High Court draws adverse inferences from failure to call relevant witness, and finds default interest clause to be an unenforceable penalty

The High Court has rejected a claim for misrepresentation, finding that although a fraudulent misrepresentation had been made, it had not induced the claimant to enter into the transaction: Ahuja Investments Ltd v Victorygame Ltd [2021] EWHC 2382 (Ch).

The court’s finding as to (lack of) inducement was based in large part on the claimant’s failure to call its former solicitor to give evidence, in circumstances where the claimant had obtained information from the solicitor in the course of the proceedings, but had successfully claimed litigation privilege in respect of the relevant communication (see our blog post here). As there was no explanation from the claimant for the failure to call the solicitor to give evidence, the judge inferred that his evidence would be unhelpful from Ahuja’s perspective.

The decision demonstrates that, while the courts will not lightly draw adverse inferences from a failure to call a witness, it may do so in an appropriate case. Here it was perhaps ironic that the claimant had successfully prevented information from the relevant witness coming before the court by asserting litigation privilege, but that information had nonetheless damaged its case because it helped justify an inference that the witness had material, but unhelpful, evidence to give.

The decision is also of interest for the court’s conclusion that a default interest provision in a loan agreement was penal where it provided for 12% interest per month (compounded monthly) on amounts outstanding after the redemption date. Continue reading

High Court finds acceleration clause is susceptible to rule on penalties, but declines to apply the rule as the amounts in question were payable in any event under a separate clause

In a recent judgment, the High Court held that a clause in a settlement agreement requiring immediate payment of all outstanding amounts in the event of a late payment (an acceleration clause) was capable of falling within the penalty doctrine, but an obligation to pay a daily sum accruing pro rata on any outstanding amounts was not: Heritage Travel and Tourism Ltd v Windhorst [2021] EWHC 2380 (Comm).

The court applied the doctrine set out by the Supreme Court decision Cavendish Square Holding BV v Talal El Makdessi [2015] UKSC 67 (considered here). That is, whether the relevant provision was a secondary obligation which imposed a detriment on the defendants that was out of all proportion to the claimant’s legitimate interest in enforcing the defendants’ primary obligations under the agreement. The court held that the acceleration clause in the agreement was a secondary obligation as it was triggered by a breach of a requirement to pay a certain amount by a particular date. However, the separate clause which provided that a daily sum would accrue so long as, and to the extent that, a further amount remained outstanding had to be considered a primary obligation. The fact that the daily sum was payable only to the extent that the further amount was outstanding did not mean the obligation to pay it was triggered by any breach; these provisions merely defined the accrual period.

In light of the conclusion that the obligation to pay the daily sum was a primary obligation, the court declined to express a concluded view as to whether the detriment on the defendants resulting from the clause was disproportionate.

This decision provides a helpful illustration of the circumstances in which a contractual obligation will be susceptible to the rule on penalties, and how it may be possible in some circumstances to avoid the application of the rule by drafting an obligation to ensure that it is not triggered by breach. Continue reading

Supreme Court restores orthodox approach to liquidated damages for delay where work never completed

The Supreme Court has overturned a Court of Appeal decision which held that a clause providing for liquidated damages for delay did not apply where the contractor had failed to complete the contracted work: Triple Point Technology, Inc. v PTT Public Company Ltd [2021] UKSC 29.

The Supreme Court’s decision restores the orthodox interpretation of liquidated damages clauses in the event that a contract is terminated before works are complete, ie liquidated damages accrue until the contract is terminated, after which the employer may be entitled to general damages arising from termination.

This was so despite the wording of the clause in this case which stated that liquidated damages were payable from the due date for delivery up to the date the employer accepted the work. The Supreme Court found that, on its proper interpretation, this language did not mean the contractor was relieved from the liability to pay liquidated damages where the works were not completed (and accepted). Rather, it meant that liquidated damages were payable “up to the date (if any)” that the work was accepted.

Nonetheless, as the interpretation of any contract will turn on its own wording in the relevant context, contracting parties may still wish to provide expressly for the effect of termination on liquidated damages, and/or to consider clarifying any liquidated damages provisions that are similarly worded to those in Triple Point.

