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||Neutral Citation Number:  EWCA Civ 385
||Case No: B2/2005/0340
IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM LIVERPOOL COUNTY COURT
HIS HONOUR JUDGE MACKAY
||Royal Courts of Justice
Strand, London, WC2A 2LL
||6th April 2006
B e f o r e :
LORD JUSTICE CHADWICK
LORD JUSTICE MOORE-BICK
MR JUSTICE LAWRENCE COLLINS
EURO LONDON APPOINTMENTS LIMITED
||- and -
||CLAESSENS INTERNATIONAL LIMITED
(Transcript of the Handed Down Judgment of
Smith Bernal WordWave Limited
190 Fleet Street, London EC4A 2AG
Tel No: 020 7421 4040 Fax No: 020 7831 8838
Official Shorthand Writers to the Court)
Mr John Pugh (instructed by Berkson & Berkson, 40 Hamilton Square, Birkenhead, Merseyside, CH41 5BP) for the Appellant
Mr Russell Bailey (instructed by Downs, 156 High Street, Dorking, Surrey, RH4 1BQ) for the Respondent
HTML VERSION OF JUDGMENT
Crown Copyright ©
LORD JUSTICE CHADWICK :
- This is an appeal from an order made on 7 February 2005 by His Honour Judge Mackay in the Liverpool County Court in proceedings brought by Euro London Appointments Limited, an employment agency, against its client, Claessens International Limited. The issue raised by the appeal is whether the claimant's standard terms and conditions include a provision which is in the nature of a penalty and so unenforceable.
The claimant's terms of business
- The claimant's terms of business for the introduction to clients of permanent and contract staff provide for the payment of a fee by the client for an "Introduction" resulting in an "Engagement". Those expressions are defined in clause 1:
"'Engagement' means the engagement, employment or use of the Applicant by the Client or any third party on a permanent or temporary basis, whether under a contract of service or for services; under an agency, licence, franchise or partnership agreement; or any other engagement; directly or through a limited company of which he is an officer or employee.
'Introduction' means (i) the Client's interview of an Applicant in person or by telephone, following the Client's instruction to the Agency to search for an Applicant; or (ii) the passing to the Client of a curriculum vitae or other information which identifies the Applicant; and which leads to an Engagement of that Applicant by the Client".
In that context "the Agency" is Euro London Appointments Limited; "the Applicant" is the person introduced by the Agency to the Client for an Engagement; and "the Client" is the person to whom the Applicant is introduced.
- Clause 3.2 of the terms of business provides that (save in a case where the Client decides to withdraw an offer of Engagement before the Engagement has commenced) no fee is payable by the Client until the Applicant commences the Engagement. The Agency will then invoice the Client. Payment is to be made within 7 days of the date of the invoice – clause 3.1(c). The Agency may charge interest on invoiced amounts unpaid for more than 7 days at the rate of 4% per annum above the National Westminster Bank base rate – clause 3.3.
- Clause 3.4 is in these terms:
"The fee payable to the Agency by the Client for an Introduction resulting in an Engagement is calculated in accordance with the accompanying Fee Structure on the Remuneration applicable during the first 12 months of the Engagement. VAT will be charged on the fee if applicable."
"Remuneration" is a defined term; but it is unnecessary, for the purposes of this appeal, to set out that definition. Where remuneration includes a salary of an amount which is between £25,000 and £35,000 per annum the relevant Fee Structure provides for payment of a fee at the rate of 20% of the salary.
- Clause 4 provides for a refund of fees in a case where the Engagement terminates prematurely. The clause is in these terms:
"4.1 In order to qualify for the following refund, the Client must pay the Agency's fee within 7 days of the date of invoice and must notify the Agency in writing of the termination of the Engagement within 7 days of its termination.
4.2 If the Engagement terminates before the expiry of 12 weeks from the commencement of the Engagement (except where the Applicant is made redundant) the fee will be refunded in accordance with the accompanying Scale of Refund set out in the schedule to these Terms of Business.
4.3 Should the Client or any subsidiary or associated Agency of the Client subsequently engage or re-engage the Applicant within the period of 6 calendar months from the date of termination of the Engagement or withdrawal of the offer, a full fee calculated in accordance with clause 3.4 above becomes payable, with no entitlement to the refund."
- The Scale of Refund is set out in the schedule:
"1. The following scale of refund only applies in the event that the Client complies with the provisions of clause 3.1 of these Terms of Business.
