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Archive for November, 2015

Contractual penalty clauses

Two cases heard together by the Supreme Court raised an issue, to quote Lord Neuberger and Lord Sumption “which has not been considered by the Supreme Court or by the House of Lords for a century, namely the principles underlying the law relating to contractual penalty clauses, or, as we will call it, the penalty rule” (Cavendish Square Holding BV v Talal El Makdessi and ParkingEye Limited v Beavis [2015] UKSC 67).

Generally speaking, the courts are very reluctant to add, omit or redraft contractual terms agreed between parties.  However, for centuries, judges have opposed one party attempting to recover a monetary sum for breach by another party of a contractual obligation (a primary obligation) and regulating the remedy for a breach of that obligation (a secondary obligation).

Their Lordships said “The penalty rule in England is an ancient, haphazardly constructed edifice which has not weathered well, and which in the opinion of some should simply be demolished, and in the opinion of others should be reconstructed and extended.  For many years, the courts have struggled to apply standard tests formulated more than a century ago for relatively simple transactions to altogether more complex situations.  The application of the rule is often adventitious.  The test for distinguishing penal from other principles is unclear.”

They therefore set out the test to be applied: “The true test 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.”

We wait to see how this test is applied in the future.