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‘The penalty rule in England is an ancient, haphazardly constructed edifice which has not weathered well, and which in the opinion of some should simply be demolished, and in the opinion of others should be reconstructed and extended.’ Per Lord Neuberger, Cavendish Square Holdings BV v Talal El Makdessi; Parking Eye Ltd v Beavis [2015] UKSC 67 at [3]. The Law Commission has asked you to prepare a written submission to review the current law on this topic and to make reasoned recommendations as to whether the law ought to be reformed, and if so in what way(s). In Makdessi and ParkingEye1 (joint appeal)both Lords Neuberger and Sumption doubted that “the courts would have invented the penalty rule today if their predecessors had not done so.”2 The current penalty rule however does not need to be abolished but should instead be reformed.3 It is evident by looking at the current law that it is clearer, more flexible and less intrusive on contracting parties than the old law. However, it still needs further reform on the fundamental distinction between primary and secondary obligations, legitimate interest and freedom to contract.

Penalty Rule. Old vs New Approach: Legitimate Interest The current law on penalty clauses applies to a wider range of cases than the old law. A penalty clause is a provision aimed at penalising the breaching party, rather than compensating the innocent party. 4 As opposed to a liquidated damages clause which is compensatory.5 The old approach was concerned with “whether a clause is a genuine preestimate of loss and therefore enforceable, or whether it is aimed at deterring a breach and therefore penal.”6 The Supreme Court found this unhelpful because it could only be applied in straightforward cases.7 It was too impractical to deal with complex cases because the courts could not apply the test without manipulating the facts of the case to fit the test’s

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Cavendish Square Holding BV (Appellant) v Talal El Makdessi (Respondent), ParkingEye Limited (Respondent) v Beavis (Appellant) [2015] UKSC 67 2 Cavendish Square Holding BV (Appellant) v Talal El Makdessi (Respondent) , ParkingEye Limited (Respondent) v Beavis (Appellant) [2015] UKSC 67 3

Cavendish Square Holding BV (Appellant) v Talal El Makdessi [2015] UKSC 67 [36] 4 Jobson v Johnson [1989] 1 WLR 1026 5 Dunlop Pneumatic Tyre Co Ltd v Selfridge Ltd [1915] AC 847 ;Cellulose Acetate Silk Co Ltd v Widnes Foundry Ltd [1933] AC 20 6

Taylor Wessing, ‘Supreme Court ruling on penalty clauses’ (17 November 2015)

accessed 20 April 2020 7 Kal KC Leung, “The penalty rule: a modern interpretation”, Denning Law Journal 2017 Col 29 pp 41-67 1|Page

parameters.8 Therefore, possibly coming to unjust and unnecessary conclusions. 9 Such as in Robophone, Lord Diplock stated that the old penalty rule was “a recipe for disaster” because the court found it incredibly hard to apply. 10

In contrast, the current law is more easily applied to more complex cases as the facts do not have to be manipulated.11 The current test requires the court to consider "whether a 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". 12 Taking into

consideration the business’ legitimate interests shows that the current law can adapt not only to financial compensation situations, it also recognised that parties could have other legitimate reasons for enforcing the other parties’ obligations according to the contract. 13 Penalty clauses under the current approach can also be applied to claims in debt and the transfer of property.14 Consequently, the current law on penalty clauses is more well-rounded in dealing with modern contracts and is to be preferred due to its improved flexibility. 15.

