Act: Bartos: Balfour + Manson LLP, Solicitors, Edinburgh (for Ness Gallagher & Co, Motherwell) (Pursuers & Appellants)

Alt: Cheyne: Lindsays, Solicitors, Edinburgh (for Macdonalds, Solicitors, Glasgow) (First and Second Defenders & Respondents)

3 August 2011

Introduction

[1] This is an appeal at the instance of the pursuers from a judgment of the Temporary Sheriff Principal of South Strathclyde, Dumfries and Galloway, sitting at Hamilton, recalling an interlocutor of the Sheriff dated 12 February 2010, sustaining the defenders' first plea-in-law and assoilzing the defenders from the crave of the writ.

[2] The substantive crave of the initial writ in the action is, at present, for payment of the sum of £35,000 (the pursuers have intimated an intention to amend to substitute a higher sum). The basis upon which the pursuers sue the action is an obligation contained in a Minute of Agreement among the parties dated and registered in the Books of Council and Session on 28 February 2007. The issue between the pursuers on the one hand and the defenders on the other, is focused by the defenders' first plea-in-law which is as follows: "The contractual provision providing that the First and Second Defenders are to make payment to the Pursuers constitutes a penalty and is unenforceable and accordingly Decree of Absolvitor ought to be granted with a finding in expenses in favour of the First and Second Defenders."

The Minute of Agreement

[3] The Minute of Agreement contemplated the development by the first defender (referred to therein as "SMG") and the second defender ("Bett") of subjects of which they were to become proprietors at Morningside, Wishaw (the "MTS site") and the development by the pursuers ("the Hill Family") of nearby subjects of which they were proprietors (the "Hill Family Site").

[4] The Minute of Agreement provided, inter alia, as follows:

"Further Considering that to facilitate the development of the MTS Site, Bett and SMG are to install a sewage system which will connect the MTS Site with the public sewage system in Newmains by way of a pipe, the line of which is shown coloured red on the plan number 1 annexed and executed as relative hereto.

Further Considering that it has been agreed that to facilitate the development of the Hill Family Site, the Hill Family will be entitled to connect to the said sewage system at no cost to them.

Bett and SMG confirm that the said sewerage system will comply in all respects with the requirements of North Lanarkshire Council as planning authority, Scottish Water and any other interested Statutory authority that the said sewerage system will have the capacity as at the date of installation of the said systems to serve the development being not more than forty, two storey residential units to be erected by the Hill Family on the Hill Family site and in the event of any alteration, upgrading or improvement of the said sewerage system as proposed is required in order to provide said capacity as at the date of installation of the systems, all costs incurred in that regard will be the sole responsibility of Bett and SMG and the Hill Family shall have no responsibility whatsoever for any such costs incurred.

Further Considering that to facilitate the development of the MTS Site, Bett and SMG will be installing a surface/storm water drainage system in their respective parts of the MTS Site.

Further Considering that to facilitate the development of the Hill Family Site, the Hill Family will be entitled to connect to the said surface/storm water system at no cost to them.

...

Bett and SMG undertake that they will use all reasonable endeavours to ensure that both the sewerage and surface/storm water systems will be completed and commissioned by 28^th March 2008 ("the Longstop Date"); But declaring that the Longstop Date shall be extended to take account of any delays caused to the said programme as a result of force majeure. In the event that Bett and SMG have not completed the said works by the Longstop Date, as such date may be extended as aforesaid, then the Hill Family shall be entitled to receive payment from Bett and SMG, jointly and severally, of a penalty of Five Thousand Pounds (£5,000) per calendar month until the said systems are completed and commissioned".

The final paragraph, which we have emphasised by italics is the particular provision of the contract upon which the action proceeds.

The action

[5] The parties came to be in dispute over completion of the sewerage and surface/storm water systems and the consequential obligation, if any, of the defenders to make payment under the Minute of Agreement. The pursuers raised the action in the Sheriff Court at Hamilton. Warrant to cite was granted on 31 March 2009. The Record was closed on 30 July 2009.

[6] In the Closed Record as amended, the pursuers aver that the sewerage and surface/storm water systems were not completed by the Longstop Date of 28 March 2008 and that payment fell due. They aver that payments were made up to and including December 2008 but not thereafter and that therefore the defenders are liable to make payment to them of a sum computed at the rate of £5000 per month until completion in terms of the Minute of Agreement. The crave in the sum of £35,000 therefore reflects what the pursuers maintain was the position as at July 2009. Counsel at the hearing of the appeal advised that it is the position of the pursuers that the system has not been completed even yet and that it would be his intention to seek leave to amend the pleadings to increase the sum sued for accordingly, should the pursuers succeed in the appeal. In their pleadings the defenders accept that the system was not completed by the Longstop Date. They do not accept that it was not completed as at December 2008. However, irrespective of whether that is so, consistent with their first plea-in-law the defenders make this averment in the penultimate sentence of Answer 6: "Explained and averred that the terms of the Minute of Agreement providing that the First and Second Defenders are to make payments of £5000 per month to the Pursuers constitute a penalty and as such is unenforceable." As was emphasised by counsel for the pursuers in the course of the argument before us, that penultimate sentence of Answer 6 contains the only averments made by the defenders in relation to the provision being an unenforceable penalty. By way of reply the pursuers deny that the provision constitutes a penalty. They aver that the sum of £5000 is based on a genuine pre-estimate of the pursuers' loss, that it is not extravagant and that it is not in terrorem. They go on to aver as follows:

