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Makdessi and the Australian Penalties Doctrine
A Introduction
1. This paper has been prepared in conjunction with a talk given to the Society of
Construction Law Australia in Brisbane in March 2016 and considers:
(1) the rationale and history of the penalty doctrine;
(2) three recent decisions of the UK and Australian courts, namely Andrews v
ANZ Banking Group Ltd (2012) 247 CLR 205 (“Andrews”), Paciocco v
ANZ Banking Group Ltd (2015) 321 ALR 584 (“Paciocco”) and
Makdessi; and
(3) whether, and if so how, recent decisions have changed the way in which
clauses might be attacked as a penalty.
B The rationale and history of the penalty doctrine
2. In Makdessi, Lords Neuberger and Sumption commented that the penalty doctrine
“is an ancient, haphazardly constructed edifice which has not weathered well”.1
Yet its history and rationaleare central to the decisionsof the Australian High
Court inAndrews and the UK Supreme Court inMakdessi.
3. In short summary, the rule originated from the practice of using defeasible bonds
to secure performance of contractual obligations by requiring payment of a sum of
money that ceased to have effect when the primary obligation was fulfilled.
Equity restrained the enforcement of the bond on terms that the debtor paid
damages, interest and costs on the basis that the “true” intention of the parties was
that the bond was merely security for the primary obligation (the equitable
jurisdiction developed alongside relief from forfeiture). The common law adopted
the equitable rulebut a different rationale; the parties meant what they said but an
intention to penalise breach was contrary to public policy and so unenforceable.
By the end of the eighteenth century the equitable jurisdiction was rarely invoked
andthe doctrine was developed by the common law in its now familiar form.2
1At [3]. 2See Makdessi per Lords Neuberger and Sumption at [3] to [11] and Andrews at [33] to [45].
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4. In Andrews, the Australian High Court brought the equitable jurisdiction back to
life and in Makdessi the UK Supreme Court relied on its historical origins to
justify its continued operation.
C Recent decisions
5. In both England and Australia, Dunlop Pneumatic Tyre Co Ltd v New Garage &
Motor Co Ltd [1915] AC 79, has long been seen as the seminal case on the
penalty doctrine and Lord Dunedin’s speech is often recited.3The case concerned a
contractual provision that required trade and sub-purchasers of Dunlop’s tyres to
pay £5 for each tyre, cover or tube that they failed to sell on for at least the list
price set by Dunlop. New Garage, a sub-purchaser, sold tyre covers for £3 12s
11d when the list price was £4 1s. Dunlop sought to claim £5 per tyre cover sold.
New Garage contended the £5 provision was unenforceable as penalty because it
was payable on a number of different breaches, some of which were minor, and
the amount payable was inordinate compared to the difference between the list
price and sale price.
6. Lord Dunedin identified the following propositions from existing case law:4
(1) The use of the words “penalty” or “liquidated damages” is not conclusive;
(2) The essence of a penalty is a payment of money stipulated as in terrorem
of the offending party; the essence of liquidated damages is a genuine
covenanted pre-estimate of damage;
(3) The question whether a sum stipulated is a penalty or liquidated damages
is a question of construction to be decided upon the terms and inherent
circumstances of each particular contract, judged at the time of making the
contract;
3See IAC (Leasing) Ltd v Humphrey (1972) 126 CLR 131, 143 (Walsh J); O’Dea v Allstates Leasing System (WA) Pty Ltd (1983) 152 CLR 359, 390 (Brennan J); the AMEV-UCDFinance Ltd v Austin 162 CLR 170, 184 (Mason and Wilson JJ), 211 (Dawson J); Ringrow Pty Ltd v BP Australia Pty Ltd (2005) 224 CLR 656, 662. 4At page 86 – 87.
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(4) Various tests “may prove helpful” or “even conclusive”:
a. It will be held to be a penalty if:
i. the sum stipulated for is extravagant and unconscionable in
amount in comparison with the greatest loss that could
conceivably be proved to have followed from the breach;
ii. the breach consists only in not paying a sum of money and
the sum stipulated is a sum greater than the sum which
ought to have been paid;
b. There is a presumption (but no more) that it is a penalty when a
single lump sum is made payable by way of compensation, on the
occurrence of one or more or all of several events, some of which
may occasion serious and others but trifling damage; and
c. It is no obstacle to the sum stipulated being a genuine pre-estimate
of damage, that the consequences of the breach are such as to make
precise pre-estimation almost an impossibility. On the contrary,
that is just the situation when it is probably that pre-estimated
damage was the true bargain between the parties.
7. The House of Lords held that the £5 provision failed the presumption at paragraph
6(4)b above yet it was upheld as enforceable.
