Sample 2:1 Undergraduate Law Report

The English Law's Approach to Liquidated Damages Clauses in Light of Cavendish Square Holding BV v Talal El Makdessi [2015] UKSC 67

Introduction

This report seeks to assess the law's position with regards liquidated damages clauses. In particular, the report will seek to identify the distinction between a liquidated damage clause and a penalty clause and address whether or not it can be said that so called penalty charge clauses are now regarded as being acceptable in English law.

Liquidated Damages Clauses

In English contract law, damages have traditionally been regarded as being awarded to recompense the injured party for the loss caused by breach, so far as money can put that party in the position it would have been in had the agreement been performed[1]. This may include loss of profit or, in the alternative, expenditure wasted in reliance on the promise[2]. However, in many complex commercial transactions parties may find it difficult to quantify potential damages in their pre-contractual negotiations[3]. Accordingly parties in commercial contracts have occasionally agreed what the damages will be between them, so that the amount of actual loss need not be proved if the stipulated breach occurs. Historically the courts upheld agreed damages in keeping with the nineteenth century emphasis on freedom of contract, subject to the rule against penalties[4].

These clauses have taken two forms; liquidated damages and penalty clauses[5]. Traditionally liquidated damages clauses were described as genuine pre-estimates of loss, and penalty clauses as threats designed to deter the other party from breaching the contract[6]. Whilst traditionally liquidated damages have been accepted by the courts, punitive damages are not ordinarily awarded for breach of contract[7]. Despite the nineteenth century contract theories emphasis on freedom of contract, the courts rejected punitive clauses in contracts as far back as Kemble v Farren[8]in 1829.

However, the difficulty that has been faced by the Courts has historically been distinguishing between the two clauses. In Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd[9]the tyre manufacturers Dunlop wished to ensure that their buyers, the New Garage Co, did not resell their tyres at a lower price. They therefore included a clause in the agreement providing that if the garage did so sell the tyres at a lower than agreed price they breached the agreement and would have to pay Dunlop a sum for each sold below the arranged price. The clause expressly stated that the sums payable would be liquidated damages and not a penalty but as found in Kemble the courts will not regard such a statement as definitive[10]. The House of Lords, overturning the Court of Appeal held that it was a valid liquidated damages clause rather than a punitive clause. In trying to distinguish between punitive clauses and true liquidated damages clauses Lord Dunedin laid down a set of principles for when a clause may be considered a liquidated damages clause rather than an unenforceable penalty clause[11].

These principles were to be applied as at the date of the agreement. First, a clause would be regarded as a penalty if the sum stipulated was "extravagant and unconscionable in amount" compared with the greatest loss that could conceivably follow from the breach[12]. Secondly, the clause would be regarded as a penalty if the breach consisted solely in failing to pay a required sum and the amount stipulated was higher than this figure. Thirdly, that there is a rebuttable presumption that a clause will be penal in nature when there is payable a lump sum by way of compensation on the occurrence of any of several events, some serious and others trifling[13]. On the other hand, Lord Dunedin stated that a genuine pre-estimate is acceptable, even if the loss itself was impossible to estimate precisely[14].

The principles set down in Dunlop consolidated the somewhat confused position of the law prior to this point[15]. However, Dunlop was still regarded as the leading authority on when a clause will be regarded as an unenforceable punitive clause[16]. Despite this, the formulaic nature of the test in Dunlop resulted in some difficulty for the Courts as seen in Lordsvale Finance Plc v Bank of Zambia[17]for example[18]. This test has been overhauled and reformulated following the Supreme Court's decision in the conjoined cases of Cavendish Square Holding BV v Talal El Makdessi and ParkingEye Ltd v Beavis[19].

The New Test

ParkingEye v Beavis was a high profile case primarily because of the consumer implications that were involved as a member of the public challenged an £85 parking charge imposed by ParkingEye through the County Court, Court of Appeal and finally Supreme Court[20]. However, the conjoined cases are important because they allowed in the Supreme Court to reconsider the English law's approach to the consideration of penalty charges[21].

