Lloyd's Maritime and Commercial Law Quarterly
DETERMINING PENALTIES AS A MATTER OF CONSTRUCTION
Francis Dawson*
Cavendish v Makdessi
In Cavendish Square Holding BV v Talal El Makdessi
1 the Supreme Court was invited to abrogate the doctrine of penalties on the ground that it was antiquated, anomalous and, given recent statutory reforms,2 unnecessary. The court declined to do so, noting that the doctrine was a long-standing principle of English law, mirrored in many other legal systems,3 and that it was broadly consistent with other well-established equitable doctrines, such as the equity of redemption and the rules providing for relief from forfeiture. Nevertheless, the court did consider it necessary to conduct an extensive reappraisal of the principles underlying the doctrine of penalties. In a number of lengthy opinions, their Lordships addressed the historical origins of the doctrine, its scope, whether it can be engaged by an event other than a breach, the circumstances which render a provision penal, and the interrelationship between the doctrine of penalties and that of the equitable doctrine of relief from forfeiture.
The court concluded that a contractual provision will not be a penalty unless the stipulation in question was a secondary obligation which imposed a detriment on a contracting party out of all proportion to the counterparty’s interest in performance.4 The court considered that the traditional dichotomy between a genuine pre-estimate of loss and a stipulation designed to be in terrorem of the defaulting party did not cover all the possibilities. There were clauses which operated on a breach, which were not genuine pre-estimates of the likely loss, but were nevertheless commercially justifiable and were not penalties.5 The determinative question in such cases was not whether a clause provided a genuine pre-estimate of the likely loss, but whether the relevant clause was intended to be penal,6 ie, does it impose a detriment which is extravagant by reference to the innocent party’s legitimate interest in the enforcement of the primary obligation.
In Cavendish, the defendant and his longstanding partner were the founders and major shareholders in an advertising company (the “Company”). They agreed to sell 47.4% of their shareholding in the Company to the plaintiffs, who already held 12.6% of the Company’s shares. Under the share purchase agreement, US$34m was made payable to the sellers on completion, and a further sum of US$31.5m was made payable after certain agreed restructurings took place. Thereafter two further payments were to be made (hereafter the “deferred payments”). Both of the deferred payments were to be calculated on the basis of an agreed multiple of after-tax profits in forthcoming financial years and were to be made after the financial statements for those years had been settled. There was an overall cap on the sum payable under the agreement of US$147.5m.
1. [2015] UKSC 67; [2016] 1 Lloyd’s Rep 55; [2015] 3 WLR 1373. The report also contains the reasons for the court’s disposition of the appeal in Parking Eye Ltd v Beavis. This note will focus exclusively on the Cavendish decision.
2. Consumer Rights Act 2015, replacing the Unfair Terms in Consumer Contracts Regulations 1999.
3. [2015] UKSC 67, [37–39] (Lord Neuberger and Lord Sumption), [165] (Lord Mance) and [262–265] (Lord Hodge).
4. Ibid, [12–13] and [32] (Lord Neuberger and Lord Sumption), [152] (Lord Mance) and [255] (Lord Hodge).
5. Ibid, [145] (Lord Mance) and [222–225] (Lord Hodge).
6. Ibid, [31] (Lord Neuberger and Lord Sumption), [152] (Lord Mance) and [255] (Lord Hodge).
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