Assessing whether a clause is an unenforceable penalty

2 December, 2015
by: Cripps Pemberton Greenish

The recent Supreme Court judgment in Cavendish Square Holding BV v El Makdessi and ParkingEye Ltd v Beavis [2015] UKSC 67 has implications on clauses that try to set an agreed payment to an innocent party upon a breach of contract (for example a liquidated damages clause in a landowner’s development agreement).

The Makdessi case related to whether clauses agreed in a contract between the parties were unenforceable penalties. That is a consideration that always had to be thought through when setting an agreed payment to the innocent party upon a breach of contract. If penal in nature (i.e. more than a genuine pre-estimate of loss) then such clauses would not be enforceable under the law pre-Makdessi.

In Makdessi the Supreme Court decided that the law on unenforceable penalties, which broadly meant that clauses such as these should provide for a payment that is a genuine pre-estimate of loss, was “an ancient, haphazardly constructed edifice which has not weathered well.” What was decided in Makdessi is that the test for an unenforceable penalty should be reformulated. Considering whether a payment is a genuine pre-estimate of loss is no longer conclusive. What we must now look at is whether the payment is “exorbitant or unconscionable” and in considering that you can look at the innocent party’s legitimate interest in ensuring that the primary obligation in the contract is met.

In theory, what that will likely mean is that the breaching party will face a tougher task in persuading a court that an agreed payment to the innocent party is unenforceable as the threshold under this new test appears to be higher than that under the old law. Whether the Supreme Court’s attempt at defining the test gives clarity will remain to be seen.