For more information, see our Construction Disputes team’s e-bulletin on the decision.

High Court finds clause imposing harsh consequences for breach of term aimed at protecting IP rights was not an unenforceable penalty

In a recent decision, the High Court has found that a clause in a settlement agreement which was aimed at protecting a business’s IP rights was not penal, despite imposing “undoubtedly extremely harsh” consequences for breach of certain obligations in a settlement agreement. Under the clause, the relevant party would cease to receive any payment under the settlement agreement, and amounts previously received would become repayable, if he breached obligations prohibiting him from claiming entitlement to the IP rights, challenging the claimants’ ownership of the rights, or challenging the validity of the rights: Permavent Ltd v Makin [2021] EWHC 467 (Ch).

The court applied the test established by the Supreme Court in Cavendish Square Holding BV v Talal El Makdessi [2015] UKSC 67 (considered here) for whether a clause is penal, namely whether the detriment imposed by the clause is out of all proportion to the innocent party’s legitimate interest in enforcing the counterparty’s obligations under the contract. If so it will be penal and therefore unenforceable. This replaced the traditional test of whether a clause is a “genuine pre-estimate of loss” and therefore compensatory, or is aimed at deterring a breach and therefore penal. It was therefore accepted, in the present case, that there is nothing impermissible, per se, in a contract term designed to deter breach, rather than merely compensate for losses resulting from a breach.

In Makdessi, the Supreme Court found that the buyer of a business had a legitimate interest in enforcing restrictive covenants, in order to protect the goodwill of the business, and the parties themselves were the best judges of how that interest should be reflected in the agreement (in the form of a clause which, among other things, deprived the buyer of certain deferred consideration that would otherwise fall due). In the present case, the judge held that the claimants had a legitimate interest in protecting IP rights which the court found were fundamental to their business. That interest went beyond mere compensation for losses directly resulting from a breach of obligations relating to those rights and, as in Makdessi, the court was not prepared to find that the detriment the parties had agreed was disproportionate.

The decision emphasises that, in considering proportionality, the court must consider the position as at the date of the agreement, rather than focusing on the breach that in fact occurred and the harm that resulted directly from it. It also illustrates that the court may be less likely to find that a clause is an unenforceable penalty where (as here) it has been entered into with the benefit of legal advice.

It is interesting, too, that in the present case the claimants did not seek to argue that the relevant clause fell outside the rule on penalties as it was a primary obligation in the form of a price adjustment clause, rather than a secondary obligation that took effect on breach. In Makdessi it appeared from the Supreme Court’s judgment as originally published that the majority had found the clause was a primary obligation and therefore outside the rule. However, Lord Clarke made a late amendment to his single paragraph judgment, which cast doubt on whether that finding formed part of the majority reasoning. In the present case, the claimants accepted that it was “arguable” that the majority had found the clause in Makdessi was (in principle) subject to the rule, and they did not seek to argue to the contrary in the present case.

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Employment Appeal Tribunal finds penalty rule did not apply where no breach relied on

The Employment Appeal Tribunal (EAT) has held that the rule against penalties did not apply where an employer imposed certain contractual provisions (which required the employee to resell shares at acquisition cost and to forfeit loan notes) following an employee’s resignation, without alleging any breach of contract on the part of the employee: Nosworthy v Instinctif Partners Ltd [2019] UKEAT 0100_18_2802.

Under the test established by the Supreme Court in Cavendish Square Holding BV v Talal El Makdessi [2015] UKSC 67 (considered here) a clause that takes effect on breach will be unenforceable as a penalty if it is out of all proportion to the innocent party’s legitimate interest in enforcing the counterparty’s obligations under the contract.

In the present case the clause could potentially take effect in two situations: (i) where the employee voluntarily resigned; and (ii) where the employee was (or could have been) dismissed for cause, ie for the employee’s breach. On the facts, the employee resigned and the employer relied on the clause. The EAT held that the rule against penalties did not apply as the employer did not allege a breach.

