Contract – Penalty – Enforcement – Contract for sale of company – Parking charges — Whether certain contractual provisions in two contracts under consideration unenforceable as penalty clauses – Correct approach to determining whether contractual provision a penalty – Application of that approach to contracts in question – Whether parking charge in second contract contrary to Unfair Terms in Consumer Contracts Regulations 1999 – First appeal allowed – Second appeal dismissed
The Supreme Court heard two appeals both of which raised issues as to the law on penalty clauses in contracts. The first case concerned a contract for the sale of a controlling stake in a holding company for a large advertising and marketing communications group; the sale contract included clauses which provided that, in the event that the respondent seller breached certain restrictive covenants against competing activities, he would not be entitled to the last two instalments of the purchase price and could also be required to sell his remaining shares to the appellant at a price which excluded the value of the goodwill in the business. The Court of Appeal held that the clauses were unenforceable penalties: see [2013] EWCA Civ 1539.
The second case concerned car parking charges. The respondent in the second case operated a car park at the Riverside retail park in Chelmsford pursuant to a contract with the owner of the retail park. The respondent paid the owner a fixed weekly amount and was entitled to keep any parking charges that it received. The terms of use of the car park were advertised on prominent signs at the entrance to the car park and at frequent intervals within it. Parking was free for the first two hours but there was a parking charge of £85 for overstaying. After the appellant overstayed by nearly an hour, the respondent sought to recover the charge from him in the sum of £50 if paid within 14 days or the full £85 thereafter. The appellant did not pay and the respondent brought proceedings in the county court to recover the sum alleged to be due
The appellant contended that the charge was unenforceable both at common law, because it was a penalty, and also under the Unfair Terms in Consumer Contracts Regulations 1999. The Court of Appeal, upholding the decision of the judge at first instance, held that the charge was enforceable since it was commercially justifiable as being neither improper in its purpose nor manifestly excessive in amount: see [2015] EWCA Civ 402; [2015] PLSCS 125.
Held: The first appeal was allowed; (Lord Toulson dissenting) the second appeal was dismissed.
(1) The penalty rule in English law was an ancient, haphazardly constructed edifice which had not weathered well. However, it was not only a long-standing principle of English law but was also common to almost all major systems of law, at least in the western world. It was also consistent with other well-established principles developed by judges which involved declining to give full force to contractual provisions, such as relief from forfeiture, the equity of redemption and refusal to grant specific performance. Moreover, statutory regulation did not cover the entire field of unfair contracts. It would therefore be inappropriate to abolish the penalty rule, although it should not be extended. Some underlying principle needed to be identified in place of artificial categorisations made as a result of unsatisfactory distinctions. The concepts of “genuine pre-estimate of loss” and “deterrence” were unhelpful. Likewise, the tests set out by Lord Dunedin in Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd [1915] AC 79 should not be treated as a comprehensive code.
(2) The question whether a damages clause was a penalty fell to be decided as a matter of construction, as at the time that it was agreed, since enforceability depended on the character of the provision itself and not on the circumstances in which it fell to be enforced. A penalty clause was a species of agreement which the common law considered to be by its nature contrary to the policy of the law, and was wholly unenforceable; the courts would instead award the common law measure of damages for the breach in question.
(3) A penalty clause was a clause engaged on breach of contract. The penalty rule therefore regulated only the remedies available for breach of a party’s primary obligations, not the primary obligations themselves. The rule was potentially engaged where, as a matter of substance rather than form, a contract contained an obligation on one party to perform an act and also provided that, if that party did not perform the act, he would pay a specified sum of money to the other party. While payment of a sum of money was the classic obligation under a penalty clause, there was no reason why an obligation to transfer assets should not also be capable of constituting a penalty.
(4) The fact that a sum was paid over as a deposit, in the sense of a surety for one party’s contractual performance, did not prevent the payment from being a penalty if, in due course, the other party forfeited the deposit in accordance with the contractual terms. Penalty clauses and forfeiture clauses had the same origin in equity. Where a proprietary interest or a “proprietary or possessory right”, such as a patent or a lease, was granted or transferred subject to revocation or determination on breach, the clause providing for determination or revocation was a forfeiture, rather than a penalty, and was enforceable subject to the court granting relief from forfeiture. However, it was possible that, in some circumstances, a provision could potentially be both a penalty clause and a forfeiture clause.
