UK Top Court Reigns Supreme on Penalties (7–0 and 6–1)

Warren Ganesh and Lydia Mak, Smyth & Co in association with RPC

To soccer fans who watch the English game, it may seem a hundred years or so in the making but there finally appears to have been a more positive outcome in connection with penalties on English or (for that matter) European soil.

In a recent landmark decision in Cavendish Square Holding BV v El Makdessi and ParkingEye Ltd v Beavis [2015] UKSC 67, the UK Supreme Court held that a better test than the traditional test (of "deterrence" and a "genuine pre-estimate of loss") for determining whether on the facts a clause is a penalty is (per Lord Neuberger and Lord Sumption, in an interesting joint judgment, at para. 32):

"… 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 difference between the traditional test (Re Dunlop Pneumatic Tyre Co Ltd [1915] AC 79) and the new formulated test matters – for example, liquidated damages clauses and forfeiture type clauses in a variety of forms are common in commercial agreements.

The new test is likely to herald a less interventionist approach by common law courts. In both cases, the validity of the disputed clause(s) was upheld on the facts (in Cavendish 7–0; in ParkingEye 6–1, with a dissenting judgment that appears somewhat incongruous). Cavendish (among other things) concerned the withholding of instalments under a deferred consideration clause; ParkingEye (as the name hints) concerned an excess parking charge.

The judgment has practical consequences and should provide for more commercial flexibility. The rule against penalties only applies to "secondary" obligations which provide for monetary type relief or loss (as opposed to damages) in the event that a party breaches a "primary" obligation. If the rule is engaged, in deciding whether a contractual provision is unenforceable, it is legitimate to consider the enforcing party's wider interests, rather than a narrow assessment of whether the provision is a "genuine pre-estimate of loss".

The UK Supreme Court's judgment should be of considerable persuasive force in Hong Kong and it will be only a matter of time before the Court of Final Appeal ("CFA") revisits the issue.

In Polyset Ltd v Panhandat Ltd [2002] 3 HKLRD 319, the majority of the CFA (albeit strictly obiter) referred to the traditional test ("genuine pre-estimate of loss") for penalties in a liquidated damages context (in contrast to, for example, contractual deposits). However, Litton NPJ's forceful partial dissent (on the facts), to the effect that in applying the equitable rule against penalties "the threshold for the court's intervention is necessarily high" as between business people dealing with each other at arm’s length (at para. 156), now looks increasingly persuasive in the local circumstances of Hong Kong (Solicitor v Law Society of Hong Kong (2008) 11 HKCFAR 117, at paras. 16–17)*.

As a passing observation, the judgment in Cavendish and ParkingEye is some 120 pages; one might marvel at a lawyer in a civil jurisdiction who is simply able to look up the relevant provision in (for example) a commercial code?



* Sounding uncannily similar to Cavendish and ParkingEye, albeit 13 years earlier, Litton NPJ also states that (Polyset at para. 155):

"…Lord Diplock expressed the equitable rule against penalties succinctly and accurately in Photo Production Ltd v Securicor Transport Ltd [1980] AC 827 at p.850F when he said:

… [the agreement] must not impose upon the breaker of a primary obligation a general secondary obligation to pay to the other party a sum of money that is manifestly intended to be in excess of the amount which would fully compensate the other party for the loss sustained by him in consequence of the breach of the primary obligation. (Emphasis added.)"