The EAT did not consider whether the rule against penalties would have applied in this case if the clause had taken effect in circumstances where the employee was dismissed for cause. It was sufficient that, on the facts, the employer was not alleging a breach. The decision is therefore of interest in suggesting that a clause will not be susceptible to the rule on penalties where it takes effect on a non-breach event – even if the same clause could potentially have been caught by the rule where it took effect on breach.

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Court of Appeal finds clause imposing liquidated damages for delay did not apply where work was never completed

In a recent decision, the Court of Appeal held that a clause providing for liquidated damages for delay did not apply where the contractor failed to complete the contracted work (the installation of a new software system). The employer under the contract was therefore entitled to recover damages for breach assessed on ordinary principles, rather than liquidated damages: Triple Point Technology Inc v PTT Public Company Ltd [2019] EWCA Civ 230.

The Court of Appeal said that the question of whether such a clause applied in these circumstances would depend on the wording of the clause itself. In relation to the specific clause before the court, the clause was focused specifically on delay between the contractual completion date and when the work was actually completed by the contractor and accepted by the employer. If that never occurred, the liquidated damages clause did not apply. The case is a useful reminder that, when drafting a liquidated damages clause, it is important to ensure there is no room for doubt as to when the clause will apply.

The Court of Appeal also rejected the appellant’s argument that the liquidated damages clause should be struck out as a penalty clause, under the test established by the Supreme Court in the leading case of Cavendish v Makdessi (considered here). The court noted that the total sums as calculated under the clause were modest when compared to the financial consequences of delay in installing the software, and concluded that it was a genuine pre-estimate of loss.

Anthea Brookes, an associate in our disputes team, outlines the decision below. Continue reading

High Court finds liquidated damages clause for delay in construction contract was not unlawful penalty

The High Court has found that clauses in engineering, procurement and construction (EPC) contracts relating to solar power plants, which provided for a delay damages rate of £500 per day per MWp, were enforceable liquidated damages clauses: GPP Big Field LLP v Solar EPC Solutions SL [2018] EWHC 2866 (Comm).

Applying the Supreme Court’s recast penalties test from Cavendish Square Holding BV v Talal El Makdessi [2015] UKSC 67 (considered here), the court rejected the contractor’s argument that the clauses were unenforceable as penalties. It found that the provisions did not exceed a genuine pre-estimate of loss, and that the sums were not in any way extravagant or unconscionable in comparison with the legitimate interest of the employer in ensuring timely performance of the contracts.

The court reached that conclusion despite the provisions being described as a “penalty” in the relevant clauses. It said this was nothing more than an equivocal indication, requiring an enquiry into the substance of the matter.

The court reached its conclusion for a number of reasons including because the parties were experienced and sophisticated commercial parties of equal bargaining power, who were capable of assessing the commercial implications of the liquidated damages provisions. The sum provided for in each liquidated damages clause was payable only on a single type of breach. The fact that the loss resulting from that breach might vary in amount depending on the circumstances did not of itself give rise to any inference that the sum was a penalty, provided that it was not extravagant and unconscionable in comparison with the greatest loss that might have been expected as likely to flow from the breach when the contract was made.

For more information please see our construction e-bulletin on the decision.

High Court finds clause allowing landlord to terminate side letter and insist on payment of higher rent in lease falls foul of rule on penalties

In a recent decision, the High Court has held that a clause in a side letter, which allowed a landlord to terminate the side letter and insist on payment of the higher rent set out in the lease, was a penalty and therefore unenforceable: Vivienne Westwood Limited v Conduit Street Development Limited [2017] EWHC 350 (Ch).

This is one of the few decisions to have struck down a clause as penal since the Supreme Court substantially rewrote the law on penalties in its decision in Cavendish v Makdessi [2015] UKSC 67 (see our blog post on that decision here and our contract disputes practical guide which considers liquidated damages here). That decision replaced the traditional test of whether a clause is (or is not) a “genuine pre-estimate of loss” with a test of whether it is out of all proportion to the innocent party’s legitimate interest in enforcing the counterparty’s obligations.

