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Practice Area: Corporate Litigation & Dispute Resolution

Corporate Insolvency: Care and Caution that should be taken by creditors and debtors

Posted on by Priyanka Kumar

The current financial climate has made getting paid outstanding debts increasingly difficult. Consequently, to put pressure on a debtor, creditors sometimes resort to serving statutory demands, or proceeding with winding-up petitions as a method of debt recovery. A winding up petition is a creditor’s petition to have a company placed into compulsory liquidation by the Court, resulting in the company being wound up.

However, using a statutory demand for a commercial debt should only be embarked upon with care and caution.

In this article we explore the key considerations that should be borne in mind for creditors who are considering serving a statutory demand and debtors who receive one.

 

What exactly is a statutory demand?

A statutory demand is a formal written demand in prescribed form from a creditor to a debtor requesting payment of the debt within 21 days. The prescribed form is governed by section 7.3 of The Insolvency (England and Wales) Rules 2016. Where the debtor is a company, the debt must be for at least £750. (Where the debtor is an individual, it must be for at least £5,000). It is a ‘pre-cursor’ to a winding-up petition (or bankruptcy petition in the case of an individual).

 

Procedure for service

The statutory demand must be served personally upon the debtor’s registered office. It is best to have this personally served (by a process server or otherwise) so there can be no doubt that the demand has been brought to the debtor’s attention.

If the debt remains unpaid and unchallenged for more than 21 day, this demonstrates that a Company is unable to pay its debts, that the debt is undisputed and therefore a winding up petition may be presented. Statutory demands are, therefore, aggressive in nature and should not simply be used as a simple debt recovery tool.

 

What should a creditor consider before serving a statutory demand?

Does the debtor dispute the debt ?

Where there is a ‘genuine dispute on substantial grounds’ about all the sums claimed in the statutory demand or winding-up petition, the court will not hesitate to restrain the creditor from taking any further steps, by setting aside the statutory demand. Unsurprisingly, it is considered an “abuse of process” for a creditor to serve a statutory demand where the debtor genuinely disputes the debt.

The dispute must be genuine. The court will not conduct a ‘mini-trial’ to determine whether the debt is due but if it is satisfied that there is a genuine dispute, it will set aside the statutory demand on the basis the correct forum for the determination of the claim is via a County or High Court claim.

So if the debtor is not paying the debt because it genuinely disputes it, a creditor should consider alternative approaches.

The advantage of using a statutory demand is that it is usually a faster way to recover payment from a debtor than using sending a Letter Before Action in accordance with the pre-action protocol for debt claims and then issuing debt recovery proceedings. However, If the debt is disputed then the Letter Before Action route is the appropriate one.

The debtor has a serious and genuine counter- claim exceeding the debt

 

This article was written by Priyanka Kumar from our litigation team. Get in touch with Priyanka today to find out how she can help you by email priyanka.kumar@wellerslawgroup.com.

Commercial Service Charges – Pay Now, Argue Later

Posted on by Joe Reeves

In the recent case of Sara & Hossein Asset Holding Ltd v Blacks Outdoor Retail Ltd, the Supreme Court considered the correct interpretation of a service charge clause in a commercial lease.  The clause related to the conclusiveness of a service charge certificate produced by the landlord in relation to the amount to be paid by a tenant.

The Court held that a landlord’s service charge certificate was conclusive (in the absence of manifest error or fraud) as to the sum payable by the tenant at that point but was not conclusive as to the tenant’s underlying liability for the service charge.

The Background

The key facts were as follows:

  • Blacks was the tenant of commercial retail premises in Liverpool, of which S&H was the landlord, under two successive leases dated 2013 and 2018. Blacks was required under the leases to make payment toward the service charges for the building.
  • The service charge provisions in the leases required that S&H must supply Blacks, on a yearly basis, with a certificate as to the “total cost and the sum payable by the tenant” and that this certificate was to be conclusive in the absence of “manifest or mathematical error or fraud”.
  • Blacks had the right to inspect receipts, invoices and other evidence relating to the service charges. However, Blacks did not have the right to set-off or counterclaim any sum against the service charges.
  • The service charge for 2017/2018 was in excess of £400,000, substantially higher than in previous years. Blacks refused to pay and S&H issued proceedings for recovery.

