The Supreme Court has allowed the appeal of Cavendish Square Holding BV against the Court of Appeal’s decision that two clauses in an agreement for the sale and purchase of an advertising business amounted to unenforceable penalties.
Lords Neuberger and Sumption (with whom Lord Clarke and Lord Carnwath agreed) described the penalty rule as “an ancient, haphazardly constructed edifice which has not weathered well”. It was unfortunate, they observed, that the four tests laid down by Lord Dunedin in Dunlop had achieved the status of quasi-statutory code. The distinctions between penalties and genuine pre-estimates of loss, and genuine pre-estimates of loss and deterrents were unsatisfactory. However, in circumstances where the rule or a variant thereof was common to all major systems of law in the western world, and where the English and Scottish Law Commissions had recommended retention of the doctrine, judicial abolition would be inappropriate.
The true test was “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.”
On the facts, neither of the impugned clauses was penal. The first, entitling Cavendish to withhold a portion of the purchase price in the event of Mr Makdessi’s default, was a ‘price adjustment clause’. Cavendish had a legitimate interest in the observance of its restrictive covenants which extended beyond the recovery of loss. The second clause, a call option entitling Cavendish to acquire Mr Makdessi’s retained shares at a price which ignored goodwill, was similarly justified in all the circumstances.
Camilla Bingham QC appeared for the Respondent, with Michael Bloch QC, instructed by Clifford Chance LLP.
Edwin Peel appeared for the Appellant with Joanna Smith QC, instructed by Squire Patton Boggs (UK) LLP.
The full text of the Supreme Court's judgment can be found here.