In extracts from 2016’s final Blundell Lecture, Mark Wonnacott QC and Elizabeth Fitzgerald air their thoughts on what a recent Supreme Court decision means for various areas of property law
On Monday 27 June, an audience of millions watched England meekly exit UEFA Euro 2016, and consoled themselves with one thought – at least this time it wasn’t on penalties. The same evening a smaller – but no less passionate – crowd at London’s Royal College of Surgeons was treated to a far more stirring team performance as two esteemed property barristers brought an end to this year’s series of Blundell Lectures. And penalties were very much the reason everyone bought a ticket.
In their lecture titled “Foul! Penalty clauses in property transactions”, Mark Wonnacott QC and Elizabeth Fitzgerald put the focus on last year’s Supreme Court ruling in the combined cases Cavendish Square Holding BV v El Makdessi; Parkingeye Ltd v Beavis [2015] UKSC 67; [2016] EGLR 15.
Here, Estates Gazette presents extracts from their lecture in which Wonnacott and Fitzgerald give their views on how Cavendish affects a number of areas familiar to property practitioners.
Forfeiture
“Traditionally, there was a clear distinction between personal and proprietary sanctions. The penalty rule was potentially engaged by personal sanctions (typically an obligation to pay a sum of money as a debt) but not by proprietary sanctions, such as the forfeiture of a lease or the loss of the right to redeem a mortgage. The remedy for proprietary sanctions was to apply for relief from forfeiture or to bring a redemption action.
All seven judges in Cavendish agreed that the penalty rule could now apply to at least some proprietary sanctions. Lord Mance said it would be absurd to draw a rigid distinction between a penalty that took the form of a transfer of money and a penalty that took the form of a transfer of property.
That naturally leads to the question of the interrelationship between the penalty rule and a forfeiture clause in a lease. Lords Neuberger and Sumption, perhaps wisely, did not want to make any final decision on the point. Lords Mance, Hodge and Toulson, however, all thought that the penalty rule could be engaged by any forfeiture clause, and that what was required was a two-stage approach.
First you ask whether the right of forfeiture is an impermissible penalty, ie is it an extravagant, exorbitant or unconscionable sanction for a breach of contract. If it is, it is simply void. If it is not extravagant, exorbitant or unconscionable, then it is enforceable, subject to the court’s power to grant relief.
We think this is wrong. The penalty rule has never been about making sanctions wholly void. It has always been part of a wider rule about making securities, for the performance of primary stipulations, proportionate. Where the security is a mortgage, it is made proportionate by allowing the borrower to redeem late; where the security is a forfeiture clause, it is made proportionate by granting relief from forfeiture to the owner of the forfeited property; and where the security is a contractual penalty, it is made proportionate by preventing its enforcement beyond the extent of the actual damage. Applying the contractual penalty rule to a forfeiture clause is a category mistake.
The expansion of the application of the rule against penalties to forfeitures of property undoubtedly throws into doubt the validity of forfeiture clauses in long leases of residential property. It is hard to think of a more extravagant and exorbitant provision than a right to deprive a residential tenant of a lease that he might have paid more than a million pounds for, because (for example) they have not washed the windows every two weeks.”
Deposits
“A deposit is a guarantee that the contract shall be performed. A deposit shares many of the characteristics and vices of a penalty and can clearly take effect as one. Deposits and penalties may be similar in function but traditionally equity regarded forfeiture of deposits as separate and distinct from the law concerning penalties. It has long been said to be part of English law that a true deposit will not be the subject of equitable relief.
What does Cavendish have to say? Lord Mance thought it absurd to draw a rigid distinction between cases of payment of moneys and the withholding of moneys due but said: ‘Such uncertainties as may exist regarding the doctrine’s applicability to deposits or to clauses forfeiting pre-payments must await decision in due course.’
Lord Hodge gave the matter more detailed consideration and stated the general rule that a deposit fixed at a reasonable figure would not bring into play the rule against penalties.
In the case of domestic property, a 10% deposit is conventional. There is no logical justification. It is difficult to say why 15% or 20% may be regarded as impermissible.