The dispute turned on the interpretation of the service charge provisions in the leases, specifically the meaning of the words “shall be conclusive” in the context of the landlord’s certificate as to the service charge payable by the tenant.   S&H argued that the clause should be interpreted literally, namely that the certificate was conclusive as to the tenant’s liability.  In other words, a “pay now, argue never” interpretation.  Blacks argued that due to the content of other provisions in the leases including those strictly defining what costs were recoverable as service charges, the clause could not be so interpreted.  Blacks argued that the clause was only conclusive as to the sums S&H had incurred, not what Blacks was necessarily liable to pay.  In other words, an “argue now, pay later” interpretation.  Blacks did not contend that there was manifest or mathematical error in the charges (“Permitted Defences”).

The matter was the subject of extensive litigation, finally reaching the Supreme Court.  The Supreme Court rejected both parties’ interpretations, essentially reaching a halfway house.  By a majority of 4 to 1, it held that S&H’s certificates were binding as to the amount Blacks had to pay on certification (subject to any Permitted Defences) but that this was not determinative of Blacks’ service charge liability.  It was open to Blacks to challenge the amount following payment.  Essentially, the Court concluded that the clause, in its true interpretation, created a “pay now, argue later” regime.   Blacks had to pay the service charges but it had the right to subsequently challenge them.

Lord Briggs, in his sole dissent, criticised the majority’s “imaginative creation” on the basis there was no reason within the lease for the majority’s interpretation.  He said he would have favoured the landlord’s interpretation.

The result of the decision is that:

  • A landlord can enforce payment of service charges due under a certification clause.
  • Payment of a service charge does not prevent a tenant from disputing the liability for such payment afterwards, for instance in relation to any costs excluded under the lease. Where sums are later successfully challenged, the tenant will be entitled to repayment of those sums.

The decision seeks to strike a balance between the interests of landlords and tenants.   It will be welcome for landlords in that it ensures a consistent cashflow.   A landlord has a clear interest in recovering sums it has properly spent on repair from its tenants, with minimal difficulty.   The benefit to tenants is that this provides that the certification as to the sum to be paid to a landlord is not necessarily final.  Where a tenant has legitimate concerns as to service charges it has paid, it retains the right to challenge them later down the line.

A lot will depend upon the specific wording of the lease and the precise facts and circumstances.  It pays for both landlords and tenants to take advice on what costs are recoverable under a lease by way of service charges.  For landlords, that will be important in making decisions about expenditure.  For tenants, it will be important in understanding what sums they are liable to pay.

This article is not intended and should not be relied upon for legal advice,  Should you wish to discuss your matter, please contact Joe Reeves of our Litigation Department on 0207 481 6383 or joe.reeves@wellerslawgroup.com.

The right to re-apportion service charges – an important ruling for landlords and tenants

Posted on by Joe Reeves

AVIVA INVESTORS GROUND RENT GP LTD AND ANOTHER (RESPONDENTS) – V – WILLIAMS AND OTHERS (APPELLANTS)

In a decision which will be of importance to residential landlords and tenants, the Supreme Court has ruled to preserve the contractual right within a lease, where provided, for the landlord to re-apportion service charges..

The Background

On 8 February 2023 the Supreme Court handed down judgment in the case of Aviva Investors Ground Rent Gp Ltd and another v Williams and others.

The case had been the subject of litigation over a number of years through various courts, from the First Tier Tribunal finally up to the Supreme Court.

The judgment given by the Supreme Court addressed the following issues:

  1. To what extent is a term in a residential lease which allows the landlord to revise the tenant’s share of the service charges invalidated by section 27A(6) of the Landlord and Tenant Act 1985?
  2. If the effect is that any discretion to re-apportion the service charge is transferred from the landlord to the First-tier Tribunal does section 27A(6) enable the tenant as well as the landlord to invoke the Tribunal’s jurisdiction?

