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English Supreme Court Reformulates Test for Penalty Clauses
In its judgment in two appeals heard together, Cavendish Square Holdings BV v Talal El Makdessi and ParkingEye Limited v Beavis [2015] UKSC 67, the English Supreme Court has reformulated the test for penalty clauses.
Before this case, the test of whether a clause was a penalty clause or a liquidated damages clause was whether it represented a genuine pre-estimate of any loss likely to be sustained. The English Supreme Court has now reformulated this test to be whether the clause imposes a detriment on the contract-breaker that is out of all proportion to any legitimate interest of the innocent party in the enforcement of the contract-breaker’s obligations under the contract.
Two appeals were before the Supreme Court in respect of this judgment, Cavendish Square Holdings v Talal El Makdessi and ParkingEye Limited v Beavis.
Mr Makdessi was the founder of the largest advertising and marketing communications group in the Middle East. Mr Makdessi sold 60 percent of his company to Cavendish, and the consideration was to be paid to him in four tranches over several years.
The sale and purchase agreement also contained a restraint of trade clause. In the event that Mr Makdessi was in breach of the restraint of trade clause, he would not be entitled to any further payments of the consideration. In addition, Cavendish would be given an option to require Mr Makdessi to sell to it all of his remaining shares in his company at net asset value, without providing for any goodwill.
ParkingEye operated a car park at a retail park that provided free parking for two hours and charged a fine of £85 for overstaying. Mr Beavis overstayed by almost an hour and was fined £85
The English Supreme Court held in both cases that the relevant clauses were not penalty clauses.
In Cavendish v El Makdessi, the Supreme Court found that contractual clauses withholding payment of the unpaid consideration could be penalty clauses, however, in this case, Cavendish had a legitimate interest to protect. It could be said that Cavendish should not be required to pay for the value of the goodwill of the business that it had bought from Mr Makdessi when his breach of the restraint of trade clause would have substantially reduced the value of that goodwill.
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In respect to ParkingEye v Beavis, the Supreme Court used the same reasoning to find that there was a legitimate interest for ParkingEye to levy the fine, which extended beyond the recovery of any loss. In particular, ParkingEye sold its services to the landowners and met its costs of doing so from charges for breach of the terms.
The Supreme Court also appeared to take into account the interest of the landowners, who received a fee from ParkingEye to operate the scheme and who leased the sites to various retailers for whom the availability of customer parking was a valuable facility. The Supreme Court held that it could take into account the landowners’ interest because the penal character of the scheme could not depend on whether the landowner operated it or employed a contractor to operate it.
The English Supreme Court’s new test means that parties have more leeway in drafting “penalty” clauses to ensure their commercial interests are protected when entering into agreements. In this respect, although the Supreme Court’s ruling in this case is not binding on the Singapore courts, Singapore courts generally treat English judgments as persuasive, and it is likely that the Singapore courts will adopt a similar position.
Duane Morris & Selvam LLP is the joint law venture between Duane Morris LLP and Selvam LLC, with its headquarters in Singapore. Its global platform and extensive range of legal services position the firm to help companies conduct business in and out of Asia, the United States, Latin America, the United Kingdom and beyond. In addition to the excellent skills of its lawyers, clients benefit from the cultural fluency and key relationships that the firm has developed over many years of practising law throughout the region. The firm has a presence in the key markets of Southeast Asia, including Singapore, Hanoi, Ho Chi Minh City and Yangon, as well as an office in Shanghai. Supporting these regional offices, the firm operates a series of country desks for India, Indonesia, Nepal, Korea, Japan, the Philippines, Malaysia and Australia, as well as an alliance in Sri Lanka. It is regularly ranked among Singapore’s leading law firms by Chambers & Partners, The Legal 500 and IFLR1000.
Written by Tham Wei Chern.
Please contact Tham Wei Chern at wctham@selvam.com.sg for more information.
The content of this update is of general interest and is not intended to apply to specific circumstances. The content should not therefore, be regarded as constituting legal advice and should not be relied on as such.
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