Cavendish Square Holding BV v Talal El Makdessi (Cavendish) and ParkingEye Limited v Beavis [2015] UKSC 67
Significance: the true test for whether a clause is unenforceable as a penalty clause is whether the impugned provision is a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation.
The penalty rule is an “ancient, haphazardly constructed edifice which has not weathered well”: [3]. However, the law relating to penalties has become “the prisoner of artificial categorisation”, with unsatisfactory distinctions being drawn between a penalty and a genuine pre-estimate of loss and a genuine pre-estimate of loss and a deterrent: [36]-[40].
The fundamental principle is that the penalty rule regulates only the contractual remedy available for the breach of primary contractual obligations, and not the fairness of those primary obligations themselves: [13].
The relevant contractual remedy typically stipulates payment of money, but it equally applies to obligations to transfer assets, or clauses where one party forfeits a deposit following its’ own
breach of contract: [14]-[18].
The established test set out by Lord Dunedin in Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 394 has been applied over-literally and did not reflect the complexity of modern commercial transactions: [18]-[30].
Concepts of deterrence and genuine pre-estimate of loss are unhelpful. The real question when a contractual provision is challenged as a penalty is whether it is penal (i.e. a punishment), not whether it is a genuine pre-estimate of loss. The fact that a clause is not a genuine pre-estimate of loss does not necessarily mean that it is penal.
The true test for whether a clause is a penalty, per Lord Neuberger in Cavendish: “whether the impugned provision is a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation“: [32].
The first step is to consider whether any (and if so what) legitimate business interest is served and protected by the clause, and if so and secondly, whether the provision made for that interest is extravagant, exorbitant or unconscionable [152]. The penalty doctrine has been applied to clauses withholding payments, and transfers of moneys worth [154-159], and may be
considered alongside relief against forfeiture: [161], per Lord Mance.
The test 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. A clause fixing a level of damages payable on breach will be a penalty if there is an extravagant disproportion between the stipulated sum and the highest level of damages that could possibly arise from the breach: [255], per Lord Hodge.