.2 for bringing to an end the continuing
relationship between WPP and a defaulting shareholder. Although triggered by
default, it amounts, like clause 5.1, to a reshaping of the parties’ primary
relationship. Had their relationship as common shareholders in the Group continued,
Mr El Makdessi would have continued to be bound by the restrictions contained in
clause 11.2, until 2016 (para 122 above), and would have had the benefit of the put
option contained in clause 15. The Relevant Option Price which Mr El Makdessi
could receive upon his exercise of the Put Option provided by clause 15 would have
been based again on eight times average OPAT over four years (starting with the
year preceding the exercise of the Option) capped at US$75m. As with the price of
the shares which Mr El Makdessi agreed to sell, so with the Option Price, the parties
clearly envisaged that a price calculated on such a basis would exceed by a multiple
a net asset based price. Clause 5.6 would not have made any real sense otherwise.
184. However, once Mr El Makdessi breached clause 11.2, the position changed
radically. It is accepted that, once such a breach occurred, it was in principle
understandable that he should be required to sever any shareholding relationship
completely by selling his remaining shares. But that would at the same time release
him from his restrictive covenants, in view of the definition of the “Relevant Date”,
set out in para 122 above. The Group without the protective benefit of the restrictive
covenants would be vulnerable (potentially for many years during which it could
legitimately have expected to be protected by the covenants) in a way which would
clearly justify revisiting the basis on which any price for the purchase of Mr El
Makdessi’s remaining shareholding was set. What the fortunes of the Group would
be, following premature severance of relations, in circumstances where it was now
open to Mr El Makdessi to compete as much as he wished, would be difficult, if not
impossible, to predict.
185. Again, Mr Bloch submits that the clause is likely to operate in a highly
random manner. A small breach committed at an early stage but of little
consequence for the Group’s OPAT will deprive the Defaulting Shareholder of a
large goodwill value; a large breach committed at an early stage to the Defaulting
Shareholder’s benefit will depress the goodwill value of the Option Shares, and cost
the Defaulting Shareholder less. But the ultimate question is in my view whether
this carefully negotiated clause, attributing a nil value to goodwill on a forced
severance of shareholding relationships triggered by a breach of basic restrictive
covenants, can be regarded as exorbitant or unconscionable, having regard to the
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completely new scenario created by any breach of the restrictive covenants. Once it
is accepted, I think inevitably, that complete severance of relationships was a natural
provision to include as a consequence of any such breach, I do not consider that an
agreement that this should take place on a basis ignoring any goodwill which might
subsist can or should be regarded as being either exorbitant or unconscionable.
186. That makes it unnecessary to consider Mr Bloch’s further submissions that,
if clause 5.6 was a penalty but it was in principle understandable that the parties
should have agreed on severance of their shareholding relationship, Cavendish could
have invited, but has not invited, any offer of the type which Dillon and Nicholls
LJJ in Jobson v Johnson considered that a contract-breaker such as Mr El Makdessi
could be required to make. In the present case, that would (presumably) be an offer
to sell the remaining shares at a fair or market price. That would go further than
anything that Dillon and Nicholls LJJ specifically endorsed in that case. It is
unnecessary to say more about this aspect of the decision in Jobson v Johnson, on
which I would in an appropriate case have wished to hear further and fuller
submissions.
187. It follows that I would allow the appeal in respect of both clauses 5.1 and 5.6.
Application of the penalty doctrine – ParkingEye Limited v Beavis
188. There is common ground between all before the court that the relationship
between ParkingEye and Mr Beavis was a contractual relationship, whereby Mr
Beavis undertook not to park for more two hours and, upon any breach of that
obligation, incurred a liability of £85, reducible, in this case, to £50 if he had paid
within 14 days of ParkingEye’s demand.
189. The Court of Appeal raised a question about this analysis, which the Supreme
Court also took up. But I am satisfied that it is correct in law. The terms of the signs
which Mr Beavis must be taken to have accepted by conduct in entering and parking
in the car park are to that effect. Mr Beavis thereby expressly agreed to stay for two
hours maximum, and to comply with the other parking restrictions, such as parking
within a marked bay and not using a blue badge holder’s bay, and to pay the
stipulated sum if he failed so to comply.
190. It may be suggested that Mr Beavis thereby promised nothing which can in
law constitute valuable consideration. He was being given a licence, on conditions,
and he would have been a trespasser if he overstayed or failed to comply with its
other conditions. But ParkingEye was not in possession of the car park, or capable
of bringing proceedings in trespass. It had a mere right to control parking at the site
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– the right to permit or refuse others to park there on such conditions as it might
stipulate. By promising ParkingEye not to overstay and to comply with its other
conditions, Mr Beavis gave ParkingEye a right, which it would not otherwise have
had, to enforce such conditions against him in contract. Even if no Parking Charge
had been stipulated, enforcement would still have been possible in law, even if a
claim for damages or for an injunction might not in practice have been likely. With
the stipulated Parking Charge, the nature of the intended contract is even clearer,
although the question arises whether the Parking Charge is an unenforceable
penalty. The quid pro quo provided by ParkingEye in return for Mr Beavis’s promise
was the grant of permission to park for up to two hours in its discretion free of
charge, on conditions. Each party thus gave the other valuable consideration.
191. ParkingEye argued that Parliament has, by the Protection of Freedoms Act
2012, effectively recognised the legitimacy of a scheme such as theirs, in a way
precluding or at least militating against any application of the penalty doctrine. The
judge and Court of Appeal (para 28) also found some support in this Act for the
view that charges of this kind are not to be regarded as unenforceable. In my view,
that is a misreading of the Act. The Act merely “makes provision for the recovery
of unpaid parking charges from the keeper or hirer of a vehicle” (section 56), in
circumstances “where (a) the driver of a vehicle is required by virtue of a relevant
obligation to pay parking charges in respect of the parking of the vehicle on relevant
land; and (b) those charges have not been paid in full” (Schedule 4, paragraph 1).
The reference to a relevant “obligation” does not exclude the penalty doctrine. On
the contrary, if a charge stipulated contractually is a penalty, there will be no
obligation.
192. There is nothing in the detailed definitions to affect this straightforward
conclusion. Schedule 4, paragraph 2(1) provides that: “‘parking charge’ – (a) in the
case of a relevant obligation arising under the terms of a relevant contract, means a
sum in the nature of a fee or charge, and (b) in the case of a relevant obligation
arising as a result of a trespass or other tort, means a sum in the nature of damages”.
“Relevant contract” is defined in wide terms including a contract which arises only
on parking and is made either with the owner or occupier of the land or with someone
like ParkingEye authorised by the owner or occupier to enter into a contract
requiring the payment of parking charges: Schedule 4, paragraph 2(1). “Relevant
obligation” means (a) an obligation arising under the terms of a relevant contract or,
(b) where there is no relevant contract, as a result of a trespass or other tort
committed by the parking: Schedule 4, paragraph 2(1). The reference to a “sum in
the nature of damages is to a sum of which adequate notice was given to drivers of
vehicles (when the vehicle was parked …)”: Schedule 4, paragraph 2(2). The
position in tort may one day merit closer examination, since it is not clear to me on
what basis, other than contractual, the driver of a vehicle can incur any obligation to
pay a sum in the nature of damages as a result of a trespass or other tort, however
much notice was given to him or her when the vehicle was parked. If there is such a
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basis, however, I have little doubt that the law would also extend the penalty doctrine
to cover it.
193. The penalty doctrine is therefore potentially applicable to the present scheme.
It is necessary to identify the interests which it serves. They are in my view clear.
Mr Beavis obtained an (admittedly revocable) permission to park and, importantly,
agreement that if and so far as he took advantage of this it would be free of charge.
ParkingEye was able to fulfil its role of providing a traffic management
maximisation scheme for BAPF. The scheme met, so far as appears, BAPF’s aim of
providing its retail park lessees with spaces in which their customers could park. All
three conditions imposed were directed to this aim, and all were on their face
reasonable. (The only comment that one might make, is that, although the signs
made clear that it was a “Customer only car park”, the Parking Charge of £85 did
not apply to this limitation, which might be important in central Chelmsford. The
explanation is, no doubt, that, unlike a barrier operated scheme where exit can be
made conditional upon showing or using a ticket or bill obtained from a local shop,
a camera operated scheme allows no such control.) The scheme gave BAPF through
ParkingEye’s weekly payments some income to cover the costs of providing and
maintaining the car park. Judging by ParkingEye’s accounts, and unless the
Chelmsford car park was out of the ordinary, the scheme also covered ParkingEye’s
costs of operation and gave their shareholders a healthy annual profit.
194. Mr de Waal for Mr Beavis and Mr Butcher for the Consumers’ Association
submit that this is to look at matters too broadly and that the focus should be on the
individual contract. They also submit that it is imbalanced and unfair in its operation
as regards Mr Beavis or any other individual user of the car park. Mr de Waal goes
so far as to suggest that the scheme contains a “concealed pitfall”, since it actually
operates not by reference to length of time spent parking, but by length of time spent
between entry into and exit from the car park. That to my mind is an a-contextual
understanding of the signs. Whether or not ParkingEye’s cameras at the entry and
exit are clearly visible, I do not believe that customers think that individual car
parking spaces are monitored or a period spent driving around such a car park
looking for a space is likely to fall outside the “2 hour max stay” or period of
“Parking limited to 2 hours” specified in the signs.
195. More significantly, Mr de Waal and Mr Butcher observe that the scheme only
works by taking advantage of human fallibility or unforeseen circumstances.
Deliberate overstayers can leave their cars for days and only pay £85 (or the reduced
sum if they pay promptly on demand). That is evidently not a problem or the scheme
would provide for some form of gradated payment. Other shoppers believe that they
will complete their shopping expedition within two hours and intend to do so. The
scheme therefore relies on human (over)optimism, that the relevant shopping
expedition will be over within two hours, or that the shopper will not find him or
herself detained in a queue at the last minute in the last shop. Those who overstay
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do not incur the £85 or reduced liability in any real sense by agreement, but by
misfortune.
196. Mr de Waal and Mr Butcher point out that the sum of £85 or £50 could well
represent a large part of a car driver’s or owner’s weekly income, eg in the case of
a pensioner, and that, even adjacently to Chelmsford Station it is likely well to
exceed any sum that would be payable for parking for say three hours in a car park
charging according to time stayed. They also submit that ParkingEye’s level of
charging compares unfavourably with that authorised under the Civil Enforcement
of Parking Contraventions (England) General Regulations 2007 (SI 2007/3483) and
the Civil Enforcement of Parking Contraventions (Guidelines on Levels of Charges)
(England) Order (SI 2007/3487). These authorise a penalty charge of £50, reducible,
if paid within 21 days, in the case of a contravention detected by an approved device
(such as CCTV) or 14 days in other cases, to £25 for parking in contravention of one
of the statutory or regulatory provisions listed in Schedule 7, paragraph 4 of the
Traffic Management Act 2004. But a scheme relating to the enforcement of parking
and parking charges by public authorities in public places is in no way analogous to
that in issue on this appeal. Further, merely because statute sets a lower level does
not mean that a higher level would not have been reasonable.
