Cavendish Square Holding BV v Makdessi

Michaelmas Term

[2015] UKSC 67

On appeal from: [2013] EWCA Civ 1539 and [2015] EWCA Civ 402

Cavendish Square Holding BV (Appellant) v Talal El Makdessi (Respondent) ParkingEye Limited (Respondent) v Beavis (Appellant)

before

Lord Neuberger, President

JUDGMENT GIVEN ON

4 November 2015

Heard on 21, 22 and 23 July 2015

Appellant (Cavendish	Respondent (Talal El
Square Holding BV)	Makdessi)
Joanna Smith QC	Michael Bloch QC
Richard Leiper	Camilla Bingham QC
James McCreath

Edwin Peel

(Instructed by Squire	(Instructed by Clifford
Patton Boggs (UK) LLP)	Chance LLP)

Respondent (ParkingEye

Appellant (Beavis)	Limited)
John de Waal QC	Jonathan Kirk QC

David Lewis	David Altaras
Ryan Hocking	Thomas Samuels

(Instructed by Harcus

(Instructed by Cubism

Sinclair)

Law)

Intervener (Consumers’

Association)

Christopher Butcher QC

(Instructed by Consumers’

Association In-House

Lawyers)

LORD NEUBERGER AND LORD SUMPTION: (with whom Lord
Carnwath agrees)

1. These two appeals raise an issue which has not been considered by the Supreme Court or by the House of Lords for a century, namely the principles underlying the law relating to contractual penalty clauses, or, as we will call it, the penalty rule. The first appeal, Cavendish Square Holding BV v Talal El Makdessi, raises the issue in relation to two clauses in a substantial commercial contract. The second appeal, ParkingEye Ltd v Beavis, raises the issue at a consumer level, and it also raises a separate issue under the Unfair Terms in Consumer Contracts

Regulations 1999 (SI 1999/2083) (“the 1999 Regulations”).

2. We shall start by addressing the law on the penalty rule generally, and will then discuss the two appeals in turn.

The law in relation to penalties

3. The penalty rule in England is an ancient, haphazardly constructed edifice which has not weathered well, and which in the opinion of some should simply be demolished, and in the opinion of others should be reconstructed and extended. For many years, the courts have struggled to apply standard tests formulated more than a century ago for relatively simple transactions to altogether more complex situations. The application of the rule is often adventitious. The test for distinguishing penal from other principles is unclear. As early as 1801, in Astley v Weldon (1801) 2 Bos & Pul 346, 350 Lord Eldon confessed himself, not for the first

time, “much embarrassed in ascertaining the principle on which [the rule was]

founded”. Eighty years later, in Wallis v Smith (1882) 21 Ch D 243, 256, Sir George

Jessel MR, not a judge noted for confessing ignorance, observed that “The ground of that doctrine I do not know”. In 1966 Diplock LJ, not a judge given to recognising

defeat, declared that he could “make no attempt, where so many others have failed,

to rationalise this common law rule”: Robophone Facilities Ltd v Blank [1966] 1

WLR 1428, 1446. The task is no easier today. But unless the rule is to be abolished or substantially extended, its application to any but the clearest cases requires some underlying principle to be identified.

Equitable origins

4. The penalty rule originated in the equitable jurisdiction to relieve from defeasible bonds. These were promises under seal to pay a specified sum of money, subject to a proviso that they should cease to have effect on the satisfaction of a

condition, usually performance of some other (“primary”) obligation. By the

beginning of the 16th century, the practice had grown up of taking defeasible bonds to secure the performance obligations sounding in damages. This enabled the holder of the bond to bring his action in debt, which made it unnecessary for him to prove his loss and made it possible to stipulate for substantially more than his loss. The common law enforced the bonds according to their letter. But equity regarded the real intention of the parties as being that the bond should stand as security only, and restrained its enforcement at common law on terms that the debtor paid damages, interest and costs. The classic statement of this approach is that of Lord Thurlow LC in Sloman v Walter (1783) 1 Bro CC 418, 419:

“… where a penalty is inserted merely to secure the enjoyment

of a collateral object, the enjoyment of the object is considered as the principal intent of the deed, and the penalty only as accessional, and, therefore, only to secure the damage really

incurred ...”

5. The essential conditions for the exercise of the jurisdiction were (i) that the penal provision was intended as a security for the recovery of the true amount of a debt or damages, and (ii) that that objective could be achieved by restraining proceedings on the bond in the courts of common law, on terms that the defendant paid damages. As Lord Macclesfield observed in Peachy v Duke of Somerset (1720) 1 Strange 447, 453:

“The true ground of relief against penalties is from the original

intent of the case, where the penalty is designed only to secure money, and the court gives him all that he expected or desired: but it is quite otherwise in the present case. These penalties or forfeitures were never intended by way of compensation, for

there can be none.”

This last reservation remained an important feature of the equitable jurisdiction to relieve. As Baggallay LJ put it in Protector Endowment Loan and Annuity Company

v Grice (1880) 5 QBD 592, 595, “where the intent is not simply to secure a sum of

money, or the enjoyment of a collateral object, equity does not relieve”.

The common law rule

6. The process by which the equitable rule was adopted by the common law is traced by Professor Simpson in his article The penal bond with conditional defeasance (1966) 82 LQR 392, 418-419. Towards the end of the 17th century, the courts of common law tentatively began to stay proceedings on a penal bond to secure a debt, unless the plaintiff was willing to accept a tender of the money, together with interest and costs. The rule was regularised and extended by two statutes of 1696 and 1705. Section 8 of the Administration of Justice Act 1696 (8 & 9 Will 3 c 11) is a prolix provision whose effect was that the plaintiff suing in the common law courts on a defeasible bond to secure the performance of covenants (not just debts) was permitted to plead the breaches and have his actual damages assessed. Judgment was entered on the bond, but execution was stayed upon payment of the assessed damages. The Administration of Justice Act 1705 (4 & 5 Anne c 16) allowed the defendant in an action on the bond to pay the amount of the actual loss, together with interest and costs, into court, and rely on the payment as a defence. These statutes were originally framed as facilities for plaintiffs suing on bonds. But by the end of the 18th century the common law courts had begun to treat the statutory procedures as mandatory, requiring damages to be pleaded and proved and staying all further proceedings on the bond: see Roles v Rosewell (1794) 5 TR 538, Hardy v Bern (1794) 5 TR 636. The effect of this legislation was thus to make it unnecessary to proceed separately in chancery for relief from the penalty and in the courts of common law for the true loss. As a result, the equitable jurisdiction was rarely invoked, and the further development of the penalty rule was entirely the work of the courts of common law.

7. It developed, however, on wholly different lines. The equitable jurisdiction to relieve from penalties had been closely associated with the jurisdiction to relieve from forfeitures which developed at the same time. Both were directed to contractual provisions which on their face created primary obligations, but which during the 17th and 18th centuries the courts of equity treated as secondary obligations on the ground that the real intention was that they should stand as a mere security for performance. The court then intervened to grant relief from the rigours of the secondary obligation in order to secure performance in another, less penal or (in modern language) more proportionate, way. In contrast, the penalty rule as it was developed by the common law courts in the course of the 19th and 20th centuries proceeded on the basis that although penalties were secondary obligations, the parties meant what they said. They intended the provision to be applied according to the letter with a view to penalising breach. The law relieved the contract-breaker of the consequences not because the objective could be secured in another way but because the objective was contrary to public policy and should not therefore be given effect at all. The difference in approach to penalties of the courts of equity and the common law courts is in many ways a classic example of the contrast between the flexible if sometimes unpredictable approach of equity and the clear if relatively strict approach of the common law.

