Pre-Fixed Damages
Cases
Dunlop Pneumatic Tyre Co. v. New Garage and Motor Co.
[1914] UKHL 861
Lord Dunedin
The respondents appealed to the Court of Appeal, when the majority of that Court—Vaughan Williams and Swinfen Eady, L.JJ.—held (Kennedy, L.J., dissenting) that the said sum of £5 was a penalty, and entered judgment for the plaintiffs for the sum of £2 as nominal damages. Appeal from that decision is now before your Lordships’ House.
We had the benefit of a full and satisfactory argument, and a citation -of the very numerous cases which have been decided on this branch of the law. The matter has been handled, and at a recent date, in the courts of highest resort. I particularly refer to Clydebank Engineering Company v. Castaneda, [1905] AC 6, 7 F. (H.L.) 77, 42 SLR 74, in your Lordships’ House, and the cases of Public Works Commissioners v. Hills, [1906] AC 368, 43 S.L.R. 894, and Webster v. Bosanquet, [1912] AC 394, 49 S.L.R. 1023, in the Privy Council. In all of these cases many of the previous cases were considered. In view of that fact and of the number of the authorities available, I do not think it advisable to attempt any detailed review of the various cases, but I shall content myself with stating succinctly the various propositions which I think are deducible from the decisions which rank as authoritative:—1. Though the parties to a contract who use the words penalty or liquidated damages may prima facie be supposed to mean what they say, yet the expression used is not conclusive. The Court must find out whether the payment stipulated is in truth a penalty or liquidated damages. This doctrine may be said to be found passim in nearly every case. 2. The essence of a penalty is a payment of money stipulated as in terrorem of the offending party; the essence of liquidated damages is a genuine covenanted pre-estimate of damage— Clydebank Engineering Company v. Castaneda.
3. The question whether a sum stipulated is penalty or liquidated damages is a question of construction to be decided upon the terms and inherent circumstances of each particular contract, judged of as at the time of the making of the contract, not as at the time of the breach— Public Works Commissioners v. Hills and Webster v. Bosanquet.
4. To assist this task of construction various tests have been suggested, which, if applicable to the case under consideration, may prove helpful or even conclusive. Such are—( a) It will be held to be penalty if the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss which could conceivably be proved to have followed from the breach—illustration given by Lord Halsbury in the Clydebank case. ( b) It will be held to be penalty if the breach consists only in not paying a sum of money, and the sum stipulated is a sum greater than the sum which ought to have been paid— Kemble v. Farren, 6 Bing. 141. This, though one of the most ancient instances, is truly a corollary to the last test. Whether it had its historical origin in the doctrine of the common law that when A promised to pay B a sum of money on a certain day and did not do so, B could only recover the sum with, in certain cases, interest, but could never recover further damages for non-timeous payment, or whether it was a survival of the time when equity reformed unconscionable bargains merely because they were unconscionable—a subject which much exercised Jessel, M.R., in Wallis v. Smith, 21 Ch. D. 243—is probably more interesting than material. ( c) There is a presumption (but no more) that it is penalty when “a single lump sum is made payable by way of compensation on the occurrence of one or more or all of several events, some of which may occasion serious and others trifling damage”—Lord Watson in Lord Elphinstone v. Monkland Iron and Coal Company, 11 A.C. 332, 13 R. (H.L.) 98, 24 S.L.R. 323. 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 preestimated damage was the true bargain between the parties— Clydebank case, Lord Halsbury; Webster v. Bosanquet, Lord Mersey.
Turning now to the facts of the case, it is evident that the damage apprehended by the appellants owing to the breaking of the agreement was an indirect and not a direct damage. So long as they got their price from the respondents for each article sold it could not matter to them directly what the respondents did with it. Indirectly it did. Accordingly the agreement is headed “Price Maintanance Agreement,” and the way in which the appellants would be damaged if prices were cut was clearly explained in evidence, and no successful attempt was made to controvert that evidence. But though damages as a whole from such a practice would be certain, yet damages from any one sale would be impossible to forecast. It is just, therefore, one of those cases where it seems quite reasonable for parties to contract that they should estimate that damage at a certain figure, and provided that the figure is not extravagant
……
The argument of the respondents was really based on two heads. They overpressed, in my judgment, the dictum of Lord Watson in Lord Elphinstone’s case, reading it as if he said that the matter was conclusive, instead of saying, as he did, that it raised a presumption, and they relied strongly on the case of Willson v. Love, [1896] 1 Q.B. 626.
