Fastest Law Search Engine

If you have any question you can ask below or enter what you are looking for!

Charterparties and the modern law of penalties

On the other hand:

  • (d) It is no obstacle to the sum stipulated being a genuine pre-estimate of damage, that the consequences of the breach are such as to make precise pre-estimation almost an impossibility. On the contrary, that is just the situation when it is probable that pre-estimated damage was the true bargain between the parties.5

        A century later in the Supreme Court in Makdessi the tendency to treat Lord Dunedin’s test in Dunlop Pneumatic Tyre as a quasi-statutory code was deprecated, and the reasoning in the other speeches highlighted.6

        In addition to liquidated damages clause the rule also applies to acceleration clauses are common in asset finance arrangements and commercial lending.7 Such clauses often work in tandem with express termination clauses, and appear to have become more common in the wake of the restrictive common law approach to damages resulting from the exercise of an express termination provision.8

        A clause which merely accelerates an entitlement to payment of the principal sum due is probably not subject to the penalty clause jurisdiction.9 In contrast, the better view is probably that an accelerated entitlement to interest should make provision for an appropriate discount (to give credit for the benefit of accelerated receipt) or else it may be vulnerable to be struck down as a penalty.10

        These principles apply directly in the case of loans, where the creditor has already had the full benefit of the contract. In respect of hire agreements it is generally not possible to combine a claim for accelerated payments with the exercise of the right to terminate and repossess the property.11

        14.2 The retreat from Dunlop

        By the end of the twentieth century renewed faith in freedom of contract, or at least in the ability of sophisticated commercial parties to know, and be able to manage, their own interests, led to increasing judicial caution and academic criticism of the penalty jurisdiction.12 Representing the former concern, Lord Woolf, delivering the advice of the Privy Council in Philips Hong Kong Ltd v Att-Gen of Hong Kong,13 warned against too ready recourse to the penalty jurisdiction in commercial cases:

        Except possibly in the case of situations where one of the parties to the contract is able to dominate the other as to the choice of the terms of a contract, it will normally be insufficient to establish that a provision is objectionably penal to identify situations where the application of the provision could result in a larger sum being recovered by the injured party than his actual loss. Even in such situations so long as the sum payable in the event of non-compliance with the contract is not extravagant, having regard to the range of losses that it could reasonably be anticipated it would have to cover at the time the contract was made, it can still be a genuine pre-estimate of the loss that would be suffered and so a perfectly valid liquidated damage provision.14

        The modern trend was clearly sceptical about invocation of the penalty rule in commercial and financial transactions.15 The turning point, and a case which proved highly influential in later cases, including in the Supreme Court, is the first instance decision of Colman J in Lordsvale Finance plc v Bank of Zambia16 concerning ‘default interest clauses’.17 An obligation to pay an enhanced rate of interest in the event of late payment or breach was accepted to fall within the penalty jurisdiction.18 However where the increased rate is not excessive and applies only from the date of default a more sympathetic approach was adopted in the financial context. Lordsvale concerned a syndicated loan agreement. Colman J observed: ‘This point is of considerable importance for English banking law because it is a well-known fact that a default interest rate uplift is very widely used, particularly in syndicated loans, such as this.’19 The defendant bank had two facility agreements with different syndicates of banks for US$100 million and $130 million respectively. The agreements provided that in the event of default the defendant was to pay interest during the period of default at the aggregate rate of (a) the cost of obtaining dollar deposits to fund the banks’ participation, (b) the margin (which was defined as 1.5 per cent) and (c) an additional, but unexplained, 1 per cent. The defendant defaulted. The plaintiffs sought to recover the default interest.

        Colman J comprehensively reviewed the authorities and held that the additional rate of 1 per cent was consistent with the increased credit risk represented by a borrower in default, and that it was enforceable. A retrospective increase in interest would fall foul of the penalty, but the same reasoning did not apply to prospective increases:

        Where, however, the loan agreement provides that the rate of interest will only increase prospectively from the time of default in payment, a rather different picture emerges. The additional amount payable is ex hypothesi directly proportional to the period of time during which the default in payment continues. Moreover, the borrower in default is not the same credit risk as the prospective borrower with whom the loan agreement was first negotiated. Merely for the pre-existing rate of interest to continue to accrue on the outstanding amount of the debt would not reflect the fact that the borrower no longer has a clean record. Given that money is more expensive for a less good credit risk than for a good credit risk, there would in principle seem to be no reason to deduce that a small rateable increase in interest charged prospectively upon default would have the dominant purpose of deterring default. That is not because there is in any real sense a genuine pre-estimate of loss, but because there is a good commercial reason for deducing that deterrence of breach is not the dominant contractual purpose of the term.20

        The shift to ‘good commercial reason’ over pre-estimate of loss was significant. However Colman J cautioned that such reasoning would not apply for more significant default rates:

        If the increased rate of interest applies only from the date of default or thereafter there is no justification for striking down as a penalty a term providing for a modest increase in the rate. I say nothing about exceptionally large increases. In such cases it may be possible to deduce that the dominant function is in terrorem the borrower. But nobody could seriously suggest that a 1 per cent increase could be such.21

        Also to be noted is Colman J’s observation that any enhanced rate should be prospective only.