197. In judging whether ParkingEye’s parking charges fall foul of the penalty
doctrine, the scheme it operates has to be seen as a whole, bearing in mind all the
interests obviously involved. This follows from what I have said in earlier parts of
this judgment in relation to the penalty doctrine generally and in relation to its
application to clause 5.1 of the agreement in the Cavendish appeal in particular. A
useful starting point is that BAPF might have decided to operate such a scheme
itself. In that case, its interest in providing for its retail lessees’ requirements for
parking for their customers would be both clear and clearly relevant. It does not
cease to be relevant, because BAPF chose to contract out the operation of the scheme
to ParkingEye. The signs disclose that ParkingEye has been engaged as car park
manager to provide a traffic space maximisation scheme. The provision of free
parking for up to two hours is an obvious benefit and attraction for customers and
so also for retail lessees and for BAPF, which has a clear interest in the retail park’s
success.
198. The £85 charge for overstaying is certainly set at a level which no ordinary
customer (as opposed to someone deliberately overstaying for days) would wish to
incur. It has to have, and is intended to have, a deterrent element, as Judge Moloney
QC recognised in his careful judgment (para 7.14). Otherwise, a significant number
of customers could all too easily decide to overstay, limiting the shopping
possibilities of other customers. Turnover of customers is obviously important for a
retail park. A scheme which imposed a much smaller charge for short overstaying
or operated with fine gradations according to the period of overstay would be likely
to be unenforceable and ineffective. It would also not be worth taking customers to
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court for a few pounds. But the scheme is transparent, and the risk which the
customer accepts is clear. The fact that, human nature being what it is, some
customers under-estimate or over-look the time required or taken for shopping, a
break or whatever else they may do, does not make the scheme excessive or
unconscionable. The charge has to be and is set at a level which enables the
managers to recover the costs of operating the scheme. It is here also set at a level
enabling ParkingEye to make a profit. Unless BAPF was itself prepared to pay
ParkingEye, which would have meant, in effect, that it was subsidising customers to
park on its own site, this was inevitable. If BAPF had attempted itself to operate
such a scheme, one may speculate that the charge might even have had to be set at
a higher level to cover its costs without profit, since ParkingEye is evidently a
specialist in the area.
199. In these circumstances, the fact that no individual episode of overstaying, or
of mis-parking, could be said to involve ParkingEye or BAPF in any ascertainable
damage is irrelevant. What matters is that a charge of the order of £85 (reducible on
prompt payment) is an understandable ingredient of a scheme serving legitimate
interests. Customers using the car park agree to the scheme by doing so. The position
was well summed-up by Judge Moloney QC (para 7.16), when he said that:
“although there is a sense in which this contractual parking
charge has the characteristics of a deterrent penalty, it is neither
improper in its purpose nor manifestly excessive in its amount.
It is commercially justifiable, not only from the viewpoints of
the landowner and ParkingEye, but also from that of the great
majority of motorists who enjoy the benefit of free parking at
the site, effectively paid for by the minority of defaulters, who
have been given clear notice of the consequences of
overstaying.”
ParkingEye Limited v Beavis – Unfair Terms in Consumer Contracts Regulations
1999
200. The 1999 Regulations address the problem of unfair terms in contracts
concluded between a seller or supplier and a consumer. They implement Directive
93/13/EEC. By virtue of regulation 3(1) (Interpretation), ParkingEye is a supplier
and Mr Beavis a consumer. Regulation 8(1) provides that “An unfair term in a
contract concluded with a consumer by a seller or supplier shall not be binding on
the consumer”.
201. Regulation 5(1) specifies what is to be understood by an unfair term. It
provides that:
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“A contractual term which has not been individually negotiated
shall be regarded as unfair if, contrary to the requirement of
good faith, it causes a significant imbalance in the parties’
rights and obligations arising under the contract, to the
detriment of the consumer.”
This repeats, exactly, the terms of article 3(1) of the Directive. The terms of the
parking contract made between ParkingEye and Mr Beavis were not of course
individually negotiated.
202. Regulation 6 provides:
“(l) Without prejudice to regulation 12, the unfairness of a
contractual term shall be assessed, taking into account the
nature of the goods or services for which the contract was
concluded and by referring, at the time of conclusion of the
contract, to all the circumstances attending the conclusion of
the contract and to all the other terms of the contract or of
another contract on which it is dependent.
(2) In so far as it is in plain intelligible language, the assessment
of fairness of a term shall not relate –
(a) to the definition of the main subject matter of the
contract, or
(b) to the adequacy of the price or remuneration, as
against the goods or services supplied in exchange.”
This, although subsection (2) is differently worded, gives effect to article 4 of the
Directive. It is not suggested in the present case that the term requiring payment of
£85 (reducible) in the event of non-compliance with ParkingEye’s regulations falls
within either limb of regulation 6(2).
203. Directive 93/13/EEC indicates in its 16th preamble that:
“the assessment, according to the general criteria chosen, of the
unfair character of terms … must be supplemented by a means
of making an overall evaluation of the different interests
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involved; whereas this constitutes the requirement of good
faith; whereas, in making an assessment of good faith,
particular regard shall be had to the strength of the bargaining
positions of the parties, whether the consumer had an
inducement to agree to the term and whether the goods or
services were sold or supplied to the special order of the
consumer; whereas the requirement of good faith may be
satisfied by the seller or supplier where he deals fairly and
equitably with the other party whose legitimate interests he has
to take into account.”
204. The Court of Justice has in Mohamed Aziz v Caixa d’Estalvis de Catalunya,
Tarragona i Manresa (Catalunyacaixa) (Case C-415/11) given guidance as to
article 3(1) of the Directive, holding that:
“Article 3(1) of Directive 93/13 must be interpreted as meaning
that:
– the concept of ‘significant imbalance’ to the
detriment of the consumer must be assessed in the
light of an analysis of the rules of national law
applicable in the absence of any agreement between
the parties, in order to determine whether, and if so
to what extent, the contract places the consumer in a
less favourable legal situation than that provided for
by the national law in force. To that end, an
assessment of the legal situation of that consumer
having regard to the means at his disposal, under
national law, to prevent continued use of unfair
terms, should also be carried out;
– in order to assess whether the imbalance arises
‘contrary to the requirement of good faith’, it must
be determined whether the seller or supplier, dealing
fairly and equitably with the consumer, could
reasonably assume that the consumer would have
agreed to the term concerned in individual contract
negotiations.”
205. Domestically, the position was considered by the House of Lords in Director
General of Fair Trading v First National Bank plc [2002] 1 AC 481 where Lord
Bingham said (para 17) that:
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“The requirement of significant imbalance is met if a term is so
weighted in favour of the supplier as to tilt the parties’ rights
and obligations under the contract significantly in his favour.
This may be by the granting to the supplier of a beneficial
option or discretion or power, or by the imposing on the
consumer of a disadvantageous burden or risk or duty. The
illustrative terms set out in Schedule 3 to the Regulations
provide very good examples of terms which may be regarded
as unfair; whether a given term is or is not to be so regarded
depends on whether it causes a significant imbalance in the
parties’ rights and obligations under the contract. This involves
looking at the contract as a whole. But the imbalance must be
to the detriment of the consumer; … The requirement of good
faith in this context is one of fair and open dealing. Openness
requires that the terms should be expressed fully, clearly and
legibly, containing no concealed pitfalls or traps. Appropriate
prominence should be given to terms which might operate
disadvantageously to the customer. Fair dealing requires that a
supplier should not, whether deliberately or unconsciously,
take advantage of the consumer’s necessity, indigence, lack of
experience, unfamiliarity with the subject matter of the
contract, weak bargaining position or any other factor listed in
or analogous to those listed in Schedule 2 to the Regulations.
Good faith in this context is not an artificial or technical
concept; nor, since Lord Mansfield was its champion, is it a
concept wholly unfamiliar to British lawyers. It looks to good
standards of commercial morality and practice. Regulation 4(1)
lays down a composite test, covering both the making and the
substance of the contract, and must be applied bearing clearly
in mind the objective which the Regulations are designed to
promote.”
206. In the same case, Lord Millett said of regulation 5(1) (para 54):
“There can be no one single test of this. It is obviously useful
to assess the impact of an impugned term on the parties’ rights
and obligations by comparing the effect of the contract with the
term and the effect it would have without it. But the inquiry
cannot stop there. It may also be necessary to consider the
effect of the inclusion of the term on the substance or core of
the transaction; whether if it were drawn to his attention the
consumer would be likely to be surprised by it; whether the
term is a standard term, not merely in similar non-negotiable
consumer contracts, but in commercial contracts freely
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negotiated between parties acting on level terms and at arms’
length; and whether, in such cases, the party adversely affected
by the inclusion of the term or his lawyer might reasonably be
expected to object to its inclusion and press for its deletion. The
list is not necessarily exhaustive; other approaches may
sometimes be more appropriate.”
207. Many of the submissions under the 1999 Regulations overlap as a matter of
fact with submissions already considered in the context of the penalty doctrine. The
legal test is of course different. It is however relevant and necessary in the present
context as in relation to the penalty doctrine to consider “the different interests
involved” (16th recital to the Directive), which brings in all the factors discussed in
paras 193-199 above. Again, reliance is placed on the fact that the charge of £85
(reducible) is incurred by overstaying for the shortest of periods, and does not vary
according to the length of overstay. But that, for reasons already indicated, is an
integral element of the scheme.
208. Reliance is also placed on the Court of Justice’s emphasis in Aziz on the need
to consider, first, what the position would have been under national law apart from
the challenged term and, second, on whether the supplier could reasonably assume
that the consumer would have agreed such a term in individual contract negotiations.
Bearing in mind the need under the Directive and Regulations to consider all the
circumstances, the Court of Justice cannot be taken to have been identifying
considerations that would by themselves be conclusive, rather than relevant. That
also reflects what Lord Millett said in the passage just quoted. It is clear that, but for
the agreement made when parking, Mr Beavis would not have had any right to park
at all, and would have been liable to damages in trespass, for which it would, almost
certainly, not have been worth BAPF’s while to pursue him. That would not have
achieved any of BAPF’s aims, and cannot here be an appropriate comparator when
assessing the legitimacy or fairness of the scheme put in place by BAPF and
ParkingEye. In reality, BAPF would have had to make some entirely different
arrangement, involving perhaps barriers with either machines to take payments or a
car park attendant to cater for overstayers. But that would not mean that BAPF or
ParkingEye could or would have lowered the charge for overstaying, which, as
stated, had to be set at a deterrent level if their aim of encouraging a regular turnover
of customers was to be achieved.
209. The submission that ParkingEye could not reasonably assume that customers
in Mr Beavis’s position would have agreed to the scheme in individual contract
negotiations is less easy to address. A customer in Mr Beavis’s position, if asked
about the terms on which he would wish to park, would no doubt have been very
satisfied with a proposal of two hours free parking, but would very probably have
asked for some form of gradated payment in the event of overstaying. Confronted
with the other interests involved and the considerations making that unacceptable
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from BAPF’s and ParkingEye’s viewpoint, I am not at all confident that he or she
would have refused to accept the risk of having to pay £85 (reducible on prompt
payment) in the event of overstaying.
210. Mr de Waal and Mr Butcher submit that this would only have been because
the customer would have under-estimated the risk, and, at this point, again suggest
that the scheme trades off the weakness of well-meaning customers. They point to
Office of Fair Trading v Ashbourne Management Services Ltd [2011] EWHC 1237
(Ch), [2011] CTLC 237, where Kitchin J held that the minimum membership term
provisions in a number of standard form gym membership contracts were unfair and
invalid, because:
“The defendants’ business model was designed and calculated
to take advantage of the naivety and inexperience of the
average consumer using gym and health clubs at the lower end
of the market. The defendants knew that the average consumer
overestimates the use he will make of the gym and health clubs
and exploited this fact.”
