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Supreme Court refuses to overturn penalty rule
19 January 2016

Following our article in June 2015 on the case of ParkingEye v Beavis concerning the penalty rule, the appeal to the Supreme Court has now been heard together with the appeal of El Makdessi v Cavendish Square Holdings BV and another, an earlier case also concerning the penalty rule. In both cases, the Supreme Court upheld the validity of the clauses and also provided some clarification on the rule against penalties which has not been considered by the House of Lords or the Supreme Court for a century.

In ParkingEye, the Court of Appeal ruled that the fine imposed was enforceable and not a penalty as it was commercially justifiable and not extravagant or unconscionable. Mr Beavis appealed this ruling to the Supreme Court. On 4 November 2015, this appeal was dismissed. The Supreme Court upheld the earlier Court of Appeal decision that none of the disputed terms contravened the penalty rule. Further, as concluded in the Court of Appeal, the fine did not infringe the Unfair Terms in Consumer Contracts Regulations 1999.

In El Makdessi, the Court of Appeal held that the disputed clause was not commercially justifiable and was an unenforceable penalty. The appeal to the Supreme Court was however, allowed.

Whilst the Supreme Court did not abolish the rule against penalties, it offered some clarity. The Supreme Court held that whether a provision is a penalty depends upon the nature of the right which the contract-breaker is being deprived of and the basis on which he is being deprived of it. Whilst this approach is similar to the one taken in ParkingEye, with the Court willing to look at penalty clauses subjectively, the Supreme Court reiterated that it will not be moving away from what are the core principles when dealing with penalty clauses.

The Supreme Court stated that the true test as to whether a clause is a penalty and therefore unenforceable 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 importance of distinguishing between “primary obligations” (conditions of the contract) and “secondary obligations” (conditions that come into effect following a breach) was therefore restated. The penalty rule only applies to secondary obligations.

Further of note, was the Supreme Court’s view that “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 a breach.”

These judgements show that there is a willingness by the Court to allow parties to decide on provisions within their agreements.  It remains to be seen what will constitute a “legitimate interest” although financial interests and protection of trade and goodwill are likely examples.  When seeking to include a provision which might fall foul of the penalty rule, identification of a legitimate interest that needs protecting is an important consideration.  Further as the penalty rule does not apply to primary obligations, careful drafting can evade the rule.

Whilst much of the attention following ParkingEye and El Makdessi has surrounded the impact that the case will have on the penalty rule, an argument was raised that the penalty in ParkingEye was in fact unfair under the Unfair Terms in Consumer Contracts Regulations 1999 (“UTCCR”) with this having been a contract that the parties did not freely negotiate. Consideration of how clauses may be interpreted under UTCCR should not be forgotten when considering the penal nature of clauses.

For more information about the Supreme Court's decision or to find out more about how the Commercial & Technology team can help you please contact Sarah Williamson on 0118 952 7247 or email [email protected].

Consistent with our policy when giving comment and advice on a non-specific basis, we cannot assume legal responsibility for the accuracy of any particular statement. In the case of specific problems we recommend that professional advice be sought.

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