For the last 100 years, anyone drafting a contract has had to beware of including “penalty clauses”, for breaches of contract, because they aren’t enforceable.
The most typical example is where a contract party has to pay a big fine if they do not perform their end of the bargain on time, for instance by bringing a project in late. In the employment context, money can often be repayable, particularly where bonuses or training is involved, should an employee leave early or otherwise breach the contract.
This case reviewed the laws in this important area for the first time in over 100 years. So, what did the Supreme Court have to say?
In this case, the Supreme Court looked at 2 potential penalty clauses.
First, there was a contract in which an employee who had sold his business breached his contractual promise not to compete with the new entity during his earn-out period. The consequences of doing this were severe, and he was required to repay much of the money already paid to him for the business, and to hand it over for a considerably reduced price.
The second case dealt with an £85 parking penalty that was levied by the private parking company, ParkingEye, in Chelmsford.
Under the old law, in a 1915 case (Dunlop Pneumatic Tyre Co Limited v. New Garage Motor Co Ltd) the law on penalty clauses was essentially framed as follows:
- If the payment of damages under the contract, for breach of it, did not amount to a genuine pre-estimate of loss to the offended party, then it was likely to be a penalty clause and unenforceable.
In this case, the Supreme Court held that Dunlop was no longer fit for purpose, and gave a different analysis of the situation. They came up with the following new principles:
- The question that should be asked is whether or not the clause is penal, and not whether it is a genuine pre-estimate of loss.
- Just because the damages payable acts as a deterrent, does not mean that it is penal.
- Whether or not a clause is penal will partly depend on whether it is unconscionable or extravagant.
Applying these principles to the cases in question, the Supreme Court held that the relevant clause in the first case (Cavendish v. L Makdessi) was not penal. They held that it was merely a price adjustment clause, and that the value of the whole sale depended on Mr Cavendish not competing. One immediate question relates to whether the clause would be penal if there was only a minor breach of the non-compete clauses by Mr Cavendish. The Supreme Court answered this by saying that “loyalty is indivisible”. The extent of the breach, and therefore the level of damages was therefore not relevant in this case.
In the case of ParkingEye, although the company did not suffer any loss at all, let alone of the £85, the Supreme Court held that the point of the contract, and the parking charge, was so that the wider public could be benefited by preventing wrongful use of the parking spaces. Furthermore, they made reference to charges other companies make in these circumstances, and found that the charge was not unconscionable or extravagant by reference to the industry norm.
Employers will be pleased that it will now be much harder for employees to argue that contractual clauses are unenforceable because they are penalty clauses.
They will be dismayed, however, that assessment of whether or not a clause is a penalty (and therefore unenforceable) or not is now so much more complicated.