2. Where the Applicant leaves during the first 12 weeks of the Engagement, a partial refund of the introduction fee shall be paid to the Client in accordance with the scale set out below, subject to the conditions in clause 4.1
|Week in which the Applicant leaves
||% of introduction fee refunded
3. There will be no refund where the Applicant leaves during or after the 13th week of the Engagement."
- As I have said, the principle that no fee is payable by the Client until the Applicant commences the Engagement is qualified in one respect. Clause 5.1 provides that if, after an offer of Engagement has been made by the Client to the Applicant, the Client decides for any reason to withdraw that offer, the Client shall be liable to pay the Agency "a minimum fee of one third of the annual Remuneration". The position, therefore, is that if the Client changes its mind between making an offer of Engagement and the acceptance of that offer by the Applicant, it becomes liable to a fee which may be greater than that which would have been payable (under the Fee Structure) if the Engagement had commenced (say, 20% of annual salary); and, in that case, there is no provision for refund.
The underlying facts
- The claim in the present proceedings is for introduction fees due to the Agency in respect of the Introduction of two Applicants to Claessens International Limited, as Client, in January 2004. The first of those Applicants, Ms Sandra Benhamed, was engaged by the Client as business development manager with effect from 5 January 2004, at a salary of £30,000. The fee payable in respect of her introduction (at 20% of salary) was £6,000. The second Applicant, Ms Claudia Ehrke, was engaged by the Client, with effect from the same date, 5 January 2004, as German account manager, also at a salary of £30,000. It had been agreed that the fee should be charged at a concessionary rate of 19% of salary – so the fee payable in respect of her introduction was £5,700. On 5 January 2004 the Agency issued invoices claiming payment of those introduction fees, with VAT. The total amount payable under the two invoices (inclusive of VAT) was £13,747.50. It is common ground that the Client did not pay the invoiced amount (or any amount) within 7 days of the date of the two invoices.
- Neither applicant remained in employment for 12 weeks. Ms Ehrke resigned on 16 January 2004. Her last working day was 22 January 2004. On the basis that she left in the third week after her Engagement, the refund to which the Client would have been entitled under clause 4.2 of the terms of business was 80% - that is to say, an amount (on fees of £5,700) of £4,560. Setting that amount against the amount payable under the relevant invoice, the balance would be £1,140 - or £1,339.50 with the addition of VAT.
- Ms Benhamed was dismissed in February 2004. Her last working day was 26 February 2004. On the basis that she left in the eighth week after her Engagement, the refund to which the Client would have been entitled under clause 4.2 was 40% - that is to say, an amount (on fees of £6,000) of £2,400. Setting that amount against the relevant invoice, the balance would be £3,600 - or £4,230 with the addition of VAT. That sum (£4,230) was paid by the Client on 5 March 2004.
- The Agency did not accept that the Client was entitled to refunds under clause 4.2.: it relied on clause 4.1 of the terms of business. The Client had not paid the Agency's fee within 7 days of the invoice date and so, it was said, the Client did not qualify for a refund in either case.
- These proceedings were commenced by a claim form issued on 24 March 2004 in the Northampton County Court. The amount claimed by the Agency was £13,547.77; but that included £3,978.27 claimed as a fee payable in respect of a temporary worker, Ms S.A. Struck. The balance (£9,517.50) was the sum of the two invoices of 5 January 2004 after deduction of the £4,230 paid on 5 March 2004. On 27 April 2004 the Client served a defence, admitting that £3,978.27 was due in respect of the temporary worker (but asserting that that sum had been paid since proceedings were commenced) and admitting that £1,339.50 was due in respect of the introduction of Ms Ehrke. That sum (£1,339.50), of course, is the amount that would be due if the Client were entitled to deduct the amounts claimed as refunds under clause 4.2 of the terms of business.
- On 11 June 2004 the Agency applied for summary judgment on the claim for £9,517.50 On 23 August 2004 the Client applied to amend its defence to add a further paragraph – paragraph 6 - in these terms:
"6. In so far as the Claimant relies upon clause 4.1 of its standard terms and conditions to deprive the Defendant of the benefit of the discount the Defendant contends that upon its proper construction clause 4.1 is a penalty clause and therefore unenforceable. In particular:
(a) the clause purports to be triggered upon the breach of the payment obligation;
(b) the consequence of the clause being triggered is that the party in breach is deprived of a substantial benefit;
(c) the value of the benefit is not a genuine pre-estimate of the loss flowing from the breach;
(d) clause 3.3 already provides a remedy for that very breach by the imposition of a liability for interest at 4% above the base rate of the National Westminster Bank."
