Welcome clarification of penalty clauses

Posted on: November 10th, 2015

After a century of waiting, in the jointly heard case of Cavendish Square Holding BV v El Makdessi and ParkingEye Ltd v Beavis [2015] UKSC 67 the Supreme Court has finally clarified the law in relation to penalty clauses and their enforceability.
Until this case, the established doctrine set out by Lord Dunedin in Dunlop Pneumatic Tyre Co v New Garage and Motor Co Ltd [1915] AC 394 prevailed. Distinctions were made between clauses providing a genuine pre-estimate of loss and unenforceable penal clauses, and between clauses pursuing genuine commercial aims and unenforceable “deterrent” clauses. However, not all clauses obviously fall within these contrasting categories. Even if the amount required by a clause bears no relationship to the loss actually attributable to the breach, it will not necessarily be a penalty if it can be shown that there is a legitimate reason why compensation for the actual loss suffered would not be sufficient. Similarly, to describe a clause as a deterrent adds nothing if the party imposing a penalty has a genuine commercial interest in doing so.
As such, the majority of the Supreme Court held that the real question in each case 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”. When determining this, the wider commercial context of a transaction will be a relevant consideration, as will whether the parties have been professionally advised when negotiating the contract. If they have, then the judgment provides strong support for the Courts shying away from interfering with the parties’ bargain thus leading to more certainty in contracts between commercial parties.