In Makdessi, a businessman sold some of his shares in a company to the claimants, Cavendish. A clause in the agreement provided that if certain restrictive covenants were breached, the final instalments of Cavendish's purchase price would be forfeited. A second clause allowed Cavendish to buy the seller's remaining shares at a price excluding goodwill. Both were challenged as penalties. The Supreme Court upheld both clauses. Lord Neuberger and Lord Sumption treated them as primary obligations governing the price and transfer of the shares. Cavendish had a legitimate interest in protecting the goodwill it had bought[22]. More importantly, in doing so, their Lordships found that the test for considering when a particular clause should be regarded as a penalty clause or not could not be reduced to the criteria set down in Dunlop[23]. This was, according to their Lordships, because the criteria set down in Dunlop had been interpreted in an over-literal way ever since, and had resulted in the law in the area being in a rather artificial state[24]. As such, the reasonableness of the parties pre-estimate of loss was argued to hold too much evidential weight in consideration of whether or not the term was a penalty[25]. In Alfred McAlpine Capital Projects Ltd v Tilebox Ltd[26]the court assessed the pre-estimate primarily on objective grounds and upheld the clause[27].

Whilst the Dunlop principles remain useful for straightforward damages clauses, their Lordships held in Makdessi that the test that should now be applied by courts in considering whether or not a clause is said to be "penal" or not, is whether or not the clause in question in substance imposes a secondary obligation upon breach and a detriment on the contract breaker that is "out of all proportion" to any legitimate interest that the other party has in the performance of the primary obligation[28]. Deterrence alone does not make a clause penal, but punishment for its own sake is not a legitimate interest.

This test has been argued to be an improvement over the test in Dunlop because it allows the Courts to view the clause within the entire commercial context of the case[29]. The test in Dunlop had resulted in a rather over-formulaic approach which left little room to consider commercial interests beyond compensation[30]. This in turn also restricted the parties autonomy and freedom of contract, as sophisticated commercial parties, well-advised and with resources and legal advisors should it is argued, be able to include such provisions if the inclusion of the clause performs a genuine commercial interest[31]. It was suggested by Lord Neuberger and Lord Sumption in Makdessi that there were genuine reasons in Dunlop for the tyre manufacturer to include such a clause outside of the scope of it being a "genuine pre-estimate of loss". For example, under the law at the time, Dunlop were entitled to ensure that their brand was protected from cheap resales which may have had a detrimental impact on their corporate image and branding[32]. Such harm was difficult to value in advance, and the inclusion of the clause was more than an in terrorem incentivisation for the party to comply with its primary obligation under the contract, which was not to resell the tyres below the agreed price[33].

Analysis

The new test set down in Makdessi therefore simplifies the courts' consideration of when a clause may be regarded as being penal in nature, and also allows a wider consideration of the overall commercial context of a clause. By considering firstly, whether the obligation imposed is a secondary one, and secondly whether it is out of all proportion to any legitimate interest in performance that the innocent party has, the Supreme Court has also reaffirmed the principle of freedom of contract[34]. Freedom of contract and autonomy of sophisticated commercial parties was argued to be ignored by the Court of Appeal in Makdessi[35] and this criticism has been remedied by the Supreme Court's decision. Where properly advised parties of comparable bargaining power have negotiated the contract, the court starts from a strong presumption that they are best placed to judge what is legitimate. In Houssein v London Credit Ltd [2026] EWCA Civ 830 the Court of Appeal upheld a default interest rate in light of the lender's interests, including the increased credit risk.

However, an issue raised by these cases is that whilst Makdessi concerned an experienced businessman with the resources and bargaining power to properly negotiate individual clauses in an agreement. As such, traditional notions of freedom of contract may be properly applicable to that particular case, and it is argued, it would be a strange decision by which a court would refuse to uphold such a freely bargained agreement for some paternalistic reasoning[36]. However, the same is not true of the appellant in ParkingEye who was instead a consumer dealing with a business in the course of their trade.

