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You are here: BAILII >> Databases >> United Kingdom Supreme Court >> Cavendish Square Holding BV v Talal El Makdessi (Rev 3) [2015] UKSC 67 (4 November 2015) URL: https://www.bailii.org/uk/cases/UKSC/2015/67.html Cite as: 162 Con LR 1, [2016] CILL 3769, [2015] 3 WLR 1373, [2016] RTR 8, [2016] BLR 1, [2015] WLR(D) 439, [2016] AC 1172, [2015] UKSC 67, [2016] 1 Lloyd's Rep 55 |
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[2015] UKSC 67
On appeal from: [2013] EWCA Civ 1539 and [2015] EWCA Civ 402
JUDGMENT
Cavendish Square Holding BV (Appellant) v Talal
El Makdessi
(Respondent)
ParkingEye Limited (Respondent) v Beavis (Appellant)
before
Lord Neuberger, President
Lord Mance
Lord Clarke
Lord Sumption
Lord Carnwath
Lord Toulson
Lord Hodge
JUDGMENT GIVEN ON
4 November 2015
Heard on 21, 22 and 23 July 2015
Appellant (Cavendish Square Holding BV) Joanna Smith QC Richard Leiper James McCreath Edwin Peel (Instructed by Squire Patton Boggs (UK) LLP) |
|
Respondent
(Talal El ![]() Michael Bloch QC Camilla Bingham QC (Instructed by Clifford Chance LLP) |
Appellant (Beavis) John de Waal QC David Lewis Ryan Hocking (Instructed by Harcus Sinclair) |
|
Respondent (ParkingEye Limited) Jonathan Kirk QC David Altaras Thomas Samuels (Instructed by Cubism Law) |
|
|
Intervener (Consumers’ Association) Christopher Butcher QC (Instructed by Consumers’ Association In-House Lawyers) |
LORD NEUBERGER AND LORD SUMPTION: (with whom Lord Carnwath agrees)
1.
These two appeals raise an issue 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. The first appeal, Cavendish Square Holding BV v Talal
El Makdessi,
raises the issue in relation to two clauses in a substantial
commercial contract. The second appeal, ParkingEye Ltd v Beavis, raises
the issue at a consumer level, and it also raises a separate issue under the
Unfair Terms in Consumer Contracts Regulations 1999 (SI 1999/2083) (“the 1999
Regulations”).
The law in relation to penalties
3. 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. As early as 1801, in Astley v Weldon (1801) 2 Bos & Pul 346, 350 Lord Eldon confessed himself, not for the first time, “much embarrassed in ascertaining the principle on which [the rule was] founded”. Eighty years later, in Wallis v Smith (1882) 21 Ch D 243, 256, Sir George Jessel MR, not a judge noted for confessing ignorance, observed that “The ground of that doctrine I do not know”. In 1966 Diplock LJ, not a judge given to recognising defeat, declared that he could “make no attempt, where so many others have failed, to rationalise this common law rule”: Robophone Facilities Ltd v Blank [1966] 1 WLR 1428, 1446. The task is no easier today. But unless the rule is to be abolished or substantially extended, its application to any but the clearest cases requires some underlying principle to be identified.
Equitable origins
4. The penalty rule originated in the equitable jurisdiction to relieve from defeasible bonds. These were promises under seal to pay a specified sum of money, subject to a proviso that they should cease to have effect on the satisfaction of a condition, usually performance of some other (“primary”) obligation. By the beginning of the 16th century, the practice had grown up of taking defeasible bonds to secure the performance obligations sounding in damages. This enabled the holder of the bond to bring his action in debt, which made it unnecessary for him to prove his loss and made it possible to stipulate for substantially more than his loss. The common law enforced the bonds according to their letter. But equity regarded the real intention of the parties as being that the bond should stand as security only, and restrained its enforcement at common law on terms that the debtor paid damages, interest and costs. The classic statement of this approach is that of Lord Thurlow LC in Sloman v Walter (1783) 1 Bro CC 418, 419:
“… where a penalty is inserted merely to secure the enjoyment of a collateral object, the enjoyment of the object is considered as the principal intent of the deed, and the penalty only as accessional, and, therefore, only to secure the damage really incurred ...”
“The true ground of relief against penalties is from the original intent of the case, where the penalty is designed only to secure money, and the court gives him all that he expected or desired: but it is quite otherwise in the present case. These penalties or forfeitures were never intended by way of compensation, for there can be none.”
This last reservation remained an important feature of the equitable jurisdiction to relieve. As Baggallay LJ put it in Protector Endowment Loan and Annuity Company v Grice (1880) 5 QBD 592, 595, “where the intent is not simply to secure a sum of money, or the enjoyment of a collateral object, equity does not relieve”.
The common law rule
6. The process by which the equitable rule was adopted by the common law is traced by Professor Simpson in his article The penal bond with conditional defeasance (1966) 82 LQR 392, 418-419. Towards the end of the 17th century, the courts of common law tentatively began to stay proceedings on a penal bond to secure a debt, unless the plaintiff was willing to accept a tender of the money, together with interest and costs. The rule was regularised and extended by two statutes of 1696 and 1705. Section 8 of the Administration of Justice Act 1696 (8 & 9 Will 3 c 11) is a prolix provision whose effect was that the plaintiff suing in the common law courts on a defeasible bond to secure the performance of covenants (not just debts) was permitted to plead the breaches and have his actual damages assessed. Judgment was entered on the bond, but execution was stayed upon payment of the assessed damages. The Administration of Justice Act 1705 (4 & 5 Anne c 16) allowed the defendant in an action on the bond to pay the amount of the actual loss, together with interest and costs, into court, and rely on the payment as a defence. These statutes were originally framed as facilities for plaintiffs suing on bonds. But by the end of the 18th century the common law courts had begun to treat the statutory procedures as mandatory, requiring damages to be pleaded and proved and staying all further proceedings on the bond: see Roles v Rosewell (1794) 5 TR 538, Hardy v Bern (1794) 5 TR 636. The effect of this legislation was thus to make it unnecessary to proceed separately in chancery for relief from the penalty and in the courts of common law for the true loss. As a result, the equitable jurisdiction was rarely invoked, and the further development of the penalty rule was entirely the work of the courts of common law.
8. With the gradual decline of the use of penal defeasible bonds, the common law on penalties was developed almost entirely in the context of damages clauses – ie clauses which provided for payment of a specified sum in place of common law damages. Because they were a contractual substitute for common law damages, they could not in any meaningful sense be regarded as a mere security for their payment. If the agreed sum was a penalty, it was treated as unenforceable. Starting with the decisions in Astley in 1801 and Kemble v Farren (1829) 6 Bing 141, the common law courts introduced the now familiar distinction between a provision for the payment of a sum representing a genuine pre-estimate of damages and a penalty clause in which the sum was out of all proportion to any damages liable to be suffered. By the middle of the 19th century, this rule was well established. In Betts v Burch (1859) 4 H & N 506, 509, Martin B regretted that he was “bound by the cases” and prevented from holding that “parties are at liberty to enter into any bargain they please” so that “if they have made an improvident bargain they must take the consequences”. But Bramwell B (at p 511) appeared to have no such reservations.
9. The distinction between a clause providing for a genuine pre-estimate of damages and a penalty clause has remained fundamental to the modern law, as it is currently understood. The question whether a damages clause is a penalty falls to be decided as a matter of construction, therefore as at the time that it is agreed: Public Works Comr v Hills [1906] AC 368, 376; Webster v Bosanquet [1912] AC 394; Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79, at pp 86-87 (Lord Dunedin); and Cooden Engineering Co Ltd v Stanford [1953] 1 QB 86, 94 (Somervell LJ). This is because it depends on the character of the provision, not on the circumstances in which it falls to be enforced. It is a species of agreement which the common law considers to be by its nature contrary to the policy of the law. One consequence of this is that relief from the effects of a penalty is, as Hoffmann LJ put it in Else (1982) Ltd v Parkland Holdings Ltd [1994] 1 BCLC 130, 144, “mechanical in effect and involves no exercise of discretion at all.” Another is that the penalty clause is wholly unenforceable: Clydebank Engineering & Shipbuilding Co Ltd v Don Jose Ramos Yzquierdo y Castaneda [1905] AC 6, 9, 10 (Lord Halsbury LC); Gilbert-Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd [1974] AC 689, 698 (Lord Reid), 703 (Lord Morris of Borth-y-Gest) and 723-724 (Lord Salmon); Scandinavian Trading Tanker Co AB v Flota Petrolera Ecuatoriana (The “Scaptrade”) [1983] 2 AC 694, 702 (Lord Diplock); AMEV-UDC Finance Ltd v Austin (1986) 162 CLR 170, 191-193 (Mason and Wilson JJ). Deprived of the benefit of the provision, the innocent party is left to his remedy in damages under the general law. As Lord Diplock put it in The “Scaptrade” at p 702:
“The classic form of penalty clause is one which provides that upon breach of a primary obligation under the contract a secondary obligation shall arise on the part of the party in breach to pay to the other party a sum of money which does not represent a genuine pre-estimate of any loss likely to be sustained by him as the result of the breach of primary obligation but is substantially in excess of that sum. The classic form of relief against such a penalty clause has been to refuse to give effect to it, but to award the common law measure of damages for the breach of primary obligation instead.”
10. Equity, on the other hand, relieves against forfeitures “where the primary object of the bargain is to secure a stated result which can effectively be attained when the matter comes before the court, and where the forfeiture provision is added by way of security for the production of that result”: Shiloh Spinners Ltd v Harding [1973] AC 691, 723 (Lord Wilberforce). As Lord Wilberforce said at p 722, the paradigm cases are the jurisdiction to relieve from a right of re-entry in a lease of land and the mortgagor’s equity of redemption (and the associated equitable right to redeem) in relation to mortgages. Save in relation to non-payment of rent, the power to grant relief from forfeiture to lessees is now contained in section 146 of the Law of Property Act 1925, and probably exclusively so (see Official Custodian for Charities v Parway Estates Departments Ltd [1985] Ch 151). Relief for mortgagors through the equitable right to redeem is (save in relation to most residential properties) largely still based on judge-made law. However, neither by statute nor on general principles of equity is a lessor’s right of re-entry or a mortgagee’s right of sale or foreclosure treated as being by its nature contrary to the policy of the law. What equity (and, where it applies, statute) typically considers to be contrary to the policy of the law is the enforcement of such rights in circumstances where their purpose, namely the performance of the obligations in the lease or the mortgage, can be achieved in other ways – normally by late substantive compliance and payment of appropriate compensation. The forfeiture or foreclosure/power of sale is therefore enforceable, equity intervening only to impose terms. These will generally require the lessee or mortgagor to rectify the breach and make good any loss suffered by the lessor or mortgagee. If the lessee or mortgagee cannot or will not do so, the forfeiture will be unconditionally enforced – although perhaps not invariably (see per Lord Templeman in Associated British Ports v CH Bailey plc [1990] 2 AC 703, 707-708 in the context of section 146, and, more generally, the judgments in Cukurova Finance International Ltd v Alfa Telecom Turkey Ltd (No 3) [2013] UKPC 20, [2015] 2 WLR 875).
In what circumstances is the penalty rule engaged?
“[P]erhaps 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.”
As Lord Hodge points out in his judgment, the Scottish authorities are to the same effect.
15. However, the capricious consequences of this state of affairs are mitigated by the fact that, as the equitable jurisdiction shows, the classification of terms for the purpose of the penalty rule depends on the substance of the term and not on its form or on the label which the parties have chosen to attach to it. As Lord Radcliffe said in Campbell Discount Co Ltd v Bridge [1962] AC 600, 622, “[t]he intention of the parties themselves”, by which he clearly meant the intention as expressed in the agreement, “is never conclusive and may be overruled or ignored if the court considers that even its clear expression does not represent ‘the real nature of the transaction’ or what ‘in truth’ it is taken to be” (and cf per Lord Templeman in Street v Mountford [1985] AC 809, 819). This aspect of the equitable jurisdiction was inherited by the courts of common law, and has been firmly established since the earliest common law cases.
16. Payment of a sum of money is the classic obligation under a penalty clause and, in almost every reported case involving a damages clause, the provision stipulates for the payment of money. However, it seems to us that there is no reason why an obligation to transfer assets (either for nothing or at an undervalue) should not be capable of constituting a penalty. While the penalty rule may be somewhat artificial, it would heighten its artificiality to no evident purpose if it were otherwise. Similarly, the fact that a sum is paid over by one party to the other party as a deposit, in the sense of some sort of surety for the first party’s contractual performance, does not prevent the sum being a penalty, if the second party in due course forfeits the deposit in accordance with the contractual terms, following the first party’s breach of contract – see the Privy Council decisions in Public Works Comr v Hills [1906] AC 368, 375-376, and Workers Trust & Merchant Bank Ltd v Dojap Investments Ltd [1993] AC 573. By contrast, in Else (1982) at p 146, Hoffmann LJ, citing Stockloser v Johnson [1954] 1 QB 476 in support, said that, unlike a case where “money has been deposited as security for due performance of [a] party’s obligation”, “retention of instalments which have been paid under contract so as to become the absolute property of the vendor does not fall within the penalty rule”, although, he added that it was “subject … to the jurisdiction for relief against forfeiture”.
17. The relationship between penalty clauses and forfeiture clauses is not entirely easy. Given that they had the same origin in equity, but that the law on penalties was then developed through common law while the law on forfeitures was not, this is unsurprising. Some things appear to be clear. Where a proprietary interest or a “proprietary or possessory right” (such as a patent or a lease) is granted or transferred subject to revocation or determination on breach, the clause providing for determination or revocation is a forfeiture and cannot be a penalty, and, while it is enforceable, relief from forfeiture may be granted: see BICC plc v Burndy Corpn [1985] Ch 232, 246-247 and 252 (Dillon LJ) and The “Scaptrade”, pp 701-703, (Lord Diplock). But this does not mean that relief from forfeiture is unavailable in cases not involving land – see Cukurova Finance International Ltd v Alfa Telecom Turkey Ltd (No 2) [2013] UKPC 2, [2015] 2 WLR 875, especially at paras 92-97, and the cases cited there.
What makes a contractual provision penal?
“whether it is, what I think gave the jurisdiction to the courts in both countries to interfere at all in an agreement between the parties, unconscionable and extravagant, and one which no court ought to allow to be enforced.”
Lord Halsbury declined to lay down any “abstract rule” for determining what was unconscionable or extravagant, saying only that it must depend on “the nature of the transaction – the thing to be done, the loss likely to accrue to the person who is endeavouring to enforce the performance of the contract, and so forth”. Lord Halsbury’s formulation has proved influential, and the two other members of the Appellate Committee both delivered concurring judgments agreeing with it. It is, however, worth drawing attention to an observation of Lord Robertson (pp 19-20) which points to the principle underlying the contrasting expressions “liquidated damages” and “penalty”:
“Now, all such agreements, whether the thing be called penalty or be called liquidate damage, are in intention and effect what Professor Bell calls ‘instruments of restraint’, and in that sense penal. But the clear presence of this does not in the least degree invalidate the stipulation. The question remains, had the respondents no interest to protect by that clause, or was that interest palpably incommensurate with the sums agreed on? It seems to me that to put this question, in the present instance, is to answer it.”
“It has been urged that as the sum of £5 becomes payable on the sale of even one tube at a shilling less than the listed price, and as it was impossible that the appellant company should lose that sum on such a transaction, the sum fixed must be a penalty. In the sense of direct and immediate loss the appellants lose nothing by such a sale. It is the agent or dealer who loses by selling at a price less than that at which he buys, but the appellants have to look at their trade in globo, and to prevent the setting up, in reference to all their goods anywhere and everywhere, a system of injurious undercutting. The object of the appellants in making this agreement, if the substance and reality of the thing and the real nature of the transaction be looked at, would appear to be a single one, namely, to prevent the disorganization of their trading system and the consequent injury to their trade in many directions. The means of effecting this is by keeping up their price to the public to the level of their price list, this last being secured by contracting that a sum of £5 shall be paid for every one of the three classes of articles named sold or offered for sale at prices below those named on the list. The very fact that this sum is to be paid if a tyre cover or tube be merely offered for sale, though not sold, shows that it was the consequential injury to their trade due to undercutting that they had in view. They had an obvious interest to prevent this undercutting, and on the evidence it would appear to me impossible to say that that interest was incommensurate with the sum agreed to be paid.”
Lord Atkinson went on to draw an analogy, which has particular resonance in the Cavendish appeal, with a clause dealing with damages for breach of a restrictive covenant on the canvassing of business by a former employee. In this context, he said (pp 92-93):
“It is, I think, quite misleading to concentrate one’s attention upon the particular act or acts by which, in such cases as this, the rivalry in trade is set up, and the repute acquired by the former employee that he works cheaper and charges less than his old master, and to lose sight of the risk to the latter that old customers, once tempted to leave him, may never return to deal with him, or that business that might otherwise have come to him may be captured by his rival. The consequential injuries to the trader’s business arising from each breach by the employee of his covenant cannot be measured by the direct loss in a monetary point of view on the particular transaction constituting the breach.”
Lord Atkinson was making substantially the same point as Lord Robertson had made in Clydebank. The question was: what was the nature and extent of the innocent party’s interest in the performance of the relevant obligation. That interest was not necessarily limited to the mere recovery of compensation for the breach. Lord Atkinson considered that the underlying purpose of the resale price maintenance clause gave Dunlop a wider interest in enforcing the damages clause than pecuniary compensation. £5 per item was not incommensurate with that interest even if it was incommensurate with the loss occasioned by the wrongful sale of a single item.
26. In Lordsvale Finance plc v Bank of Zambia [1996] QB 752, Colman J was concerned with a common form provision in a syndicated loan agreement for interest to be payable at a higher rate during any period when the borrower was in default. There was authority that such provisions were penal: Lady Holles v Wyse (1693) 2 Vern 289; Strode v Parker (1694) 2 Vern 316, Wallingford v Mutual Society (1880) 5 App Cas 685, 702 (Lord Hatherley). But Colman J held that the clause was valid because its predominant purpose was not to deter default but to reflect the greater credit risk associated with a borrower in default. At pp 763-764, he observed that a provision for the payment of money upon breach could not be categorised as a penalty simply because it was not a genuine pre-estimate of damages, saying that 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.”