Legitimate Interest However, the current penalty rule does not expressly define what is considered to be a ‘legitimate interest’. This allows for a wide range of judicial interpretation as to what

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Cavendish Square Holding BV (Appellant) v Talal El Makdessi (Respondent), ParkingEye Limited (Respondent) v Beavis (Appellant) [2015] UKSC 67 [31] 9 Robophone Facilities Ltd v Blank [1966] 1 WLR 1428, 1446 (Diplock LJ). 10 Robophone Facilities Ltd v Blank [1966] 1 WLR 1428, 1446 (Diplock LJ). 11 Taylor Wessing, ‘Supreme Court ruling on penalty clauses’ (17 November 2015)

accessed 20 April 2020 12 Cavendish Square Holding BV v Talal El Makdessi [2013] EWCA Civ 1539 and [2015] EWCA Civ 402 [32] 13 13 Taylor Wessing, ‘Supreme Court ruling on penalty clauses’ (17 November 2015)

accessed 20 April 2020 14

Nick Tall, Cavendish Square and the "modern approach" to contractual penalties, Ent. L.R. 2013, 24(4), 146-149 ; Firma C-Trade SA v Newcastle Protection and Indemnity Assoc (The Fanti) [1989] 1 Lloyd’s Rep. 239 ,(Burton J) 15

David Nitek and Maura McIntosh, ‘Supreme Court rewrites English law rule on penalties’ (4 November 2015) < https://hsfnotes.com/litigation/2015/11/04/supreme-court-rewritesenglish-law-rule-on-penalties/> accessed 20 April 2020

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constitutes a legitimate interest. 16 As well as how much emphasis should be put on having a ‘legitimate interest’.17 The undefined ‘terms’ risks creating inconsistent case law, which is usually relied upon when terms are vague; making the principle unreliable and unpredictable. Whilst a strict definition was not given, Lords Mance and Hodge provided tests which can act as guidance in order to determine whether the innocent party has a ‘legitimate interest’. 18 Paraphrased, an innocent party can have no proper interest in punishing the defaulter, their interest must be an appropriate alternative to performance. 19 Therefore, the current approach is concerned with clauses being oppressive in nature rather than a clause being a genuine preestimate of loss.20 This allows for the courts to acknowledge other legitimate interests other than monetary. This allows for a more flexible approach when determining whether a clause is penal.21 Whilst there is at least guidance on the matter as to what can be considered a ‘legitimate interest’, the fact that there is not complete certainty creates ambiguity and so needs reformed.

Recommendation for reform of ‘Legitimate Interest’ The English courts should consider adopting the approach of the Singapore courts and amend the$English$test$of$“commercial$justification”$and$instead$say$that$a$clause$in$unenforceable$ if$it$cannot$offer$any$“genuine$or$compelling$reason$for$the$court”. 22$This$approach$is$easier$ to$understand$because$it$is$easier$to$deduce$what$a$‘genuine$or$compelling$reason’$

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David Nitek and Maura McIntosh, ‘Supreme Court rewrites English law rule on penalties’ (4 November 2015) < https://hsfnotes.com/litigation/2015/11/04/supreme-court-rewritesenglish-law-rule-on-penalties/> accessed 20 April 2020 17 David Nitek and Maura McIntosh, ‘Supreme Court rewrites English law rule on penalties’ (4 November 2015) < https://hsfnotes.com/litigation/2015/11/04/supreme-court-rewritesenglish-law-rule-on-penalties/> accessed 20 April 2020 18 Taylor Wessing, ‘Supreme Court ruling on penalty clauses’ (17 November 2015)

accessed 20 April 2020 19 Taylor Wessing, ‘Supreme Court ruling on penalty clauses’ (17 November 2015)

accessed 20 April 2020 20 Nick Tall, Cavendish Square and the "modern approach" to contractual penalties, Ent. L.R. 2013, 24(4), 146-149; 21 Taylor Wessing, ‘Supreme Court ruling on penalty clauses’ (17 November 2015)

accessed 20 April 2020 22

Pun Serge v Joy Head Investments Ltd [2010] 4 SLR 478; Xia Zhengyan v Geng Changqing [2015] 3 SLR 732; [2015] SGCA 22 3|Page

compared$to$what$‘legitimate$interest’$means.$Using$the$term$‘commercial$justification’$it$is$ hard$to$pinpoint$what$constitutes$such$a$justification.$Whilst$it$is$acknowledged$that$ Singapore’s$‘term’$is$also$ambiguous$to$a$certain$extent$because$it$is$not$laid$out$what$ ‘genuine’$means,$you$can$still$deduce$its$meaning$using$common$sense.$This$consequently$ creates$more$certainty$than$‘commercial$justification’$does. 23$