The dispute concerned the apportionment of service charges payable by leaseholders of 38 individual flats in a building located in Southsea, Hampshire.  The leaseholders were obliged to pay service charges towards the cost to the landlord (Aviva Investors Ground Rent Gp Ltd) of maintaining the building and wider estate.  Within their long leases, there was a clause which provided for the payment of service charges by residential leaseholders as either a fixed percentage of the costs or “such part as the landlord may otherwise reasonably determine”.

The landlord had for many years been demanding service charge payments in proportions different to (and above) the fixed percentages provided in the leases, under the provision for re-apportionment of service charges.   The leaseholders issued proceedings against the landlord seeking to challenge that practice.

Section 27A(6) of the Landlord and Tenant Act 1985 gives the First-Tier Tribunal (Property Chamber) (the FTT) jurisdiction to make decisions about service charge payments, including whether they are payable and if so, in what amounts.  The leaseholders had argued that the effect of section 27A(6) was to render void the apportionment provision in the leases.

As stated above, the case had been litigated over a number of years, finally culminating in an appeal by the leaseholders to the Supreme Court.  Previously, the FTT had held that the relevant provision in the leases was not void and that the re-apportionments were reasonable.  Subsequently, the Upper Tribunal (Lands Chamber) ruled that the re-apportionment provision was void pursuant to s 27A(6).   The landlord had appealed and the Court of Appeal allowed the appeal, ruling that the re-apportionment provision was not wholly void and that the effect of s 27A(6) was to transfer the discretion to vary the service charge proportions from the landlord to the FTT.  The leaseholders appealed to the Supreme Court.

The central question in the appeal was whether section 27A(6) renders void a contractual provision in a lease which provides for a leaseholder to pay a fixed proportion of service charges or such other proportion as the landlord may determine.   The leaseholders had, in relation to this, maintained that the apportionments by the landlord were unreasonable.

The Supreme Court unanimously dismissed the appeal, finding that the revised apportionments of service charges by the landlord were valid.

The court held that section 27A(6) was plainly an anti-avoidance provision, designed to preserve the jurisdiction of the FTT in determining whether service charges were reasonable in amount.   It was not the effect of section 27A(6) to deprive a landlord of its managerial decision making.  In other words, it did not operate to prevent the landlord from exercising a contractual right to revise and re-apportion service charges, merely to maintain the jurisdiction of the FTT in determining the reasonableness of the amounts in question.   The Court found that a lease provision would however be void if it aimed to oust or limit the jurisdiction of the FTT in determining the reasonableness of a service charge, for instance a provision making the landlord’s decision binding.

The Court found that section 27A(6) was not intended to remove the ability to vary service charge apportionments.  In this regard it rejected the leaseholders’ approach, finding that the effect of this would be to remove altogether the power to vary service charges.  This would have the effect of having apportionment fixed for many decades over the full term of a lease, even where the apportionment might overwise be varied, for instance by the increase of additional contributing flats in a building.  That would be a commercially unattractive result clearly not intended by the parties.

The result will be welcome to landlords as it confirms  the contractual right where contained within a lease to re-apportion service charges and the ability of the landlord to make managerial decisions in this regard.  It is also an important reminder of the jurisdiction and ability of the FTT to assess the reasonableness and amount of service charges.   This will no doubt be of consequence to many residential landlords and tenants throughout the country.

This article is not intended and should not be relied upon for legal advice,  Should you wish to discuss your matter, please contact Joe Reeves of our Litigation Department on 0207 481 6383 or joe.reeves@wellerslawgroup.com.

Payment under a construction contract and the right to adjudicate

Posted on by Wellers

We continue to receive a number of enquiries from contractors and sub-contractors unaware of their right to adjudicate under a construction contract for non-payment, despite the fact statutory adjudication was introduced 25 years ago.

Many clients have come to us after being advised by previous solicitors to commence County Court proceedings, which can be a lengthy and costly process, by which time the paying party may be insolvent.

