Murray v Leisureplay Plc

A contractual payment triggered by breach is not penal merely because it may exceed common law damages or omits an allowance for mitigation. The court asks broadly whether, when the contract was made, the provision’s predominant function was compensatory or deterrent. A discrepancy from likely loss is relevant but not decisive. Particular caution is required before invalidating a commercially justifiable provision that is neither extravagant nor unconscionable.

Under Companies Act 1985 sections 320 and 322, an unapproved agreement to acquire a director’s substantial non-cash asset contravenes section 320 even if the acquisition is never completed. The statutory indemnity covers loss directly resulting from the prohibited arrangement, including due-diligence costs incurred to implement it, but not indirectly related expenditure.

The appellant chief executive sued his former employer under a service agreement requiring payment of one year’s gross salary and benefits following wrongful termination. Stanley Burnton J held that the payment provision was an unenforceable penalty because it made no allowance for mitigation. The employee appealed and also challenged the treatment of a proposed common law damages amendment and relief under section 727 of the Companies Act 1985.

The employer cross-appealed against the rejection of part of its counterclaim under sections 320 and 322. It sought costs incurred in pursuing an unapproved arrangement to acquire a company from the employee, including due-diligence fees and the cost of hiring an additional director.

The principal questions were whether the contractual payment was penal, which expenses resulted from the prohibited arrangement, and whether the employee’s application for statutory relief required further factual findings.

1. The appeal on the penalty issue was allowed. Arden, Clarke and Buxton LJJ agreed that the provision requiring payment of one year’s gross salary and benefits was not a penalty. Clarke LJ preferred Buxton LJ’s broader approach where it differed from Arden LJ’s step-by-step formulation.

   The modern inquiry is whether, at the time of contracting, the predominant function of the provision was to deter breach or to compensate the innocent party. Comparison between the stipulated sum and likely common law damages is a guide, not an inflexible test. The party resisting enforcement bears the burden of showing that the provision is penal. Courts should be cautious before invalidating a commercial agreement and should consider whether the sum is extravagant or unconscionable and whether its terms have a commercial explanation.

2. The absence of an allowance for mitigation was not decisive. The clause provided certainty, avoided disputes about alternative earnings and facilitated a prompt, clean termination. Its commercial context also included restrictive covenants, the employer’s payment-in-lieu option, the possible release of pension contribution claims and market acceptance of one-year protection. The employer had not shown the provision to be extravagant, unconscionable or predominantly deterrent.

3. The agreement was construed so that remuneration paid during an incomplete notice period reduced the contractual payment proportionately. Otherwise nearly a full year’s notice could produce both that remuneration and an additional full year’s payment. Clause 17.2 could also release arrears of pension contributions where the employer’s obligation arose outside the pension scheme.

4. The employer’s cross-appeal under sections 320 and 322 of the Companies Act 1985 was allowed in part. An agreement by which a company is to acquire a director’s substantial asset contravenes section 320 without shareholder approval, even if the acquisition is not completed. Section 322(3)(b) covered due-diligence costs directly resulting from the prohibited agreement. It did not cover the cost of hiring an additional director, which was not contemplated by that agreement and was only indirectly connected with it.

5. The question whether the employee should receive relief under section 727 was remitted to Stanley Burnton J. It required factual findings which the Court of Appeal was not equipped to make. The amendment issue became academic, although the court indicated that it would otherwise have allowed the proposed common law damages claim to proceed.

1. Court of Appeal (Civil Division): In [2005] EWCA Civ 963 , allowed the employee’s appeal on the penalty and section 727 issues, allowed the employer’s cross-appeal in part under section 320, and remitted the section 727 question.
2. High Court, Queen’s Bench Division: Stanley Burnton J held the contractual payment to be a penalty, refused a late amendment claiming common law damages, and rejected the employer’s claim for professional and additional-director costs under section 322.