In ParkingEye, the respondents ParkingEye operated a car park in which the appellant, Mr Beavis had parked. The car park had a stay duration limit of two hours and signs indicated clearly that any overstay would result in an £85 charge being imposed on the driver. The appellant stayed for nearly three hours and subsequently received a charge of £85. Applying the new test set down in Makdessi it could clearly be argued that ParkingEye had a legitimate interest in ensuring that the car park was not clogged up by overstaying customers, and in funding the parking scheme through the charges. The £85 charge was held to be not out of all proportion to those interests by the Court. However, as a consumer, Mr Beavis also argued that he was protected by the provisions of the Unfair Terms in Consumer Contracts Regulations 1999 (the Regulations)[37]. These provisions provided that a term in a consumer contract that has not been individually negotiated will be unfair if, contrary to the requirement of good faith, it causes a significant imbalance in the parties' rights and obligations arising under the contract to the detriment of the consumer[38]. By reference to the non-exhaustive list of terms which may be regarded unfair as included in Schedule 2 to the Regulations, the Court held that this may be the case where any consumer is required to pay a "disproportionately high" sum in compensation for the breach of an obligation[39]. The majority separately held that the charge was fair under the Regulations. The signs were prominent, the charge supported two hours of free parking and a reasonable motorist could be expected to agree to those terms. Lord Toulson dissented on the question of fairness[40].

This is notable because such a determination is likely to be applied in the future under the Consumer Rights Act 2015[41] (CRA), which replaced the Regulations for consumer contracts entered into from 1 October 2015. This is because the fairness test in the Regulations is retained in s62(4) CRA, and now also applies to individually negotiated terms[42]. A term requiring disproportionately high compensation for non-performance is among those that may be unfair under Schedule 2, paragraph 6. An unfair term is not binding on the consumer. The earlier decision in Office of Fair Trading v Abbey National Plc[43] concerned the exclusion of a review of the adequacy of the price of a package of banking services. It did not decide that bank charges were generally fair. It may be argued therefore in light of the ParkingEye decision, that the rule against penalty charges has been severely restricted[44]. Whether a consumer charge is fair depends on the circumstances when the term was agreed and the other terms of the contract, as well as the amount charged.

Conclusion

The law on penalties in English law was fundamentally altered by the decision in Makdessi and ParkingEye. According to the new test, a clause will only be unenforceable for being penal in nature if it imposes a secondary obligation on breach whose detriment is "out of all proportion" to any legitimate interest that the other party has in performance. If the clause is a penalty, the injured party can still claim ordinary damages for loss caused by the breach. It is argued that whilst this may be defensible with regards arguments of freedom of contract and party autonomy, it may lead to unfairness and difficulty for consumers who may find it difficult to show that a charge is 'disproportionately' high, although they retain the separate protection of the statutory fairness test.

Bibliography

Table of Cases

Addis v Gramophone Co Ltd [1909] AC 488

Alfred McAlpine Capital Projects Ltd v Tilebox Ltd [2005] EWHC 281 (TCC)

Attorney General v Blake [2000] UKHL 45

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

Cellulose Acetate Silk Co v Widnes Foundry [1933] AC 20

Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd [1914] UKHL 1

Else (1982) Ltd v Parkland Holdings Ltd [1994] 1 BCLC 130

Houssein v London Credit Ltd [2026] EWCA Civ 830

Kemble v Farren (1829) 6 Bing 141

Lordsvale Finance Plc v Bank of Zambia [1996] 3 WLR 688

Office of Fair Trading v Abbey National Plc [2009] UKSC 6

ParkingEye Ltd v Beavis [2015] UKSC 67

Table of Legislation

Consumer Rights Act 2015

Unfair Terms in Consumer Contracts Regulations 1999 SI 1999/2083

Secondary Sources

Barclay T, 'Fair is Foul and Foul is Fair?' [2015] S.J 159 [42] 38

Fuller L.L., Perdue W.R., 'The Reliance Interest in Contract Damages' in Richard Stone, James Devenney, Text, Cases and Materials on Contract Law (3^rd edn Routledge 2014)

Giliker P, 'Case Note England and Wales, UKSC 4 November 2015, Cavendish Square Holdings BV v Makdessi; ParkingEye Ltd v Beavis [2017] Euro Rev Priv L 25 [1] 173

MacIntyre E, Business Law (5^th edn Longman 2010)

McKendrick E, Contract Law (11^th edn Palgrave 2015)

McKendrick E, Contract Law: Text, Cases and Materials (6^th edn OUP 2014)

Nicholson A, 'Too Entrenched to be Challenged? A Commentary on the rule against Contractual Penalties post Cavendish v Makdessi and ParkingEye v Beavis' [2016] EJCLI 22 [3] Sheffield Hallam University Research Archive (original journal site accessed on 16 June 2017)

