In a recent landmark decision, the highest court in England and Wales, the Supreme Court, considered the long-established principles underlying the Contractual Penalty Clauses Act (the Criminal Rule). The Supreme Court delivered a joint judgment in Cavendish Square Holding BV v Talal El Makdessi (El Makdessi) and ParkingEye Ltd v Beavis [2015] UKSC 67 (ParkingEye), which is one of the most important decisions of English common law in the last 100 years. The Code of Contract Penalties in England was entirely developed by common law judges without general legal intervention. The Supreme Court has stated that ”[t]he criminal rule in England is an old randomly constructed building that is not well patinated.” [3] In 2015, Supreme Court Justices Lord Neuberger and Lord Sumption reformulated the penalty clause test as follows: the Supreme Court then reformulated the common law test to determine what constitutes an unenforceable penalty clause. They noted that the validity of such a clause depends on whether the party seeking to enforce the clause can assert a legitimate interest in enforcing the clause:[23] The Supreme Court has held that the application of the penal rule ”may still concern drafting issues.” It is therefore important to build contractual arrangements that do not fall under the rule of the penalty clause. In Azimut-Benetti SpA v. Healey[22], the Court of First Instance must consider a provision under which a boat builder was entitled to terminate the contract for non-payment of instalments and to claim 20% of the contractually agreed price as lump sum damages. Clarke J. stuck to the clause, stating that commercially reasonable terms should be enforceable unless the overriding purpose was to prevent the other party from violating. On the basis of the facts, it was clear that the purpose of the clause was to establish a predetermined commercial solution in the event that the buyer defaulted.

We do not believe that take or pay clauses should be worded differently in light of Cavendish. The fact remains that a properly worded clause which provides that the buyer may take and pay or simply pay is likely to be interpreted by an English court as a principal obligation which is not subject to the criminal law, although this has not yet been definitively decided in all cases. The origins of the penal rule date back to the 16th century. This brings us back to the concern of the courts to prevent exploitation at a time when credit was scarce and borrowers were particularly vulnerable. Essentially, a penalty is a payment of money set out in the contract and is unenforceable against the offending party if it is an exorbitant alternative to common law damages. Traditionally, a penalty clause was inapplicable under English law. However, in Cavendish Square Holding BV v. Talal El Makdessi (hereinafter ”Makdessi”) and ParkingEye Limited v. Beavis (`ParkingEye`), the Supreme Court presented a new penalty clause criterion.

This test is based on the legitimate interests of the parties and is much more flexible than the test previously strictly followed. In 2005, Jackson LJ in Alfred McAlpine Projects v. Tilebox[19] concluded that it had seen only four reported cases in which a clause had been removed as a penalty. That same year, in the Court of Appeal`s decision in murray v. Leisureplay plc[20], Arden LJ has raised a number of five issues that the Court should consider with respect to sanctions:[21] The new test applies to terms of any relevant contract governed by English law, whether at the Gulf Cooperation Council (GCC) or elsewhere. A clause that provides for a high payment in the context of the performance of obligations is not a legal sanction. [24] In Berg v. Blackburn Rovers FC[25], it was found that if a football club exercised its right to terminate the employment of a coach against payment of the salary outstanding under the contract, it was the enforcement of a clause and not a provision to limit the infringement. Therefore, it could not have been a penalty. For English law, this position was reaffirmed by the Supreme Court in Makdessi. [23] A contractual penalty clause is an express provision of a contract. It obliges the non-contractual party to compensate the injured party for compensation to the injured party.

In addition to the principles of primary and secondary obligations, proportionality and the legitimacy of deterrence, the Supreme Court`s decision in El Makdessi also stressed the importance of taking into account the circumstances in which the parties concluded the contract – ”in a contract negotiated between duly advised parties with 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 an offence [35]. This is relevant for franchise agreements that may arise in this spectrum, depending on whether it is an international agreement, a national multi-unit or high-value agreement, or a franchise agreement for national commercial format units. In ZCCM, for example, the Tribunal found that the plaintiff had a legitimate interest in demanding strict compliance with the settlement agreement, that the defendant knew what it was signing, and that the agreement was an arm`s length agreement entered into by the defendant with the assistance of expert legal advice. From time to time, a company may be involved in a contractual dispute aimed at obtaining a heavy fine. These disputes relate to punitive clauses, and there are certain circumstances in which these sanctions may or may not be enforceable. The Supreme Court also confirmed that the rule against sanctions will only apply to secondary obligations, i.e. obligations that arise in the event of a breach of a primary obligation. [23] A clause that sets out onerous provisions in a contract may be onerous, but if it is not triggered by a breach, it is not a penalty under the law. Their lordships also noted that a penalty clause can often be a simple payment of money, but it can also include other things, such as withholding payments, asset transfer requirements, or (depending on the facts they have) a request for reimbursement of a non-refundable deposit. If a contracting party can prove that it applies a penalty clause to protect a legitimate interest and that the sanction is not exorbitant or unscrupulous, the following principles now apply: The criminal rule applies to violations of ”primary obligations”. Therefore, the main objective of the elaboration will be to formulate a penalty clause as a primary obligation and not as a secondary obligation.

Courts won`t be fooled by labels, but clauses can be saved by careful drafting. An example of this is the High Court decision in Holyoake v. Candy, in which various clauses of a credit agreement were not considered punitive clauses because they were not triggered by a breach of contract. Lord Hodge went on to explain that ”the correct criterion for a penalty is whether the sum or compensation agreed upon as a result of a breach of contract is exorbitant or unscrupulous when the interest of the innocent party in performing the contract is taken into account [255]”. The general position of the courts is that where contracts have been concluded between economically experienced companies, there is a strong presumption that the parties are the best judges of the economic impact of the damages they have agreed, and that the court should therefore intervene only slowly in this process. This principle is reinforced in situations where contracts have been drafted with the help of legal expertise. This was clearly expressed in Cavendish and has been reaffirmed ever since. As a general rule, whether a particular term constitutes a sanction depends on the broader factual and commercial context. One car park belonged to the British Airways pension fund, which signed a contract with ParkingEye to act on their behalf. Users were allowed to park for free until 2 a.m. Any time spent beyond the 2-hour time limit may incur a fee of £85.00. For example, the consensus regarding the ”take or pay” provisions (and remains, as mentioned below) that they could not be penalties because it was not the payment of damages for breach of contract.

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