8. With the gradual decline of the use of penal defeasible bonds, the common law on penalties was developed almost entirely in the context of damages clauses –

ie clauses which provided for payment of a specified sum in place of common law damages. Because they were a contractual substitute for common law damages, they could not in any meaningful sense be regarded as a mere security for their payment. If the agreed sum was a penalty, it was treated as unenforceable. Starting with the decisions in Astley in 1801 and Kemble v Farren (1829) 6 Bing 141, the common law courts introduced the now familiar distinction between a provision for the payment of a sum representing a genuine pre-estimate of damages and a penalty clause in which the sum was out of all proportion to any damages liable to be suffered. By the middle of the 19th century, this rule was well established. In Betts

v Burch (1859) 4 H & N 506, 509, Martin B regretted that he was “bound by the cases” and prevented from holding that “parties are at liberty to enter into any

bargain they please” so that “if they have made an improvident bargain they must

take the consequences”. But Bramwell B (at p 511) appeared to have no such

reservations.

9. The distinction between a clause providing for a genuine pre-estimate of damages and a penalty clause has remained fundamental to the modern law, as it is currently understood. The question whether a damages clause is a penalty falls to be decided as a matter of construction, therefore as at the time that it is agreed: Public Works Comr v Hills [1906] AC 368, 376; Webster v Bosanquet [1912] AC 394; Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79, at pp 86-87 (Lord Dunedin); and Cooden Engineering Co Ltd v Stanford [1953] 1 QB 86, 94 (Somervell LJ). This is because it depends on the character of the provision, not on the circumstances in which it falls to be enforced. It is a species of agreement which the common law considers to be by its nature contrary to the policy of the law. One consequence of this is that relief from the effects of a penalty is, as Hoffmann LJ put it in Else (1982) Ltd v Parkland Holdings Ltd [1994] 1 BCLC 130,

144, “mechanical in effect and involves no exercise of discretion at all.” Another is

that the penalty clause is wholly unenforceable: Clydebank Engineering & Shipbuilding Co Ltd v Don Jose Ramos Yzquierdo y Castaneda [1905] AC 6, 9, 10 (Lord Halsbury LC); Gilbert-Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd [1974] AC 689, 698 (Lord Reid), 703 (Lord Morris of Borth-y-Gest) and 723- 724 (Lord Salmon); Scandinavian Trading Tanker Co AB v Flota Petrolera Ecuatoriana (The “Scaptrade”) [1983] 2 AC 694, 702 (Lord Diplock); AMEV-UDC

Finance Ltd v Austin (1986) 162 CLR 170, 191-193 (Mason and Wilson JJ). Deprived of the benefit of the provision, the innocent party is left to his remedy in

damages under the general law. As Lord Diplock put it in The “Scaptrade” at p 702:

“The classic form of penalty clause is one which provides that

upon breach of a primary obligation under the contract a secondary obligation shall arise on the part of the party in breach to pay to the other party a sum of money which does not represent a genuine pre-estimate of any loss likely to be sustained by him as the result of the breach of primary obligation but is substantially in excess of that sum. The classic form of relief against such a penalty clause has been to refuse to give effect to it, but to award the common law measure of

damages for the breach of primary obligation instead.”

10. Equity, on the other hand, relieves against forfeitures “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”: Shiloh Spinners Ltd v Harding

[1973] AC 691, 723 (Lord Wilberforce). As Lord Wilberforce said at p 722, the paradigm cases are the jurisdiction to relieve from a right of re-entry in a lease of

land and the mortgagor’s equity of redemption (and the associated equitable right to

redeem) in relation to mortgages. Save in relation to non-payment of rent, the power to grant relief from forfeiture to lessees is now contained in section 146 of the Law of Property Act 1925, and probably exclusively so (see Official Custodian for Charities v Parway Estates Departments Ltd [1985] Ch 151). Relief for mortgagors through the equitable right to redeem is (save in relation to most residential properties) largely still based on judge-made law. However, neither by statute nor

on general principles of equity is a lessor’s right of re-entry or a mortgagee’s right

of sale or foreclosure treated as being by its nature contrary to the policy of the law. What equity (and, where it applies, statute) typically considers to be contrary to the policy of the law is the enforcement of such rights in circumstances where their purpose, namely the performance of the obligations in the lease or the mortgage, can

be achieved in other ways – normally by late substantive compliance and payment

of appropriate compensation. The forfeiture or foreclosure/power of sale is therefore enforceable, equity intervening only to impose terms. These will generally require the lessee or mortgagor to rectify the breach and make good any loss suffered by the lessor or mortgagee. If the lessee or mortgagee cannot or will not do so, the forfeiture

will be unconditionally enforced – although perhaps not invariably (see per Lord

Templeman in Associated British Ports v CH Bailey plc [1990] 2 AC 703, 707-708 in the context of section 146, and, more generally, the judgments in Cukurova Finance International Ltd v Alfa Telecom Turkey Ltd (No 3) [2013] UKPC 20, [2015] 2 WLR 875).

11. The penalty rule as it has been developed by the judges gives rise to two questions, both of which have a considerable bearing on the questions which arise on these appeals. In what circumstances is the rule engaged at all? And what makes a contractual provision penal?

In what circumstances is the penalty rule engaged?

12. In England, it has always been considered that a provision could not be a penalty unless it provided an exorbitant alternative to common law damages. This meant that it had to be a provision operating upon a breach of contract. In Moss Empires Ltd v Olympia (Liverpool) Ltd [1939] AC 544, this was taken for granted by Lord Atkin (p 551) and Lord Porter (p 558). As a matter of authority the question is settled in England by the decision of the House of Lords in Export Credits

Guarantee Department v Universal Oil Products Co [1983] 1 WLR 399 (“ECGD”).

Lord Roskill, with whom the rest of the committee agreed, said at p 403:

“[P]erhaps the main purpose, of the law relating to penalty

clauses is to prevent a plaintiff recovering a sum of money in respect of a breach of contract committed by a defendant which bears little or no relationship to the loss actually suffered by the plaintiff as a result of the breach by the defendant. But it is not and never has been for the courts to relieve a party from the consequences of what may in the event prove to be an onerous

or possibly even a commercially imprudent bargain.”

As Lord Hodge points out in his judgment, the Scottish authorities are to the same effect.

13. This principle is worth restating at the outset of any analysis of the penalty rule, because it explains much about the way in which it has developed. There is a fundamental difference between a jurisdiction to review the fairness of a contractual obligation and a jurisdiction to regulate the remedy for its breach. 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, which depended on the treatment of penal defeasible bonds as secondary obligations or, as Lord Thurlow LC put it in 1783 in Sloman as

“collateral” or “accessional” to the primary obligation. And it provided the whole

basis of the classic distinction made at law between a penalty and a genuine pre- estimate of loss, the former being essentially a way of punishing the contract-breaker rather than compensating the innocent party for his breach. We shall return to that distinction below.

