How might your commercial contracts be affected by the end of the Brexit transition period, and what can you do to protect your position?

On 30 December 2020, the UK government and the European Commission signed the EU–UK Trade and Cooperation Agreement (TCA) which now governs the trade relationship between the UK and the EU following the end of the transition period on 1 January 2021. The following checklist sets out some of the key provisions of a commercial contract that will need to be considered.

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For legal advice and assistance, contact Christopher Buck, Associate Partner & Corporate Solicitor, at Franklins on 01908 660966 or email christopher.buck@franklins-sols.co.uk.

From time to time a business may become involved in a contractual dispute whereby a large monetary penalty is sought. These disputes sometimes relate to penalty clauses that have been incorporated within a contract and understanding whether such penalties may or may not be enforceable is crucial to determining the extent of a defaulting party’s liability.

What is a penalty clause?

In simple terms, a penalty clause is a contractual provision that requires the defaulting party to provide monetary compensation to the innocent party in respect of a breach of a secondary obligation contained within a contract.

When is a penalty clause enforceable and which case law has changed the way we interpret penalty clauses?

In the landmark combined judgment of Cavendish Square Holdings BV v Makdessi; ParkingEye Ltd v Beavis [2015] UKSC 67, the Supreme Court sought to clarify the way in which penalty clauses should be interpreted in commercial contracts. The last case to substantially consider their enforceability was over 100 years ago in the case of Dunlop Pneumatic Tyre Company Ltd v New Garage Motor Co Ltd [1915] in which Lord Dunedin set out four key tests to be applied when determining whether the clause in question is a genuine pre-estimate of liquidated damages or a penalty.

The key tests applied under Dunlop involved assessing whether the extent of the monetary compensation sought was ‘unconscionable’ and ‘extravagant’ in comparison to the loss incurred by the innocent party. Consideration was also given to whether the loss was so disproportionate it could only be intended to deter a breach of contract. If the loss was found to be wholly disproportionate, it would be construed as a penalty and unenforceable.

The decisions of both Cavendish and ParkingEye reconsidered the tests to be applied when considering the enforceability of penalty clauses. They established that a clause can only be considered to be penal where it is a matter of substance, not form. In particular, in order to consider whether a clause in question is a penalty clause depends entirely upon whether the clause relates to a primary or secondary contractual obligation. If a breach of the obligation gives rise to a new one, this would be construed as a conditional primary obligation. However, in the instance that the breach gave rise to an obligation that would not otherwise exist, it would be a secondary obligation that is an alternative to damages and could be found to be a penalty clause.

The Supreme Court were keen to uphold the doctrine of penalties and, while acknowledging that Lord Dunedin’s key tests were still relevant, the majority held that the commercial approach to adopt was to have regard to the innocent party’s interests, whether these were being legitimately protected and whether the remedy the clause seeks to impose is proportionate to the innocent party’s interest. If these two tests can be established, the penalty clause will be enforceable.

Can a penalty clause be disputed?

A penalty clause may be disputed if the party to which the penalty is imposed against is of the opinion that the penalty sought far exceeds the innocent party’s attempt at quantifying a genuine pre-estimate of a loss incurred and which also seeks to act as a deterrent to the innocent party ever committing a breach of the relevant clause. Ordinarily, penalty clauses imposed in respect of primary obligations are enforceable. However, secondary obligations are not. It will be a matter of interpretation as to whether a penalty clause is enforceable applying the tests established following the Supreme Court’s judgement in Cavendish and ParkingEye.

For advice and assistance in relation to the drafting of a penalty clause within a contract or understanding the enforceability of any penalty provisions, contact Christopher Buck, Associate Partner & Commercial Solicitor within our Business Services team on 01908 660966 / 01604 828282 or email christopher.buck@franklins-sols.co.uk.

The United Kingdom along with the rest of the world is currently in unchartered territory. Extensive travel bans have been implemented, schools have been closed and the stock markets are in freefall with the FTSE 100 falling to levels not seen since the financial crisis.

It has become apparent that no government was adequately prepared for a pandemic of this nature and it is undeniable that the uncertainty is worrying for all sectors of the economy.

With that being said, it is inevitable that commercial contracts are being delayed so it is worthwhile taking the time to assess what your legal options are if you are unable to fulfil your contractual obligations.

A contract is a legally enforceable agreement that creates rights and obligations between those who agree to be bound by its terms, provided that certain key elements are present (namely, offer, acceptance, consideration, intention to create legal relations and certainty of terms).