27. Colman J’s approach was approved by Mance LJ, delivering the leading judgment in the Court of Appeal in Cine Bes Filmcilik ve Yapimcilik v United International Pictures [2004] 1 CLC 401, para 13. A similar view was taken by Arden LJ in Murray v Leisureplay plc [2005] IRLR 946, para 54, where she posed the question
“Has the party who seeks to establish that the clause is a penalty shown that the amount payable under the clause was imposed in terrorem, or that it does not constitute a genuine pre-estimate of loss for the purposes of the Dunlop case, and, if he has shown the latter, is there some other reason which justifies the discrepancy between [the amount payable under the clause and the amount payable by way of damages in common law]?” (emphasis added).
She considered that the clause in question had advantages for both sides, and pointed out that no evidence had been adduced to show that the clause lacked commercial justification: see paras 70-76. But Buxton LJ put the matter on a wider basis for which Clarke LJ (para 105) expressed a preference. He referred to the speech of Lord Atkinson in Dunlop and suggested that the ratio of the actual decision in that case had been that “an explanation of the clause in commercial rather than deterrent terms was available”. All three members of the court endorsed the approach of Colman J in Lordsvale and Mance LJ in Cine Bes.
28. Colman J in Lordsvale and Arden LJ in Murray were inclined to rationalise the introduction of commercial justification as part of the test, by treating it as evidence that the impugned clause was not intended to deter. Later decisions in which a commercial rationale has been held inconsistent with the application of the penalty rule, have tended to follow that approach: see, for example, Euro London Appointments Ltd v Claessens International Ltd [2006] 2 Lloyd’s Rep 436, General Trading Company (Holdings) Ltd v Richmond Corpn Ltd [2008] 2 Lloyd's Rep 475 It had the advantage of enabling them to reconcile the concept of commercial justification with Lord Dunedin’s four tests. But we have some misgivings about it. The assumption that a provision cannot have a deterrent purpose if there is a commercial justification, seems to us to be questionable. By the same token, we agree with Lord Radcliffe’s observations in Campbell Discount at p 622, where he said:
“… I do not myself think that it helps to identify a penalty, to describe it as in the nature of a threat ‘to be enforced in terrorem’ (to use Lord Halsbury’s phrase in Elphinstone v Monkland Iron & Coal Co Ltd (1886) 11 App Cas 332, 348). I do not find that that description adds anything of substance to the idea conveyed by the word ‘penalty’ itself, and it obscures the fact that penalties may quite readily be undertaken by parties who are not in the least terrorised by the prospect of having to pay them and yet are, as I understand it, entitled to claim the protection of the court when they are called upon to make good their promises.”
Moreover, the penal character of a clause depends on its purpose, which is ordinarily an inference from its effect. As we have already explained, this is a question of construction, to which evidence of the commercial background is of course relevant in the ordinary way. But, for the same reason, the answer cannot depend on evidence of actual intention: see Chartbrook Ltd v Persimmon Homes Ltd [2009] AC 1101, paras 28-47 (Lord Hoffmann). However, while we have misgivings about some aspects of their reasoning, these aspects are peripheral to the essential point which Colman J and Buxton LJ were making, and we consider that their emphasis on justification provides a valuable insight into the real basis of the penalty rule. It is the same insight as that of Lord Robertson in Clydebank and Lord Atkinson in Dunlop. A damages clause may properly be justified by some other consideration than the desire to recover compensation for a breach. This must depend on whether the innocent party has a legitimate interest in performance extending beyond the prospect of pecuniary compensation flowing directly from the breach in question.
29. The availability of remedies for a breach of duty is not simply a question of providing a financial substitute for performance. It engages broader social and economic considerations, one of which is that the law will not generally make a remedy available to a party, the adverse impact of which on the defaulter significantly exceeds any legitimate interest of the innocent party. In the famous case of White & Carter (Councils) Ltd v McGregor [1962] AC 413, Lord Reid observed, at p 431:
“It may well be that, if it can be shown that a person has no legitimate interest, financial or otherwise, in performing the contract rather than claiming damages, he ought not to be allowed to saddle the other party with an additional burden with no benefit to himself. If a party has no interest to enforce a stipulation, he cannot in general enforce it: so it might be said that, if a party has no interest to insist on a particular remedy, he ought not to be allowed to insist on it. And, just as a party is not allowed to enforce a penalty, so he ought not to be allowed to penalise the other party by taking one course when another is equally advantageous to him. … Here the respondent did not set out to prove that the appellants had no legitimate interest in completing the contract and claiming the contract price rather than claiming damages. … Parliament has on many occasions relieved parties from certain kinds of improvident or oppressive contracts, but the common law can only do that in very limited circumstances.”
In White & Carter the innocent party was entitled to ignore the repudiation of the contract-breaker and proceed to perform, claiming his remuneration in debt rather than limiting himself to damages, notwithstanding that this course might be a great deal more expensive for the contract-breaker. This, according to Lord Reid (p 431), was because the contract-breaker “did not set out to prove that the appellants had no legitimate interest in completing the contract and claiming the contract price rather than claiming damages”.
30. More generally, the attitude of the courts, reflecting that of the Court of Chancery, is that specific performance of contractual obligations should ordinarily be refused where damages would be an adequate remedy. This is because the minimum condition for an order of specific performance is that the innocent party should have a legitimate interest extending beyond pecuniary compensation for the breach. The paradigm case is the purchase of land or certain chattels such as ships, which the law recognises as unique. Because of their uniqueness the purchaser’s interest extends beyond the mere award of damages as a substitute for performance. As Lord Hoffmann put it in addressing a very similar issue “the purpose of the law of contract is not to punish wrongdoing but to satisfy the expectations of the party entitled to performance”: Co-operative Insurance Society Ltd v Argyll Stores (Holdings) Ltd [1998] AC 1, 15.
“A penalty, as its name suggests, is in the nature of a punishment for non-observance of a contractual stipulation; it consists of the imposition of an additional or different liability upon breach of the contractual stipulation ...”
All definition is treacherous as applied to such a protean concept. This one can fairly be said to be too wide in the sense that it appears to be apt to cover many provisions which would not be penalties (for example most, if not all, forfeiture clauses). However, in so far as it refers to “punishment” and “an additional or different liability” as opposed to “in terrorem” and “genuine pre-estimate of loss”, this definition seems to us to get closer to the concept of a penalty than any other definition we have seen. The real question when a contractual provision is challenged as a penalty is whether it is penal, not whether it is a pre-estimate of loss. These are not natural opposites or mutually exclusive categories. A damages clause may be neither or both. The fact that the clause is not a pre-estimate of loss does not therefore, at any rate without more, mean that it is penal. To describe it as a deterrent (or, to use the Latin equivalent, in terrorem) does not add anything. A deterrent provision in a contract is simply one species of provision designed to influence the conduct of the party potentially affected. It is no different in this respect from a contractual inducement. Neither is it inherently penal or contrary to the policy of the law. The question whether it is enforceable should depend on whether the means by which the contracting party’s conduct is to be influenced are “unconscionable” or (which will usually amount to the same thing) “extravagant” by reference to some norm.
33. The penalty rule is an interference with freedom of contract. It undermines the certainty which parties are entitled to expect of the law. Diplock LJ was neither the first nor the last to observe that “The court should not be astute to descry a ‘penalty clause’”: Robophone at p 1447. As Lord Woolf said, speaking for the Privy Council in Philips Hong Kong Ltd v Attorney General of Hong Kong (1993) 61 BLR 41, 59, “the court has to be careful not to set too stringent a standard and bear in mind that what the parties have agreed should normally be upheld”, not least because “[a]ny other approach will lead to undesirable uncertainty especially in commercial contracts”.
“A millionaire may enter into a contract in which he is to pay liquidated damages, or a poor man may enter into a similar contract with a millionaire, but in each case the question is exactly the same, namely, whether the sum stipulated as damages for the breach was exorbitant or extravagant ...”
Should the penalty rule be abrogated?
Should the penalty rule be extended?
40.
In the course of his cogent submissions, Mr Bloch QC, who appeared for
Mr Makdessi
on the first appeal, suggested that, as an alternative to
confirming or abrogating the penalty rule, this court could extend it, so that
it applied more generally. As he pointed out, this was the course taken by the
High Court of Australia, and it would have the advantage of rendering the
penalty rule less formalistic in its application, and, which may be putting the
point in a different way, less capable of avoidance by ingenious drafting.
41. This step has recently been taken in Australia. Until recently, the law in Australia was the same as it is in England: see IAC Leasing Ltd v Humphrey (1972) 126 CLR 131, 143 (Walsh J); O’Dea v Allstates Leasing System (WA) Pty Ltd (1983) 152 CLR 359, 390 (Brennan J); AMEV-UDC at p 184 (Mason and Wilson JJ, citing ECGD among other authorities), 211 (Dawson J); Ringrow Pty Ltd v BP Australia Pty Ltd (2005) 224 CLR 656, 662. However, a radical departure from the previous understanding of the law occurred with the decision of the High Court of Australia in Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205. The background to this case was very similar to that in Office of Fair Trading v Abbey National plc [2010] 1 AC 696. It concerned the application of the penalty rule to contractual bank charges payable when the bank bounced a cheque or allowed the customer to draw in excess of his available funds or agreed overdraft limit. These might in a loose sense be regarded as banking irregularities, but they did not involve any breach of contract on the part of the customer. On that ground Andrew Smith J had held in the Abbey National case that the charges were incapable of being penalties: [2008] 2 All ER (Comm) 625, paras 295-299 (the point was not appealed). In Andrews, the High Court of Australia disagreed. They engaged in a detailed historical examination of the equitable origin of the rule and concluded that there subsisted, independently of the common law rule, an equitable jurisdiction to relieve against any sufficiently onerous provision which was conditional upon a failure to observe some other provision, whether or not that failure was a breach of contract. At para 10, they defined a penalty as follows:
“In general terms, a stipulation prima facie imposes a penalty on a party (the first party) if, as a matter of substance, it is collateral (or accessory) to a primary stipulation in favour of a second party and this collateral stipulation, upon the failure of the primary stipulation, imposes upon the first party an additional detriment, the penalty, to the benefit of the second party. In that sense, the collateral or accessory stipulation is described as being in the nature of a security for and in terrorem of the satisfaction of the primary stipulation. If compensation can be made to the second party for the prejudice suffered by failure of the primary stipulation, the collateral stipulation and the penalty are enforced only to the extent of that compensation. The first party is relieved to that degree from liability to satisfy the collateral stipulation.”
42. Any decision of the High Court of Australia has strong persuasive force in this court. But we cannot accept that English law should take the same path, quite apart from its inconsistency with established and unchallenged House of Lords authority. In the first place, although the reasoning in Andrews was entirely historical, it is not in fact consistent with the equitable rule as it developed historically. The equitable jurisdiction to relieve from penalties arose wholly in the context of bonds defeasible in the event of the performance of a contractual obligation. It necessarily posited a breach of that obligation. Secondly, if there is a distinct and still subsisting equitable jurisdiction to relieve against penalties which is wider than the common law jurisdiction, with three possible exceptions it appears to have left no trace in the authorities since the fusion of law and equity in 1873. The first arguable exception is in In re Dagenham (Thames) Dock Co; Ex p Hulse (1873) LR 8 Ch App 1022 (followed by the Privy Council in Kilmer v British Columbia Orchard Lands Ltd [1913] AC 319), where the Court of Appeal granted a purchaser, who had been in possession for five years and carried out improvements, further time to pay the second and final instalment of a purchase price on the ground that the clause requiring him to vacate and to forfeit the first instalment for not having paid the second instalment on time, was a “penalty”. However, James and Mellish LJJ may have been treating the clause as a forfeiture (as they both also used that expression in their brief judgments), and in any event they treated the purchaser in the same way as a mortgagor in possession asking for more time to pay. Further, as Romer LJ pointed out in Stockloser at pp 497-498, the decision could be justified by the fact that time had already been extended twice by agreement, and in any event there was no question of the vendor being required to repay the first instalment. The second arguable exception is no more than an unsupported throw-away line in the judgment of Diplock LJ in Robophone at p 1446, where he said it was “by no means clear” whether penalty clauses “are simply void”, but, on analysis, he was dealing with a rather different point (namely that discussed by Lord Atkin in the passage that follows). The third exception is the unsatisfactory decision in Jobson v Johnson [1989] 1 WLR 1026, to which we shall return in paras 84-87 below. It is relevant to add in this connection that the law of penalties has been held to be the same in England and Scotland: Stair Memorial Encyclopaedia of the Laws of Scotland, vol 15, paras 783-801, and see Clydebank. Yet equity, although influential, has never been a distinct branch of Scots law. In the modern law of both countries, the penalty rule is an aspect of the law of contract. Thirdly, the High Court’s redefinition of a penalty is, with respect, difficult to apply to the case to which it is supposedly directed, namely where there is no breach of contract. It treats as a potential penalty any clause which is “in the nature of a security for and in terrorem of the satisfaction of the primary stipulation.” By a “security” it means a provision to secure “compensation … for the prejudice suffered by the failure of the primary stipulation”. This analysis assumes that the “primary stipulation” is some kind of promise, in which case its failure is necessarily a breach of that promise. If, for example, there is no duty not to draw cheques against insufficient funds, it is difficult to see where compensation comes into it, or how bank charges for bouncing a cheque or allowing the customer to overdraw can be regarded as securing a right of compensation. Finally, the High Court’s decision does not address the major legal and commercial implications of transforming a rule for controlling remedies for breach of contract into a jurisdiction to review the content of the substantive obligations which the parties have agreed. Modern contracts contain a very great variety of contingent obligations. Many of them are contingent on the way that the parties choose to perform the contract. There are provisions for termination upon insolvency, contractual payments due on the exercise of an option to terminate, break-fees chargeable on the early repayment of a loan or the closing out of futures contracts in the financial or commodity markets, provisions for variable payments dependent on the standard or speed of performance and “take or pay” provisions in long-term oil and gas purchase contracts, to take only some of the more familiar types of clause. The potential assimilation of all of these to clauses imposing penal remedies for breach of contract would represent the expansion of the courts’ supervisory jurisdiction into a new territory of uncertain boundaries, which has hitherto been treated as wholly governed by mutual agreement.
The first appeal:
Cavendish v El Makdessi
The factual and procedural history
44.
Mr Makdessi
founded a group of companies (“the Group”) which by 2008 had
become the largest advertising and marketing communications group in the Middle
East, and operated through a network of around 20 companies with more than 30
offices in over 15 countries. At that time, Mr
Makdessi
was one of the most
influential Lebanese business leaders, his name was closely identified with the
business of the Group, and he had very strong relationships with its clients
and senior employees.
45.
In 2008, the holding company of the Group was Team Y & R Holdings
Hong Kong Ltd (“the Company”). The Company had 1,000 issued shares, which were
owned by Mr Makdessi
and Mr Joseph Ghossoub, with the exception of 126 shares
which were held by Young & Rubicam International Group BV (“Y & RIG”), a
company in the WPP group of companies (“WPP”), the world’s largest market
communications services group.
46.
By an agreement of 28 February 2008 (“the Agreement”) Mr Makdessi
and Mr
Ghossoub (described as “the Sellers”) agreed to sell to Y & RIG (described
as “the Purchaser”) 474 shares (described as “the Sale Shares”) in the Company.
Y & RIG then transferred those shares to Cavendish Square Holdings BV
(“Cavendish”), another WPP company, and by a novation agreement of 29 February
2008, Cavendish was substituted for Y & RIG as a party to the Agreement.
Thus Cavendish came to hold 60% of the Company while the Sellers retained 40%. For
present purposes, Y & RIG can be ignored and the Purchaser can be treated
as Cavendish.
47.
The Agreement had been the subject of extensive negotiations over six
months, and both sides were represented by highly experienced and respected
commercial lawyers: Allen & Overy acting for Cavendish, and Lewis Silkin
for the Sellers, Mr Makdessi
and Mr Ghossoub.
48.
By clause 3.1, the price payable by Cavendish “[i]n consideration of
the sale of the Sale Shares and the obligations of the Sellers herein” (and
which was to be apportioned 53.88% to Mr Makdessi
and 46.12% to Mr Ghossoub)
was to be paid by Cavendish in the following way:
i) A “Completion Payment” of US$34m to be paid on completion of the Agreement;
ii) A “Second Payment” of US$31.5m to be paid into escrow on completion, and to be released in four instalments, as restructuring of the Group companies took effect;
iii) An “Interim Payment”, to be paid 30 days after agreement of the group operating profits (“OPAT”) for 2007-2009, and to be the amount by which the product of eight, 0.474 and the average annual OPAT 2007-2009 exceeded US$63m (being the sum of the earlier payments less US$ 2.5m representing interest);
iv) A “Final Payment”, to be paid 30 days after agreement of the OPAT for 2007-2011, and to be the amount by which the product of a figure between seven and ten (depending on the level of profit), 0.474 and the annual average annual OPAT for 2009-2011 exceeded the aggregate of US$63m and the Interim Payment.
49. Clause 3.2 of the Agreement provided that, if the Interim Payment and/or the Final Payment turned out to be a negative figure, it or they should be treated as zero, but there was to be no claw back of the earlier payments. Clause 3.3 of the Agreement provided that the maximum of all payments would be US$147.5m. By clause 9.1 of, and paragraph 2.15(c) of Schedule 7 to, the Agreement, the Sellers warranted that the Net Asset Value (“NAV”) of the Company at 31 December 2007 was just over US$69.74m.
50.
Clause 15 contained a put option which entitled each of the Sellers
to require Cavendish, by a Notice served at any time between 1 January and 31
March in 2011 or any subsequent year (in the case of Mr Makdessi)
and any time
between 1 January and 31 March in 2017 or in any subsequent year (in the case
of Mr Ghossoub), to buy all their remaining shares in the Company. The price
payable on the exercise of this option was (subject to a cap of US$75m in the
case of each Seller) to be the relevant seller’s proportion of a sum eight
times the average OPAT for a reference period of seven years (the year in which
the notice was served, the previous year and the two subsequent years). It was
to be payable by instalments.
51. Clause 11 was concerned with the “protection of goodwill”. Clause 11.1 provided as follows:
“11.1. Each Seller recognises the importance of the goodwill of the Group to [Cavendish] and the WPP Group which is reflected in the price to be paid by the Purchaser for the Sale Shares. Accordingly, each Seller commits as set out in this clause 11 to ensure that the interest of each of [Cavendish] and the WPP Group in that goodwill is properly protected.”
52.
