With two judgments recently delivered in the Supreme Court, it is important to consider the consequences for lawyers drafting or negotiating, and advising on commercial contracts.
The drafting of commercial contracts – especially in relation to clauses that would previously have been deemed penalties – will now be governed by the judgments in Cavendish and ParkingEye.
The judgments have established that where a deterrent is used, this will no longer equate to a penalty.
In Cavendish, a Share Purchase Agreement (“SPA”) was put in place regarding shares being sold by the defendant to the claimant. Should the defendant breach the non-competition covenant, the SPA provided for two outcomes. The first, is defendant would no longer be entitled to receive outstanding payments of significant sums under the SPA. The second was the claimant could choose to exercise a right in purchasing the defendant’s remaining shares at a reduced figure.
Upon the defendant beginning work for the claimant’s competitor – and as such breaching the non-competition clause – it was up to the court to decide whether the two clauses, and thus two outcomes, were penalties. The court held that the outcomes were primary obligations, as they were conditions of the contract, and, as they did not impose a secondary obligation, they were upheld and enforceable.
ParkingEye used a deterrent. This was an £85.00 fine, which would be imposed on anyone overstaying the 2-hour time limit in the car park. Signs in the car park clearly displayed the 2-hour maximum free stay, and that the fine would be imposed if anyone exceeded this limit. The court found the fine was a deterrent for people overstaying the limit in the car park. The court found however, that it was not a penalty clause.
Previously, it was established a clause may be found to be a penalty where a sum greater than a genuine pre-estimate of loss is demanded by the claimant.
The fine in ParkingEye was not found to be a penalty, as the land-owner of the car park had a legitimate interest in wanting a prompt turnover in their car park. This, on top of ParkingEye’s interest in making a profit, was enough to show it was a deterrent, but did not equate to a penalty.
As such, the previous rule surrounding penalty clauses has been abolished, and the recent judgments have determined a greater allowance for clauses, which intend to deter a party from doing something. A deterrence will not amount to a penalty, unless it requires a secondary obligation arising further to the breach.
The fine imposed in ParkingEye would be the primary obligation. Primary obligations are terms of the contract which are enforceable, even where they are a deterrent. A secondary obligation, which makes a further imposition, may be found to be a penalty. However, the court went on to state that even secondary obligations could be justified on wide grounds.
The case between Marks & Spencer and BNP Paribas regarding overpaid rent was concluded in December 2015. The court had to decide whether there was an implied term in the lease between the parties, which would allow M&S to receive back an apportioned sum of rent that had been overpaid. M&S had paid rent in advance for a period that extended after the break date of the lease. Further to the break clause terminating the lease early, M&S looked to claim for the rent which was paid for the period after the break date.
The court unanimously held that no such implied term could be found and, as such, M&S’s appeal was to be dismissed. The judges’ reasoning was that a professionally drafted lease was entered into by the parties, which did not stipulate or imply the inclusion of the implied term. Therefore, to go against the law stipulating landlords retain any rent paid in advance, was not considered to be the appropriate way forward by the court. They found the inclusion of such a term would have required to be expressly included in the lease.
Moving forwards, it is important to consider this ruling and, as such, the implications of break clauses when drafting a lease. It is worth thinking about the payment dates for the rent and whether these coincide with the break clause to avoid such a problem. Similarly, it may be advisable to include a clause that expressly confirms the position of the parties upon the exercising of the break clause and any claim for overpaid rent.
The above cases show how two important areas of commercial law have been clarified. As such, the importance of clear drafting and the inclusion of the relevant express terms are paramount. This highlights the need to receive legal advice when negotiating and entering into commercial contracts. Please feel free to comment below with any questions, or contact me to discuss any contractual term issues you may have.