The problem in this respect was that the defendants, who operated gym membership
schemes, themselves accepted that it was “a notorious fact that many people join
such gym clubs having resolved to exercise regularly but fail to attend at all after
two or three months”.
211. A reading of Kitchin J’s judgment indicates how fact sensitive his
conclusions were, differing according to his analysis of the particular terms of
different contracts before him. In particular, because contracts 11 to 13 before him
allowed early termination in a wider range of circumstances (eg medical, change of
employment or a move of more than 15 miles: para 50), he was prepared to accept
a minimum term not exceeding 12 months – this, even though the identified problem
related to members joining enthusiastically without thinking that they might well be
leaving after only two or three months; and he added that he might well have been
prepared to accept up to 24 or 36 months, had the contracts given an option to
terminate after 12 months, coupled with a requirement to reimburse the differential
between the agreed subscription and a shorter term subscription in respect of the
period up to termination (para 174). There was therefore a balancing of all the
interests involved at each stage.
212. Although the submissions that the scheme was unfair within the meaning of
the 1999 Regulations were forcefully presented, I cannot ultimately accept them.
Judge Moloney QC summarised his conclusions as follows (para 7.18):
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“a. It is difficult to categorise as not in good faith a simple
and familiar provision of this sort of which very clear notice
was given to the consumer in advance.
b. There is not a significant imbalance between the parties’
rights and obligations, when the motorist is given a valuable
privilege (two hours free parking) in return for a promise to pay
a specified sum in the event of overstaying, provided that sum
is not disproportionately high.
c. The charge in question is not disproportionately high,
and insofar as it exceeds compensation its amount is justifiable,
and not in bad faith or detrimental to the consumer.”
213. I agree with the way Judge Moloney QC put it, as did the Court of Appeal.
In the result, I would dismiss Mr Beavis’s appeal.
Conclusion
214. It follows that in the Cavendish case, I would allow Cavendish’s appeal in
relation to both clause 5.1 and clause 5.6; and that I would also dismiss Mr Beavis’s
appeal in the second case brought by ParkingEye.
LORD HODGE:
215. I adopt with gratitude the summary of the facts and the procedural history of
the two appeals in the joint judgment of Lord Neuberger and Lord Sumption (at
paras 44-68 in relation to the Cavendish appeal and paras 89-96 in relation to Mr
Beavis’s appeal). Like them, I would allow the Cavendish appeal and dismiss the
appeal by Mr Beavis.
216. Cavendish’s primary submission was that this court should abolish the rule
that the courts do not enforce penalty clauses. This issue affects Scots law as well
as English law as the rule is essentially the same in each jurisdiction, although the
Scottish courts have in certain circumstances a power to abate the penalty which the
English courts do not. Scots law has used English authorities in its development –
see Bell’s Principles of the Law of Scotland (10th ed) section 34 – and has, through
the case of Clydebank Engineering and Shipbuilding Co Ltd v Castaneda [1905] AC
6, (1905) 7 F (HL) 77, had a significant influence on the development of English
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law. I therefore focus on authorities from both jurisdictions in this judgment but also
refer to authorities from other common law jurisdictions.
217. The Cavendish appeal raises three principal issues:
i) What is the scope of the rule against penalties?
ii) Whether that rule should be abrogated or at least altered so as not to
apply in commercial transactions where the contracting parties are of equal
bargaining power and each acts on skilled legal advice? And if not,
iii) Whether and, if so, how the rule should be applied in the circumstances
of the appeal?
218. I have come to the conclusion that the rule, which in each jurisdiction is now
a rule of the law of contract, should not be abrogated. I have also concluded that its
application in the circumstances of the Cavendish contract does not require the court
to refuse to give effect to the parties’ agreement. I set out my reasoning below before
turning more briefly to Mr Beavis’s appeal.
The scope of the rule against penalties
219. The modern law in relation to penalty clauses was laid down by the House of
Lords and the Judicial Committee of the Privy Council in a quartet of cases over 100
years ago. First, the House of Lords examined a liquidated damages clause in the
Clydebank Engineering case in 1904. Then the Privy Council applied the decision
in Clydebank to a retention clause in Public Works Comr v Hills [1906] AC 368 and
to a liquidated damages clause in Webster v Bosanquet [1912] AC 394. Finally, in
Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79,
which again concerned a liquidated damages clause, the House of Lords, in the
speech of Lord Dunedin, set out an approach to the rule which has dominated
judicial discussion ever since.
220. In that case at pp 86-88 Lord Dunedin drew various propositions of law from
the earlier three cases of the quartet. To assist later discussion I set out those
propositions so far as necessary:
“1. Though the parties to a contract who use the words
‘penalty’ or ‘liquidated damages’ may prima facie be supposed
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to mean what they say, yet the expression used is not
conclusive. The court must find out whether the payment
stipulated is in truth a penalty or liquidated damages. This
doctrine may be said to be found passim in nearly every case.
2. The essence of a penalty is a payment of money stipulated
as in terrorem of the offending party; the essence of liquidated
damages is a genuine covenanted pre-estimate of damage
(Clydebank Engineering …).
3. The question whether a sum stipulated is penalty or
liquidated damages is a question of construction to be decided
upon the terms and inherent circumstances of each particular
contract, judged of as at the time of the making of the contract,
not as at the time of the breach (Public Works Comr v Hills and
Webster v Bosanquet).
4. To assist this task of construction various tests have been
suggested, which if applicable to the case under consideration
may prove helpful, or even conclusive. Such are:
(a) It will be held to be penalty if the sum stipulated for
is extravagant and unconscionable in amount in
comparison with the greatest loss that could conceivably
be proved to have followed from the breach. (Illustration
given by Lord Halsbury in Clydebank case.)
(b) It will be held to be a penalty if the breach consists
only in not paying a sum of money, and the sum
stipulated is a sum greater than the sum which ought to
have been paid (Kemble v Farren 6 Bing 141). This
though one of the most ancient instances is truly a
corollary to the last test. …
(c) There is a presumption (but no more) that it is a
penalty when ‘a single lump sum is made payable by
way of compensation, on the occurrence of one or more
or all of several events, some of which may occasion
serious and others but trifling damage’ (Lord Watson in
Elphinstone v Monkland Iron and Coal Co 11 App Cas
332).
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On the other hand:
(d) It is no obstacle to the sum stipulated being a genuine
pre-estimate of damage, that the consequences of the
breach are such as to make precise pre-estimation
almost an impossibility. On the contrary, that is just the
situation when it is probable that pre-estimated damage
was the true bargain between the parties (Clydebank
Case, Lord Halsbury at p 11; Webster v Bosanquet, Lord
Mersey at p 398).”
221. I observe that Lord Dunedin stated the first three propositions without
qualification. The first and the third have caused no difficulty: the court looks to the
substance of the transaction and approaches the matter as a question of construing
the particular contract at the time when it was made. The second has caused
difficulty when it has been treated as creating in all cases a dichotomy between a
genuine pre-estimate of damage on the one hand and a deterrent against breach on
the other, if the former is understood to be a calculation of what common law
damages would be. Indeed, in the Dunlop case itself the clause was upheld not
because an individual discounted sale would cause loss of the stipulated magnitude
but because of the danger of repeated undercutting of the appellant’s prices for their
products, which would disrupt their trading system – see in particular Lord Atkinson
at pp 92-93. I will return to that proposition. Lord Dunedin prefaced the tests in the
fourth proposition with a recognition that they might be neither helpful nor
conclusive in a particular case. That is important, but, as I shall seek to explain, I
take issue with that approach in relation to proposition 4(a), which in my view
contains the essence of the test, where the contractual provisions seek to fix a sum
payable as damages, and an adapted form of that test applies where the clause is
protecting other interests of the innocent party.
(a) The clauses to which the rule against penalties applies
222. One of the reasons for the problem with the second proposition has been that
the penalty doctrine applies not only to clauses which seek to set the damages to be
paid on breach of contract but also to clauses which set out other consequences of a
breach of contract. Thus in Lordsvale Finance plc v Bank of Zambia [1996] QB 752
Colman J, in a celebrated judgment dealing with a contractual provision to increase
the rate of interest on a loan during a period of default, did not ask himself whether
the provision was a genuine pre-estimate of damage. He considered whether it was
commercially justifiable to increase the consideration payable under an executory
contract upon the happening of default. He concluded that the 1% prospective
increase in the interest rate was commercially justifiable so long as the dominant
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purpose was not to deter the borrower from breach. In my view, that decision was
clearly correct as a default affected the credit risk that the lender undertook.
223. The Court of Appeal in Cine Bes Filmcilik Ve Yapimcilik v United
International Pictures [2004] 1 CLC 401 supported Colman J’s approach. Mance
LJ, who produced the leading judgment, recognised (at para 15) that there were
clauses which might operate on breach and which were commercially justifiable but
which did not fall into either category of a dichotomy between a genuine preestimate of damages and a penalty. In that case UIP had granted a licence to Cine
Bes to show films on its movie channel. There were disputes over the licence
agreement which resulted in litigation which the parties compromised in an
agreement to grant a fresh licence. UIP later terminated the fresh licence on the
ground of Cine Bes’s breach of contract. One of the provisions that Cine Bes
challenged as a penalty was that it should pay to UIP not only its enforcement costs
for the default on the fresh licence but also its litigation costs in the prior litigation.
The Court of Appeal rejected this challenge, Mance LJ stating (at para 33):
“The agreement regarding past litigation costs was
understandable in the overall context of the settlement of the
prior litigation. It would be wrong to treat it as if it were there
to deter [Cine Bes] from, or to penalise or punish [Cine Bes]
for, any default. It was an understandable and reasonable
commercial condition upon which UIP was prepared to dispose
of the prior litigation, and to enter into the fresh licence.”
Mance LJ, drawing on Colman J’s analysis, drew a distinction between a reasonable
commercial condition on the one hand and a punishment on the other. As I shall
seek to show, there is support for this dichotomy in the older case law.
224. The Court of Appeal again considered the penalty doctrine in Murray v
Leisureplay plc [2005] IRLR 946, which concerned a provision in the employment
contract of a chief executive that entitled him to one year’s gross salary in the event
of the termination of his employment without one year’s notice. The company
challenged this entitlement as a penalty because common law damages would have
given the director a sum after deduction of tax and national insurance contributions
and he would have been under an obligation to mitigate his loss. The court rejected
this challenge, accepting that the provision, which provided the director with
generous reassurance against dismissal and could result in greater recovery than the
amount of his actual loss which he could recover at common law, was commercially
justified.
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225. In my view, this broader approach of Colman J and the Court of Appeal
involves a correct analysis of the law and escapes the straightjacket into which the
law risked being placed by an over-rigorous emphasis on a dichotomy between a
genuine pre-estimate of damages on the one hand and a penalty on the other. To
justify that view I will have to look briefly at the law before Dunlop. Before doing
so, it is necessary to look at other provisions relating to breach of contract to which
the rule against penalties has been applied or may apply and in particular (i) clauses
withholding payments which were otherwise due, (ii) clauses requiring the party in
breach to transfer property to the innocent party and (iii) clauses providing for the
payment of a non-refundable deposit in a contract of sale.