Clause 11.2 provided that, in Mr Makdessi’s
case, until two years after
he ceased to hold any shares in the Company or the date of the final instalment
of any payment under clause 15, and in Mr Ghossoub’s case, until two years
after he ceased employment with the Company, the Sellers would not (a) carry
on, or be engaged or interested in “Restricted Activities” (ie the provision of
goods or services which competed with the Group companies) in “Prohibited
Areas” (ie in countries in which any of the Group companies carried on
business); (b) solicit or accept orders, enquiries or business in respect of
Restricted Activities in the Prohibited Areas; (c) divert orders, enquiries or
business from any Group company; or (d) employ or solicit any senior employee
or consultant of any Group company.
54.
Under clause 7.5, Messrs El Makdessi
and Ghossoub agreed that, within
four months of completion, they would dispose of any shares in Carat Middle
East Sarl (“Carat”), and procure the termination of a joint venture agreement
which another Carat company had entered into with a member of the Aegis group
of companies. Carat describes itself on its website as “the world’s leading independent
media planning and buying specialist … [o]wned by global media group Aegis
Group plc … [with] more than 5,000 people in 70 countries worldwide”. It is a
competitor of WPP, including Cavendish and the Company.
“5.1 If a Seller becomes a Defaulting Shareholder [which is defined as including ‘a Seller who is in breach of clause 11.2’] he shall not be entitled to receive the Interim Payment and/or the Final Payment which would other than for his having become a Defaulting Shareholder have been paid to him and [Cavendish]’s obligations to make such payment shall cease. …
5.6. Each Seller hereby grants an option to [Cavendish] pursuant to which, in the event that such Seller becomes a Defaulting Shareholder, [Cavendish] may require such Seller to sell to [Cavendish] all … of the Shares held by that Seller (the Defaulting Shareholder Shares). [Cavendish] shall buy and such Seller shall sell … the Defaulting Shareholder Shares… within 30 days of receipt by such Seller of a notice from [Cavendish] exercising such option in consideration for the payment by [Cavendish] to such Seller of the Defaulting Shareholder Option Price [defined as ‘an amount equal to the [NAV] on the date that the relevant Seller becomes a Defaulting Shareholder multiplied by [the percentage which represents the proportion of the total shares the relevant Seller holds].”
56.
Mr Ghossoub signed an agreement by which he agreed to remain an employee
and director of the Company. During the negotiations, Mr Makdessi
had made it
clear that he did not wish to remain an employee. However, he signed an
agreement, by which he became a non-executive director of the Company (as well
as other companies in the Group) and non-executive chairman, for an initial
term of 18 months which was renewable. Under this he agreed to certain specific
obligations by way of ongoing support of the Company.
57.
Mr Makdessi
resigned as non-executive chairman of the Company in April
2009. On 1 July 2009, at the Company’s request, he resigned as non-executive
director of all companies in the Group, save the Company itself. He was removed
from the board of the Company on 27 April 2011, after the commencement of these
proceedings.
58.
Mr Makdessi
has been paid his share of the first two payments stipulated
by clause 3.1, namely the Completion Payment and the Second Payment, together
with some additional interest. However, he has not yet been paid the remaining
payments under clause 3.1, namely the Interim Payment or the Final Payment, or
any part thereof. His remaining shares represent just over 21.5% of the whole
issued share capital of the Company.
59.
By December 2010, Cavendish and the Company concluded that Mr Makdessi
had acted in breach of his duties to the Company as a director and in breach of
his obligations to Cavendish under clause 11.2 of the Agreement. On 13 December
2010 Cavendish gave notice of the exercise of its Call Option under clause 5.6.
60.
In December 2010, these proceedings were commenced against Mr Makdessi,
with Cavendish suing for breach of the Agreement, and the Company suing for
breach of fiduciary duty. Their re-amended particulars allege that in breach of
his fiduciary duties and the restrictive covenants Mr
Makdessi
had throughout
2008 and 2009 in Lebanon and Saudi Arabia (both of which were within the
Prohibited Area), in breach of clause 11.2, engaged in Restricted Activities,
solicited clients and employees away from Group companies and accepted orders
in respect of Restricted Activities.
61.
The essence of the complaints was that Mr Makdessi
had (i) continued to
provide services to Carat, including assisting it to generate business,
diverting business to it and soliciting clients and diverting their business to
it; and (ii) set up rival advertising agencies in Lebanon and Saudi Arabia with
“Adrenalin” in their name and that those agencies had poached or tried to poach
a number of the Company’s customers and employees.
62.
Mr Makdessi
subsequently admitted that from February 2008 he had had an
ongoing, unpaid involvement in the affairs of Carat pending the appointment of
a replacement CEO and that such involvement placed him in breach of fiduciary
duty to the Company with effect from 1 July 2008, and that, if the covenants in
clause 11.2 were valid and enforceable (as they have been held to be) his
involvement in the affairs of Carat rendered him a Defaulting Shareholder
within the meaning of the Agreement. The Company’s claim for breach of
fiduciary duty was settled by its acceptance of a payment into court made by Mr
Makdessi
in the sum of US$500,000. Cavendish claimed to have
suffered loss and damage in the form of a loss of value of its shareholding in
the Company, but it subsequently accepted that such loss was irrecoverable as
it was merely “reflective” of the loss which could be claimed, indeed had been
claimed, by the Company.
63.
More importantly for present purposes, Cavendish claimed that Mr
Makdessi’s
admissions of breach of fiduciary duty demonstrated that he was in
breach of clause 11.2 in relation to (at least) his continued involvement in
Carat. Cavendish accordingly sought a declaration that he was a Defaulting
Shareholder, was not entitled to the Interim Payment or the Final
Payment as a result of clause 5.1, and was obliged, as of the date 30 days
after the service of its notice exercising the Call Option, namely 14 January
2011, to sell to Cavendish all his shares in the Company at the Defaulting
Shareholder Option Price, and it sought specific performance of the latter
obligation.
64.
The case was tried by Burton J and the appeal was heard in the Court of
Appeal by Patten, Tomlinson and Christopher Clarke LJJ. The issue at both
stages was the same, namely whether clauses 5.1 and 5.6 were valid and
enforceable as Cavendish contended, or whether as Mr Makdessi
argued they both
were void and unenforceable because they constituted penalties. The courts
below were naturally constrained by the perceived need to fit any analysis into
the framework set by Lord Dunedin’s four principles. Burton J felt able to
escape those constraints, and concluded that the two provisions were valid and
enforceable. However, Christopher Clarke LJ, giving the leading judgment in the
Court of Appeal, held that the two provisions were unenforceable penalties
under the penalty rule as traditionally understood. No short summary can do
justice to Christopher Clarke LJ’s thoughtful and careful analysis, but
essentially he felt unable to uphold Burton J’s decision because he felt bound
by the traditional explanation of the rule as being directed against deterrent
clauses as such: see [2012] EWHC 3582 (Comm) and [2013] EWCA Civ 1539
respectively. Cavendish now appeals to this court.
The implications of the Agreement
65.
Clause 5 deals with the obligations of a “Defaulting Shareholder”. So
far as Mr Makdessi
was concerned, that meant a Seller in breach of the
restrictive covenants at clause 11.2. In the case of Mr Ghossoub, who remained
an employee of the Company, it meant a Seller who was either in breach of the
restrictive covenants or else had been summarily dismissed on any of a number
of specified grounds, all of them serious and potentially discreditable to the
Company.
66.
The background to clause 5 is of some importance. Burton J found that
the Agreement was negotiated in detail over a considerable period by parties
dealing on equal terms with professional assistance of a high order. Cavendish
was acquiring 47.4% of the Company so as to bring its holding up to 60%. It is
common ground that a large proportion of the purchase price represented
goodwill. The NAV (without goodwill) of the Company was warranted by the
Sellers at over US$69.7m as at 31 December 2007, whereas the maximum
consideration for 47.4% of the Company, including the profit-related element,
was US$147.5m, implying a maximum value of more than US$300m for the whole
Group. Clause 11.1 recorded the Sellers’ recognition that the restrictive
covenants reflected the importance of the goodwill, and Burton J found that its
value was heavily dependent on the continuing loyalty of Mr Makdessi
and Mr
Ghossoub. Subject to various options, they retained a 40% shareholding between
them and were expected to maintain their connection with the business for a
minimum period, Mr Ghossoub as an employee and director, and Mr
Makdessi
as a
non-executive director and chairman. The following summary in the agreed
Statement of Facts and Issues is based on the unchallenged evidence given at
the trial:
“The structure of the Agreement was typical of acquisition agreements in the marketing sector. As in this case, the vendor is typically the founder or operator of the business, and has important relationships with clients and key staff. If they decide to turn against the business, its success can be significantly affected, and provisions are therefore included to protect the value of the investment, and in particular the value of the goodwill represented by the vendor’s existing personal relationships. The respondent fell into that category; the importance of personal relationships with clients is even stronger in the Middle East than the UK, and he had very strong relationships with clients and senior employees, and he was such a well known figure that if he acted against the Group, it would inevitably cause it to lose value.”
67.
Clause 3.1 provided that the first two instalments of the purchase price
amounted to US$65.5m, which would be received by the Sellers in any event. The
effect of clause 5.1 was that in the event that a Seller acted in breach of the
restrictive covenants, he would not be entitled to receive the last two
instalments of the purchase price, the Interim Payment and the Final Payment,
both of which were calculated by reference to the audited consolidated profit
of the Company for years after completion of the Agreement (2007-2009 for the
Interim Payment, and 2007-2011 for the Final Payment). The result of
Cavendish’s exercise of its rights under clause 5.1 according to its terms was
to reduce the consideration for the Defaulting Shareholder’s shares from his
proportion of the maximum of US$147.5m to his proportion of US$65.5m. In Mr
Makdessi’s
case, he would receive up to US$44,181,600 less.
68.
Under clause 15, the Sellers had a put option to require Cavendish to
buy their remaining shareholdings, which in Mr Makdessi’s
case was first exercisable
during the first three months of 2011. The provisions determining the option
price have been summarised in para 50 above. It was a multiple of average
audited consolidated profit over a reference period, a formula which would
reflect the value of goodwill. The effect of clause 5.6 was that if before the
exercise of the clause 15 put option a Seller was in breach of the restrictive
covenants, Cavendish acquired an option to acquire his retained shareholding at
a lower price, namely the relevant proportion of the net asset value at the
time of the default. The result of Cavendish’s implementation of clause 5.6,
according to its terms, was that insofar as, at the date of default, Mr
Makdessi’s
shareholding had a value attributable to goodwill, he would not
receive it and would not be able to exercise the clause 15 put option in 2011.
Was clause 5.1 contrary to the penalty rule?
74. Where, against this background, does clause 5.1 stand? It is plainly not a liquidated damages clause. It is not concerned with regulating the measure of compensation for breach of the restrictive covenants. It is not a contractual alternative to damages at law. Indeed in principle a claim for common law damages remains open in addition, if any could be proved. The clause is in reality a price adjustment clause. Although the occasion for its operation is a breach of contract, it is in no sense a secondary provision. The consideration fixed by clause 3.1 is said to be payable “[i]n consideration of the sale of the Sale Shares and the obligations of the Sellers herein”. Those obligations of the Sellers herein include the restrictive covenants. Clause 5.1 belongs with clauses 3 and 6, among the provisions which determine Cavendish’s primary obligations, ie those which fix the price, the manner in which the price is calculated and the conditions on which different parts of the price are payable. Its effect is that the Sellers earn the consideration for their shares not only by transferring them to Cavendish, but by observing the restrictive covenants. As Burton J said at para 59 of his judgment, “[t]he juxtaposition on the one hand of substantial delayed payment for goodwill and on the other hand a series of covenants which is intended to safeguard and protect that goodwill is of particular significance”.
75.
Although clause 5.1 has no relationship, even approximate, with the
measure of loss attributable to the breach, Cavendish had a legitimate interest
in the observance of the restrictive covenants which extended beyond the
recovery of that loss. It had an interest in measuring the price of the
business to its value. The goodwill of this business was critical to its value
to Cavendish, and the loyalty of Mr Makdessi
and Mr Ghossoub was critical to
the goodwill. The fact that some breaches of the restrictive covenants would
cause very little in the way of recoverable loss to Cavendish is therefore
beside the point. As Burton J graphically observed in para 43 of his judgment,
once Cavendish could no longer trust the Sellers to observe the restrictive
covenants, “the wolf was in the fold”. Loyalty is indivisible. Its absence in a
business like this introduces a very significant business risk whose impact
cannot be measured simply by reference to the known and provable consequences
of particular breaches. It is clear that this business was worth considerably
less to Cavendish if that risk existed than if it did not. How much less? There
are no juridical standards by which to answer that question satisfactorily. We
cannot know what Cavendish would have paid without the assurance of the
Sellers’ loyalty, even assuming that they would have bought the business at
all. We cannot know whether the basic price or the maximum price fixed by
clause 3.1 would have been the same if they were not adjustable in the event of
breach of the restrictive covenants. We cannot know what other provisions of
the agreement would have been different, or what additional provisions would
have been included on that hypothesis. These are matters for negotiation, not
forensic assessment (save in the rare cases where the contract or the law
requires it). They were matters for the parties, who were, on both sides,
sophisticated, successful and experienced commercial people bargaining on equal
terms over a long period with expert legal advice and were the best judges of
the degree to which each of them should recognise the proper commercial
interests of the other.
76.
We have already drawn attention to the fact that damages are in
principle recoverable in addition to the price reduction achieved by clause
5.1. In this case, the Company recovered US$500,000 from Mr Makdessi.
Cavendish
has abandoned any claim of their own for damages, because any loss of theirs
would simply reflect the Company’s loss. But it would not always be so. There
are hypotheses, for example that the restrictive covenants had been broken
after he ceased to be a director, in which Cavendish’s loss by his breach of
the restrictive covenants would not have been reflective and might in principle
have been recovered in addition to the reduction of the price under clause 5.1.
Does any of this matter? We do not think so. Clause 5.1 is not concerned with
the measure of compensation for the breach. It cannot be regarded as penal
simply because damages are recoverable in addition. The real question is whether
any damages have been suffered on account of the breach in circumstances where
the price has been adjusted downwards on account of the same breach. As between
Mr
Makdessi
and the Company, the right of Cavendish to a price reduction cannot
affect the measure or recoverability of the Company’s loss. It is res inter
alios acta. It is an open question whether the right to a price reduction
would go to abate any loss recoverable by Cavendish themselves if they had
suffered any. We do not propose to resolve it on this appeal: the issue does
not arise and was not argued. It is enough to note that if Cavendish’s loss is
not abated, that would be because the law regards Cavendish as having suffered
it notwithstanding its right to the reduction. That can hardly make clause 5.1
a penalty.
78. We conclude, in agreement with Burton J, that clause 5.1 was not a penalty.
Was clause 5.6 contrary to the penalty rule?
79. Clause 5.6 gives rise to more difficult questions, but the analysis is essentially the same.
81.
The logic of the price formula for the sale of the retained shares under
clause 5.6 is similar to that of the price adjustment achieved by clause 5.1
for the sale of the transferred shares. It reflects the reduced price which
Cavendish was prepared to pay for the acquisition of the business in
circumstances where it could not count on the loyalty of Mr Makdessi
and/or Mr
Ghossoub. We have dealt with this point in the context of clause 5.1. It also
reflects the fact that with the severance of the connection between the
Defaulting Shareholder and the Company, no goodwill will in future be
attributable to his role in the business. Indeed, the assumption must be that a
Seller in breach of the restrictive covenants may be actively engaged in
undermining the goodwill attributable to his former role in the business. It is
true that the severance of the connection between a Defaulting Shareholder and
the Group will not necessarily destroy the whole of the goodwill of the
business which was sold to Cavendish, especially if the other Seller remains
loyal. But so far as the Group is able to retain some or all of the goodwill
built up by the Defaulting Shareholder in the past, that will presumably be due
to the efforts of others.
83.
More fundamentally, a contractual provision conferring an option to
acquire shares, not by way of compensation for a breach of contract but for
distinct commercial reasons, belongs as it seems to us among the parties’
primary obligations, even if the occasion for its operation is a breach of
contract. This may be tested by asking how the penalty rule could be applied to
it without making a new contract for the parties. The Court of Appeal simply
treated clause 5.6 as unenforceable, and declared that Mr Makdessi
was not
obliged to sell his shares whether at the specified price or at all. That
cannot be right, since the severance of the shareholding connection was in
itself entirely legitimate, and indeed commercially sensible. If the option to
acquire the retained shares is to stand, the price formula cannot be excised
without substituting something else. Yet there is no juridical basis on which a
different pricing formula can be imposed. There is no fall-back position at
common law, as there is in the case of a damages clause.
84.
Mr Bloch argued that this difficulty can be surmounted by granting Mr
Makdessi
a remedy corresponding to the one ordered by the Court of Appeal in Jobson
v Johnson. We do not accept this. Jobson arose out of a contract for
the sale of a substantial shareholding in a football club for a consideration
payable by instalments. The contract provided that in the event of default in
the payment of any instalment, the purchaser would be obliged to transfer the
shareholding back to the vendors at a price which was said to represent a
substantial undervalue. This was a forfeiture. The purchaser would have been
entitled to relief in equity if he had been in a position to pay, albeit late.
The purchaser had in fact counterclaimed for such relief, but the counterclaim
had been struck out on account of his failure to comply with his disclosure
obligations. That left only a contention, advanced by way of defence, that the
obligation to transfer back the shares was also a penalty. As briefly discussed
in para 17 above, that may or may not have been an argument which was open to
him, and it is unnecessary to decide that issue on this appeal. The Court of
Appeal accepted the argument and held that the penalty rule could apply not only
to an obligation to pay money upon a breach of contract, but also to an
obligation to transfer assets in that event. This gives rise to no difficulty
at least in principle, in a case where the court could simply decline to
enforce the penalty, leaving the innocent party to his ordinary remedies at
law. That was the position in Jobson, because the Court of Appeal
construed the share transfer clause as a purely secondary obligation which was
intended simply to secure the payment of the price: see pp 1031-1032, 1037
(Dillon LJ), pp 1043-1044, 1045 (Nicholls LJ). On that basis, Mr Johnson could
in theory have been left to obtain judgment for the amount of the outstanding
instalments and if necessary levy execution against the shares. However, we are
bound to observe that this would appear to be a somewhat peculiar outcome. If
the purchaser had been able to argue that he was entitled to relief from
forfeiture, the court would presumably have dealt with his case on that basis
and would not have considered the penalty argument at all. Accordingly, on the
Court of Appeal’s reasoning, as a result of his default in giving disclosure,
he was able to achieve a better result than he would have done if he had given
disclosure and been able to seek relief from forfeiture.