Andrews v ANZ Banking Group Ltd (2012) 247 CLR 205
8. Andrews concerned the application of the penalty rule to contractual bank fees
payable when the bank bounced a cheque or allowed the customer to draw in
excess of their available funds or agreed overdraft limit. At first instance, Gordon
J held that such fees were not payable on breach of contract and that the bank’s
customers did not have an obligation or responsibility to avoid such fees,
therefore,the penalty doctrine did not apply. The customers appealed.5
5 Two issues relating to the scope of the doctrine were removed from the Full Court of the Federal Court to the High Court for determination.
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9. To determine the proper scope of the doctrine, the Australian High Court traced its
origins. It noted that equity’s intervention began in relation to bonds that were
accompanied by a condition,the performance or occurrence of which discharged
the bond.6Such conditions may be an occurrence or event, which need not be some
act or omission analogous to a contractual promise.7As such, the High Court held
that it did not follow that the penalty doctrine was only engaged by broken
contractual promises.8 Furthermore, on review of the relevant authorities, the High
Court concluded that this equitable jurisdiction had not been absorbed by the
common law.9
10. This led the High Court to formulate the scope of the equitable doctrine as
follows:10
In general terms, a stipulation prima facie imposes a penalty on a party (‘the first party’) if, as a matter of substance, it is collateral (or accessory) to a primary stipulation in favour of a second party and this collateral stipulation, upon the failure of the primary stipulation, imposes upon the first party an additional detriment, the penalty, to the benefit of the secondary party.
11. Applying this test to the facts, that the fees were not payable upon breach of
contract and that the bank’s customers had no responsibility or obligation to avoid
the occurrence of events upon which the fees were paid, did “not render the fees
incapable of characterisation as penalties”.11
Paciocco v ANZ Banking Group Ltd (2015) 321 ALR 584
6 At [34].7 At [39].8 At [45].9At [51] – [63].10 At [10].11 At [84].
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12. Paciocco is currently subject to an appeal to the Australian High Court.12 Like
Andrews, the dispute related to bank fees (honour fees, dishonour fees, non-
payment fees, late payment fees and overlimit fees).
13. At first instance,Gordon J held that the late payment fees could be set asideon the
basis they were penalties (amongst other matters). In relation to the other types of
fees, she held that they were not payable on breach (therefore, the common law
rule did not apply) and that they were not collateral or accessory to a primary
stipulation (such that the equitable rule did not apply either).13For example, in
relation to the honour fee, Gordon J stated:14
Properly construed, the provision which entitled ANZ to charge the Honour Fee did not impose a fee to be regarded as security for performance by the customer of other obligations to ANZ. It was a fee charged in accordance with pre-existing arrangements according to whether ANZchose to provide something more and further to the customer…
14. On appeal to the Full Federal Court, the court described the relevant test as
follows:
(1) The task is to assess “whether the clause in question is penal in
character”by a consideration of the meaning and content of the words
used and the inherent circumstances judged at the time the contract was
made;15
(2) Following Andrews, that required a consideration of whether:16
…the secondary stipulation is, as a matter of substance, collateral or accessory to a primary stipulation in favour of the obligee and upon failure of which, the secondary stipulation imposes an additional detriment for the benefit of the obligee: Andrews (HC) at [10]; the secondary stipulation is in the nature of security for, and in terrorem of, the satisfaction of the primary stipulation; Andrews (HC) at [10]; and (as an essential element) the secondary stipulation imposes an additional detriment that is out of all proportion to the loss suffered by
12Paciocco v Australia and New Zealand Banking Group Ltd [2015] HCATrans 229. 13Paciocco v Australia and New Zealand Banking Group Ltd (2014) 309 ALR 249. 14 At [202].15 At [95].16 At [95].
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the obligee on the failure of the primary stipulation or that is inordinate or extravagant or oppressive; Ringrow at [21], [28] and [32]…
(3) There is a dichotomy between the penal character of a clause and a
genuine pre-estimate of loss;17
(4) However, where a clause is not a genuine pre-estimate of loss, it may be
that the clause is not a “collateral or accessory clause at all” (and so fall
outside the scope of the doctrine) or be “part of the bargain for another
right”;18
(5) “the object and purpose of the doctrine of penalties is vindicated if one
considers whether the agreed sum is commensurate with the interest
protected by the bargain”;19 and
(6) Extrinsic evidence is available to set a clause in context to ascertain its true
character as penal or not.20
15. On the facts, the Federal Court held that the late payment fees were properly
characterised as payable on breach: that was the plain meaning of the clauses and
commensurate with how they were expressed.21However, the late payment fee
charged was not extravagant and unconscionable.22 The interestANZ was entitled
to protect by the charging of the fees included protecting the risk caused by late
payment,23 the need to put up further regulatory capital24and operational costs,
such as the cost of collecting the funds.25 Further, Gordon J was correct to
characterise the other types of fee as neither payable on breach nor upon failure of
a collateral stipulation.26
17At [96] – [99].18 At [100].19 At [103].20 At [209].21 See [87].22 At [186].23 At [162] and [164]24 At [167].25 At [171].26 At [217 - 244].
