FML Timeline: Cavendish Square Holdings BV v Makdessi and Parking Eye Limited v Beavis

To print a complete version of this article, click the PDF on the top right. Facts

In Cavendish, Mr Makdessi agreed to sell to Cavendish Square a controlling stake in the holding company of the largest advertising and marketing communications group in the Middle East. The terms of the agreement stated that if Mr Makdessi breached certain restrictive covenants: (a) he would not be entitled to the final two instalments of the sale price (clause 5.1); and (b) that he may be obliged to sell his remaining, minority, shares to Cavendish for an amount excluding any value for goodwill (clause 5.6). Mr Makdessi argued that both provisions were void and unenforceable because they constituted penalties.

In ParkingEye, Mr Beavis overstayed a free two-hour car parking limit by almost an hour. A number of notices stated that failure to comply with the free two-hour limit would result in a parking charge of £85. Accordingly, ParkingEye subsequently sent Mr Beavis a parking charge of £85 (or £50 if paid within 14 days). Mr Beavis raised two arguments as to why he should not have to pay the charge, namely that it was (a) unenforceable at common law because it was a penalty, and/or (b) unfair and therefore unenforceable by virtue of the Unfair Terms in Consumer Contracts Regulations 1999 (SI 1999/2083).

Decision

The Supreme Court allowed the appeal in Cavendish and dismissed the appeal in ParkingEye, thus upholding the validity of the disputed clauses in both cases.

The Court said that the rule against contractual penalties should not be abolished but neither should it be extended, albeit it did then proceed to amend the test to be applied in determining whether a contractual provision was penal.

The Court held that the test is whether the provision is a secondary obligation which constitutes 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”.

Cavendish

In relation to Clause 5.1, the Court held that this constituted a price adjustment clause. Although the occasion for its operation was a breach of contract, it was in no sense a secondary provision. Clause 5.1 belonged among the provisions which determined Cavendish’s primary obligations, i.e. those which fixed the price, the manner in which the price was calculated and the conditions on which different parts of the price were payable. The effects were that Mr Makdessi earnt the consideration for his shares not only by transferring them to Cavendish but by observing the restrictive covenants.

The Court further acknowledged that although clause 5.1 had 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 the business was critical to its value, and the loyalty of Mr Makdessi was critical to its goodwill. The fact that some of the breaches of restrictive covenant would cause very little in the way of recoverable loss to Cavendish was therefore considered to be beside the point.

The Court held that the legitimate interest which justified clause 5.1 also justified clause 5.6. 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 among the parties’ primary obligations, even if the occasion for its operation is a breach of contract.

So the penalty doctrine was not engaged as the alleged penal clauses constituted primary obligations.

ParkingEye

The £85 charge for overstaying the two hour parking limit did engage the penalty rule as it was payable on breach. But the Court held that ParkingEye had a legitimate interest in charging overstaying motorists which extended beyond the recovery of any loss. The £85 charge had two main objects: (a) to manage the efficient use of parking space in the interest of local retail outlets and of the users of those outlets who wished to find spaces in which to park their cars; and (b) to provide an income stream to enable ParkingEye to meet the costs of operating the scheme and make a profit from its services. The Court added that ParkingEye could not charge overstayers whatever it liked. It could not charge a sum which would be out of all proportion to its interest. But in this case, it was held that there was no reason to suppose that £85 was out of all proportion to its interests and that the £85 charge was neither extravagant nor unconscionable.

Noteworthy/ Novel points

• The penalties doctrine is only engaged on breach
• skilled drafting can (probably) avoid the doctrine being applicable by casting the relevant provision as a primary obligation, as in the Cavendish case; and
• where the doctrine is engaged, the essential issue is whether there is a “legitimate interest” in the provision being enforced. Where a legitimate interest is established, the next question is whether the clause is “exorbitant or unconscionable”. Whether in practice this is different from the old test of “deterrence” or “genuine pre-estimate of loss” remains to be seen.

For further information, please refer to our article here.