85. In terms of achieving a fair commercial result, it is perhaps understandable that the Court of Appeal took the course that they did. Rather than applying the well-established principles relating to penalties, they invoked the authorities on relief from forfeiture, which Mr Johnson had been prevented from claiming, and applied them to the penalty rule. They held that in equity a penalty was enforceable pro tanto, or on what Nicholls LJ called a “scaled down” basis, ie only to the extent of any actual loss suffered by the breach. The court achieved this by offering the vendor the choice of (i) taking an order for specific performance of the retransfer, conditional upon its being ascertained that this would not overcompensate him for the non-payment of the outstanding instalments, or (ii) taking an order for the sale of the shares by the court, the outstanding instalment and interest to be paid to him out of the proceeds and the balance to be paid to the defaulting purchaser. A somewhat similar approach was later taken by the High Court of Australia in Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205, which also adopted the concept of partial enforcement.
“At least since the advent of the Judicature system a penalty provision has been regarded as unenforceable or, perhaps void, ab initio: Citicorp Australia Ltd v Hendry (1985) 4 NSWLR 1. In all that time it has been thought that no action could be brought on such a clause, no doubt because the courts should not lend their aid to the enforcement in any way of a provision which is oppressive. However, this is not the only reason why the courts would refuse to lend their aid. In the majority of cases involving penalties, the courts, if called upon to assist in partial enforcement of the kind suggested by the appellant, would be required to undertake an unfamiliar role. They would need to rewrite the clause so as to permit the plaintiff to recover the loss he has actually sustained. Penalty clauses are not, generally speaking, so expressed as to entitle the plaintiff to recover his actual loss. Instead they prescribe the payment of a sum which is exorbitant or a sum to be ascertained by reference to a formula which is not an acceptable pre-estimate of damage. In either case the court, if it were to enforce the clause, would be performing a function very different from that which it undertakes when it severs or reads down an unenforceable covenant, such as a covenant in restraint of trade. In the ultimate analysis, in whatever form it be expressed, the appellant’s argument amounts to an invitation to the court to develop a new law of compensation, distinct from common law damages, which would govern the entitlement of plaintiffs who insist on the inclusion of penalty clauses in their contracts.”
87.
Even if the course taken by the Court of Appeal in Jobson had
been right, it would not be available to Mr Makdessi
because clause 5.6 cannot
sensibly be analysed as a mere security for the performance of the restrictive
covenants. But in our opinion the analysis of Mason and Wilson JJ was correct,
and so far as it related to the form of relief, Jobson was wrongly
decided. In the first place, the treatment of a penalty clause as partly
enforceable, although supported by some turns of phrase in old cases concerned
with other issues, is contrary to consistent modern authority. So, with
respect, is the treatment of its enforcement as discretionary according to the
circumstances at the time of the breach. If, as the authorities show, the penal
consequences of a contractual provision fall to be determined as at the time of
the agreement, and a provision found to be a penalty is unenforceable, it is
impossible to see how it can be enforceable on terms. Secondly, the Court of
Appeal accepted that the court could not rewrite the parties’ contract by
specifically enforcing the retransfer of the shares to the vendors at a higher
price or enforcing the retransfer of some only of the shares: see p 1037
(Dillon LJ), p 1042 (Nicholls LJ). Yet that is in reality what they did, by
refusing to enforce the retransfer unless the vendor agreed to vary its effect.
Third, the Court of Appeal interpreted the provision for the retransfer of the
shares as a “security” for the payment of the outstanding instalments. They
placed the word “security” in inverted commas because the obligation was purely
personal. But the Court of Appeal’s order treated it as if it was an equitable
mortgage of the shares, which it manifestly was not. It appears to us that the
Court of Appeal were, as a matter of legal analysis, treating the clause in
question as a forfeiture and not a penalty, and granting relief from forfeiture
on appropriate terms, although in doing so they purported to be treating it as
a penalty clause, because they were constrained to do so in the light of the
pleadings. So far as the relief granted in Jobson is concerned, the
decision was entirely orthodox if it is treated as a forfeiture case, but it
was wrong in principle if it is treated as a penalty case.
The second appeal: ParkingEye v Beavis
The factual and procedural history
89. British Airways Pension Fund (“the Fund”) owns the Riverside Retail Park in Chelmsford. The Fund leases sites on the Retail Park to various multiple retailers, but retains overall control of the site. There is a car park located at the Retail Park, and, on 25 August 2011, the Fund entered into a contract with ParkingEye Ltd in respect of management services at that car park.
“ParkingEye
car park management
2 hour max stay
Customer only car park
4 hour maximum stay for Fitness Centre Members
Failure to comply with the following
will result in a Parking Charge of £85
· Parking limited to 2 hours (no return within 1 hour)
· Park only within marked bays
· Blue badge holders only in marked bays”.
Below this main part of the signs in small, but legible black print on the same orange background is the following information:
“ParkingEye Ltd is solely engaged to provide a traffic space maximisation scheme. We are not responsible for the car park surface, other motor vehicles, damage or loss to or from motor vehicles or user’s safety. The parking regulations for this car park apply 24 hours a day, all year round, irrespective of the site opening hours. Parking is at the absolute discretion of the site. By parking within the car park, motorists agree to comply with the car park regulations. Should a motorist fail to comply with the car park regulations, the motorist accepts that they are liable to pay a Parking Charge and that their name and address will be requested from the DVLA.
Parking charge Information: A reduction of the Parking Charge is available for a period, as detailed in the Parking Charge Notice. The reduced amount payable will not exceed £75, and the overall amount will not exceed £150 prior to any court action, after which additional costs will be incurred.”
Below that information, in somewhat larger print are the words: “This car park is private property”. At the very bottom of the signs on a black background is ParkingEye’s name, telephone number and address in orange, and a drawing of a padlock, a drawing of a surveillance camera with the words “car park monitored by ANPR systems” in small letters underneath, and two logos recording that ParkingEye was a member of the British Parking Association (“BPA”) and that it was a BPA “approved operator”.
93. Before Judge Moloney QC and before the Court of Appeal, Mr Beavis raised two arguments as to why he should not have to pay the £85 charge, namely that it was (i) unenforceable at common law because it is a penalty, and/or (ii) unfair and therefore unenforceable by virtue of the 1999 Regulations. The Court of Appeal (Moore-Bick and Patten LJJ and Sir Timothy Lloyd) upheld Judge Moloney QC’s decision rejecting each of his arguments – see [2015] EWCA Civ 402. Mr Beavis now appeals to this court, maintaining both his arguments.
Introductory
“13.4 You should allow the driver a reasonable period to leave the private car park after the parking contract has ended, before you take enforcement action.”
Clause 19 provides:
“19.5 If the parking charge that the driver is being asked to pay is for a breach of contract or act of trespass, this charge must be based on the genuine pre-estimate of loss that you suffer. We would not expect this amount to be more than £100. If the charge is more than this, operators must be able to justify the amount in advance.
19.6 If your parking charge is based on a contractually agreed sum, that charge cannot be punitive or unreasonable. If it is more than the recommended amount in 19.5 and is not justified in advance, it could lead to an investigation by the Office of Fair Trading.”
The maximum of £100 recommended by the BPA may be compared with the penalties charged by local authorities, which are regulated by statute. The Civil Enforcement of Parking Contraventions (Guidelines on Levels of Charges) (England) Order 2007 (SI 2007/3487) lays down guidelines for the level of penalties outside Greater London. For “higher level contraventions” (essentially unauthorised on-street parking), the recommended penalty is capped at £70 and for other contraventions at £50. The corresponding figures for Greater London are £130 and £80.
Parking charges and the penalty rule
“a. The need to provide parking spaces for their commercial tenants’ prospective customers;
b. The desirability of that parking being free so as to attract customers;
c. The need to ensure a reasonable turnover of that parking so as to increase the potential number of such customers;
d. The related need to prevent ‘misuse’ of the parking for purposes unconnected with the tenants’ business, for example by commuters going to work or shoppers going to off-park premises; and
e. The desirability of running that parking scheme at no cost, or ideally some profit, to themselves.”
Parking charges and the Unfair Terms in Consumer Contracts Regulations 1999
103. Under regulation 5(1), a contractual term which has not been individually negotiated
“shall be regarded as unfair if, contrary to the requirement of good faith, it causes a significant imbalance in the parties’ rights and obligations arising under the contract, to the detriment of the consumer.”
Regulation 6(1) provides that
“the unfairness of a contractual term shall be assessed, taking into account the nature of the goods or services for which the contract was concluded and by referring, at the time of conclusion of the contract, to all the circumstances attending the conclusion of the contract and to all the other terms of the contract or of another contract on which it is dependent.”
An “indicative and non-exhaustive” list of terms which “may” be regarded as unfair by this test is contained in Schedule 2. This includes at paragraph 1(e) a term “requiring any consumer who fails to fulfil his obligation to pay a disproportionately high sum in compensation”.
105. The reason is that although it arguably falls within the illustrative description of potentially unfair terms at paragraph 1(e) of Schedule 2 to the Regulations, it is not within the basic test for unfairness in regulations 5(1) and 6(1). The Regulations give effect to Council Directive 93/13/EEC on unfair terms in consumer contracts, and these rather opaque provisions are lifted word for word from articles 3 and 4 of the Directive. The effect of the Regulations was considered by the House of Lords in Director General of Fair Trading v First National Bank plc [2002] 1 AC 481. But it is sufficient now to refer to Aziz v Caixa d’Estalvis de Catalunya, Tarragona i Manresa (Case C-415/11) [2013] 3 CMLR 89, which is the leading case on the topic in the Court of Justice of the European Union. Aziz was a reference from a Spanish court seeking guidance on the criteria for determining the fairness of three provisions in a loan agreement. They provided for (i) the acceleration of the repayment schedule in the event of the borrower’s default, (ii) the charging of default interest, and (iii) the unilateral certification by the lender of the amount due for the purpose of legal proceedings. The judgment of the Court of Justice is authority for the following propositions:
1) The test of “significant imbalance” and “good faith” in article 3 of the Directive (regulation 5(1) of the 1999 Regulations) “merely defines in a general way the factors that render unfair a contractual term that has not been individually negotiated” (para 67). A significant element of judgment is left to the national court, to exercise in the light of the circumstances of each case.
2) The question whether there is a “significant imbalance in the parties’ rights” depends mainly on whether the consumer is being deprived of an advantage which he would enjoy under national law in the absence of the contractual provision (paras 68, 75). In other words, this element of the test is concerned with provisions derogating from the legal position of the consumer under national law.
3) However, a provision derogating from the legal position of the consumer under national law will not necessarily be treated as unfair. The imbalance must arise “contrary to the requirements of good faith”. That will depend on “whether the seller or supplier, dealing fairly and equitably with the consumer, could reasonably assume that the consumer would have agreed to such a term in individual contract negotiations” (para 69).
4) The national court is required by article 4 of the Directive (regulation 6(1) of the 1999 Regulations) to take account of, among other things, the nature of the goods or services supplied under the contract. This includes the significance, purpose and practical effect of the term in question, and whether it is “appropriate for securing the attainment of the objectives pursued by it in the member state concerned and does not go beyond what is necessary to achieve them” (paras 71-74). In the case of a provision whose operation is conditional upon the consumer’s breach of another term of the contract, it is necessary to assess the importance of the latter term in the contractual relationship.
“whether such contractual terms are common, that is to say they are used regularly in legal relations in similar contracts, or are surprising, whether there is an objective reason for the term and whether, despite the shift in the contractual balance in favour of the user of the term in relation to the substance of the term in question, the consumer is not left without protection” (para AG75).
Advocate General Kokott returned to the question of legitimate interest when addressing default interest. She observed that a provision requiring the payment upon default of a sum exceeding the damage caused, may be justified if it serves to encourage compliance with the borrower’s obligations:
“If default interest is intended merely as flat-rate compensation for damage caused by default, a default interest rate will be substantially excessive if it is much higher than the accepted actual damage caused by default. It is clear, however, that a high default interest rate motivates the debtor not to default on his contractual obligations and to rectify quickly any default which has already occurred. If default interest under national law is intended to encourage observance of the agreement and thus the maintenance of payment behaviour, it should be regarded as unfair only if it is much higher than is necessary to achieve that aim” (para AG87).
Finally, the Advocate General observes that the impact of a term alleged to be unfair must be examined broadly and from both sides. Provisions favouring the lender may indirectly serve the interest of the borrower also, for example by making loans more readily available (para AG94).
112. The second argument which should be mentioned is that the £85 charge for overstayers “takes advantage of the consumer’s requirement to park in that particular place to shop or visit a particular location”. If this car park is unusually attractively located for shoppers and others, the evidence shows that the £85 charge has not been fixed at a particularly high level to reflect that fact. Further, as Mr Kirk QC pointed out on behalf of ParkingEye, it is equally true that the consumer gets the benefit of free parking in that unusually attractively located car park for two hours, and, save in unusual circumstances, it is entirely within his or her control whether the two-hour limit is exceeded. And if the consumer considers that the circumstances are unusual, he or she can invoke the appeals procedure.
Conclusion on the two appeals
115.
For these reasons, we would allow the appeal in Cavendish v El
Makdessi
and dismiss the appeal in ParkingEye v Beavis, and we would
declare that none of the terms impugned on the two appeals contravenes the
penalty rule, and that the charge in issue in ParkingEye v Beavis does
not infringe the 1999 Regulations.
LORD MANCE:
Introduction
116.
These two appeals raise wide-ranging and difficult questions about the
current law governing contractual penalties. The cases lie at opposite ends of
a financial spectrum. In the first, the appellant, Cavendish Square Holding BV
(“Cavendish”), is part of the world’s leading marketing communications group
(“WPP”), while the respondent, Mr Talal El Makdessi,
was co-founder and
co-owner with Mr Joseph Ghossoub of the Middle East’s largest advertising and
marketing communications group (“the Group”). Prior to 2008 WPP held 12.6% of
the shares of the Group. In 2008 Mr El
Makdessi
and Mr Ghoussoub agreed to sell
to Cavendish a further 47.4% of the Group’s shares (in the form of an interest
in Team Y & R Holdings Hong Kong Ltd (“Team”), a holding company set up to facilitate
the transaction).
117.
The transaction was effected by a sale and purchase agreement dated 28
February 2008, whereby Mr El Makdessi
and Mr Ghoussoub agreed to make the 47.4%
shareholding available in the ratio of 53.88% to 46.12%. The price was payable
in stages: US$65.5m (Mr El
Makdessi’s
share being 53.88%) was payable on
completion of the sale and Group reorganisation. Thereafter, there were to be
Interim and Final Payments derived from a multiple of the Group’s audited
consolidated operating profit (“OPAT”) between respectively 2007 and 2009 and
2007 and 2011. Clause 11.2 was a clause prohibiting Mr El
Makdessi
from various
competitive or potentially competitive activity. Clauses 5.1 and 5.6 provided
that, if he breached clause 11.2, he would not be entitled to receive the
Interim and/or Final Payments, and could be required to sell Cavendish the rest
of his shares at a “Defaulting Shareholder Option Price”, based on asset value
and so ignoring any goodwill value. Mr El
Makdessi
also became non-executive
chair of Team with a service agreement binding him to remain in position for at
least 18 months.
118.
It is accepted by Mr El Makdessi
that he did subsequently breach clause
11.2, and was thereby also in breach of fiduciary duty towards Team. The
present proceedings were initiated by both Cavendish and Team. Team’s claim was
settled in October 2012 when it accepted a Part 36 payment of US$500,000 made
by Mr El
Makdessi.
Cavendish’s claim is for declarations that Mr El
Makdessi’s
breach of clause 11.2 means that clauses 5.1 and 5.6 now have the effect stated
in the previous paragraph. Mr El
Makdessi
maintains that they are unenforceable
penalty clauses.
120.
Cavendish succeeded before Burton J on 14 December 2012, although only
on condition that it agreed to credit Mr El Makdessi
with the US$500,000
recovered from him by Team. The Court of Appeal (Patten, Tomlinson and
Christopher Clarke LJJ), [2013] EWCA Civ 1539, over-ruled Burton J, [2012] EWHC 3582 (Comm), on 26 November 2013, holding both clauses to be unenforceable
penalties. The court held however that the judge had had, on his view of the
case, no basis to impose a condition that Cavendish agree to credit Mr El
Makdessi
with the US$500,000 (and the contrary has not been suggested before
the Supreme Court). Mr Beavis has so far failed at both instances, before Judge
Moloney QC on 19 May 2014 and the Court of Appeal (Moore-Bick and Patten LJJ
and Sir Timothy Lloyd) on 23 April 2015, [2015] EWCA Civ 402. The appellants in
both cases now appeal with the permission of the Supreme Court in the case of
Mr El
Makdessi
and of the Court of Appeal in the case of Mr Beavis.
Cavendish v Mr El Makdessi
– facts
121.
I can summarise and take the relevant terms of the sale and purchase
agreement to which Cavendish and Mr El Makdessi
were parties from the agreed
Statement of Facts and Issues (“SFI”):
“10. By clause 2.1 of the Agreement, Joe and the respondent (defined as ‘the Sellers’) agreed to sell 47.4% of the shareholding in the Company. Clause 3 set out the consideration for that sale, which pursuant to Schedule 1 was to be shared between the respondent and Joe in shares of 53.88% and 46.12% respectively. The consideration, payment of which was not expressed to be subject to any condition, was as follows:
(1) A payment of US$34,000,000 on completion;
(2) A second payment of US$31,500,000 to be paid into escrow on completion and released to Joe and the respondent in accordance with clauses 3.6 to 3.12 (which in short provided for the sum to become payable in stages as the various restructurings provided for in the Agreement took effect).
(3) A further payment (‘the Interim Payment’) was to become payable on its ‘Due Date’ and was to be calculated as follows:
8 x Average 2007-2009 ‘OPAT’ x 47.4% minus US$63,000,000
(4) A final payment (‘the Final Payment’) was to become payable on its ‘Due Date’, and was to be calculated as follows:
‘M’ x Average 2007-2011 ‘OPAT’ x 47.4% minus US$63,000,000 and the Interim Payment.
11. ‘OPAT’ was defined in Schedule 12 as meaning the audited consolidated operating profit of the Group, and ‘Due Date’ was defined as meaning 30 days after the relevant OPAT was agreed or determined. The figure ‘M’ in the definition of Final Payment was a figure varying between seven and ten depending on the growth of OPAT over the period 2007 to 2011.