14. This means that in some cases the application of the penalty rule may depend on how the relevant obligation is framed in the instrument, ie whether as a conditional primary obligation or a secondary obligation providing a contractual alternative to damages at law. Thus, where a contract contains an obligation on one party to perform an act, and also provides that, if he does not perform it, he will pay the other party a specified sum of money, the obligation to pay the specified sum is a secondary obligation which is capable of being a penalty; but if the contract does not impose (expressly or impliedly) an obligation to perform the act, but simply provides that, if one party does not perform, he will pay the other party a specified sum, the obligation to pay the specified sum is a conditional primary obligation and cannot be a penalty.

15. However, the capricious consequences of this state of affairs are mitigated by the fact that, as the equitable jurisdiction shows, the classification of terms for the purpose of the penalty rule depends on the substance of the term and not on its form or on the label which the parties have chosen to attach to it. As Lord Radcliffe said

in Campbell Discount Co Ltd v Bridge [1962] AC 600, 622, “[t]he intention of the parties themselves”, by which he clearly meant the intention as expressed in the

agreement, “is never conclusive and may be overruled or ignored if the court

considers that even its clear expression does not represent ‘the real nature of the transaction’ or what ‘in truth’ it is taken to be” (and cf per Lord Templeman in Street

v Mountford [1985] AC 809, 819). This aspect of the equitable jurisdiction was inherited by the courts of common law, and has been firmly established since the earliest common law cases.

16. Payment of a sum of money is the classic obligation under a penalty clause and, in almost every reported case involving a damages clause, the provision stipulates for the payment of money. However, it seems to us that there is no reason why an obligation to transfer assets (either for nothing or at an undervalue) 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. Similarly, 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 – see the Privy Council decisions in Public Works Comr v Hills [1906]

AC 368, 375-376, and Workers Trust & Merchant Bank Ltd v Dojap Investments Ltd [1993] AC 573. By contrast, in Else (1982) at p 146, Hoffmann LJ, citing Stockloser v Johnson [1954] 1 QB 476 in support, said that, unlike a case where

“money has been deposited as security for due performance of [a] party’s

obligation”, “retention of instalments which have been paid under contract so as to become the absolute property of the vendor does not fall within the penalty rule”,

although, he added that it was “subject … to the jurisdiction for relief against

forfeiture”.

17. The relationship between penalty clauses and forfeiture clauses is not entirely easy. Given that they had the same origin in equity, but that the law on penalties was then developed through common law while the law on forfeitures was not, this is unsurprising. Some things appear to be clear. Where a proprietary interest or a

“proprietary or possessory right” (such as a patent or a lease) is granted or

transferred subject to revocation or determination on breach, the clause providing for determination or revocation is a forfeiture and cannot be a penalty, and, while it is enforceable, relief from forfeiture may be granted: see BICC plc v Burndy Corpn

[1985] Ch 232, 246-247 and 252 (Dillon LJ) and The “Scaptrade”, pp 701-703,

(Lord Diplock). But this does not mean that relief from forfeiture is unavailable in

cases not involving land – see Cukurova Finance International Ltd v Alfa Telecom

Turkey Ltd (No 2) [2013] UKPC 2, [2015] 2 WLR 875, especially at paras 92-97, and the cases cited there.

18. 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. But it is right to mention the possibility that, in some circumstances, a provision could, at least potentially, be a penalty clause as well as a forfeiture clause. We see the force of the arguments to that effect advanced by Lord Mance and Lord Hodge in their judgments.

What makes a contractual provision penal?

19. As we have already observed, until relatively recently this question was answered almost entirely by reference to straightforward liquidated damages clauses. It was in that context that the House of Lords sought to restate the law in two seminal decisions at the beginning of the 20th century, Clydebank in 1904 and Dunlop in 1915.

20.       Clydebank was a Scottish appeal about a shipbuilding contract with a

provision (described as a “penalty”) for the payment of £500 per week for delayed

delivery. The provision was held to be a valid liquidated damages clause, not a penalty. Lord Halsbury (p 10) said that the distinction between the two depended on

“whether it is, what I think gave the jurisdiction to the courts in

both countries to interfere at all in an agreement between the parties, unconscionable and extravagant, and one which no

court ought to allow to be enforced.”

Lord Halsbury declined to lay down any “abstract rule” for determining what was

unconscionable or extravagant, saying only that it must depend on “the nature of the

transaction – the thing to be done, the loss likely to accrue to the person who is endeavouring to enforce the performance of the contract, and so forth”. Lord Halsbury’s formulation has proved influential, and the two other members of the

Appellate Committee both delivered concurring judgments agreeing with it. It is, however, worth drawing attention to an observation of Lord Robertson (pp 19-20)

which points to the principle underlying the contrasting expressions “liquidated

damages” and “penalty”:

“Now, all such agreements, whether the thing be called penalty

or be called liquidate damage, are in intention and effect what

Professor Bell calls ‘instruments of restraint’, and in that sense

penal. But the clear presence of this does not in the least degree invalidate the stipulation. The question remains, had the respondents no interest to protect by that clause, or was that interest palpably incommensurate with the sums agreed on? It seems to me that to put this question, in the present instance, is

to answer it.”

21. Dunlop arose out of a contract for the supply of tyres, covers and tubes by a manufacturer to a garage. The contract contained a number of terms designed to

protect the manufacturer’s brand, including prohibitions on tampering with the

marks, restrictions on the unauthorised export or exhibition of the goods, and on resales to unapproved persons. There was also a resale price maintenance clause, which would now be unlawful but was a legitimate restriction of competition according to the notions prevailing in 1914. It was this clause which the purchaser had broken. The contract provided for the payment of £5 for every tyre, cover or tube sold in breach of any provision of the agreement. Once again, the provision was held to be a valid liquidated damages clause. In his speech, Lord Dunedin formulated

four tests “which, if applicable to the case under consideration, may prove helpful,

or even conclusive” (p 87). They were (a) that the provision would be penal if “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”; (b) that the provision would be penal if the breach consisted only in the

non-payment of money and it provided for the payment of a larger sum; (c) that

there was “a presumption (but no more)” that it would be penal if it was payable in

a number of events of varying gravity; and (d) that it would not be treated as penal
by reason only of the impossibility of precisely pre-estimating the true loss.