O'Sullivan J, 'Lost on Penalties' [2014] CLJ 73 [3] 480

Poole J, Textbook on Contract Law (13^th edn OUP 2016)

Zhu S, 'Performance Interest and Unconscionability in Affirmation Cases' [2017] KSLR 8 [1] 20

Footnotes

[1] Attorney General v Blake [2000] UKHL 45

[2] Lon L. Fuller, William R. Perdue, 'The Reliance Interest in Contract Damages' in Richard Stone, James Devenney, Text, Cases and Materials on Contract Law (3^rd edn Routledge 2014) 642

[3] Ewan MacIntyre, Business Law (5^th edn Longman 2010) 229

[4] Jill Poole, Textbook on Contract Law (13^th edn OUP 2016) 389

[5] ibid

[6] Ewan MacIntyre, Business Law (5^th edn Longman 2010) 229

[7] Addis v Gramophone Co Ltd [1909] AC 488

[8] (1829) 6 Bing 141

[9] [1914] UKHL 1

[10] (1829) 6 Bing 141

[11] Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd [1914] UKHL 1 (L Dunedin) 1

[12] ibid

[13] ibid

[14] Dunlop (n 11), see also Cellulose Acetate Silk Co v Widnes Foundry [1933] AC 20

[15] Ewan McKendrick, Contract Law: Text, Cases and Materials (6^th edn OUP 2014) 908

[16] Paula Giliker, 'Case Note England and Wales, UKSC 4 November 2015, Cavendish Square Holdings BV v Makdessi; ParkingEye Ltd v Beavis [2017] Euro Rev Priv L 25 [1] 173

[17] [1996] 3 WLR 688

[18] Alex Nicholson, 'Too Entrenched to be Challenged? A Commentary on the rule against Contractual Penalties post Cavendish v Makdessi and ParkingEye v Beavis' [2016] EJCLI 22 [3] Sheffield Hallam University Research Archive accessed on 3 November 2026

[19] [2015] UKSC 67

[20] Theo Barclay, 'Fair is Foul and Foul is Fair?' [2015] S.J 159 [42] 38

[21] ibid

[22] Cavendish Square Holding BV v Talal El Makdessi [2015] UKSC 67 (L Neuberger and L Sumption) 3, 74–75, 80–83

[23] ibid 22, 31–32

[24] ibid 22

[25] Ewan McKendrick, Contract Law (11^th edn Palgrave 2015) 374

[26] [2005] EWHC 281 (TCC)

[27] Ewan McKendrick, Contract Law (11^th edn Palgrave 2015) 374

[28] Cavendish Square Holding BV v Talal El Makdessi [2015] UKSC 67 (L Neuberger and L Sumption) 32

[29] ibid

[30] Else (1982) Ltd v Parkland Holdings Ltd [1994] 1 BCLC 130 (Hoffmann LJ) 144

[31] Janet O'Sullivan, 'Lost on Penalties' [2014] CLJ 73 [3] 480

[32] Cavendish Square Holding BV v Talal El Makdessi [2015] UKSC 67 (L Neuberger and L Sumption) 31, see also 21–24

[33] ibid

[34] Sicheng Zhu, 'Performance Interest and Unconscionability in Affirmation Cases' [2017] KSLR 8 [1] 20

[35] Janet O'Sullivan, 'Lost on Penalties' [2014] CLJ 73 [3] 480

[36] ibid

[37] Unfair Terms in Consumer Contracts Regulations 1999 SI 1999/2083

[38] ibid Reg 5(1)

[39] ibid Schedule 2 Para 1(e)

[40] ParkingEye Ltd v Beavis [2015] UKSC 67 (L Neuberger and L Sumption) 104, 107–109, and Lord Toulson dissenting at 315

[41] Consumer Rights Act 2015

[42] ibid s62(4), see also s62(1), (5) and Schedule 2, paragraph 6

[43] [2009] UKSC 6

[44] Alex Nicholson, 'Too Entrenched to be Challenged? A Commentary on the rule against Contractual Penalties post Cavendish v Makdessi and ParkingEye v Beavis' [2016] EJCLI 22 [3] Sheffield Hallam University Research Archive (original journal site accessed on 16 June 2017)