12. Thus the Interim and Final Payments in essence obliged the purchaser to make further payments to Joe and the respondent calculated by reference to the Group’s profitability in the years 2007 to 2011.
13. Clause 3.2 provided that if the calculation of the Interim Payment or the Final Payment resulted in a negative figure, it was to be treated as zero and Joe and the respondent would not be required to repay any sum already paid.
14. Clause 3.3 capped the total amount of all payments at US$147,500,000.
15. By clause 9.1, paragraph 2.15 of Schedule 7, and Schedule 11, Joe and the respondent warranted that the net assets of the entire Group, not just their share, as at 31 December 2007 were US$69,744,340.
16. Under the Agreement, therefore, a substantial part of the purchase consideration comprised goodwill:
a. The Completion and Second Payments totalled $65.5m and were for 47.4% of the equity (47.4% of the warranted 2007 NAV being $33,058,817);
b. At its highest (assuming no decrease in NAV) some US$114.44m would be payable for goodwill ($147,500,000 - $33,058,817), representing 77% of the aggregate purchase consideration.
17. Clause 11 was entitled ‘Protection of Goodwill’, and provided that:
‘11 PROTECTION OF GOODWILL
11.1 Each Seller recognises the importance of the goodwill of the Group to the Purchaser and the WPP Group which is reflected in the price to be paid by the Purchaser for [the shares]. Accordingly, each Seller commits as set out in this clause 11 to ensure that the interest of each of the Purchaser and the WPP Group in that goodwill is properly protected.’
18. Clause 11.2 then set out various restrictive covenants (‘the Restrictive Covenants’) entered into by Joe and the respondent:
‘11.2 Until the date 24 months after the Relevant Date, no Seller will directly or indirectly without the Purchaser’s prior consent:
(a) carry on or be engaged, concerned, or interested, in competition with the Group, in the Restricted Activities within the Prohibited Area;
(b) solicit or knowingly accept any orders, enquiries or business in respect of the Restricted Activities in the Prohibited Area from any Client;
(c) divert away from any Group Company any orders, enquiries or business in respect of the Restricted Activities from any Client; or
(d) employ, solicit or entice away from or endeavour to employ, solicit, or entice away from any Group Company any senior employee or consultant employed or engaged by that Group Company.’
19. By virtue of the definitions in Schedule 12 of the Agreement, ‘Restricted Activities’ meant the provision of products and/or services of a competitive nature to those being provided by the Group, ‘Prohibited Area’ meant any countries in which the Group carried on the business of marketing communications and ancillary services, and ‘Client’ meant any client or potential client of the Group who had placed an order with the Group during the past 12 months or been in discussions with the Group during that period.
20. As to the several covenants:-
(a) the effect of any breach of the covenant against employing or soliciting senior employees could be less than a breach of the covenants against competitive activity; the respondent’s position is that it was likely, in many circumstances, to be markedly less; and
(b) Losses attributable to breaches of the covenant against solicitation could vary, the respondent says were likely to vary widely, according to the nature, extent, duration and success of the solicitation.
21. By clause 7.5, the respondent agreed that within four months after completion he would dispose of any shares held by him in Carat Middle East Sarl (‘Carat’) and procure that a joint venture agreement of 19 December 2003 to which Group Carat (Nederland) BV and Aegis International BV, on the one hand, and the respondent, on the other, were parties, would be terminated.
22. By the time of trial, the respondent had conceded that (if the Restrictive Covenants were enforceable) he was in breach thereof by reason of his ongoing, unpaid involvement in the affairs of Carat (‘the Breach’).
23. It is the provisions providing for the consequences of breach which are in issue in this appeal. By reason of the Breach, the respondent became a ‘Defaulting Shareholder’ within the meaning of the definition in Schedule 12. Clause 5.1 is headed ‘DEFAULT’ and includes two relevant provisions.
24. First, clause 5.1 provides that on becoming a Defaulting Shareholder, the respondent would not be entitled to receive the Interim Payment or the Final Payment:
‘If a Seller becomes a Defaulting Shareholder he shall not be entitled to receive the Interim Payment and/or the Final Payment which would other than for his having become a Defaulting Shareholder have been paid to him and the Purchaser’s obligation to make such payments shall cease.’
25. In money terms, the effect of this provision is that in the event of a default by the respondent, he could receive up to $44,181,600 less than would have been the case had he not acted in breach. If both Sellers were to default, they could lose up to US$82m ($147.5-$65.5) between them.
26. Second, clause 5.6 grants an option over the respondent’s remaining shares in the Group whereby in the event that he became a Defaulting Shareholder, the appellant could require him to sell those remaining shares:
‘Each Seller hereby grants an option to the Purchaser pursuant to which, in the event that such Seller becomes a Defaulting Shareholder, the Purchaser may require such Seller to sell to the Purchaser (or its nominee) all (and not some only) of the Shares held by that Seller (the Defaulting Shareholder Shares). The Purchaser (or its nominee) shall buy and such Seller shall sell with full title guarantee the Defaulting Shareholder Shares ... within 30 days of receipt by such Seller of a notice from the Purchaser exercising such option in consideration for the payment by the Purchaser to such Seller of the Defaulting Shareholder Option Price.’
27. The ‘Defaulting Shareholder Option Price’ is defined in Schedule 12 as meaning the proportion of the Net Asset Value of the company equal to the proportion of shares sold by the Defaulting Shareholder, a formula which excludes the value of goodwill. By clause 5.7, this could be satisfied either in cash or by issuing shares in WPP, at the absolute discretion of the appellant.
28. Clause 15.1 granted the Sellers a put option by which they could require the appellant to purchase all their remaining shares in the Company:
‘Each Seller is hereby granted an option by the Purchaser pursuant to which such Seller may, subject to clause 15.2, by service of an Option Notice in the form set out in Schedule 10 (the Option Notice) require the Purchaser (or its nominee) to purchase from him all (and not some only) of the Shares held by that Seller (the Option Shares). The Purchaser (or its nominee) shall buy and the Seller shall sell with full title guarantee the Option Shares ... within 30 days of receipt of the Option Notice in consideration for the payment when due of the price determined in accordance with clause 15.3 (the Option Price).’
29. In money terms, the effect of clause 5.6 is that insofar as the retained shares of a Defaulting Shareholder have, at the date when he becomes a Defaulting Shareholder, a value which is attributable to goodwill, he will not receive it. He will not be able to exercise the put option otherwise available in 2011 and subsequent years, which would give him a price, not exceeding $75m, which reflected goodwill.
30. As of the date of the Agreement, the respondent was, and was bound to remain, a director for at least 18 months and was entitled to remain thereafter as long as he was a shareholder unless Cavendish considered that his outside business interests were likely to result in a material ongoing conflict with his duties as a director. For so long as he did remain a director, any breach of clause 11.2 would give rise to a cause of action for breach of fiduciary duty to the Company.
31. The Agreement contained no provision which precluded the Company from bringing a claim for damages for conduct rendering the respondent a Defaulting Shareholder.
32. As with the agreement as a whole, these provisions were subject to negotiation and amendment between the parties. …
33. The structure of the Agreement was typical of acquisition agreements in the marketing sector. As in this case, the vendor is typically the founder or operator of the business, and has important relationships with clients and key staff. If they decide to turn against the business, its success can be significantly affected, and provisions are therefore included to protect the value of the investment, and in particular the value of the goodwill represented by the vendor’s existing personal relationships. The respondent fell into that category; the importance of personal relationships with clients is even stronger in the Middle East than the UK, and he had very strong relationships with clients and senior employees, and he was such a well known figure that if he acted against the Group, it would inevitably cause it to lose value. …”
122.
Paragraphs 25 and 29 of this agreed summary outline the effect of
clauses 5.1 and 5.6 of the sale and purchase agreement, on which Cavendish
relies but which Mr El Makdessi
submits to be penal and unenforceable. Since
clauses 5.1 and 5.6 operate because Mr El
Makdessi
became a Defaulting
Shareholder by reason of breach of clause 11.2, both clauses need to be
considered with reference to the nature, scope and duration of the restrictive
covenants in favour of Cavendish which clause 11.2 contains. As para 33 of the
agreed summary records, the restrictive covenants represented very significant
protections of the value of the goodwill which Cavendish was to acquire. Clause
11.2 provides for such protection to continue until 24 months after the “Relevant
Date”. By Schedule 12:
“Relevant Date means in respect of a Seller the later of the date of termination of his employment by the Group, the date that he no longer holds any Shares or the date of payment of the final instalment of the Option Price pursuant to clause 15.5(b).”
Clause 16.1 provided that:
“Save as otherwise expressly provided by this agreement no Seller shall transfer, sell, charge, Encumber or otherwise dispose of all or part of his interest in any Shares.”
The put option referred to in para 28 of the agreed summary
was only exercisable by Mr El Makdessi
by option notice served “at any time
between 1 January and 31 March in 2011 or in any subsequent year” (clause
15.2). Upon its exercise, the Option Price was payable in two instalments, the
second or final instalment being due “within 30 days of the agreement or final
determination of OPAT for N+2” (clause 15.5(b)). OPAT means under Schedule 12
“the audited consolidated operating profit … in any 12-month accounting period
ending 31 December”. N means “the financial year in which the Option Notice is
served” (clause 15.3). N+2 thus means the year 2013, and the earliest date of
full payment of any Option Price under clause 15 would be some date in 2014, once
the OPAT for N+2 was agreed or finally determined. That would be the (earliest)
Relevant Date, assuming that Mr El
Makdessi
had previously determined his
employment by the Group which he was only committed to maintain for 18 months
from the date of the agreement (para 30 of the agreed summary). Under the terms
of the sale and purchase agreement dated 28 February 2008, Mr El
Makdessi
was
bound by the restrictive covenants for a further 24 months, ie until a date in
2016, some eight years after the sale and purchase agreement. There has been no
challenge in this court to the reasonableness of this lengthy restriction, and
it underlines the importance of goodwill to the agreement and to the buyers,
Cavendish, in particular.
ParkingEye Limited v Beavis - facts
“ParkingEye
car park management
2 hour max stay
Customer only car park
4 hour maximum stay for Fitness Centre Members
Failure to comply with the following will result in a Parking Charge of: £85
Parking limited to 2 hours
(no return within 1 hour)
Park only within marked bays
Blue badge holders only in marked bays
ParkingEye Ltd is solely engaged to provide a traffic space maximisation scheme. We are not responsible for the car park surface, other motor vehicles, damage or loss to or from motor vehicles or user’s safety. The parking regulations for this car park apply 24 hours a day, all year round, irrespective of the site opening hours. Parking is at the absolute discretion of the site. By parking within the car park, motorists agree to comply with the car park regulations. Should a motorist fail to comply with the car park regulations, the motorist accepts that they are liable to pay a Parking Charge and that their name and address will be requested from the DVLA. Parking charge Information: A reduction of the Parking Charge is available for a period, as detailed in the Parking Charge Notice. The reduced amount payable will not exceed £75, and the overall amount will not exceed £150 prior to any court action, after which additional costs will be incurred.
This car park is private property.”
The issues
126.
This section of the judgment concerns the doctrine of penalties. I deal
later with the issues arising under the Unfair Terms in Consumer Contracts
Regulations 1999: see paras 200-213 below. Miss Joanna Smith QC for Cavendish
invites the Supreme Court to undertake a fundamental review of the law
regarding penalties. In her submission it is outdated, incoherent and
unnecessary, and should be abolished. Alternatively, it should have no place in
relation to “commercial” contracts, by which I understand her to mean contracts
at arm’s length between equally balanced parties, like Cavendish and Mr El
Makdessi.
In the further alternative, she submits that it is or should be held
to be inapplicable to any clauses other than those requiring payment of money
on breach, and/or to clauses not aimed at compensating for the breach, but for
which some other valid commercial reason exists.
127.
Mr Bloch QC for Mr El Makdessi
resists these submissions. In his
submission, the doctrine fulfils a tried and well-established role, there is no
impetus, let alone one based on any research or review, for its abolition or
restriction and it is, on principle and authority, applicable to the types of
clause in issue in this case. He submits that the law governing penalties
enables and requires account to be taken of the interests intended to be
protected by the relevant clause – a proposition that Miss Smith was in reply
at first inclined to dispute, but after questioning and reflection later
herself endorsed. But protection of such interests is, in Mr Bloch’s
submission, subject to the over-riding control that it must not be extravagant,
oppressive or manifestly excessive. In his submission the present clauses are
precisely that, since their effect is in the case of clause 5.1 to deprive Mr El
Makdessi
of part of the agreed consideration, and to do so in a way which bears
no resemblance to any loss which his breach may have caused Cavendish or the
Group. On the contrary, the smaller the loss it has caused, the larger the
penalty effect, and vice versa. As to clause 5.6, its effect is to give
Cavendish a right on any default by Mr El
Makdessi
to force him to part with
his remaining shareholding, at a price likely to be well below its actual
value, again in circumstances where the difference in value in no way reflects
any loss which the default may have caused Cavendish or the Group, and where
the smaller the loss caused to the Group, the larger the difference in value of
which Mr El
Makdessi
is deprived.
129. The law of penalties in this jurisdiction currently applies to contractual clauses operating on a breach of contract by the other party to the contract: see the statements to that effect by Lord Roskill in Export Credits Guarantee Department v Universal Oil Products Co [1983] 1 WLR 399 at pp 402H and 404C (although the facts of that case were quite special). This limitation has on occasion been seen as a weakness or even as an indication of inherent fragility in the doctrine’s underpinning. The High Court of Australia has quite recently addressed this aspect head-on, holding that breach is not an essential aspect of the doctrine; the essential question is whether the contract imposes a restriction from doing the particular act, reserving a payment if it is done, or whether it confers a right to do the act in return for payment of an equivalent: Andrews v Australia and New Zealand Banking Group Ltd [2012] HCA 30, 247 CLR 205, Paciocco v Australia and New Zealand Banking Group Ltd [2015] FCAFC 50, para 95.
The concept of a penalty
132. In the first decision, the Scottish appeal of Clydebank Engineering and Shipbuilding Co v Don Jose Ramos Yzquierdo y Castaneda [1905] AC 6, the House was concerned with an expressed “penalty” of £500 per week for late delivery of four torpedo boats to the Spanish Government. The Earl of Halsbury LC distinguished at p 10 between an agreed sum for damages and a penalty to be held over the other party in terrorem and Lord Davey at p 15 between a clause providing for liquidate damages or for a punishment irrespective of the damage caused. But the Earl of Halsbury went on to stress how “extremely complex, difficult, and expensive” any proof of damages would have been, how it would involve “before one’s mind the whole administration of the Spanish Navy” and how “absolutely idle and impossible [it would be] to enter into a question of that sort unless you had some kind of agreement between the parties as to what was the real measure of damages which ought to be applied” (pp 11-12). He also rejected out of hand submissions that a warship has no value at all, and that, had the torpedo boats been delivered on time, they would have been sunk, like much else of the Spanish fleet, in the Spanish-American war (of 1898, after the United States intervened in support of Cuban independence).
“The question remains, had the respondents no interest to protect by that clause, or was that interest palpably incommensurate with the sums agreed on? It seems to me that to put this question, in the present instance, is to answer it. Unless injury to a state is as matter of law inexpressible in money, Spain was or might be deeply interested in the early delivery of these ships and deeply injured by delay.
To my thinking, Lord Moncreiff has, in two sentences, admirably stated the case: ‘The subject-matter of the contracts, and the purposes for which the torpedo-boat destroyers were required, make it extremely improbable that the Spanish Government ever intended or would have agreed that there should be inquiry into, and detailed proof of, damage resulting from delay in delivery. The loss sustained by a belligerent, or an intending belligerent, owing to a contractor’s failure to furnish timeously warships or munitions of war, does not admit of precise proof or calculation; and it would be preposterous to expect that conflicting evidence of naval or military experts should be taken as to the probable effect on the suppression of the rebellion in Cuba or on the war with America of the defenders’ delay in completing and delivering those torpedo-boat destroyers.’”
At p 19, Lord Robertson also described a penalty as a sum “merely stipulated in terrorem [which] could not possibly have formed … a genuine pre-estimate of the creditor’s probable or possible interest in the due performance of the principal obligation”.
134. Lord Robertson’s last words were quoted by the Judicial Committee of the Privy Council (which included the Lord Chancellor, Lord Davy and Lord Dunedin) in the second decision, Public Works Comr v Hills [1906] AC 368, 375-376. The Board’s advice was that the clause in that case was a penalty. The clause, contained in one railway construction contract, provided for the forfeiture, on non-completion of the railway within the stipulated time, of whatever retention moneys were held as a result of two separate railway construction contracts together with a further £10,000. The “determining factor” was in the Board’s advice that the sum was not a “definite sum, but is liable to great fluctuation in amount dependent on events not connected with the fulfilment of this contract” (p 376).
135. The third decision is the English appeal in Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79. Under Dunlop’s standard terms, distributors undertook not to sell or offer the goods to any private customers or to any co-operative society at less than Dunlop’s current list prices, not to sell to persons whose supplies Dunlop had decided to suspend, and not to exhibit or export without Dunlop’s consent. The terms stipulated for payment of £5 for every tyre, cover, or tube sold or offered in breach of such undertakings. Dunlop’s unchallenged evidence was price cutting would indirectly damage their business as a whole (p 88). On this basis the House held that the stipulation was not a penalty.
“But though damage as a whole from such a practice would be certain, yet damage from any one sale would be impossible to forecast. It is just, therefore, one of those cases where it seems quite reasonable for parties to contract that they should estimate that damage at a certain figure, and provided that figure is not extravagant there would seem no reason to suspect that it is not truly a bargain to assess damages, but rather a penalty to be held in terrorem.”
137. Lord Atkinson spelled the point out at pp 91-93 (italics added):
“In the sense of direct and immediate loss the appellants lose nothing by such a sale. It is the agent or dealer who loses by selling at a price less than that at which he buys, but the appellants have to look at their trade in globo, and to prevent the setting up, in reference to all their goods anywhere and everywhere, a system of injurious undercutting. The object of the appellants in making this agreement, if the substance and reality of the thing and the real nature of the transaction be looked at, would appear to be a single one, namely, to prevent the disorganization of their trading system and the consequent injury to their trade in many directions. The means of effecting this is by keeping up their price to the public to the level of their price list, this last being secured by contracting that a sum of 5l shall be paid for every one of the three classes of articles named sold or offered for sale at prices below those named on the list. The very fact that this sum is to be paid if a tyre cover or tube be merely offered for sale, though not sold, shows that it was the consequential injury to their trade due to undercutting that they had in view. They had an obvious interest to prevent this undercutting, and on the evidence it would appear to me impossible to say that that interest was incommensurate with the sum agreed to be paid.