Each party is entitled to expect the performance of a contract which has been agreed. If you terminate a contract without a common law or contractual right to do so, this would normally amount to repudiation, which in itself attracts significant consequences for the benefit of the ‘innocent party’. It is therefore pertinent to be aware of the two key exceptions to a breach of contract, these are force majeure and the common law doctrine of frustration, both of which are considered in turn below.

Force Majeure

Force Majeure is a phrase derived from French civil law which means ‘superior force’. You will find that most commercial contracts include an express force majeure clause tucked away at the back as it is not an automatic right. It is intended to suspend or terminate contractual obligations following the occurrence of certain events which are outside the parties’ reasonable control and that prevent them from performing their obligations. You will need to carefully asses the specific wording of the relevant clause, normally it will contain a non-exhaustive list of circumstances which would be deemed as a ‘force majeure event’ as there is no statutory or common law definition.

It is important to check whether a pandemic or epidemic is specifically covered as the World Health Organisation has recently declared that the outbreak of Covid-19 has reached pandemic levels. In the event that neither pandemic nor epidemic is listed it may be worth considering whether “any law or any action taken by a government or public authority” is included and indeed applicable instead, especially if the government move to enforce a mandatory lockdown.  In any event, it is likely that any counterparty will resist reliance on such a clause leading to the possibility of litigation.

In comparison, a short form force majeure clause would normally contain wording to the effect of “neither party shall be in breach of this agreement nor liable for delay in performing, or failure to perform, any of its obligations under this agreement if such delay or failure result from events, circumstances or causes beyond its reasonable control…..”. Obviously, this is a much wider definition and in the absence of a list of specified events, it means it is open to interpretation on whether this clause would extend to cover Covid-19.

Once it has been established that a force majeure event has occurred, causation also has to be established, i.e. that the outbreak of Covid-19 has prevented, hindered or delayed a party from performing any of its contractual obligations. If performance has only been made more difficult or expensive then the protection is unlikely to apply. A party seeking to rely on the force majeure clause should also be able to demonstrate the use of reasonable endeavours to mitigate any loss.

There may also be a process to follow in that the affected party has to serve notice on the other party within a certain number of days to notify them that a force majure event has occurred. Time is therefore potentially of the essence. 

If you can successfully establish that a force majure event has occurred the clause will typically provide that the parties’ obligations under the contract are suspended until the force majeure event ceases. At this point, the contract will be ‘resurrected’. Alternatively, you may find that a more commercially attractive option has been drafted which states that so long as the performance of your obligations are continuously prevented, hindered or delayed for a certain number of weeks or days the agreement may be terminated by both parties. In terms of costs, unless the clause specifically details recovery provisions the general position is that any costs incurred or payments made will not be recoverable.

Frustration

In the absence of an express force majeure clause in a commercial contract, the common law doctrine of frustration may assist a party who is unable to fulfil its contractual obligations. You would need to demonstrate that a frustrating event has occurred after the contract was formed which, due to no consequence of your own, has made it impossible for you to carry out your contractual obligations or that they have become radically different.

Whilst this may seem like an attractive alternative, each case will be assessed on its own merits and case law has shown that a very high threshold must be met before the court will deem that a contract is truly frustrated. This is so parties are not released from their contractual obligations too easily. Please note in the past it has been deemed that a contract is not frustrated where:-

• a force majeure clause in the agreement covers the situation instead (unless such clause is incomplete);
• the contract is more difficult or expensive to perform;
• there are changes in economic conditions; and
• the frustrating event should have been pre-empted or is due to the conduct of one of the parties.

These are only a few examples, but seem particularly relevant in the context of this article.

If a contract has been frustrated, all parties will be released from their future (not past) obligations immediately and the contract will be automatically brought to an end. Neither party may sue for breach. The allocation of loss is then decided by the Law Reform (Frustrated Contracts) Act 1943. Under the Act payments can be recovered in full or in part, in a manner deemed equitable by the courts.

Insurance

Finally, you should also check your business insurance or speak to your broker to see what risks are covered. Standard commercial insurance policies typically only provide cover against a wide range of day-to-day risks, therefore unless you have put specific cover in place which protects your business against interruption arising from a infectious disease or forced closure by the authorities it is unlikely that you will be able to make a claim. Even if your policy covers such perils you may find that a claim can only be made in relation to specific diseases named in the cover.

If you require legal assistance regarding contracts, please do not hesitate to contact Christopher Buck, Associate Partner in our Business Services team on 01908 660966 / 01604 828282 or at christopher.buck@franklins-sols.co.uk who will be happy to assist.