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Cavendish Square Holding BV v Talal El Makdessi and ParkingEye Limited v Beavis [2015] UKSC 67

Cavendish Square Holding BV v Talal El Makdessi and ParkingEye Limited v Beavis [2015] UKSC 67
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Michaelmas Term
[2015] UKSC 67
On appeal from: [2013] EWCA Civ 1539 and [2015] EWCA Civ 402


Cavendish Square Holding BV (Appellant) v Talal El Makdessi (Respondent)

ParkingEye Limited (Respondent) v Beavis (Appellant)


Lord Neuberger, President
Lord Mance
Lord Clarke
Lord Sumption
Lord Carnwath
Lord Toulson
Lord Hodge


4 November 2015

Heard on 21, 22 and 23 July 2015

Appellant (Cavendish Square Holding BV)
Joanna Smith QC
Richard Leiper
James McCreath
Edwin Peel
(Instructed by Squire Patton Boggs (UK) LLP)

Respondent (Talal El Makdessi)
Michael Blocj QC
Camilla Bingham QC
(Instructed by Clifford Chance LLP)

Appellant (Beavis)
John de Waal QC
David Lewis
Ryan Hocking
(Instructed by Harcus Sinclair)

Respondent (ParkingEye Limited)
Jonathan Kirk QC
David Altaras
Thomas Samuels
(Instructed by Cubism Law)

Intervener (Consumers’ Association)
Christopher Butcher QC
(Instructed by Consumers’ Association In-House Lawyers)


LORD NEUBERGER AND LORD SUMPTION: (with whom Lord Carnwath agrees)

1. These two appeals raise an issue which has not been considered by the Supreme Court or by the House of Lords for a century, namely the principles underlying the law relating to contractual penalty clauses, or, as we will call it, the penalty rule. The first appeal, Cavendish Square Holding BV v Talal El Makdessi, raises the issue in relation to two clauses in a substantial commercial contract. The second appeal, ParkingEye Ltd v Beavis, raises the issue at a consumer level, and it also raises a separate issue under the Unfair Terms in Consumer Contracts Regulations 1999 (SI 1999/2083) (“the 1999 Regulations”).
2. We shall start by addressing the law on the penalty rule generally, and will then discuss the two appeals in turn.

The law in relation to penalties

3. The penalty rule in England is an ancient, haphazardly constructed edifice which has not weathered well, and which in the opinion of some should simply be demolished, and in the opinion of others should be reconstructed and extended. For many years, the courts have struggled to apply standard tests formulated more than a century ago for relatively simple transactions to altogether more complex situations. The application of the rule is often adventitious. The test for distinguishing penal from other principles is unclear. As early as 1801, in Astley v Weldon (1801) 2 Bos & Pul 346, 350 Lord Eldon confessed himself, not for the first time, “much embarrassed in ascertaining the principle on which [the rule was] founded”. Eighty years later, in Wallis v Smith (1882) 21 Ch D 243, 256, Sir George Jessel MR, not a judge noted for confessing ignorance, observed that “The ground of that doctrine I do not know”. In 1966 Diplock LJ, not a judge given to recognising defeat, declared that he could “make no attempt, where so many others have failed, to rationalise this common law rule”: Robophone Facilities Ltd v Blank [1966] 1 WLR 1428, 1446. The task is no easier today. But unless the rule is to be abolished or substantially extended, its application to any but the clearest cases requires some underlying principle to be identified.
Equitable origins

4. The penalty rule originated in the equitable jurisdiction to relieve from defeasible bonds. These were promises under seal to pay a specified sum of money,

subject to a proviso that they should cease to have effect on the satisfaction of a condition, usually performance of some other (“primary”) obligation. By the beginning of the 16th century, the practice had grown up of taking defeasible bonds to secure the performance obligations sounding in damages. This enabled the holder of the bond to bring his action in debt, which made it unnecessary for him to prove his loss and made it possible to stipulate for substantially more than his loss. The common law enforced the bonds according to their letter. But equity regarded the real intention of the parties as being that the bond should stand as security only, and restrained its enforcement at common law on terms that the debtor paid damages, interest and costs. The classic statement of this approach is that of Lord Thurlow LC in Sloman v Walter (1783) 1 Bro CC 418, 419:

“… where a penalty is inserted merely to secure the enjoyment of a collateral object, the enjoyment of the object is considered as the principal intent of the deed, and the penalty only as accessional, and, therefore, only to secure the damage really incurred ...”

5. The essential conditions for the exercise of the jurisdiction were (i) that the penal provision was intended as a security for the recovery of the true amount of a debt or damages, and (ii) that that objective could be achieved by restraining proceedings on the bond in the courts of common law, on terms that the defendant paid damages. As Lord Macclesfield observed in Peachy v Duke of Somerset (1720) 1 Strange 447, 453:

“The true ground of relief against penalties is from the original intent of the case, where the penalty is designed only to secure money, and the court gives him all that he expected or desired: but it is quite otherwise in the present case. These penalties or forfeitures were never intended by way of compensation, for there can be none.”

This last reservation remained an important feature of the equitable jurisdiction to relieve. As Baggallay LJ put it in Protector Endowment Loan and Annuity Company v Grice (1880) 5 QBD 592, 595, “where the intent is not simply to secure a sum of money, or the enjoyment of a collateral object, equity does not relieve”.

The common law rule

6. The process by which the equitable rule was adopted by the common law is traced by Professor Simpson in his article The penal bond with conditional

defeasance (1966) 82 LQR 392, 418-419. Towards the end of the 17th century, the courts of common law tentatively began to stay proceedings on a penal bond to secure a debt, unless the plaintiff was willing to accept a tender of the money, together with interest and costs. The rule was regularised and extended by two statutes of 1696 and 1705. Section 8 of the Administration of Justice Act 1696 (8 & 9 Will 3 c 11) is a prolix provision whose effect was that the plaintiff suing in the common law courts on a defeasible bond to secure the performance of covenants (not just debts) was permitted to plead the breaches and have his actual damages assessed. Judgment was entered on the bond, but execution was stayed upon payment of the assessed damages. The Administration of Justice Act 1705 (4 & 5 Anne c 16) allowed the defendant in an action on the bond to pay the amount of the actual loss, together with interest and costs, into court, and rely on the payment as a defence. These statutes were originally framed as facilities for plaintiffs suing on bonds. But by the end of the 18th century the common law courts had begun to treat the statutory procedures as mandatory, requiring damages to be pleaded and proved and staying all further proceedings on the bond: see Roles v Rosewell (1794) 5 TR 538, Hardy v Bern (1794) 5 TR 636. The effect of this legislation was thus to make it unnecessary to proceed separately in chancery for relief from the penalty and in the courts of common law for the true loss. As a result, the equitable jurisdiction was rarely invoked, and the further development of the penalty rule was entirely the work of the courts of common law.

7. It developed, however, on wholly different lines. The equitable jurisdiction to relieve from penalties had been closely associated with the jurisdiction to relieve from forfeitures which developed at the same time. Both were directed to contractual provisions which on their face created primary obligations, but which during the 17th and 18th centuries the courts of equity treated as secondary obligations on the ground that the real intention was that they should stand as a mere security for performance. The court then intervened to grant relief from the rigours of the secondary obligation in order to secure performance in another, less penal or (in modern language) more proportionate, way. In contrast, the penalty rule as it was developed by the common law courts in the course of the 19th and 20th centuries proceeded on the basis that although penalties were secondary obligations, the parties meant what they said. They intended the provision to be applied according to the letter with a view to penalising breach. The law relieved the contract-breaker of the consequences not because the objective could be secured in another way but because the objective was contrary to public policy and should not therefore be given effect at all. The difference in approach to penalties of the courts of equity and the common law courts is in many ways a classic example of the contrast between the flexible if sometimes unpredictable approach of equity and the clear if relatively strict approach of the common law.

8. With the gradual decline of the use of penal defeasible bonds, the common law on penalties was developed almost entirely in the context of damages clauses –

ie clauses which provided for payment of a specified sum in place of common law damages. Because they were a contractual substitute for common law damages, they could not in any meaningful sense be regarded as a mere security for their payment. If the agreed sum was a penalty, it was treated as unenforceable. Starting with the decisions in Astley in 1801 and Kemble v Farren (1829) 6 Bing 141, the common law courts introduced the now familiar distinction between a provision for the payment of a sum representing a genuine pre-estimate of damages and a penalty clause in which the sum was out of all proportion to any damages liable to be suffered. By the middle of the 19th century, this rule was well established. In Betts v Burch (1859) 4 H & N 506, 509, Martin B regretted that he was “bound by the cases” and prevented from holding that “parties are at liberty to enter into any bargain they please” so that “if they have made an improvident bargain they must take the consequences”. But Bramwell B (at p 511) appeared to have no such reservations.
9. The distinction between a clause providing for a genuine pre-estimate of damages and a penalty clause has remained fundamental to the modern law, as it is currently understood. The question whether a damages clause is a penalty falls to be decided as a matter of construction, therefore as at the time that it is agreed: Public Works Comr v Hills [1906] AC 368, 376; Webster v Bosanquet [1912] AC 394; Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79, at pp 86-87 (Lord Dunedin); and Cooden Engineering Co Ltd v Stanford [1953] 1 QB86, 94 (Somervell LJ). This is because it depends on the character of the provision, not on the circumstances in which it falls to be enforced. It is a species of agreement which the common law considers to be by its nature contrary to the policy of the law. One consequence of this is that relief from the effects of a penalty is, as Hoffmann LJ put it in Else (1982) Ltd v Parkland Holdings Ltd [1994] 1 BCLC 130, 144, “mechanical in effect and involves no exercise of discretion at all.” Another is that the penalty clause is wholly unenforceable: Clydebank Engineering & Shipbuilding Co Ltd v Don Jose Ramos Yzquierdo y Castaneda [1905] AC 6, 9, 10 (Lord Halsbury LC); Gilbert-Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd [1974] AC 689, 698 (Lord Reid), 703 (Lord Morris of Borth-y-Gest) and 723-724 (Lord Salmon); Scandinavian Trading Tanker Co AB v Flota Petrolera Ecuatoriana (The “Scaptrade”) [1983] 2 AC 694, 702 (Lord Diplock); AMEV-UDC Finance Ltd v Austin (1986) 162 CLR 170, 191-193 (Mason and Wilson JJ). Deprived of the benefit of the provision, the innocent party is left to his remedy in damages under the general law. As Lord Diplock put it in The “Scaptrade” at p 702:

“The classic form of penalty clause is one which provides that upon breach of a primary obligation under the contract a secondary obligation shall arise on the part of the party in breach to pay to the other party a sum of money which does not represent a genuine pre-estimate of any loss likely to be sustained by him as the result of the breach of primary

obligation but is substantially in excess of that sum. The classic form of relief against such a penalty clause has been to refuse to give effect to it, but to award the common law measure of damages for the breach of primary obligation instead.”
10. Equity, on the other hand, relieves against forfeitures “where the primary object of the bargain is to secure a stated result which can effectively be attained when the matter comes before the court, and where the forfeiture provision is added by way of security for the production of that result”: Shiloh Spinners Ltd v Harding [1973] AC 691, 723 (Lord Wilberforce). As Lord Wilberforce said at p 722, the paradigm cases are the jurisdiction to relieve from a right of re-entry in a lease of land and the mortgagor’s equity of redemption (and the associated equitable right to redeem) in relation to mortgages. Save in relation to non-payment of rent, the power to grant relief from forfeiture to lessees is now contained in section 146 of the Law of Property Act 1925, and probably exclusively so (see Official Custodian for Charities v Parway Estates Departments Ltd [1985] Ch 151). Relief for mortgagors through the equitable right to redeem is (save in relation to most residential properties) largely still based on judge-made law. However, neither by statute nor on general principles of equity is a lessor’s right of re-entry or a mortgagee’s right of sale or foreclosure treated as being by its nature contrary to the policy of the law. What equity (and, where it applies, statute) typically considers to be contrary to the policy of the law is the enforcement of such rights in circumstances where their purpose, namely the performance of the obligations in the lease or the mortgage, can be achieved in other ways – normally by late substantive compliance and payment of appropriate compensation. The forfeiture or foreclosure/power of sale is therefore enforceable, equity intervening only to impose terms. These will generally require the lessee or mortgagor to rectify the breach and make good any loss suffered by the lessor or mortgagee. If the lessee or mortgagee cannot or will not do so, the forfeiture will be unconditionally enforced – although perhaps not invariably (see per Lord Templeman in Associated British Ports v CH Bailey plc [1990] 2 AC 703, 707-708 in the context of section 146, and, more generally, the judgments in Cukurova Finance International Ltd v Alfa Telecom Turkey Ltd (No 3) [2013] UKPC 20, [2015] 2 WLR 875).

11. The penalty rule as it has been developed by the judges gives rise to two questions, both of which have a considerable bearing on the questions which arise on these appeals. In what circumstances is the rule engaged at all? And what makes a contractual provision penal?

In what circumstances is the penalty rule engaged?

12. In England, it has always been considered that a provision could not be a penalty unless it provided an exorbitant alternative to common law damages. This

meant that it had to be a provision operating upon a breach of contract. In Moss Empires Ltd v Olympia (Liverpool) Ltd [1939] AC 544, this was taken for granted by Lord Atkin (p 551) and Lord Porter (p 558). As a matter of authority the question is settled in England by the decision of the House of Lords in Export Credits Guarantee Department v Universal Oil Products Co [1983] 1 WLR 399 (“ECGD”). Lord Roskill, with whom the rest of the committee agreed, said at p 403:
“[P]erhaps the main purpose, of the law relating to penalty clauses is to prevent a plaintiff recovering a sum of money in respect of a breach of contract committed by a defendant which bears little or no relationship to the loss actually suffered by the plaintiff as a result of the breach by the defendant. But 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.”

As Lord Hodge points out in his judgment, the Scottish authorities are to the same effect.

13. This principle is worth restating at the outset of any analysis of the penalty rule, because it explains much about the way in which it has developed. There is a fundamental difference between a jurisdiction to review the fairness of a contractual obligation and a jurisdiction to regulate the remedy for its breach. Leaving aside challenges going to the reality of consent, such as those based on fraud, duress or undue influence, the courts do not review the fairness of men’s bargains either at law or in equity. The penalty rule regulates only the remedies available for breach of a party’s primary obligations, not the primary obligations themselves. This was not a new concept in 1983, when ECGD was decided. It had been the foundation of the equitable jurisdiction, which depended on the treatment of penal defeasible bonds as secondary obligations or, as Lord Thurlow LC put it in 1783 in Sloman as “collateral” or “accessional” to the primary obligation. And it provided the whole basis of the classic distinction made at law between a penalty and a genuine preestimate of loss, the former being essentially a way of punishing the contract-breaker rather than compensating the innocent party for his breach. We shall return to that distinction below.

14. This means that in some cases the application of the penalty rule may depend on how the relevant obligation is framed in the instrument, ie whether as a conditional primary obligation or a secondary obligation providing a contractual alternative to damages at law. Thus, where a contract contains an obligation on one party to perform an act, and also provides that, if he does not perform it, he will pay the other party a specified sum of money, the obligation to pay the specified sum is a secondary obligation which is capable of being a penalty; but if the contract does

not impose (expressly or impliedly) an obligation to perform the act, but simply provides that, if one party does not perform, he will pay the other party a specified sum, the obligation to pay the specified sum is a conditional primary obligation and cannot be a penalty.

15. However, the capricious consequences of this state of affairs are mitigated by the fact that, as the equitable jurisdiction shows, the classification of terms for the purpose of the penalty rule depends on the substance of the term and not on its form or on the label which the parties have chosen to attach to it. As Lord Radcliffe said in Campbell Discount Co Ltd v Bridge [1962] AC 600, 622, “[t]he intention of the parties themselves”, by which he clearly meant the intention as expressed in the agreement, “is never conclusive and may be overruled or ignored if the court considers that even its clear expression does not represent ‘the real nature of the transaction’ or what ‘in truth’ it is taken to be” (and cf per Lord Templeman in Street v Mountford [1985] AC 809, 819). This aspect of the equitable jurisdiction was inherited by the courts of common law, and has been firmly established since the earliest common law cases.

16. Payment of a sum of money is the classic obligation under a penalty clause and, in almost every reported case involving a damages clause, the provision stipulates for the payment of money. However, it seems to us that there is no reason why an obligation to transfer assets (either for nothing or at an undervalue) should not be capable of constituting a penalty. While the penalty rule may be somewhat artificial, it would heighten its artificiality to no evident purpose if it were otherwise. Similarly, the fact that a sum is paid over by one party to the other party as a deposit, in the sense of some sort of surety for the first party’s contractual performance, does not prevent the sum being a penalty, if the second party in due course forfeits the deposit in accordance with the contractual terms, following the first party’s breach of contract – see the Privy Council decisions in Public Works Comr v Hills [1906] AC 368, 375-376, and Workers Trust & Merchant Bank Ltd v Dojap Investments Ltd [1993] AC 573. By contrast, in Else (1982) at p 146, Hoffmann LJ, citing Stockloser v Johnson [1954] 1 QB 476 in support, said that, unlike a case where “money has been deposited as security for due performance of [a] party’s obligation”, “retention of instalments which have been paid under contract so as to become the absolute property of the vendor does not fall within the penalty rule”, although, he added that it was “subject … to the jurisdiction for relief against forfeiture”.