Their object is akin in some respects to that which a trader has in binding a former employee not to set up, or carry on, a rival business within a certain area. The trader’s object is to prevent competition, and especially to prevent his old customers whom the employee knows from being enticed away from him. If one takes for example the case of a plumber, the carrying on of the trade of a plumber may mean anything from mending gas pipes for a few pence apiece up to doing all the plumbing work of a big hotel. If the employee should mend one hundred of such pipes for twenty old customers at 6d apiece, for which the employer would charge 1s apiece, could it possibly be contended that the trader’s loss was only one hundred sixpences, 21 10s? It is, I think, quite misleading to concentrate one’s attention upon the particular act or acts by which, in such cases as this, the rivalry in trade is set up, and the repute acquired by the former employee that he works cheaper and charges less than his old master, and to lose sight of the risk to the latter that old customers, once tempted to leave him, may never return to deal with him, or that business that might otherwise have come to him may be captured by his rival. The consequential injuries to the trader’s business arising from each breach by the employee of his covenant cannot be measured by the direct loss in a monetary point of view on the particular transaction constituting the breach. An old customer may be as effectively enticed away from him through the medium of a 10s job done at a cheap rate as by a 50l job done at a cheap rate, or a reputation for cheap workmanship may be acquired possibly as effectively in one case as in the other.”
“Such damage will in every case consist in the disturbance or derangement of the system of distribution by means of which the appellants’ goods reach the ultimate consumer.”
“2. The essence of a penalty is a payment of money stipulated as in terrorem of the offending party; the essence of liquidated damages is a genuine covenanted pre-estimate of damage (Clydebank Engineering and Shipbuilding Co v Don Jose Ramos Yzquierdo y Castaneda [1905] AC 6).”
“I do not find that that description adds anything of substance to the idea conveyed by the word ‘penalty’ itself, and it obscures the fact that penalties may quite readily be undertaken by parties who are not in the least terrorised by the prospect of having to pay them ...”
141. Lord Radcliffe’s comment has been quoted with approval in the Court of Appeal in Cine Bes Filmcilik ve Yapimcilik v United International Pictures [2004] 1 CLC 401 and again in Murray v Leisureplay plc [2005] EWCA Civ 963, [2005] IRLR 946, paras 47 and 109, per Arden LJ and Buxton LJ. In Cine Bes, para 13, I regarded as a “more accessible paraphrase of the concept of penalty” that adopted by Colman J in Lordsvale Finance plc v Bank of Zambia [1996] QB 752, 762G. Colman J there said that the Dunlop Pneumatic Tyre case 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.”
a. A sum is a penalty if “extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach”.
b. If the breach consists only in not paying a sum of money, a sum stipulated as payable on the breach greater than any that ought to have been paid will be a penalty.
c. There is a presumption (but no more) that it is penalty when “a single lump sum is made payable by way of compensation, on the occurrence of one or more or all of several events, some of which may occasion serious and others but trifling damage”.
d. On the other hand, it is “no obstacle to the sum stipulated being a genuine pre-estimate of damage, that the consequences of the breach are such as to make precise pre-estimation almost an impossibility. On the contrary, that is just the situation when it is probable that pre-estimated damage was the true bargain between the parties (Clydebank Case, Lord Halsbury, at p 11)”.
144. In 1986 the High Court of Australia thought, when examining recent English authority, that the underlying test of extravagance, exorbitance or unconscionability to be derived from the Clydebank Engineering and Dunlop cases had been eroded by decisions in which the focus had been more narrowly on a comparison between the agreed sum and any possible loss which could be awarded for the breach of contract in question: AMEV-UDC Finance Ltd v Austin [1986] HCA 63, 162 CLR 170, 190. It advocated a return to the original concept. This was taken up by the Privy Council in Philips Hong Kong Ltd v Attorney General of Hong Kong (1993) 61 BLR 41, where Lord Woolf emphasised the interest that parties have in being able to know with a reasonable degree of certainty the extent of their liability and the risks that they run (p 54). But both these cases accept a basic dichotomy between penal and compensatory provisions.
“… the borrower in default is not the same credit risk as the prospective borrower with whom the loan agreement was first negotiated. Merely for the pre-existing rate of interest to continue to accrue on the outstanding amount of the debt would not reflect the fact that the borrower no longer has a clean record. Given that money is more expensive for a less good credit risk than for a good credit risk, there would in principle seem to be no reason to deduce that a small rateable increase in interest charged prospectively upon default would have the dominant purpose of deterring default. That is not because there is in any real sense a genuine pre-estimate of loss, but because there is a good commercial reason for deducing that deterrence of breach is not the dominant contractual purpose of the term.
It is perfectly true that for upwards of a century the courts have been at pains to define penalties by means of distinguishing them for liquidated damages clauses. The question that has always had to be addressed is therefore whether the alleged penalty clause can pass muster as a genuine pre-estimate of loss. That is because the payment of liquidated damages is the most prevalent purpose for which an additional payment on breach might be required under a contract. However, 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 therefore 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.”
147. In a whole series of cases across the world, courts have taken their cue from Lordsvale and held that provisions in loan agreements for uplifting the interest rate for the future after a default should not be regarded as penalties, save where the uplift is evidently extravagant: see eg Hong Leuong Finance Ltd v Tan Gin Huay [1999] 2 SLR 153, Beil v Mansell (No 2) (2006) 2 Qd R 499, PSAL Ltd v Kellas-Sharpe [2012] QSC 31, Elberg v Fraval [2012] VSC 342, Place Concorde East Ltd Partnership v Shelter Corp of Canada Ltd (2003) 43 BLR (3d) 54 and In re Mandarin Container [2004] 3 HKLRD 554.
“I have also found valuable Colman J’s further observation[s] in Lordsvale at pp 763g-764a, which indicate that a dichotomy between a genuine pre-estimate of damages and a penalty does not necessarily cover all the possibilities. There are clauses which may operate on breach, but which fall into neither category, and they may be commercially perfectly justifiable.”
150. In Murray v Leisureplay plc [2005] EWCA Civ 963, [2005] IRLR 946, a later Court of Appeal (Arden, Clarke and Buxton LJJ) agreed with the approach taken in Lordsvale and Cine Bes, with Clarke and Buxton LJJ stressing the importance of the commercial context, even in cases where there would be no difficulty about assessing damages (at respectively paras 105 and 118). The case concerned a clause in a chief executive’s employment contract entitling him to payment of a year’s gross salary in the event of wrongful termination of his employment without a year’s notice.
151. The dicta in para 15 in Cine Bes were considered recently by the Federal Court of Australia in Paciocco v Australia and New Zealand Banking Group Ltd [2015] FCAFC 50, at para 99. The case concerned fees charged by banks for late payment, for honour and over-limit payments and for non-payments. Allsop CJ thought that any difficulties about accepting a dichotomy could be avoided by a different analysis, which he expressed at para 103 as follows:
“The object and purpose of the doctrine of penalties is vindicated if one considers whether the agreed sum is commensurate with the interest protected by the bargain: Andrews (HC) at para 75; Dunlop at pp 91-93; Clydebank at pp 15-17, 19 and 20; Public Works Comr v Hills at pp 375-376. This is not to say that the inquiry is unconnected with recoverable damages, but the question of extravagance and unconscionability by reference, as Lord Dunedin said in Dunlop, to the greatest loss that could conceivably be proved to have followed from the breach, is to be understood as reflecting the obligee’s interest in the due performance of the obligation: Public Works Comr v Hills at pp 375-376. One only needs to reflect on the facts of Dunlop and the justification for the payment that was found to be legitimate to appreciate these matters.”
Can the penalty doctrine apply to clauses withholding payments?
154. In the cases so far discussed, the provision in issue required payment of money. A number of authorities have considered whether and how far the doctrine extends beyond provisions for payment of money. First, the penalty doctrine has been applied to provisions not requiring the payment of money by, but authorising the withholding of moneys otherwise due to, the party in breach. Although the point was apparently conceded (p 693H), several members of the House accepted this in Gilbert-Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd [1974] AC 689. The clause there provided that, in the event that a sub-contractor failed “to comply with any of the provisions of this sub-contract”, the contractor might “suspend or withhold payment of any moneys due”. Lord Reid said (p 698C-F) that, read literally, this would entitle the contractor to withhold sums far in excess of any fair estimate of the value of his claims and was an unenforceable penalty, and Lord Morris, Viscount Dilhorne and Lord Salmon spoke to similar effect (pp 703G, 711D and 723H). Hunter J adopted and applied their statements in Hong Kong in the building contract case of Hsin Chong Construction Co Ltd v Hong Kong and Kowloon Wharf and Godown Co Ltd [1984] HKCFI 212, paras 22-23.
156. In Public Works Comr v Hills the Privy Council applied the penalty doctrine to a clause forfeiting, on a termination for non-completion of works, sums lodged by a contractor with the Cape Agent-General as security for its performance and for release back to it in three stages as it progressed the works. Since the sums were only lodged by way of security and were to be returned if the works progressed, the contractor could be seen to have a continuing interest in them, which the clause forfeited. More recently in Workers Trust & Merchant Bank Ltd v Dojap Investments Ltd [1993] AC 573, the Privy Council treated Public Works Comr v Hills as authority that the doctrine applies to the forfeiture of a deposit exceeding the sum of 10% of the contract price customarily paid in respect of the sale of land. It left open the unresolved question discussed in Stockloser v Johnson [1954] 1 QB 476, whether the doctrine applies, or the court has any other equitable power, to address a situation where a party is given possession of property on terms that he will pay for property by instalments, in default of which he will forfeit any interest in the property and the instalments already paid. However, still more recently, Eder J in Cadogan Petroleum Holdings Ltd v Global Process Systems LLC [2013] 2 Lloyd’s Rep 26 held the doctrine inapplicable to forfeiture of prepayments made towards the acquisition of property in the form of two gas plants. The contract provided for a series of such pre-payments, not all of which GPS completed making. It never therefore acquired the gas plants, and Cadogan relied on a contractual clause forfeiting all pre-payments which GPS had made. It appears that there may be Scots authority to like effect: see Zemhunt (Holdings) Ltd v Control Securities [1991] Scot CS CSIH 6, 1992 SC 58, 1992 SCLR 151, although that case itself only concerned a 10% deposit.
Can the penalty doctrine apply to transfers of money’s worth?
158. There is substantial Australian authority in the same sense. In Bysouth v Shire of Blackburn and Mitcham (No 2) [1928] VLR 562, Irvine CJ held at pp 574-575 with Mann and Lowe JJ agreeing at p 579 that a provision for forfeiture by the council of its contractors’ property in and upon the works in the event of breach was penal. In Forestry Commission of New South Wales v Stefanetto (1976) 133 CLR 507, Mason and Jacobs JJ took the same view in the High Court. In Wollondilly Shire Council v Picton Power Lines Pty Ltd (1994) 33 NSWLR 551, 555G, the doctrine was applied to a provision requiring the defaulting contractor to sell back property to the council at its original sale price, with Handley JA observing that, since equity looks to substance not form, the doctrine must apply to the transfer of money’s worth as well as money. In Ringrow Pty Ltd v BP Australia Pty Ltd , the High Court of Australia cited Jobson v Johnson for the same proposition in relation to a clause requiring a petrol station to be sold back to BP at a price excluding goodwill. The argument failed on the facts, because of expert evidence, which the trial judge accepted, that in the context of this particular station there was no monetary value attaching to any goodwill. Finally, the High Court in Andrews again cited Jobson v Johnson for the proposition that the doctrine applied to the transfer of property.
The relationship between the penalty doctrine and relief against forfeiture
160. Jobson v Johnson proceeds on the basis that a case may raise for consideration both the penalty doctrine and the power of the court to relieve against forfeiture. In my opinion, that is both logical and correct in principle under the current law. A penalty clause imposes a sanction for breach which is extravagant to the point where the court will in no circumstances enforce it according to its terms. The power to relieve against forfeiture relates to clauses which do not have that character, but which nonetheless operate on breach to deprive a party of an interest in a manner which would not be penal. That it would not be penal is evident from the fact that the court will only grant relief on the basis that the breach is rectified by performance. “[I]n the ordinary course”, as the Privy Council said in Cukurova Finance International Ltd v Alfa Telecom Turkey Ltd [2013] UKPC 20, [2015] 2 WLR 875, para 13, “relief in equity will only be granted on the basis of conditions requiring performance, albeit late, of the contract in accordance with its terms as to principal, interest and costs: see eg per Lord Parker of Waddington in Kreglinger v New Patagonia Meat and Cold Storage Co Ltd [1914] AC 25, at pp 49-50 and per Lord Wilberforce in Shiloh Spinners Ltd v Harding [1973] AC 691, at pp 722C and 723H”. The two doctrines, both originating in equity, therefore operate at different points and with different effects. Consideration whether a clause is penal occurs necessarily as a preliminary to considering whether it should be enforced, or whether relief should be granted against forfeiture.
Should the penalty doctrine be abolished or restricted?
165.
I note in parenthesis that many national European legal systems already appear to contain similar provisions, even if only introduced legislatively as appears to be the case in France by laws of 9 July 1975 and 11 October 1985 amending article 1152 of the Code civil (and reversing the effect of the Cour de cassation decision in Paris frères c Dame Juillard Civ 14 February 1866). Germany in contrast takes a broad view of the interests which may be protected by a clause imposing a financial liability on breach (Vertragsstrafe), including among them not merely compensation, but also deterrence. But in non-business cases, the court has the power to reduce any penalty to an appropriate level under BGB (the Civil Code), section 343. However, HGB (the Commercial Code) para 248 exempts contracts between businessmen from the scope of BGB section 343, although such contracts appear still to be susceptible to control if they are standard form contracts (not the case with that between Cavendish and Mr El Makdessi)
or in terms so abusive as to infringe other principles applicable generally, although only in extreme cases, such as those governing Guten Sitten, Wucher or Treu und Glauben (BGB sections 138 and 242).
166. At the court’s request, Cavendish also included as an appendix to its case a valuable examination of the law of, and relevant academic commentary from, other common law countries: Australia, Canada, New York and other United States’ states and sources, Scotland, New Zealand, Singapore and Hong Kong. It is sufficient to say that all these countries retain a doctrine broadly on the same lines as the current English doctrine. In both Australia and Canada, emphasis has been placed on the root principles of extravagance, exorbitance or unconscionability, to be found in the Clydebank Engineering and Dunlop cases: AMEV-UDC Finance Ltd v Austin [1978] 2 SCR 916 and Waddams, The Law of Damages (Nov 2014), para 8-340. In Australia, the doctrine has been extended, as I have noted, to cover situations falling short of breach: Andrews. In both Singapore and Hong Kong, the approach in Philips Hong Kong has been followed. In Australia, it is established that the penalty doctrine applies to clauses calling for the transfer of property (para 158 above) as well as to the withholding of sums due, and there is also Hong Kong authority for the latter (para 154 above). Waddams, The Law of Contracts, 6th ed (2010), para 461 cites Jobson v Johnson for the proposition that it applies to clauses requiring transfer of property at an undervalue in Canada, and there is no suggestion of disagreement on either of these points in any other common law country. It would be odd, to say the least, if the United Kingdom separated itself from so general a consensus.
Application of the penalty doctrine - Cavendish
171.
The relevant trigger to the operation of both clauses 5.1 and 5.6 is the
definition of “Defaulting Shareholder”, to include “a Seller who is in breach
of clause 11.2 hereof”. Clause 11.2 contains various restrictive covenants. It
is common ground (SFI para 20: para 121 above) that the breach of the covenant
against employing or soliciting senior employees could be less than a breach of
the covenants against competitive activity, and that losses from breaches of
the covenant against solicitation could vary, according to the nature, extent,
duration and success of the solicitation. Mr El Makdessi
would say “markedly”
less and vary “widely”.
“The object of the appellants in making this agreement, if the substance and reality of the thing and the real nature of the transaction be looked at, would appear to be a single one, namely, to prevent the disorganization of their trading system and the consequent injury to their trade in many directions.
…
It is, I think, quite misleading to concentrate one’s attention upon the particular act or acts by which, in such cases as this, the rivalry in trade is set up, … The consequential injuries to the trader’s business arising from each breach by the employee of his covenant cannot be measured by the direct loss in a monetary point of view on the particular transaction constituting the breach.”
This was said in a context where Dunlop was protecting the whole of its business, involving many actual and potential transactions with many different purchasers, by imposing trading restrictions on every purchaser. In the present case, Cavendish is protecting the whole of the business, of which it was to be majority shareholder, involving many actual and potential transactions with many different customers, by imposing a competitive restriction on the sellers from whom it was buying the majority control. In each case, the focus should be on the overall picture, not on the individual breaches.
“more complicated when the stipulation, though still a single stipulation, is capable of being broken more than once, and in more ways than one, such as a stipulation not to solicit the customers of a firm. A solicitation which is unsuccessful, can give rise to only nominal damages, and even if it be successful the actual damage may vary greatly according to the value of the custom which is thereby directly or indirectly lost to the firm. Still, whatever damage there is must be the same in kind for every possible breach, and the fact that it may vary in amount for each particular breach has never been held to raise any presumption or inference that the sum agreed to be paid is a penalty, at any rate in cases where the parties have referred to it as agreed or liquidated damages.
The question becomes still more complicated where a single sum is agreed to be paid on the breach of a number of stipulations of varying importance. It is said that in such a case there arises an inference or presumption against the sum in question being in the nature of agreed damages, even though the parties have referred to it as such. My Lords, in this respect I think a distinction should be drawn between cases in which the damage likely to accrue from each stipulation is the same in kind and cases in which the damage likely to accrue varies in kind with each stipulation. Cases of the former class seem to me to be completely analogous to those of a single stipulation, which can be broken in various ways and with varying damage; but probably it would be difficult for the court to hold that the parties had pre-estimated the damage if they have referred to the sum payable as a penalty.
In cases, however, of the latter class, I am inclined to think that the prima facie presumption or inference is against the parties having pre-estimated the damage, even though the sum payable is referred to as agreed or liquidated damages. The damage likely to accrue from breaches of the various stipulations being in kind different, a separate pre-estimate in the case of each stipulation would be necessary, and it would not be very likely that the same result would be arrived at in respect of each kind of damage.”