22. Lord Dunedin’s speech in Dunlop achieved the status of a quasi-statutory code in the subsequent case-law. Some of the many decisions on the validity of damages clauses are little more than a detailed exegesis or application of his four tests with a view to discovering whether the clause in issue can be brought within one or more of them. In our view, this is unfortunate. In the first place, Lord Dunedin proposed his four tests not as rules but only as considerations which might prove

helpful or even conclusive “if applicable to the case under consideration”. He did

not suggest that they were applicable to every case in which the law of penalties was engaged. Second, as Lord Dunedin himself acknowledged, the essential question

was whether the clause impugned was “unconscionable” or “extravagant”. The four

tests are a useful tool for deciding whether these expressions can properly be applied to simple damages clauses in standard contracts. But they are not easily applied to more complex cases. To deal with those, it is necessary to consider the rationale of the penalty rule at a more fundamental level. What is it that makes a provision for

the consequences of breach “unconscionable”? And by comparison with what is a penalty clause said to be “extravagant”? Third, none of the other three Law Lords expressly agreed with Lord Dunedin’s reasoning, and the four tests do not all feature

in any of their speeches. Indeed, it appears that, in his analysis at pp 101-102, Lord Parmoor may have taken a more restrictive view of what constituted a penalty than did Lord Dunedin. More generally, the other members of the Appellate Committee gave their own reasons for concurring in the result, and they also repay consideration. For present purposes, the most instructive is that of Lord Atkinson, who approached the matter on an altogether broader basis.

23. Lord Atkinson pointed (pp 90-91) to the critical importance to Dunlop of the

protection of their brand, reputation and goodwill, and their authorised distribution
network. Against this background, he observed (pp 91-92):

“It has been urged that as the sum of £5 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. In the sense of direct and immediate loss the appellants lose nothing by such a sale. It is the agent or dealer who loses by selling at a price less than that at which he buys, but the appellants have to look at their trade in globo, and to prevent the setting up, in reference to all their goods anywhere and everywhere, a system of injurious undercutting. 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 a single one, namely, to prevent the disorganization 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 £5 shall be paid for every one of the three classes of articles named sold or offered for sale at prices below those named on the list. The very fact that this sum is to be paid if a tyre cover or tube be merely offered for sale, though not sold, 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.”

Lord Atkinson went on to draw an analogy, which has particular resonance in the Cavendish appeal, with a clause dealing with damages for breach of a restrictive covenant on the canvassing of business by a former employee. In this context, he said (pp 92-93):

“It is, I think, quite misleading to concentrate one’s attention

upon the particular act or acts by which, in such cases as this, the rivalry in trade is set up, and the repute acquired by the former employee that he works cheaper and charges less than his old master, and to lose sight of the risk to the latter that old customers, once tempted to leave him, may never return to deal with him, or that business that might otherwise have come to him may be captured by his rival. The consequential injuries to

the trader’s business arising from each breach by the employee

of his covenant cannot be measured by the direct loss in a monetary point of view on the particular transaction

constituting the breach.”

Lord Atkinson was making substantially the same point as Lord Robertson had made in Clydebank. The question was: what was the nature and extent of the innocent

party’s interest in the performance of the relevant obligation. That interest was not

necessarily limited to the mere recovery of compensation for the breach. Lord Atkinson considered that the underlying purpose of the resale price maintenance clause gave Dunlop a wider interest in enforcing the damages clause than pecuniary compensation. £5 per item was not incommensurate with that interest even if it was incommensurate with the loss occasioned by the wrongful sale of a single item.

24. Although the other members of the Appellate Committee did not express themselves in the same terms as Lord Atkinson, their approach was entirely

consistent with his. Lord Parker at p 97 said that “whether the sum agreed to be paid

on the breach is really a penalty must depend on the circumstances of each particular

case”, and at p 99, echoing Lord Atkinson’s fuller treatment of the point, as just set

out, he described the damage which would result from any breach as “consist[ing]

in the disturbance or derangement of the system of distribution by means of which

[Dunlop’s] goods reach the ultimate consumer”. In their speeches, Lord Dunedin (p

87), Lord Parker (p 98) and Lord Parmoor (p 103) ultimately were content to rest their decision that the £5 was not a penalty on the ground that an exact pre-estimate of loss was impossible, whereas, in the passages quoted above, Lord Atkinson analysed why that was so. It seems clear that the actual result of the case was

strongly influenced by Lord Atkinson’s reasoning. The clause was upheld although,

on the face of it, it failed all but the last of Lord Dunedin’s tests. The £5 per item

applied to breaches of very variable significance and it was impossible to relate the loss attributable to the sale of that item. It was justifiable only by reference to the wider interests identified by Lord Atkinson.

25.       The great majority of cases decided in England since Dunlop have concerned

more or less standard damages clauses in consumer contracts, and Lord Dunedin’s

four tests have proved perfectly adequate for dealing with those. More recently, however, the courts have returned to the possibility of a broader test in less

straightforward cases, in the context of the supposed “commercial justification” for

clauses which might otherwise be regarded as penal. An early example is the

decision of the House of Lords in The “Scaptrade”, where at p 702, Lord Diplock,

with whom the rest of the Appellate Committee agreed, observed that a right to withdraw a time-chartered vessel for non-payment of advance hire was not a penalty because its commercial purpose was to create a fund from which the cost of providing the chartered service could be funded.

26. In Lordsvale Finance plc v Bank of Zambia [1996] QB 752, Colman J was concerned with a common form provision in a syndicated loan agreement for interest to be payable at a higher rate during any period when the borrower was in default. There was authority that such provisions were penal: Lady Holles v Wyse (1693) 2 Vern 289; Strode v Parker (1694) 2 Vern 316, Wallingford v Mutual Society (1880) 5 App Cas 685, 702 (Lord Hatherley). But Colman J held that the clause was valid because its predominant purpose was not to deter default but to reflect the greater credit risk associated with a borrower in default. At pp 763-764, he observed that a provision for the payment of money upon breach could not be categorised as a penalty simply because it was not a genuine pre-estimate of damages, saying that there would seem to be:

“no reason in principle why a contractual provision the effect

of which was to increase the consideration payable under an executory contract upon the happening of a default should be struck down as a penalty if the increase could in the circumstances be explained as commercially justifiable, provided always that its dominant purpose was not to deter the

other party from breach.”

27.       Colman J’s approach was approved by Mance LJ, delivering the leading

judgment in the Court of Appeal in Cine Bes Filmcilik ve Yapimcilik v United International Pictures [2004] 1 CLC 401, para 13. A similar view was taken by Arden LJ in Murray v Leisureplay plc [2005] IRLR 946, para 54, where she posed the question

“Has the party who seeks to establish that the clause is a penalty

shown that the amount payable under the clause was imposed in terrorem, or that it does not constitute a genuine pre-estimate of loss for the purposes of the Dunlop case, and, if he has shown

the latter, is there some other reason which justifies the discrepancy between [the amount payable under the clause and

the amount payable by way of damages in common law]?”

(emphasis added).

She considered that the clause in question had advantages for both sides, and pointed out that no evidence had been adduced to show that the clause lacked commercial justification: see paras 70-76. But Buxton LJ put the matter on a wider basis for which Clarke LJ (para 105) expressed a preference. He referred to the speech of Lord Atkinson in Dunlop and suggested that the ratio of the actual decision in that

case had been that “an explanation of the clause in commercial rather than deterrent

terms was available”. All three members of the court endorsed the approach of

Colman J in Lordsvale and Mance LJ in Cine Bes.

28. Colman J in Lordsvale and Arden LJ in Murray were inclined to rationalise the introduction of commercial justification as part of the test, by treating it as evidence that the impugned clause was not intended to deter. Later decisions in which a commercial rationale has been held inconsistent with the application of the penalty rule, have tended to follow that approach: see, for example, Euro London

Appointments Ltd v Claessens International Ltd [2006] 2 Lloyd’s Rep 436, General Trading Company (Holdings) Ltd v Richmond Corpn Ltd [2008] 2 Lloyd’s Rep 475.