Subject to permission to amend the defence being granted, the application notice of 23 August 2004 sought summary judgment for the defendant on the ground that the issue of the penalty clause would be decisive of the whole claim.
- Those applications came before District Judge Peake on 19 October 2004. He was sitting in the Birkenhead County Court, to which the proceedings had been transferred. The district judge allowed the amendment to the defence and gave judgment for the claimant in the sum admitted by the defendant (£1,339.50), with interest of £60 and costs (which he assessed at £1,224.50). He did so for reasons set out in the written judgment which he handed down on 3 November 2004. Put shortly, he found that clause 4.1 in the Agency's terms of business was a disguised penalty clause: the clause was included in order to reinforce the obligation in clause 3.1(c) that payment be made in 7 days but it had an effect that was 'disproportionate' and thus penal. So clause 4.1 could not be relied upon as an answer to the Client's claim to set-off the amounts that would otherwise be due, by way of refund, under clause 4.2 of the terms of business.
- The Agency appealed. The appeal came before His Honour Judge Mackay, sitting in the Liverpool County Court, on 7 February 2005. He dismissed the appeal and ordered the Agency to pay costs of £2,500. He set out the classic statement, in the speech of Lord Dunedin in Dunlop Pneumatic Tyre Company Limited v New Garage and Motor Car Company Limited  AC 79, that a stipulation:
". . . will be held to be a penalty if the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss which could conceivably be proved to have followed from the breach"
He referred to ECGD v Universal Oil Products Limited  2 AER 205 and Interfoto Picture Library Limited v Stiletto Visual Programmes Limited  1 AER 348. And he went on to say this:
"I have come to the conclusion that this is a difficult matter, but it is matter which I can see clearly. The clause, in my view, is a penalty clause. It is there to encourage prompt payment. Because of the manifestations of the effect of that clause it means that, for example, if an employee were to leave after a very short period of time, and a large refund would be applicable, a person who has not paid within the 7 days would not get that refund, and we could be talking about a substantial part of the amount of money which the client would owe the agency. It seems to me, therefore, that the conclusion could well be that the result of the operation would be, to use the words of the learned District Judge, 'disproportionate', which are inappropriate in the circumstances. A more appropriate use of wording would be 'extravagant and unconscionable'."
The issue on this appeal
- The Agency appeals to this Court. In granting permission for what is, of course, a second appeal, Lord Justice Mance said this:
"I think that this appeal raises a point of principle of sufficient interest and general importance to justify a second appeal. If clause 3.1(c) had not appeared in the contract, could clause 4.1 – on its face introducing a simple condition precedent to any right to a refund – have been treated as involving a penalty? And, if not, should the introduction of clause 3.1(c) make a difference? How far does the law of penalties extend to check stringent provisions, not involving payment of money or forfeiture of monetary claims already due or property already owned? . . ."
The rule against penalties
- The rule against penalties is an exception to the general principle of English law that a contract should be enforced in accordance with its terms. As Lord Justice Diplock pointed out in Philip Bernstein (Successors) Ltd v Lydiate Textiles Ltd, ( CA Transcript 238, reported sub nom Sterling Industrial Facilities v Lydiate Textiles Ltd 106 SJ 669) "the ordinary rule which the courts apply is that contracts should be enforced, pacta sunt servanda, unless they can be brought within that limited category of cases in which, for reasons of public policy, the court refuses to give effect to the agreement of the parties. . . . One limited and well-known class is the class of penalty". He summarised the principle underlying that class in these words:
"In the ordinary way a penalty is a sum which, by the terms of a contract, a promisor agrees to pay to the promisee in the event of non-performance by the promisor of one or more of the obligations and which is excess of the damage caused by such non-performance."
He observed that there was nothing to throw doubt on the proposition, accepted by Mr Justice Gorman in In re Apex Supply Co Ltd  Ch 108, that "the penalty area is limited to the narrow field which I have described". His statement of the principle was adopted by this Court in Export Credits Guarantee Department v Universal Oil Products Co and others  2 All ER 205, 215f-g, 217j.