17. The relationship between penalty clauses and forfeiture clauses is not entirely easy. Given that they had the same origin in equity, but that the law on penalties was then developed through common law while the law on forfeitures was not, this is unsurprising. Some things appear to be clear. Where a proprietary interest or a “proprietary or possessory right” (such as a patent or a lease) is granted or transferred subject to revocation or determination on breach, the clause providing

for determination or revocation is a forfeiture and cannot be a penalty, and, while it is enforceable, relief from forfeiture may be granted: see BICC plc v Burndy Corpn [1985] Ch 232, 246-247 and 252 (Dillon LJ) and The “Scaptrade”, pp 701-703, (Lord Diplock). But this does not mean that relief from forfeiture is unavailable in cases not involving land – see Cukurova Finance International Ltd v Alfa Telecom Turkey Ltd (No 2) [2013] UKPC 2, [2015] 2 WLR 875, especially at paras 92-97, and the cases cited there.
18. What is less clear is whether a provision is capable of being both a penalty clause and a forfeiture clause. It is inappropriate to consider that issue in any detail in this judgment, as we have heard very little argument on forfeitures – unsurprisingly because in neither appeal has it been alleged that any provision in issue is a forfeiture from which relief could be granted. But it is right to mention the possibility that, in some circumstances, a provision could, at least potentially, be a penalty clause as well as a forfeiture clause. We see the force of the arguments to that effect advanced by Lord Mance and Lord Hodge in their judgments.

What makes a contractual provision penal?

19. As we have already observed, until relatively recently this question was answered almost entirely by reference to straightforward liquidated damages clauses. It was in that context that the House of Lords sought to restate the law in two seminal decisions at the beginning of the 20th century, Clydebank in 1904 and Dunlop in 1915.

20. Clydebank was a Scottish appeal about a shipbuilding contract with a provision (described as a “penalty”) for the payment of £500 per week for delayed delivery. The provision was held to be a valid liquidated damages clause, not a penalty. Lord Halsbury (p 10) said that the distinction between the two depended on

“whether it is, what I think gave the jurisdiction to the courts in both countries to interfere at all in an agreement between the parties, unconscionable and extravagant, and one which no court ought to allow to be enforced.”

Lord Halsbury declined to lay down any “abstract rule” for determining what was unconscionable or extravagant, saying only that it must depend on “the nature of the transaction – the thing to be done, the loss likely to accrue to the person who is endeavouring to enforce the performance of the contract, and so forth”. Lord Halsbury’s formulation has proved influential, and the two other members of the Appellate Committee both delivered concurring judgments agreeing with it. It is,

however, worth drawing attention to an observation of Lord Robertson (pp 19-20) which points to the principle underlying the contrasting expressions “liquidated damages” and “penalty”:
“Now, all such agreements, whether the thing be called penalty or be called liquidate damage, are in intention and effect what Professor Bell calls ‘instruments of restraint’, and in that sense penal. But the clear presence of this does not in the least degree invalidate the stipulation. The question remains, had the respondents no interest to protect by that clause, or was that interest palpably incommensurate with the sums agreed on? It seems to me that to put this question, in the present instance, isto answer it.”

21. Dunlop arose out of a contract for the supply of tyres, covers and tubes by a manufacturer to a garage. The contract contained a number of terms designed to protect the manufacturer’s brand, including prohibitions on tampering with the marks, restrictions on the unauthorised export or exhibition of the goods, and on resales to unapproved persons. There was also a resale price maintenance clause, which would now be unlawful but was a legitimate restriction of competition according to the notions prevailing in 1914. It was this clause which the purchaser had broken. The contract provided for the payment of £5 for every tyre, cover or tube sold in breach of any provision of the agreement. Once again, the provision was held to be a valid liquidated damages clause. In his speech, Lord Dunedin formulated four tests “which, if applicable to the case under consideration, may prove helpful, or even conclusive” (p 87). They were (a) that the provision would be penal if “the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach”; (b) that the provision would be penal if the breach consisted only in the non-payment of money and it provided for the payment of a larger sum; (c) that there was “a presumption (but no more)” that it would be penal if it was payable in a number of events of varying gravity; and (d) that it would not be treated as penal by reason only of the impossibility of precisely pre-estimating the true loss.

22. Lord Dunedin’s speech in Dunlop achieved the status of a quasi-statutory code in the subsequent case-law. Some of the many decisions on the validity of damages clauses are little more than a detailed exegesis or application of his four tests with a view to discovering whether the clause in issue can be brought within one or more of them. In our view, this is unfortunate. In the first place, Lord Dunedin proposed his four tests not as rules but only as considerations which might provehelpful or even conclusive “if applicable to the case under consideration”. He did not suggest that they were applicable to every case in which the law of penalties was engaged. Second, as Lord Dunedin himself acknowledged, the essential question was whether the clause impugned was “unconscionable” or “extravagant”. The four

tests are a useful tool for deciding whether these expressions can properly be applied to simple damages clauses in standard contracts. But they are not easily applied to more complex cases. To deal with those, it is necessary to consider the rationale of the penalty rule at a more fundamental level. What is it that makes a provision for the consequences of breach “unconscionable”? And by comparison with what is a penalty clause said to be “extravagant”? Third, none of the other three Law Lords expressly agreed with Lord Dunedin’s reasoning, and the four tests do not all feature in any of their speeches. Indeed, it appears that, in his analysis at pp 101-102, Lord Parmoor may have taken a more restrictive view of what constituted a penalty than did Lord Dunedin. More generally, the other members of the Appellate Committee gave their own reasons for concurring in the result, and they also repay consideration. For present purposes, the most instructive is that of Lord Atkinson, who approached the matter on an altogether broader basis.
23. Lord Atkinson pointed (pp 90-91) to the critical importance to Dunlop of the protection of their brand, reputation and goodwill, and their authorised distribution network. Against this background, he observed (pp 91-92):

“It has been urged that as the sum of £5 becomes payable on the sale of even one tube at a shilling less than the listed price, and as it was impossible that the appellant company should lose that sum on such a transaction, the sum fixed must be a penalty. In the sense of direct and immediate loss the appellants lose nothing by such a sale. It is the agent or dealer who loses by selling at a price less than that at which he buys, but the appellants have to look at their trade in globo, and to prevent the setting up, in reference to all their goods anywhere and everywhere, a system of injurious undercutting. The object of the appellants in making this agreement, if the substance and reality of the thing and the real nature of the transaction be looked at, would appear to be a single one, namely, to prevent the disorganization of their trading system and the consequent injury to their trade in many directions. The means of effecting this is by keeping up their price to the public to the level of their price list, this last being secured by contracting that a sum of £5 shall be paid for every one of the three classes of articles named sold or offered for sale at prices below those named on the list. The very fact that this sum is to be paid if a tyre cover or tube be merely offered for sale, though not sold, shows that it was the consequential injury to their trade due to undercutting that they had in view. They had an obvious interest to prevent this undercutting, and on the evidence it would appear to me impossible to say that that interest was incommensurate with the sum agreed to be paid.”

Lord Atkinson went on to draw an analogy, which has particular resonance in the Cavendish appeal, with a clause dealing with damages for breach of a restrictive covenant on the canvassing of business by a former employee. In this context, he said (pp 92-93):

“It is, I think, quite misleading to concentrate one’s attention upon the particular act or acts by which, in such cases as this, the rivalry in trade is set up, and the repute acquired by the former employee that he works cheaper and charges less than his old master, and to lose sight of the risk to the latter that old customers, once tempted to leave him, may never return to deal with him, or that business that might otherwise have come to him may be captured by his rival. The consequential injuries to the trader’s business arising from each breach by the employee of his covenant cannot be measured by the direct loss in a monetary point of view on the particular transaction constituting the breach.”

Lord Atkinson was making substantially the same point as Lord Robertson had made in Clydebank. The question was: what was the nature and extent of the innocent party’s interest in the performance of the relevant obligation. That interest was not necessarily limited to the mere recovery of compensation for the breach. Lord Atkinson considered that the underlying purpose of the resale price maintenance clause gave Dunlop a wider interest in enforcing the damages clause than pecuniary compensation. £5 per item was not incommensurate with that interest even if it was incommensurate with the loss occasioned by the wrongful sale of a single item.

24. Although the other members of the Appellate Committee did not express themselves in the same terms as Lord Atkinson, their approach was entirely consistent with his. Lord Parker at p 97 said that “whether the sum agreed to be paid on the breach is really a penalty must depend on the circumstances of each particular case”, and at p 99, echoing Lord Atkinson’s fuller treatment of the point, as just set out, he described the damage which would result from any breach as “consist[ing] in the disturbance or derangement of the system of distribution by means of which [Dunlop’s] goods reach the ultimate consumer”. In their speeches, Lord Dunedin (p 87), Lord Parker (p 98) and Lord Parmoor (p 103) ultimately were content to rest their decision that the £5 was not a penalty on the ground that an exact pre-estimate of loss was impossible, whereas, in the passages quoted above, Lord Atkinson analysed why that was so. It seems clear that the actual result of the case was strongly influenced by Lord Atkinson’s reasoning. The clause was upheld although, on the face of it, it failed all but the last of Lord Dunedin’s tests. The £5 per item applied to breaches of very variable significance and it was impossible to relate the loss attributable to the sale of that item. It was justifiable only by reference to the wider interests identified by Lord Atkinson.

25. The great majority of cases decided in England since Dunlop have concerned more or less standard damages clauses in consumer contracts, and Lord Dunedin’s four tests have proved perfectly adequate for dealing with those. More recently, however, the courts have returned to the possibility of a broader test in less straightforward cases, in the context of the supposed “commercial justification” for clauses which might otherwise be regarded as penal. An early example is the decision of the House of Lords in The “Scaptrade”, where at p 702, Lord Diplock, with whom the rest of the Appellate Committee agreed, observed that a right to withdraw a time-chartered vessel for non-payment of advance hire was not a penalty because its commercial purpose was to create a fund from which the cost of providing the chartered service could be funded.
26. In Lordsvale Finance plc v Bank of Zambia [1996] QB 752, Colman J was concerned with a common form provision in a syndicated loan agreement for interest to be payable at a higher rate during any period when the borrower was in default. There was authority that such provisions were penal: Lady Holles v Wyse (1693) 2 Vern 289; Strode v Parker (1694) 2 Vern 316, Wallingford v Mutual Society (1880) 5 App Cas 685, 702 (Lord Hatherley). But Colman J held that the clause was valid because its predominant purpose was not to deter default but to reflect the greater credit risk associated with a borrower in default. At pp 763-764, he observed that a provision for the payment of money upon breach could not be categorised as a penalty simply because it was not a genuine pre-estimate of damages, saying that there would seem to be:

“no reason in principle why a contractual provision the effect of which was to increase the consideration payable under an executory contract upon the happening of a default should be struck down as a penalty if the increase could in the circumstances be explained as commercially justifiable, provided always that its dominant purpose was not to deter the other party from breach.”

27. Colman J’s approach was approved by Mance LJ, delivering the leading judgment in the Court of Appeal in Cine Bes Filmcilik ve Yapimcilik v United International Pictures [2004] 1 CLC 401, para 13. A similar view was taken by Arden LJ in Murray v Leisureplay plc [2005] IRLR 946, para 54, where she posed the question

“Has the party who seeks to establish that the clause is a penalty shown that the amount payable under the clause was imposed in terrorem, or that it does not constitute a genuine pre-estimate of loss for the purposes of the Dunlop case, and, if he has shown the latter, is there some other reason which justifies the

discrepancy between [the amount payable under the clause and the amount payable by way of damages in common law]
?” (emphasis added).
She considered that the clause in question had advantages for both sides, and pointed out that no evidence had been adduced to show that the clause lacked commercial justification: see paras 70-76. But Buxton LJ put the matter on a wider basis for which Clarke LJ (para 105) expressed a preference. He referred to the speech of Lord Atkinson in Dunlop and suggested that the ratio of the actual decision in that case had been that “an explanation of the clause in commercial rather than deterrent terms was available”. All three members of the court endorsed the approach of Colman J in Lordsvale and Mance LJ in Cine Bes.

28. Colman J in Lordsvale and Arden LJ in Murray were inclined to rationalise the introduction of commercial justification as part of the test, by treating it as evidence that the impugned clause was not intended to deter. Later decisions in which a commercial rationale has been held inconsistent with the application of the penalty rule, have tended to follow that approach: see, for example, Euro London Appointments Ltd v Claessens International Ltd [2006] 2 Lloyd’s Rep 436, General Trading Company (Holdings) Ltd v Richmond Corpn Ltd [2008] 2 Lloyd’s Rep 475. It had the advantage of enabling them to reconcile the concept of commercial justification with Lord Dunedin’s four tests. But we have some misgivings about it. The assumption that a provision cannot have a deterrent purpose if there is a commercial justification, seems to us to be questionable. By the same token, we agree with Lord Radcliffe’s observations in Campbell Discount at p 622, where he said:

“… I do not myself think that it helps to identify a penalty, to describe it as in the nature of a threat ‘to be enforced in terrorem’ (to use Lord Halsbury’s phrase in Elphinstone v Monkland Iron & Coal Co Ltd (1886) 11 App Cas 332, 348). I do not find that that description adds anything of substance to the idea conveyed by the word ‘penalty’ itself, and it obscures the fact that penalties may quite readily be undertaken by parties who are not in the least terrorised by the prospect of having to pay them and yet are, as I understand it, entitled to claim the protection of the court when they are called upon to make good their promises.”

Moreover, the penal character of a clause depends on its purpose, which is ordinarily an inference from its effect. As we have already explained, this is a question of construction, to which evidence of the commercial background is of course relevant in the ordinary way. But, for the same reason, the answer cannot depend on evidence

of actual intention: see Chartbrook Ltd v Persimmon Homes Ltd [2009] AC 1101, paras 28-47 (Lord Hoffmann). However, while we have misgivings about some aspects of their reasoning, these aspects are peripheral to the essential point which Colman J and Buxton LJ were making, and we consider that their emphasis on justification provides a valuable insight into the real basis of the penalty rule. It is the same insight as that of Lord Robertson in Clydebank and Lord Atkinson in Dunlop. A damages clause may properly be justified by some other consideration than the desire to recover compensation for a breach. This must depend on whether the innocent party has a legitimate interest in performance extending beyond the prospect of pecuniary compensation flowing directly from the breach in question.
29. The availability of remedies for a breach of duty is not simply a question of providing a financial substitute for performance. It engages broader social and economic considerations, one of which is that the law will not generally make a remedy available to a party, the adverse impact of which on the defaulter significantly exceeds any legitimate interest of the innocent party. In the famous case of White & Carter (Councils) Ltd v McGregor [1962] AC 413, Lord Reid observed, at p 431:

“It may well be that, if it can be shown that a person has no legitimate interest, financial or otherwise, in performing the contract rather than claiming damages, he ought not to be allowed to saddle the other party with an additional burden with no benefit to himself. If a party has no interest to enforce a stipulation, he cannot in general enforce it: so it might be said that, if a party has no interest to insist on a particular remedy, he ought not to be allowed to insist on it. And, just as a party is not allowed to enforce a penalty, so he ought not to be allowed to penalise the other party by taking one course when another is equally advantageous to him. … Here the respondent did not set out to prove that the appellants had no legitimate interest in completing the contract and claiming the contract price rather than claiming damages. … Parliament has on many occasions relieved parties from certain kinds of improvident or oppressive contracts, but the common law can only do that in very limited circumstances.”

In White & Carter the innocent party was entitled to ignore the repudiation of the contract-breaker and proceed to perform, claiming his remuneration in debt rather than limiting himself to damages, notwithstanding that this course might be a great deal more expensive for the contract-breaker. This, according to Lord Reid (p 431), was because the contract-breaker “did not set out to prove that the appellants had no legitimate interest in completing the contract and claiming the contract price rather than claiming damages”.

30. More generally, the attitude of the courts, reflecting that of the Court of Chancery, is that specific performance of contractual obligations should ordinarily be refused where damages would be an adequate remedy. This is because the minimum condition for an order of specific performance is that the innocent party should have a legitimate interest extending beyond pecuniary compensation for the breach. The paradigm case is the purchase of land or certain chattels such as ships, which the law recognises as unique. Because of their uniqueness the purchaser’s interest extends beyond the mere award of damages as a substitute for performance. As Lord Hoffmann put it in addressing a very similar issue “the purpose of the law of contract is not to punish wrongdoing but to satisfy the expectations of the party entitled to performance”: Co-operative Insurance Society Ltd v Argyll Stores (Holdings) Ltd [1998] AC 1, 15.