It had the advantage of enabling them to reconcile the concept of commercial

justification with Lord Dunedin’s four tests. But we have some misgivings about it.

The assumption that a provision cannot have a deterrent purpose if there is a commercial justification, seems to us to be questionable. By the same token, we agree with Lord Radcliffe’s observations in Campbell Discount at p 622, where he

said:

“… I do not myself think that it helps to identify a penalty, to

describe it as in the nature of a threat ‘to be enforced in

terrorem’ (to use Lord Halsbury’s phrase in Elphinstone v

Monkland Iron & Coal Co Ltd (1886) 11 App Cas 332, 348). I do not find that that description adds anything of substance to

the idea conveyed by the word ‘penalty’ itself, and it obscures

the fact that penalties may quite readily be undertaken by parties who are not in the least terrorised by the prospect of having to pay them and yet are, as I understand it, entitled to claim the protection of the court when they are called upon to

make good their promises.”

Moreover, the penal character of a clause depends on its purpose, which is ordinarily an inference from its effect. As we have already explained, this is a question of construction, to which evidence of the commercial background is of course relevant in the ordinary way. But, for the same reason, the answer cannot depend on evidence of actual intention: see Chartbrook Ltd v Persimmon Homes Ltd [2009] AC 1101, paras 28-47 (Lord Hoffmann). However, while we have misgivings about some aspects of their reasoning, these aspects are peripheral to the essential point which Colman J and Buxton LJ were making, and we consider that their emphasis on justification provides a valuable insight into the real basis of the penalty rule. It is the same insight as that of Lord Robertson in Clydebank and Lord Atkinson in Dunlop. A damages clause may properly be justified by some other consideration than the desire to recover compensation for a breach. This must depend on whether the innocent party has a legitimate interest in performance extending beyond the prospect of pecuniary compensation flowing directly from the breach in question.

29. The availability of remedies for a breach of duty is not simply a question of providing a financial substitute for performance. It engages broader social and economic considerations, one of which is that the law will not generally make a remedy available to a party, the adverse impact of which on the defaulter significantly exceeds any legitimate interest of the innocent party. In the famous case of White & Carter (Councils) Ltd v McGregor [1962] AC 413, Lord Reid observed, at p 431:

“It may well be that, if it can be shown that a person has no

legitimate interest, financial or otherwise, in performing the contract rather than claiming damages, he ought not to be allowed to saddle the other party with an additional burden with no benefit to himself. If a party has no interest to enforce a stipulation, he cannot in general enforce it: so it might be said that, if a party has no interest to insist on a particular remedy, he ought not to be allowed to insist on it. And, just as a party is not allowed to enforce a penalty, so he ought not to be allowed to penalise the other party by taking one course when another

is equally advantageous to him. … Here the respondent did not

set out to prove that the appellants had no legitimate interest in completing the contract and claiming the contract price rather

than claiming damages. … Parliament has on many occasions

relieved parties from certain kinds of improvident or oppressive contracts, but the common law can only do that in

very limited circumstances.”

In White & Carter the innocent party was entitled to ignore the repudiation of the contract-breaker and proceed to perform, claiming his remuneration in debt rather than limiting himself to damages, notwithstanding that this course might be a great deal more expensive for the contract-breaker. This, according to Lord Reid (p 431),

was because the contract-breaker “did not set out to prove that the appellants had no

legitimate interest in completing the contract and claiming the contract price rather

than claiming damages”.

30. More generally, the attitude of the courts, reflecting that of the Court of Chancery, is that specific performance of contractual obligations should ordinarily be refused where damages would be an adequate remedy. This is because the minimum condition for an order of specific performance is that the innocent party should have a legitimate interest extending beyond pecuniary compensation for the breach. The paradigm case is the purchase of land or certain chattels such as ships,

which the law recognises as unique. Because of their uniqueness the purchaser’s

interest extends beyond the mere award of damages as a substitute for performance.

As Lord Hoffmann put it in addressing a very similar issue “the purpose of the law

of contract is not to punish wrongdoing but to satisfy the expectations of the party

entitled to performance”: Co-operative Insurance Society Ltd v Argyll Stores

(Holdings) Ltd [1998] AC 1, 15.

31. In our opinion, the law relating to penalties has become the prisoner of artificial categorisation, itself the result of unsatisfactory distinctions: between a penalty and genuine pre-estimate of loss, and between a genuine pre-estimate of loss and a deterrent. These distinctions originate in an over-literal reading of Lord

Dunedin’s four tests and a tendency to treat them as almost immutable rules of

general application which exhaust the field. In Legione v Hateley (1983) 152 CLR

406, 445, Mason and Deane JJ defined a penalty as follows:

“A penalty, as its name suggests, is in the nature of a

punishment for non-observance of a contractual stipulation; it consists of the imposition of an additional or different liability

upon breach of the contractual stipulation ...”

All definition is treacherous as applied to such a protean concept. This one can fairly be said to be too wide in the sense that it appears to be apt to cover many provisions which would not be penalties (for example most, if not all, forfeiture clauses).

However, in so far as it refers to “punishment” and “an additional or different

liability” as opposed to “in terrorem” and “genuine pre-estimate of loss”, this

definition seems to us to get closer to the concept of a penalty than any other definition we have seen. The real question when a contractual provision is challenged as a penalty is 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 of loss does not therefore, at any rate without more, mean that it is penal. To describe it as a deterrent (or, to use the Latin equivalent, in terrorem) does not add anything. A deterrent provision in a contract is simply one species of provision designed to influence the conduct of the party potentially affected. It is no different in this respect from a contractual inducement. Neither is it inherently penal or contrary to the policy of the law. The question whether it is enforceable should depend on whether the means by

which the contracting party’s conduct is to be influenced are “unconscionable” or (which will usually amount to the same thing) “extravagant” by reference to some

norm.

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. In the case of a straightforward damages clause, that interest will rarely extend beyond

compensation for the breach, and we therefore expect that Lord Dunedin’s four tests

would usually be perfectly adequate to determine its validity. But compensation is not necessarily the only legitimate interest that the innocent party may have in the

performance of the defaulter’s primary obligations. This was recognised in the early

days of the penalty rule, when it was still the creature of equity, and is reflected in Lord Macclesfield’s observation in Peachy (quoted in para 5 above) about the

application of the penalty rule to provisions which were “never intended by way of compensation”, for which equity would not relieve. It was reflected in the result in

Dunlop. And it is recognised in the more recent decisions about commercial justification. And, as Lord Hodge shows, it is the principle underlying the Scottish authorities.

33. The penalty rule is an interference with freedom of contract. It undermines the certainty which parties are entitled to expect of the law. Diplock LJ was neither

the first nor the last to observe that “The court should not be astute to descry a

‘penalty clause’”: Robophone at p 1447. As Lord Woolf said, speaking for the Privy

Council in Philips Hong Kong Ltd v Attorney General of Hong Kong (1993) 61 BLR

41, 59, “the court has to be careful not to set too stringent a standard and bear in mind that what the parties have agreed should normally be upheld”, not least because

“[a]ny other approach will lead to undesirable uncertainty especially in commercial

contracts”.

