United Kingdom Supreme Court

The law in relation to penalties

“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.”

In what circumstances is the penalty rule engaged?

“[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.

What makes a contractual provision penal?

“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, 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.”

“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.”

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.

“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 (which will usually amount to the same thing) “extravagant” by reference to some norm.

“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 ...”

Should the penalty rule be abrogated?

Should the penalty rule be extended?

The first appeal: Cavendish v El Makdessi

The factual and procedural history

“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.”

Was clause 5.1 contrary to the penalty rule?

Was clause 5.6 contrary to the penalty rule?

“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 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.”

The second appeal: ParkingEye v Beavis

The factual and procedural history

“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 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”.

“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.

Parking charges and the penalty rule

“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.”

Parking charges and the Unfair Terms in Consumer Contracts Regulations 1999

“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

“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”.

“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).

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).

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 two-hour limit is exceeded. And if the consumer considers that the circumstances are unusual, he or she can invoke the appeals procedure.

Conclusion on the two appeals

LORD MANCE:

Introduction

“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 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

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 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:

‘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:

‘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 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. …”

“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 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

“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.

This car park is private property.”

The issues

The concept of a penalty

“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 torpedo-boat 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”.

“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.”

“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 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.”

“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.”

“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 ...”

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)”.

“… 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 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.”

“I have also found valuable Colman J’s further observation[s] in Lordsvale at pp 763g-764a, which indicate that a dichotomy 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.”

Can the penalty doctrine apply to clauses withholding payments?

The relationship between the penalty doctrine and relief against forfeiture

Should the penalty doctrine be abolished or restricted?

Application of the penalty doctrine - Cavendish

“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 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.

“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 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.”

Application of the penalty doctrine - ParkingEye Limited v Beavis

“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

“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.

“(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).

“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 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.”

“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.”

“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 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.”

“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.”

Conclusion

LORD HODGE:

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?

The scope of the rule against penalties

“1. Though the parties to a contract who use the words ‘penalty’ or ‘liquidated damages’ may prima facie be supposed 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).

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).”

(a) The clauses to which the rule against penalties applies

“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.

(b) The true test for a penalty

“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.”

“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.

“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.

“[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.

“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 ...”

(ii) Whether the rule against penalties should be abrogated or altered?

The application of the rule against penalties:

(a) in the Cavendish appeal

(b) in Mr Beavis’s appeal

Mr Beavis’s other ground of appeal: the Unfair Terms in Consumer Contracts Regulations 1999

Conclusion

LORD CLARKE:

LORD TOULSON: (dissenting in part on ParkingEye Limited)

“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.”

“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.”