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Cavendish Square Holdings v Makdessi [2015] 3 WLR 1373
16. Makdessi concerned the sale of some of the shares in Mr Makdessi’s Middle
Eastern media business to Cavendish, a holding company in the world’s leading
marketing communication services group. Under the agreement, Cavendish was
to pay various stage payments to Mr Makdessi. Two clauses applied in the event
Mr Makdessi became a “Defaulting Shareholder”:27
(1) Pursuant to clause 5.1, Mr Makdessi was not entitled to receive two of the
stage payments (the “Interim Payment” and the “Final Payment”);
(2) Pursuant to clause 5.6, Mr Makdessi granted an option to Cavendish to
require him to sell some or all of his remaining shares at the “Defaulting
Shareholder Option Price” (effectively a net asset valuation which took no
account of goodwill).
17. Mr Makdessi conceded that he was a Defaulting Shareholder but contended that
clauses 5.1 and 5.6 were penalty clauses, relying primarily on the Dunlop
propositions (see paragraph 6 above). He argued that the amount he was
precluded from receiving pursuant to clause 5.1 could be as much as $44,181,600,
which was not a genuine pre-estimate of the loss that might be suffered by reason
of a breach of restrictive covenants of different types and differing levels of
severity. In relation to clause 5.6, he contended the failure to include goodwill in
the valuation required him to transfer the shares at an undervalue and precluded
him from exercising a put option that would have required a sale at a price not
exceeding $75m.
18. At first instance Burton J found the clauses were not penal as there was a
commercial purpose for each; 5.1 was designed to adjust the commercial
consideration for the deal and 5.6 was design to decouple the parties in the event
27Which was defined as including ‘a seller who is in breach of clause 11.2’. Clause 11.2 provided that, until two years after MrMakdessi ceased to hold any shares in the company or the date of the final installment, he would not: carry on, or be engaged or interested with, solicit or accept orders in relation to “restricted activities” (ie the provision of goods and services which competed with the group companies) in “prohibited areas” (ie in countries in which any of the group companies carried on business); divert orders, enquiries or business from any group company; or employ or solicit any senior employee or consultant from any group company.
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of a breach. The Court of Appeal disagreed and Mr Makdessi appealed to the
Supreme Court.
19. Shortly before the hearing, the case of Parkingeye was joined for consideration by
the Supreme Court. It concerned whether an £85 charge for overstaying in a car
park was a penalty. The court at first instance and the Court of Appeal held that it
was not, primarily because it was in Parkingeye’s legitimate interest to apply the
charge to encourage a high turnover of parking.
20. Given its history, the Supreme Court was not prepared to abolish the doctrine
altogether. As to its scope, the Court held as follows:
(1) The impugned provision must provide a contractual alternative to damages
at law on breach of contract.28The Supreme Court was not prepared to
follow the approach of the Australian High Court in Andrews. The
majority commented that that would “represent the expansion of the
courts’ supervisory jurisdiction into a new territory of uncertain
boundaries, which has hitherto been treated as wholly governed by mutual
agreement”.29 This is likely to feature heavily in the forthcoming appeal in
Paciocco;
(2) In addition, the following types of clauses that apply on breach (but may
not be classified as a secondary obligation) fall within the penalty doctrine:
a. Forced transfer clauses. The majoritycommented:30
…it seems to us that there is no reason why an obligation to transfer assets … should not be capable of constituting a penalty. While the penalty rule may be somewhat artificial, it would heighten its artificiality to no evident purpose if it were otherwise.
b. Forfeiture of a deposit paid as surety for performance. The
majority commented:31
28 At [74], [129] and [222].29 At [42].30 At [16]. See also Lord Hodge at [230 - 232].31 At [16]. See also Lord Hodge at [238].
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…the fact that a sum is paid over by one party to the other party as a deposit, in the sense of some sort of surety for the first party’s contractual performance, does not prevent the sum being a penalty, if the second party in due course forfeits the deposit in accordance with the contractual terms, following the first party’s breach of contract.
c. Withholding clauses (possibly). Lord Mance and Lord Hodge held
the doctrine applies to such clauses32andthe majority said they
were:33
…prepared to assume, without deciding, that a contractual provision may in some circumstances be a penalty if it disentitles the contract-breaker from receiving a sum of money which would otherwise have been due to him.