        14.3 The modern restatement of the penalty rule

        On 4 November 2015 a seven-judge Supreme Court handed down its judgments in the conjoined appeals in Cavendish Square Holding BV v Makdessi and ParkingEye v Beavis,22 representing respectively a commercial case and a consumer one. It was the longest Supreme Court judgment of that year. In Makdessi, following extensive negotiations between the parties, both represented by highly experienced commercial lawyers, Mr Makdessi agreed to sell his controlling stake in the Middle East’s largest advertising and marketing communications group to Cavendish for a sum of up to US$147 million, the price reflecting significant goodwill in the business which Mr Makdessi had founded. The contract contained restrictive covenants, requiring Mr Makdessi not to compete with his old business, and provided (by clause 5.1) that in the event of breach Mr Makdessi would not be entitled to outstanding instalments of the price, and (by clause 5.6) he would be required to sell his remaining shares at a price excluding goodwill. When Mr Makdessi breached the non-compete provisions Cavendish sought declarations enforcing those terms. Burton J upheld the contractual provisions, but the Court of Appeal held both clauses were unenforceable penalties. Cavendish appealed. In ParkingEye Mr Beavis outstayed his welcome in a privately-owned retail park car park, in defiance of prominent notices providing for a maximum stay of two hours. The operator of the car park sought the specified £85 overstay charge, which would have reduced to £50 if paid within 14 days. Mr Beavis challenged the claim under both the common law doctrine of penalties and the then Unfair Terms in Consumer Contracts Regulations 1999.23 The judge and the Court of Appeal rejected those arguments. Mr Beavis appealed.

        The Supreme Court allowed the appeal in Makdessi, but dismissed the appeal in ParkingEye, with Lord Toulson dissenting in part. There are a number of different strands in the reasoning. Whilst the core of reasoning is largely consistent, differently constituted majorities need to be identified in relation to some collateral issues.

        First, the Supreme Court rejected an invitation to scrap the jurisdiction over penalties. In their joint judgment Lord Neuberger P and Lord Sumption (Lord Carnwath agreeing) acknowledged that:

        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.24

        The equitable origins and subsequent common law development of the rule in both English and Scots law were thoroughly picked over in the lengthy speeches. The Supreme Court was unanimous that the common law rule on penalties should not be abolished because it was a long-standing provision of English law. It was common to most legal systems and international restatements of contract law. Neither of the Law Commissions had recommended abolition of the rule when they had considered it. It provided a useful rule to prevent oppressive terms in areas not subject to statutory regulation, such as in the case of small businesses.

        However, and also unanimously, the Court held that the penalty rule should not be extended to onerous provisions dependent on contingencies which did not amount to a breach of contract, refusing to follow the extension adopted by the High Court of Australia in its equivalent to the ‘bank charges’ litigation in Andrews v Australia & New Zealand Banking Group Ltd.25 The Supreme Court was emphatic that the courts had no power at common law to regulate the parties’ primary obligations under a contract. In respect of the parties’ secondary obligations, at common law the long-standing penalty rule applied to agreed or liquidated damages clauses. It also extended to provisions providing for the withholding of money or the transfer of property on breach.

        At the heart of these judgments lay a twenty-first century restatement of the penalty jurisdiction: a clause was penal if as a matter of substance it was a secondary obligation on a party in breach which was extravagant or unconscionable in the sense that it imposed a detriment out of all proportion to the legitimate interest of the innocent party in enforcing the underlying primary obligation.

        Whether an agreed damages clause or other clause was a penalty was often described as an exercise in construction, and therefore determined notionally at the time it was agreed. Lords Neuberger and Sumption nevertheless stated that classification was a matter of substance not form.26 However the reference to the ‘substance’ of the provision may mean it is more properly described as an exercise in characterisation or categorisation, rather than pure construction.27 Accordingly it would appear that the courts may now have to have regard to more material than in an ordinary exercise in contractual construction, where the evidence is restricted to the surrounding circumstances (and prior negotiations and subsequent conduct are excluded).28 But in Makdessi Lords Neuberger and Sumption restricted the exercise to the time of the agreement because ‘it depends on the character of the provision, not on the circumstances in which it falls to be enforced.’29

        Crucially, the fact that a provision acted as a deterrent or did not represent a genuine pre-estimate of loss did not mean it was a penalty, since the legitimate interest of the innocent party might extend beyond compensation.

