Cavendish Square Holdings BV & Anor v El Makdessi

A restraint in a negotiated business sale is enforceable where it protects a legitimate business interest and goes no further than reasonably necessary. The court gives weight to equality of bargaining power and the commercial context, but retains control over clearly unreasonable restraints.

The modern penalty doctrine is not confined to genuine pre-estimates of damages. It may apply to provisions requiring payment, transfer of property, or withholding of sums. The central questions are commercial justification, extravagance or oppression, deterrent purpose, and the circumstances of negotiation. A penalty cannot be enforced in its penal form, but the court cannot rewrite the parties’ bargain.

Cavendish acquired shares in a Middle Eastern advertising group from the defendant and another seller. The agreement contained restrictive covenants and provisions depriving a defaulting shareholder of deferred consideration and requiring the sale of remaining shares at a net asset value.

The defendant admitted breaches of fiduciary duty and involvement in a competing business. The company’s fiduciary-duty claim was compromised for $500,000. The remaining issues concerned restraint of trade, penalties, and construction of the call option provisions.

1. Restraint of trade. The restrictive covenants were enforceable. The purchaser had a legitimate interest in protecting the goodwill, customer connections and workforce of the acquired business. In a vendor–purchaser agreement, the onus on the purchaser is not heavy, particularly where the covenant was negotiated by experienced parties of equal bargaining power. The deferred restraint was sufficiently certain and was tied to the seller’s continuing shareholding and other interests. A minimum period of about eight and a half years was not unreasonable in the circumstances. [2012] EWHC 3582 (Comm) [15]–[24].
2. Clause 5.6. The call option requiring sale of the shares at net asset value was not a penalty. It served the commercial purpose of promptly separating the defaulting shareholder from the purchaser. The valuation method had been negotiated and was not shown to be oppressive or extravagant. [2012] EWHC 3582 (Comm) [42]–[51].
3. Clause 5.1. The withholding of deferred consideration could fall within the penalty doctrine. Standing alone, the clause had commercial justification as an adjustment to consideration for goodwill and was not extravagant or oppressive. However, after the company had received $500,000 for the same underlying loss, enforcing the clause without credit would amount to double recovery and an extravagant return. Clause 5.1 was therefore penal in the circumstances.
4. The court could not rewrite Clause 5.1 by selecting which deferred payment should be restored. Consistently with Jobson v Johnson, the court could give effect to a penal provision only to the extent permitted by law and could offer a remedy that avoided penal enforcement. Cavendish was therefore invited to repay or credit the $500,000. If it did so, the court would declare that no payment was due under Clause 3 by reason of Clause 5.1 and order specific performance of Clause 5.6. [2012] EWHC 3582 (Comm) [52]–[63].
5. Construction. Clause 5.6 required only a notice exercising the option. It did not require the notice to state the correctly calculated option price. The agreement was binding and certain, and the price could be calculated later under the specified mechanism. [2012] EWHC 3582 (Comm) [64]–[68].