Penalty Rule. Old vs New Approach: Freedom to Contract The current law allows parties to contract freely and negotiate the terms of their contract without fear of judicial intervention. 24 The old approach was more invasive because if it could be proven that the clause did not represent a genuine pre-estimate of losses then the clause could then potentially be deemed a penalty and, therefore, unenforceable. This could allow parties to escape liability for a breach of a contract which they deem disadvantageous. 25 This would require more judicial intervention and, therefore, infringe on the principle of freedom to contract.26

In contrast, the current law on the penalty rule only applies to secondary obligations and not to every clause requiring additional payment in the contract. 27 Therefore, allowing more freedom for the negotiating parties without fear of judicial intervention. A 'primary' obligation is a stand alone contractual obligation, while a 'secondary' obligation is only triggered as a consequence of a party committing a breach of contract. Its purpose is to

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Simmons-Simmons, ‘What you need to know about liquidated damages – prat 5’ ( 3 October 2016) assessed April 20 2020 24 David Nitek and Maura McIntosh, ‘Supreme Court rewrites English law rule on penalties’ (4 November 2015) < https://hsfnotes.com/litigation/2015/11/04/supreme-court-rewritesenglish-law-rule-on-penalties/> accessed 20 April 2020 25 Hardwicke, ‘The Law on Penalties After ParkingEye v Beavis’ (4 November 2015) https://hardwicke.co.uk/the-law-on-penalties-after-parkingeye-v-beavis/ > accessed 20 April 2020 26 David Nitek and Maura McIntosh, ‘Supreme Court rewrites English law rule on penalties’ (4 November 2015) < https://hsfnotes.com/litigation/2015/11/04/supreme-court-rewritesenglish-law-rule-on-penalties/> accessed 20 April 2020 27 Taylor Wessing, ‘Supreme Court ruling on penalty clauses’ (17 November 2015)

accessed 20 April 2020 4|Page

provide a contractual alternative to damages. 28 The current law, and by extension the judiciary are therefore aware, that because the contracting parties negotiated freely, the judiciary should ‘safeguard the scope of judicial intervention in the context of agreed remedy clauses.’.29 This therefore shows that the courts are taking a more supervisory role in the current approach.30 This is also supported by Jacson J as well as others as a way to reduce uncertainty when pursuing damages and in allocating risk loss. 31

Freedom to Contract However, the current law on penalty clauses can be avoided by the careful drafting of contracts. 32 This, puts into question the necessity of the penalty rule in English contract law. 33 Being able to avoid the penalty rule through drafting could potentially mean that parties with less bargaining power than their counterpart could be obligated to pay an extortionate fee for breach of contract. However, whilst this may have worked with the old approach, the current law requires the court to take into consideration the bargaining powers of both parties as well

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Pinsent Masons, ‘Practical Implications of Penalty clauses in English law’ (18 July 2018) https://www.pinsentmasons.com/out-law/guides/practical-implications-penalty-clausesenglish-law > accessed 20 April 2020 29

Cavendish Square Holding BV (Appellant) v Talal El Makdessi (Respondent); ParkingEye Limited (Respondent) v Beavis (Appellant) [2015] UKSC 67, Burton J ; Bobby Lindsay, ‘Penalty Clauses in the Supreme Court: a legitimately interesting decision?’ (Edin. L.R. 2016, 20(2), 204-210) 30