The latest decision is of particular interest for its discussion of whether a clause is in substance a secondary obligation which takes effect on breach of a primary obligation, so that the rule on penalties is engaged, or whether it is a conditional primary obligation and therefore falls outside the rule. In Makdessi itself, a number of the Justices found that a clause depriving the seller of a business of deferred consideration in circumstances where he breached a non-compete provision was, in reality, a price adjustment clause – ie a primary rather than a secondary provision, which was not susceptible to the rule on penalties. (In any event, the Supreme Court found that the clause was not out of proportion to the seller’s legitimate interest in enforcing the non-compete provisions, and was therefore enforceable.)

The present decision gives a further illustration that the distinction between a conditional primary obligation and a secondary obligation is a rather fine one. The practical message is that, whenever a clause takes effect on breach, it would be prudent to assume that the rule on penalties may be engaged. The question of whether it is enforceable will then come down to whether the clause is out of all proportion to the innocent party’s legitimate interest in performance of the contract.

The decision also suggests that the question of whether a clause provides for the same consequences irrespective of whether a breach is minor or serious, which the judge said had long been a hallmark of a penalty clause, remains an important consideration post-Makdessi.

The case is also of interest for its discussion of the meaning of a clause allowing termination for “any breach” of contract. In a number of cases, such a clause has been interpreted as requiring a breach that is repudiatory at common law, on the basis that a broader interpretation would flout business common sense (see our contract disputes practical guide on termination here). Here, however, the judge was not prepared to imply even a term requiring a “material” breach, commenting that the test of materiality is “fraught with conceptual uncertainty” – which may come as a surprise to many, given the frequency with which commercial parties agree provisions allowing termination for “material” breach.

David Nitek and Maura McIntosh, a partner and professional support consultant in the disputes team, consider the decision further below.

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Supreme Court rewrites English law rule on penalties

In a judgment handed down this morning, the Supreme Court has in effect re-written the rule on penalties, saying that the underlying rationale of the rule in English law has been misunderstood and that as a result the rule has been applied in many situations where it is both unnecessary and unjust: Cavendish Square Holding BV v Talal El Makdessi; ParkingEye Limited v Beavis [2015] UKSC 67.

The Supreme Court has rejected the traditional test of whether a clause that takes effect on breach is a “genuine pre-estimate of loss” and therefore compensatory, or whether it is aimed at deterring a breach and therefore penal. The true principle, as established in the judgment, is whether the clause is out of all proportion to the innocent party’s legitimate interest in enforcing the counterparty’s obligations under the contract. If so it will be penal and therefore unenforceable.

The decision helpfully recognises that a party can, in some circumstances, have a legitimate interest in enforcing performance which goes beyond simply being compensated for losses. On this basis, the Supreme Court has overturned the Court of Appeal’s judgment in Makdessi (outlined here) which found that provisions in a share purchase agreement which took effect if the seller breached certain restrictive covenants were unenforceable penalties. The Supreme Court concluded that the buyer had a legitimate interest in enforcing the covenants, in order to protect the goodwill of the business, and the parties themselves were the best judges of how that interest should be reflected in the agreement.

The Supreme Court’s decision therefore introduces a more flexible test as to whether or not a clause will be found to be penal, and therefore unenforceable, than the traditional question of whether a clause was aimed at deterrence rather than compensation. Of course, the question of precisely what will amount to a legitimate interest, and whether a clause is out of proportion to that interest, may be open to debate in many cases. But the decision provides a much more helpful starting point, and is likely to mean less interference in contracts freely negotiated between commercial parties of similar bargaining power.

The decision is also helpful in confirming that a clause may fall outside the rule against penalties altogether if takes effect in circumstances other than a breach of contract, for example a payment which is conditional on performance rather than an entitlement to liquidated damages in the event of breach. It may therefore be possible to avoid the application of the rule with careful drafting, though the judgment does make it clear that classification of the term will depend on substance rather than mere form. David Nitek and Maura McIntosh, a partner and professional support consultant in the disputes team, consider the decision further below.

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