Alternatively, clients have commenced insolvency proceedings and fall at the first hurdle if there is a genuine dispute. A client will be subject to a costs order if the debtor has been successful in setting aside a statutory demand, which is a precursor to liquidation of a company or the bankruptcy of an individual.

Adjudication

Adjudication is a way of resolving disputes in construction contracts. The right to adjudicate is governed by S.108 of the Housing Grants, Construction and Regeneration Act 1996 (“the Act”). The Act sets out certain procedural requirements which enable either party to a dispute, to refer the matter to an adjudicator, who is then required to reach a decision within 28 days of being served with the Referral Notice.

If a construction contract does not comply with these requirements, a statutory default scheme known as the Scheme for Construction Contracts will apply. If the construction contract contains adjudication provisions, but does not comply with the requirements of S.108, the Scheme will again apply.

The Referring Party of a dispute who appoints an adjudicator, has the added advantage that, its solicitors have spent weeks/months preparing for the adjudication, putting the other party (the Responding Party) on the back foot, with little time to prepare a Response.  This may result in payment being made before an adjudicator has reached his/her decision.

In the event that the losing party does not comply with the adjudicator’s decision, enforcement proceedings can be commenced in the Technology & Construction Court (“the TCC”) and you would normally apply for Summary Judgment. The TCC will enforce adjudication decisions without enquiring as to the correctness, subject to two exceptions.

The purpose of adjudication is to expedite cash flow during the construction contract and it is not uncommon to have multiple adjudications, throughout the duration of a project, but not adjudicated at the same time.

The payment terms of a construction contract are also regulated by Part II of the Act. So, before you decide to commence an adjudication, do you have a construction contract?

A construction contract

 A construction contract is defined by  the Act and are agreements for any of the following:

  • carrying out of construction operations.
  • providing one’s own labour, or the labour of others, for the carrying out of construction operations.
  • arranging for the carrying out of construction operations by others e.g. under a sub-contract.
  • It extends to architectural, design, advice on building, interior or exterior decoration, engineering, demolitions, surveying work and on the laying-out of landscape.
  • Installation of mechanical, electrical and heating works. to include maintenance of the works.
  • A collateral warranty as to the carrying out of construction work. Parkwood Leisure Ltd v Laing O’ Rourke Wales and West Ltd [2013] EWHC 2665 (TCC).Whether you can adjudicate will depend upon the timing and the wording of the warranty. Timing is paramount: Toppan Holdings Ltd & Anor v Simply Construct (UK) LLP [2021] EWHC 2110 (TCC).
  • Government contracts are construction contracts under the Act.

Exclusions

The following are excluded from being a construction contract:

  • Agreements which primarily relate to the financing of works
  • Development agreements containing provision for the disposal of an interest in land
  • Contracts between employers and employees.
  • Supply only contracts: manufacture and delivery of building/engineering, unless the contract also provides for their installation on site
  • Oil and gas exploration, mining and industries plants
  • Contracts with residential occupiers that occupy or intend to occupy the property

All construction contracts, except those with a duration of less than 45 days, must contain a right to instalments, stage payments or other periodic payments.

The Act prohibits withholding or reduction of payments, except after proper notice and prohibits pay-when-paid clauses, except in circumstances of insolvency.  The Act provides a right to suspend performance for non-payment.

Payment under the Act

The Act has the following provisions regarding payment:

  1. It requires a construction contract to provide for interim payments.
  2. It requires the contract to provide a mechanism for determining what sums became due and when is the due date.
  3. It requires the contract to provide a final date for payment which would be later than the due date
  4. The contract must require the employer to serve a payment notice within five days of the due date
  5. If an Employer wishes to resist paying a contractor’s final account, it is obliged to serve a pay less notice

Payment notices and pay less notices

A valid payment notice confirms the sum to be paid by way of an interim or final payment or any other payment provided for in the contract, unless a valid pay less notice is served. S&T (UK) Ltd v Grove Developments Ltd [2018] EWCA Civ 2448 at [37]–[42].