- The relevant contractual provision in the ECGD case provided for the payment of a stated sum by one party to the contract (A) to the other party (B) in the event of the non-performance by A of one of more contractual obligations owed by A not to B himself but to C, who was not a party to the contract between A and B – (ibid, 218b-c, in the judgment of Lord Justice Slade). When that case went to the House of Lords, Lord Roskill (with whom the other members of the House agreed) observed,  1 WLR 399, 402H;  2 All ER, 205, 223f:
". . . the reason why the defendant's submissions failed in the courts below can be simply stated. The clause was not a penalty clause because it provided for payment of money on the happening of a specified event other than a breach of contractual duty owed by the contemplated payer to the contemplated payee."
The House was invited to extend the rule against penalties so as to bring the relevant clause within it (ibid, 403D; 223g-j). It declined to do so.
The application of the rule to the present case
- The provision of the agency agreement which is said to contravene the rule against penalties is the first limb of clause 4.1 – "In order to qualify for the following refund, the Client must pay the Agency's fee within 7 days of the date of invoice . . .". But, as Lord Justice Mance pointed out when giving permission to appeal, that provision is no more than a condition precedent. It imposes no obligation on the Client. It requires no payment of money. If it stood alone, the first limb of clause 4.1 could not be regarded as a penalty within the rule as summarised by Lord Justice Diplock in the Philip Bernstein case.
- The first limb of clause 4.1 does not stand alone. It must be read with paragraph (c) of clause 3.1 – "The Client agrees . . . (c) to pay the Agency's fee within 7 days of the date of invoice". When read together, it can be seen that the condition precedent in the first limb of clause 4.1 reflects the obligation imposed on the Client by clause 3.1(c). But it remains the position that the first limb of clause 4.1, of itself, imposes no obligation on the client. The question (again as Lord Justice Mance pointed out) is whether the link between the condition precedent in first limb of clause 4.1 and the obligation imposed by clause 3.1(c) brings the condition precedent within the rule against penalties.
- In my view the answer to that question is 'No'. The condition precedent in the first limb of clause 4.1 and the payment obligation imposed by clause 3.1(c) are not inter-dependent. The point can be illustrated by supposing a case where the agreement provided, in clause 3.1(c), that the Agency's fee be paid within, say, 14 days; but that, to qualify for refund under clause 4.1, the fee must be paid with 7 days. The commercial effect of the agreement would be unaltered – save that the Agency could not sue for its fee until the 14 days had elapsed. But, in that case, because failure to pay within the time limited by clause 4.1 would involve no breach of obligation on the part of the Client, the rule against penalties as summarised in the Philip Bernstein case would have no application. I can see no reason in principle why the position should not be the same in a case (such the present) where the time limited by clause 4.1 happens to be the same as that imposed by the payment obligation in clause 3.1(c). Although there may be practical considerations – and some obvious convenience – in having the same time limit in both clauses 4.1 and 3.1(c), the fact that the time limit is the same in the two clauses is of no legal relevance.
- In reaching that conclusion, I have not overlooked the fact that the link between the first limb of clause 4.1 and clause 3.1(c) is reflected in paragraph 1 of the Scale of Refund – "the following scale of refund only applies in the event that the Client complies with the provisions of Clause 3.1 of these Terms of Business". But, in that respect, paragraph 1 of the Scale of Refund adds nothing. The position would be the same – in relation to the question whether the condition precedent in first limb of clause 4.1 and the obligation imposed by clause 3.1(c) were or were not inter-dependent - if that paragraph had not been included. Paragraph 1 of the Scale of Refund has a wider purpose than that of linking the first limb of clause 4.1 with clause 3.1(c). It introduces, as an additional qualification for entitlement to refund, a requirement that there be prompt compliance with paragraphs (a) and (b) of clause 3.1.
- It follows that I would hold that the rule against penalties, as summarised by Lord Justice Diplock in the Philip Bernstein case, has no application in the present case.
A wider principle
- It was submitted on behalf of the respondent, in the course of oral argument, that, properly understood, the rule against penalties has a wider reach than the statement in the Philip Bernstein case might suggest; and that. properly understood, the contractual provisions in the agency agreement fall within that reach.
- In addressing that submission it is pertinent to have in mind that, as I have said, the House of Lords, when invited to take the opportunity in the ECGD case ( 2 All ER 205) to extend the rule against penalties, declined to do so. Lord Roskill said this (ibid, 223j-224d):
"[Counsel] invited your Lordships to look at the number of authorities in support of his proposition that the relevant law should now be extended, and contended that those authorities showed that the way remained open for such an extension. Those cases are referred to in the judgments of the courts below and I shall not refer to them again for, with respect, I am unable to find the slightest support in any of them for [Counsel's] submissions.