31. In our opinion, the law relating to penalties has become the prisoner of artificial categorisation, itself the result of unsatisfactory distinctions: between a penalty and genuine pre-estimate of loss, and between a genuine pre-estimate of loss and a deterrent. These distinctions originate in an over-literal reading of Lord Dunedin’s four tests and a tendency to treat them as almost immutable rules of general application which exhaust the field. In Legione v Hateley (1983) 152 CLR 406, 445, Mason and Deane JJ defined a penalty as follows:

“A penalty, as its name suggests, is in the nature of a punishment for non-observance of a contractual stipulation; it consists of the imposition of an additional or different liability upon breach of the contractual stipulation ...”

All definition is treacherous as applied to such a protean concept. This one can fairly be said to be too wide in the sense that it appears to be apt to cover many provisions which would not be penalties (for example most, if not all, forfeiture clauses). However, in so far as it refers to “punishment” and “an additional or different liability” as opposed to “in terrorem” and “genuine pre-estimate of loss”, this definition seems to us to get closer to the concept of a penalty than any other definition we have seen. The real question when a contractual provision is challenged as a penalty is whether it is penal, not whether it is a pre-estimate of loss. These are not natural opposites or mutually exclusive categories. A damages clause may be neither or both. The fact that the clause is not a pre-estimate of loss does not therefore, at any rate without more, mean that it is penal. To describe it as a deterrent (or, to use the Latin equivalent, in terrorem) does not add anything. A deterrent provision in a contract is simply one species of provision designed to influence the conduct of the party potentially affected. It is no different in this respect from a contractual inducement. Neither is it inherently penal or contrary to the policy of the law. The question whether it is enforceable should depend on whether the means by which the contracting party’s conduct is to be influenced are “unconscionable” or
(which will usually amount to the same thing) “extravagant” by reference to some norm.

32. The true test 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 innocent party can have no proper interest in simply punishing the defaulter. His interest is in performance or in some appropriate alternative to performance. In the case of a straightforward damages clause, that interest will rarely extend beyond compensation for the breach, and we therefore expect that Lord Dunedin’s four tests would usually be perfectly adequate to determine its validity. But compensation is not necessarily the only legitimate interest that the innocent party may have in the performance of the defaulter’s primary obligations. This was recognised in the early days of the penalty rule, when it was still the creature of equity, and is reflected in Lord Macclesfield’s observation in Peachy (quoted in para 5 above) about the application of the penalty rule to provisions which were “never intended by way of compensation”, for which equity would not relieve. It was reflected in the result in Dunlop. And it is recognised in the more recent decisions about commercial justification. And, as Lord Hodge shows, it is the principle underlying the Scottish authorities.

33. The penalty rule is an interference with freedom of contract. It undermines the certainty which parties are entitled to expect of the law. Diplock LJ was neither the first nor the last to observe that “The court should not be astute to descry a ‘penalty clause’”: Robophone at p 1447. As Lord Woolf said, speaking for the Privy Council in Philips Hong Kong Ltd v Attorney General of Hong Kong (1993) 61 BLR 41, 59, “the court has to be careful not to set too stringent a standard and bear in mind that what the parties have agreed should normally be upheld”, not least because “[a]ny other approach will lead to undesirable uncertainty especially in commercial contracts”.

34. Although the penalty rule originates in the concern of the courts to prevent exploitation in an age when credit was scarce and borrowers were particularly vulnerable, the modern rule is substantive, not procedural. It does not normally depend for its operation on a finding that advantage was taken of one party. As Lord Wright MR observed in Imperial Tobacco Company (of Great Britain) and Ireland v Parslay [1936] 2 All ER 515, 523:

“A millionaire may enter into a contract in which he is to pay liquidated damages, or a poor man may enter into a similar contract with a millionaire, but in each case the question is exactly the same, namely, whether the sum stipulated as damages for the breach was exorbitant or extravagant ...”

35. But for all that, the circumstances in which the contract was made are not entirely irrelevant. In a negotiated contract between properly advised parties of comparable bargaining power, the strong initial presumption must be that the parties themselves are the best judges of what is legitimate in a provision dealing with the consequences of breach. In that connection, it is worth noting that in Philips Hong Kong at pp 57-59, Lord Woolf specifically referred to the possibility of taking into account the fact that “one of the parties to the contract is able to dominate the other as to the choice of the terms of a contract” when deciding whether a damages clause was a penalty. In doing so, he reflected the view expressed by Mason and Wilson JJ in AMEV-UDC at p 194 that the courts were thereby able to “strike a balance between the competing interests of freedom of contract and protection of weak contracting parties” (citing Atiyah, The Rise and Fall of Freedom of Contract (1979), Chapter 22). However, Lord Woolf was rightly at pains to point out that this did not mean that the courts could thereby adopt “some broader discretionary approach”. The notion that the bargaining position of the parties may be relevant is also supported by Lord Browne-Wilkinson giving the judgment of the Privy Council in Workers Bank. At p 580, he rejected the notion that “the test of reasonableness [could] depend upon the practice of one class of vendor, which exercises considerable financial muscle” as it would allow such people “to evade the law against penalties by adopting practices of their own”. In his judgment, he decided that, in contracts for sale of land, a clause providing for a forfeitable deposit of 10% of the purchase price was valid, although it was an anomalous exception to the penalty rule. However, he held that the clause providing for a forfeitable 25% deposit in that case was invalid because “in Jamaica, the customary deposit has been 10%” and “[a] vendor who seeks to obtain a larger amount by way of forfeitable deposit must show special circumstances which justify such a deposit”, which the appellant vendor in that case failed to do.
Should the penalty rule be abrogated?

36. The primary case of Miss Smith QC, who appeared for Cavendish in the first appeal, was that the penalty rule should now be regarded as antiquated, anomalous and unnecessary, especially in the light of the growing importance of statutory regulation in this field. It is the creation of the judges, and, she argued, the judges should now take the opportunity to abolish it. There is a case to be made for taking this course. It was expounded with considerable forensic skill by Miss Smith, and has some powerful academic support: see Sarah Worthington, Common Law Values: the Role of Party Autonomy in Private Law, in The Common Law of Obligations: Divergence and Unity (ed A Robertson and M Tilbury (2015)), pp 18-26. We rather doubt that the courts would have invented the rule today if their predecessors had not done so three centuries ago. But this is not the way in which English law develops, and we do not consider that judicial abolition would be a proper course for this court to take.

37. The first point to be made is that the penalty rule is not only a long-standing principle of English law, but is common to almost all major systems of law, at any rate in the western world. It has existed in England since the 16th century and can be traced back to the same period in Scotland: McBryde, The Law of Contract in Scotland, 3rd ed (2007), paras 22-148. The researches of counsel have shown that it has been adopted with some variants in all common law jurisdictions, including those of the United States. A corresponding rule was derived from Roman law by Pothier, Traité des Obligations, No 346, which is to be found in the Civil Codes of France (article 1152), Germany (for non-commercial contracts only) (sections 343, 348), Switzerland (article 163.3), Belgium (article 1231) and Italy (article 1384). It is included in influential attempts to codify the law of contracts internationally, including the Unidroit Principles of International Commercial Contracts (2010) (article 7.4.13), and the UNCITRAL Uniform Rules on Contract Clauses for an Agreed Sum Due upon Failure of Performance (article 6). In January 1978 the Committee of Ministers of the Council of Europe recommended a number of common principles relating to penal clauses, including (article 7) that a stipulated sum payable on breach “may be reduced by the court when it is manifestly excessive”.

38. It is true that statutory regulation, which hardly existed at the time that the penalty rule was developed, is now a significant feature of the law of contract. In England, the landmark legislation was the Unfair Contract Terms Act 1977. For most purposes, the Act was superseded by the Unfair Terms in Consumer Contracts Regulations 1994 (SI 1994/3159), which was in turn replaced by the 1999 Regulations, both of which give effect to European Directives. The 1999 Regulations contain an “indicative and non-exhaustive list of the terms which may be regarded as unfair”, including terms which have the object or effect of “requiring any consumer who fails to fulfil his obligation to pay a disproportionately high sum in compensation”. Nonetheless, statutory regulation is very far from covering the whole field. Penalty clauses are controlled by the 1999 Regulations, but the Regulations apply only to consumer contracts and the control of unfair terms under regulations 3 and 5 is limited to those which have not been individually negotiated. There are major areas, notably non-consumer contracts, which are not regulated by statute. Some of those who enter into such contracts, for example professionals and small businesses, may share many of the characteristics of consumers which are thought to make the latter worthy of legal protection. The English Law Commission considered penalty clauses in 1975 (Working Paper No 61, Penalty Clauses and Forfeiture of Monies Paid, April 1975), at a time when there was no relevant statutory regulation, and the Scottish Law Commission reported on them in May 1999 (Report No 171). Neither of these Reports recommended abolition of the rule. On the contrary, both recommended legislation which would have expanded its scope.

39. Further, although there are justified criticisms that can be made of the penalty rule, it is consistent with other well-established principles which have been developed by judges (albeit mostly in the Chancery courts) and which involve the court in declining to give full force to contractual provisions, such as relief from forfeiture, the equity of redemption, and refusal to grant specific performance, as discussed in paras 10-11 and 29-30 above. Finally, the case for abolishing the rule depends heavily on anomalies in the operation of the law as it has traditionally been understood. Many, though not all of these are better addressed (i) by a realistic appraisal of the substance of contractual provisions operating upon breach, and (ii) by taking a more principled approach to the interests that may properly be protected by the terms of the parties’ agreement.
Should the penalty rule be extended?

40. In the course of his cogent submissions, Mr Bloch QC, who appeared for Mr Makdessi on the first appeal, suggested that, as an alternative to confirming or abrogating the penalty rule, this court could extend it, so that it applied more generally. As he pointed out, this was the course taken by the High Court of Australia, and it would have the advantage of rendering the penalty rule less formalistic in its application, and, which may be putting the point in a different way, less capable of avoidance by ingenious drafting.

41. This step has recently been taken in Australia. Until recently, the law in Australia was the same as it is in England: see IAC Leasing Ltd v Humphrey (1972) 126 CLR 131, 143 (Walsh J); O’Dea v Allstates Leasing System (WA) Pty Ltd (1983) 152 CLR 359, 390 (Brennan J); AMEV-UDC at p 184 (Mason and Wilson JJ, citing ECGD among other authorities), 211 (Dawson J); Ringrow Pty Ltd v BP Australia Pty Ltd (2005) 224 CLR 656, 662. However, a radical departure from the previous understanding of the law occurred with the decision of the High Court of Australia in Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205. The background to this case was very similar to that in Office of Fair Trading v Abbey National plc [2010] 1 AC 696. It concerned the application of the penalty rule to contractual bank charges payable when the bank bounced a cheque or allowed the customer to draw in excess of his available funds or agreed overdraft limit. These might in a loose sense be regarded as banking irregularities, but they did not involve any breach of contract on the part of the customer. On that ground Andrew Smith J had held in the Abbey National case that the charges were incapable of being penalties: [2008] 2 All ER (Comm) 625, paras 295-299 (the point was not appealed). In Andrews, the High Court of Australia disagreed. They engaged in a detailed historical examination of the equitable origin of the rule and concluded that there subsisted, independently of the common law rule, an equitable jurisdiction to relieve against any sufficiently onerous provision which was conditional upon a failure to observe some other provision, whether or not that failure was a breach of contract. At para 10, they defined a penalty as follows:

“In general terms, a stipulation prima facie imposes a penalty on a party (the first party) if, as a matter of substance, it is collateral (or accessory) to a primary stipulation in favour of a second party and this collateral stipulation, upon the failure of the primary stipulation, imposes upon the first party an additional detriment, the penalty, to the benefit of the second party. In that sense, the collateral or accessory stipulation is described as being in the nature of a security for and in terrorem of the satisfaction of the primary stipulation. If compensation can be made to the second party for the prejudice suffered by failure of the primary stipulation, the collateral stipulation and the penalty are enforced only to the extent of that compensation. The first party is relieved to that degree from liability to satisfy the collateral stipulation.”

42. Any decision of the High Court of Australia has strong persuasive force in this court. But we cannot accept that English law should take the same path, quite apart from its inconsistency with established and unchallenged House of Lords authority. In the first place, although the reasoning in Andrews was entirely historical, it is not in fact consistent with the equitable rule as it developed historically. The equitable jurisdiction to relieve from penalties arose wholly in the context of bonds defeasible in the event of the performance of a contractual obligation. It necessarily posited a breach of that obligation. Secondly, if there is a distinct and still subsisting equitable jurisdiction to relieve against penalties which is wider than the common law jurisdiction, with three possible exceptions it appears to have left no trace in the authorities since the fusion of law and equity in 1873. The first arguable exception is in In re Dagenham (Thames) Dock Co; Ex p Hulse (1873) LR 8 Ch App 1022 (followed by the Privy Council in Kilmer v British Columbia Orchard Lands Ltd [1913] AC 319), where the Court of Appeal granted a purchaser, who had been in possession for five years and carried out improvements, further time to pay the second and final instalment of a purchase price on the ground that the clause requiring him to vacate and to forfeit the first instalment for not having paid the second instalment on time, was a “penalty”. However, James and Mellish LJJ may have been treating the clause as a forfeiture (as they both also used that expression in their brief judgments), and in any event they treated the purchaser in the same way as a mortgagor in possession asking for more time to pay. Further, as Romer LJ pointed out in Stockloser at pp 497-498, the decision could be justified by the fact that time had already been extended twice by agreement, and in any event there was no question of the vendor being required to repay the first instalment. The second arguable exception is no more than an unsupported throw-away line in the judgment of Diplock LJ in Robophone at p 1446, where he said it was “by no means clear” whether penalty clauses “are simply void”, but, on analysis, he was dealing with a rather different point (namely that discussed by Lord Atkin in the passage that follows). The third exception is the unsatisfactory decision in Jobson v Johnson [1989] 1 WLR 1026, to which we shall return in paras

84-87 below. It is relevant to add in this connection that the law of penalties has been held to be the same in England and Scotland: Stair Memorial Encyclopaedia of the Laws of Scotland, vol 15, paras 783-801, and see Clydebank. Yet equity, although influential, has never been a distinct branch of Scots law. In the modern law of both countries, the penalty rule is an aspect of the law of contract. Thirdly, the High Court’s redefinition of a penalty is, with respect, difficult to apply to the case to which it is supposedly directed, namely where there is no breach of contract. It treats as a potential penalty any clause which is “in the nature of a security for and in terrorem of the satisfaction of the primary stipulation.” By a “security” it means a provision to secure “compensation … for the prejudice suffered by the failure of the primary stipulation”. This analysis assumes that the “primary stipulation” is some kind of promise, in which case its failure is necessarily a breach of that promise. If, for example, there is no duty not to draw cheques against insufficient funds, it is difficult to see where compensation comes into it, or how bank charges for bouncing a cheque or allowing the customer to overdraw can be regarded as securing a right of compensation. Finally, the High Court’s decision does not address the major legal and commercial implications of transforming a rule for controlling remedies for breach of contract into a jurisdiction to review the content of the substantive obligations which the parties have agreed. Modern contracts contain a very great variety of contingent obligations. Many of them are contingent on the way that the parties choose to perform the contract. There are provisions for termination upon insolvency, contractual payments due on the exercise of an option to terminate, break-fees chargeable on the early repayment of a loan or the closing out of futures contracts in the financial or commodity markets, provisions for variable payments dependent on the standard or speed of performance and “take or pay” provisions in long-term oil and gas purchase contracts, to take only some of the more familiar types of clause. The potential assimilation of all of these to clauses imposing penal remedies for breach of contract would represent the expansion of the courts’ supervisory jurisdiction into a new territory of uncertain boundaries, which has hitherto been treated as wholly governed by mutual agreement.

43. We would accept that the application of the penalty rule can still turn on questions of drafting, even where a realistic approach is taken to the substance of the transaction and not just its form. But we agree with what Hoffmann LJ said in Else (1982) at p 145, namely that, while it is true that the question whether the penalty rule applies may sometimes turn on “somewhat formal distinction[s]”, this can be justified by the fact that the rule “being an inroad upon freedom of contract which is inflexible … ought not to be extended”, at least by judicial, as opposed to legislative, decision-making.

The first appeal: Cavendish v El Makdessi

The factual and procedural history

44. Mr Makdessi founded a group of companies (“the Group”) which by 2008 had become the largest advertising and marketing communications group in the Middle East, and operated through a network of around 20 companies with more than 30 offices in over 15 countries. At that time, Mr Makdessi was one of the most influential Lebanese business leaders, his name was closely identified with the business of the Group, and he had very strong relationships with its clients and senior employees.

45. In 2008, the holding company of the Group was Team Y & R Holdings Hong Kong Ltd (“the Company”). The Company had 1,000 issued shares, which were owned by Mr Makdessi and Mr Joseph Ghossoub, with the exception of 126 shares which were held by Young & Rubicam International Group BV (“Y & RIG”), a company in the WPP group of companies (“WPP”), the world’s largest market communications services group.