"In negotiating the payment of £5,000 per month in advance of signing the Minute of Agreement hereinbefore condescended upon, the Pursuers reasonably estimated that upon the sale of the 'Hill Family site', a minimum price of £1,500,000 would be achieved. The Pursuers reasonably estimated a rate of return on investing that sum of money of 4%. At that time, the Pursuers had investments with the Royal Bank of Scotland receiving a return of 5%. A copy of a letter from Royal Bank of Scotland to Mr R T Hill dated 23^rd July 2009 is produced in process and referred to for its terms. A rate of return of 4% on £1,500,000 achieves a figure of £60,000 or £5,000 per month. The 'Hill Family site' was marketed for sale by the Pursuers with Whyte and Barrie Commercial, Chartered Surveyors, 32 Campbell Street, Hamilton, in November 2007. The property was marketed at offers over £1,500,000. The Second Defenders offered to purchase the 'Hill Family site' in terms of an offer (undated) sent to Messrs Whyte and Barrie, Chartered Surveyors, for the sum of £1,007.050. A copy of that offer is produced in process and referred to for its terms. Ultimately, a closing date was fixed on the marketing of the property for 14^th February 2008 and four offers were received at prices ranging from £1,105,000 to £2,100,000. The highest offer was accepted. That offer in the sum of £2,100,000 was subject to the deduction of any abnormal costs not to exceed £500,000 resulting in a 'net' price after this deduction of not less than £1,600,000. Due to the deterioration in the housing market that offer did not lead to the sale of the 'Hill Family site'".

Procedure in the Sheriff Court

[7] Parties went to debate before the Sheriff on 9 November 2009. The defenders' motion was for dismissal in terms of their first and fourth (a general plea to the relevancy and specification of the pursuers' pleadings) pleas-in-law. The pursuers' motion was to uphold their second plea-in-law (a plea to relevancy) to the extent of excluding from probation the penultimate sentence of Answer 6. These being the only averments in support of the Defenders' first plea-in-law it followed from the pursuers' submission that that plea should be repelled. The Sheriff upheld the pursuers' submissions and in terms of her interlocutor of 12 February 2010, sustained the pursuers' second plea-in-law to the extent of excluding the identified averments from probation, repelled the defenders' first and fourth pleas-in-law and allowed proof on the parties' remaining averments.

[8] The defenders appealed to the Sheriff Principal. As we have already indicated, the Temporary Sheriff Principal allowed the appeal and pronounced decree of absolvitor (as parties were to agree before this Court, per incuriam, in that all the defenders could have sought at that stage was dismissal). We shall have occasion to return to his reasoning, but, putting it shortly, the Temporary Sheriff Principal held that the provision imposed a liability to make payment on the occurrence of what was a breach of contract; that it was therefore potentially an unenforceable penalty clause; that while it was for the party seeking to show that the clause is a penalty to raise the issue it was then for the party relying on the clause to demonstrate that it was a genuine pre-estimate of losses or damage caused by the breach; that the defenders had raised the issue; that the pursuers had averred sufficient to enable them to lead evidence as to the genuineness of the provision as a pre-estimate of their loss; but that because there were no averments on behalf of the pursuers that but for the failure to complete the system by the Longstop Date they would have been able to sell their site and realise the return contemplated, they could not succeed.

Discussion and decision

[9] The motion made by Mr Bartos on behalf of the pursuers, as appellants in this Court, was to recall the interlocutor of the Sheriff Principal and restore the interlocutor of the Sheriff, thereby allowing a proof on what would be the only outstanding issues: whether the system has been completed in terms of the Minute of Agreement and, if so, when. Mr Cheyne, on behalf of the defenders, moved that the Court adhere to the interlocutor of the Sheriff Principal.

[10] There was no dispute as between counsel as to what was the context in which the issues arose, what were these issues, and what were the applicable legal principles.