My Lords, one purpose, perhaps the main purpose, of the law relating to penalty clauses is to prevent a plaintiff recovering a sum of money in respect of a breach of contract committed by a defendant which bears little or no relationship to the loss actually suffered by the plaintiff as a result of the breach by the defendant. But it is not and never has been for the courts to relieve a party from the consequences of what may in the event prove to be an onerous or possibly even a commercially imprudent bargain. The defendants could only secure the finance from Kleinworts if the ECGD were prepared to give Kleinworts the guarantee which Kleinworts required. The ECGD were only prepared to give their guarantee to Kleinworts on the terms of the premium agreement which included the stringent right of recourse provided for in cl 7(1). The defendants accepted those terms which provided for the right of recourse to arise on the happening of a specified event, and that specified event has now happened. But, as . . . Lord Keith observed during the argument, this is not a case where the ECGD are seeking to recover more than their actual loss as compensation by way of damages for breach of a contract to which they were a party. They are seeking, and only seeking, to recover their actual loss, namely the sums which they became legally obliged to pay and have paid to Kleinworts. I am afraid I find it impossible to see how on the facts there can be any room for the invocation of the law relating to penalty clauses."
Those observations give little (if any) encouragement to the submission that what I may describe as the traditional statement of the rule against penalties can no longer be treated as definitive. But there is more recent authority (although not in the House of Lords) to which we were referred.
- We were taken – as was the judge - to the decision of this Court in Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd  1 All ER 348. The plaintiff had supplied photographic transparencies to the defendant, an advertising agency) on conditions which required that the transparencies be returned within 14 days from the date of delivery. Those conditions included the following term: "A holding fee of £5.00 plus VAT per day will be charged for each transparency which is retained by you longer than the said period of 14 days". The defendant failed to return the transparencies at the end of the 14 day period and the plaintiff sought to enforce the holding charge (which, in aggregate, amounted to a sum in excess of £3,780). The claim succeeded in the County Court. The appeal was allowed on the basis that, where a condition was particularly onerous or unusual and would not generally be known to the other party, the party seeking to rely upon it must show that it had fairly and reasonably been brought to the attention of the other party; and that that requirement was not met on the facts.
- The relevance of the Interfoto case, in the present context, lies in observations made in the judgments of the two members of the Court. Lord Justice Dillon said this (ibid, 350d-e):
"It has to be said, however, that the holding fee charged by the plaintiffs by condition 2 is extremely high and in my view exorbitant. . . . It would seem therefore that the defendants would have had a strong case for saying that condition 2 was void and unenforceable as a penalty clause; but that point was not taken in the court below or in the notice of appeal."
Lord Justice Bingham, after referring to "an overriding principle" recognised by the law of obligations "in many civil law systems, and perhaps in most legal systems outside the common law world" that "in making and carrying out contracts parties should act in good faith", explained that English law had committed itself to no such principle. He said this (ibid, 353a-b):
"English law . . . has developed piecemeal solutions in response to demonstrated problems of unfairness. Many examples could be given. Thus equity has intervened to strike down unconscionable bargains. Parliament has stepped in to regulate the imposition of exemption clauses and the form of certain hire-purchase agreements. The common law also has made its contribution, by holding that certain classes of contract require the utmost good faith, by treating as irrecoverable what purport to be agreed estimates of damage but are in truth a disguised penalty for breach, and in many other ways."
He reached the conclusion (ibid, 357j) that the defendant was to be relieved of the liability which clause 2 of the plaintiff's standard terms sought to impose because the plaintiff had not done "what was necessary to draw this unreasonable and extortionate clause fairly to [the defendant's] attention". But he went on to say this, in the final paragraph of his judgment (ibid, 358a-b):
"In reaching the conclusion I have expressed I would not wish to be taken as deciding that condition 2 was not challengeable as a disguised penalty clause. This point was not argued before the judge nor raised in the notice of appeal. It was accordingly not argued before us. I have accordingly felt bound to assume, somewhat reluctantly, that condition 2 would be enforceable if fully and fairly brought to the defendants' attention."