46. By an agreement of 28 February 2008 (“the Agreement”) Mr Makdessi and Mr Ghossoub (described as “the Sellers”) agreed to sell to Y & RIG (described as “the Purchaser”) 474 shares (described as “the Sale Shares”) in the Company. Y & RIG then transferred those shares to Cavendish Square Holdings BV (“Cavendish”), another WPP company, and by a novation agreement of 29 February 2008, Cavendish was substituted for Y & RIG as a party to the Agreement. Thus Cavendish came to hold 60% of the Company while the Sellers retained 40%. For present purposes, Y & RIG can be ignored and the Purchaser can be treated as Cavendish.

47. The Agreement had been the subject of extensive negotiations over six months, and both sides were represented by highly experienced and respected commercial lawyers: Allen & Overy acting for Cavendish, and Lewis Silkin for the Sellers, Mr Makdessi and Mr Ghossoub.

48. By clause 3.1, the price payable by Cavendish “[i]n consideration of the sale of the Sale Shares and the obligations of the Sellers herein” (and which was to be apportioned 53.88% to Mr Makdessi and 46.12% to Mr Ghossoub) was to be paid by Cavendish in the following way:


A “Completion Payment” of US$34m to be paid on completion of the Agreement;



A “Second Payment” of US$31.5m to be paid into escrow on completion, and to be released in four instalments, as restructuring of the Group companies took effect;


An “Interim Payment”, to be paid 30 days after agreement of the group operating profits (“OPAT”) for 2007-2009, and to be the amount by which the product of eight, 0.474 and the average annual OPAT 2007-2009 exceeded US$63m (being the sum of the earlier payments less US$ 2.5m representing interest);


A “Final Payment”, to be paid 30 days after agreement of the OPAT for 2007-2011, and to be the amount by which the product of a figure between seven and ten (depending on the level of profit), 0.474 and the annual average annual OPAT for 2009-2011 exceeded the aggregate of US$63m and the Interim Payment.

Clause 6 contained provisions relating to the “calculation of OPAT and payment of the consideration”.

49. Clause 3.2 of the Agreement provided that, if the Interim Payment and/or the Final Payment turned out to be a negative figure, it or they should be treated as zero, but there was to be no claw back of the earlier payments. Clause 3.3 of the Agreement provided that the maximum of all payments would be US$147.5m. By clause 9.1 of, and paragraph 2.15(c) of Schedule 7 to, the Agreement, the Sellers warranted that the Net Asset Value (“NAV”) of the Company at 31 December 2007 was just over US$69.74m.

50. Clause 15 contained a put option which entitled each of the Sellers to require Cavendish, by a Notice served at any time between 1 January and 31 March in 2011 or any subsequent year (in the case of Mr Makdessi) and any time between 1 January and 31 March in 2017 or in any subsequent year (in the case of Mr Ghossoub), to buy all their remaining shares in the Company. The price payable on the exercise of this option was (subject to a cap of US$75m in the case of each Seller) to be the relevant seller’s proportion of a sum eight times the average OPAT for a reference period of seven years (the year in which the notice was served, the previous year and the two subsequent years). It was to be payable by instalments.

51. Clause 11 was concerned with the “protection of goodwill”. Clause 11.1 provided as follows:

“11.1. Each Seller recognises the importance of the goodwill of the Group to [Cavendish] and the WPP Group which is reflected in the price to be paid by the Purchaser for the Sale Shares. Accordingly, each Seller commits as set out in this clause 11 to ensure that the interest of each of [Cavendish] and the WPP Group in that goodwill is properly protected.”

52. Clause 11.2 provided that, in Mr Makdessi’s case, until two years after he ceased to hold any shares in the Company or the date of the final instalment of any payment under clause 15, and in Mr Ghossoub’s case, until two years after he ceased employment with the Company, the Sellers would not (a) carry on, or be engaged or interested in “Restricted Activities” (ie the provision of goods or services which competed with the Group companies) in “Prohibited Areas” (ie in countries in which any of the Group companies carried on business); (b) solicit or accept orders, enquiries or business in respect of Restricted Activities in the Prohibited Areas; (c) divert orders, enquiries or business from any Group company; or (d) employ or solicit any senior employee or consultant of any Group company.

53. Clause 11.7 started by recording that Cavendish “recognises the importance of the goodwill of the Group to the Sellers and to the value of the Interim Payment and the Final Payment”. It then contained a covenant by Cavendish that neither it nor any other WPP company would “without the Sellers’ prior written consent other than within the Group companies, trade in any of the [23 identified] countries … using [specified] names [including ‘Adrenalin’]”.

54. Under clause 7.5, Messrs El Makdessi and Ghossoub agreed that, within four months of completion, they would dispose of any shares in Carat Middle East Sarl (“Carat”), and procure the termination of a joint venture agreement which another Carat company had entered into with a member of the Aegis group of companies. Carat describes itself on its website as “the world’s leading independent media planning and buying specialist … [o]wned by global media group Aegis Group plc … [with] more than 5,000 people in 70 countries worldwide”. It is a competitor of WPP, including Cavendish and the Company.

55. The two provisions of central relevance for present purposes were included in clause 5, which was headed “Default”. Clauses 5.1 and 5.6 provided:

“5.1 If a Seller becomes a Defaulting Shareholder [which is defined as including ‘a Seller who is in breach of clause 11.2’] he shall not be entitled to receive the Interim Payment and/or the Final Payment which would other than for his having become a Defaulting Shareholder have been paid to him and

[Cavendish]’s obligations to make such payment shall cease. …

5.6. Each Seller hereby grants an option to [Cavendish] pursuant to which, in the event that such Seller becomes a Defaulting Shareholder, [Cavendish] may require such Seller to sell to [Cavendish] all … of the Shares held by that Seller (the Defaulting Shareholder Shares). [Cavendish] shall buy and such Seller shall sell … the Defaulting Shareholder Shares… within 30 days of receipt by such Seller of a notice from [Cavendish] exercising such option in consideration for the payment by [Cavendish] to such Seller of the Defaulting Shareholder Option Price [defined as ‘an amount equal to the [NAV] on the date that the relevant Seller becomes a Defaulting Shareholder multiplied by [the percentage which represents the proportion of the total shares the relevant Seller holds].”

56. Mr Ghossoub signed an agreement by which he agreed to remain an employee and director of the Company. During the negotiations, Mr Makdessi had made it clear that he did not wish to remain an employee. However, he signed an agreement, by which he became a non-executive director of the Company (as well as other companies in the Group) and non-executive chairman, for an initial term of 18 months which was renewable. Under this he agreed to certain specific obligations by way of ongoing support of the Company.

57. Mr Makdessi resigned as non-executive chairman of the Company in April 2009. On 1 July 2009, at the Company’s request, he resigned as non-executive director of all companies in the Group, save the Company itself. He was removed from the board of the Company on 27 April 2011, after the commencement of these proceedings.

58. Mr Makdessi has been paid his share of the first two payments stipulated by clause 3.1, namely the Completion Payment and the Second Payment, together with some additional interest. However, he has not yet been paid the remaining payments under clause 3.1, namely the Interim Payment or the Final Payment, or any part thereof. His remaining shares represent just over 21.5% of the whole issued share capital of the Company.

59. By December 2010, Cavendish and the Company concluded that Mr Makdessi had acted in breach of his duties to the Company as a director and in breach of his obligations to Cavendish under clause 11.2 of the Agreement. On 13

December 2010 Cavendish gave notice of the exercise of its Call Option under clause 5.6.

60. In December 2010, these proceedings were commenced against Mr Makdessi, with Cavendish suing for breach of the Agreement, and the Company suing for breach of fiduciary duty. Their re-amended particulars allege that in breach of his fiduciary duties and the restrictive covenants Mr Makdessi had throughout 2008 and 2009 in Lebanon and Saudi Arabia (both of which were within the Prohibited Area), in breach of clause 11.2, engaged in Restricted Activities, solicited clients and employees away from Group companies and accepted orders in respect of Restricted Activities.

61. The essence of the complaints was that Mr Makdessi had (i) continued to provide services to Carat, including assisting it to generate business, diverting business to it and soliciting clients and diverting their business to it; and (ii) set up rival advertising agencies in Lebanon and Saudi Arabia with “Adrenalin” in their name and that those agencies had poached or tried to poach a number of the Company’s customers and employees.

62. Mr Makdessi subsequently admitted that from February 2008 he had had an ongoing, unpaid involvement in the affairs of Carat pending the appointment of a replacement CEO and that such involvement placed him in breach of fiduciary duty to the Company with effect from 1 July 2008, and that, if the covenants in clause 11.2 were valid and enforceable (as they have been held to be) his involvement in the affairs of Carat rendered him a Defaulting Shareholder within the meaning of the Agreement. The Company’s claim for breach of fiduciary duty was settled by its acceptance of a payment into court made by Mr Makdessi in the sum of US$500,000. Cavendish claimed to have suffered loss and damage in the form of a loss of value of its shareholding in the Company, but it subsequently accepted that such loss was irrecoverable as it was merely “reflective” of the loss which could be claimed, indeed had been claimed, by the Company.

63. More importantly for present purposes, Cavendish claimed that Mr Makdessi’s admissions of breach of fiduciary duty demonstrated that he was in breach of clause 11.2 in relation to (at least) his continued involvement in Carat. Cavendish accordingly sought a declaration that he was a Defaulting Shareholder, was not entitled to the Interim Payment or the Final Payment as a result of clause 5.1, and was obliged, as of the date 30 days after the service of its notice exercising the Call Option, namely 14 January 2011, to sell to Cavendish all his shares in the Company at the Defaulting Shareholder Option Price, and it sought specific performance of the latter obligation.

64. The case was tried by Burton J and the appeal was heard in the Court of Appeal by Patten, Tomlinson and Christopher Clarke LJJ. The issue at both stages was the same, namely whether clauses 5.1 and 5.6 were valid and enforceable as Cavendish contended, or whether as Mr Makdessi argued they both were void and unenforceable because they constituted penalties. The courts below were naturally constrained by the perceived need to fit any analysis into the framework set by Lord Dunedin’s four principles. Burton J felt able to escape those constraints, and concluded that the two provisions were valid and enforceable. However, Christopher Clarke LJ, giving the leading judgment in the Court of Appeal, held that the two provisions were unenforceable penalties under the penalty rule as traditionally understood. No short summary can do justice to Christopher Clarke LJ’s thoughtful and careful analysis, but essentially he felt unable to uphold Burton J’s decision because he felt bound by the traditional explanation of the rule as being directed against deterrent clauses as such: see [2012] EWHC 3582 (Comm) and [2013] EWCA Civ 1539 respectively. Cavendish now appeals to this court.

The implications of the Agreement

65. Clause 5 deals with the obligations of a “Defaulting Shareholder”. So far as Mr Makdessi was concerned, that meant a Seller in breach of the restrictive covenants at clause 11.2. In the case of Mr Ghossoub, who remained an employee of the Company, it meant a Seller who was either in breach of the restrictive covenants or else had been summarily dismissed on any of a number of specified grounds, all of them serious and potentially discreditable to the Company.

66. The background to clause 5 is of some importance. Burton J found that the Agreement was negotiated in detail over a considerable period by parties dealing on equal terms with professional assistance of a high order. Cavendish was acquiring 47.4% of the Company so as to bring its holding up to 60%. It is common ground that a large proportion of the purchase price represented goodwill. The NAV (without goodwill) of the Company was warranted by the Sellers at over US$69.7m as at 31 December 2007, whereas the maximum consideration for 47.4% of the Company, including the profit-related element, was US$147.5m, implying a maximum value of more than US$300m for the whole Group. Clause 11.1 recorded the Sellers’ recognition that the restrictive covenants reflected the importance of the goodwill, and Burton J found that its value was heavily dependent on the continuing loyalty of Mr Makdessi and Mr Ghossoub. Subject to various options, they retained a 40% shareholding between them and were expected to maintain their connection with the business for a minimum period, Mr Ghossoub as an employee and director, and Mr Makdessi as a non-executive director and chairman. The following summary in the agreed Statement of Facts and Issues is based on the unchallenged evidence given at the trial:

“The structure of the Agreement was typical of acquisition agreements in the marketing sector. As in this case, the vendor is typically the founder or operator of the business, and has important relationships with clients and key staff. If they decide to turn against the business, its success can be significantly affected, and provisions are therefore included to protect the value of the investment, and in particular the value of the goodwill represented by the vendor’s existing personal relationships. The respondent fell into that category; the importance of personal relationships with clients is even stronger in the Middle East than the UK, and he had very strong relationships with clients and senior employees, and he was such a well known figure that if he acted against the Group, it would inevitably cause it to lose value.”

67. Clause 3.1 provided that the first two instalments of the purchase price amounted to US$65.5m, which would be received by the Sellers in any event. The effect of clause 5.1 was that in the event that a Seller acted in breach of the restrictive covenants, he would not be entitled to receive the last two instalments of the purchase price, the Interim Payment and the Final Payment, both of which were calculated by reference to the audited consolidated profit of the Company for years after completion of the Agreement (2007-2009 for the Interim Payment, and 2007-2011 for the Final Payment). The result of Cavendish’s exercise of its rights under clause 5.1 according to its terms was to reduce the consideration for the Defaulting Shareholder’s shares from his proportion of the maximum of US$147.5m to his proportion of US$65.5m. In Mr Makdessi’s case, he would receive up to US$44,181,600 less.

68. Under clause 15, the Sellers had a put option to require Cavendish to buy their remaining shareholdings, which in Mr Makdessi’s case was first exercisable during the first three months of 2011. The provisions determining the option price have been summarised in para 50 above. It was a multiple of average audited consolidated profit over a reference period, a formula which would reflect the value of goodwill. The effect of clause 5.6 was that if before the exercise of the clause 15 put option a Seller was in breach of the restrictive covenants, Cavendish acquired an option to acquire his retained shareholding at a lower price, namely the relevant proportion of the net asset value at the time of the default. The result of Cavendish’s implementation of clause 5.6, according to its terms, was that insofar as, at the date of default, Mr Makdessi’s shareholding had a value attributable to goodwill, he would not receive it and would not be able to exercise the clause 15 put option in 2011.

Was clause 5.1 contrary to the penalty rule?
69. Clause 5.1 disentitles a Defaulting Shareholder from receiving money which would otherwise have been due to him as his proportion of the price of the transferred shares. If this constitutes a forfeiture, it would appear that, at least on the current state of the authorities, there would be no jurisdiction to relieve against it, because a contractual right to be paid money is not a proprietary or possessory interest in property: The “Scaptrade” and BICC (see para 17 above). But there is some, albeit rather unsatisfactory, authority that such a clause may be a penalty.

70. Gilbert-Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd [1974] AC 689 concerned a provision in a building subcontract entitling the contractor to “suspend or withhold” the payment of money due to the subcontractor upon any breach of contract. Four members of the Appellate Committee accepted, obiter, a concession by counsel that this was a penalty: see p 698 (Lord Reid), pp 703-704 (Lord Morris of Borth-y-Gest), p 711 (Viscount Dilhorne), pp 723-724 (Lord Salmon). This was because it allowed the contractor to withhold all sums due, and not just the estimated damages flowing from the sub-contractor’s breach. The result was to put intolerable pressures on the latter’s cash-flow which was calculated to force him into submission.

71. The only other English decision directly in point is Socony Mobil Oil Co Inc v West of England Ship Owners Mutual Insurance Association Ltd (The “Padre Island”) [1987] 2 Lloyd’s Rep 529 (Saville J), [1989] 1 Lloyd’s Rep 239 (CA); [1991] 2 AC 1, a case notable for the multiplicity of arguments and the diversity of judicial opinions. It was a claim under the Third Parties (Rights Against Insurers) Act 1930 by cargo claimants who had obtained judgment for damages against an insolvent ship owner entered with the defendant P & I Club. Saville J dismissed the claim on the ground that under the standard “pay to be paid” clause in the rules recovery from the club was conditional on the ship owner having first paid the judgment creditor. Since this had not happened there was no claim to be transferred under the 1930 Act. The Court of Appeal allowed the appeal on this point. They were wrong to do so, as the House of Lords subsequently held. But on the footing that the “pay to be paid” clause did not bar the claim, the Court of Appeal went on to consider an alternative argument on behalf of the club, based on a provision in its rules that cover should retrospectively cease upon the insured’s failure to pay a call. The judgment creditor’s answer to this argument was that the provision was unenforceable as a penalty. Saville J had held (i) that this last question did not arise because on the facts the retrospective cesser clause would not have applied anyway, but (ii) that the penalty rule was not engaged because it applied only to provisions which required the contract-breaker to pay money. The Court of Appeal upheld him on (i), as a result of which (ii) did not arise. But Stuart-Smith LJ considered point (ii), obiter. He thought, on the basis of Gilbert-Ash, that the penalty rule could apply to a provision disentitling the contract-breaker from receiving a sum of money. He

could “see no distinction between withholding or disentitling a person to a sum of money which is due to him and requiring him to pay a sum of money” (p 262). O’Connor LJ said (p 265) that if the point had arisen he would have been of the same view as Stuart-Smith LJ. Bingham LJ disagreed, and would have held that the penalty rule was not engaged.