34. Although the penalty rule originates in the concern of the courts to prevent exploitation in an age when credit was scarce and borrowers were particularly vulnerable, the modern rule is substantive, not procedural. It does not normally depend for its operation on a finding that advantage was taken of one party. As Lord Wright MR observed in Imperial Tobacco Company (of Great Britain) and Ireland v Parslay [1936] 2 All ER 515, 523:

“A millionaire may enter into a contract in which he is to pay

liquidated damages, or a poor man may enter into a similar contract with a millionaire, but in each case the question is exactly the same, namely, whether the sum stipulated as

damages for the breach was exorbitant or extravagant ...”

35. But for all that, the circumstances in which the contract was made are not entirely irrelevant. 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. In that connection, it is worth noting that in Philips Hong Kong at pp 57-59, Lord Woolf specifically referred to the possibility of taking into

account the fact that “one of the parties to the contract is able to dominate the other

as to the choice of the terms of a contract” when deciding whether a damages clause

was a penalty. In doing so, he reflected the view expressed by Mason and Wilson JJ

in AMEV-UDC at p 194 that the courts were thereby able to “strike a balance

between the competing interests of freedom of contract and protection of weak

contracting parties” (citing Atiyah, The Rise and Fall of Freedom of Contract

(1979), Chapter 22). However, Lord Woolf was rightly at pains to point out that this

did not mean that the courts could thereby adopt “some broader discretionary approach”. The notion that the bargaining position of the parties may be relevant is

also supported by Lord Browne-Wilkinson giving the judgment of the Privy Council

in Workers Bank. At p 580, he rejected the notion that “the test of reasonableness

[could] depend upon the practice of one class of vendor, which exercises

considerable financial muscle” as it would allow such people “to evade the law

against penalties by adopting practices of their own”. In his judgment, he decided

that, in contracts for sale of land, a clause providing for a forfeitable deposit of 10% of the purchase price was valid, although it was an anomalous exception to the penalty rule. However, he held that the clause providing for a forfeitable 25%

deposit in that case was invalid because “in Jamaica, the customary deposit has been

10%” and “[a] vendor who seeks to obtain a larger amount by way of forfeitable deposit must show special circumstances which justify such a deposit”, which the

appellant vendor in that case failed to do.

Should the penalty rule be abrogated?

36. The primary case of Miss Smith QC, who appeared for Cavendish in the first appeal, was that the penalty rule should now be regarded as antiquated, anomalous and unnecessary, especially in the light of the growing importance of statutory regulation in this field. It is the creation of the judges, and, she argued, the judges should now take the opportunity to abolish it. There is a case to be made for taking this course. It was expounded with considerable forensic skill by Miss Smith, and has some powerful academic support: see Sarah Worthington, Common Law Values: the Role of Party Autonomy in Private Law, in The Common Law of Obligations: Divergence and Unity (ed A Robertson and M Tilbury (2015)), pp 18-26. We rather doubt that the courts would have invented the rule today if their predecessors had not done so three centuries ago. But this is not the way in which English law develops, and we do not consider that judicial abolition would be a proper course for this court to take.

37. The first point to be made is that the penalty rule is not only a long-standing principle of English law, but is common to almost all major systems of law, at any rate in the western world. It has existed in England since the 16th century and can be traced back to the same period in Scotland: McBryde, The Law of Contract in Scotland, 3rd ed (2007), paras 22-148. The researches of counsel have shown that it has been adopted with some variants in all common law jurisdictions, including those of the United States. A corresponding rule was derived from Roman law by Pothier, Traité des Obligations, No 346, which is to be found in the Civil Codes of France (article 1152), Germany (for non-commercial contracts only) (sections 343, 348), Switzerland (article 163.3), Belgium (article 1231) and Italy (article 1384). It is included in influential attempts to codify the law of contracts internationally, including the Unidroit Principles of International Commercial Contracts (2010) (article 7.4.13), and the UNCITRAL Uniform Rules on Contract Clauses for an Agreed Sum Due upon Failure of Performance (article 6). In January 1978 the Committee of Ministers of the Council of Europe recommended a number of common principles relating to penal clauses, including (article 7) that a stipulated

sum payable on breach “may be reduced by the court when it is manifestly

excessive”.

38. It is true that statutory regulation, which hardly existed at the time that the penalty rule was developed, is now a significant feature of the law of contract. In England, the landmark legislation was the Unfair Contract Terms Act 1977. For most purposes, the Act was superseded by the Unfair Terms in Consumer Contracts Regulations 1994 (SI 1994/3159), which was in turn replaced by the 1999 Regulations, both of which give effect to European Directives. The 1999

Regulations contain an “indicative and non-exhaustive list of the terms which may

be regarded as unfair”, including terms which have the object or effect of “requiring

any consumer who fails to fulfil his obligation to pay a disproportionately high sum

in compensation”. Nonetheless, statutory regulation is very far from covering the

whole field. Penalty clauses are controlled by the 1999 Regulations, but the Regulations apply only to consumer contracts and the control of unfair terms under regulations 3 and 5 is limited to those which have not been individually negotiated. There are major areas, notably non-consumer contracts, which are not regulated by statute. Some of those who enter into such contracts, for example professionals and small businesses, may share many of the characteristics of consumers which are thought to make the latter worthy of legal protection. The English Law Commission considered penalty clauses in 1975 (Working Paper No 61, Penalty Clauses and Forfeiture of Monies Paid, April 1975), at a time when there was no relevant statutory regulation, and the Scottish Law Commission reported on them in May 1999 (Report No 171). Neither of these Reports recommended abolition of the rule. On the contrary, both recommended legislation which would have expanded its scope.

39. Further, although there are justified criticisms that can be made of the penalty rule, it is consistent with other well-established principles which have been developed by judges (albeit mostly in the Chancery courts) and which involve the court in declining to give full force to contractual provisions, such as relief from forfeiture, the equity of redemption, and refusal to grant specific performance, as discussed in paras 10-11 and 29-30 above. Finally, the case for abolishing the rule depends heavily on anomalies in the operation of the law as it has traditionally been understood. Many, though not all of these are better addressed (i) by a realistic appraisal of the substance of contractual provisions operating upon breach, and (ii) by taking a more principled approach to the interests that may properly be protected

by the terms of the parties’ agreement.

Should the penalty rule be extended?

40. In the course of his cogent submissions, Mr Bloch QC, who appeared for Mr Makdessi on the first appeal, suggested that, as an alternative to confirming or abrogating the penalty rule, this court could extend it, so that it applied more generally. As he pointed out, this was the course taken by the High Court of Australia, and it would have the advantage of rendering the penalty rule less formalistic in its application, and, which may be putting the point in a different way, less capable of avoidance by ingenious drafting.

