Makdessi v Cavendish Square Holdings BV
ParkingEye Ltd v Beavis
Citations:  UKSC 67;  AC 1172;  3 WLR 1373;  2 All ER 519;  1 Lloyd’s Rep 55;  2 CLC 686;  BLR 1;  RTR 8.
This case was a joint appeal from two separate cases.
In the first case, the defendant agreed to sell to the claimant an controlling interest in a marketing company. Both sides were represented and advised by highly experienced commercial lawyers. The price was $147m, payable in instalments. The contract contained a no-compete clause. It stated that if the defendant competed with the company, they would be disentitled to further payments. Additionally, the claimant would get an option to buy his remaining shares.
The defendant breached the no-compete clause. The claimant sought a declaration that the defendant was no longer entitled to payments and was obliged to sell his remaining shares. The defendant responded that the no-compete clause was a penalty clause, and therefore unenforceable. The claimant argued that it was not a penalty clause. Alternatively, they thought that the penalty clause rule should not apply in cases where the parties have equal bargaining power.
In the second case, the defendant parked his car in the claimant’s shopping centre car park. A notice at the entrance set out the terms of the parking agreement. It stated that parking was free for the first two hours, after which a fine of £85 would be imposed.
The defendant overstayed in the car park, and the claimant issued the £85 fee. The defendant contended that this part of the notice was a penalty clause and therefore unenforceable.
In the alternative, the defendant claimed that the clause was void for unfairness under the Unfair Terms in Consumer Contracts Regulations 1999. Schedule 2 of those Regulations provides a list of terms which ‘may’ be regarded as unfair. Paragraph 1(e) of this Schedule includes clauses ‘requiring any consumer who fails to fulfil his obligation to pay a disproportionately high sum in compensation’. The defendant thought that this described the clause in this case.
- Were the two clauses in issue penalty clauses?
- Should the penalty clause rule be abolished or restricted?
- Was the clause in the second case void for unfairness under consumer rights legislation?
The Supreme Court held that the penalty clause rule should not be abolished, since it was a long-standing rule and protects people against oppressive bargains.
- In the first case, the court held that the claimant had a legitimate interest in the observance of the no-compete clause. This interest extended beyond the recovery of compensation for losses. Competition would damage the company’s goodwill, and the defendant’s loyalty was critical to that goodwill. As the parties were both sophisticated commercial parties of equal bargaining power, the court thought it should be slow to conclude that the clause was illegitimate. As such, the clause did not breach the penalty rule.
- Lords Neuberger, Sumption and Carnwarth were also of the opinion that the clauses in the first case were price adjustment clauses. Rather than applying if the defendant was in breach of contract, they made the payment due to him contingent on certain behaviour (such as not competing). Therefore, the clauses did not engage the penalty rule at all.
- In the second case, the court also concluded that the charge was not a penalty. The charge was disproportionate to any loss the claimant might suffer as a result of the defendant overstaying. However, the claimant had a legitimate interest in preserving the use of parking spaces for other users. It could only achieve this by deterring people from overstaying.
- As for the application of the Unfair Terms in Consumer Contracts Regulations 1999 in the second case, the court thought that the clause might fall within the scope of paragraph 1(e) of Schedule 2. However, the clause did not fail the basic test of unfairness as described in regulations 5(1) and 6(1). Any imbalance in the parties rights did not arise contrary to the requirements of good faith. This was because the claimant had a legitimate interest in deterring people from overstaying. The penalty was no higher than necessary to achieve the goal, and the defendant was aware of the two-hour limit.
This Case is Authority For…
The penalty clause rule only applies to clauses which impose detriments in response a breach of contract. It does not apply to clauses which stipulate that money (or a detriment imposed) must be paid in response to some other event. The classification of a clause depends on the substance and effect of the clause, not on how the parties label it.
A provision is a penalty clause if it imposes a detriment which is out of all proportion to any legitimate interest of the innocent party.
This represented a change from the pre-existing law. The previous law provided that a clause was a penalty if it did not represent a genuine attempt to pre-estimate the innocent party’s loss or was designed to deter breach. This case indicates that the purpose of a clause can now be to deter breach without necessarily falling afoul of the penalty rule. The key is whether the innocent party has a legitimate interest extending beyond compensation for his losses. However, Lord Neuberger did note that the ‘innocent party can have no proper interest in simply punishing the defaulter’.
The fact that a clause creates a significant imbalance between the business and consumer is not enough on its own to make a term unfair under consumer rights legislation. That imbalance must arise contrary to the requirements of good faith.
In a commercial contract negotiated between parties of equal bargaining power, there is a strong initial presumption that the parties are the best judge of what is legitimate in terms of dealing with the consequences of breach.
Lord Toulson dissented in the second case in relation to the application of the Unfair Terms in Consumer Contracts Regulations 1999. He stressed that the presumption of consumer rights legislation is that consumers are in special need of protection. As such, there is a heavy burden on businesses to show that they are acting fairly. Since £85 was a substantial sum of money and applied even if the customer only overstayed for a short time, he did not think that the claimant had shown the charge was fair.