72. These two cases thus provide some support for the contention that clause 5.1 is capable of engaging the penalty rule. On the other hand, it has been held that a clause which renders instalments irrecoverable by a defaulting purchaser is a forfeiture but not a penalty: see Else (1982) and Stockloser, cited in para 16 above. If that is so, then there is a powerful argument for saying that a clause which renders instalments of payment irrecoverable by a defaulting vendor should, by the same token, not be a penalty, but at best a forfeiture.

73. We are, however, prepared to assume, without deciding, that a contractual provision may in some circumstances be a penalty if it disentitles the contractbreaker from receiving a sum of money which would otherwise have been due to him. But even on that assumption, it will not always be a penalty. That must depend on the nature of the right of which the contract-breaker is being deprived and the basis on which he is being deprived of it. The provision thought to be penal in Gilbert-Ash was a good example of a secondary provision operating upon a breach of the subcontractor’s primary obligations. It authorised the contractor to withhold all remuneration due to the subcontractor if the latter had committed any breach of contract until the contractor’s claim had been resolved. It was a security, albeit an exorbitant one, for the contractor’s claim. The retrospective cesser clause in the West of England Club’s rules in The “Padre Island” was very different. It forfeited an accrued right to indemnity permanently. Clauses of this kind are potentially harsher than those which operate simply as a security. But they may define the primary obligations of the parties, in which case the penalty rule will not apply to them. It is not a proper function of the penalty rule to empower the courts to review the fairness of the parties’ primary obligations, such as the consideration promised for a given standard of performance. For example, the consideration due to one party may be variable according to one or more contingencies, including the contingency of his breach of the contract. There is no reason in principle why a contract should not provide for a party to earn his remuneration, or part of it, by performing his obligations. If as a result his remuneration is reduced upon his non-performance, there is no reason to regard that outcome as penal. Suppose that a contract of insurance provided that it should be cancelled ab initio if the insured failed to pay the premium within three months of inception. The effect would be to forfeit any claim upon a casualty occurring in the first three months but it would be difficult to regard the provision as penal on that account. One reason why Bingham LJ disagreed with Stuart-Smith LJ was that he considered the retrospective cesser clause to be no different. “I do not myself think it unreasonable”, he said (p 254), “that a member should lose his cover in respect of a period for which he fails to pay

his premium.” He may well have been right to analyse the clause in that way, but it is a fair criticism of Stuart-Smith LJ’s approach that he did not consider this aspect of the matter at all.

74. Where, against this background, does clause 5.1 stand? It is plainly not a liquidated damages clause. It is not concerned with regulating the measure of compensation for breach of the restrictive covenants. It is not a contractual alternative to damages at law. Indeed in principle a claim for common law damages remains open in addition, if any could be proved. The clause is 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. The consideration fixed by clause 3.1 is said to be payable “[i]n consideration of the sale of the Sale Shares and the obligations of the Sellers herein”. Those obligations of the Sellers herein include the restrictive covenants. Clause 5.1 belongs with clauses 3 and 6, among the provisions which determine Cavendish’s primary obligations, ie those which fix the price, the manner in which the price is calculated and the conditions on which different parts of the price are payable. Its effect is that the Sellers earn the consideration for their shares not only by transferring them to Cavendish, but by observing the restrictive covenants. As Burton J said at para 59 of his judgment, “[t]he juxtaposition on the one hand of substantial delayed payment for goodwill and on the other hand a series of covenants which is intended to safeguard and protect that goodwill is of particular significance”.

75. Although clause 5.1 has no relationship, even approximate, with the measure of loss attributable to the breach, Cavendish had a legitimate interest in the observance of the restrictive covenants which extended beyond the recovery of that loss. It had an interest in measuring the price of the business to its value. The goodwill of this business was critical to its value to Cavendish, and the loyalty of Mr Makdessi and Mr Ghossoub was critical to the goodwill. The fact that some breaches of the restrictive covenants would cause very little in the way of recoverable loss to Cavendish is therefore beside the point. As Burton J graphically observed in para 43 of his judgment, once Cavendish could no longer trust the Sellers to observe the restrictive covenants, “the wolf was in the fold”. Loyalty is indivisible. Its absence in a business like this introduces a very significant business risk whose impact cannot be measured simply by reference to the known and provable consequences of particular breaches. It is clear that this business was worth considerably less to Cavendish if that risk existed than if it did not. How much less? There are no juridical standards by which to answer that question satisfactorily. We cannot know what Cavendish would have paid without the assurance of the Sellers’ loyalty, even assuming that they would have bought the business at all. We cannot know whether the basic price or the maximum price fixed by clause 3.1 would have been the same if they were not adjustable in the event of breach of the restrictive covenants. We cannot know what other provisions of the agreement would have been different, or what additional provisions would have been included on that

hypothesis. These are matters for negotiation, not forensic assessment (save in the rare cases where the contract or the law requires it). They were matters for the parties, who were, on both sides, sophisticated, successful and experienced commercial people bargaining on equal terms over a long period with expert legal advice and were the best judges of the degree to which each of them should recognise the proper commercial interests of the other.

76. We have already drawn attention to the fact that damages are in principle recoverable in addition to the price reduction achieved by clause 5.1. In this case, the Company recovered US$500,000 from Mr Makdessi. Cavendish has abandoned any claim of their own for damages, because any loss of theirs would simply reflect the Company’s loss. But it would not always be so. There are hypotheses, for example that the restrictive covenants had been broken after he ceased to be a director, in which Cavendish’s loss by his breach of the restrictive covenants would not have been reflective and might in principle have been recovered in addition to the reduction of the price under clause 5.1. Does any of this matter? We do not think so. Clause 5.1 is not concerned with the measure of compensation for the breach. It cannot be regarded as penal simply because damages are recoverable in addition. The real question is whether any damages have been suffered on account of the breach in circumstances where the price has been adjusted downwards on account of the same breach. As between Mr Makdessi and the Company, the right of Cavendish to a price reduction cannot affect the measure or recoverability of the Company’s loss. It is res inter alios acta. It is an open question whether the right to a price reduction would go to abate any loss recoverable by Cavendish themselves if they had suffered any. We do not propose to resolve it on this appeal: the issue does not arise and was not argued. It is enough to note that if Cavendish’s loss is not abated, that would be because the law regards Cavendish as having suffered it notwithstanding its right to the reduction. That can hardly make clause 5.1 a penalty.

77. We do not doubt that price adjustment clauses are open to abuse, and if clause 5.1 were a disguised punishment for the Sellers’ breach, it would make no difference that it was expressed as part of the formula for determining the consideration. But before a court can reach that conclusion, it must have some reason to do so. In this case, there is none. On the contrary, all the considerations summarised above point the other way.

78. We conclude, in agreement with Burton J, that clause 5.1 was not a penalty.

Was clause 5.6 contrary to the penalty rule?

79. Clause 5.6 gives rise to more difficult questions, but the analysis is essentially the same.

80. The purpose of requiring a Defaulting Shareholder to sell his retained shares was to sever the connection between the Company and a major shareholder if he were to compete against it (and also, in the case of Mr Ghossoub, if he were to be dismissed for discreditable conduct). The severance of the connection is completed by clause 14.2, which provides that upon ceasing to be a shareholder he will no longer be entitled to a seat on the board or to appoint a nominee in his place. In itself, this is not said to be objectionable. The objection is to the formula which excludes the value of goodwill from the calculation of the price. It is not and could not be suggested that the exclusion of goodwill serves to compensate for the estimated loss attributable to the breach. Any recoverable damages for the breach of the restrictive covenants will be recoverable on top of the forced sale of the Defaulting Shareholder’s retained shares. Indeed, the effect of excluding the value of goodwill is to achieve what Mr Bloch called a “reverse sliding scale”. The more trivial the effect of the breach on the value of the goodwill, the greater will be the Defaulting Shareholder’s loss in being deprived of any goodwill element in the price.

81. The logic of the price formula for the sale of the retained shares under clause 5.6 is similar to that of the price adjustment achieved by clause 5.1 for the sale of the transferred shares. It reflects the reduced price which Cavendish was prepared to pay for the acquisition of the business in circumstances where it could not count on the loyalty of Mr Makdessi and/or Mr Ghossoub. We have dealt with this point in the context of clause 5.1. It also reflects the fact that with the severance of the connection between the Defaulting Shareholder and the Company, no goodwill will in future be attributable to his role in the business. Indeed, the assumption must be that a Seller in breach of the restrictive covenants may be actively engaged in undermining the goodwill attributable to his former role in the business. It is true that the severance of the connection between a Defaulting Shareholder and the Group will not necessarily destroy the whole of the goodwill of the business which was sold to Cavendish, especially if the other Seller remains loyal. But so far as the Group is able to retain some or all of the goodwill built up by the Defaulting Shareholder in the past, that will presumably be due to the efforts of others.

82. In our view, the same legitimate interest which justifies clause 5.1 justifies clause 5.6 also. It was an interest in matching the price of the retained shares to the value that the Sellers were contributing to the business. There is a perfectly respectable commercial case for saying that Cavendish should not be required to pay the value of goodwill in circumstances where the Defaulting Shareholder’s efforts and connections are no longer available to the Company, and indeed are being deployed to the benefit of the Company’s competitors, and where goodwill going forward would be attributable to the efforts and connections of others. It seems likely that clause 5.6 was expected to influence the conduct of the Sellers after Cavendish’s acquisition of control in a way that would benefit the Company’s business and its proprietors during the period when they were yoked together. To that extent it may be described as a deterrent. But that is only objectionable if it is penal, ie if the object

was to punish. But the price formula in clause 5.6 had a legitimate function which had nothing to do with punishment and everything to do with achieving Cavendish’s commercial objective in acquiring the business. And, like clause 5.1, it was part of a carefully constructed contract which had been the subject of detailed negotiations over many months between two sophisticated commercial parties, dealing with each other on an equal basis with specialist, experienced and expert legal advice.

83. More fundamentally, a contractual provision conferring an option to acquire shares, not by way of compensation for a breach of contract but for distinct commercial reasons, belongs as it seems to us among the parties’ primary obligations, even if the occasion for its operation is a breach of contract. This may be tested by asking how the penalty rule could be applied to it without making a new contract for the parties. The Court of Appeal simply treated clause 5.6 as unenforceable, and declared that Mr Makdessi was not obliged to sell his shares whether at the specified price or at all. That cannot be right, since the severance of the shareholding connection was in itself entirely legitimate, and indeed commercially sensible. If the option to acquire the retained shares is to stand, the price formula cannot be excised without substituting something else. Yet there is no juridical basis on which a different pricing formula can be imposed. There is no fallback position at common law, as there is in the case of a damages clause.

84. Mr Bloch argued that this difficulty can be surmounted by granting Mr Makdessi a remedy corresponding to the one ordered by the Court of Appeal in Jobson v Johnson. We do not accept this. Jobson arose out of a contract for the sale of a substantial shareholding in a football club for a consideration payable by instalments. The contract provided that in the event of default in the payment of any instalment, the purchaser would be obliged to transfer the shareholding back to the vendors at a price which was said to represent a substantial undervalue. This was a forfeiture. The purchaser would have been entitled to relief in equity if he had been in a position to pay, albeit late. The purchaser had in fact counterclaimed for such relief, but the counterclaim had been struck out on account of his failure to comply with his disclosure obligations. That left only a contention, advanced by way of defence, that the obligation to transfer back the shares was also a penalty. As briefly discussed in para 17 above, that may or may not have been an argument which was open to him, and it is unnecessary to decide that issue on this appeal. The Court of Appeal accepted the argument and held that the penalty rule could apply not only to an obligation to pay money upon a breach of contract, but also to an obligation to transfer assets in that event. This gives rise to no difficulty at least in principle, in a case where the court could simply decline to enforce the penalty, leaving the innocent party to his ordinary remedies at law. That was the position in Jobson, because the Court of Appeal construed the share transfer clause as a purely secondary obligation which was intended simply to secure the payment of the price: see pp 1031-1032, 1037 (Dillon LJ), pp 1043-1044, 1045 (Nicholls LJ). On that basis, Mr Johnson could in theory have been left to obtain judgment for the amount

of the outstanding instalments and if necessary levy execution against the shares. However, we are bound to observe that this would appear to be a somewhat peculiar outcome. If the purchaser had been able to argue that he was entitled to relief from forfeiture, the court would presumably have dealt with his case on that basis and would not have considered the penalty argument at all. Accordingly, on the Court of Appeal’s reasoning, as a result of his default in giving disclosure, he was able to achieve a better result than he would have done if he had given disclosure and been able to seek relief from forfeiture.

85. In terms of achieving a fair commercial result, it is perhaps understandable that the Court of Appeal took the course that they did. Rather than applying the wellestablished principles relating to penalties, they invoked the authorities on relief from forfeiture, which Mr Johnson had been prevented from claiming, and applied them to the penalty rule. They held that in equity a penalty was enforceable pro tanto, or on what Nicholls LJ called a “scaled down” basis, ie only to the extent of any actual loss suffered by the breach. The court achieved this by offering the vendor the choice of (i) taking an order for specific performance of the retransfer, conditional upon its being ascertained that this would not overcompensate him for the non-payment of the outstanding instalments, or (ii) taking an order for the sale of the shares by the court, the outstanding instalment and interest to be paid to him out of the proceeds and the balance to be paid to the defaulting purchaser. A somewhat similar approach was later taken by the High Court of Australia in Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205, which also adopted the concept of partial enforcement.

86. The difficulty about this approach was pointed out by Mason and Wilson JJ in the High Court of Australia in AMEV-UDC at pp 192-193:

“At least since the advent of the Judicature system a penalty provision has been regarded as unenforceable or, perhaps void, ab initio: Citicorp Australia Ltd v Hendry (1985) 4 NSWLR 1. In all that time it has been thought that no action could be brought on such a clause, no doubt because the courts should not lend their aid to the enforcement in any way of a provision which is oppressive. However, this is not the only reason why the courts would refuse to lend their aid. In the majority of cases involving penalties, the courts, if called upon to assist in partial enforcement of the kind suggested by the appellant, would be required to undertake an unfamiliar role. They would need to rewrite the clause so as to permit the plaintiff to recover the loss he has actually sustained. Penalty clauses are not, generally speaking, so expressed as to entitle the plaintiff to recover his actual loss. Instead they prescribe the payment of a sum which is exorbitant or a sum to be ascertained by reference

to a formula which is not an acceptable pre-estimate of damage. In either case the court, if it were to enforce the clause, would be performing a function very different from that which it undertakes when it severs or reads down an unenforceable covenant, such as a covenant in restraint of trade. In the ultimate analysis, in whatever form it be expressed, the appellant’s argument amounts to an invitation to the court to develop a new law of compensation, distinct from common law damages, which would govern the entitlement of plaintiffs who insist on the inclusion of penalty clauses in their contracts.”
87. Even if the course taken by the Court of Appeal in Jobson had been right, it would not be available to Mr Makdessi because clause 5.6 cannot sensibly be analysed as a mere security for the performance of the restrictive covenants. But in our opinion the analysis of Mason and Wilson JJ was correct, and so far as it related to the form of relief, Jobson was wrongly decided. In the first place, the treatment of a penalty clause as partly enforceable, although supported by some turns of phrase in old cases concerned with other issues, is contrary to consistent modern authority. So, with respect, is the treatment of its enforcement as discretionary according to the circumstances at the time of the breach. If, as the authorities show, the penal consequences of a contractual provision fall to be determined as at the time of the agreement, and a provision found to be a penalty is unenforceable, it is impossible to see how it can be enforceable on terms. Secondly, the Court of Appeal accepted that the court could not rewrite the parties’ contract by specifically enforcing the retransfer of the shares to the vendors at a higher price or enforcing the retransfer of some only of the shares: see p 1037 (Dillon LJ), p 1042 (Nicholls LJ). Yet that is in reality what they did, by refusing to enforce the retransfer unless the vendor agreed to vary its effect. Third, the Court of Appeal interpreted the provision for the retransfer of the shares as a “security” for the payment of the outstanding instalments. They placed the word “security” in inverted commas because the obligation was purely personal. But the Court of Appeal’s order treated it as if it was an equitable mortgage of the shares, which it manifestly was not. It appears to us that the Court of Appeal were, as a matter of legal analysis, treating the clause in question as a forfeiture and not a penalty, and granting relief from forfeiture on appropriate terms, although in doing so they purported to be treating it as a penalty clause, because they were constrained to do so in the light of the pleadings. So far as the relief granted in Jobson is concerned, the decision was entirely orthodox if it is treated as a forfeiture case, but it was wrong in principle if it is treated as a penalty case.
88. The Court of Appeal in this case thought clauses 5.1 and 5.6 should both be treated in the same way when it came to applying the penalty rule, and we take the same view, but, in agreement with Burton J at first instance, we consider that neither clause is avoided by the penalty rule.