21. The Supreme Court gave three formulations of the test:
(1) The majority:34
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
(2) Lord Mance:35
What is necessary in each case is to consider, first, whether any (and if so what) legitimate business interest is served and protected by the clause, and second, whether, assuming such an interest to exist, the provision made for the interest is nevertheless in the circumstances extravagant, exorbitant or unconscionable. In judging what is extravagant, exorbitant or unconscionable, I consider … that the extent to which the parties were negotiating at arm’s length on the basis of legal advice and have every opportunity to appreciate what they were agreeing must at least be a relevant factor.
(3) Lord Hodge (with whom Lord Toulson agreed):36
whether the sum or remedy stipulated as a consequence of a breach of contract is exorbitant or unconscionable when regard is had to the innocent party’s interest in the performance of the contract.
22. The following guiding comments are likely to be useful:32 At [170] and [226].33 At [73].34 At [32].35 At [152].36 At [255].
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(1) “In a negotiated contract between properly advised parties of comparable
bargaining power, the strong initial presumption must be that the parties
themselves are the best judges of what is legitimate in a provision dealing
with the consequences of breach”;37
(2) The law has “become the prisoner of artificial categorisation”38 and it is
“unfortunate” that Lord Dunedin’s speech in Dunlop has achieved the
status of “a quasi-statutory code”.39 However, Lord Dunedin’s
propositions are a “useful tool” in a simple case;40
(3) The assumption that a provision cannot have a deterrent purpose if it also
had a commercial justification was questionable. The answer lies in
accepting that a clause may be properly justified by some consideration
other than the desire to recover compensation for breach;41
(4) The real question when a contractual provision is challenged is:42
whether it is penal, not whether it is a pre-estimate of loss… These are not natural opposites or mutually exclusive categories. A damages clause may be neither or both. The fact that the clause is not a pre-estimate does not therefore, at any rate without more, mean it is penal. To describe it is a deterrent … does not add anything.
23. On the facts in Makdessi, the Supreme Court was unanimous that clauses 5.1 and
5.6 were designed to protect the legitimate commercial interests of Cavendish,
namely the goodwill in Mr Makdessi’s business, which was critical to its value,
and therefore not penal. More fundamentally, the majority held that the clauses
were primary obligations such that the doctrine was not engaged at all (perhaps
somewhat ominously, Lord Hodge concluded clause 5.6 was a secondary
obligation).
37 At [35].38 At [31].39 At [22].40 At [22].41 At [152].42 At [31].
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24. Similarly, in Parkingeyethe majority (Lord Toulson dissenting) held that the
landlord and operator of the car park had legitimate interests in stipulating a sum
extending beyond compensation: that car spaces were made available for shoppers
and the costs of operating the car park could be met.
D The narrow view
25. On one view, recent decisions of the UK and Australian Courts have not
significantly changed the way in which clauses might be attacked as a penalty.
The Courts have always been reluctant to intervene (particularly where a contract
is entered into by sophisticated and well-advised parties), many decisions appear
to focus on the innocent party’s legitimate interest in the bargain (as opposed to a
precise monetary evaluation of the cost of breach) and the propositions in Dunlop
have not constrained the Courts (indeed, the impugned clause in Dunlop satisfied
one of Lord Dunedin’s persuasive examples yet was found not to amount to a
penalty). Four ways in which it might be argued the law has changed are
considered below.
1) A greater reluctance to intervene?
26. In Makdessithe Supreme Court was not prepared to abolish the doctrine
altogether, but it might be thought that, in reversing the Court of Appeal’s
decision that clauses 5.1 and 5.6 were penal, the UK Courts (and potentially the
Australian Courts after the Paciocco appeal) are likely to display an even greater
reluctance to intervene.
27. Yet, successfully invoking the doctrine has always been a formidable hurdle. For
example:
(1) In Grocon Constructions (Qld) Pty Ltd v Juniper Developer (No 2) Pty Ltd
[2015] QCA 291, in relation to a challenged liquidated damages clause in
a construction contract, the Queensland Court of Appeal notedthat Counsel
had not found any decided case in which the penalty doctrine had been
successfully applied in a similar context.43
43 The Queensland Court of appeal also referred to the UK High Court in Alfred McAlpine Capital Projects Limited v Tilebox Limited [2005] EWHC 281 in which Jackson J quoted Hudson’s statement that “there would appear in fact to be virtually no reported cases in the United Kingdom where periodical liquidated damages for delay in building contract have been held excessive so as to
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(2) In Alfred McAlpine Capital Projects Ltd v Tilebox Ltd [2005] BLR 271
(TCC). Mr Justice Jackson stated:44
…the courts are predisposed, where possible, to uphold contractual terms which fix the level of damages for breach. This predisposition is even stronger in the case of commercial contracts freely entered into between parties of comparable bargaining power.
(3) In Murray v Leisureplay [2005] IRLR 946 Lord Justice Buxton stated:45
…if the court cannot say with some confidence that the clause is indeed intended as a deterrent, it appears to be forced back upon finding it to be a genuine pre-estimate of loss.
