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The rule on penalty clauses applied in the High Court

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In a previous blog (which you can read here), I discussed the change to the rule on penalty clauses resulting from the Supreme Court’s decision in Cavendish Square Holding BV v Talal El Makdessi and ParkingEye Ltd v Beavis [2015] UKSC 67.

In that case, it was established that a clause will be a penalty and therefore unenforceable if:

  • the clause is a secondary obligation that is activated when a party to a contract breaches a primary obligation; and
  • the secondary obligation imposes on the breaching party a detriment out of all proportion to any legitimate interest the innocent party has in the performance of the primary obligation.

I have been waiting to see how the courts would apply the rule and that wait is over, following the High Court decision in Vivienne Westwood Limited v Conduit Street Development Limited [2017] EWHC 350 (Ch).

The case centred on a side letter that was signed by the landlord (Conduit Street Development Limited) and tenant (Vivienne Westwood Limited) at the same time as they entered into a lease. The letter granted the tenant a rent concession, allowing it to pay a lower rent for a period of 10 years.

Another clause in the letter allowed the landlord to terminate the side letter if the tenant breached any term of the lease or the side letter and to insist on payment of a higher rent – contained in the lease. The court was asked to determine if this amounted to a penalty. Deputy Judge Fancourt held that:

  • The clause was a secondary obligation capable of being a penalty;
  • The effect of the clause was to allow the landlord to terminate the side letter and to insist on payment of the higher rent, both retrospectively and in the future. The tenant was therefore liable for the higher rent not only in the future, but during the previous years that it had enjoyed the lower rate; and
  • The tenant’s obligation to pay applied even if the breach was minor and did not take into consideration the actual or likely consequences of the breach on the landlord.

The court concluded that the effect of the clause was disproportionate to the legitimate interest the landlord had in having its tenant comply with its obligations. Therefore, the clause was a penalty and unenforceable.

The decision highlights the need to avoid including an overly onerous term in a contract which could be considered a penalty and therefore unenforceable.

If you are concerned about a clause in any contract that you are a party to or would like assistance with drafting a contract, please contact Thomas Emmett from our Chelmsford office on 01245 453847 for a no obligation chat.