The second appeal: ParkingEye v Beavis

The factual and procedural history

89. British Airways Pension Fund (“the Fund”) owns the Riverside Retail Park in Chelmsford. The Fund leases sites on the Retail Park to various multiple retailers, but retains overall control of the site. There is a car park located at the Retail Park, and, on 25 August 2011, the Fund entered into a contract with ParkingEye Ltd in respect of management services at that car park.

90. At all material times since then, ParkingEye has displayed about 20 signs at the entrance to the car park and at frequent intervals throughout it. The signs are large, prominent and legible, so that any reasonable user of the car park would be aware of their existence and nature, and would have a fair opportunity to read them if he or she wished to do so.

91. The upper 80% or so of the signs are worded and laid out substantially as follows (mostly in black print on an orange background):

car park management

2 hour max stay

Customer only car park

4 hour maximum stay for Fitness Centre Members

Failure to comply with the following will result in a Parking Charge of £85


Parking limited to 2 hours (no return within 1 hour)


Park only within marked bays


Blue badge holders only in marked bays”.

Below this main part of the signs in small, but legible black print on the same orange background is the following information:

“ParkingEye Ltd is solely engaged to provide a traffic space maximisation scheme. We are not responsible for the car park surface, other motor vehicles, damage or loss to or from motor vehicles or user’s safety. The parking regulations for this car

park apply 24 hours a day, all year round, irrespective of the site opening hours. Parking is at the absolute discretion of the site. By parking within the car park, motorists agree to comply with the car park regulations. Should a motorist fail to comply with the car park regulations, the motorist accepts that they are liable to pay a Parking Charge and that their name and address will be requested from the DVLA.

Parking charge Information: A reduction of the Parking Charge is available for a period, as detailed in the Parking Charge Notice. The reduced amount payable will not exceed £75, and the overall amount will not exceed £150 prior to any court action, after which additional costs will be incurred.”

Below that information, in somewhat larger print are the words: “This car park is private property”. At the very bottom of the signs on a black background is ParkingEye’s name, telephone number and address in orange, and a drawing of a padlock, a drawing of a surveillance camera with the words “car park monitored by ANPR systems” in small letters underneath, and two logos recording that ParkingEye was a member of the British Parking Association (“BPA”) and that it was a BPA “approved operator”.

92. At 2.29 on the afternoon of 15 April 2013, Mr Beavis drove his motor car into the car park and parked it there. He did not leave until two hours 56 minutes later, thereby overstaying the two-hour limit by nearly an hour. ParkingEye obtained Mr Beavis’s name and address from the Driver and Vehicle Licensing Agency (“DVLA”), and sent him a standard “First Parking Charge Notice” which demanded that he pay the £85 charge within 28 days, but stated that, if he paid within 14 days, the charge would be reduced to £50. The Notice also informed him of an appeals procedure. Mr Beavis ignored this demand, as well as a subsequent standard form reminder notice and warning letter. ParkingEye then began proceedings in the County Court to recover the £85 alleged to be due. A claim of this size would normally have been dealt with by a District Judge under the small claims procedure, but it was recognised that the case raised some points of principle which were likely to affect many other similar claims, so it was heard by the Designated Civil Judge for East Anglia.

93. Before Judge Moloney QC and before the Court of Appeal, Mr Beavis raised two arguments as to why he should not have to pay the £85 charge, namely that it was (i) unenforceable at common law because it is a penalty, and/or (ii) unfair and therefore unenforceable by virtue of the 1999 Regulations. The Court of Appeal (Moore-Bick and Patten LJJ and Sir Timothy Lloyd) upheld Judge Moloney QC’s

decision rejecting each of his arguments – see [2015] EWCA Civ 402. Mr Beavis now appeals to this court, maintaining both his arguments.


94. It was common ground before the Court of Appeal, and is common ground in this court, that on the facts which we have just summarised there was a contract between Mr Beavis and ParkingEye. 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. Those terms were that he would stay for not more than two hours, that he would park only within the marked bays, that he would not park in bays reserved for blue badge holders, and that on breach of any of those terms he would pay £85. 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. The £85 is described in the notice as a “parking charge”, but no one suggests that that label is conclusive. In our view it was not, as a matter of contractual analysis, a charge for the right to park, nor was it a charge for the right to overstay the two-hour limit. Not only is the £85 payable upon certain breaches which may occur within the two-hour free parking period, but there is no fixed period of time for which the motorist is permitted to stay after the two hours have expired, for which the £85 could be regarded as consideration. The licence having been terminated under its terms after two hours, the presence of the car would have constituted a trespass from that point on. In the circumstances, the £85 can only be regarded as a charge for contravening the terms of the contractual licence.

95. Schemes of this kind (including a significant discount on prompt payment after the first demand) are common in the United Kingdom. Some are operated by private landowners, some by parking management companies like ParkingEye, and some by local authorities. They are subject to a measure of indirect regulation. Under section 54 of the Protection of Freedoms Act 2012, parked cars may not be immobilised or towed away by a private operator, but section 56 and Schedule 4 provide for the recovery of parking charges. Where a motorist becomes liable by contract for a “sum in the nature of a fee or charge” or in tort for a “sum in the nature of damages”, there is a right under certain conditions to recover it: Schedule 4, paragraph 4. One of those conditions is that the keeper’s details must have been supplied by the Secretary of State in response to an application for the information: ibid, para 11. The Secretary of State’s functions in relation to the provision of this information are performed by the DVLA. Under article 27(1)(e) of the Road Vehicles (Registration and Licensing) Regulations 2002 (SI 2002/2742), the Secretary of State is empowered to make available particulars in the vehicle register to anyone who “has reasonable cause for wanting the particulars to be made available to him”. Since 2007, the policy of the Secretary of State has been to disclose the information for parking enforcement purposes only to members of an accredited trade association. The criteria for accreditation were stated in Parliament

to include the existence of “a clear and enforced code of conduct (for example relating to conduct, parking charge signage, charge levels, appeals procedure, approval of ticket wording and appropriate pursuit of penalties” (Hansard (HC Debates), 24 July 2006, col 95WS).

96. As at April 2013, there was only one relevant accredited trade association, the BPA, to which reference was made on the Notice, and to which ParkingEye still belongs. The BPA Code of Practice is a detailed code of regulation governing signs, charges and enforcement procedures. Clause 13 deals with grace periods. Clause 13.4 provides:

“13.4 You should allow the driver a reasonable period to leave the private car park after the parking contract has ended, before you take enforcement action.”

Clause 19 provides:

“19.5 If the parking charge that the driver is being asked to pay is for a breach of contract or act of trespass, this charge must be based on the genuine pre-estimate of loss that you suffer. We would not expect this amount to be more than £100. If the charge is more than this, operators must be able to justify the amount in advance.

19.6 If your parking charge is based on a contractually agreed sum, that charge cannot be punitive or unreasonable. If it is more than the recommended amount in 19.5 and is not justified in advance, it could lead to an investigation by the Office of Fair Trading.”

The maximum of £100 recommended by the BPA may be compared with the penalties charged by local authorities, which are regulated by statute. The Civil Enforcement of Parking Contraventions (Guidelines on Levels of Charges) (England) Order 2007 (SI 2007/3487) lays down guidelines for the level of penalties outside Greater London. For “higher level contraventions” (essentially unauthorised on-street parking), the recommended penalty is capped at £70 and for other contraventions at £50. The corresponding figures for Greater London are £130 and £80.

Parking charges and the penalty rule

97. ParkingEye concedes that the £85 is payable upon a breach of contract, and that it is not a pre-estimate of damages. As it was not the owner of the car park, ParkingEye could not recover damages, unless it was in possession, in which case it may be able to recover a small amount of damages for trespass. This is because it lost nothing by the unauthorised use resulting from Mr Beavis overstaying. On the contrary, at least if the £85 is payable, it gains by the unauthorised use, since its revenues are wholly derived from the charges for breach of the terms. The notice at the entrance describes ParkingEye as being engaged to provide a “traffic space maximisation scheme”, which is an exact description of its function. In the agreed Statement of Facts and Issues, the parties state that “the predominant purpose of the parking charge was to deter motorists from overstaying”, and that the landowner’s objectives include the following:

“a. The need to provide parking spaces for their commercial tenants’ prospective customers;

b. The desirability of that parking being free so as to attract customers;

c. The need to ensure a reasonable turnover of that parking so as to increase the potential number of such customers;

d. The related need to prevent ‘misuse’ of the parking for purposes unconnected with the tenants’ business, for example by commuters going to work or shoppers going to off-park premises; and

e. The desirability of running that parking scheme at no cost, or ideally some profit, to themselves.”

98. Against this background, it can be seen that the £85 charge had two main objects. One was to manage the efficient use of parking space in the interests of the retail outlets, and of the users of those outlets who wish to find spaces in which to park their cars. This was to be achieved by deterring commuters or other long-stay motorists from occupying parking spaces for long periods or engaging in other inconsiderate parking practices, thereby reducing the space available to other members of the public, in particular the customers of the retail outlets. The other purpose was to provide an income stream to enable ParkingEye to meet the costs of operating the scheme and make a profit from its services, without which those

services would not be available. These two objectives appear to us to be perfectly reasonable in themselves. Subject to the penalty rule and the Regulations, the imposition of a charge to deter overstayers is a reasonable mode of achieving them. Indeed, once it is resolved to allow up to two hours free parking, it is difficult to see how else those objectives could be achieved.

99. In our opinion, while the penalty rule is plainly engaged, the £85 charge is not a penalty. The reason is that although ParkingEye 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. The scheme in operation here (and in many similar car parks) is that the landowner authorises ParkingEye to control access to the car park and to impose the agreed charges, with a view to managing the car park in the interests of the retail outlets, their customers and the public at large. That is an interest of the landowners because (i) they receive a fee from ParkingEye for the right to operate the scheme, and (ii) they lease sites on the retail park to various retailers, for whom the availability of customer parking was a valuable facility. It is an interest of ParkingEye, because it sells its services as the managers of such schemes and meets the costs of doing so from charges for breach of the terms (and if the scheme was run directly by the landowners, the analysis would be no different). As we have pointed out, 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. Mr Butcher QC, who appeared for the Consumers’ Association (interveners), submitted that because ParkingEye was the contracting party its interest was the only one which could count. For the reason which we have given, ParkingEye had a sufficient interest even if that submission be correct. But in our opinion it is not correct. The penal character of this scheme cannot depend on whether the landowner operates it himself or employs a contractor like ParkingEye to operate it. The motorist would not know or care what if any interest the operator has in the land, or what relationship it has with the landowner if it has no interest. This conclusion is reinforced when one bears in mind that the question whether a contractual provision is a penalty turns on the construction of the contract, which cannot normally turn on facts not recorded in the contract unless they are known, or could reasonably be known, to both parties.

100. 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. The trial judge, Judge Moloney QC, found that the £85 charge was neither extravagant nor unconscionable having regard to the level of charges imposed by local authorities for overstaying in car parks on public land. The Court of Appeal agreed and so do we. It is higher than the penalty that a motorist would have had to pay for overstaying in an on-street parking space or a local authority car park. But a local authority would not necessarily allow two hours of free parking, and in any event the difference is not

substantial. The charge is less than the maximum above which members of the BPA must justify their charges under their code of practice. The charge is prominently displayed in large letters at the entrance to the car park and at frequent intervals within it. The mere fact that many motorists regularly use the car park knowing of the charge is some evidence of its reasonableness. They are not constrained to use this car park as opposed to other parking facilities provided by local authorities, Network Rail, commercial car park contractors or other private landowners. They must regard the risk of having to pay £85 for overstaying as an acceptable price for the convenience of parking there. The observations of Lord Browne-Wilkinson in Workers Bank at p 580 referred to in para 35 above are in point. While not necessarily conclusive, the fact that ParkingEye’s payment structure in its car parks (free for two hours and then a relatively substantial sum for overstaying) and the actual level of charge for overstaying (£85) are common in the UK provides support for the proposition that the charge in question is not a penalty. No other evidence was furnished by Mr Beavis to show that the charge was excessive.

101. We conclude, in agreement with the courts below, that the charge imposed on Mr Beavis was not a penalty.

Parking charges and the Unfair Terms in Consumer Contracts Regulations 1999

102. The 1999 Regulations subject the terms of consumer contracts to a fairness test. An unfair term is not binding on a consumer: regulation 8(1). The fairness test is not applicable to all terms in consumer contracts. It does not apply to certain core terms, namely those which define the “main subject matter of the contract” nor to the adequacy of the price or remuneration for the goods or services supplied: regulation 6(2). But it follows from the fact that the £85 charge is a charge for acting in breach of the primary terms that it is not excluded from the fairness test under either of these heads. The issue is therefore whether the test is satisfied.

103. Under regulation 5(1), a contractual term which has not been individually negotiated

“shall be regarded as unfair if, contrary to the requirement of good faith, it causes a significant imbalance in the parties’ rights and obligations arising under the contract, to the detriment of the consumer.”

Regulation 6(1) provides that

“the unfairness of a contractual term shall be assessed, taking into account the nature of the goods or services for which the contract was concluded and by referring, at the time of conclusion of the contract, to all the circumstances attending the conclusion of the contract and to all the other terms of the contract or of another contract on which it is dependent.”

An “indicative and non-exhaustive” list of terms which “may” be regarded as unfair by this test is contained in Schedule 2. This includes at paragraph 1(e) a term “requiring any consumer who fails to fulfil his obligation to pay a disproportionately high sum in compensation”.

104. In our opinion, the same considerations which show that the £85 charge is not a penalty, demonstrate that it is not unfair for the purpose of the Regulations.

105. The reason is that although it arguably falls within the illustrative description of potentially unfair terms at paragraph 1(e) of Schedule 2 to the Regulations, it is not within the basic test for unfairness in regulations 5(1) and 6(1). The Regulations give effect to Council Directive 93/13/EEC on unfair terms in consumer contracts, and these rather opaque provisions are lifted word for word from articles 3 and 4 of the Directive. The effect of the Regulations was considered by the House of Lords in Director General of Fair Trading v First National Bank plc [2001] 1 AC 481. But it is sufficient now to refer to Aziz v Caixa d’Estalvis de Catalunya, Tarragona i Manresa (Case C-415/11) [2013] 3 CMLR 89, which is the leading case on the topic in the Court of Justice of the European Union. Aziz was a reference from a Spanish court seeking guidance on the criteria for determining the fairness of three provisions in a loan agreement. They provided for (i) the acceleration of the repayment schedule in the event of the borrower’s default, (ii) the charging of default interest, and (iii) the unilateral certification by the lender of the amount due for the purpose of legal proceedings. The judgment of the Court of Justice is authority for the following propositions:


The test of “significant imbalance” and “good faith” in article 3 of the Directive (regulation 5(1) of the 1999 Regulations) “merely defines in a general way the factors that render unfair a contractual term that has not been individually negotiated” (para 67). A significant element of judgment is left to the national court, to exercise in the light of the circumstances of each case.


The question whether there is a “significant imbalance in the parties’ rights” depends mainly on whether the consumer is being deprived of an advantage which he would enjoy under national law in the absence


of the contractual provision (paras 68, 75). In other words, this element of the test is concerned with provisions derogating from the legal position of the consumer under national law.


However, a provision derogating from the legal position of the consumer under national law will not necessarily be treated as unfair. The imbalance must arise “contrary to the requirements of good faith”. That will depend on “whether the seller or supplier, dealing fairly and equitably with the consumer, could reasonably assume that the consumer would have agreed to such a term in individual contract negotiations” (para 69).


The national court is required by article 4 of the Directive (regulation 6(1) of the 1999 Regulations) to take account of, among other things, the nature of the goods or services supplied under the contract. This includes the significance, purpose and practical effect of the term in question, and whether it is “appropriate for securing the attainment of the objectives pursued by it in the member state concerned and does not go beyond what is necessary to achieve them” (paras 71-74). In the case of a provision whose operation is conditional upon the consumer’s breach of another term of the contract, it is necessary to assess the importance of the latter term in the contractual relationship.

106. In its judgment, the Court of Justice drew heavily on the opinion of Advocate General Kokott, specifically endorsing her analysis at a number of points. That analysis, which is in the nature of things more expansive than the court’s, repays careful study. In the Advocate General’s view, the requirement that the “significant imbalance” should be contrary to good faith was included in order to limit the Directive’s inroads into the principle of freedom of contract. “[I]t is recognised,” she said, “that in many cases parties have a legitimate interest in organising their contractual relations in a manner which derogates from the [rules of national law]” (para AG73). In determining whether the seller could reasonably assume that the consumer would have agreed to the relevant term in a negotiation, it is important to consider a number of matters. These include

“whether such contractual terms are common, that is to say they are used regularly in legal relations in similar contracts, or are surprising, whether there is an objective reason for the term and whether, despite the shift in the contractual balance in favour of the user of the term in relation to the substance of the term in question, the consumer is not left without protection” (para AG75).