Now, in the first place, I have considerable doubt whether the stipulated payment here can fairly be said to deal with the breaches, “some of which”—I am quoting Lord Watson’s words—“may occasion serious and others but trifling damage.” As a mere matter of construction I doubt whether clause 5 applies to anything but sales below price. But I will assume that it does. None the less the mischief, as I have already pointed out, is an indirect mischief, and I see no data on which, as a matter of construction, I could settle in my own mind that the indirect damage from selling a cover would differ in magnitude from the indirect damage from selling a tube, or that the indirect damage from a cutting-price sale would differ from the indirect damage from supply at full price to a hostile because prohibited agent. You cannot weigh such things in a chemical balance. The character of the agricultural land which was ruined by slag heaps in Elphinstone’s case was not all the same, but no objection was raised by Lord Watson to applying an overhead rate per acre, the sum not being in itself unconscionable.
I think that Elphinstone’s case, or rather the dicta in it, do go this length, that if there are various breaches to which one indiscriminate sum to be paid in breach is applied, then the strength of the claim must be taken at its weakest link. If you can see clearly that the loss on one particular breach could never amount to the stipulated sum, then you may come to the conclusion that the sum is a penalty, but further than this it does not go. So, for the reasons already stated, I do not think that the present case forms an instance of what I have just expressed.
As regards Willson’s case, I do not think it material to consider whether it was well decided on the facts, for it was decided on the viewof the facts that the manurial value of straw and of hay were known ascertainable quantities as at the time of the bargain, and radically different, so that the damage resulting from the want of one could never be the same as the damage resulting from the want of the other.
Added to that the parties there had said penalty, and the effort was to make out that they really meant liquidated damages; and lastly, if my view of the facts in the present case is correct, then Rigby, L.J., would have agreed with me, for the last words of his judgment are as follows—“On the other hand it is stated that when the damages caused by a breach of contract are incapable of being ascertained, the sum made by the contract payable on such a breach is to be regarded as liquidated damages. The question arises, what is meant in this statement by the expression ‘incapable of being ascertained.’ In their proper sense the words appear to refer to a case where no rule or measure of damages is available for the guidance of a jury as to the amount of damages, and the judge would have to tell them they must fix the amount as best they can.” To arrive at the indirect damage in this case, supposing no sum had been stipulated, that is just what a judge would in my opinion have had to do.
On the whole matter, therefore, I go with the opinion of Kennedy, L.J., and I move your Lordships that the appeal be allowed and judgment given for the sum as brought out by the master, the appellants to have their costs in this House and in the courts below.
Lord Atkinson
The action out of which this appeal arises was brought upon a contract entered into between the appellants, through the agency of Messrs Pellant Limited, and the respondents, claiming amongst other things to recover a sum of £5 in respect of each of the breaches of this contract complained of. The sole question for decision on this appeal is whether the sum of £5 is a penalty or liquidated damages.
The appellants are extensive and well-known manufacturers of motor tyres, covers, and tubes—a trade in which there is keen competition. They have no patents protecting their manufacture. Success over their competitors depends on the reputation acquired for their products, and largely upon the efficiency of the organisation of their business. Ninety-nine per cent. of their output in this class of goods is sold through what one of their managers, who was examined as a witness, described as their distributing organisation. It consists in this, that they sell to motor-car manufacturers, persons called factors who re-sell to retail agents, and retail agents themselves, and that all these latter sell to the public, the users of the goods.