226. Clauses withholding payments on breach: I see no principled reason why the
law on penalties should be confined to clauses that require the contract-breaker to
pay money in the event of breach and not extend to clauses that in the same
circumstance allow the innocent party to withhold moneys which are otherwise due.
Indeed, there is ample authority to support the view that clauses which allow the
innocent party to withhold payments on breach may be unenforceable as penalties
where the sums retained are, or may be, wholly disproportionate to the loss suffered
by the withholding party. One of the quartet of cases to which I referred in para 219
above – Public Works Comr v Hills – is an example of the application of the rule
against penalties to a clause seeking in the event of a breach of contract to withhold
money otherwise due to a contractor. In English law the House of Lords in GilbertAsh (Northern) Ltd v Modern Engineering (Bristol) Ltd [1974] AC 689 considered
a clause in a construction sub-contract that allowed the main contractor to suspend
or withhold payment of any moneys due to the sub-contractor if the sub-contractor
failed to comply with any of its conditions. While the contractor conceded that this
part of the contractual clause was a penalty, it is clear from the speeches of their
Lordships that they agreed with the concession: see Lord Reid at p 698D-F, Lord
Morris of Borth-y-Gest at p 703G, Viscount Dilhorne at p 711D and Lord Salmon
at p 723H. The majority of the Court of Appeal (Stuart-Smith and O’Connor LJJ)
followed that approach in The Fanti and the Padre Island (No 2) [1989] 1 Lloyd’s
Rep 239.
227. Cavendish has argued that such clauses should be seen as forfeiture clauses
to which the law of penalties should not apply. Ms Smith urged that it would be a
recipe for confusion if a single clause were to be classified in two different ways. I
disagree. There is no reason in principle why a contractual provision, which involves
forfeiture of sums otherwise due, should not be subjected to the rule against
penalties, if the forfeiture is wholly disproportionate either to the loss suffered by
the innocent party or to another justifiable commercial interest which that party has
sought to protect by the clause. If the forfeiture is not so exorbitant and therefore is
enforceable under the rule against penalties, the court can then consider whether
under English law it should grant equitable relief from forfeiture, looking at the
position of the parties after the breach and the circumstances in which the contract
Page 100
was broken. This was the approach which Dillon LJ adopted in BICC plc v Burndy
Corpn [1985] Ch 232 and in which Ackner LJ concurred. The court risks no
confusion if it asks first whether, as a matter of construction, the clause is a penalty
and, if it answers that question in the negative, considers whether relief in equity
should be granted having regard to the position of the parties after the breach.
228. I therefore conclude that clauses that authorise the withholding of sums
otherwise due to the contract-breaker may fall within the scope of the rule against
penalties.
229. Different considerations may arise when, on its rescission of a contract of
sale, the vendor seeks to retain instalments of the price which the purchaser has
made; in English law the equitable remedy against forfeiture may be available to
preserve the purchaser’s claim for restitution of the instalments: Stockloser v
Johnson [1954] 1 QB 476; Else (1982) Ltd v Parkland Holdings Ltd [1994] 1 BCLC
130. But we are not concerned with such circumstances in this appeal.
230. Clauses requiring the transfer of property on breach: Again I see no reason
in principle why the rule against penalties should not extend to clauses that require
the contract-breaker to transfer property to the innocent party on breach. There is
authority in both English law and Scots law supporting this approach. In Jobson v
Johnson [1989] 1 WLR 1026 the Court of Appeal considered a clause that required
a purchaser of shares to re-transfer shares to the vendor for a fixed consideration if
he defaulted on payment of instalments of the price. The clause was treated as a
penalty because it fixed the re-transfer price at a modest figure regardless of the
number of the much larger instalments which the purchaser had paid before his
default. The case was an unusual one and the approach of the court to a remedy was
influenced by the absence of a counterclaim for relief from forfeiture. I do not accept
the conclusion in that case that the court had power in English law to modify a
penalty (see para 283 below). But that does not, in my view, call into question the
court’s unanimous conclusion that the clause was caught by the rule against
penalties. See also Else (1982) Ltd (above) Evans LJ at pp 137h and 138e. As I have
said in para 227 above I see no confusion resulting from an assessment first, whether
a clause is a penalty and, if it is not, considering whether to grant relief from
forfeiture.
231. In the Scottish case of Watson v Noble (1885) 13 R 347 a ship-owner sold
seven shares in a trawler to the appellant and was paid £100 for them. In a
subsequent agreement the owner agreed to employ the appellant as captain of the
vessel and to hold the shares in trust for him. The ship-owner imposed an obligation
on the captain to remain sober and attentive to his duties on pain of dismissal and
forfeiture of both his shares and the right to claim repayment of the £100 which he
had paid for the shares. In an application by the appellant for repayment of the £100
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after his dismissal, the Second Division treated the forfeiture of the shares as a
penalty which could not be enforced and, because the ship-owner refused to transfer
the shares, required him to repay the £100 which he had received for them.
232. There is also considerable support in Australian authority for the application
of the rule against penalties to clauses requiring a party in breach to transfer property
to the innocent party. See, for example, Bysouth v Shire of Blackburn and Mitcham
(No 2) [1928] VLR 562, Irvine CJ at pp 574-575; Forestry Commission of New
South Wales v Stefanetto (1976) 133 CLR 507, Mason J at p 521; Wollondilly Shire
Council v Picton Power Lines Pty Ltd (1994) 33 NSWLR 551, Handley JA at p
555F-G; Ringrow Pty Ltd v BP Australia Pty Ltd (2005) 224 CLR 656 in which the
point was conceded (p 665); and Interstar Wholesale Finance Pty Ltd v Integral
Home Loans Pty Ltd [2008] NSWCA 310, Allsop P at paras 101-102. The Court of
Appeal in New Zealand has taken a similar view: Amaltal Corpn Ltd v Maruha (NZ)
Corpn Ltd [2004] 2 NZLR 614, Blanchard J at para 61.
233. I am satisfied therefore that the rule against penalties can be applied to a
contractual term that provides for the transfer on breach of contract of property from
the contract-breaker to the innocent party.
234. Clauses requiring the purchaser to pay an extravagant non-refundable
deposit: In English law a non-refundable deposit is a guarantee by a purchaser that
the contract will be performed: Howe v Smith (1884) 27 Ch D 89, Cotton LJ at p 95;
Soper v Arnold (1889) 14 App Cas 429, 435 per Lord MacNaghten. It provides the
vendor with some assurance of performance while the property is taken off the
market during the period from the date of the contract to the completion of
performance. If the contract is performed, the deposit forms part of the purchase
price. If the purchaser breaks the contract, the vendor keeps the deposit. As Fry LJ
stated in Howe v Smith (at p 101):
“It is not merely a part payment, but is then also an earnest to
bind the bargain so entered into, and creates by the fear of its
forfeiture a motive in the payer to perform the rest of the
contract.”
Where the deposit was fixed at a reasonable figure, its forfeiture on breach of
contract does not bring into play the rule against penalties, its purpose not being
related to any loss that the vendor may have suffered and that he may seek to recover
in damages: Wallis v Smith (1882) 21 Ch D 243, Jessel MR at p 258. But in
Stockloser v Johnson [1954] 1 QB 476, Denning LJ suggested (at p 491) that a party
could not call a stipulation for an initial payment of 50% of the purchase price a
deposit and thereby achieve a forfeiture from which equity could give no relief. He
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said (at p 492) that the equity of restitution was to be tested not at the time of the
contract but by the conditions existing when it was invoked. This suggests that he
was considering relief from forfeiture rather than the rule against penalties. More
directly relevant is Lord Radcliffe’s statement in Campbell Discount Co Ltd v
Bridge [1962] AC 600, when discussing deposits (at p 624):
“… I do not see any sufficient reason why in the right setting a
sum of money may not be treated as a penalty, even though it
arises from an obligation that is essentially a guarantee.”
235. The Judicial Committee of the Privy Council has developed the idea that an
extravagant deposit should not be forfeited on breach of contract. In Linggi
Plantations Ltd v Jagatheesan [1972] 1 MLJ 89, Lord Hailsham (at p 94) suggested
that where, on investigation, the real nature of an initial payment, which was termed
a deposit, was shown to be the imposition of a penalty, it might be recovered by the
purchaser, and that it was only a reasonable deposit that was irrecoverable. More
recently, in Workers Trust & Merchant Bank Ltd v Dojap Investments Ltd [1993]
AC 573, the Board addressed the question whether a deposit of 25% of the purchase
price in the contract for the purchase of land from a bank at auction in Jamaica
(where 10% deposits were customary) could be forfeited. Lord Browne-Wilkinson,
who gave the Board’s advice, spoke (at p 579) of the risk that the special treatment
which the law gives to deposits being abused if the contracting parties attach the
label “deposit” to a penalty. The Privy Council made the validity of a deposit
conditional upon whether it was “reasonable as earnest money”. Lord BrowneWilkinson stated (at p 580):
“In order to be reasonable a true deposit must be objectively
operating as ‘earnest money’ and not as a penalty. To allow the
test of reasonableness to depend upon the practice of one class
of vendor, which exercises considerable financial muscle,
would be to allow them to evade the law against penalties by
adopting practices of their own.”
The Board therefore took as a norm the long established practice both in Jamaica
and the United Kingdom of a deposit of 10% and required a vendor who sought a
larger percentage to show special circumstances to justify that deposit. In effect, the
Board applied a test of commercial justification akin to the test which Colman J later
applied in Lordsvale Finance plc.
236. In Polyset Ltd v Panhandat Ltd (2002) 5 HKCFAR 234 the Hong Kong Court
of Final Appeal carried out a thorough review of the law relating to deposits. The
court considered the cases which I have mentioned and concluded that the court
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would intervene to prevent forfeiture where parties abused the concept of deposit.
The forfeiture of a deposit would be enforced only if it were “reasonable as earnest
money”. Where the deposit exceeded the conventional amount, the court would
permit forfeiture only if the party seeking to forfeit could show that exceptional
circumstances justified the higher amount (Ribeiro PJ at para 90, Bokhary PJ at
paras 10-18, Chan PJ at paras 40-42; Lord Millett NPJ at para 165). Because
Bokhary PJ and Ribeiro PJ considered that the test of “genuine pre-estimate of loss”
applied in the rule against penalties when considering whether a sum was liquidated
damages, they did not view the “reasonable as earnest money” test as part of the law
of penalties. But if, as I think correct, the true test for penalties is wider than the
“genuine pre-estimate of loss” test (see paras 242-255 below), the Hong Kong
court’s conclusions were wholly consistent with Lord Browne-Wilkinson’s
approach in Workers Trust.
237. Historically, Scots law has followed English law in treating deposits as
outside the rule against penalties, citing English authorities in support of the view
that a deposit was a guarantee of or security for performance: Commercial Bank of
Scotland Ltd v Beal (1890) 18 R 80; Roberts & Cooper v Salvesen & Co 1918 SC
794; Zemhunt (Holdings) Ltd v Control Securities plc 1992 SC 58. There has been
no discussion whether that exclusion is confined to reasonable deposits. But in none
of those cases was there a question whether the deposit was extravagant. In Roberts
& Cooper, in which the First Division upheld the forfeiture of a £3,000 deposit on
the purchase of a ship for £30,000 when the purchaser repudiated the contract, Lord
Skerrington (at p 814) suggested that there was no reason why in a proper case a
clause for the forfeiture of a purchaser’s deposit should not be construed as a penalty
and be unenforceable. I agree. As Scots law has followed English law in relation to
the law of deposits, I see no reason why it should not adopt the modern approach of
excluding only reasonable deposits from the rule against penalties.