41. This step has recently been taken in Australia. Until recently, the law in Australia was the same as it is in England: see 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); AMEV-UDC at p 184 (Mason and Wilson JJ, citing ECGD among other authorities), 211 (Dawson J); Ringrow Pty Ltd v BP Australia Pty Ltd (2005) 224 CLR 656, 662. However, a radical departure from the previous understanding of the law occurred with the decision of the High Court of Australia in Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205. The background to this case was very similar to that in Office of Fair Trading v Abbey National plc [2010] 1 AC 696. It concerned the application of the penalty rule to contractual bank charges payable when the bank bounced a cheque or allowed the customer to draw in excess of his available funds or agreed overdraft limit. These might in a loose sense be regarded as banking irregularities, but they did not involve any breach of contract on the part of the customer. On that ground Andrew Smith J had held in the Abbey National case that the charges were incapable of being penalties: [2008] 2 All ER (Comm) 625, paras 295-299 (the point was not appealed). In Andrews, the High Court of Australia disagreed. They engaged in a detailed historical examination of the equitable origin of the rule and concluded that there subsisted, independently of the common law rule, an equitable jurisdiction to relieve against any sufficiently onerous provision which was conditional upon a failure to observe some other provision, whether or not that failure was a breach of contract. At para 10, they defined a penalty as follows:

“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 second party. In that sense, the collateral or accessory stipulation is described as being in the nature of a security for and in terrorem of the satisfaction of the primary stipulation. If compensation can be made to the second party for the prejudice suffered by failure of the primary stipulation, the collateral stipulation and the penalty are enforced only to the extent of that compensation. The first party is relieved to that degree from

liability to satisfy the collateral stipulation.”

42. Any decision of the High Court of Australia has strong persuasive force in this court. But we cannot accept that English law should take the same path, quite apart from its inconsistency with established and unchallenged House of Lords authority. In the first place, although the reasoning in Andrews was entirely historical, it is not in fact consistent with the equitable rule as it developed historically. The equitable jurisdiction to relieve from penalties arose wholly in the context of bonds defeasible in the event of the performance of a contractual obligation. It necessarily posited a breach of that obligation. Secondly, if there is a distinct and still subsisting equitable jurisdiction to relieve against penalties which is wider than the common law jurisdiction, with three possible exceptions it appears to have left no trace in the authorities since the fusion of law and equity in 1873. The first arguable exception is in In re Dagenham (Thames) Dock Co; Ex p Hulse (1873) LR 8 Ch App 1022 (followed by the Privy Council in Kilmer v British Columbia Orchard Lands Ltd [1913] AC 319), where the Court of Appeal granted a purchaser, who had been in possession for five years and carried out improvements, further time to pay the second and final instalment of a purchase price on the ground that the clause requiring him to vacate and to forfeit the first

instalment for not having paid the second instalment on time, was a “penalty”.

However, James and Mellish LJJ may have been treating the clause as a forfeiture (as they both also used that expression in their brief judgments), and in any event they treated the purchaser in the same way as a mortgagor in possession asking for more time to pay. Further, as Romer LJ pointed out in Stockloser at pp 497-498, the decision could be justified by the fact that time had already been extended twice by agreement, and in any event there was no question of the vendor being required to repay the first instalment. The second arguable exception is no more than an unsupported throw-away line in the judgment of Diplock LJ in Robophone at p 1446,

where he said it was “by no means clear” whether penalty clauses “are simply void”,

but, on analysis, he was dealing with a rather different point (namely that discussed by Lord Atkin in the passage that follows). The third exception is the unsatisfactory decision in Jobson v Johnson [1989] 1 WLR 1026, to which we shall return in paras 84-87 below. It is relevant to add in this connection that the law of penalties has been held to be the same in England and Scotland: Stair Memorial Encyclopaedia of the Laws of Scotland, vol 15, paras 783-801, and see Clydebank. Yet equity, although influential, has never been a distinct branch of Scots law. In the modern law of both countries, the penalty rule is an aspect of the law of contract. Thirdly,

295. I disagree with the other members of the court in the parking case. Since I am a lone voice of dissent and the judgments are already exceedingly long, I will state my reasons briefly. Everyone agrees that there was a contract between Mr Beavis and ParkingEye, but I begin by looking at what was the consideration for, and essential content of, the contract. The parties were content to argue the case, as they had in the Court of Appeal, on the basis that by using the car park Mr Beavis entered into a contract by which he agreed to leave it within two hours; and that his failure to do so was a breach of contract for which he agreed to pay £85 (subject to a discount for prompt payment). Moore-Bick LJ expressed doubt whether this was the correct analysis, and since this is a test case it is right to consider the matter.

296. Where parties intend to enter into legal relations, it does not require much to constitute consideration. Some benefit must be conferred both ways; but the benefit provided by the promisor does not have to be for the promisee personally; it may be for some third party whom the promisee wishes to benefit. (This has nothing to do with the doctrine of privity.) Any act or promise in exchange for an act or promise can constitute consideration.

297. In this case we are concerned with a car park forming an integral part of a retail park occupied by a number of well-known chains. The use of the car park was not merely a benefit to the user. It was of obvious benefit to the freeholder (and the lessees of the retail outlets) that members of the public should be attracted to the retail park by its availability, and that was no doubt why it was provided. As Mr Christopher Butcher QC correctly submitted, the use of the car park by Mr Beavis was sufficient consideration for a contract governing the terms of its usage. The form

of notice stated that “Parking is at the absolute discretion of the site”, but once a

motorist had parked he would obviously have to be given reasonable notice of a
requirement to leave.

298. The most important term of the contract was that the user was permitted to stay for a maximum of two hours. That requirement was displayed in bigger and bolder letters than anything else. There were subsidiary requirements; that the user should not return within one hour after leaving; that parking should be within the bays marked; and that certain bays were restricted to use by blue badge holders (ie persons with mobility problems). The contract further stated, although this was not

legally necessary, that “By parking within the car park, motorists agree to comply with the car park regulations”, meaning the provisions stated in the notice (since

there were no other regulations). Overstaying would therefore be a breach of contract (as, for example, would be parking except within the lines of an appropriate marked bay). In the case of a breach of any description, the user agree to pay the sum of £85. This was therefore, as the parties rightly accepted, an agreement to pay a specified figure for a breach of contract. It was not an agreement allowing a motorist to overstay in consideration of a payment of £85. On overstaying (or for that matter on returning within one hour after leaving the car park) the user would be a trespasser. We are not concerned in this case whether the agreement to pay £85 would leave the landowner free to sue the user for damages for trespass, although he would no doubt in theory be entitled to seek injunctive relief.

299.     It is convenient to consider the effect of the Unfair Terms in Consumer

Contracts Regulations 1999 (“the Regulations”) before considering the effect of the

common law on penalty clauses. Regulation 8(1) provides that an unfair term in a contract concluded with a consumer by a seller or supplier shall not be binding on the consumer. An unfair term is defined in regulation 5(1):

“A contractual term which has not been individually negotiated

shall be regarded as unfair if, contrary to the requirement of

good faith, it causes a significant imbalance in the parties’

rights and obligations arising under the contract, to the

detriment of the consumer.”

300. Regulation 6(1) requires the question of unfairness to be assessed, taking into account the nature of the goods or services, and by referring to all the circumstances at the time of the conclusion of the contract and to all the other terms of the contract.