[11] The context is the law's attempt to resolve the tension between competing principles: on the one hand, as Lord Justice Clerk Inglis put it in Craig v M'Beath (1863) 1 M 1020 at 1022, "it is not legal to stipulate for punishment" and, on the other, as Lord Blackburn said in Caledonian Rly Co v North British Rly Co (1881) 8R (HL) 23 at 31, "a bargain is a bargain". Hence the uncontroversial rules that Lord Macfadyen summarised in paragraph [15] of his Opinion in City Inn Ltd v Shepherd Construction Ltd 2002 SLT 781:

"For a contractual provision to be regarded as imposing a penalty, and therefore as being unenforceable, it must, in my opinion, stipulate for payment by one party to another of a sum of money which (a) is payable on the occurrence of a breach of contract committed by the former party (EFT Commercial Ltd v Security Change Ltd 1992 SC 414), and (b) does not constitute a genuine pre-estimate of the loss likely to be suffered by the latter party as a result of the relevant breach of contract, but is instead unconscionable in respect that it is designed to operate in terrorem, or oppressively or punitively (Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co [1915] AC 79, per Lord Dunedin at 86, para 2; Clydebank Engineering and Shipbuilding Co v Castaneda (1904) 7F (HL) 77; AMEV UDC Finance Ltd v Austin (1987) 68 ALR 185)."

[12] In presenting the appeal on behalf of the pursuers, Mr Bartos identified two issues as arising:

(1) In terms of the contract is the sum of £5,000 per month due in consequence of the breach of the contractual obligation? and

(2) Esto it is due in consequence of a breach, is it exorbitant and unconscionable and designed to operate in terrorem?.

If either question was to be answered in the negative, then the provision was not an enforceable penalty and, for as long as the system remained uncompleted, the defenders were due to make payment to the pursuers at the rate of £5,000 per month.

[13] Mr Bartos first turned to issue (1). He submitted that the relevant obligation imposed by the Minute of Agreement was to "use all reasonable endeavours" to ensure completion and commissioning of the system by the Longstop Date. That was a quite different obligation from an obligation to ensure completion and commissioning by the Longstop Date. It was conceivable that the defenders might not achieve completion by the relevant date and yet, because they had used all reasonable endeavours they would not be in breach of contract. Payment depended on the Longstop Date being reached without completion of the system irrespective of whether the defenders were in breach. There was no mention of breach of contract in the pleadings. Rather this was an action for payment based on the non-occurrence of a specified event. The obligation to pay did not depend on a breach of contract and therefore, when regard was had to the rules summarised by Lord Macfadyen in City Inns Ltd supra, there could be no question of it being an unforceable penalty. Mr Cheyne's response on behalf of the defenders and respondents was to submit that, properly construed, a failure to complete by the Longstop Date constituted a breach of the defenders' obligation. The primary obligation was to complete the systems by the Longstop Date, but that obligation was, he said, subject to the qualification that the defenders only required to use reasonable endeavours to do so. Thus, he submitted failure to complete the systems by that date amounted to a breach of contract.

[14] We are not persuaded that Mr Cheyne's formulation of the obligation is, in any discernible way, different from an obligation to use all reasonable endeavours to ensure completion by the Longstop Date. Neither do we consider that the Sheriff Principal's treatment of the matter at paragraphs 68 to 72 of his judgment really engages with the argument put forward by Mr Bartos. In the cases to which the Sheriff Principal refers, Robertson v Driver's Trustees [1881] 8 R 555 and City Inn Ltd supra, failures to complete by a specified date were held to amount to breach of contract. However, the wording in each of these cases is different from that in the present case. In Robertson v Driver's Trustees (supra) Lord Young, supra at 562, refers to "a distinct time bargain and a stipulation by the parties that if the contractor failed to complete the contract within the time distinctly limited" and in City Inn Ltd Lord Macfadyen quotes an obligation on the contractor that he shall "regularly and diligently proceed with the works and shall complete the same on or before the Completion Date". These would seem to be cases where there was an obligation on the contractor to complete by a stipulated date and an associated provision providing for payment on failure to achieve that. We therefore do not agree with the Sheriff Principal when he says that it appears to him impossible to distinguish the type of clause in the present case from that dealt with by Lord Macfadyen in City Inn Ltd. We see force in Mr Bartos' contention that the relevant obligation here was one to use all reasonable endeavours and that while failure to complete by the Longstop Date might indicate that the defenders had not used all reasonable endeavours and therefore were in breach of the obligation, failure to complete, by itself, could not be said to amount to a breach of contract. However, it is a nice question and, given our conclusion on the second issue it is not one on which we require to come to a concluded view. We therefore approach the second issue on the assumption that the provision might be said to be one arising on a breach of contract by the defenders.