Advocate General Kokott returned to the question of legitimate interest when addressing default interest. She observed that a provision requiring the payment upon default of a sum exceeding the damage caused, may be justified if it serves to encourage compliance with the borrower’s obligations:

“If default interest is intended merely as flat-rate compensation for damage caused by default, a default interest rate will be substantially excessive if it is much higher than the accepted actual damage caused by default. It is clear, however, that a high default interest rate motivates the debtor not to default on his contractual obligations and to rectify quickly any default which has already occurred. If default interest under national law is intended to encourage observance of the agreement and thus the maintenance of payment behaviour, it should be regarded as unfair only if it is much higher than is necessary to achieve that aim” (para AG87).

Finally, the Advocate General observes that the impact of a term alleged to be unfair must be examined broadly and from both sides. Provisions favouring the lender may indirectly serve the interest of the borrower also, for example by making loans more readily available (para AG94).

107. In our opinion the term imposing the £85 charge was not unfair. The term does not exclude any right which the consumer may be said to enjoy under the general law or by statute. But it may fairly be said that in the absence of agreement on the charge, Mr Beavis would not have been liable to ParkingEye. He would have been liable to the landowner in tort for trespass, but that liability would have been limited to the occupation value of the parking space. To that extent there was an imbalance in the parties’ rights. But it did not arise “contrary to the requirement of good faith”, because ParkingEye and the landlord to whom ParkingEye was providing the service had a legitimate interest in imposing a liability on Mr Beavis in excess of the damages that would have been recoverable at common law. ParkingEye had an interest in inducing him to observe the two-hour limit in order to enable customers of the retail outlets and other members of the public to use the available parking space. To echo the observations of the Advocate General at para AG94 of her opinion, charging overstayers £85 underpinned a business model which enabled members of the public to park free of charge for two hours. This was fundamental to the contractual relationship created by Mr Beavis’s acceptance of the terms of the notice, whose whole object was the efficient management of the car park. It was an interest of exactly the kind envisaged by the Advocate General at para AG87 of her opinion and by the Court of Justice at para 74 of the judgment. There is no reason to regard the amount of the charge as any higher than was necessary to achieve that objective.

108. Could ParkingEye, “dealing fairly and equitably with the consumer, … reasonably assume that the consumer would have agreed to such a term in individual contract negotiations”? The concept of a negotiated agreement to enter a car park is somewhat artificial, but it is perfectly workable provided that one bears in mind that the test, as Advocate General Kokott pointed out in Aziz at para AG75, is objective. The question is not whether Mr Beavis himself would in fact have agreed to the term imposing the £85 charge in a negotiation, but whether a reasonable motorist in his position would have done so. In our view a reasonable motorist would have agreed. In the first place, motorists generally and Mr Beavis in particular did accept it. In the case of non-negotiated standard terms that would not ordinarily be entitled to much weight. But although the terms, like all standard contracts, were presented to motorists on a take it or leave it basis, they could not have been briefer, simpler or more prominently proclaimed. If you park here and stay more than two hours, you will pay £85. Motorists could hardly avoid reading the notice and were under no pressure to accept its terms.

109. Objectively, they had every reason to do so. They were being allowed two hours of free parking. In return they had to accept the risk of being charged £85 if they overstayed. Overstaying penalties are, as we have mentioned, both a normal feature of parking contracts on public and on private land, and important for the efficient management of the space in the interests of the general body of users and the neighbouring outlets which they may frequent. They are beneficial not just to ParkingEye, the landowner and the retail outlets, but to the motorists themselves, because they make parking space available to them which might otherwise be clogged up with commuters and other long-stay users. The amount of the charge was not exorbitant in comparison to the general level of penalties imposed for parking infractions. Nor is there any reason to think that it was higher than necessary to ensure considerate use by motorists of the available space. And, while we accept Mr Butcher’s submission that the fact that the £85 charge is broadly comparable to charges levied by local authorities for parking in public car parks is not enough to show that it was levied in good faith, it is nonetheless a factor which assists ParkingEye in that connection. The risk of having to pay it was wholly under the motorist’s own control. All that he needed was a watch. In our opinion, a hypothetical reasonable motorist would have agreed to objectively reasonable terms, and these terms are objectively reasonable.

110. It is right to mention three further arguments which were raised by Mr de Waal QC on behalf of Mr Beavis to support his case that the £85 charge was unfair, and which we have not so far specifically addressed.

111. First, Mr de Waal relied on the fact that it was payable by a motorist who overstayed even by a minute. The Consumers’ Association expanded on this point by observing that there are many reasons why a motorist may overstay, some of which may be due to unforeseen circumstances. We cannot accept this.

ParkingEye’s business model could have had a graduated charge for overstayers based on how long they overstayed, but the fact that it did not do so does not render it unfair. Even if it had done, it would presumably have involved a specific sum for each hour or part of an hour, in which case the same complaint could be made. More fundamentally, as we have explained, the £85 charge for overstayers was not a payment for being permitted to park after the two hours had expired: it was a sum imposed for staying for more than two hours. The notion of a single sum between £50 and £100 for overstaying even by a minute, appears to be a very common practice, in that it is adopted by many, probably the majority of, public and private car park operators. As for the suggestion that the overstay may have arisen from unforeseen circumstances, we find it hard to regard that as relevant. The object of the £85 charge is simply to influence the behaviour of motorists by causing them to leave within two hours. It is reasonable that the risk of exceeding it should rest with the motorist, who is in a position to organise his time as he sees fit. There are many circumstances in life when the only way of being on time is to allow for contingency and arrive early. This is accepted by every motorist who uses metered on-street parking while shopping. The legal basis on which he is made liable for overstaying penalties is of course different in that case. It is statutory and not contractual. But the underlying rationale and justification is precisely the same, namely to ration scarce parking space. It is right to add that, as communicated to any overstayer from whom the charge is demanded, ParkingEye has an appeals procedure, and the BPA Code of Practice provides at paragraph 13.4 for a reasonable grace period after the expiry of the fixed parking period. The appeals procedure provides a degree of protection for any overstayer, who would be able to cite any special circumstances as a reason for avoiding the charge. And, while the Code of Practice is not a contractual document, it is in practice binding on the operator since its existence and observance is a condition of his ability to obtain details of the registered keeper from the DVLA. In assessing the fairness of a term, it cannot be right to ignore the regulatory framework which determines how and in what circumstances it may be enforced.

112. The second argument which should be mentioned is that the £85 charge for overstayers “takes advantage of the consumer’s requirement to park in that particular place to shop or visit a particular location”. If this car park is unusually attractively located for shoppers and others, the evidence shows that the £85 charge has not been fixed at a particularly high level to reflect that fact. Further, as Mr Kirk QC pointed out on behalf of ParkingEye, it is equally true that the consumer gets the benefit of free parking in that unusually attractively located car park for two hours, and, save in unusual circumstances, it is entirely within his or her control whether the twohour limit is exceeded. And if the consumer considers that the circumstances are unusual, he or she can invoke the appeals procedure.

113. Finally, Mr de Waal submitted that it was unfair to make the minority who contravene the parking rules bear the whole cost of running the car park. In our view,

if the £85 charge is itself such as a reasonable motorist would accept, the mere imbalance between the position of those who comply and those who do not cannot possibly make the charge unfair. It arises only because both categories are allowed two hours of free parking, and because the great majority of users of the car park (more than 99.5%, we were told) observe the rules.

114. Accordingly, we agree with the courts below that the £85 charge in this case does not infringe the 1999 Regulations.

Conclusion on the two appeals

115. For these reasons, we would allow the appeal in Cavendish v El Makdessi and dismiss the appeal in ParkingEye v Beavis, and we would declare that none of the terms impugned on the two appeals contravenes the penalty rule, and that the charge in issue in ParkingEye v Beavis does not infringe the 1999 Regulations.



116. These two appeals raise wide-ranging and difficult questions about the current law governing contractual penalties. The cases lie at opposite ends of a financial spectrum. In the first, the appellant, Cavendish Square Holding BV (“Cavendish”), is part of the world’s leading marketing communications group (“WPP”), while the respondent, Mr Talal El Makdessi, was co-founder and coowner with Mr Joseph Ghossoub of the Middle East’s largest advertising and marketing communications group (“the Group”). Prior to 2008 WPP held 12.6% of the shares of the Group. In 2008 Mr El Makdessi and Mr Ghoussoub agreed to sell to Cavendish a further 47.4% of the Group’s shares (in the form of an interest in Team Y & R Holdings Hong Kong Ltd (“Team”), a holding company set up to facilitate the transaction).

117. The transaction was effected by a sale and purchase agreement dated 28 February 2008, whereby Mr El Makdessi and Mr Ghoussoub agreed to make the 47.4% shareholding available in the ratio of 53.88% to 46.12%. The price was payable in stages: US$65.5m (Mr El Makdessi’s share being 53.88%) was payable on completion of the sale and Group reorganisation. Thereafter, there were to be Interim and Final Payments derived from a multiple of the Group’s audited consolidated operating profit (“OPAT”) between respectively 2007 and 2009 and 2007 and 2011. Clause 11.2 was a clause prohibiting Mr El Makdessi from various competitive or potentially competitive activity. Clauses 5.1 and 5.6 provided that, if

he breached clause 11.2, he would not be entitled to receive the Interim and/or Final Payments, and could be required to sell Cavendish the rest of his shares at a “Defaulting Shareholder Option Price”, based on asset value and so ignoring any goodwill value. Mr El Makdessi also became non-executive chair of Team with a service agreement binding him to remain in position for at least 18 months.

118. It is accepted by Mr El Makdessi that he did subsequently breach clause 11.2, and was thereby also in breach of fiduciary duty towards Team. The present proceedings were initiated by both Cavendish and Team. Team’s claim was settled in October 2012 when it accepted a Part 36 payment of US$500,000 made by Mr El Makdessi. Cavendish’s claim is for declarations that Mr El Makdessi’s breach of clause 11.2 means that clauses 5.1 and 5.6 now have the effect stated in the previous paragraph. Mr El Makdessi maintains that they are unenforceable penalty clauses.

119. In the second case, the appellant, Mr Beavis, was the owner and driver of a vehicle which he parked in a retail shopping car park adjacent to Chelmsford railway station. The owner of the retail site and car park, British Airways Pension Fund (“BAPF”), had engaged ParkingEye Ltd, the respondent, to provide “a traffic space maximisation scheme”. The scheme involved the erection at the entrance to and throughout the car part of prominent notices, including the injunctions “2 hour max stay” and “Parking limited to 2 hours”, coupled with the further notice “Failure to comply … will result in a Parking Charge of £85”. Underneath, it also stated: “By parking within the car park, motorists agree to comply with the car park regulations”. Mr Beavis left his car parked for 56 minutes over a permitted two-hour period. He maintains that the £85 charge demanded of him by ParkingEye (reducible to £50 if he had paid within 14 days) is an unenforceable penalty. Further or alternatively, he maintains that it is unfair and invalid within the meaning of the Unfair Terms in Consumer Contracts Regulations 1999.

120. Cavendish succeeded before Burton J on 14 December 2012, although only on condition that it agreed to credit Mr El Makdessi with the US$500,000 recovered from him by Team. The Court of Appeal (Patten, Tomlinson and Christopher Clarke LJJ), [2013] EWCA Civ 1539, over-ruled Burton J, [2012] EWHC 3582 (Comm), on 26 November 2013, holding both clauses to be unenforceable penalties. The court held however that the judge had had, on his view of the case, no basis to impose a condition that Cavendish agree to credit Mr El Makdessi with the US$500,000 (and the contrary has not been suggested before the Supreme Court). Mr Beavis has so far failed at both instances, before Judge Moloney QC on 19 May 2014 and the Court of Appeal (Moore-Bick and Patten LJJ and Sir Timothy Lloyd) on 23 April 2015, [2015] EWCA Civ 402. The appellants in both cases now appeal with the permission of the Supreme Court in the case of Mr El Makdessi and of the Court of Appeal in the case of Mr Beavis.
Cavendish v Mr El Makdessi – facts

121. I can summarise and take the relevant terms of the sale and purchase agreement to which Cavendish and Mr El Makdessi were parties from the agreed Statement of Facts and Issues (“SFI”):

“10. By clause 2.1 of the Agreement, Joe and the respondent (defined as ‘the Sellers’) agreed to sell 47.4% of the shareholding in the Company. Clause 3 set out the consideration for that sale, which pursuant to Schedule 1 was to be shared between the respondent and Joe in shares of 53.88% and 46.12% respectively. The consideration, payment of which was not expressed to be subject to any condition, was as follows:

(1) A payment of US$34,000,000 on completion;

(2) A second payment of US$31,500,000 to be paid into escrow on completion and released to Joe and the respondent in accordance with clauses 3.6 to 3.12 (which in short provided for the sum to become payable in stages as the various restructurings provided for in the Agreement took effect).

(3) A further payment (‘the Interim Payment’) was to become payable on its ‘Due Date’ and was to be calculated as follows:

8 x Average 2007-2009 ‘OPAT’ x 47.4% minus US$63,000,000

(4) A final payment (‘the Final Payment’) was to become payable on its ‘Due Date’, and was to be calculated as follows:

‘M’ x Average 2007-2011 ‘OPAT’ x 47.4% minus US$63,000,000 and the Interim Payment.

11. ‘OPAT’ was defined in Schedule 12 as meaning the audited consolidated operating profit of the Group, and ‘Due Date’ was defined as meaning 30 days after the relevant OPAT was

agreed or determined. The figure ‘M’ in the definition of Final Payment was a figure varying between seven and ten depending on the growth of OPAT over the period 2007 to 2011.

12. Thus the Interim and Final Payments in essence obliged the purchaser to make further payments to Joe and the respondent calculated by reference to the Group’s profitability in the years 2007 to 2011.

13. Clause 3.2 provided that if the calculation of the Interim Payment or the Final Payment resulted in a negative figure, it was to be treated as zero and Joe and the respondent would not be required to repay any sum already paid.

14. Clause 3.3 capped the total amount of all payments at US$147,500,000.

15. By clause 9.1, paragraph 2.15 of Schedule 7, and Schedule 11, Joe and the respondent warranted that the net assets of the entire Group, not just their share, as at 31 December 2007 wereUS$69,744,340.

16. Under the Agreement, therefore, a substantial part of the purchase consideration comprised goodwill:


The Completion and Second Payments totalled $65.5m and were for 47.4% of the equity (47.4% of the warranted 2007 NAV being $33,058,817);


At its highest (assuming no decrease in NAV) some US$114.44m would be payable for goodwill ($147,500,000 - $33,058,817), representing 77% of the aggregate purchase consideration.

17. Clause 11 was entitled ‘Protection of Goodwill’, and provided that:


11.1 Each Seller recognises the importance of the goodwill of the Group to the Purchaser and the WPP Group which is reflected in the price to be paid by the Purchaser for [the shares]. Accordingly, each Seller commits as set out in this clause 11 to ensure that the interest of each of the Purchaser and the WPP Group in that goodwill is properly protected.’

18. Clause 11.2 then set out various restrictive covenants (‘the Restrictive Covenants’) entered into by Joe and the respondent:

‘11.2 Until the date 24 months after the Relevant Date, no Seller will directly or indirectly without the Purchaser’s prior consent:


carry on or be engaged, concerned, or interested, in competition with the Group, in the Restricted Activities within the Prohibited Area;


solicit or knowingly accept any orders, enquiries or business in respect of the Restricted Activities in the Prohibited Area from any Client;


divert away from any Group Company any orders, enquiries or business in respect of the Restricted Activities from any Client; or


employ, solicit or entice away from or endeavour to employ, solicit, or entice away from any Group Company any senior employee or consultant employed or engaged by that Group Company.’

19. By virtue of the definitions in Schedule 12 of the Agreement, ‘Restricted Activities’ meant the provision of products and/or services of a competitive nature to those being provided by the Group, ‘Prohibited Area’ meant any countries in which the Group carried on the business of marketing communications and ancillary services, and ‘Client’ meant any client or potential client of the Group who had placed an order

with the Group during the past 12 months or been in discussions with the Group during that period.

20. As to the several covenants:-


the effect of any breach of the covenant against employing or soliciting senior employees could be less than a breach of the covenants against competitiveactivity; the respondent’s position is that it was likely, in many circumstances, to be markedly less; and


Losses attributable to breaches of the covenant against solicitation could vary, the respondent says were likely to vary widely, according to the nature, extent, duration and success of the solicitation.

21. By clause 7.5, the respondent agreed that within four months after completion he would dispose of any shares held by him in Carat Middle East Sarl (‘Carat’) and procure that a joint venture agreement of 19 December 2003 to which Group Carat (Nederland) BV and Aegis International BV, on the one hand, and the respondent, on the other, were parties, would be terminated.

22. By the time of trial, the respondent had conceded that (if the Restrictive Covenants were enforceable) he was in breach thereof by reason of his ongoing, unpaid involvement in the affairs of Carat (‘the Breach’).

