Starting off the discussion, Bobby noted that the locus classicus on penalty clauses was generally taken to be the speech of Viscount Dunedin in Dunlop Pneumatic Tyre Co v New Garage and Motor Co Ltd (1915) AC 79. This case perpetrated the distinction between a liquidated damages clause, which would be enforceable, and a penalty clause, which would not be enforceable. The line of demarcation drawn between the two was that a clause would be penal where it did not involve a genuine pre-estimate of loss. Bobby noted that it is implicit that what was conceived by Viscount Dunedin is that the doctrine would only apply to clauses which were triggered by a breach of contract.
Cavendish & ParkingEye
In Cavendish’s case, Clause 5.1 of the parties’ agreement had disentitled Mr. Makdessi, upon default of the agreement, from receiving payments totaling $44,181,600. Clause 5.6 also had the effect of forcing him to sell his remaining stake in the company to Cavendish at a decreased value. Cavendish sought enforcement of the clauses which eventually led to the appeal to the Supreme Court. The appeal was subsequently co-joined with ParkingEye’s case.
In ParkingEye, the British Airways Pension Fund selected ParkingEye as sole provider of car park management services. Those wishing to park their cars in the car park managed by ParkingEye could do so for free, for two hours. Drivers exceeding that period would become liable to a £85 parking charge, reducible to £50 if paid within a fortnight. Mr. Beavis was not so prompt and eventually ParkingEye raised a small claim against him.
Hearing the co-joined appeals, the Supreme Court held that the clauses did not amount to penalty clauses and hence were valid. In examining the decisions, Bobby noted that the judgment of the court in Cavendish & ParkingEye revolved around three key issues: The first is whether the penalty doctrine should be abrogated? The second is whether the doctrine should be extended to apply to clauses other than those operable on breach? And thirdly, what should the test for penalty be?
a. Should the penalty doctrine be abrogated?
Bobby observed each of the justices rejected any inroads into the general application of the doctrine. Lords Neuberger and Sumption opposed an abolition out of fidelity to precedent and distaste for judicial legislation. Lord Mance also considered it undesirable for English law to get rid of a doctrine present in harmonisation proposal in numerous civil and common law jurisdictions. Furthermore, Lord Hodge stressed that it was undesirable for the court to be dragged into questions of relative bargaining power and effectiveness of representation.
Bobby observed that one argument which was raised at first instance in ParkingEye, but not continued at the appellate level, was that the penalty doctrine had no role in a case covered by the consumer protection legislation. He pointed out that there is some force in this contention: the statutory regime provides protection for the consumer which goes above that provided by the penalty doctrine. However, the removal of doctrinal overlap may not be a sufficient reason for reform which may be seen as removing protection from a consumer which is otherwise enjoyed by commercial parties.
Bobby further remarked that it is understandable that the Supreme Court was reluctant to abrogate a centuries old doctrine. However, the usual objection to judicial legislation — that it is retrospective and prospective — may not be convincing. Bobby argued that such a move would not invalidate preexisting clauses or require their renegotiation, though there may be need to support that assertation with empirical investigation and data.
b. Should the doctrine be extended to apply to clauses other than those operable on breach?
Bobby noted that their Lordships were mindful of the fact that the prohibition on penalty can be evaded by drafting clauses in slightly different fashion: if one thinks of contractual terms in terms of incentives, rather than penalties, the restriction may be circumvented. Bobby observed that the ability to circumvent this restriction led the High Court of Australia in Andrews v ANZ Bank (2012) HCA 30 to remove the limitation in 2012. This case was brought to the attention of the court in Cavendish & ParkingEye, but the court stated that the decision was incorrect. Bobby added that although the Court did not state the reason for rejecting the decision in Andrew’s case, it would appear that the Supreme Court was ‘anti-fusionist’, holding that a separate equitable jurisdiction to relieve from penalties existed co-extensively with the common law; and if there was such a jurisdiction in England, it had since fallen into abeyance. Bobby noted that the Supreme Court, interestingly, called Scots law into action, stating that Scotland lacks a separate equitable jurisdiction and have also retained the breach limitation.