- It can be said, of course, that the question whether the clause on which the plaintiff sought to rely in the Interfoto case was a penalty did not arise for decision. But, nevertheless, the observations which I have set out must be given due weight. If I may say so, I share the view that the clause under consideration in that case must be regarded as vulnerable to attack under the rule against penalties. But for the attempt to present the charge for late return of the transparencies as a "holding fee", it would have been unarguable that the charge of £5 per day was not a penalty within the statement of the rule in the Philip Bernstein case. The charge was a sum which the defendant agreed to pay to the plaintiff in the event of non-performance by the defendant of its contractual obligation to return the transparencies within 14 days and which was in excess of the damage caused to the plaintiff by such non-performance. In referring to the clause as "a disguised penalty clause", Lord Justice Bingham was pointing out that, if that was the true nature of the bargain, the clause could not be taken outside the rule against penalties by presenting the charge as a "holding fee". Save in that respect (if at all), his observations do not go beyond Lord Justice Diplock's statement of the rule, in the Philip Bernstein case.
- But this is not a case in which the relevant provisions in clause 4.1 of the agency agreement and paragraph 1 of the Scale of Refund impose any charge or payment obligation. As I have already explained, those provisions have effect as conditions precedent to entitlement to refund. They impose no charge and deprive the Client of no benefit to which it would be otherwise entitled. They define the circumstances in which the right to refund arises: they do not defeat the right to refund when it arises, nor any other existing right to refund. Further, as I shall show later in this judgment, those provisions meet a commercial need which arises directly out of the fact that the parties have decided to make provision for some entitlement to refund. That need is independent of any wish which the Agency might otherwise have to ensure that payment obligations were met promptly. It would arise whether or not clause 3.1(c) imposed the payment obligation which it does.
- We were taken to the decision of Mr Justice Coleman in Lordsvale Finance Plc v Bank of Zambia  QB 752. The plaintiff was assignee of monies due from the defendant bank under syndicated loan agreements. The loan agreements provided for the payment of interest in the event of default at an uplifted rate. The point, so far as material in the present context, is set out in the judgment in these terms (ibid, 761E):
"The defendants contend that, inasmuch as the constituents of the default interest under article 10.03(A) include at (i) 1 per cent., a rate completely unexplained, in addition to the margin (defined in article 1 as 11/2 per cent) and the cost of obtaining dollar deposits to fund the bank's participation, the 1 per cent is a penalty. It is said to be in terrorem the borrower, its sole function being to ensure compliance with the agreements. . . . "
Mr Justice Coleman, in a passage which has been cited with approval in two subsequent decisions in this Court – Cine Bes Filmcilik ve Yapimcilik and another v United International Pictures and others  EWCA Civ 1669, , and Murray v Leisureplay Plc  EWCA Civ 963,  – directed himself (ibid, 762H) that the speeches in Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd  AC 79 showed that:
". . . whether a provision is to be treated as a penalty is a matter of construction to be resolved by asking whether at the time the contract was entered into the predominant contractual function of the provision was to deter a party from breaking the contract or to compensate the innocent party for breach. That the contractual function is deterrent rather than compensatory can be deduced by comparing the amount that would be payable on breach with the loss that might be sustained if breach occurred."
He accepted (ibid, 763B-C) that a clause which sought to provide that, on the happening of a default, the rate of interest payable on a loan were to be increased with retrospective effect would "have all the indicia of a penalty". But he held that the position was different where, on default, the increase in the rate was prospective. That was not because, in latter case, there was "in any real sense a genuine pre-estimate of loss", but because there was "a good commercial reason for deducing that deterrence of breach is not the dominant contractual purpose of the term". He went on (ibid, 763H-764A) to explain that:
". . . the jurisdiction in relation to penalty clauses is concerned not primarily with the enforcement of inoffensive liquidated damages clauses but rather with protection against the effect of penalty clauses. There would seem to be no reason in principle why a contractual provision the effect of which was to increase the consideration payable under an executory contract upon the happening of a default should be struck down as a penalty if the increase could in the circumstances be explained as commercially justifiable, provided always that its dominant purpose was not to deter the other party from breach."
The test of "commercial justification" was endorsed by Lord Justice Mance in the Cine Bes case  EWCA Civ 1669,  and by Lord Justice Buxton in Murray v Leisureplay  EWCA Civ 963, .