238. I conclude therefore that in both English law and Scots law (a) a deposit
which is not reasonable as earnest money may be challenged as a penalty and (b)
where the stipulated deposit exceeds the percentage set by long established practice
the vendor must show special circumstances to justify that deposit if it is not to be
treated as an unenforceable penalty.
239. Circumstances other than breach of contract: The rule against penalties
applies only in the context of a breach of contract. In English law the House of Lords
has so held in Export Credits Guarantee Department v Universal Oil Products Co
[1983] 1 WLR 399, 403 per Lord Roskill. In Scots law the question has not reached
the House of Lords or the Supreme Court. But in Granor Finance Ltd v Liquidator
of Eastore Ltd 1974 SLT 296, Lord Keith, when a Lord Ordinary, held (p 298) that
the rule against penalties had no application in a case which was not a case of breach
of contract, and more recently, in EFT Commercial Ltd v Security Change Ltd 1992
SC 414, the First Division has re-asserted that position.
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240. Mr Bloch, counsel for Mr Makdessi, suggested in the course of debate that
the court could extend the rule against penalties. He referred to the controversial
decision of the High Court of Australia in Andrews v Australia and New Zealand
Banking Group Ltd (2012) 247 CLR 205, in which the court held that bank charges,
which were imposed on customers on the occurrence of events which were not
breaches of contract, could be characterised as penalties and thus be unenforceable.
241. As this suggestion is peripheral to the main arguments in this appeal, I deal
with it shortly. I am satisfied that the rule against penalties in both English and Scots
law has applied only in relation to secondary obligations – penal remedies for breach
of contract. In Scotland, the courts administer an equitable as well as a common law
jurisdiction without having two branches of jurisdiction. There is no freestanding
equitable jurisdiction to render unenforceable as penalties stipulations operative as
a result of events which do not entail a breach of contract. Such an innovation would,
if desirable, require legislation.
(b) The true test for a penalty
242. In para 221 above I suggested (a) that there was a problem in the way in
which the courts had read Lord Dunedin’s second proposition and (b) that his
proposition 4(a) contained the essence of the test: that is, whether the secondary
obligation was exorbitant and unconscionable.
243. The rule against penalties is a rule of contract law based on public policy. It
is a question of construction of the parties’ contract judged by reference to the
circumstances at the time of contracting; the public policy is that the courts will not
enforce a stipulation for punishment for breach of contract.
244. In the first of the quartet of cases, Clydebank Engineering, the House of Lords
held that the courts would not enforce a measure that was extravagant and
unconscionable: Earl of Halsbury LC at p 10, Lord Davey at p 16 and Lord
Robertson at p 20. Different expressions were used to describe the manifestly
excessive nature of the measure in comparison with the interest which the
challenged clause protected. But at its heart was the idea of exorbitance or gross
excessiveness.
245. The phrase in Lord Dunedin’s second proposition appears to have come from
the opinion of Lord Kyllachy as Lord Ordinary in the Clydebank Engineering case
((1903) 5 F 1016 at p 1022) where he contrasted a measure which was “reasonable
and moderate” and one which was “exorbitant and unconscionable” and said of the
latter that:
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“the amount stipulated might be such as to make it plain that it
was merely stipulated in terrorem, and could not possibly have
formed … a genuine pre-estimate of the creditor’s probable or
possible interest in the due performance of the principal
obligation.”
246. While Lord Kyllachy’s emphasis on a genuine pre-estimate suggests that he
was considering clauses which are intended to fix the level of damages paid on
breach of contract, the overriding test of exorbitance fits the wider range of
circumstances in which the rule against penalties has been applied, including
enhanced interest charges (Lordsvale Finance), the agreement to pay an employee
sums in excess of common law damages (Murray), and deposits (Workers Trust &
Merchant Bank Ltd). Lord Robertson’s focus in the Clydebank Engineering case on
the innocent party’s interest in the due performance of the principal obligation and
his posing of the question –
“had the respondents no interest to protect by that clause, or
was that interest palpably incommensurate with the sums
agreed on?”
– provide the framework for the application of the exorbitance test to those wider
circumstances.
247. Lord Dunedin’s propositions were his summary of existing authorities. In his
second proposition he drew on Lord Kyllachy’s phrase to state the paradigms of a
penalty on the one hand and liquidated damages on the other. Exorbitance featured
in his proposition 4(a) and also in the speeches of Lord Atkinson (p 97:
“unreasonable, unconscionable or extravagant”) and Lord Parmoor (p 101:
“extravagant or unconscionable”; “extravagant disproportion between the agreed
sum and the amount of any damage capable of pre-estimate”). The focus on the
disproportion between the specified sum and damage capable of pre-estimation
makes sense in the context of a damages clause but is an artificial concept if applied
to clauses which have another commercial justification.
248. Similarly, I doubt whether it is helpful to rely on the concept of deterrence.
Many contractual provisions are coercive in nature, encouraging a contracting party
to perform his or her obligations; the prospect of liability in common law damages
itself is a spur to performance. Similarly, a deposit provides a motive for
performance (para 234 above). Instead, the broader test of exorbitance or manifest
excess compared with the innocent party’s commercial interests fits the various
applications of the rule against penalties and is consistent with the repeated warnings
by the courts against imposing too stringent a standard. Thus in Robophone
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Facilities Ltd v Blank [1966] 1 WLR 1428 (CA) Diplock LJ warned (at p 1447E),
“The court should not be astute to descry a ‘penalty clause’”. In Philips Hong Kong
Ltd v Attorney General of Hong Kong (1993) 61 BLR 41, Lord Woolf (at p 59) said:
“[T]he court has to be careful not to set too stringent a standard
and bear in mind that what the parties have agreed should
normally be upheld. Any other approach will lead to
undesirable uncertainty especially in commercial contracts.”
In Murray (above) Arden LJ expressed a similar view when she said (at para 43),
“The parties are allowed a generous margin”.
249. When the court makes a value judgment on whether a provision is exorbitant
or unconscionable, it has regard to the legitimate interests, commercial or otherwise,
which the innocent party has sought to protect. Where the obligation which has been
breached is to pay money on a certain date, the innocent party’s interests are
normally fully served by the payment of the stipulated sum together with interest
and the costs of recovery. More complex questions arise where there is an obligation
to perform by a certain date, such as the construction of the torpedo boats in
Clydebank Engineering, as the assessment of the loss suffered by the innocent party
may often be difficult and parties may have an interest in fixing the level of
compensation in advance to avoid the necessity of an expensive trial. In Scots law a
distinction has also been drawn between the breach of an obligation to perform some
act and the wilful breach of a prohibition; in the latter circumstance the court is less
inclined to treat a harsh contractual remedy as unconscionable. Thus in Forrest &
Barr v Henderson, Coulbourn & Co (1869) 8 M 187, Lord Neaves (at p 202) stated:
“There are great differences in the stipulations themselves that
are so made, and, in particular, there is a great difference
according as the breach of contract consists in faciendo and in
non faciendo. If a man wilfully goes against what he has
promised not to do, that is an unfavourable case for restriction.”
Lord Deas expressed a similar view at p 196.
250. As the rule against penalties is based on public policy and has developed over
time, its current form is of more significance than its historical development. Lord
Neuberger and Lord Sumption have discussed the origins and development of the
rule in English law in paras 4-11 of their judgment. Professor David Ibbetson in “A
Historical Introduction to the Law of Obligations” (1999) (pp 255-256) records how
Scots law and South Africa’s Roman-Dutch law came to influence the modern
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English rule in Dunlop. It may therefore be helpful to say something about the
development of the rule in Scots law.
251. In early Scots law penalties were associated with usury. While there are
examples of the Court of Session enforcing penalties in the early 16th century, in
Home v Hepburn (1549) Mor 10033 the Court of Session prohibited the imposition
of punishments for breach of contract. In the abbreviated report of that case the court
held:
“de practica regni, poenae conventionales non possunt exigi,
nisi quatenus interest actores, quia sapiunt quendam usuram et
inhonestum questum …”
Balfour’s Practicks (1579) gives a vernacular account of the case in these terms
(Stair Society vol I, p 151):
“Be the law of this realme, poena conventionales, sic as ane
soume of money adjectit, with consent of parties, in ony
contract or obligatioun, in name of pane, may not be askit be
ony persoun bot in sa far as he is interestit, hurt or skaithit;
because all sic painis are in ane maner usuraris, and dishonest,
made for lucre or gane.”
It is of note that the judgment referred to the innocent party’s interest in performance
(“interesse” – to have an interest) as well his injury or damage (“skaith”),
foreshadowing Lord Robertson’s formulation in Clydebank Engineering. Viscount
Stair in his “Institutions of the Law of Scotland” regarded the power to modify
exorbitant bonds and contracts as part of the nobile officium of the Court of Session,
recognising that “necessitous debtors” yield to “exorbitant penalties” (Stair, IV.3.2).
A penalty clause was seen as a secondary obligation, an additional means of
enforcement; tendering the penalty did not release the contract-breaker from his
primary obligation: University of Glasgow v Faculty of Physicians and Surgeons
(1840) 1 Rob 397, 415.
252. The Court of Session, “as the supreme court of law and equity,” exercised an
equitable power of mitigation (Bell, Commentaries on the Law of Scotland, 7th ed
(1870) vol I, 700). Many of the cases concerned the imposition of additional rent on
an agricultural tenant who departed from the agreed cropping cycle of the land (as
in Stration v Graham (1789) 3 Pat 119). In relation to penalty clauses in bonds, the
courts enforced the penalty only to the extent of recovering the principal sum due,
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interest and expenses. The power to modify a penalty was placed on a statutory basis
and the extant provision is section 5 of the Debts Securities (Scotland) Act 1856:
“[A]nd in all cases where penalties for non-payment, over and
above performance, are contained in bonds or other obligations
for sums of money, and are made the subject of adjudication,
or of demand in any other shape, it shall be in the power of the
court to modify and restrict such penalties, so as not to exceed
the real and necessary expenses incurred in making the debt
effectual.”
More recently, in Wirral Borough Council v Currys Group plc 1998 SLT 463, Lord
Hamilton (at p 467) confirmed that the statutory power to modify extends to money
obligations other than bonds. Although the Scottish Parliament has enacted
legislation to abolish the remedy of adjudication as a means of debt recovery (the
Bankruptcy and Diligence etc (Scotland) Act 2007), the court retains a power to
modify such penalties for failure to fulfil monetary obligations.
253. By the mid-19th century, case law on penalty clauses had moved to contracts
for the supply of goods and services and construction contracts. Three cases, in
which Lord Inglis participated, provided the backdrop for the Clydebank
Engineering decision, the first of the quartet of cases which set out the modern law.
