In the hotly anticipated joint judgment on penalties, the Supreme Court has allowed the appeal in Cavendish v El Makdessi and dismissed the appeal in ParkingEye v Beavis [2015] UKSC 67, and held that none of the contractual terms complained of on the two appeals contravenes the penalty rule, and that the charge in issue in ParkingEye v Beavis does not infringe the Unfair Terms in Consumer Contracts Regulations (SI 1999/2083) (UTCCR). The UTCCR have now been replaced by the Consumer Rights Act 2015 but the unfair terms provisions are substantially the same. Neither case arose in an IT context but the decision is of significance to any lawyer drafting commercial or consumer contracts so it will be of interest to SCL members.
Before reaching its decision on the specific cases, the Supreme Court reviewed the development of the penalty rule (pointing out that it was the first time in a century that it had had the opportunity to do so) and decided that they weren’t going to abolish it: it still served a useful purpose. It had been argued during the hearing that there was no need for the penalty rule.
The Court noted that Lord Dunedin’s famous ‘four tests’ set out in the House of Lords in Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd [1914] UKHL 1 were fine for simple cases but didn’t work so well for those with more complex facts. In particular, the court said that the penalty rule only regulates the contractual remedy for the breach of a primary contractual obligation. It does not regulate the fairness of the primary obligation. In other words, the rule cannot be used by a party to get out of a bad bargain.
The rule can be invoked not only for the penalty clauses which require the payment or forfeiture of sums of money, but also in relation to the transfer of assets (including, for example, shares). The key question is whether the effect of the relevant clause is ‘extravagant’ or ‘unconscionable’ by reference to some norm.
The Court effectively came up with a new test:
‘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 facts of the cases
The cases were very different, with one arising in the consumer law arena and the other in a commercial context.
In Parkingeye, Mr Beavis drove into a car park managed by ParkingEye at a retail park in Chelmsford. Prominent signs stipulated that the maximum stay was two hours, after which a parking charge of £85 would be payable (reduced to £50 if paid within 14 days). He stayed nearly three hours and was charged £85, which he refused to pay. The High Court and Court of Appeal found in favour of ParkingEye. The issues on appeal to the Supreme Court were:
1. Whether a charge of £85 for exceeding a maximum car parking period was an unenforceable penalty?
2. Whether a charge of £85 for exceeding a maximum car parking period was unfair under the UTCCR?
The Supreme Court found that ParkingEye had a legitimate interest in charging the £85: controlling parking in the interests of retail outlets and their shoppers, and providing an income stream. Consequently it found that there was no penalty under common law, and that the term was not unfair under the UTCCR (although there was a dissenting judgment on the UTCCR point).
In Cavendish Square Holding BV v Talal El Makdessi the dispute concerned an agreement, under which Mr El Makdessi agreed to sell a controlling stake in what became the largest advertising group in the Middle East. Mr El Makdessi conceded that, if enforceable, he breached restrictive covenants contained in the agreement by reason of his ongoing, unpaid involvement in the affairs of a company called Carat. As a result, under clause 5.1, Mr El Makdessi would forfeit the final two instalments of deferred consideration payable by Cavendish for his shares. Under clause 5.6, Mr El Makdessi would be required to transfer all his remaining shares to Cavendish at a price which excluded any value referable to goodwill. Mr El Makdessi claimed that clauses 5.1 and 5.6 were unenforceable penalty clauses. The Court of Appeal, overturning the trial judge’s conclusions, agreed with Mr El Makdessi. The issues on appeal to the Supreme Court were:
1. Whether the rule against penalties applies to commercial contracts between sophisticated parties.
2. If the rule does apply to such contracts, whether clauses 5.1 and 5.6 are within the scope of the rule.
3. If the clauses are within the scope of the rule against penalties, whether the Court of Appeal was wrong to conclude that they were penal and therefore unenforceable.
The Supreme Court allowed the appeal. In relation to the first issue, the Court unanimously held that the penalty rule should not be abolished: to reverse such a long-standing principle of law would need the strongest of reasons. The rule, Lord Mance noted in his judgment, protects businesses, including small businesses, which may well have a need for it even though consumer reliance on the rule is now likely to have been negated due to protections in the Consumer Rights Act 2015. Neither clauses 5.1 or 5.6 were unenforceable penalties, although the judges reached this conclusion in different ways. Lord Neuberger and Lord Sumption felt that the penalty rule did not apply to the clauses at all. Clause 5.1 was, in essence, a price adjustment clause which triggered the payment of deferred payments conditional on Mr El Makdessi complying with his covenants. It was a primary obligation, rather than secondary, even though it only operated in the event of breach. Clause 5.6 was assessed in similar terms as a primary obligation. Lord Hodge considered the clauses to be secondary obligations and therefore subject to scrutiny under the penalty rule. While the losses suffered by Mr El Makdessi were very significant, Cavendish had a legitimate interest to protect the goodwill of the group. Although the terms were harsh, they were not exorbitant or unconscionable and it was relevant that the contract was negotiated in detail by parties of equal bargaining power and with skilled legal advice.
Implications for drafters of commercial and consumer contracts
Mr Beavis and Which? Have commented that the ruling in Parkingeye could now lead to people being more severely fined for things like missing appointments or being late for a nursery pick-up, or more significantly for IT lawyers, overusing wifi in a hotel. It is too early to say whether companies will be able to increase the burden on consumers, it seems unlikely with the Consumer Rights Act 2015 now being in force. Interestingly, as mentioned above, one judge dissented on the question of whether the charge was unfair under the UTCCR, considering that it was, which may give hope to people arguing similar points in future on slightly different facts and may lead businesses to think twice before imposing penalty-like obligations on their consumer customers.
Potentially of more interest to members of SCL is the impact on general commercial contracts, rather than consumer contracts. While such statements will not necessarily be conclusive in court proceedings, it may help a contracting party to state in a contract that a particular clause is to protect relevant business interests and is seen as being proportionate, to try to prevent the other side from arguing that the provision is an unenforceable penalty.
Helen Hart and Jon English are solicitors at LexisPSL Commercial. Both have extensive legal experience in private practice and as in-house legal advisers.
