Cavendish Square Holding BV v Makdessi

The Supreme Court restated and applied the law on contractual penalty clauses (the "penalty rule"): a provision operating on breach will be a penalty if it imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in enforcing the primary obligation. Where a clause is a true primary obligation it will not be a penalty; where it is a secondary obligation the enquiry is a matter of construction at the time of contracting and an evaluation of whether the provision is "extravagant" or "unconscionable" in the light of the interest protected.

Applying that test, the court held that Cavendish’s clauses (clause 5.1 withholding deferred payments and clause 5.6 giving a call option to acquire retained shares at net asset value on default) were not penalties: they formed part of a negotiated commercial allocation of price and risk intended to protect Cavendish’s legitimate interest in goodwill and the value of the business. The court also held that the ParkingEye £85 charge for overstaying was not a penalty and did not offend the Unfair Terms in Consumer Contracts Regulations 1999 on the facts before the court.

Background and parties.

• Cavendish v El Makdessi: Cavendish (part of WPP) acquired 47.4% of a marketing group. The sale agreement provided completion and deferred payments (Interim and Final Payments) tied to profits and contained restrictive covenants (clause 11.2) protecting goodwill. Clauses 5.1 and 5.6 deprived a defaulting seller of the deferred payments and enabled Cavendish to acquire retained shares at net asset value if the seller became a "Defaulting Shareholder" for breach of the restrictive covenants.
• ParkingEye v Beavis: ParkingEye managed a private retail car park and posted signs allowing two hours free parking and imposing a contractual "parking charge" of £85 for overstaying. Mr Beavis overstayed and resisted payment arguing the charge was a penalty and (alternatively) unfair under the 1999 Regulations.

Procedural posture and relief sought. The Cavendish litigation reached the Supreme Court on appeal from the Court of Appeal ([2013] EWCA Civ 1539) after trial in the Commercial Court ([2012] EWHC 3582 (Comm)). Cavendish sought declarations that Mr Makdessi was a Defaulting Shareholder, that he had no entitlement to the deferred payments, and an order for sale of his remaining shares at the Defaulting Shareholder Option Price (specific performance). In the ParkingEye case the motorist defended an action for the £85 charge on penalty and unfair-terms grounds; the point reached the Supreme Court on appeal from the Court of Appeal ([2015] EWCA Civ 402).

Issues before the Court.

• What is the correct modern test for identifying a contractual penalty? (scope, rationale and whether the doctrine should be abolished or extended);
• Whether clauses 5.1 and 5.6 in the Cavendish sale agreement were penalties and thus unenforceable;
• Whether the ParkingEye £85 charge was a contractual penalty or an unfair term under the Unfair Terms in Consumer Contracts Regulations 1999.

Court’s reasoning (concise).

• The court reviewed history and authorities and adopted as the true test whether a secondary obligation on breach imposes a detriment "out of all proportion" to any legitimate interest of the innocent party in performance or in an appropriate substitute for performance. The focus is on the substance of the term at the time of contracting and the legitimate interests protected, not simply whether the sum is a pre-estimate of loss.
• Clauses 5.1 and 5.6 were part of a negotiated commercial scheme to price and protect goodwill: they adjusted price contingent on continued loyalty and permitted forced severance on default with a net-asset valuation rather than a damages formula. The clauses were not penal because Cavendish had a legitimate interest in protecting the value of the business and the clauses were not extravagant or unconscionable in the commercial context of a sophisticated, negotiated transaction. The Court declined to abolish or confine the penalty rule.
• On ParkingEye, the £85 charge was a contractual charge for breach of a licence condition (overstaying), imposed to deter long stay and to fund the management scheme. The charge was not out of proportion to the legitimate interests served and, on the facts and regulatory context (BPA code, comparable practice, prominence of signage), did not contravene the 1999 Regulations.

The Supreme Court allowed Cavendish’s appeal: clauses 5.1 and 5.6 are not penalties because they form part of a negotiated commercial allocation of price and risk intended to protect a legitimate interest (goodwill) and are not extravagant or unconscionable. The Court declined to abolish or limit the penalty rule. The Court also dismissed the challenge to ParkingEye’s charge, holding that the £85 charge was not a penalty and did not breach the Unfair Terms in Consumer Contracts Regulations 1999 on the facts before the court.

Trial: Burton J, Commercial Court ([2012] EWHC 3582 (Comm)). Court of Appeal: [2013] EWCA Civ 1539 (Cavendish appeal reversed at CA); parallel appeal ParkingEye v Beavis from [2015] EWCA Civ 402. Appeal to the Supreme Court: [2015] UKSC 67 (this judgment).