Cavendish Square Holding BV v Talal El Makdessi; ParkingEye Ltd v Beavis

Heard on 21, 22 and 23 July 2015

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").

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

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.

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 …"

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 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.

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.

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...