2) A new test?
28. Whilst the Supreme Court in Makdessi expressed the applicable test in new terms,
arguably it reflects that which the Courts were already doing.
29. Firstly, determining whether a clause was “a genuine pre-estimate” of damage
necessarily required the Courts to have regard to the substance of transactions,
rather than conduct a simple monetary evaluation of the likely loss; after all, the
difficulties in quantifying that loss might be the very reason the parties entered
into the clause. To take an old example, in Clydebank Engineering and
Shipbuilding Co Ltd v Castaneda[1905] AC 6, the House of Lords considered a
provision in a shipbuilding contractrequiring payment of £500 a week for late
delivery of four torpedo boats to the Spanish Government, which were for use
against Cuba in their war for independence.46 The provision was held to be a valid
liquidated damages clause. As stated by Lord Chancellor Halsbury:47
constituted a penalty” (at [47]). 44At [48(3)]. 45At [114]. 46 It was said that if the boats had been delivered on time the Spanish government may have been in a position to establish a blockade around the coast of Cuba, the Cuban insurrection might have been crushed and American intervention avoided. In the event, America did intervene and Spain relinquished its sovereignty over Cuba.47At 78 – 79.
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Supposing there was no such bargain, and supposing the Spanish Government had to prove damages in the ordinary way … just imagine what would have to be the cross examination …
I need not pursue that topic. It is obvious on the face of it that the very thing intended to be provided against by this pactional amount of damages is to avoid that kind of minute and somewhat difficult and complex system of examination which would be necessary … in order to do that properly … one ought to have before one’s mind the whole administration of the Spanish Navy – how are they going to use their torpedo-boat destroyers in one place rather than another… It would be absolutely idle and impossible to enter into a question of that sort…
30. Secondly, in MakdessiLords Neuberger and Sumption (with whom Lord
Carnwarth agreed) appear to suggest the “new test” merely enlivens the forgotten
speech of Lord Atkinson in Dunlop, such that it isn’t a new formulation at all.48 Of
the £5 charge, Lord Atkinson said:
It has been urged that as the sum of 5l becomes payable on the sale of even one tube at a shilling less than the listed price, and as it was impossible that the appellant company should lose that sum on such a transaction, the sum fixed must be a penalty … The object of the appellants in making this agreement, if the substance and reality of the thing and the real nature of the transaction be looked at, would appear to be … to prevent the disorganisation of their trading system and the consequent injury to their trade in many directions. The means of effecting this is by keeping up their price to the public to the level of their price list, this last being secured by contracting that a sum of 5l shall be paid …The very fact that his sum is to be paid … shows that it was the consequential injury to their trade due to undercutting that they had in view. They had an obvious interest to prevent this undercutting, and on the evidence it would appear to me impossible to say that that interest was incommensurate with the sum agreed to be paid.(emphasis added)
31. Third, the “legitimate interest” test is remarkably similar to the language and
analysis the UK and Australian Courts have long since adopted:
(1) Lord Robertson in Clydebank said the question to be answered was “had
the respondents no interest to protect by that clause, or was that interest
palpably incommensurate with the sums agreed on”’;49
48See [22 – 24]. 49At [19 – 20].
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(2) Lord Justice Arden in Murray v Leisureplay stated that “The real question
is whether the sums for which the parties have provided to be paid on
breach differ substantially from the sums that would be recoverable at
common law and whether there is shown to be no justification for that”50
and explained that the finding of a commercial explanation was the reason
why the impugned clause was upheld in Dunlop;51
(3) In Paciocco,Allsop CJ stated that the distinction between extravagance and
unconscionability and a genuine pre-estimate of damage required the
concept of a genuine pre-estimate “to be a broad objective one, not limited
to a clause expressly said to be a genuine pre-estimate of damage or
containing a sum actually fixed in amount be reference to
contemporaneous considerations concerned with such”.52 Similarly,
Middleton J commented that “One starting point in considering whether a
penalty has been imposed is to identify the commercial interests that are
sought to be protected by the bargain reached between the parties”.53
32. This being so, the tests applied in Australia and the UK may not be materially
different. As LordMance commented in Makdessi, so long as the test in
Pacioccois applied in a wide sense (focusing on the “interest protected by the
bargain” or the “interest in the due performance of the obligation”)it would
“appear to lead to the same result” as the line of cases on which the Supreme
Court based its decision in Makdessi.54
3) A greater scope of operation?
33. Following Makdessi and Andrews arguments may well focus on whether a clause
falls within the scope of the doctrine at all. The Australian High Court in
50 At [46].51 At [117].52 At [25].53 At [401].54 At [153].
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Andrewsheld that the equitable doctrine is not limited to cases arising out of a
breach of contract, and, whilst affirming that breach is still part of the UK test, the
Supreme Court in Makdessiconfirmed that the doctrine will apply to some types
of clauses which may not be classed as secondary obligations.