If an employer (owner/developer) fails to serve a valid pay less notice and fails to pay the amount claimed, the contractor will be able to recover the amount claimed by bringing an adjudication, without the adjudicator having to decide the substantive merits of the payment application.

These are known as ‘smash and grab’ adjudications. If you fail to serve a valid pay less notice and wish to obtain a reduction in the amount due or pursue a counterclaim or cross-claim, you will have to pay the full amount first and then pursue the reduction or other claim, by bringing proceedings or by set-off against a subsequent payment. This is known as a true value adjudication.

The notice requirements apply to all payments provided for by the contract: liquidated damages or repayment of overpaid instalments. It also applies to payments due following completion of the works or termination of a contract.

When deciding if a payment notice (or a pay less notice) is valid and complies with the relevant statutory and contractual requirements, it has to be construed objectively –  how a reasonable recipient would have understood the notice.

A payment notice (and a pay less notice) has to make plain that it is a payment notice (or a pay less notice). Each has to set out clearly the sum which is said to be due and/or to be deducted and the basis on which that sum is calculated. This can be zero. Beyond that, the question of whether or not it is a valid notice in accordance with the contract is a matter of fact.

Grove Developments Ltd v S&T (UK) Ltd [2018] EWHC 123 (TCC) at [20]–[31] per Coulson J upheld by the Court of Appeal: see S&T (UK) Ltd v Grove Developments Ltd [2018] EWCA Civ 2448 at [46]–[59].

What happens if the payer does not serve a payment notice?

Section 110B deals with situations where there is a default in service of the payer’s payment notice.  There are two situations:

  1. Where the contract requires the payer to give the payment notice, and a valid notice is not given, the payee may serve a payment notice instead.
  2. Where a contract provides for the payee to make a payment application before the time for the payer’s payment notice, default in service of the payer’s payment notice, makes the application count as the payment notice. The application must be one which states the amount which the payee considers will become due and the basis on which it is calculated, and it must be given in accordance with the contract..

If you have been provided with a construction contract for execution by an employer, it is likely to be a JCT or NEC contract. They have a suite of standard form contracts for use in the construction industry in the UK to help deliver projects.

It sets out the responsibilities of all the parties within the process and their obligations to each other. The intention of these contracts was to give a balanced allocation of risk between the parties. These contracts are prepared by an employer’s construction solicitor, who will have appended to it, the employer’s schedule of contract amendments, with the objective of increasing the liability of the contractor under a contract and reducing the employer’s risk. It will often have amendments to the payment clauses contained in these contracts. For this reason, it is imperative that you obtain legal advice, so you are aware of all pitfalls, and if it is commercially viable for you to enter into the contact. Upon obtaining legal advice, you may be able to re-negotiate certain terms of the contract.

Whether you are an employer, main contractor or sub-contractor. and you require advice in relation to payment notices and pay less notices, under a construction contract, or wish to obtain our Guide to Adjudication, please contact Teresa Johnston on 0207 481 2422, 07584 229 373 or via email at Teresa.Johnston@wellerslawgroup.com

 

 

Commercial leases – when time is of the essence

Posted on by Joe Reeves

Where time is of the essence in relation to the exercise of a right, the failure to exercise that right within the time limit specified means that the right is lost. An example of this might be where a contractor fails to complete works by a certain deadline, in which case it may lose the contractual right to complete those works and the innocent party will be entitled to terminate the contract.

What is the position then in relation to commercial leases, in particular in relation to the exercise of a break clause, or triggering a rent review clause?

Rent Review

It is important to ascertain the position and to comply with any deadlines as failure to do so could be severe. For a landlord, failure to exercise a rent review clause in time may mean it cannot operate the rent review and loses out on a higher rent, for a potentially significant period of time. For a tenant, failure to respond to any rent review notice in time may result in the rent automatically being increased to the figure proposed by the landlord, even if unrealistic and well above market rate.