In Johnston v Robertson (1861) 23 D 646, the Second Division held that a charge of
£5 per week for the late completion of a poor house was liquidated damages and not
a penalty; Lord Justice Clerk Inglis (at p 655) posed the question whether the
stipulation was a reasonable and appropriate mode of enforcing the obligation to
complete the work by the specified date and whether the sum was proportionate to
the loss suffered by the innocent party. In Craig v McBeath (1863) 1 M 1020, 1022,
Lord Justice Clerk Inglis cited Home v Hepburn in support of the proposition that
“Parties cannot lawfully enter into an agreement that the one party shall be punished
at the suit of the other”. Lord Young enunciated a similar principle in Robertson v
Driver’s Trs (1881) 8 R 555, 562, stating that the law will not let people punish each
other. In Forrest & Barr (above), which concerned the purchase and erection of a
crane in a shipyard by a specified date and a penalty of £20 per day for delay, Lord
President Inglis stated (at p 193) that equity would interfere to prevent a claim being
maintained to an exorbitant and unconscionable amount. Lord Deas, Lord Ardmillan
and Lord Neaves used the same expressions (at pp 198, 199 and 203 respectively);
Lord Kinloch (at p 201) spoke of a claim being “so utterly extravagant and
unreasonable” that the court could infer that it was a penalty or punishment.
254. This approach to penalty clauses is consistent with the judgments of the
House of Lords in Dunlop in which an extravagant disproportion between an agreed
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sum and the innocent party’s interest in the due performance of the contract would
amount to what Lord Parmoor described (p 100) as:
“a penal sum inserted as a punishment on the defaulter
irrespective of the amount of any loss which could at the time
have been in contemplation of the parties …”
255. I therefore conclude that the correct test for a penalty is whether the sum or
remedy stipulated as a consequence of a breach of contract is exorbitant or
unconscionable when regard is had to the innocent party’s interest in the
performance of the contract. Where the test is to be applied to a clause fixing the
level of damages to be paid on breach, an extravagant disproportion between the
stipulated sum and the highest level of damages that could possibly arise from the
breach would amount to a penalty and thus be unenforceable. In other circumstances
the contractual provision that applies on breach is measured against the interest of
the innocent party which is protected by the contract and the court asks whether the
remedy is exorbitant or unconscionable.
(ii) Whether the rule against penalties should be abrogated or altered?
256. I am not persuaded that there is any proper basis for abrogating the rule
against penalties or restricting its application to commercial transactions where the
parties are unequal in their bargaining power and there is a risk of oppression.
257. The rule against penalties is an exception to the general approach of the
common law that parties are free to contract as they please and that the courts will
enforce their agreements – pacta sunt servanda. The rule against penalties may have
been motivated in part by a desire to prevent oppression of the weaker party by the
more powerful party to a contractual negotiation. As I have said, Viscount Stair
spoke of this danger when he spoke of necessitous debtors having to yield to
exorbitant penalties (IV.3.2). Diplock LJ in Robophone (p 1447A) recognised the
reality that many contracting parties could not contract à la carte but had to accept
the table d’hôte of the standard term contract. In AMEV–UDC Finance Ltd v Austin
(1986) 162 CLR 170, Mason and Wilson JJ (at pp 193-194) suggested that the rule
was aimed at preventing oppression and that the nature of the relationship between
the contracting parties was a factor relevant to unconscionableness. In Philips v
Hong Kong (pp 58-59) Lord Woolf suggested that in some cases the fact that one of
the contracting parties was able to dominate the other as to the choice of the contract
terms was relevant to the application of the rule. But the application of the rule does
not depend on any disparity of power of the contracting parties: Imperial Tobacco
Co (of Great Britain and Ireland) Ltd v Parslay [1936] 2 All ER 515 (CA), Lord
Wright MR at p 523. Because the rule is not so limited, Ms Joanna Smith QC argued
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that the rule interferes with freedom of contract in circumstances in which it is not
needed.
258. The rule may also be criticised because it can be circumvented by careful
drafting. Indeed one of Cavendish’s arguments was that clause 5.1 could have been
removed from the scope of the rule if it had been worded so as to make the payment
of the instalments conditional upon performance of the clause 11 obligations. This
is a consequence of the rule applying only in the context of breach of contract. But
where it is clear that the parties have so circumvented the rule and that the substance
of the contractual arrangement is the imposition of punishment for breach of
contract, the concept of a disguised penalty may enable a court to intervene: see
Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd [1989] QB 433,
Bingham LJ at pp 445-446 and, more directly, the American Law Institute’s
“Restatement of the Law, Second, Contracts” section 356 on liquidated damages
and penalties, in which the commentary suggests that the court’s focus on the
substance of the contractual term would enable it in an appropriate case to identify
disguised penalties.
259. It may also be said against the rule that it promotes uncertainty in commercial
dealings as the contracting parties may not be able to foresee the judges’ value
judgment on whether a particular provision is exorbitant or unconscionable. There
is beyond doubt real benefit in parties being able to agree the consequences of a
breach of contract, particularly where there would be difficulty in ascertaining the
sum in damages which was appropriate to compensate the innocent party for loss
caused by the breach. Parties save on transaction costs where they can avoid
expensive litigation on the consequences of breach of contract. It has also been said
that judges should be modest in their assumptions that they know about business:
Wallis v Smith (1882) 21 Ch D 243, Jessel MR at p 266.
260. Legislative measures have been introduced to control unfair terms in
contracts. In recent years, the Unfair Terms in Consumer Contracts Regulations
1999 and the Consumer Protection from Unfair Trading Regulations 2008 have
given effect to European Directives and more recently the Consumer Rights Act
2015 has been brought into force. But while this legislation may have reduced the
need for the rule against penalties in consumer contracts, it has no bearing on
commercial contracts.
261. There are therefore arguments that can be made against the rule against
penalties, or at least against its scope. But I am persuaded that the rule against
penalties should remain part of our law, principally for three reasons.
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262. First, there remain significant imbalances in negotiating power in the
commercial world. Small businesses often contract with large commercial entities
and have little say as to the terms of their contracts. Examples such as the
relationship between a main contractor and a sub-contractor in the construction
industry and that between a large retail chain and a small supplier spring to mind.
263. Secondly, abolition of the rule against penalties would go against the flow of
legal developments both nationally and internationally. Both the Law Commission
of England and Wales and the Scottish Law Commission have looked at the rule
against penalties and neither has recommended its abolition. The Law
Commission’s Working Paper No 61 on “Penalty Clauses and Forfeiture of Monies
Paid” in 1975 proposed the extension of judicial control to embrace penalty clauses
that come into operation without any breach of contract. More recently, the Scottish
Law Commission’s “Report on Penalty Clauses” in 1999 recommended the
retention of judicial control over penalties whether they took the form of a payment
of money, a forfeiture of money, a transfer of property or a forfeiture of property. It
recommended a criterion of “manifestly excessive” and the abolition of any
requirement that the clause be founded in a pre-estimate of damages. It also
recommended that judicial control should not be confined to cases where the
promisor is in breach of contract.
264. As counsel’s very helpful researches showed, other common law countries
such as Australia, Canada, New Zealand, Singapore and Hong Kong have rules
against penalties, as has the commercially important law of New York, the Uniform
Commercial Code and, as I have mentioned, the American Law Institute’s
“Restatement of the Law, Second, Contracts”.
265. In the civil law tradition, which has had a profound influence on Scots law
and which under Lord Mansfield influenced the development of English commercial
law, the modern civil codes of Belgium (article 1231), France (article 1152),
Germany (section 343), and Italy (article 1384) and the Swiss Code of Obligations
(article 163) all provide for the modification of contractual penalties using tests such
as “manifestly excessive”, “disproportionately high”, or “excessive”. Further, in
what Mr Bloch described as “soft law”, recent international instruments prepared by
expert lawyers, such as the Council of Europe’s Resolution (78) 3 on Penal Clauses
in Civil Law (1978) (article 7), the Principles of European Contract Law (1995)
(article 9.509), the Unidroit Principles of International Commercial Contracts
(1994) (article 7.4.13) and Uncitral texts on liquidated damages and penalty clauses
(1983) (article 8) also provide for the restriction of “grossly excessive” or
“manifestly excessive” or “substantially disproportionate” penalty clauses. The
Draft Common Frame of Reference (III – 3:712) also provides for the reduction of
stipulated payments for non-performance if they are “grossly excessive”.
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266. Thirdly, I am not persuaded that the rule against penalties prevents parties
from reaching sensible arrangements to fix the consequences of a breach of contract
and thus avoid expensive disputes. The criterion of exorbitance or
unconscionableness should prevent the enforcement of only egregious contractual
provisions.
267. Ms Smith’s alternative proposal, that the rule should not extend to
commercial transactions in which the parties are of equal bargaining power and each
acts on skilled legal advice, does not appeal to me. Creating such a gateway to the
application of the rule would risk adding to the expense of commercial disputes by
requiring the court to rule on issues of fact about the bargaining power of the parties
and the calibre of their respective legal advisers.
268. I therefore turn to the application of the rule against penalties in the two
appeals.
The application of the rule against penalties:
(a) in the Cavendish appeal
269. Clause 5.1, which removes a seller’s valuable rights to receive the interim
payment and final payment if he is in breach of clause 11.2, was likely to deprive
the defaulting shareholder of a substantial sum of money. The parties have agreed
that the enforcement of the clause would deprive Mr El Makdessi of up to
$44,181,600. Breach of clause 11.2 therefore comes at a high price.
270. There is clearly a strong argument, which Lord Neuberger and Lord
Sumption favour, that in substance clause 5.1 is a primary obligation which made
payment of the interim and final payments conditional upon the seller’s performance
of his clause 11.2 obligations. But even if it were correct to analyse clause 5.1 as a
secondary provision operating on breach of the seller’s primary obligation, I am
satisfied that it is not an unenforceable penalty clause for the following six reasons.
271. First, it is important to consider the nature of the obligations of the sellers
which could trigger the withholding of the instalments under clause 5.1. Clause 11.2
imposed restrictive covenants on the sellers, prohibiting them from competing with
the company. Having sold substantial blocks of shares in the company for a price
which attributed a high value to its goodwill, the sellers were prohibited from
derogating from what they had sold.
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272. Secondly, the factual matrix in the uncontested evidence of Mr Andrew Scott,
WPP’s director of corporate development, and Mr Ghossoub and recorded in the
agreed statement of facts and issues showed the importance of personal relationships
in the marketing sector and particularly in the Middle East. The statement of facts
and issues recorded (at para 5) that the success of the Group’s business depended on
the personal relationships which Mr Ghossoub and Mr El Makdessi had built up
with their key clients and in para 33, which Lord Neuberger and Lord Sumption
quote at para 66 of their judgment, it explained that the agreement was structured to
protect the goodwill of the Group. The continued loyalty of the sellers was critically
important to preserving the value of the Group’s goodwill.
273. Thirdly, that evidence and the agreement itself showed that a large proportion
of the agreed purchase price was attributable to that goodwill. Extrapolating from
the maximum consideration which the sellers could have received for the shares
which they sold, the company had a maximum value of $300m which compares with
its certified NAV (without goodwill) of $69.7m.
274. Cavendish therefore needed to be assured of the sellers’ loyalty. It had a very
substantial and legitimate interest in protecting the value of the company’s goodwill.
It did so by giving the sellers a strong financial incentive to remain loyal to the
company by complying with the restrictions set out in clause 11.2. The sellers, who,
like Cavendish, had access to expert legal advice and negotiated the contract over
several months, agreed to peril their entitlement to the deferred consideration on
their continued loyalty.
275. Fourthly, I am not persuaded by Mr Bloch’s argument that clause 5.1 was
exorbitant because it could be triggered by a minor breach of clause 11.2, such as an
unsuccessful solicitation of a senior employee. That appears to me to be unrealistic.
