Date: 02 December 2024
A penalty clause is a liquidated damages clause which the court will not enforce on the basis that, rather than the clause representing, eg a genuine pre-estimate of the loss caused by the breach, the provision is excessive and extravagant, a deterrent against breach, which lacks other sufficient, commercial justification.
The current law on what constitutes an unenforceable penalty clause has been set out in Cavendish Square Holding BV v Talal El Makdessi; ParkingEye Ltd v Beavis [2015] UKSC 67. The court held that the key considerations are whether there is a secondary obligation being imposed, if is there a legitimate interest served and protected by the clause, and if so, is the provision purporting to serve that interest out of proportion by being extravagant, exorbitant or unconscionable.
The case of Cargill International Trading Pte Ltd v Uttam Galva Steels Limited [2019] EWHC 476 (Comm) demonstrates that relatively high rates of interest payable under a default compensation clause will not necessarily be deemed to be a penalty if it was commercially justified.
In terms of customary deposit rates, Workers Trust & Merchant Bank Ltd v Dojap Investments Ltd [1993] 2 WLR 701 held that where the customary deposit was 10%, a seller who seeks to obtain a larger amount by way of a forfeitable deposit must show special circumstances which justify such a deposit.
For a case where the default interest rate was held to be an unenforceable penalty, the court held in Ahuja Investments Ltd v Victorygame Ltd and Pandher [2021] EWHC 2382 (Ch) that a default rate equivalent to a 400% increase in the primary interest rate was, when combined with a provision for monthly capitalisation of interest, “so obviously extravagant, exorbitant and oppressive” that it should properly be characterised as a penalty.
The most recent case on this topic is Houssein & Others v London Credit Limited & Another [2024] EWCA Civ 721 where the court confirmed that it is ‘self-evident’ that there is good commercial justification for charging a higher rate of interest after a default in repayment. However, the question of whether the interest rate in this case is was extravagant, exorbitant or unconscionable was remitted to the High Court judge for determination.
The current law on what constitutes an unenforceable penalty clause has been set out in Cavendish Square Holding BV v Talal El Makdessi; ParkingEye Ltd v Beavis [2015] UKSC 67. The court held that the key considerations are whether there is a secondary obligation being imposed, if is there a legitimate interest served and protected by the clause, and if so, is the provision purporting to serve that interest out of proportion by being extravagant, exorbitant or unconscionable.
The case of Cargill International Trading Pte Ltd v Uttam Galva Steels Limited [2019] EWHC 476 (Comm) demonstrates that relatively high rates of interest payable under a default compensation clause will not necessarily be deemed to be a penalty if it was commercially justified.
In terms of customary deposit rates, Workers Trust & Merchant Bank Ltd v Dojap Investments Ltd [1993] 2 WLR 701 held that where the customary deposit was 10%, a seller who seeks to obtain a larger amount by way of a forfeitable deposit must show special circumstances which justify such a deposit.
For a case where the default interest rate was held to be an unenforceable penalty, the court held in Ahuja Investments Ltd v Victorygame Ltd and Pandher [2021] EWHC 2382 (Ch) that a default rate equivalent to a 400% increase in the primary interest rate was, when combined with a provision for monthly capitalisation of interest, “so obviously extravagant, exorbitant and oppressive” that it should properly be characterised as a penalty.
The most recent case on this topic is Houssein & Others v London Credit Limited & Another [2024] EWCA Civ 721 where the court confirmed that it is ‘self-evident’ that there is good commercial justification for charging a higher rate of interest after a default in repayment. However, the question of whether the interest rate in this case is was extravagant, exorbitant or unconscionable was remitted to the High Court judge for determination.