The general presumption is that time is not of the essence in relation to the operation of a rent review clause. However, this will be displaced in the following instances:

  • Where time is stated to be of the essence in the rent review clause;
  • Where the wording set out in the rent review clause is sufficiently emphatic to show that time was intended to be of the essence (for instance, where the clause states that no other date or deadline is acceptable);
  • Where the rent review clause contains other indications that are consistent only with time being of the essence (for instance, if the clause sets a deadline for service of a tenant’s counter-notice and then spells out the consequences if the tenant fails to meet that deadline); and
  • Where the lease contains other provisions evidencing that the parties intended the rent review deadlines to be strictly observed (for example, where there is an interrelationship between the exercise of a rent review clause and another deadline in the lease, such as the exercise of a break clause).

It is the general presumption that time is not of the essence in relation to rent review and therefore not uncommon for landlords to delay in the implementation of rent review, particularly in a stagnant market where they will realistically not be able to get a better rent.

Break Clauses

By contrast to rent review, time will always be of the essence in relation to the operation of a break clause, unless it is specifically stated not to be.

Failure to operate a break clause in time could have severe repercussions for a tenant wishing to vacate as the lease will continue. The Courts have traditionally taken a strict approach towards compliance with break notices by tenants and therefore it is imperative that no deadlines are missed. For instance, if a lease requires 6 months’ notice of exercise of a break clause, failure to provide 6 months’ notice will mean that the right is lost and the tenant will be unable to break the lease.

It is good practice for any tenant in negotiating a lease, to carefully consider the wording of any proposed break notice. In addition, the tenant should seek to ensure that the validity of a break notice is not contingent upon any pre-conditions, for instance the vacant possession of the property. In practice, this will not always be achievable and will be a matter of negotiation between the parties when the lease is agreed.

Where there is a dispute as to whether time is of the essence, the starting point will always be to consider the wording of the lease, as well as the factual circumstances existing between the parties at the time the lease was agreed.

This article is not intended and should not be relied upon for legal advice, Should you wish to discuss your matter, please contact Joe Reeves of our Litigation Department on 0207 481 6383 or joe.reeves@wellerslawgroup.com.

Penalty Clauses in Commercial Contracts

Posted on by Joe Reeves

It is a well-established principle of English law that, where one party is in breach of contract, the aim of damages is to compensate the innocent party for the loss it has suffered as a result of the breach. Unlike in other jurisdictions, particularly the US, English common law does not recognise the concept of punitive or special damages.

Commonly, in commercial contracts, parties will seek to agree terms setting out the financial extent of liability on either party in the event of default. Such terms are known as liquidated damages clauses and are often used in oil and gas, manufacturing and construction contracts, when performance of the parties’ obligations is often set within tight timescales and failure to do so can have consequences on the ongoing contract. So, for instance, parties to a construction contract may agree that, if one party fails to deliver materials on time such that the project is delayed, it will pay a fixed sum of money per day, until delivery is made.   It can be beneficial to use liquidated damages clauses, for various reasons.

Benefits of liquidated damages clauses are:

  • They provide certainty – the parties will know the extent of their liability in the event of default.
  • Ease of Enforcement – there will be a specific clause for the innocent party to rely on, making enforcement much easier.
  • Limitation of liability – the parties will know the limit of their liability. This might be beneficial for a party in default if, for instance, the actual loss caused by its breach is higher than the sum imposed by the liquidated damages clause.   This can be viewed as a benefit or a disadvantage, depending on whose side it is considered from.
  • Preserving the ongoing commercial relationship – where, notwithstanding the breach, the parties need to continue to work together to complete the contract, litigious proceedings are a distraction at best and are expensive and commercially very damaging. Where there is an ongoing commercial relationship between the parties, a liquidated damages clause allows them to deal with the breach quickly and effectively, so they can resume the performance of the remaining obligations of the contract.

As opposed to claims for unliquidated damages, which are often fraught with issues over causation, proof of loss and remoteness of damage, liquidated damages clauses do not carry such legal difficulties.

However, following the principle stated above, the measure of liquidated damages must be such that it is a reasonable assessment of loss and intended to have the effect of compensating the innocent party, rather than punishing the party in breach, or of simply acting as a deterrent to any breach.