Clause 5.1 was not addressing the loss which Cavendish might suffer from breach
of the restrictive covenant, whether an isolated and minor breach or repeated and
fundamental breaches. It was addressing the disloyalty of a seller who was prepared
in any way to attack the company’s goodwill. No question therefore arises of a
presumption of a penalty where the same sum is payable on the occurrence of several
events which may cause serious or trifling damages as in Lord Dunedin’s
proposition 4(c) in Dunlop. In any event, that presumption would not apply because
the losses arising from any breach of clause 11.2 were generically the same – see
Lord Parker of Waddington in Dunlop at p 98. As Lord Neuberger and Lord
Sumption have said (para 75), loyalty is indivisible.
276. Fifthly, Mr Bloch submitted that clause 5.1 might operate perversely as far
as Mr El Makdessi was concerned because a minor breach of clause 11.2, which did
not harm the company’s goodwill, would result in his losing more by the loss of the
interim and final payments than a major breach which diminished the profits of the
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company and thus the deferred consideration. Similarly, he submitted that a breach
that was detected before the interim payment or the final payment would have more
serious consequences for the seller than one detected later. But again clause 5.1 is
not addressing the loss which Cavendish may incur from a particular breach. The
relevant questions are broader, namely (i) whether Cavendish had a legitimate
interest in the circumstances to protect its investment in the company and (ii)
whether the making of its later instalments of price depend upon each seller’s
performance of his clause 11.2 obligations was a manifestly excessive means of
protecting that interest.
277. Finally, I am not persuaded that the company’s entitlement to seek a
disgorgement of Mr El Makdessi’s profits arising from his breach of fiduciary duty
and the possibility that Cavendish itself might have a claim in damages if Mr El
Makdessi breached clause 11.2 after he ceased to be a director make the operation
of clause 5.1 exorbitant or unconscionable. The former is res inter alios acta as each
of Cavendish and the company have separate legal personality. Any award of
damages to Cavendish would be designed to place it in the same position financially
as if the contract had been performed. If an award of damages together with the price
reduction which clause 5.1 effects involved double counting, I would expect the
price reduction to be credited against the claim for damages.
278. In summary, I am persuaded that in the circumstances of this share purchase,
Cavendish had a very substantial legitimate interest to protect by making the
deferred consideration depend upon the continued loyalty of the sellers through their
compliance with the prohibitions in clause 11.2. I do not construe clause 5.1 as a
stipulation for punishment for breach; it is neither exorbitant nor unconscionable but
is commensurate with Cavendish’s legitimate interests. It may therefore be enforced.
279. Clause 5.6, which provides for the compulsory transfer of the defaulting
shareholder’s retained shareholding, is more difficult. But I have come to the view
that it also may be enforced. Mr El Makdessi does not contest the obligation placed
on the defaulting shareholder to transfer his shares on breach of contract. But he
challenges the price at which the compulsory transfer is to be effected, as the formula
for the calculation of the price excludes the value of goodwill.
280. There is again a strong argument, which Lord Neuberger and Lord Sumption
favour, that clause 5.6 is a primary obligation to which the rule against penalties
does not apply. But if all such clauses were treated as primary obligations, there
would be considerable scope for abuse. I construe the clause as a secondary
obligation, which is designed to deter (a) the sellers from breaching their clause 11.2
obligations and (b) a seller who is an employee from misconduct which damages
the interests of the Group and leads to summary dismissal (viz the Schedule 12
definition of “defaulting shareholder”).
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281. Clause 5.6, like clause 5.1, is not a provision which fixes the damages payable
for a breach of contract. It seeks to regulate the terms on which a defaulting
shareholder severs his connection with the company. It falls to be construed in the
context of the agreement as a whole, in which Cavendish agreed to pay a price for
the shares which it purchased on the basis that the sellers remained involved in the
company for transitional periods and complied with their clause 11.2 duties for at
least two years after they had exercised their put options under clause 15 or had
otherwise ceased to hold shares in the company. I think that Mr El Makdessi was
correct in accepting that, if a seller acted in breach of clause 11.2 by competing with
the company in any of the ways listed in that clause, Cavendish would act reasonably
in seeking to remove him from any involvement in the company, including by the
compulsory transfer of his shareholding. On the departure of the defaulting
shareholder, the company would lose both his work on its behalf and also his
valuable personal connections. It was readily foreseeable at the time of contracting
that the departure on default of either of the sellers would cause significant damage
to the company’s goodwill and thus materially reduce its value.
282. Against that background, the question for the court is whether the defaulting
shareholder option price, which was the net asset value of the company excluding
any goodwill value, was an exorbitant or unconscionable undervaluation when
measured against Cavendish’s legitimate interest in protecting its investment from
the risk of either of the sellers acting against the company’s interests. In my view,
the terms were harsh; but they were not exorbitant. They were not a punishment but,
in the particular context of the purchase of a marketing business in the Middle East,
were a legitimate means of encouraging the sellers to comply with their clause 11.2
obligations which were critical to Cavendish’s investment. Nor were the terms
unconscionable for any broader reason. The contract was negotiated in detail by
parties of relatively equal bargaining power and with skilled legal advice; a seller
could readily comply with the obligations in clause 11.2, which were, in Lord
Neaves’s words in Forrest & Barr (para 249 above), obligations in non faciendo, or
prohibitions.
283. For completeness, I comment on Mr Bloch’s suggestion that the court has a
power to modify the terms on which clause 5.6 would operate. In English law a
penalty clause cannot be enforced. For the reasons given by Lord Neuberger and
Lord Sumption in their judgment (at paras 84-87) I think that the decision of the
Court of Appeal in Jobson v Johnston was incorrect in so far as it modified a penalty
clause and should be overruled. In Scots law the statutory power of the court to
modify a penalty (para 252 above) does not extend to a penalty in support of a
primary obligation other than for payment of a sum of money. If there is in Scots
law a residual common law power of modification of penalties in support of primary
obligations such as to supply goods or services as in Craig v McBeath (above), I do
not see how the power of abatement can extend to modifying the price of a
compulsorily transferred asset.
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(b) in Mr Beavis’s appeal
284. I agree (a) that the relationship between ParkingEye and Mr Beavis was a
contractual relationship in the form of a licence and (b) that the parking charge
incurred on breach of the obligation to park for no more than two hours engages the
rule against penalties. If my analysis of the rule against penalties is correct, the only
relevant questions are (i) did ParkingEye have a legitimate interest to protect by the
imposition of the parking charge (ii) whether the level of the charge is exorbitant or
unconscionable.
285. This is because, first, the charge was not and did not purport to be a claim for
damages for any loss that ParkingEye would suffer as a result of a motorist
exceeding the two-hour maximum parking time. ParkingEye suffered no loss.
Secondly, the fact that the charge encouraged the motorist to comply with the terms
of the licence and deterred him or her from overstaying or parking irresponsibly
outside the marked parking bays did not make it a penalty. Deterrence in that sense
is not the test for a penalty.
286. ParkingEye had a legitimate interest to protect. It provided a service to its
clients, the owners of the retail park which leased units to retailers. It undertook to
manage the car park in a way which benefitted the owners and the retailers and also
the public seeking to visit units within the retail park by encouraging the public to
remain in the car park for no longer than two hours. ParkingEye imposed the parking
charge in order to encourage the prompt turnover of car parking spaces and also to
fund its own business activities and make a profit.
287. That legitimate interest would not justify the parking charge if it were out of
all proportion to that interest, or, in other words, exorbitant. In deciding whether the
charge was exorbitant, I think that the court can look at the statutorily authorised
practice of local authorities in England and Wales and also the recommendations of
the accredited trade association, the BPA. Neither is conclusive and the question is
ultimately a value judgment by the court. But local authority practice, the BPA
guidance, and also the evidence that it is common practice in the United Kingdom
to allow motorists to stay for two hours in such private car parks and then to impose
a charge of £85, support the view that such a charge was not manifestly excessive.
There was no other evidence that suggested otherwise. In so far as the criterion of
unconscionableness allows the court to address considerations other than the size of
the penalty in relation to the protected interest, the fact that motorists entering the
car park were given ample warning of both the time limit of their licence and the
amount of the charge also supports the view that the parking charge was not
unconscionable.
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288. I therefore conclude that the rule against penalties is no bar against the
enforcement of the parking charge imposed on Mr Beavis.
Mr Beavis’s other ground of appeal: the Unfair Terms in Consumer Contracts
Regulations 1999
289. I was initially in some doubt about the correct answer to this challenge. But
on further consideration I am persuaded for the reasons given by Lord Neuberger
and Lord Sumption and also by Lord Mance that the £85 charge did not infringe the
1999 Regulations.
Conclusion
290. I would therefore allow the appeal in Cavendish v El Makdessi and dismiss
the appeal in ParkingEye v Beavis and make the declarations that Lord Neuberger
and Lord Sumption propose in para 115 of their joint judgment.
LORD CLARKE:
291. I agree that the appeal in Cavendish should be allowed, that that in Beavis
should be dismissed and that we should make the declarations proposed by Lord
Neuberger and Lord Sumption. In reaching those conclusions I agree with the
reasoning of Lord Neuberger and Lord Sumption, Lord Mance and Lord Hodge,
save that on the question whether clauses 5.1 and 5.6 are capable of constituting
penalties, I agree with Lord Hodge in having an open mind about clause 5.1, and in
concluding that clause 5.6 is a secondary obligation – see paras 270 and 280
respectively. As to the relationship between penalties and forfeiture, my present
inclination is to agree with Lord Hodge (in para 227) and with Lord Mance (in paras
160 and 161) that in an appropriate case the court should ask first whether, as a
matter of construction, the clause is a penalty and, if it answers that question in the
negative, it should ask (where relevant) whether relief against forfeiture should be
granted in equity having regard to the position of each of the parties after the breach.
LORD TOULSON: (dissenting in part on ParkingEye Limited)
292. I agree with paras 116 to 187 of the judgment of Lord Mance and paras 216
to 283 of the judgment of Lord Hodge. In short, I agree with them on all points of
general principle about the doctrine of penalties, its interrelationship with forfeiture
and the application of the principles in the Cavendish case.
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293. On the essential nature of a penalty clause, I would highlight and endorse
Lord Hodge’s succinct statement at para 255 that “the correct test for a penalty is
whether the sum or remedy stipulated as a consequence of a breach of contract is
exorbitant or unconscionable when regard is had to the innocent party’s interest in
the performance of the contract”. Parties and courts should focus on that test, bearing
in mind a) that it is impossible to lay down abstract rules about what may or may
not be “extravagant or unconscionable”, because it depends on the particular facts
and circumstances established in the individual case (as Lord Halsbury said in the
Clydebank case, [1905] AC 6, 10, and Lord Parmoor said in the Dunlop case, [1915]
AC 79, 101), and b) that “exorbitant or unconscionable” are strong words. I agree
with Lord Mance (para 152) that the word “unconscionable” in this context means
much the same as “extravagant”.