301. Regulation 6(2) excludes from the assessment of fairness terms (provided that they are in plain intelligible language) relating to the definition of the main subject matter of the contract or to the adequacy of the price or remuneration, as against the goods or services supplied in exchange. The term which levies £85 on a user of the car park who overstays, or returns within an hour or parks badly, does not provide remuneration for the services of ParkingEye, nor does it relate to the definition of the subject matter of the contract. It is simply a penalty for doing one of the things prohibited. Its enforceability depends on whether it satisfies the requirement of fairness within the meaning of the Regulations.

302. Schedule 2 to the Regulations provides an indicative list of terms which may

be considered unfair, including a term requiring a consumer who fails to fulfil his
obligation to pay a disproportionately high sum in compensation.

303.     The Regulations give effect to the European Council Directive 93/13/EEC of

5 April 1993 on unfair terms in consumer contracts (“the Directive”). Article 3(1)

of the Directive is the counterpart to regulation 5(1) and is identically worded.

304. In Director General of Fair Trading v First National Bank plc [2001] UKHL 52, [2002] 1 AC 481, para 17, Lord Bingham described this provision as laying down a composite test, covering both the making and the substance of the contract, which must be applied bearing in mind the object which the Regulations are designed to promote. He said that fair dealing requires that the supplier should not,

deliberately or unconsciously, take advantage of the consumer’s necessity,

indigence, lack of experience, unfamiliarity with the subject matter of the contract, weak bargaining position or any factor listed in or analogous to those listed in the Schedule.

305. In the same case Lord Millett, at para 54, suggested as a matter for consideration whether, as between parties negotiating freely a contract on level

terms, the party adversely affected by the term “or his lawyer” might reasonably be

expected to object to it.

306. More recently in Aziz v Caixa d’Estalvis de Catalunya, Tarragona i Manresa (Case C-415/11) [2013] 3 CMLR 89, the Court of Justice of the European Union has addressed the interpretation of article 3(1) of the Directive. It observed (at para 44) that the system of protection introduced by the Directive is based on the idea that the consumer is in a weak position vis-à-vis the seller or supplier.

307.     In agreement with the opinion of Advocate General Kokott, the court held

that the reference in article 3(1) to a “significant imbalance” in the parties’ rights

and obligations under the contract must be interpreted as requiring the court to evaluate to what extent the term places the consumer in a worse position than would have been the situation under the relevant national law in the absence of that term. Applying that test, it follows that the £85 penalty clause created a significant imbalance within the meaning of the regulation, because it far exceeded any amount which was otherwise likely to be recoverable as damages for breach of contract or trespass.

308. As to whether the imbalance was contrary to the requirement of good faith, the court, at para 76 in agreement with the Advocate General held that

“in order to assess whether the imbalance arises ‘contrary to the

requirement of good faith’, it must be determined whether the

seller or supplier, dealing fairly and equitably with the consumer, could reasonably assume that the consumer would have agreed to the term concerned in individual contract

negotiations.”

309. That test is significantly more favourable to the consumer than would be applied by a court in this country under the penalty doctrine. Whereas the starting point at common law is that parties should be kept to their bargains, and it is for those objecting that a clause is penal to establish its exorbitant nature, the starting point of the Directive is that the consumer needs special protection, and it is for the supplier to show that a non-core term which is significantly disadvantageous to the consumer, as compared with the ordinary operation of the law without that term, is one which the supplier can fairly assume that the consumer would have agreed in individual negotiations on level terms. The burden is on the supplier to adduce the evidence necessary to justify that conclusion.

310. I do not consider that such an assumption could fairly be made in the present case. The Consumers’ Association through Mr Butcher advanced a number of telling points. By most people’s standards £85 is a substantial sum of money. Mr Butcher

reminded the court by way of comparison that the basic state pension is £115 per week. There may be many reasons why the user of a car park in a retail park may unintentionally overstay by a short period. There may be congestion in the shops or the user may be held up for any number of reasons. There may be congestion trying to get out of the car park. In short there may be numerous unforeseen circumstances. No allowance is made for disabilities (other than the provision of bays for blue badge holders). Similarly there may be good reasons for a person to return to the car park within two hours, for example because the shopper has left something behind (and the car park may incidentally be half empty). There may be reasons why a user parks with his wheels outside the marked bay (for example because of the way the adjacent vehicle is parked or because he is a wheelchair user and none of the blue bays are available). Examples could be multiplied. The point is that the penalty clause makes no allowance for circumstances, allows no period of grace and provides no room for adjustment.

311. The court was referred to a code of practice published by the British Parking Association which addresses some of these matters, but the significant fact is that it is not a contractual document. A competent lawyer representing a user in individual negotiation might be expected, among other things, to argue that the supplier should at least commit to following the code of practice.

312. More broadly the penalty clause places the whole cost of running the car park on the shoulders of those who overstay by possibly a very short time, although their contribution to the cost will have been very small. The trial judge and the Court of Appeal were impressed by a comparison with the charges at local authority car parks. The comparison is seductive but superficial. Apart from the fact that local authorities operate under a different statutory scheme, a large amount of the cost is raised from all users by hourly charges, as distinct from placing the entire burden on the minority of overstayers; and there is not the same feature in the case of a municipal car park as there is in a supermarket car park, where the car park is ancillary to the use of the retail units some of whose customers are then required to underwrite the entire cost as a result of overstaying.

313. There is of course an artificiality in postulating a hypothetical negotiation between the supplier and an individual customer with the same access to legal advice, but because it is a consumer contract, and because the supplier is inserting a

term which alters the legal effect under the core terms in the supplier’s favour, the supplier requires as it were to put itself in the customer’s shoes and consider whether

it “can reasonably assume that the customer would have agreed” to it.

314. I am not persuaded that it would be reasonable to make that assumption in this case and I would therefore have allowed the appeal. It has been suggested that managing the effective use of parking space in the interests of the retailer and the users of those outlets who wished to find spaces to park could only work by deterring people from occupying space for a long time. But that is a guess. It may be so; it may not. ParkingEye called no evidence on the point. But it is common knowledge that many supermarket car parks make no such charge. I return to the point that it was for ParkingEye to show the factual grounds on which it could reasonably assume that a customer using that car park would have agreed, in individual negotiations, to pay £85 if he overstayed for a minute, or parked with his wheels not entirely within a marked bay, or for whatever reason returned to the car park in less than one hour (perhaps because he had left something behind). On the bare information which was placed before the court, I am not persuaded that ParkingEye has shown grounds for assuming that a party who was in a position to bargain individually, and who was advised by a competent lawyer, would have agreed to the penalty clause as it stood.

315. Lord Neuberger and Lord Sumption in para 107 have substituted their judgment of reasonableness of the clause for the question whether the supplier could reasonably have assumed that the customer would have agreed with the term, and on that approach there is not much, if any, difference in substance from the test whether it offended the penalty doctrine at common law. That approach is consistent with their statement in para 104 that the considerations which show that it is not a penalty demonstrate also that it does not offend the Regulations. I consider that the approach waters down the test adopted by the CJEU and at the very least that the point is not acte clair.

316.     Mr Beavis’s argument that the clause was a penalty at common law is more

questionable, but in the circumstances nothing would be gained by discussing that
matter further.