175.
It is submitted, however, by Mr Bloch that clause 5.1 is penal for a
different reason, because of the size and haphazard nature of its potential
impact in forfeiting entitlement to receive the Interim and/or Final Payments,
so far as not yet paid at the time of its breach. Taking the size of impact, it
is common ground that a substantial part of the purchase price comprised
goodwill (SFI, para 16). This is clear from the terms of the agreement alone
(especially clauses 11.1 and 11.7), but is further confirmed by the evidence of
Mr Scott for Cavendish and by the figures alone. The net assets of the entire
Group were, by the terms of the sale and purchase agreement, warranted by Mr El
Makdessi
to be US$69.7m as at 31 December 2007. That indicates that in broad
terms around US$33m of the US$65.5m paid to Mr El
Makdessi
and Mr Ghoussoub by
way of Completion and Second Payments was seen as attributable to the Group’s
net asset value. Their total entitlement was capped under clause 3.3 at
US$147.5m. Deducting the net asset value element of the Completion and Second Payments,
the anticipated goodwill value must have been up to US$114.5m, of which US$32.5m
(about 26%) was covered by the Completion and Second Payments, meaning that up
to US$82m was anticipated to come by way of the Interim and Final Payments, of
which Mr El
Makdessi’s
53.88% share would be some US$44m. On Cavendish’s case,
Mr El
Makdessi’s
breach of clause 11.2 deprives him of any claim to this or any
other goodwill element of the value of his shares over and above that already
covered by the Completion and Second Payments.
177.
That, however, amounts to a very crude link, at best. And it means that
clause 5.1 is only capable of operating as any form of protection for Cavendish
against breaches occurring for something over four years from the date of
agreement, while clause 11.2 is capable of continuing and being broken for a
much longer period of years (24 months after the Relevant Date, itself
potentially postponed until whenever Mr El Makdessi
exercises the put option
provided by clause 15).
178.
Further, Mr Bloch can point to a respect in which the mechanism of
clause 5.1 is likely to work in a quite opposite direction to any that would be
expected: that is, in inverse ratio to any loss caused to the Group by the
breach. The earlier and greater the breach, the more likely that Mr El Makdessi
would be profiting by it at the expense of the Group, in a way affecting the
Group’s OPAT and so reducing the Interim and Final Payments and the impact of
their loss under clause 5.1. In contrast, a small breach with small
consequences for the Group at an early stage would leave the Group’s OPAT
unaffected, and would mean that clause 5.1 had the maximum possible impact on
Mr El
Makdessi.
180.
Cavendish’s general response nonetheless appears to me to have
substantial force. The essence of what the parties were agreeing was that
goodwill was crucial, and that there could be no further question of paying for
any goodwill element of Mr El Makdessi’s
shares if he committed a breach of his
non-competitive obligations under clause 11.2. It is true that, in the
circumstances existing for at least the first 18 months after the agreement,
any such breach would be actionable in damages by Team, with the result that
Cavendish’s loss would in theory be made good and it could itself have had no
contractual claim for damages because of the rule precluding recovery of
reflective loss. But after 18 months this would not necessarily be the case,
and even during the 18-month period, it is understandable that Cavendish should
no longer be prepared to pay any further goodwill element, once competitive
activity by Mr El
Makdessi
had cast a doubt over the current and future value
of the Group’s goodwill. As with a bank loan, so here, on a much larger scale,
it can be said that any such breach could and would change in a fundamental
respect the risk element involved in Cavendish’s purchase of a large block of
shares in the Group.
182.
I turn to clause 5.6. This raises somewhat different considerations. It
is a provision requiring Mr El Makdessi
as the party in breach to transfer
property in his remaining shares against his will at a price based on net asset
value alone. It is explained in terms of a desire to sever all interest from
someone who has breached his contract. But it does so, first by imposing on the
contract-breaker a forced deprivation of property which was not otherwise
agreed to be sold under the contract broken, and second by doing this at a
price which (unlike clause 5.1 which leaves the contract-breaker with a
substantial element of goodwill value, under the Completion and Second
Payments) deprives him of the whole of any goodwill value attaching to such
property.
183.
I accept that a forced transfer for no consideration or for a
consideration which does not reflect the value of the asset transferred may
constitute a penalty within the scope of the penalty doctrine. But clause 5.6
must be viewed in nature and impact as a composite whole as well as in context.
It operates as an element in a mechanism provided by clauses 5 and 11.2 for
bringing to an end the continuing relationship between WPP and a defaulting
shareholder. Although triggered by default, it amounts, like clause 5.1, to a
reshaping of the parties’ primary relationship. Had their relationship as
common shareholders in the Group continued, Mr El Makdessi
would have continued
to be bound by the restrictions contained in clause 11.2, until 2016 (para 122
above), and would have had the benefit of the put option contained in clause
15. The Relevant Option Price which Mr El
Makdessi
could receive upon his
exercise of the Put Option provided by clause 15 would have been based again on
eight times average OPAT over four years (starting with the year preceding the
exercise of the Option) capped at US$75m. As with the price of the shares which
Mr El
Makdessi
agreed to sell, so with the Option Price, the parties clearly
envisaged that a price calculated on such a basis would exceed by a multiple a
net asset based price. Clause 5.6 would not have made any real sense otherwise.
184.
However, once Mr El Makdessi
breached clause 11.2, the position changed
radically. It is accepted that, once such a breach occurred, it was in
principle understandable that he should be required to sever any shareholding
relationship completely by selling his remaining shares. But that would at the
same time release him from his restrictive covenants, in view of the definition
of the “Relevant Date”, set out in para 122 above. The Group without the
protective benefit of the restrictive covenants would be vulnerable
(potentially for many years during which it could legitimately have expected to
be protected by the covenants) in a way which would clearly justify revisiting
the basis on which any price for the purchase of Mr El
Makdessi’s
remaining
shareholding was set. What the fortunes of the Group would be, following
premature severance of relations, in circumstances where it was now open to Mr El
Makdessi
to compete as much as he wished, would be difficult, if not
impossible, to predict.
186.
That makes it unnecessary to consider Mr Bloch’s further submissions
that, if clause 5.6 was a penalty but it was in principle understandable that
the parties should have agreed on severance of their shareholding relationship,
Cavendish could have invited, but has not invited, any offer of the type which
Dillon and Nicholls LJJ in Jobson v Johnson considered that a
contract-breaker such as Mr El Makdessi
could be required to make. In the
present case, that would (presumably) be an offer to sell the remaining shares
at a fair or market price. That would go further than anything that Dillon and
Nicholls LJJ specifically endorsed in that case. It is unnecessary to say more
about this aspect of the decision in Jobson v Johnson, on which I would
in an appropriate case have wished to hear further and fuller submissions.
187. It follows that I would allow the appeal in respect of both clauses 5.1 and 5.6.
Application of the penalty doctrine - ParkingEye Limited v Beavis
“although there is a sense in which this contractual parking charge has the characteristics of a deterrent penalty, it is neither improper in its purpose nor manifestly excessive in its amount. It is commercially justifiable, not only from the viewpoints of the landowner and ParkingEye, but also from that of the great majority of motorists who enjoy the benefit of free parking at the site, effectively paid for by the minority of defaulters, who have been given clear notice of the consequences of overstaying.”
ParkingEye Limited v Beavis - Unfair Terms in Consumer Contracts Regulations 1999
201. Regulation 5(1) specifies what is to be understood by an unfair term. It provides that:
“A contractual term which has not been individually negotiated shall be regarded as unfair if, contrary to the requirement of good faith, it causes a significant imbalance in the parties’ rights and obligations arising under the contract, to the detriment of the consumer.”
This repeats, exactly, the terms of article 3(1) of the Directive. The terms of the parking contract made between ParkingEye and Mr Beavis were not of course individually negotiated.
“(l) Without prejudice to regulation 12, the unfairness of a contractual term shall be assessed, taking into account the nature of the goods or services for which the contract was concluded and by referring, at the time of conclusion of the contract, to all the circumstances attending the conclusion of the contract and to all the other terms of the contract or of another contract on which it is dependent.
(2) In so far as it is in plain intelligible language, the assessment of fairness of a term shall not relate -
(a) to the definition of the main subject matter of the contract, or
(b) to the adequacy of the price or remuneration, as against the goods or services supplied in exchange.”
This, although subsection (2) is differently worded, gives effect to article 4 of the Directive. It is not suggested in the present case that the term requiring payment of £85 (reducible) in the event of non-compliance with ParkingEye’s regulations falls within either limb of regulation 6(2).
203. Directive 93/13/EEC indicates in its 16th preamble that:
“the assessment, according to the general criteria chosen, of the unfair character of terms … must be supplemented by a means of making an overall evaluation of the different interests involved; whereas this constitutes the requirement of good faith; whereas, in making an assessment of good faith, particular regard shall be had to the strength of the bargaining positions of the parties, whether the consumer had an inducement to agree to the term and whether the goods or services were sold or supplied to the special order of the consumer; whereas the requirement of good faith may be satisfied by the seller or supplier where he deals fairly and equitably with the other party whose legitimate interests he has to take into account.”
“Article 3(1) of Directive 93/13 must be interpreted as meaning that:
- the concept of ‘significant imbalance’ to the detriment of the consumer must be assessed in the light of an analysis of the rules of national law applicable in the absence of any agreement between the parties, in order to determine whether, and if so to what extent, the contract places the consumer in a less favourable legal situation than that provided for by the national law in force. To that end, an assessment of the legal situation of that consumer having regard to the means at his disposal, under national law, to prevent continued use of unfair terms, should also be carried out;
- in order to assess whether the imbalance arises ‘contrary to the requirement of good faith’, it must be determined whether the seller or supplier, dealing fairly and equitably with the consumer, could reasonably assume that the consumer would have agreed to the term concerned in individual contract negotiations.”
205. Domestically, the position was considered by the House of Lords in Director General of Fair Trading v First National Bank plc [2002] 1 AC 481 where Lord Bingham said (para 17) that:
“The requirement of significant imbalance is met if a term is so weighted in favour of the supplier as to tilt the parties’ rights and obligations under the contract significantly in his favour. This may be by the granting to the supplier of a beneficial option or discretion or power, or by the imposing on the consumer of a disadvantageous burden or risk or duty. The illustrative terms set out in Schedule 3 to the Regulations provide very good examples of terms which may be regarded as unfair; whether a given term is or is not to be so regarded depends on whether it causes a significant imbalance in the parties’ rights and obligations under the contract. This involves looking at the contract as a whole. But the imbalance must be to the detriment of the consumer; … The requirement of good faith in this context is one of fair and open dealing. Openness requires that the terms should be expressed fully, clearly and legibly, containing no concealed pitfalls or traps. Appropriate prominence should be given to terms which might operate disadvantageously to the customer. Fair dealing requires that a supplier should not, whether deliberately or unconsciously, take advantage of the consumer’s necessity, indigence, lack of experience, unfamiliarity with the subject matter of the contract, weak bargaining position or any other factor listed in or analogous to those listed in Schedule 2 to the Regulations. Good faith in this context is not an artificial or technical concept; nor, since Lord Mansfield was its champion, is it a concept wholly unfamiliar to British lawyers. It looks to good standards of commercial morality and practice. Regulation 4(1) lays down a composite test, covering both the making and the substance of the contract, and must be applied bearing clearly in mind the objective which the Regulations are designed to promote.”
206. In the same case, Lord Millett said of regulation 5(1) (para 54):
“There can be no one single test of this. It is obviously useful to assess the impact of an impugned term on the parties’ rights and obligations by comparing the effect of the contract with the term and the effect it would have without it. But the inquiry cannot stop there. It may also be necessary to consider the effect of the inclusion of the term on the substance or core of the transaction; whether if it were drawn to his attention the consumer would be likely to be surprised by it; whether the term is a standard term, not merely in similar non-negotiable consumer contracts, but in commercial contracts freely negotiated between parties acting on level terms and at arms’ length; and whether, in such cases, the party adversely affected by the inclusion of the term or his lawyer might reasonably be expected to object to its inclusion and press for its deletion. The list is not necessarily exhaustive; other approaches may sometimes be more appropriate.”
210. Mr de Waal and Mr Butcher submit that this would only have been because the customer would have under-estimated the risk, and, at this point, again suggest that the scheme trades off the weakness of well-meaning customers. They point to Office of Fair Trading v Ashbourne Management Services Ltd [2011] EWHC 1237 (Ch), [2011] CTLC 237, where Kitchin J held that the minimum membership term provisions in a number of standard form gym membership contracts were unfair and invalid, because:
“The defendants’ business model was designed and calculated to take advantage of the naivety and inexperience of the average consumer using gym and health clubs at the lower end of the market. The defendants knew that the average consumer overestimates the use he will make of the gym and health clubs and exploited this fact.”
The problem in this respect was that the defendants, who operated gym membership schemes, themselves accepted that it was “a notorious fact that many people join such gym clubs having resolved to exercise regularly but fail to attend at all after two or three months”.
“a. It is difficult to categorise as not in good faith a simple and familiar provision of this sort of which very clear notice was given to the consumer in advance.
b. There is not a significant imbalance between the parties’ rights and obligations, when the motorist is given a valuable privilege (two hours free parking) in return for a promise to pay a specified sum in the event of overstaying, provided that sum is not disproportionately high.
c. The charge in question is not disproportionately high, and insofar as it exceeds compensation its amount is justifiable, and not in bad faith or detrimental to the consumer.”
Conclusion
LORD HODGE:
216. Cavendish’s primary submission was that this court should abolish the rule that the courts do not enforce penalty clauses. This issue affects Scots law as well as English law as the rule is essentially the same in each jurisdiction, although the Scottish courts have in certain circumstances a power to abate the penalty which the English courts do not. Scots law has used English authorities in its development – see Bell’s Principles of the Law of Scotland (10th ed) section 34 – and has, through the case of Clydebank Engineering and Shipbuilding Co Ltd v Castaneda [1905] AC 6, (1905) 7 F (HL) 77, had a significant influence on the development of English law. I therefore focus on authorities from both jurisdictions in this judgment but also refer to authorities from other common law jurisdictions.
217. The Cavendish appeal raises three principal issues:
i) What is the scope of the rule against penalties?
ii) Whether that rule should be abrogated or at least altered so as not to apply in commercial transactions where the contracting parties are of equal bargaining power and each acts on skilled legal advice? And if not,
iii) Whether and, if so, how the rule should be applied in the circumstances of the appeal?
The scope of the rule against penalties
219. The modern law in relation to penalty clauses was laid down by the House of Lords and the Judicial Committee of the Privy Council in a quartet of cases over 100 years ago. First, the House of Lords examined a liquidated damages clause in the Clydebank Engineering case in 1904. Then the Privy Council applied the decision in Clydebank to a retention clause in Public Works Comr v Hills [1906] AC 368 and to a liquidated damages clause in Webster v Bosanquet [1912] AC 394. Finally, in Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79, which again concerned a liquidated damages clause, the House of Lords, in the speech of Lord Dunedin, set out an approach to the rule which has dominated judicial discussion ever since.
“1. Though the parties to a contract who use the words ‘penalty’ or ‘liquidated damages’ may prima facie be supposed to mean what they say, yet the expression used is not conclusive. The court must find out whether the payment stipulated is in truth a penalty or liquidated damages. This doctrine may be said to be found passim in nearly every case.
2. The essence of a penalty is a payment of money stipulated as in terrorem of the offending party; the essence of liquidated damages is a genuine covenanted pre-estimate of damage (Clydebank Engineering …).
3. The question whether a sum stipulated is penalty or liquidated damages is a question of construction to be decided upon the terms and inherent circumstances of each particular contract, judged of as at the time of the making of the contract, not as at the time of the breach (Public Works Comr v Hills and Webster v Bosanquet).
4. To assist this task of construction various tests have been suggested, which if applicable to the case under consideration may prove helpful, or even conclusive. Such are:
(a) It will be held to be penalty if the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach. (Illustration given by Lord Halsbury in Clydebank case.)
(b) It will be held to be a penalty if the breach consists only in not paying a sum of money, and the sum stipulated is a sum greater than the sum which ought to have been paid (Kemble v Farren 6 Bing 141). This though one of the most ancient instances is truly a corollary to the last test. …
(c) There is a presumption (but no more) that it is a penalty when ‘a single lump sum is made payable by way of compensation, on the occurrence of one or more or all of several events, some of which may occasion serious and others but trifling damage’ (Lord Watson in Elphinstone v Monkland Iron and Coal Co 11 App Cas 332).
On the other hand:
(d) It is no obstacle to the sum stipulated being a genuine pre-estimate of damage, that the consequences of the breach are such as to make precise pre-estimation almost an impossibility. On the contrary, that is just the situation when it is probable that pre-estimated damage was the true bargain between the parties (Clydebank Case, Lord Halsbury at p 11; Webster v Bosanquet, Lord Mersey at p 398).”
(a) The clauses to which the rule against penalties applies
223. The Court of Appeal in Cine Bes Filmcilik Ve Yapimcilik v United International Pictures [2004] 1 CLC 401 supported Colman J’s approach. Mance LJ, who produced the leading judgment, recognised (at para 15) that there were clauses which might operate on breach and which were commercially justifiable but which did not fall into either category of a dichotomy between a genuine pre-estimate of damages and a penalty. In that case UIP had granted a licence to Cine Bes to show films on its movie channel. There were disputes over the licence agreement which resulted in litigation which the parties compromised in an agreement to grant a fresh licence. UIP later terminated the fresh licence on the ground of Cine Bes’s breach of contract. One of the provisions that Cine Bes challenged as a penalty was that it should pay to UIP not only its enforcement costs for the default on the fresh licence but also its litigation costs in the prior litigation. The Court of Appeal rejected this challenge, Mance LJ stating (at para 33):
“The agreement regarding past litigation costs was understandable in the overall context of the settlement of the prior litigation. It would be wrong to treat it as if it were there to deter [Cine Bes] from, or to penalise or punish [Cine Bes] for, any default. It was an understandable and reasonable commercial condition upon which UIP was prepared to dispose of the prior litigation, and to enter into the fresh licence.”
Mance LJ, drawing on Colman J’s analysis, drew a distinction between a reasonable commercial condition on the one hand and a punishment on the other. As I shall seek to show, there is support for this dichotomy in the older case law.