If the test in Cavendish is applied logically there is no obvious reason why a 10% deposit should be considered safe. But the fact is that a 10% deposit has generally been sacrosanct and under “normal circumstances” it is likely to remain beyond challenge.
However, the mere fact that it may now be common place in respect of certain types of developments to contract for a deposit in excess of 10% will not of itself make such a deposit justifiable. A vendor wishing to protect itself against the uncertainties of a long completion date would be well advised to exercise caution before extracting a large deposit from the purchaser.”
Break options
“Without a doubt, the thing that has provided more professional fun for property litigators than anything else in the past 20 years has been defeating conditional break options for trivial breaches, either of the tenant’s covenants or of some other stipulation in the lease (it has been less fun for the tenants and their advisers’ professional indemnity insurers).
“If you act for the landlord, what generally happens is you turn up in the county court saying that there were some small arrears of rent or was some minor disrepair on break date, or that there was some formal defect in the notice or in the way it was served, with the result that the tenant is stuck with the lease for the rest of the term.
After you have got over the judge’s initial outrage, you take them to all those decisions which say that if any conditions are attached to an option, complete performance of those conditions is necessary in order to trigger the option, and any subsisting non-compliance on the relevant date is fatal.
Is this still the law post-Cavendish? Cavendish makes it clear that, where the option takes the form of a condition precedent (for example, an option to renew a lease) the penalty rule cannot save the tenant, if the tenant does not comply strictly with all the conditions attached to that option. It cannot save the tenant because the conditions attached to a condition precedent are themselves part of the primary stipulation, which grants the estate, rather than a secondary sanction for breach.
But the conditions attached to a condition subsequent are different. In the case of a forfeiture, the breach triggers the exercise of the condition subsequent, but it is hard to see why there should be a difference where the breach prevents the exercise of a divesting put option (like a break clause) instead. Either the penalty rule is engaged by conditions subsequent or it is not.
There is no conceptual difference between a sanction which deprives a contract breaker of valuable property and a sanction which binds the contract breaker to onerous property; they are just opposite sides of the same coin.
Are you going to be able to persuade the judge that it is a penalty? Of course you are. The judge is going to be itching to say it is a penalty.”
Jervis v Harris clauses
“Confining the doctrine of penalties to secondary obligations allows the rule to be circumvented very easily by careful drafting. Jervis v Harris [1996] Ch 195 is a good example of form defeating substance. In Jervis v Harris the lease contained a clause which entitled the landlord to enter the property to carry out repairs which the tenant ought to have carried out and then to recover the cost of the repairs from the tenant. One might think that the tenant’s liability to pay the landlord’s costs of doing the works arose from its breach of contract and thus could potentially be irrecoverable as a penalty. Millett LJ held that it was not.
We think that, in the right circumstances, the court might be willing to revisit the question of whether a Jervis v Harris clause is a penalty. That is not to say that every Jervis v Harris clause is going to be a penalty. In each case, it will be necessary to compare the financial loss which the landlord would suffer, if the works were not done, with the cost of the works which are going to be visited on the tenant, if they are, and ask whether the cost is exorbitant or unconscionable compared with the financial damage.”
What the Supreme Court decided in Cavendish
In two conjoined appeals – one involving a clause in a share sale agreement, the other involving an £85 parking charge for exceeding a two-hour limit in a privately-owned car park – the Supreme Court declined to abolish the doctrine against penalty clauses in contracts. Instead, they found that contractual penalties are void if they are exorbitant or unconscionable. Following the court’s restatement of the applicability of the doctrine, the test for striking down penal clauses comes down to two questions:
- What is the legitimate interest that the innocent party has in the performance of the primary obligation?
- When compared to that interest, is the sanction for non-performance exorbitant, unconscionable or out of all proportion?
For more on the decision see “The philosophy of penalties”, EG, 30 January 2016, p100, and “Legal notes: Penalty kicks”, EG, 28 November 2015, p111.
Mark Wonnacott QC is a barrister at Maitland Chambers and Elizabeth Fitzgerald is a barrister at Falcon Chambers. The Blundell Property Law Lectures are supported by Falcon Chambers.