The appellants produce price lists of these goods of theirs varying from time to time. They invariably sell at these prices to the members of their distributing organisation under agreements similar to that sued upon, giving, however, discount and rebates at varying rates. These agreements are styled price—maintenance agreements, and their main purpose obviously is to prevent the sale to the public, the users either directly or indirectly of the goods which the appellants manufacture at prices less than those named in their price lists. The result of this is that competition having reduced these prices to the lowest remunerative scale, the agent secures his remuneration by selling at the prices at which he buys. If he sells at lower prices than these the loss comes out of his discount and rebates, his own profits. The manager in his evidence explains elaborately the dislocation of the distributing organisation of the appellants, and the injury to their trade which would ensue, from the sale by one or more of their agentsor factors of their goods at prices less than those named in these lists. He pointed out that if the business of one of their agents in any particular place was undercut by such sales the agent would, owing to the diminution of his remuneration, most probably throw up his agency and become the agent of a competitor, thus leaving the field open to the rivals of the appellants; that it was essential for their trade that their wares should be obtainable all over the country at as many places as possible; that though the consequential injury to their trade by this undercutting, would, or might, be very serious, it would be very difficult to prove in evidence the precise amount of their loss in money; that considering all these things, the appellant company fixed £5, the sum mentioned in the agreement, as a fair and reasonable sum for liquidated damage in respect of the breaches specified. This evidence was uncontradicted.
In a good deal of the argument which has been addressed to your Lordships on behalf of the respondents, the true object of this price-maintenance agreement and the nature of the consequential injury to the plaintiffs’ trade flowing from the breaches of it have been somewhat lost sight of. It has been urged that as the sum of £5 becomes payable on the sale of even one tube at a shilling less than the listed price, and as it was impossible that the appellant company should lose that sum on such a transaction, the sum fixed must be a penalty. In the sense of direct and immediate loss the appellants lose nothing by such a sale. It is the agent or dealer who loses by selling at a price less than that at which he buys, but the appellants have to look at their trade in globo, and to prevent the setting up, in reference to all their goods anywhere and every where, a system of injurious undercutting.
The object of the appellants in making this agreement, if the substance and reality of the thing and the real nature of the transaction be looked at, would appear to be a single one, namely, to prevent the disorganisation of their trading system and the consequent injury to their trade in many directions. The means of effecting this is by keeping up their price to the public to the level of their price-list, this last being secured by contracting that a sum of £5 shall be paid for every one of the three classes of articles named sold or offered for sale at prices below those named on the list. The very fact that this sum is to be paid if a tyre cover or tube be merely offered for sale, though not sold, shows that it was the consequential injury to their trade due to undercutting which they had in view. They had an obvious interest in preventing this undercutting, and on the evidence it would appear to me impossible to say that their interest was incommensurate with the sum which it was agreed to pay.
Their object is akin in some respects to that which a trader has in binding a former employee not to set up or carry on a rival business within a certain area. The trader’s object is to prevent competition, and especially to prevent his old customers whom the employee knows from being enticed away from him. If one takes, for example, the case of a plumber, the carrying on of the trade of a plumber may mean anything from mending gas-pipes for a few pence apiece up to doing all the plumbing work of a big hotel. If the employee should mend a hundred of such pipes for twenty old customers at 6d. apiece, for which the employer would charge 1s. apiece, could it possibly be contended that the trader’s loss was only a hundred sixpences—£2, 10s.? It is, I think, quite misleading to concentrate one’s attention upon the particular act or acts by which in such cases as this the rivalry in trade is set up and the repute acquired by the former employee that he works cheaper and charges less than his old master, and to lose sight of the risk to the latter that old customers once tempted to leave him may never return to deal with him, or that business which might otherwise have come to him may be captured by his rival. The consequential injuries to the trader’s business arising from each breach by the employee of his covenant cannot be measured by the direct loss in a monetary point of view on the particular transaction involved in the breach. An old customer may be as effectively enticed away from him through the medium of a 10s. job done at a cheap rate as by a £50 job done at a cheap rate, or a reputation for cheap workmanship may be acquired possibly as effectively in one case as in the other.