- The decision in the Lordsville case throws no light on the question whether the link between the condition precedent in first limb of clause 4.1 and the obligation imposed by clause 3.1(c) brings the condition precedent within the reach of the rule against penalties. But it does assist on the secondary or consequential question: if the link between the condition precedent and the payment obligation does bring the condition precedent within the reach of the rule against penalties, is the condition precedent struck down by that rule. It shows that that secondary question may turn on the dominant contractual purpose of the condition precedent. Or, to put the point another way: is the condition precedent properly to be treated as a disguised penalty clause.
Dominant contractual purpose
- There is, of course, no doubt that the condition precedent is intended to encourage early payment of the introduction fee. But it does not follow that that its dominant contractual purpose is to avoid interest loss. Indeed, as I have pointed out, the effect of clause 3.3 is that clause 4.1 is not needed for that purpose. If (which I doubt) the secondary question – what is the dominant contractual purpose of the condition precedent - arises in the present case, the decision in the Lordsville case shows that, in order to answer that question, it is necessary to examine the relationship between the Agency, the Applicant and the Client in order to set clause 4.1 in its commercial context.
- The Agency becomes entitled to payment of a fee when an Introduction which it has made leads to the Engagement of the Applicant by the Client. It is not the Introduction alone which entitles the Agency to payment – no matter what expense it may have incurred in searching for and identifying a suitable Applicant, or in passing information to the Client. Payment is earned only when the following conditions are satisfied: (i) the Client decides that the Applicant meets its requirements and makes an offer of Engagement; (ii) the offer is accepted by the Applicant, leading to the commencement of the Engagement (clause 3.2); or (iii) the offer is withdrawn before it is accepted (clause 5.1). No fee is payable if: (iv) the Client does not make an offer of Engagement; or (v) the Client makes an offer of Engagement which the Applicant does not accept.
- It can be seen, therefore, that the effect of the standard terms is that the Agency takes the risk that it will have provided an Introduction for no reward in cases (iv) and (v) - where the Introduction leads to no offer of Engagement and where the Introduction leads to an offer of Engagement but the Applicant decides not to accept the offer. The latter may be seen as a case where the Applicant (who may be taken to have invited an offer) changes his mind. But (as might be expected) the Agency does not take that risk in case (iii) - where the Introduction leads to an offer of Engagement which is withdrawn before acceptance. That may be seen as a case where the Client changes its mind. But it was necessary, also, to make some provision for cases where the Introduction leads to an offer of Engagement which is accepted but terminates prematurely – that is to say, cases which in which either the Client or the Applicant has a change of mind shortly after commencement of the Engagement. Who – as between Agency and Client – is to bear the risk, in those cases, that the Introduction will prove to be of little or no value.
- It is for those cases that clause 4.2 of the standard terms – read with the Scale of Refund - makes provision. The effect of clause 4.2 and the Scale of Refund is that the Agency bears the whole of the risk that it will have provided an Introduction for no reward in cases where the Engagement terminates in the first two weeks after commencement; and bears no such risk where the Engagement continues for twelve weeks or more. Between those parameters, the risk is shared between the Agency and the Client. That is the bargain which the parties have made.
- That bargain is made on terms. To adapt the words of Lord Roskill in the ECGD case, the Client could only secure the promise of a refund which it required on terms which made the entitlement to refund conditional upon compliance with the requirements in clause 4.1 of the agreement and paragraph 1 of the Scale of Refund. First, clause 4.1 (to which reference is made in paragraph 2 of the Scale of Refund itself) which requires that there is to be no refund unless (i) the Client has paid the Agency's fee within seven days of the invoice date and (ii) the Client has notified the Agency in writing within seven days of the termination of the Engagement. Second, paragraph 1 of the Scale of Refund which requires that the Client shall have complied with the provisions of clause 3.1 of the Terms of Business. Clause 3.1 includes not only paragraph (c) – the obligation to pay the Agency's fee within 7 days of the invoice date – but also paragraphs (a) and (b). Clause 3.1(a) requires the Client to notify the Agency immediately of any offer of an Engagement which it makes to an Applicant. Clause 3.1(b) requires the Client to notify the Agency immediately that its offer of an Engagement has been accepted. Compliance with those requirements is as much a condition precedent to the right to refund under clause 4.2 as compliance with the payment requirement in clause 3.1(c). And third, clause 4.3 which provides that, should the Applicant be re-engaged – within six months following termination of the Engagement in circumstances in which the Client was entitled to a refund – a full fee (calculated in accordance with clause 3.4) will become payable on re-engagement, with no further entitlement to a refund.