Jeancharm LTD V Baarnet Football Club ltd 92 Con. L.R. 26 at [15], per Jacob J; Murray v Leisureplay Plc [2005] I.R.L.R. 946 AT [43], per Arden LJ, at [106], per Clarke LJ and at [114], per Buxton LJ; Jacson J in Alfred McAlpine Construction Ltd v Panatown Ltd [2001] 1 AC 518 [47](3) 31

Mathias Cheung, ‘Shylock’s construction law: the brave new life of liquidated damages’ Const. L.J. 2017, 33(3), 173-187 32

Taylor Wessing, ‘Supreme Court ruling on penalty clauses’ (17 November 2015)

accessed 20 April 2020; Kal KC Leung, “The penalty rule: a modern interpretation”, Denning Law Journal 2017 Col 29 pp 41-67 [61]; Nick Tall, Cavendish Square and the "modern approach" to contractual penalties, Ent. L.R. 2013, 24(4), 146-149 33

Dorota Galeza, ‘Getting rid of the penalty doctrine- the implications of the joint cases Cavendish Square v El Makdessi and ParkingEye v Beavis’ I.C.C.L.R. 2016, 27(6), 175-178 5|Page

as their legitimate interests so as to make sure that the true nature of the disputed clause is not to punish but to compensate. 34

Recommendation for reform of Freedom to Contract The English courts should consider the suggestion made by the council in Cavendish. It was suggested that ‘high powered commercial actors who have access to legal advice’ should be held against a different standard than those who are not ‘commercial actors’. 35 This would allow the courts to further support the principle of freedom to contract by allow those with more bargaining powers more freedom. 36 However, this would mean there are multiple ways of applying the penalty rule and so would make its application more complex. Despite this, it would allow for more freedom for parties with equal bargaining powers than there normally would be.37 This is positive because it would lower fears of constant judicial intervention and so further the fundamental principle of freedom to contract. 38

Primary and Secondary Obligations: Primary and Secondary Obligations The current law on the penalty rule fails to explain the distinction between a primary and secondary obligation, and, therefore, requires reform. 39 This distinction is key because it determines whether the courts can determine whether a clause is penal or not. Without definitions of these terms, it would allow for more judicial discretion and not only cause inconsistent judgements but possibly obscure the penalty rule therefore making the current law unpredictable and uncertain. As evident by Lord Toulson’s dissent in ParkingEye as he

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Cavendish Square Holding BV (Appellant) v Talal El Makdessi (Respondent), ParkingEye Limited (Respondent) v Beavis (Appellant) [2015] UKSC 67 35

Bobby Lindsay, ‘Penalty Clauses in the Supreme Court: a legitimately interesting decision?’ (Edin. L.R. 2016, 20(2), 204-210) 36

David Nitek and Maura McIntosh, ‘Supreme Court rewrites English law rule on penalties’ (4 November 2015) < https://hsfnotes.com/litigation/2015/11/04/supreme-court-rewritesenglish-law-rule-on-penalties/> accessed 20 April 2020 37 David Nitek and Maura McIntosh, ‘Supreme Court rewrites English law rule on penalties’ (4 November 2015) < https://hsfnotes.com/litigation/2015/11/04/supreme-court-rewritesenglish-law-rule-on-penalties/> accessed 20 April 2020 38 David Nitek and Maura McIntosh, ‘Supreme Court rewrites English law rule on penalties’ (4 November 2015) < https://hsfnotes.com/litigation/2015/11/04/supreme-court-rewritesenglish-law-rule-on-penalties/> accessed 20 April 2020 39 Kal KC Leung, “The penalty rule: a modern interpretation”, Denning Law Journal 2017 Col 29 pp 41-67 [48] 6|Page

believed the disputed clause (clause 5.1) to be a primary rather than secondary obligation. 40 His judgment on this matter makes clear that even the judiciary feel that the distinction is unclear. This was also a problem in the old approach, it was unclear what ‘extravagant and unconscionable’ meant and what would constitute passing these thresholds. 41 This was also paramount to the test and, therefore, created uncertainty when it was not defined. 42 It is evident that both approaches to the penalty rule rest on key terms being defined so as to clarify their respective tests.