34. Determining the appropriate boundaries of interference has always been difficult.
It has always been possible to circumvent the penalties doctrine by careful
drafting. If matters are structured differently, the obligation to make, or the
entitlement to withhold, payment may not be dependent on any breach.55As Lord
Denning stated in Bridge v Campbell Discount Co Ltd:56
Let no one mistake the injustice of this. It means that equity commits itself to an absurd paradox: it will grant relief to a man who breaks his contract but will penalise the man who keeps it.
35. However, neither jurisdiction has radically changed the landscape in recent
decisions:
(1) Whilst extending the operation of the doctrine to a wider class of
provisions than the UK, on a proper reading of Andrewsthe equitable
doctrine does not apply to all primary obligations. Rather, the impugned
provision needs to be akin to the defeasible bond that equity historically
sought to govern (see Section B above). Paciocco is a prime example of
the limits of the Andrewstest. Whilst not payable on breach, the relevant
bank fees were also not “collateral or accessory to a primary stipulation”
and so the doctrine had no operation. As Allsop CJ stated:57
Sometimes, the proper conclusion may not be that the sum is a genuine pre-estimate of loss, but that the sum is payable for an additional benefit, a conclusion made by reference to the antecedent enquiry whether it is a collateral or accessory clause at all, or whether it is part of the bargain for another right … If it is so regarded, it necessarily takes its character as something different in nature from a clause which
55 The Scottish Law Commission referred to the “glorious possibilities for a draftsman” (Discussion Paper No 103, “Discussion Paper on Penalty Clauses”, December 1997 p30). 56[1962] AC 600 at 629.57At [100].
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in terms or in its origins of contractual creation was intended by the parties as agreed damages…
(2) The Supreme Court in Makdessirecognised a couple of very narrow
categories of exception that were supported by previous authority.
Obviously there are very great difficulties in providing the Courts with a
general supervisory jurisdiction to review the content of substantive
obligations the parties have agreed and so the categories are necessarily
confined.58
4) A two-stage test?
36. As noted by Lord Mance in Makdessi, a forfeitureclause might be considered to
raise both the penalty doctrine and relief from forfeiture under the common
law.59Lord Hodge suggested a two stage test might apply when considering such a
clause:60
There is no reason in principle why a contractual provision, which involves forfeiture of sums otherwise due, should not be subjected to the rule against penalties, if the forfeiture is wholly disproportionate either to the loss suffered by the innocent party or to another justifiable commercial interest which that party has sought to protect by the clause. If the forfeiture is not so exorbitant and therefore is enforceable under the rule against penalties, the court can then consider whether under English law it should grant equitable relief from forfeiture, looking at the position of the parties after the breach and the circumstances in which the contract was broken.
37. Snell suggests the rationale for the relief against forfeiture doctrine is that where a
right is acquired to secure a particular primary outcome, it can be controlled by
reference to that purpose.61 In Cukurova Finance International v Alfa Telecom
Turkey Ltd [2013] UKPC 2, Lord Neuberger described the paradigm case as:62
… where the primary object of the bargain is to secure a stated result which can be effectively attained when the matter comes before the court, and where
58 See, for example, Makdessi at [42]. 59 At [160]. See, for example, Jobson v Johnson [1989] 1 WLR 1026 and BICCplc v BurndyCorpn [1985] Ch 232. 60 At [277]. See also Lord Mance at [160 - 161], Lord Clarke at [291] and Lord Toulson at [294]. 61Snell’s Equity, 33rded, at 13-022. 62At [90].
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the forfeiture provision is added by way of security for the production of that result.
38. But the reference to a two-stage test in Makdessi may not be particularly
revolutionary:
(1) Whether a two-stage test is to be applied was not conclusively determined.
As the majority stated:63
What is less clear is whether a provision is capable of being both a penalty clause and a forfeiture clause. It is inappropriate to consider that issue in any detail in this judgment, as we have heard very little argument on forfeitures – unsurprisingly because in neither appeal has it been alleged that any provision in issue is a forfeiture from which relief could be granted …
(2) Relief from forfeiture is limited to the forfeiture of proprietary or
possessory rights, as opposed to merely contractual rights (Scandinavian
Trading Tanker Co AB v FlotaPetroleraEcuatoriana (“The Scaptrade”)
[1983] 2 AC 694 (HL)). As such the class of contracts to which a two-
stage test might apply is limited;
(3) It is necessary to establish that the provision is a forfeiture, which may be
narrowly construed by the Courts. For example, in Man UK Properties
Ltd v Falcon Investments Ltd [2015] EWHC 1324 (Ch), Warren J
considered that a term that allowed A to acquire all of B’s shares in a SPV
set up for the joint purchase of a property in the event B failed to pay its
half share within 11 months of completion, stated was not a forfeiture
provision but “a rational and commercial way of dealing with what, in the
context of a joint venture, is an important element of the contract between
the parties”.64
(4) In the context of penalties, a court is likely to exercise caution before
preventing a party from enforcing a term that is otherwise contractually
valid (see for example Else (1982) Ltd v Parkland Holdings [1994] 1
63At [18]. 64 At [37].
