In April 2013 I wrote an article about liquidated damages clauses in commercial contracts, in the light of the decision in Cavendish Square Holdings v El Makdessi (https://www.stephens-scown.co.uk/blog/2013/04/liquidated-damages/). A few months later I wrote a follow-up article commenting on how the law regarding liquidated damages and penalties had developed in the light of the Court of Appeal decision in the case of Unaoil Limited v Leighton Offshore Limited (https://www.stephens-scown.co.uk/blog/2014/10/penalties-and-liquidated-damages/).
Both these 2013 and 2014 cases, and many others before them, were developments from the foundation principles in this field, which were laid down by Lord Dunedin, exactly 100 years ago, in the case of Dunlop Pneumatic Tyre v New Garage Motor. Later this year the Supreme Court plans to review the existing law in this area, and will hopefully deliver much needed guidance to both lawyers and non-lawyers who come across liquidated damages clauses in their contracts.
In Dunlop, Lord Dunedin explained that the underlying rationale of the rule is that the court will not enforce a contractual provision for payment in the event of breach of contract, where the amount to be paid is out of all proportion to the loss caused by the breach. Traditionally, the essence of the rule was that if a liquidated damages clause, instead of being a genuine pre-estimate of loss, required excessive payment in the event of breach, it was likely to be unenforceable as a penalty clause, because its function was to act as a deterrent and not to compensate the innocent party.
The rule has been reformulated since Dunlop and, more recently, the courts have shown a willingness to adopt a more flexible approach to the enforceability of liquidated damages clauses, by applying a broader test which consists of asking whether there is any commercial justification for a discrepancy between the sum in the clause and the amount the innocent party would have received if damages had been assessed at common law.
The Court of Appeal decision in Cavendish Square Holdings v El Makdessi demonstrates the inherent uncertainty in the approach to assessing commercial justification, which requires the court to examine the contract as a whole, in the circumstances and context in which it was made.
Subsequently, however, in the case of ParkingEye Ltd v Beavis, the Court of Appeal appeared to water down the rule against penalties. In that case, Mr Beavis overstayed a 2 hour period of free parking by 56 minutes and was required to pay £85 to the parking management company. He refused to pay, and the company sued him. The court decided that the £85 charge was not a penalty, while accepting it bore no direct relationship to the loss that the company could suffer. The court justified its decision on the basis that a £85 was not extravagant and moreover there were social and commercial reasons for upholding the clause.
Both the ParkingEye case and the Cavendish Square Holdings case are due to be considered by the Supreme Court later this summer. In the meantime, commercial lawyers will wait in eager anticipation of the Supreme Court’s guidance on the subject.
Chris Harper is a partner and head of the dispute resolution team in Exeter. He specialises in commercial litigation and is named as a leader in his field by independent guides to the legal profession Legal 500 and Chambers. To contact Chris please call 01392 210700 or email email@example.com.