[15] On the assumption that the payment provision was seen to impose an obligation which arose on a breach of contract, Mr Bartos submitted that it was for the party in breach to plead and establish the grounds upon which the obligation to pay was exorbitant and unconscionable and therefore unenforceable as a penalty: Craig v McBeath supra; and Cameron-Head v Cameron & Co 1919 SC 627 at 632 and 634. Among the errors made by the Sheriff Principal was that which related to the onus of proof when a question arose as to whether a provision was or was not an unenforceable penalty. The Sheriff Principal had misunderstood what had been submitted to him on behalf of the pursuers. It was not the case, as stated by the Sheriff Principal at paragraph 73 of his judgment, that while it was for the party seeking to show that the clause is a penalty to raise the issue it was then for the party relying upon the clause to demonstrate that it was a genuine pre-estimate of losses or of damage caused by breach of contract which gave rise to the entitlement to payment. Rather, it is the party who has asserted that a provision was a penalty to establish, by averment and evidence, that it was indeed exorbitant and unconscionable and designed to operate in terrorem. The Sheriff Principal therefore erred in approaching the matter on the basis that the question was whether the pursuers had made sufficient relevant and specific averments to enable them to lead evidence to demonstrate that the provision was a genuine pre-estimate of damage. It was, of course, open to the pursuers to attempt to do this by way of answering the defenders' averment that the provision was an unenforceable penalty, but that did not alter the fact that the onus lay on the defenders and, accordingly, the primary question was whether the defenders had made sufficient specific averments to support their proposition. Here the defenders had provided no more by way of averment than the penultimate sentence of answer 6. That was limited to the assertion that the provision constituted a penalty and as such was unenforceable. There was nothing further which would allow the defenders to lead evidence to show why this might be so. The Sheriff Principal should accordingly have upheld the Sheriff's interlocutor.

[16] However, the Sheriff Principal's error did not cease at that point. In the assessment of whether a payment provision is exorbitant or unconscionable, a court required to look at the position as at the date of the contract, and not the date of the breach, parties having at that earlier point of conclusion of the contract a wide discretion in fixing the amount of pre-estimated damages: Clydebank Engineering & Shipbuilding Co Ltd v Castaneda supra at 82 at 84, Dunlop Pneumatic Tyre Co Ltd v New Garage Motor Co Ltd supra at 101. The proper approach for the Court was to consider whether 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: Dunlop Pneumatic Tyre supra at 87. Moreover, stipulating for pre-estimated damages is recognised as a useful means of allowing the need for proof of a loss caused by breach and accordingly, the party founding on such provision does not need to prove such loss: Clydebank Engineering supra at 83 and Dunlop Pneumatic Tyre supra at 95. The Sheriff Principal failed to appreciate this. Having held that the pursuers had averred sufficient to enable them to lead evidence as to the genuineness of their pre-estimate of loss in the event of breach (albeit, it is indicated above, it was with the sufficiency of the defenders' averments that he should primarily have been concerned), he went on to hold the pursuers' case to be irrelevant because the pursuers' averments disclosed that the reason for which the projected sale of the Hill Family site fell through was not the delay in completion of the system but, rather, because of a deterioration in the housing market. He was simply not entitled to do that. Whether a party suing on a liquidated damages provision in the contract had in the actual event suffered damage in consequence of the breach was irrelevant.

[17] In reply Mr Cheyne focused on the pursuers' averments which were intended to answer the defenders' contention that the provision was an unenforceable penalty clause. These averments were irrelevant. The Sheriff Principal was entitled to decide as he had.

[18] We agree with the submissions of counsel for the pursuers in relation to the second issue. It was for the defenders, as the parties claiming that the provision was an unenforceable penalty clause to make averments in support of that proposition. This they singularly have failed to do. Whether a provision falls to be regarded as an unenforceable penalty is to be determined by reference to the position as at the date of the conclusion of the contract and not the date of its breach. This does not necessarily have the result that averments relating to events occurring subsequent to breach are wholly irrelevant. Such averments may in some cases throw a light on whether or not there was a genuine pre-estimate of damage: Phillips Hong Kong Ltd v The Attorney General of Hong Kong [1993] 61BLR 41. On that view it cannot be said that the pursuers' averments about their attempt to sell the Hill Family site were irrelevant but, as we have already indicated, the critical anterior question, which the Sheriff Principal failed to consider, was whether the defenders had made averments in support of their contention that the provision was an unenforceable penalty. It appears from his judgment that the Sheriff Principal considered that it was for the pursuers not only to establish that the provision was a genuine pre-estimate of damages but that the supposed breach of contract had given rise to a loss of the sort that the pre-estimate had been directed at quantifying. There is in our view no such requirement. As was submitted on behalf of the pursuers, the whole purpose of a provision such as that found here is to obviate the need for proof; not only proof as to how the loss should be quantified but also proof that the loss had in fact occurred.

[19] We shall therefore allow the appeal, recall the interlocutor of the Sheriff Principal dated 19 August 2010 and restore the interlocutor of the Sheriff dated 12 February 2010. We shall reserve all questions of expenses.