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BLCL 130 (CA) per Lord Justice Hoffman at 145, approving of the view
adopted by the Australian High Court in Legione v Hateley (1983) 152
CLR 406);
(5) It is questionable whether equity would intervene in circumstances where a
Court has found the relevant clause not to be out of all proportion to the
legitimate interest of the innocent party.Further, in the usual case, relief
from forfeiture will only be available if the guilty party is ready and
willing to remedy the breach by providing, in substance, the benefits that
the forfeiture clause aimed to secure.65Yet, the very reason why such a
clause might be included in the contract is because it is impossible (or at
least very difficult) to otherwise remedy the damage.
E The wider view
39. But there is also a wider view: that Makdessi has opened a crack in the edifice of
contractual autonomy that might well have considerable significance, both in the
treatment of liquidated damages clauses and perhaps also in the more important
territory of onerous time barring notice provisions.
40. The key to this wider view lies in the distinction between legal rights themselves,
and the enforceability of those rights. This is a distinction that is perhaps more
widely applied in civil law jurisdictions than in the common law,66 but it is by no
means unknown in the common law. Thus, for example, the doctrine of laches and
its statutory manifestation, limitation, which does not extinguish legal rights
which have become statute barred, but merely bars their enforceability. Another
example of the distinction is the doctrine of relief from forfeiture, which is the
doctrine into which Makdessi has now breathed new life. Makdessi does nothing
to suggest any increased willingness of the courts to interfere with the bargain
which the parties have made, but does suggest new ways in which the courts
65Snell’s Equity, 33rded, at 13-025. 66It has been noted that “The differences between the common law and civil law have become much less in recent years”; “A Common Law of Construction Contracts”—Or Vive La Différence?” Dr Donald Charrett, International Construction Law Review, 13 Dec 2011.
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might regulate how such bargains may be enforced. Lords Neuberger and
Sumption stressed the unwillingness to interfere with the bargain:67
Leaving aside challenges going to the reality of consent, such as those based on fraud, duress or undue influence, the courts do not review the fairness of men’s bargains either at law or in equity. The penalty rule regulates only the remedies available for breach of a party’s primary obligations, not the primary obligations themselves. This was not a new concept in 1983, when ECGD was decided. It had been the foundation of the equitable jurisdiction…
41. But identified a different test, not dissimilar from the civil law concept of
proportionality, when it comes to enforceability:68
32. 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 innocent party can have no proper interest in simply punishing the defaulter. His interest is in performance or in some appropriate alternative to performance.
42. The two stage test was endorsed by Lord Hodge has been noted above.69It is worth
also noting what was said by Lord Clarke:70
…As to the relationship between penalties and forfeiture, my present inclination is to agree with Lord Hodge (in para 227) and with Lord Mance (in paras 160 and 161) that in an appropriate case the court should ask first whether, as a matter of construction, the clause is a penalty and, if it answers that question in the negative, it should ask (where relevant) whether relief against forfeiture should be granted in equity having regard to the position of each of the parties after the breach.
43. And by Lord Toulson:71
67At [13].68At [32].69At paragraph 36.70 At [291].71 At [294].
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I would reject that argument for the reasons given by Lord Mance and Lord Hodge. I agree with them that the proper approach is to consider first whether the clause was an exorbitant provision to have included in the contract at the time when it was made; and, if not, to consider next whether any relief should properly be granted under the equitable doctrine of relief against forfeiture in the circumstances at and after the time of the breach. As Lord Mance and Lord Hodge have noted, this approach was followed by the Court of Appeal (Ackner, Kerr and Dillon LJJ) in BICCplc v Bundy Corpn [1985] Ch 232. It is logical and just.
44. The cumulative impact of these dicta might be seen, not merely as a speculative
suggestion, but as a firm foundation for the propositions:
(1) that there is a two-stage test;
(2) that the 2nd stage of the test is to look, not merely at the circumstances
prevailing at the time the contract was made, but at the consequences of
the breach, and in particular whether the innocent party has suffered any
and if so what loss;
(3) that principles of proportionality apply to the 2nd test;
(4) that if the consequence of allowing enforcement of the impugned provision
would be out of all proportion to any legitimate interest of the innocent
party, then principles of contractual autonomy should not prevent the court
from denying enforcement of the impugned provision.