(5) The penal character of a clause depended on its purpose, which was ordinarily an inference from its effect, as a question of construction to which evidence of the commercial background was relevant, although the answer could not depend on evidence of actual intention. The first step is to consider whether any, and if so what, legitimate business interest was served and protected by the clause, and, second, whether the provision made for that interest was extravagant, exorbitant or unconscionable. The fact that it required payment of a sum which was not a genuine pre-estimate of loss would not necessarily make it penal if there was some other reason which justified the discrepancy between the sum payable and the amount that would be awarded as common law damages. The innocent party might have a legitimate interest in performance extending beyond the prospect of pecuniary compensation flowing directly from the breach in question. Similarly, the fact that a provision had a deterrent effect did not make it penal if there was a legitimate interest in influencing the conduct of the contracting party which was not satisfied by the mere right to recover damages for breach of contract. The true test was whether the impugned provision was a secondary obligation which imposed a detriment on the contract-breaker which was out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation. The innocent party could have no proper interest in simply punishing the defaulter; his interest was in performance or some appropriate alternative to performance.
(6) The modern penalty rule was substantive, not procedural, and did not normally depend for its operation on a finding that advantage had been taken of one party. However, the circumstances in which the contract was made were not entirely irrelevant. In a negotiated contract between properly advised parties of comparable bargaining power, the strong initial presumption had to be that the parties themselves were the best judges of what was legitimate in a provision dealing with the consequences of breach.
(7) Applying those principles, the clauses impugned in the first case were not contrary to the penalty rule. Assuming, without deciding, that a contractual provision could 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, such a provision would not always be a penalty. It would depend on the nature of the right of which the contract-breaker was being deprived and the basis on which he was being deprived of it. Although the impugned clauses had no relationship, even approximate, with the measure of loss attributable to the breach, the appellant purchaser had a legitimate interest in the observance of the restrictive covenants which went beyond the recovery of that loss. It had an interest in measuring the price of the business to its value.
(8) In the second case, the £85 parking charge was payable no breach of contract and was not a pre-estimate of damages. The respondent lost nothing as a result of the unauthorised use of the car park resulting from the appellant overstaying. The main objects of the charge were, first, to manage the efficient use of parking spaces in the interests of the retail outlets, and the users of those outlets who wished to find spaces in which to park their cars, and, second, to provide an income stream to the respondent to meet the costs of operating the scheme and make a profit from its services, without which those services would not be available. While the penalty rule was engaged in those circumstances, the charge was not a penalty. Although the respondent was not liable to suffer loss as a result of overstaying motorists, it had a legitimate interest in charging them which extended beyond the recovery of any loss. It made no difference that the charge was a deterrent to overstaying. Nor did the penal character of such a scheme depend on whether landowner operated it or employed a contractor like the respondent to do so. While the respondent could not charge a sum that was out of all proportion to its interest or that of the landowner for which it was providing the service, there was no reason to suppose that £85 was out of all proportion to its interests. It was neither extravagant nor unconscionable having regard to the level of charges imposed by local authorities for overstaying in car parks on public land. Further, the mere fact that many motorists regularly used the car park knowing of the charge was some evidence of its reasonableness.
The same considerations that showed that the charge was not a penalty also demonstrated that it was not unfair for the purposes of the 1999 Regulations. Although there was a significant imbalance in the parties’ respective rights, that imbalance was not contrary to the requirements of good faith since the respondent and the landowner had a legitimate interest in imposing a liability on the appellant in excess of the damages that would have been recoverable at common law: Aziz v Caixa d’Estalvis de Catalunya, Tarragona i Manresa Case C-415/11 [2013] 3 CMLR 89 applied.
Joanna Smith QC, Richard Leiper, James McCreath and Edwin (instructed by Squire Patton Boggs (UK) LLP) appeared for the appellant in the first appeal; Michael Bloch QC and Camilla Bingham QC (instructed by Clifford Chance LLP) appeared for the respondent in the first appeal; John de Waal QC, David Lewis and Ryan Hocking (instructed by Harcus Sinclair) appeared for the appellant in the second appeal; Jonathan Kirk QC, David Altaras and Thomas Samuels (instructed by Cubism law) appeared for the respondent in the second appeal; Christopher Butcher QC (instructed by the legal department of the Consumers’ Association) appeared for the Consumers’ Association as intervener.
Sally Dobson, barrister
Click here to read transcript: Cavendish Square and Parkingeye
