New Supreme Court judgment on penalty clauses

The UK Supreme Court has handed down (on 4th November 2015) its judmgent in two conjoined appeals on the application of contractual penalty clauses: Cavendish Square Holding v Makdessi and ParkingEye Ltd v Beavis [2015] UKSC 67. The judgments are important ones, and have generated a degree of press interest in this morning’s newspapers. Not all of this is accurate or helpful. Even The Times has rather missed the point by reporting the story under the headline “Judges clear car parks to charge huge penalty fees.” In fact the Justices of the Supreme Court have done no such thing, their judgments specifically reinforcing the existing penalty clause rule that, to be valid, any contractually stipulated sums payable on breach must not be extravagant, unconscionable or incommensurate with the interest of the party seeking to enforce the clause. Indeed, in the ParkingEye appeal, the charge which the respondent was seeking to enforce was less than the amount of parking penalties regularly enforced by local authorities. One should not always believe what one reads in the press.

Reading the judgment itself is much more illuminating. The first matter worthy of note is that the Supreme Court has taken the opportunity to reiterate its belief that the rule against contractual penalty clauses does not need to be reformed or abolished. Cavendish Square Holding’s argument that the rule ought to be abolished flew in the face of prior recommendations by both the English and Scottish Law Commissions that the rule be retained. The Justices noted that Cavendish’s argument was “made without the benefit of the sort of research into the consequences and merits of such a step, which the Law Commission or Parliament would undertake before venturing upon it” (Para 43). The decision of the Supreme Court is likely to solidify the position of the penalty clause rule in both English and Scots law, securing its status for the foreseeable future.

Two important points about the operation of the penalty clause rule, emerge from the Supreme Court’s decision in the two appeals. First, the rule only operates as a break on the validity of a secondary obligation, i.e. an obligation which comes into being if a primary obligation (of payment or performance) under the contract is broke. The rule does not operate to allow assessment of the reasonableness or potentially exorbitant nature of primary obligations themselves. As Lord Roskill noted in a previous decision of the House of Lords: “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” (Export Credits Guarantee Department v Universal Oil Products Co [1983] 1 WLR 399, at 403). This point was crucial in the determination of the outcome in the first of the two conjoined appeals, Cavendish Square Holding v Makdessi. The two clauses in question in that appeal had the effect of entitling Cavendish Square to deprive, in certain circumstances, Mr Makdessi of a substantial sum that would otherwise have been payable to him (and to force him to transfer shares he owned). Lord Neuberger and Lord Sumption (with whom Lord Carnwath agreed) noted that there was uncertainty in English law of whether a forfeiture provision of this sort could even count as a penalty, commenting “there is some, albeit rather unsatisfactory, authority that such a clause may be a penalty” (para 69). But, proceeding on the assumption (though not deciding) that a contractual provision might in some circumstances be a penalty if it disentitled the contract breaker from receiving a sum of money which would otherwise have been due to him, they concluded that the clause before the court was not a penalty clause; on the contrary, it was “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” (para 74). So, although in some cases English law allows a disguised penalty clause to be recognised for what it is (and hence for the disguise to be ignored), a clause which states that a party is only to earn certain consideration if it complies with various restrictive covenants (which Mr Makdessi had not) is fundamentally a clause about the circumstances in which a primary obligation will be due under a contract. As such, it does not fall within the ambit of the penalty clause rule and thus cannot be scrutinised under that rule as to its fairness or proportionateness.

The second important point arises out of the second of the conjoined appeals, that of ParkingEye v Beavis. In this case, Mr Beavis had been charged £85 for overstaying a free two hour parking limit by 56 minutes (i.e. by almost 50% more time than that allowed). He argued that this charge was a penalty clause. ParkingEye did not own the car park in which Mr Beavis had parked; they merely managed it for the owner. That meant that Mr Beavis’s overstaying in the car park did not cause ParkingEye any pecuniary loss at all. Did that mean that its £85 charge was a penalty, being wholly out of proportion to any loss they might suffer? Hitherto, it might have been maintained that the stipulation of a sum payable upon breach could only be justified if some losses accrue to the victim of the breach, and therefore that, if a party cannot or does not suffer any loss as a result of a breach, then it cannot claim any sum stipulated as payable on breach. But that is not so, say the Justices in this judgment: Lords Neuberger and Sumption assert that the real question is – what is the nature and extent of the innocent party’s interest in the performance of the relevant obligation; such interest is not necessarily limited to the mere recovery of compensation for the breach (para 23). In this case, ParkingEye (and the landlord for whom they acted in managing the car park) had a legitimate interest in ensuring that only customers of the shopping centre used the car park, and that such customers did not stay too long in the car park (otherwise they would prevent others from shopping). The £85 charge was designed to act as a deterrent against overstaying, and “deterrence is not penal if there is a legitimate interest in influencing the conduct of the contracting party which is not satisfied by the mere right to recover damages for breach of contract” (para 99). Importantly, they added (in opposition to the newspaper headline’s suggestion of “huge penalty fees” that:

“None of this means that ParkingEye could charge overstayers whatever it liked. It could not charge a sum which would be out of all proportion to its interest or that of the landowner for whom it is providing the service. But there is no reason to suppose that £85 is out of all proportion to its interests” (para 100).

The application of the common law penalty rule meant therefore that the £85 charge was not a penalty, but a proportionate sum payable on breach of the obligation not to park for more than the 2 hours permitted.

By way of an aside, it is of interest that the Supreme Court thought that Mr Beavis’s parking was the result of a contract he had entered into with ParkingEye. Mr Beavis gave no obvious consideration for the 2 hour free parking he was permitted by ParkingEye. This looks very much like a gratuitous permission to park, an arrangement which one might have thought would not be a valid contract under English law. That did not seem to trouble the Supreme Court, however, Lords Neuberger and Sumption briefly noting only that:

“Mr Beavis had a contractual licence to park his car in the retail park on the terms of the notice posted at the entrance, which he accepted by entering the site … Moore-Bick LJ in the Court of Appeal was inclined to doubt this analysis, and at one stage so were we. But, on reflection, we think that it is correct.”

This blogger at least would have liked to have heard more from the Supreme Court about why this was, under English law, a valid contract, and not merely a gratuitous licence to occupy land for a period of time.

By way of conclusion, and to return to the main thrust of this blog post, this judgment of the Supreme Court is a significant one. It represents a clear defence of the continuing appropriateness of a rule alleviating against excessive contractual penalties. It serves as a reminder of a crucial aspect of the rule, that it only operates so as to allow an assessment of secondary obligations, arising upon breach, and not of primary obligations relating to payment or transfer of property. It also develops the law by holding that, although the victim of a breach may not suffer any pecuniary loss as a result of the breach, that does not mean that it cannot recover a stipulated sum from the breaching party. It can, so long as it has a legitimate interest in so recovering. Such an interest is perfectly possible of arising in relation to a property management scheme, such as the operation of a car park by an agent of the owner of the car park. That said, any sum stipulated cannot be out of all proportion to its interest. There is no danger of this judgment leading to huge or excessive parking charges of the sort suggested in the newspaper reports on the case.