45. In the case of a liquidated damages clause, the paradigm case might be one in
which a liquidated damages clause, although perhaps not penal at the time of the
formation of the contract, might lead to the forfeiture of the contractor’s right to
be paid a significant part of the contract price notwithstanding that the principal
might have suffered no loss whatsoever as a result of some delay in completion. It
is worth recalling howLord Wilberforce had put the point in Shiloh:72
There cannot be any doubt that from the earliest times courts of equity have asserted the right to relieve against the forfeiture of property. The jurisdiction
72Shiloh Spinners Ltd v Harding [1973] AC 691.
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has not been confined to any particular type of case…I would fully endorse this: it remains true today that equity expects men to carry out their bargains and will not let them buy their way out by uncovenanted payment. But it is consistent with these principles that we should reaffirm the right of courts of equity in appropriate and limited cases to relieve from forfeiture for breach of covenant or condition where the primary object of the bargain is to secure a stated result which can effectively be attained when the matter comes before the court, and where the forfeiture provision is added by way of security for the production of that result. The word 'appropriate' involves consideration of the conduct of the applicant for relief, in particular whether his default was wilful, of the gravity of the breaches, and of the disparity between the value of the property of which forfeiture is claimed as compared with the damage caused by the breach.
46. Note the reference to “limited cases”. Viscount Dilhorne also emphasised this in Cukurova:73
that the cases in which it is right to give relief against forfeiture where there has been a wilful breach of covenant are likely to be few in number and where the conduct of the person seeking to secure the forfeiture has been wholly unreasonable and of a rapacious and unconscionable character.
47. They may be cases where it would be wholly unreasonable, rapacious and
unconscionable for a principal to deduct liquidated damages from a contractor,
particularly where the contractor’s delay has caused the principal no loss
whatsoever. Inevitably, such cases will be the exception rather than the rule.
48. Much more common, these days, are cases where the “black letter” enforcement
of a contract would lead to a contractor forfeiting his rights to extensions of time
and/or money because of a failure fully to comply with time-barring notice
provisions. It is not unusual now to see construction contracts, typically bespoke,
which provide for the contractor to give three, four or five separate notices in
respect of each and every event which – by the primary bargain between the
parties – entitle the contractor to time and/or money. The requirements for these
notices are often onerous, and the time limits for them are often short. They are
typically expressed to be conditions precedent to the contractor’s entitlement to
time/money.
73Cukurova Finance International Ltd &Anor v Alfa Telecom Turkey Ltd (British Virgin Islands) [2013] UKPC 2.
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49. To some extent, of course, these provisions serve a useful and legitimate purpose,
so that the principal may know what risks are affecting the project, and whether
the contractor intends to make any claims arising out of those risks. But equally,
there are some circumstances where
(1) the notice provisions appear to have been drafted with a view of ensuring
that they are practically impossible to comply with;
(2) the principal has at all times known full well of the event in question;
(3) the principal has also at all times known full well also that the contractor
intends to claim in respect of that event;
(4) the effect of allowing enforcement of the notice provision would amount
to a forfeiture of the contractor’s rights to be paid for additional work, and
to be given relief from liquidated damages where that additional work
causes delay.
50. The dicta referred to above did not arise in the context of time-barring notice
provisions. But a reading of them in that context might well suggest that the
doctrine of relief from forfeiture might well be available in an appropriate case.
The effect of the doctrine would not be to nullify the impugned clause, but to
rather to relieve a contractor from its consequences where the legitimate
commercial purpose of the clause is satisfied by other means, and where the
consequence of applying the clause would be wholly disproportionate to the
detriment (if any) suffered by the owner as a result of not having each of the
stipulated notices delivered to it as required by the contract.
51. The application of the doctrine of relief from forfeiture in these ways is, of course,
sparselycharted water. There are significant unanswered questions, not least how
it came to be that in Makdessithe Supreme Court has apparently come to a
different view from the House of Lords decision in Scaptrade74 without any
discussion of that case,75 and whether the courts in Australia will follow the
Makdessi lead at all down the relief from forfeiture track. But the law has 74See paragraph (2) above.
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continually needed to adapt and to develop in response to social and commercial
developments, and the increasingly widespread use of onerous time-barring
provisions might well prompt common law courts around the world to make
increased use of its powers to control disproportionate and unconscionable
enforcement of contractual provisions.
March 2016
MARCUS TAVERNER QC
ADAM CONSTABLE QC
ROBERT FENWICK ELLIOTT
JENNIE WILD
KEATING CHAMBERS
75If Scaptrade had been applied in Makdessi, the question of relief from forfeiture could not have even arisen, since both Makdessi and Parkingeye were about forfeiture of money, and not “proprietary or possessory rights”.
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