23. It is the provisions providing for the consequences of breach which are in issue in this appeal. By reason of the Breach, the respondent became a ‘Defaulting Shareholder’ within the meaning of the definition in Schedule 12. Clause 5.1 is headed ‘DEFAULT’ and includes two relevant provisions.

24. First, clause 5.1 provides that on becoming a Defaulting Shareholder, the respondent would not be entitled to receive the Interim Payment or the Final Payment:

‘If a Seller becomes a Defaulting Shareholder he shall not be entitled to receive the Interim Payment and/or the Final Payment which would other than for his having become a Defaulting Shareholder have been paid to him and the Purchaser’s obligation to make such payments shall cease.’

25. In money terms, the effect of this provision is that in the event of a default by the respondent, he could receive up to $44,181,600 less than would have been the case had he not acted in breach. If both Sellers were to default, they could lose up to US$82m ($147.5-$65.5) between them.

26. Second, clause 5.6 grants an option over the respondent’s remaining shares in the Group whereby in the event that he became a Defaulting Shareholder, the appellant could require him to sell those remaining shares:

‘Each Seller hereby grants an option to the Purchaser pursuant to which, in the event that such Seller becomes a Defaulting Shareholder, the Purchaser may require such Seller to sell to the Purchaser (or its nominee) all (and not some only) of the Shares held by that Seller (the Defaulting Shareholder Shares). The Purchaser (or its nominee) shall buy and such Seller shall sell with full title guarantee the Defaulting Shareholder Shares ... within 30 days of receipt by such Seller of a notice from the Purchaser exercising such option in consideration for the payment by the Purchaser to such Seller of the Defaulting Shareholder Option Price.’

27. The ‘Defaulting Shareholder Option Price’ is defined in Schedule 12 as meaning the proportion of the Net Asset Value of the company equal to the proportion of shares sold by the Defaulting Shareholder, a formula which excludes the value of goodwill. By clause 5.7, this could be satisfied either in cash or by issuing shares in WPP, at the absolute discretion of the appellant.

28. Clause 15.1 granted the Sellers a put option by which they could require the appellant to purchase all their remaining shares in the Company:

‘Each Seller is hereby granted an option by the Purchaser pursuant to which such Seller may, subject to clause 15.2, by service of an Option Notice in the form set out in Schedule 10 (the Option Notice) require the Purchaser (or its nominee) to purchase from him all (and not some only) of the Shares held by that Seller (the Option Shares). The Purchaser (or its nominee) shall buy and the Seller shall sell with full title guarantee the Option Shares ... within 30 days of receipt of the Option Notice in consideration for the payment when due of the price determined in accordance with clause 15.3 (the Option Price).’

29. In money terms, the effect of clause 5.6 is that insofar as the retained shares of a Defaulting Shareholder have, at the date when he becomes a Defaulting Shareholder, a value which is attributable to goodwill, he will not receive it. He will not be able to exercise the put option otherwise available in 2011 and subsequent years, which would give him a price, not exceeding $75m, which reflected goodwill.

30. As of the date of the Agreement, the respondent was, and was bound to remain, a director for at least 18 months and was entitled to remain thereafter as long as he was a shareholder unless Cavendish considered that his outside business interests were likely to result in a material ongoing conflict with his duties as a director. For so long as he did remain a director, any breach of clause 11.2 would give rise to a cause of action for breach of fiduciary duty to the Company.

31. The Agreement contained no provision which precluded the Company from bringing a claim for damages for conduct rendering the respondent a Defaulting Shareholder.

32. As with the agreement as a whole, these provisions were subject to negotiation and amendment between the parties. …

33. The structure of the Agreement was typical of acquisition agreements in the marketing sector. As in this case, the vendor is typically the founder or operator of the business, and has important relationships with clients and key staff. If they decide to turn against the business, its success can be significantly

affected, and provisions are therefore included to protect the value of the investment, and in particular the value of the goodwill represented by the vendor’s existing personal relationships. The respondent fell into that category; the importance of personal relationships with clients is even stronger in the Middle East than the UK, and he had very strong relationships with clients and senior employees, and he was such a well known figure that if he acted against the Group, it would inevitably cause it to lose value. …”

122. Paragraphs 25 and 29 of this agreed summary outline the effect of clauses 5.1 and 5.6 of the sale and purchase agreement, on which Cavendish relies but which Mr El Makdessi submits to be penal and unenforceable. Since clauses 5.1 and 5.6 operate because Mr El Makdessi became a Defaulting Shareholder by reason of breach of clause 11.2, both clauses need to be considered with reference to the nature, scope and duration of the restrictive covenants in favour of Cavendish which clause 11.2 contains. As para 33 of the agreed summary records, the restrictive covenants represented very significant protections of the value of the goodwill which Cavendish was to acquire. Clause 11.2 provides for such protection to continue until 24 months after the “Relevant Date”. By Schedule 12:

“Relevant Date means in respect of a Seller the later of the date of termination of his employment by the Group, the date that he no longer holds any Shares or the date of payment of the final instalment of the Option Price pursuant to clause 15.5(b).”

Clause 16.1 provided that:

“Save as otherwise expressly provided by this agreement no Seller shall transfer, sell, charge, Encumber or otherwise dispose of all or part of his interest in any Shares.”

The put option referred to in para 28 of the agreed summary was only exercisable by Mr El Makdessi by option notice served “at any time between 1 January and 31 March in 2011 or in any subsequent year” (clause 15.2). Upon its exercise, the Option Price was payable in two instalments, the second or final instalment being due “within 30 days of the agreement or final determination of OPAT for N+2” (clause 15.5(b)). OPAT means under Schedule 12 “the audited consolidated operating profit … in any 12-month accounting period ending 31 December”. N means “the financial year in which the Option Notice is served” (clause 15.3). N+2 thus means the year 2013, and the earliest date of full payment of any Option Price under clause 15 would be some date in 2014, once the OPAT for N+2 was agreed

or finally determined. That would be the (earliest) Relevant Date, assuming that Mr El Makdessi had previously determined his employment by the Group which he was only committed to maintain for 18 months from the date of the agreement (para 30 of the agreed summary). Under the terms of the sale and purchase agreement dated 28 February 2008, Mr El Makdessi was bound by the restrictive covenants for a further 24 months, ie until a date in 2016, some eight years after the sale and purchase agreement. There has been no challenge in this court to the reasonableness of this lengthy restriction, and it underlines the importance of goodwill to the agreement and to the buyers, Cavendish, in particular.

ParkingEye Limited v Beavis - facts

123. The signs exhibited at the entrance and throughout the car park are large, prominent and legible. They are worded as follows (the words down to “marked bays” all being given especial prominence):

car park management
2 hour max stay
Customer only car park
4 hour maximum stay for Fitness Centre Members
Failure to comply with the following will result in a Parking Charge of:
Parking limited to 2 hours
(no return within 1 hour)
Park only within marked bays
Blue badge holders only in marked bays

ParkingEye Ltd is solely engaged to provide a traffic space maximisation scheme. We are not responsible for the car park surface, other motor vehicles, damage or loss to or from motor vehicles or user’s safety. The parking regulations for this car park apply 24 hours a day, all year round, irrespective of the site opening hours. Parking is at the absolute discretion of the site. By parking within the car park, motorists agree to comply with the car park regulations. Should a motorist fail to comply with the car park regulations, the motorist accepts that they are liable to pay a Parking Charge and that their name and address will be requested from the DVLA. Parking charge Information: A reduction of the Parking Charge is available for a period, as detailed in the Parking Charge Notice. The reduced amount payable will not exceed £75, and the overall amount will not exceed £150 prior to any court
action, after which additional costs will be incurred.

This car park is private property.”

124. ParkingEye operated the arrangements at the Chelmsford car park under a “Supply Agreement for Car Park Management” made with BAPF on 25 August 2011. ParkingEye guarantees BAPF an undisclosed minimum weekly amount forthe privilege, for which it appears, in practice, to have been paying BAPF about £1,000 per week. Neither BAPF nor ParkingEye makes any charge for parking by motorists who comply with the two-hour maximum stay and other regulations. So ParkingEye’s only income is from those required to pay the £85 (or reduced) charge. ParkingEye operates a number of other car parks on a similar basis. Its annual accounts for the year ended 31 August 2013 show an operating profit of over £1.6m, and a net profit after tax of about £1m, on a turnover of over £14m.

125. Parking at the site is monitored by ParkingEye by automatic number plate recognition cameras to monitor the entry into and departure of vehicles from the car park. The cameras showed Mr Beavis’s vehicle driving into the car park at 14.29 pm on 15 April 2013 and leaving at 17.26 pm, a stay of two hours and 56 minutes. Mr Beavis admits having been the driver. ParkingEye obtained the vehicle’s registered keeper’s details from the DVLA, and sent a First Parking Charge Notice which included statements to the effect that the parking charge of £85 was payable within 28 days of the date of the notice, but would be discounted to £50 if paid within 14 days, and that there was an appeals procedure (which did not however include any power to grant discretionary relief). Mr Beavis did not pay or appeal, and the present proceedings were begun against him.

The issues

126. This section of the judgment concerns the doctrine of penalties. I deal later with the issues arising under the Unfair Terms in Consumer Contracts Regulations 1999: see paras 200-213 below. Miss Joanna Smith QC for Cavendish invites the Supreme Court to undertake a fundamental review of the law regarding penalties. In her submission it is outdated, incoherent and unnecessary, and should be abolished. Alternatively, it should have no place in relation to “commercial” contracts, by which I understand her to mean contracts at arm’s length between equally balanced parties, like Cavendish and Mr El Makdessi. In the further alternative, she submits that it is or should be held to be inapplicable to any clauses other than those requiring payment of money on breach, and/or to clauses not aimed at compensating for the breach, but for which some other valid commercial reason exists.

127. Mr Bloch QC for Mr El Makdessi resists these submissions. In his submission, the doctrine fulfils a tried and well-established role, there is no impetus, let alone one based on any research or review, for its abolition or restriction and it

is, on principle and authority, applicable to the types of clause in issue in this case. He submits that the law governing penalties enables and requires account to be taken of the interests intended to be protected by the relevant clause – a proposition that Miss Smith was in reply at first inclined to dispute, but after questioning and reflection later herself endorsed. But protection of such interests is, in Mr Bloch’s submission, subject to the over-riding control that it must not be extravagant, oppressive or manifestly excessive. In his submission the present clauses are precisely that, since their effect is in the case of clause 5.1 to deprive Mr El Makdessi of part of the agreed consideration, and to do so in a way which bears no resemblance to any loss which his breach may have caused Cavendish or the Group. On the contrary, the smaller the loss it has caused, the larger the penalty effect, and vice versa. As to clause 5.6, its effect is to give Cavendish a right on any default by Mr El Makdessi to force him to part with his remaining shareholding, at a price likely to be well below its actual value, again in circumstances where the difference in value in no way reflects any loss which the default may have caused Cavendish or the Group, and where the smaller the loss caused to the Group, the larger thedifference in value of which Mr El Makdessi is deprived.

128. Mr John de Waal QC for Mr Beavis, and Mr Christopher Butcher QC for the Consumers’ Association, interveners, submit that there is a dichotomy between agenuine pre-estimate and a deterrent clause, that the focus must be on the particular contractual relationship in issue, and general commercial or other considerations cannot detract from that focus or justify what would otherwise amount to a penalty. Mr Jonathan Kirk QC for ParkingEye does not challenge the existing law of penalties, but, like Miss Smith, submits that it is inapplicable to clauses not aimed at compensating for the breach, but for which some other valid (not necessarily commercial) reason exists. That, he submits, is the present case.

129. The law of penalties in this jurisdiction currently applies to contractual clauses operating on a breach of contract by the other party to the contract: see the statements to that effect by Lord Roskill in Export Credits Guarantee Department v Universal Oil Products Co [1983] 1 WLR 399 at pp 402H and 404C (although the facts of that case were quite special). This limitation has on occasion been seen as a weakness or even as an indication of inherent fragility in the doctrine’s underpinning. The High Court of Australia has quite recently addressed this aspect head-on, holding that breach is not an essential aspect of the doctrine; the essential question is whether the contract imposes a restriction from doing the particular act, reserving a payment if it is done, or whether it confers a right to do the act in return for payment of an equivalent: Andrews v Australia and New Zealand Banking Group Ltd [2012] HCA 30, 247 CLR 205, Paciocco v Australia and New Zealand Banking Group Ltd [2015] FCAFC 50, para 95.

130. The present appeals do not raise for consideration whether there should be any such extension of the doctrine, but rather whether it should be abolished or

restricted, in English law. For my part, if the doctrine survives in English law, I do not see the distinction between situations of breach and non-breach as being without rational or logical underpinning. It is true that clever drafting may create apparent incongruities in particular cases. But in most cases parties know and reflect in their contracts a real distinction, legal and psychological, between what, on the one hand, a party can permissibly do and what, on the other hand, constitutes a breach and may attract a liability to damages for - or even to an injunction to restrain - the breach. In Mr Beavis’s appeal, Mr de Waal also suggested that ParkingEye could have economic reasons for formulating the liability to pay £85 (or a reduced £50) as a liability for breach, rather than as a consideration payable for parking for longer than two hours. As a consideration, he suggested, it would have attracted VAT and ParkingEye could furthermore have incurred liability for rates as a person in beneficial occupation of the car park.

The concept of a penalty

131. The doctrine of penalties is commonly expressed as involving a dichotomy between compensatory and deterrent clauses. In Robophone Facilities Ltd v Blank [1966] 1 WLR 1428, 1446H-1447A, Diplock LJ even expressed the doctrine in terms of a rule of public policy that did not “permit a party to a contract to recover in an action a sum greater than the measure of damages to which he would be entitled at common law”. All three of the early 20th century decisions of highest jurisdictions which together constitute the origin of the modern doctrine contain dicta suggestive of a mutually exclusive dichotomy. But all three show that there is no requirement that the measure of damages at common law should be ascertainable - indeed that an inability to ascertain this can justify an agreement to pay a fixed sum on breach. In this connection, they point to a broad understanding of the interests which can justify such an agreement. All three decisions must also be read in context, which involved interests different from those relevant on the present appeals.

132. In the first decision, the Scottish appeal of Clydebank Engineering and Shipbuilding Co v Don Jose Ramos Yzquierdo y Castaneda [1905] AC 6, the House was concerned with an expressed “penalty” of £500 per week for late delivery of four torpedo boats to the Spanish Government. The Earl of Halsbury LC distinguished at p 10 between an agreed sum for damages and a penalty to be held over the other party in terrorem and Lord Davey at p 15 between a clause providing for liquidate damages or for a punishment irrespective of the damage caused. But the Earl of Halsbury went on to stress how “extremely complex, difficult, and expensive” any proof of damages would have been, how it would involve “before one’s mind the whole administration of the Spanish Navy” and how “absolutely idle and impossible [it would be] to enter into a question of that sort unless you had some
kind of agreement between the parties as to what was the real measure of damages which ought to be applied” (pp 11-12). He also rejected out of hand submissions that a warship has no value at all, and that, had the torpedo boats been delivered on

time, they would have been sunk, like much else of the Spanish fleet, in the Spanish-American war (of 1898, after the United States intervened in support of Cuban independence).

133. Lord Davey and Lord Robertson indicated that they saw the ultimate question as being whether the shipbuilders had shown that the clause was exorbitant, extravagant or unconscionable to the point where it could not be regarded as commensurate with the interest protected: see pp 16 and 20. Lord Robertson encapsulated his view of the issue as follows:

“The question remains, had the respondents no interest to protect by that clause, or was that interest palpably incommensurate with the sums agreed on? It seems to me that to put this question, in the present instance, is to answer it. Unless injury to a state is as matter of law inexpressible in money, Spain was or might be deeply interested in the early delivery of these ships and deeply injured by delay.

To my thinking, Lord Moncreiff has, in two sentences, admirably stated the case: ‘The subject-matter of the contracts, and the purposes for which the torpedo-boat destroyers were required, make it extremely improbable that the Spanish Government ever intended or would have agreed that there should be inquiry into, and detailed proof of, damage resulting from delay in delivery. The loss sustained by a belligerent, or an intending belligerent, owing to a contractor’s failure to furnish timeously warships or munitions of war, does not admit of precise proof or calculation; and it would be preposterous to expect that conflicting evidence of naval or military experts should be taken as to the probable effect on the suppression of the rebellion in Cuba or on the war with America of the defenders’ delay in completing and delivering those torpedoboat destroyers.’”

At p 19, Lord Robertson also described a penalty as a sum “merely stipulated in terrorem [which] could not possibly have formed … a genuine pre-estimate of the creditor’s probable or possible interest in the due performance of the principal obligation”.

134. Lord Robertson’s last words were quoted by the Judicial Committee of the Privy Council (which included the Lord Chancellor, Lord Davy and Lord Dunedin) in the second decision, Public Works Comr v Hills [1906] AC 368, 375-376. The
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Referring Principles


Vertragsstrafe, penalty, clause, Vertragstrafeversprechen
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