- The commercial imperative which underlies clause 4.3 is obvious. Clause 4.3 is needed to avoid a situation in which, within a few weeks after the Engagement has commenced, the Client terminates the contract of employment, claims a refund of the Agency's fee and then re-engages the Applicant without a further Introduction. It could not be suggested that the terms of clause 4.3 are extravagant or unconscionable.
- Paragraph 1 of the Scale of Refund is a condition precedent to the entitlement to refund. That paragraph encourages the Client to comply promptly with the requirements as to notification in paragraphs (a) and (b) of clause 3.1; as well as encouraging it to make prompt payment of the invoice – paragraph (c) of clause 3.1. Prompt compliance with the requirements as to notification is of obvious commercial importance to the Agency. It is by the Client's prompt compliance with the requirement in clause 3.1(b) that the Agency learns that a fee has become payable under clause 3.4. Further, prompt compliance with the requirement under clause 3.1(a) – if not followed by a notification under clause 3.1(b) – alerts the Agency to the possibility that a cancellation fee may have become payable under clause 5.1. It could not be suggested that those stipulations are not of such commercial importance to the Agency that paragraph 1 of the Scale of Refund – in so far as it requires compliance with those stipulations as a condition precedent to the entitlement to refund – is extravagant or unconscionable.
- Prompt notification that the Engagement has terminated – required under the second limb of paragraph 4.1 - is a further condition precedent to the entitlement to refund. Again, that stipulation is of obvious commercial importance to the Agency. Prompt notification that an Engagement has terminated within the twelve week period alerts the Agency to the need to provide for the refund which it will be obliged to make: it enables the Agency to maintain proper control of its cash flow and to identify that a potential liability has crystallised. It could be said that, far from being extravagant or unconscionable, the second limb of clause 4.1 is essential if the Agency is to conduct its affairs responsibly.
- It is within that context that the parties have agreed to the condition precedent which finds expression in the first limb of clause 4.1 and in paragraph 1 of the Scale of Refund – in so far as that paragraph requires compliance with the payment obligation in clause 3.1(c). The commercial need for prompt compliance with the payment obligation goes beyond the interest loss which the Agency suffers as a result of late payment. And, in any event, clause 3.3 is included in order to avoid that loss. The need for prompt compliance with the payment obligation goes directly to the credit risk which the Agency is willing to accept. The likely effect of the refund provisions (absent the condition precedent as to prompt payment) would be that the Client would not make any payment to the Agency until the end of the twelve week period. If the Client could set-off the potential refund against the introduction fee, it would have a powerful incentive to withhold payment of the introduction fee until it knew whether or not there would be a refund due. In the meantime, the Agency would bear the credit risk. The inclusion of the condition precedent as to prompt payment counters the incentive to withhold payment: it provides a powerful incentive (perhaps, a more powerful incentive) to make payment of the introduction fee before it is known whether there will be a refund due. The Client bears the credit risk. The allocation of the credit risk over the twelve week period to the Client – rather than to the Agency – is, as it seems to me, the dominant contractual purpose of the condition precedent in the first limb of clause 4.1 and (by reference) in paragraph 1 of the Scale of Refund.
- It follows, if I were wrong in my view that, on a true analysis, the link between the condition precedent in first limb of clause 4.1 and the obligation imposed by clause 3.1(c) does not bring the condition precedent within the reach of the rule against penalties, I would hold that the dominant contractual purpose underlying the condition precedent is not deterrence. There is no reason in principle why the condition precedent as to prompt payment in clause 4.1 of the agreement and (by reference) in paragraph 1 of the Scale of Refund should not be given effect.
- I would allow this appeal. I would set aside the order of 7 February 2005. Subject to any further submissions that counsel may wish to make on the computation of the judgment sum, I would vary the order of 19 October 2004 by substituting the sum of £9,517.50 for the sum of £1,339.50. There will need to be a corresponding adjustment to that figure for interest.
Lord Justice Moore-Bick:
- I agree.
Mr Justice Lawrence Collins:
- I also agree. The short answer to the Client's point on penalty is that the Agency was suing for its agreed fee. That cannot have been a penalty. It is true that in some cases (such as inadvertent failure to pay on time) the condition precedent in clause 4.1 could operate harshly to deprive a client of a refund to which it might otherwise have been entitled. In effect the Client was seeking relief against forfeiture of the refund. But clause 4.1 is not a forfeiture provision, and, even if it were, this is not the class of case where relief would have been available.
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