        In a negotiated contract between two parties of equal bargaining power the strong initial presumption was that they were the best judges of what was legitimate. Accordingly in Makdessi, given that the goodwill in the business and the loyalty of Mr Makdessi was fundamental to the transaction the parties were the best judges of the appropriate consequences of breaches of the non-compete provisions. In Beavis the defendant was a contractual licensee on the terms of the notices, and although neither the car park owner nor the claimant enforcement company would expect to incur £85 of loss on each infringement, they had a legitimate interest in the efficient use of the parking spaces at the retail centre which could only be achieved by deterring customers from overstaying. Accordingly the charge was not a penalty at common law. Further, in Beavis (Lord Toulson dissenting) the provision did not infringe the 1999 Regulations because the charge was no higher than necessary to achieve the claimant’s objectives, and the defendant was well aware of the restriction, so it was not unfair.

        Whilst not in issue, the relationship between the common law penalty rule and the equitable jurisdiction to relieve against forfeiture was authoritatively discussed. A majority of the justices, comprising Lords Mance, Clarke, Toulson and Hodge agreed that a provision might engage both the common law penalty rule and the equitable jurisdiction to relieve against forfeiture. The two doctrines operated at different points and with differing consequences. The former was a rule invalidating extravagant or exorbitant provisions which as a matter of construction were penalties. The equitable jurisdiction provided discretionary relief, having regard to the position of the parties after breach, usually on condition that the breach was rectified by performance, in circumstances where the clause was not penal in effect.30

        A different majority comprising Lords Neuberger, Sumption, Carnwath and Hodge held that insofar as it had suggested that a penalty clause might be partially enforceable Jobson v Johnson31 was wrong and should be over-ruled.

        Whilst neither abolishing nor extending the penalty rule this case is a radical restatement of the governing principle which is likely to significantly restrict its operation in respect of commercial bargains. Giving centre stage to Lord Diplock’s (or the philosopher John Austin’s) scheme of primary and secondary contractual obligations (e.g. in the time charter case of The Scaptrade)32 the Supreme Court refused to extend the rule to cases where the penalty was not triggered by breach, resisting the Australian development in the bank charges context in Andrews v ANZ.

        The new ‘legitimate interest’ in performance test was clearly inspired by Lord Reid’s discussion, in the context of the action for an agreed sum, in White & Carter (Councils) Ltd v McGregor.33 The jettisoning of the supposed requirement of a genuine pre-estimate of loss or that the clause should not act as a deterrent was supported by reference to the influential first instance judgment of Colman J concerning default interest clauses in Lordsvale Finance.

        Despite a plethora of recent new editions on charterparties and laytime, all came too late to consider the impact of the Supreme Court’s re-writing of the penalty jurisdiction.

        14.4 Voyage charters

        The most obvious topic for discussion is demurrage in voyage charters. The new edition of Scrutton on Charterparties defines demurrage parenthetically as ‘liquidated damages payable for delay beyond the agreed laytime’.34 Chapter 15 goes on to discuss demurrage in detail but with no reference to the penalty rule or Dunlop. Neither the new edition of Schofield on Laytime and Demurrage35 nor Professor Baughen’s new iteration of Summerskill on Laytime36 feature the word ‘penalty’ in their indices. So too Dunlop does not appear in their respective tables of cases. In its detailed consideration Schofield on Laytime and Demurrage records that after some doubt the current view is that demurrage is liquidated damages.37 The authoritative statement is Lord Brandon’s speech in The Lips.38

        It is essential to the decision of that question to have in mind the legal nature of demurrage: both what it is and what it is not. I deal first with what demurrage is not. It is not money payable by a Charterer as the consideration for the exercise by him of a right to detain a chartered ship beyond the stipulated lay days. If demurrage were that, it would be a liability sounding in debt. I deal next with what demurrage is. It is a liability in damages to which a Charterer becomes subject because, by detaining the chartered ship beyond the stipulated lay days, he is in breach of his contract. Most, if not all, voyage charters contain a demurrage clause, which prescribes a daily rate at which the damages for such detention are to be quantified. The effect of such a clause is to liquidate the damages payable: it does not alter the nature of the Charterer’s liability, which is and remains a liability for damages, albeit liquidated damages. In the absence of any provision to the contrary in the charter the Charterer’s liability for demurrage accrues de die in diem from the moment when, after the lay days have expired, the detention of the ship by him begins. These propositions of law are so well established that the citation of authority for them is perhaps unnecessary.39

        Only gold members can continue reading. Log In or Register to continue