Primary and Secondary Obligations This puts into question if the penalty rule should be expanded. As counsel for Mr. Makdessi suggested, the penalty doctrine should be expanded by allowing the penalty rule to be used in cases where a breach has not occurred. 43 Such as in Andrews where the Australian courts widened the existence of their equitable jurisdiction. 44 However, the English courts refused to do so stating that it would confuse law and equity. 45 Even though the courts justified this decision unconvincingly based on the history of English law, the Supreme Court was correct in being cautious about removing this limitation. As, if they did, it would render every clause in a contract reviewable which would require ‘widespread review, renegotiation, and

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Hardwicke, ‘The Law on Penalties After ParkingEye v Beavis’ (4 November 2015) https://hardwicke.co.uk/the-law-on-penalties-after-parkingeye-v-beavis/ > accessed 20 April 2020 41

Cavendish Square Holding BV (Appellant) v Talal El Makdessi (Respondent), ParkingEye Limited (Respondent) v Beavis (Appellant) [2015] UKSC 67 [21] 42

Dorota Galeza, ‘Getting rid of the penalty doctrine- the implications of the joint cases Cavendish Square v El Makdessi and ParkingEye v Beavis’ I.C.C.L.R. 2016, 27(6), 175-178 43

Cavendish Square Holding BV (Appellant) v Talal El Makdessi (Respondent), ParkingEye Limited (Respondent) v Beavis (Appellant) [2015] UKSC 67 [21] 44

Bobby Lindsay, ‘Penalty Clauses in the Supreme Court: a legitimately interesting decision?’ (Edin. L.R. 2016, 20(2), 204-210) ; Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205 45 Cavendish Square Holding BV (Appellant) v Talal El Makdessi (Respondent), ParkingEye Limited (Respondent) v Beavis (Appellant) [2015] UKSC 67; Lords Neuberger and Sumption 7|Page

revision.’46 This ‘solution’ would also create uncertainty as to the future of contract law if it were to be implemented. Additionally, due to primary and secondary obligations being heavily dependent on the substance of the contact, the courts will have to potentially deal with penalty clauses on a case by case basis.47 However, both the ‘solutions’ presented in Andrews and by the Supreme Court do not provide clarity. 48 This means that legal advisors simply have to systematically determine the scope and definition of the terms based on cases such as Makdessi and ParkingEye.49

Recommendation Primary and Secondary Obligations Arguably what could be done is that the courts give guidance on how the terms should be interpreted. This would eliminate the unpredictability which comes with such uncertainty. For example, Lord Mance in Makdessi and ParkingEye could have come to concluding view on the disputed clause 5.1 which would clarify the distinction between primary and secondary clauses so as to provide more clarity in future cases. 50

Conclusion The current penalty rule is an improvement on the approach towards determining the existence of the penalty rule as it is more flexible; The judiciary is more cautious in interpreting clauses. Even so, it still has some ambiguity and, therefore, requires further reform.

46

Bobby Lindsay, ‘Penalty Clauses in the Supreme Court: a legitimately interesting decision?’ (Edin. L.R. 2016, 20(2), 204-210)

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Cavendish Square Holding BV (Appellant) v Talal El Makdessi (Respondent), ParkingEye Limited (Respondent) v Beavis (Appellant) [2015] UKSC 67 [15] ; Kal KC Leung, “The penalty rule: a modern interpretation”, Denning Law Journal 2017 Col 29 pp 41-67 48

Kal KC Leung, “The penalty rule: a modern interpretation”, Denning Law Journal 2017 Col 29 pp 41-67 49 Dorota Galeza, ‘Getting rid of the penalty doctrine- the implications of the joint cases Cavendish Square v El Makdessi and ParkingEye v Beavis’ I.C.C.L.R. 2016, 27(6), 175-178 [3] 50
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