Nowhere has this principle come into play more evidently than in relation to the issue of penalty clauses. Broadly speaking, a penalty clause is a contractual provision which levies an excessive monetary penalty on a party in breach of contract which is out of all proportion to the loss suffered by the innocent party.   Penalty clauses are generally unenforceable in English law.   In considering the issue down through the years, the Courts have differentiated between a sum representing a genuine pre-estimate of damages (an enforceable liquidated damages clause) and a sum which is out of all proportion to any damages likely to be suffered by the innocent party (an unenforceable penalty clause).

 

The history of the law in this area is best exemplified in the case of Dunlop Pneumatic Tyre Co Ltd – v – New City Garage [1915], in which New City Garage breached a contract with Dunlop to sell tyres at an agreed price, as well as selling Dunlop tyres to certain black-listed customers. Dunlop sued and sought to enforce a provision in the contract which provided that a fixed sum would be payable in the event of any breach of the agreement. The House of Lords dismissed Dunlop’s claim on the basis that the fixed sums were penalties, not genuine pre-estimates of loss.   In reaching its decision, the Court was no doubt influenced by the fact that the contract provided for a fixed price to be paid in the event of any breach, no matter the nature of that breach.   Such a clause rendered it more difficult to argue that the fixed sum was a genuine pre-estimate of loss. The Court, in reaching its decision, set out the following factors for consideration:

  • The sum required to be paid was an “extravagant and unconscionable” deterrent, in light of the loss likely to be suffered by the innocent party:
    • It exceeded the maximum possible loss
    • Different breaches on the part of New City Garage gave rise to the same penalty
    • It was not a genuine pre-estimate of loss, rather it was a sum clearly in excess of the loss likely to be suffered and as a result a deterrent and so unenforceable

Over the years however, there has been a shift in the Court’s approach. The Courts have slowly but surely began to accept that there were circumstances where parties could agree in their interests to have a commercial solution to a dispute which could render an agreed fixed remedy commercially justifiable.  The shift in the legal landscape culminated in the cases of Cavendish Square – v- Makdessi [2015] and ParkingEye Ltd – v – Beavis [2015], which were heard jointly in the Supreme Court.

The decisions in these cases mark a radical change in the Court’s approach to dealing with liquidated damages clauses.

The first question to consider is whether the contract imposes a primary obligation or a secondary obligation. A primary obligation is a stand-alone contractual obligation, whereas a secondary obligation is only triggered as a consequence of breach of contract and is intended to provide an agreed contractual remedy, for instance, a secondary obligation to pay a fixed sum in the event of breach of a primary obligation.   The question of whether a clause is a penalty clause (and therefore unenforceable) only arises in relation to a breach of a primary obligations, when the Court may seek to review and regulate the remedy imposed by the secondary obligation.

The Court departed from the “genuine pre-estimate” rule in Dunlop.   Rather, they recognised that where an innocent party could demonstrate that it was using a clause in a contract to protect a legitimate interest and the penalty is not exorbitant or unconscionable, it does not have to be a genuine pre-estimate of loss.   The Court held that 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”.   Therefore, the correct analysis to be applied is now as follows:

  • Is the disputed contractual term a primary or secondary obligation?
  • If it is the latter, does the innocent party have a legitimate interest to protect?
  • If not, the clause will be a penalty clause and unenforceable. If so, is the remedy imposed by the secondary obligation out of all proportion to the interest to the innocent party in the contract being performed? Again, if it is, it will be a penalty clause and unenforceable.

It should be noted that the Makdessi case was complex and often it will not be easy to determine whether a clause in a contract is a penalty clause.   The wording of the clause itself must be analysed, as well as the expectations and interests of the parties when they entered into the contract, in order to form an informed view of the position. Furthermore, care should also be taken when drafting commercial agreements to ensure that obligations and remedies within them can be justified, should there subsequently be a dispute over their terms.

This article is not intended and should not be relied upon for legal advice. Should you wish to discuss your matter, please contact Joe Reeves of our Litigation Department on 0207 481 6383 or joe.reeves@wellerslawgroup.com.

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