224. The Court of Appeal again considered the penalty doctrine in Murray v Leisureplay plc [2005] IRLR 946, which concerned a provision in the employment contract of a chief executive that entitled him to one year’s gross salary in the event of the termination of his employment without one year’s notice. The company challenged this entitlement as a penalty because common law damages would have given the director a sum after deduction of tax and national insurance contributions and he would have been under an obligation to mitigate his loss. The court rejected this challenge, accepting that the provision, which provided the director with generous reassurance against dismissal and could result in greater recovery than the amount of his actual loss which he could recover at common law, was commercially justified.
232. There is also considerable support in Australian authority for the application of the rule against penalties to clauses requiring a party in breach to transfer property to the innocent party. See, for example, Bysouth v Shire of Blackburn and Mitcham (No 2) [1928] VLR 562, Irvine CJ at pp 574-575; Forestry Commission of New South Wales v Stefanetto (1976) 133 CLR 507, Mason J at p 521; Wollondilly Shire Council v Picton Power Lines Pty Ltd (1994) 33 NSWLR 551, Handley JA at p 555F-G; Ringrow Pty Ltd v BP Australia Pty Ltd (2005) 224 CLR 656 in which the point was conceded (p 665); and Interstar Wholesale Finance Pty Ltd v Integral Home Loans Pty Ltd [2008] NSWCA 310, Allsop P at paras 101-102. The Court of Appeal in New Zealand has taken a similar view: Amaltal Corpn Ltd v Maruha (NZ) Corpn Ltd [2004] 2 NZLR 614, Blanchard J at para 61.
234. Clauses requiring the purchaser to pay an extravagant non-refundable deposit: In English law a non-refundable deposit is a guarantee by a purchaser that the contract will be performed: Howe v Smith (1884) 27 Ch D 89, Cotton LJ at p 95; Soper v Arnold (1889) 14 App Cas 429, 435 per Lord MacNaghten. It provides the vendor with some assurance of performance while the property is taken off the market during the period from the date of the contract to the completion of performance. If the contract is performed, the deposit forms part of the purchase price. If the purchaser breaks the contract, the vendor keeps the deposit. As Fry LJ stated in Howe v Smith (at p 101):
“It is not merely a part payment, but is then also an earnest to bind the bargain so entered into, and creates by the fear of its forfeiture a motive in the payer to perform the rest of the contract.”
Where the deposit was fixed at a reasonable figure, its forfeiture on breach of contract does not bring into play the rule against penalties, its purpose not being related to any loss that the vendor may have suffered and that he may seek to recover in damages: Wallis v Smith (1882) 21 Ch D 243, Jessel MR at p 258. But in Stockloser v Johnson [1954] 1 QB 476, Denning LJ suggested (at p 491) that a party could not call a stipulation for an initial payment of 50% of the purchase price a deposit and thereby achieve a forfeiture from which equity could give no relief. He said (at p 492) that the equity of restitution was to be tested not at the time of the contract but by the conditions existing when it was invoked. This suggests that he was considering relief from forfeiture rather than the rule against penalties. More directly relevant is Lord Radcliffe’s statement in Campbell Discount Co Ltd v Bridge [1962] AC 600, when discussing deposits (at p 624):
“… I do not see any sufficient reason why in the right setting a sum of money may not be treated as a penalty, even though it arises from an obligation that is essentially a guarantee.”
“In order to be reasonable a true deposit must be objectively operating as ‘earnest money’ and not as a penalty. To allow the test of reasonableness to depend upon the practice of one class of vendor, which exercises considerable financial muscle, would be to allow them to evade the law against penalties by adopting practices of their own.”
The Board therefore took as a norm the long established practice both in Jamaica and the United Kingdom of a deposit of 10% and required a vendor who sought a larger percentage to show special circumstances to justify that deposit. In effect, the Board applied a test of commercial justification akin to the test which Colman J later applied in Lordsvale Finance plc.
236. In Polyset Ltd v Panhandat Ltd (2002) 5 HKCFAR 234 the Hong Kong Court of Final Appeal carried out a thorough review of the law relating to deposits. The court considered the cases which I have mentioned and concluded that the court would intervene to prevent forfeiture where parties abused the concept of deposit. The forfeiture of a deposit would be enforced only if it were “reasonable as earnest money”. Where the deposit exceeded the conventional amount, the court would permit forfeiture only if the party seeking to forfeit could show that exceptional circumstances justified the higher amount (Ribeiro PJ at para 90, Bokhary PJ at paras 10-18, Chan PJ at paras 40-42; Lord Millett NPJ at para 165). Because Bokhary PJ and Ribeiro PJ considered that the test of “genuine pre-estimate of loss” applied in the rule against penalties when considering whether a sum was liquidated damages, they did not view the “reasonable as earnest money” test as part of the law of penalties. But if, as I think correct, the true test for penalties is wider than the “genuine pre-estimate of loss” test (see paras 242-255 below), the Hong Kong court’s conclusions were wholly consistent with Lord Browne-Wilkinson’s approach in Workers Trust.
237. Historically, Scots law has followed English law in treating deposits as outside the rule against penalties, citing English authorities in support of the view that a deposit was a guarantee of or security for performance: Commercial Bank of Scotland Ltd v Beal (1890) 18 R 80; Roberts & Cooper v Salvesen & Co 1918 SC 794; Zemhunt (Holdings) Ltd v Control Securities plc 1992 SC 58. There has been no discussion whether that exclusion is confined to reasonable deposits. But in none of those cases was there a question whether the deposit was extravagant. In Roberts & Cooper, in which the First Division upheld the forfeiture of a £3,000 deposit on the purchase of a ship for £30,000 when the purchaser repudiated the contract, Lord Skerrington (at p 814) suggested that there was no reason why in a proper case a clause for the forfeiture of a purchaser’s deposit should not be construed as a penalty and be unenforceable. I agree. As Scots law has followed English law in relation to the law of deposits, I see no reason why it should not adopt the modern approach of excluding only reasonable deposits from the rule against penalties.
240.
Mr Bloch, counsel for Mr Makdessi,
suggested in the course of debate
that the court could extend the rule against penalties. He referred to the
controversial decision of the High Court of Australia in Andrews v Australia
and New Zealand Banking Group Ltd (2012) 247 CLR 205, in which the court
held that bank charges, which were imposed on customers on the occurrence of
events which were not breaches of contract, could be characterised as penalties
and thus be unenforceable.
(b) The true test for a penalty
“the amount stipulated might be such as to make it plain that it was merely stipulated in terrorem, and could not possibly have formed … a genuine pre-estimate of the creditor’s probable or possible interest in the due performance of the principal obligation.”
“had the respondents no interest to protect by that clause, or was that interest palpably incommensurate with the sums agreed on?”
- provide the framework for the application of the exorbitance test to those wider circumstances.
248. Similarly, I doubt whether it is helpful to rely on the concept of deterrence. Many contractual provisions are coercive in nature, encouraging a contracting party to perform his or her obligations; the prospect of liability in common law damages itself is a spur to performance. Similarly, a deposit provides a motive for performance (para 234 above). Instead, the broader test of exorbitance or manifest excess compared with the innocent party’s commercial interests fits the various applications of the rule against penalties and is consistent with the repeated warnings by the courts against imposing too stringent a standard. Thus in Robophone Facilities Ltd v Blank [1966] 1 WLR 1428 (CA) Diplock LJ warned (at p 1447E), “The court should not be astute to descry a ‘penalty clause’”. In Philips Hong Kong Ltd v Attorney General of Hong Kong (1993) 61 BLR 41, Lord Woolf (at p 59) said:
“[T]he court has to be careful not to set too stringent a standard and bear in mind that what the parties have agreed should normally be upheld. Any other approach will lead to undesirable uncertainty especially in commercial contracts.”
In Murray (above) Arden LJ expressed a similar view when she said (at para 43), “The parties are allowed a generous margin”.
“There are great differences in the stipulations themselves that are so made, and, in particular, there is a great difference according as the breach of contract consists in faciendo and in non faciendo. If a man wilfully goes against what he has promised not to do, that is an unfavourable case for restriction.”
Lord Deas expressed a similar view at p 196.
251. In early Scots law penalties were associated with usury. While there are examples of the Court of Session enforcing penalties in the early 16th century, in Home v Hepburn (1549) Mor 10033 the Court of Session prohibited the imposition of punishments for breach of contract. In the abbreviated report of that case the court held:
“de practica regni, poenae conventionales non possunt exigi, nisi quatenus interest actores, quia sapiunt quendam usuram et inhonestum questum …”
Balfour’s Practicks (1579) gives a vernacular account of the case in these terms (Stair Society vol I, p 151):
“Be the law of this realme, poena conventionales, sic as ane soume of money adjectit, with consent of parties, in ony contract or obligatioun, in name of pane, may not be askit be ony persoun bot in sa far as he is interestit, hurt or skaithit; because all sic painis are in ane maner usuraris, and dishonest, made for lucre or gane.”
It is of note that the judgment referred to the innocent party’s interest in performance (“interesse” – to have an interest) as well his injury or damage (“skaith”), foreshadowing Lord Robertson’s formulation in Clydebank Engineering. Viscount Stair in his “Institutions of the Law of Scotland” regarded the power to modify exorbitant bonds and contracts as part of the nobile officium of the Court of Session, recognising that “necessitous debtors” yield to “exorbitant penalties” (Stair, IV.3.2). A penalty clause was seen as a secondary obligation, an additional means of enforcement; tendering the penalty did not release the contract-breaker from his primary obligation: University of Glasgow v Faculty of Physicians and Surgeons (1840) 1 Rob 397, 415.
“[A]nd in all cases where penalties for non-payment, over and above performance, are contained in bonds or other obligations for sums of money, and are made the subject of adjudication, or of demand in any other shape, it shall be in the power of the court to modify and restrict such penalties, so as not to exceed the real and necessary expenses incurred in making the debt effectual.”
More recently, in Wirral Borough Council v Currys Group plc 1998 SLT 463, Lord Hamilton (at p 467) confirmed that the statutory power to modify extends to money obligations other than bonds. Although the Scottish Parliament has enacted legislation to abolish the remedy of adjudication as a means of debt recovery (the Bankruptcy and Diligence etc (Scotland) Act 2007), the court retains a power to modify such penalties for failure to fulfil monetary obligations.
“a penal sum inserted as a punishment on the defaulter irrespective of the amount of any loss which could at the time have been in contemplation of the parties ...”
(ii) Whether the rule against penalties should be abrogated or altered?
257. The rule against penalties is an exception to the general approach of the common law that parties are free to contract as they please and that the courts will enforce their agreements – pacta sunt servanda. The rule against penalties may have been motivated in part by a desire to prevent oppression of the weaker party by the more powerful party to a contractual negotiation. As I have said, Viscount Stair spoke of this danger when he spoke of necessitous debtors having to yield to exorbitant penalties (IV.3.2). Diplock LJ in Robophone (p 1447A) recognised the reality that many contracting parties could not contract à la carte but had to accept the table d’hôte of the standard term contract. In AMEV–UDC Finance Ltd v Austin (1986) 162 CLR 170, Mason and Wilson JJ (at pp 193-194) suggested that the rule was aimed at preventing oppression and that the nature of the relationship between the contracting parties was a factor relevant to unconscionableness. In Philips v Hong Kong (pp 58-59) Lord Woolf suggested that in some cases the fact that one of the contracting parties was able to dominate the other as to the choice of the contract terms was relevant to the application of the rule. But the application of the rule does not depend on any disparity of power of the contracting parties: Imperial Tobacco Co (of Great Britain and Ireland) Ltd v Parslay [1936] 2 All ER 515 (CA), Lord Wright MR at p 523. Because the rule is not so limited, Ms Joanna Smith QC argued that the rule interferes with freedom of contract in circumstances in which it is not needed.
258. The rule may also be criticised because it can be circumvented by careful drafting. Indeed one of Cavendish’s arguments was that clause 5.1 could have been removed from the scope of the rule if it had been worded so as to make the payment of the instalments conditional upon performance of the clause 11 obligations. This is a consequence of the rule applying only in the context of breach of contract. But where it is clear that the parties have so circumvented the rule and that the substance of the contractual arrangement is the imposition of punishment for breach of contract, the concept of a disguised penalty may enable a court to intervene: see Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd [1989] QB 433, Bingham LJ at pp 445-446 and, more directly, the American Law Institute’s “Restatement of the Law, Second, Contracts” section 356 on liquidated damages and penalties, in which the commentary suggests that the court’s focus on the substance of the contractual term would enable it in an appropriate case to identify disguised penalties.
268. I therefore turn to the application of the rule against penalties in the two appeals.
The application of the rule against penalties:
(a) in the Cavendish appeal
269.
Clause 5.1, which removes a seller’s valuable rights to receive the
interim payment and final payment if he is in breach of clause 11.2, was likely
to deprive the defaulting shareholder of a substantial sum of money. The
parties have agreed that the enforcement of the clause would deprive Mr El Makdessi
of up to $44,181,600. Breach of clause 11.2 therefore comes at a high price.
272.
Secondly, the factual matrix in the uncontested evidence of Mr Andrew
Scott, WPP’s director of corporate development, and Mr Ghossoub and recorded in
the agreed statement of facts and issues showed the importance of personal
relationships in the marketing sector and particularly in the Middle East. The
statement of facts and issues recorded (at para 5) that the success of the
Group’s business depended on the personal relationships which Mr Ghossoub and
Mr El Makdessi
had built up with their key clients and in para 33, which Lord
Neuberger and Lord Sumption quote at para 66 of their judgment, it explained
that the agreement was structured to protect the goodwill of the Group. The
continued loyalty of the sellers was critically important to preserving the value
of the Group’s goodwill.
276.
Fifthly, Mr Bloch submitted that clause 5.1 might operate perversely as
far as Mr El Makdessi
was concerned because a minor breach of clause 11.2,
which did not harm the company’s goodwill, would result in his losing more by
the loss of the interim and final payments than a major breach which diminished
the profits of the company and thus the deferred consideration. Similarly, he
submitted that a breach that was detected before the interim payment or the
final payment would have more serious consequences for the seller than one
detected later. But again clause 5.1 is not addressing the loss which Cavendish
may incur from a particular breach. The relevant questions are broader, namely
(i) whether Cavendish had a legitimate interest in the circumstances to protect
its investment in the company and (ii) whether the making of its later
instalments of price depend upon each seller’s performance of his clause 11.2
obligations was a manifestly excessive means of protecting that interest.
277.
Finally, I am not persuaded that the company’s entitlement to seek a
disgorgement of Mr El Makdessi’s
profits arising from his breach of fiduciary
duty and the possibility that Cavendish itself might have a claim in damages if
Mr El
Makdessi
breached clause 11.2 after he ceased to be a director make the
operation of clause 5.1 exorbitant or unconscionable. The former is res
inter alios acta as each of Cavendish and the company have separate legal
personality. Any award of damages to Cavendish would be designed to place it in
the same position financially as if the contract had been performed. If an
award of damages together with the price reduction which clause 5.1 effects
involved double counting, I would expect the price reduction to be credited
against the claim for damages.
279.
Clause 5.6, which provides for the compulsory transfer of the defaulting
shareholder’s retained shareholding, is more difficult. But I have come to the
view that it also may be enforced. Mr El Makdessi
does not contest the
obligation placed on the defaulting shareholder to transfer his shares on
breach of contract. But he challenges the price at which the compulsory
transfer is to be effected, as the formula for the calculation of the price excludes
the value of goodwill.
281.
Clause 5.6, like clause 5.1, is not a provision which fixes the damages
payable for a breach of contract. It seeks to regulate the terms on which a
defaulting shareholder severs his connection with the company. It falls to be
construed in the context of the agreement as a whole, in which Cavendish agreed
to pay a price for the shares which it purchased on the basis that the sellers
remained involved in the company for transitional periods and complied with
their clause 11.2 duties for at least two years after they had exercised their
put options under clause 15 or had otherwise ceased to hold shares in the
company. I think that Mr El Makdessi
was correct in accepting that, if a seller
acted in breach of clause 11.2 by competing with the company in any of the ways
listed in that clause, Cavendish would act reasonably in seeking to remove him
from any involvement in the company, including by the compulsory transfer of
his shareholding. On the departure of the defaulting shareholder, the company
would lose both his work on its behalf and also his valuable personal
connections. It was readily foreseeable at the time of contracting that the departure
on default of either of the sellers would cause significant damage to the
company’s goodwill and thus materially reduce its value.
(b) in Mr Beavis’s appeal
Mr Beavis’s other ground of appeal: the Unfair Terms in Consumer Contracts Regulations 1999
Conclusion
290.
I would therefore allow the appeal in Cavendish v El Makdessi and
dismiss the appeal in ParkingEye v Beavis and make the declarations that
Lord Neuberger and Lord Sumption propose in para 115 of their joint judgment.
LORD CLARKE:
LORD TOULSON: (dissenting in part on ParkingEye Limited)
293. On the essential nature of a penalty clause, I would highlight and endorse Lord Hodge’s succinct statement at para 255 that “the correct test for a penalty is whether the sum or remedy stipulated as a consequence of a breach of contract is exorbitant or unconscionable when regard is had to the innocent party’s interest in the performance of the contract”. Parties and courts should focus on that test, bearing in mind a) that it is impossible to lay down abstract rules about what may or may not be “extravagant or unconscionable”, because it depends on the particular facts and circumstances established in the individual case (as Lord Halsbury said in the Clydebank case, [1905] AC 6, 10, and Lord Parmoor said in the Dunlop case, [1915] AC 79, 101), and b) that “exorbitant or unconscionable” are strong words. I agree with Lord Mance (para 152) that the word “unconscionable” in this context means much the same as “extravagant”.
“A contractual term which has not been individually negotiated shall be regarded as unfair if, contrary to the requirement of good faith, it causes a significant imbalance in the parties’ rights and obligations arising under the contract, to the detriment of the consumer.”
304. In Director General of Fair Trading v First National Bank plc [2001] UKHL 52, [2002] 1 AC 481, para 17, Lord Bingham described this provision as laying down a composite test, covering both the making and the substance of the contract, which must be applied bearing in mind the object which the Regulations are designed to promote. He said that fair dealing requires that the supplier should not, deliberately or unconsciously, take advantage of the consumer’s necessity, indigence, lack of experience, unfamiliarity with the subject matter of the contract, weak bargaining position or any factor listed in or analogous to those listed in the Schedule.
“in order to assess whether the imbalance arises ‘contrary to the requirement of good faith’, it must be determined whether the seller or supplier, dealing fairly and equitably with the consumer, could reasonably assume that the consumer would have agreed to the term concerned in individual contract negotiations.”