294. On the inter-relationship between the law relating to penalties and forfeiture
clauses, I agree specifically with paras 160-161 of Lord Mance’s judgment and paras
227-230 of Lord Hodge’s judgment. Ms Smith argued in her written case and orally
that if relief were to be granted at all to Mr El Makedessi it should be pursuant to
the relief against forfeiture, because clauses such as 5.1 were properly to be regarded
as forfeiture clauses and the penalty doctrine was therefore not capable of being
applied. I would reject that argument for the reasons given by Lord Mance and Lord
Hodge. I agree with them that the proper approach is to consider first whether the
clause was an exorbitant provision to have included in the contract at the time when
it was made; and, if not, to consider next whether any relief should properly be
granted under the equitable doctrine of relief against forfeiture in the circumstances
at and after the time of the breach. As Lord Mance and Lord Hodge have noted, this
approach was followed by the Court of Appeal (Ackner, Kerr and Dillon LJJ) in
BICC plc v Bundy Corpn [1985] Ch 232. It is logical and just.
295. I disagree with the other members of the court in the parking case. Since I am
a lone voice of dissent and the judgments are already exceedingly long, I will state
my reasons briefly. Everyone agrees that there was a contract between Mr Beavis
and ParkingEye, but I begin by looking at what was the consideration for, and
essential content of, the contract. The parties were content to argue the case, as they
had in the Court of Appeal, on the basis that by using the car park Mr Beavis entered
into a contract by which he agreed to leave it within two hours; and that his failure
to do so was a breach of contract for which he agreed to pay £85 (subject to a
discount for prompt payment). Moore-Bick LJ expressed doubt whether this was the
correct analysis, and since this is a test case it is right to consider the matter.
296. Where parties intend to enter into legal relations, it does not require much to
constitute consideration. Some benefit must be conferred both ways; but the benefit
provided by the promisor does not have to be for the promisee personally; it may be
for some third party whom the promisee wishes to benefit. (This has nothing to do
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with the doctrine of privity.) Any act or promise in exchange for an act or promise
can constitute consideration.
297. In this case we are concerned with a car park forming an integral part of a
retail park occupied by a number of well-known chains. The use of the car park was
not merely a benefit to the user. It was of obvious benefit to the freeholder (and the
lessees of the retail outlets) that members of the public should be attracted to the
retail park by its availability, and that was no doubt why it was provided. As Mr
Christopher Butcher QC correctly submitted, the use of the car park by Mr Beavis
wassufficient consideration for a contract governing the terms of its usage. The form
of notice stated that “Parking is at the absolute discretion of the site”, but once a
motorist had parked he would obviously have to be given reasonable notice of a
requirement to leave.
298. The most important term of the contract was that the user was permitted to
stay for a maximum of two hours. That requirement was displayed in bigger and
bolder letters than anything else. There were subsidiary requirements; that the user
should not return within one hour after leaving; that parking should be within the
bays marked; and that certain bays were restricted to use by blue badge holders (ie
persons with mobility problems). The contract further stated, although this was not
legally necessary, that “By parking within the car park, motorists agree to comply
with the car park regulations”, meaning the provisions stated in the notice (since
there were no other regulations). Overstaying would therefore be a breach of
contract (as, for example, would be parking except within the lines of an appropriate
marked bay). In the case of a breach of any description, the user agree to pay the
sum of £85. This was therefore, as the parties rightly accepted, an agreement to pay
a specified figure for a breach of contract. It was not an agreement allowing a
motorist to overstay in consideration of a payment of £85. On overstaying (or for
that matter on returning within one hour after leaving the car park) the user would
be a trespasser. We are not concerned in this case whether the agreement to pay £85
would leave the landowner free to sue the user for damages for trespass, although
he would no doubt in theory be entitled to seek injunctive relief.
299. It is convenient to consider the effect of the Unfair Terms in Consumer
Contracts Regulations 1999 (“the Regulations”) before considering the effect of the
common law on penalty clauses. Regulation 8(1) provides that an unfair term in a
contract concluded with a consumer by a seller or supplier shall not be binding on
the consumer. An unfair term is defined in regulation 5(1):
“A contractual term which has not been individually negotiated
shall be regarded as unfair if, contrary to the requirement of
good faith, it causes a significant imbalance in the parties’
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rights and obligations arising under the contract, to the
detriment of the consumer.”
300. Regulation 6(1) requires the question of unfairness to be assessed, taking into
account the nature of the goods or services, and by referring to all the circumstances
at the time of the conclusion of the contract and to all the other terms of the contract.
301. Regulation 6(2) excludes from the assessment of fairness terms (provided
that they are in plain intelligible language) relating to the definition of the main
subject matter of the contract or to the adequacy of the price or remuneration, as
against the goods or services supplied in exchange. The term which levies £85 on a
user of the car park who overstays, or returns within an hour or parks badly, does
not provide remuneration for the services of ParkingEye, nor does it relate to the
definition of the subject matter of the contract. It is simply a penalty for doing one
of the things prohibited. Its enforceability depends on whether it satisfies the
requirement of fairness within the meaning of the Regulations.
302. Schedule 2 to the Regulations provides an indicative list of terms which may
be considered unfair, including a term requiring a consumer who fails to fulfil his
obligation to pay a disproportionately high sum in compensation.
303. The Regulations give effect to the European Council Directive 93/13/EEC of
5 April 1993 on unfair terms in consumer contracts (“the Directive”). Article 3(1)
of the Directive is the counterpart to regulation 5(1) and is identically worded.
304. In Director General of Fair Trading v First National Bank plc [2001] UKHL
52, [2002] 1 AC 481, para 17, Lord Bingham described this provision as laying
down a composite test, covering both the making and the substance of the contract,
which must be applied bearing in mind the object which the Regulations are
designed to promote. He said that fair dealing requires that the supplier should not,
deliberately or unconsciously, take advantage of the consumer’s necessity,
indigence, lack of experience, unfamiliarity with the subject matter of the contract,
weak bargaining position or any factor listed in or analogous to those listed in the
Schedule.
305. In the same case Lord Millett, at para 54, suggested as a matter for
consideration whether, as between parties negotiating freely a contract on level
terms, the party adversely affected by the term “or his lawyer” might reasonably be
expected to object to it.
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306. More recently in Aziz v Caixa d’Estalvis de Catalunya, Tarragona i Manresa
(Case C-415/11) [2013] 3 CMLR 89, the Court of Justice of the European Union
has addressed the interpretation of article 3(1) of the Directive. It observed (at para
44) that the system of protection introduced by the Directive is based on the idea
that the consumer is in a weak position vis-à-vis the seller or supplier.
307. In agreement with the opinion of Advocate General Kokott, the court held
that the reference in article 3(1) to a “significant imbalance” in the parties’ rights
and obligations under the contract must be interpreted as requiring the court to
evaluate to what extent the term places the consumer in a worse position than would
have been the situation under the relevant national law in the absence of that term.
Applying that test, it follows that the £85 penalty clause created a significant
imbalance within the meaning of the regulation, because it far exceeded any amount
which was otherwise likely to be recoverable as damages for breach of contract or
trespass.
308. As to whether the imbalance was contrary to the requirement of good faith,
the court, at para 76 in agreement with the Advocate General held that
“in order to assess whether the imbalance arises ‘contrary to the
requirement of good faith’, it must be determined whether the
seller or supplier, dealing fairly and equitably with the
consumer, could reasonably assume that the consumer would
have agreed to the term concerned in individual contract
negotiations.”
309. That test is significantly more favourable to the consumer than would be
applied by a court in this country under the penalty doctrine. Whereas the starting
point at common law is that parties should be kept to their bargains, and it is for
those objecting that a clause is penal to establish its exorbitant nature, the starting
point of the Directive is that the consumer needs special protection, and it is for the
supplier to show that a non-core term which is significantly disadvantageous to the
consumer, as compared with the ordinary operation of the law without that term, is
one which the supplier can fairly assume that the consumer would have agreed in
individual negotiations on level terms. The burden is on the supplier to adduce the
evidence necessary to justify that conclusion.
310. I do not consider that such an assumption could fairly be made in the present
case. The Consumers’ Association through Mr Butcher advanced a number of telling
points. By most people’s standards £85 is a substantial sum of money. Mr Butcher
reminded the court by way of comparison that the basic state pension is £115 per
week. There may be many reasons why the user of a car park in a retail park may
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unintentionally overstay by a short period. There may be congestion in the shops or
the user may be held up for any number of reasons. There may be congestion trying
to get out of the car park. In short there may be numerous unforeseen circumstances.
No allowance is made for disabilities (other than the provision of bays for blue badge
holders). Similarly there may be good reasons for a person to return to the car park
within two hours, for example because the shopper has left something behind (and
the car park may incidentally be half empty). There may be reasons why a user parks
with his wheels outside the marked bay (for example because of the way the adjacent
vehicle is parked or because he is a wheelchair user and none of the blue bays are
available). Examples could be multiplied. The point is that the penalty clause makes
no allowance for circumstances, allows no period of grace and provides no room for
adjustment.
311. The court was referred to a code of practice published by the British Parking
Association which addresses some of these matters, but the significant fact is that it
is not a contractual document. A competent lawyer representing a user in individual
negotiation might be expected, among other things, to argue that the supplier should
at least commit to following the code of practice.
312. More broadly the penalty clause places the whole cost of running the car park
on the shoulders of those who overstay by possibly a very short time, although their
contribution to the cost will have been very small. The trial judge and the Court of
Appeal were impressed by a comparison with the charges at local authority car
parks. The comparison is seductive but superficial. Apart from the fact that local
authorities operate under a different statutory scheme, a large amount of the cost is
raised from all users by hourly charges, as distinct from placing the entire burden on
the minority of overstayers; and there is not the same feature in the case of a
municipal car park as there is in a supermarket car park, where the car park is
ancillary to the use of the retail units some of whose customers are then required to
underwrite the entire cost as a result of overstaying.
313. There is of course an artificiality in postulating a hypothetical negotiation
between the supplier and an individual customer with the same access to legal
advice, but because it is a consumer contract, and because the supplier is inserting a
term which alters the legal effect under the core terms in the supplier’s favour, the
supplier requires as it were to put itself in the customer’s shoes and consider whether
it “can reasonably assume that the customer would have agreed” to it.
314. I am not persuaded that it would be reasonable to make that assumption in
this case and I would therefore have allowed the appeal. It has been suggested that
managing the effective use of parking space in the interests of the retailer and the
users of those outlets who wished to find spaces to park could only work by deterring
people from occupying space for a long time. But that is a guess. It may be so; it
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may not. ParkingEye called no evidence on the point. But it is common knowledge
that many supermarket car parks make no such charge. I return to the point that it
was for ParkingEye to show the factual grounds on which it could reasonably
assume that a customer using that car park would have agreed, in individual
negotiations, to pay £85 if he overstayed for a minute, or parked with his wheels not
entirely within a marked bay, or for whatever reason returned to the car park in less
than one hour (perhaps because he had left something behind). On the bare
information which was placed before the court, I am not persuaded that ParkingEye
has shown grounds for assuming that a party who was in a position to bargain
individually, and who was advised by a competent lawyer, would have agreed to the
penalty clause as it stood.
315. Lord Neuberger and Lord Sumption in para 107 have substituted their
judgment of reasonableness of the clause for the question whether the supplier could
reasonably have assumed that the customer would have agreed with the term, and
on that approach there is not much, if any, difference in substance from the test
whether it offended the penalty doctrine at common law. That approach is consistent
with their statement in para 104 that the considerations which show that it is not a
penalty demonstrate also that it does not offend the Regulations. I consider that the
approach waters down the test adopted by the CJEU and at the very least that the
point is not acte clair.
316. Mr Beavis’s argument that the clause was a penalty at common law is more
questionable, but in the circumstances nothing would be gained by discussing that
matter further.