Bobby remarked that the Supreme Court was correct to be wary about acting as judicial legislators. Removal of the breach limitation would subject every clause in every contract to potential review.
Bobby noted that recommendations were made by the Law Commission of England and Wales in 1975 ,and the SLC in 1999 and 2010 (in its draft bill) for the breach limitation to be removed .However, nothing was made of the recommendations by both law Commissions, with the SLC receiving adverse comments from two law firms, one of which noted that the removal would ‘damage Scotland’s reputation as a place to do business’.
c. What should be the test for penalty?
In further examining the decision in Cavendish and ParkingEye, Bobby pointed out that the question before the Supreme Court was essentially whether liquidated damages/penalty distinction, which is founded on whether or not there was an attempt to pre-estimate the loss, exhausted the full range of the penalty doctrine. Their Lordships, in Cavendish and ParkingEye, subjected the decision of Viscount Dunedin to close scrutiny. They observed that Viscount Dunedin had admitted that his test was not exhaustive or even generally applicable. They also noted that the other members of the Court in Dunlop’s case had formulated the test slightly differently. Particular focus was laid on the Irish Judge, Lord Atkinson, who stated that ‘it was impossible to say that the interest was incommensurate with the sum agreed to be paid.’
Bobby observed that the Supreme Court reformulated the test, stating that the question should be whether the impugned provision is a secondary obligation which imposes a detriment on the contract maker out of all proportion to any legitimate interest of the innocent party. Lord Mance also expresses his view in slightly differently language in terms that the test should be whether the provision for the interest is ‘extravagant, exorbitant or unconscionable’.
Bobby further stressed that one issue which may prove important in future cases is the question of whose interest may legitimately be taken into account: is it the interest of the innocent party which the clause seeks to protect or can it include the broader interests of other parties or the general society. He noted that both Lord Neuberger and Sumption held that the broader interest could be considered. Lord Hodge made restrictive reference to the ‘innocent party’s interest’. Bobby observed that this was an issue in ParkingEye, as ParkingEye Ltd could be said to solely have had a legitimate interest in making money from the charges. If however the broader interest of the public in finding ready parking at a convenient location could be taken into account, this could arguably be justifiable.
Bobby stated that that the SLC in its 1999 recommendation and 2010 draft bill had abrogated the exclusive focus on ‘genuine pre-estimate loss’ and had instead formulated a test which looks at whether the penalty ‘clause is manifestly excessive….’ Bobby noted that the test in Cavendish and ParkingEye may be ‘close to this’ and that Lords Neuberger, Sumption, Mance and Hodge each thought that the test applied was the same as that in the Principles of European Contract Law (which influenced the 1999 SLC recommendation).Lord Hodge also referred to the DCFR with its high standard of ‘grossly excessive’. Bobby added that the decision clearly proceeds with harmonisation as an objective.
In conclusion, Bobby recommends that if the SLC was to take further reform steps, in view of the decisions in Cavendish & ParkingEye, then the SLC may want to consider the following points: First, the decision in Cavendish is highly dependent on the distinction between primary and secondary obligations (although this distinction didn’t matter in the case). Scotland takes a different approach to primary obligations and performance interest by conceiving of specific implement as primary contractual remedy, whereas in England, specific performance is only available where damages are an inadequate remedy. Secondly, what should be the basis for a jurisdiction to relieve from penalties?
Is an economic justification convincing? Would a concept based on state monopoly on punishment be preferable? Thirdly, what is the effect of a clause being declared penal? Is it void, unenforceable or invalid. These terms appear discriminately in Cavendish. What are the differences and do they matter? Lastly, can a penalty clause have a third party effect? In this regard, Bobby observed that the recent bill of the SLC, which was earlier discussed at the GFSL Forum, may have a third party effect.
In closing the discussion, comments were received from the participants, one of whom remarked that it would be difficult to imagine what would constitute penalty clauses in the light of the language used in Cavendish’s case (‘excessive, exorbitant and unconscionable’).
It is hoped that the SLC will take a robust approach to the issues raised in the decisions, in the event it decides to reevaluate its reform position.