Cavendish Square Holding BV v Talal El Makdessi [2015] UKSC 67

Two conjoined appeals examined the law on contractual penalty clauses. In Cavendish, share sale clauses forfeiting deferred payments and forcing share transfers at undervalue upon breach of restrictive covenants were upheld. In ParkingEye, an £85 parking overstay charge was held neither penal nor unfair under consumer regulations. The Supreme Court reformulated the penalty rule.

Facts

The Supreme Court heard two conjoined appeals raising the principles underlying the contractual penalty rule. In Cavendish Square Holding BV v El Makdessi, Mr Makdessi sold a controlling interest in a Middle Eastern advertising group to Cavendish (part of WPP) under a heavily negotiated agreement. The price included deferred Interim and Final Payments calculated by reference to operating profits, plus a put option allowing Mr Makdessi to sell his retained 40% shareholding. Clause 11.2 imposed restrictive covenants protecting goodwill. Clauses 5.1 and 5.6 provided that, if Mr Makdessi breached clause 11.2 and became a “Defaulting Shareholder”, he would forfeit the Interim and Final Payments and could be required to sell his remaining shares at a price based on net asset value, excluding goodwill. Mr Makdessi admitted breach but argued the clauses were unenforceable penalties.

In ParkingEye Ltd v Beavis, Mr Beavis parked in a retail park car park managed by ParkingEye, which offered two hours’ free parking subject to a prominently displayed £85 charge for overstayers. He overstayed by approximately 56 minutes and refused to pay, contending the charge was a penalty and unfair under the Unfair Terms in Consumer Contracts Regulations 1999.

Issues

The principal issues were: (1) the correct formulation and scope of the penalty rule; (2) whether the rule should be abolished or extended; (3) whether clauses 5.1 and 5.6 in Cavendish were unenforceable penalties; (4) whether the £85 parking charge was a penalty; and (5) whether the parking charge was unfair under the 1999 Regulations.

Arguments

Cavendish argued that the penalty rule was antiquated and should be abolished, or restricted to non-commercial contracts. Mr Makdessi contended both clauses were penalties because they bore no relationship to loss; the smaller the breach, the greater the forfeiture. Mr Beavis and the Consumers’ Association argued the £85 charge was a deterrent unrelated to loss, and that the clause caused significant imbalance contrary to good faith. ParkingEye argued it had legitimate commercial interests beyond compensation that justified the charge.

Judgment

Reformulation of the penalty rule

The Court declined to abolish or substantially extend the penalty rule, noting its long pedigree and presence in comparable legal systems. The Court rejected the Australian approach in Andrews v ANZ Banking Group extending the rule to non-breach situations. The Court held that the traditional dichotomy between genuine pre-estimate of loss and deterrent had become too restrictive. Lord Neuberger and Lord Sumption formulated the true test:

“The true test 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 Court emphasised that the rule applies only to secondary obligations triggered by breach, not to primary obligations defining what parties must do or what consideration is payable.

Cavendish

The Court unanimously allowed Cavendish’s appeal. Clause 5.1 was best analysed as a price adjustment clause forming part of the primary obligations: the sellers earned the deferred consideration not only by transferring shares but by observing the restrictive covenants which protected the goodwill being purchased. Cavendish had a legitimate interest extending beyond pecuniary compensation, namely matching the price to the value of the business which depended on the sellers’ continuing loyalty. Clause 5.6 was justified on similar grounds: severing the connection between a defaulting shareholder and the Group was commercially reasonable, and excluding goodwill from the buyback price reflected the legitimate commercial position. Neither clause was extravagant, exorbitant or unconscionable, particularly given the contract was negotiated between sophisticated parties with expert legal advice on equal terms.

ParkingEye

The Court held (Lord Toulson dissenting on the Regulations point) that the £85 charge was not a penalty. Although ParkingEye suffered no direct loss from overstaying, it had a legitimate interest in charging overstayers extending beyond compensation: managing efficient use of parking space for retailers and customers, and generating income to fund the scheme. The charge was not out of all proportion to those interests, was prominently displayed, comparable to local authority penalties, and below the BPA’s recommended maximum.

On the 1999 Regulations, applying Aziz v Caixa d’Estalvis, the majority held that although there was some imbalance compared to the consumer’s position under general law, it did not arise contrary to good faith. ParkingEye had a legitimate interest in inducing compliance, the charge underpinned a business model providing free parking, and a hypothetical reasonable motorist would have agreed to the terms which were prominently displayed and objectively reasonable.

Dissent

Lord Toulson dissented on the Regulations issue in ParkingEye, considering that ParkingEye had not shown it could reasonably assume an individually negotiating consumer with legal advice would have agreed to the £85 charge, particularly given it allowed no grace period, took no account of disabilities or unforeseen circumstances, and placed the entire cost of the scheme on a minority of overstayers.

Implications

The decision is a landmark restatement of the penalty rule. The traditional Dunlop test focusing on “genuine pre-estimate of loss” versus “in terrorem” deterrent has been displaced in complex commercial cases by a broader test focused on whether the secondary obligation is out of all proportion to any legitimate interest of the innocent party. Lord Dunedin’s four tests remain useful for straightforward damages clauses but are not exhaustive. The rule does not apply to primary obligations, and courts will respect the bargains of sophisticated commercial parties dealing at arm’s length with legal advice. The decision narrows the scope for challenging carefully drafted commercial provisions as penalties, increases certainty in commercial contracting, and confirms that legitimate commercial interests beyond compensation may justify clauses that would not satisfy a pure pre-estimate test. For consumers, the case confirms that the penalty rule and the unfair terms regime operate distinctly, though here produced the same result. The decision will affect drafting of share purchase agreements, parking enforcement schemes, loan default provisions, and many other contractual contexts where clauses operate upon breach.

Verdict: The Supreme Court allowed Cavendish’s appeal (holding clauses 5.1 and 5.6 enforceable and not penalties) and dismissed Mr Beavis’s appeal (holding the £85 parking charge was neither a penalty nor unfair under the 1999 Regulations). Lord Toulson dissented in part on the Regulations issue in ParkingEye.

Source: Cavendish Square Holding BV v Talal El Makdessi [2015] UKSC 67