In many cases a person may contract to do or abstain from doing an act which is a composite act, the product or result of almost numberless other acts. For instance, if one should contract with a builder to build a house of the best materials and with the most skilled workmanship, and to hand over possession of the same completed on a certain day for £1000, £500 to be paid if the agreement was not performed, every firegrate set which on completion would be found to be of bad material, every door which would be then found to have been defectively hung, every cubic foot of masonry which would be found to have been badly and improperly built, would in volve a breach of the agreement, but it would be quite illegitimate to thus disintegrate the obligation to do what the parties regarded as a single whole into a number of obligations to do a number of things of varying importance, and treat the £500 as prima facie a penalty because these individual breaches of the agreement did not cause in many instances any injury commensurate with that sum. This is the very ground, or one of the rounds, upon which Lord Herschell rests his judgment in Lord Elphinstone v. Monkland Iron and Coal Company, 24 S.L.R. 323. He said—“The agreement does not provide for the payment of a sum upon the non-performance of any one of many obligations differing in importance. It has reference to a single obligation, and the sum to be paid bears a strict proportion to the extent to which that obligation is left unfulfilled.”
In the present case the agreement of the parties, in effect though possibly not in form, did little if anything more than impose a single obligation, namely, to sell or endeavour to sell the goods of the appellants at the prices named in their lists, though of course as they sold different kinds of goods this single obligation might be violated in many ways. Much reliance was placed by the respondents on the well-known passage in the judgment of Lord Watson in the last-mentioned case, to the effect that where a single lump sum is made payable by way of compensation, on the occurrence of one or more of several events, some of which may occasion serious and others but trifling damage, the presumption is that the partner intended the sum to be penal and subject to modification. It is quite true that, as mentioned by Swinfen Eady, L.J., Lord Esher in Willson v. Love, [1896] 1 Q.B. 626, said that he thought that this passage meant the same thing as if it ran “some of which occasion serious and others less serious damage.” With all respect, this alteration would mean that the damage resulting from each event should be uniform in amount—a construction which would mean that the stipulated compensation must presumably be a penalty in almost every conceivable case. Moreover, Lord Watson’s statement of the law as it stands was approved by Lord Davey in Clydebank Engineering Company v. Castaneda, 42 SLR 74, and in Webster v. Bosanquet, 43 S.L.R. 894, without any qualification of that kind.
In this last-mentioned case, as in the present, the contract provided that the amount specified should be paid as “liquidated damages and not as a penalty.” The covenant upon which the matter in controversy turned was contained in a deed made on the dissolution of a partnership between two partners, the plaintiff and defendant, and it provided that the defendant should not during a certain period be at liberty to sell the whole or part of the tea crops of two estates named to any person other than the plaintiff without first offering to him the option of buying the same, and further provided that on breach of this covenant by the defendant he should pay to the petitioner the sum of £500 as “liquidated damages and not as a penalty.”
Now it will be observed that this covenant would be violated by the sale of any appreciable part, in a business point of view, of the crops of either of these estates, no matter how relatively small that part might be compared with the entire crop of either. It is also clear that the object of the parties when they executed the deed was to secure to the plaintiff the option of buying the entire crops of both estates, and that when they fixed this sum of £500 they were thinking of the loss which the plaintiff might sustain by the loss of that option. The amount of tea sold by the defendant in breach of the covenant was considerable—nearly 54,000 Ib. It was laid down that in determining whether a sum contracted to be paid is liquidated damages or a penalty one is to consider whether the contract, whatever its language, would at the time it was entered into have been unconscionable and extravagant, and one which no court ought to allow to be enforced if this sum were to be treated as liquidated damages, having regard to any possible amount of damages conceived to have been in the contemplation of the parties when they made the contract. Lord Mersey, in delivering the judgment of the Board, said—“When making the contract it was impossible to foresee the extent of the injury which might be sustained by the plaintiff if sales of tea were made without his consent. That such sales might seriously affect his business was obvious, and the very uncertainty of the loss to arise made it all the more reasonable for the parties to agree beforehand as to what the damages should be. And furthermore, it is well known that damages of this kind, though very real, may be difficult of proof, and that the proof may entail considerable expense.” Those remarks are, having regard to the evidence in the present case, particularly applicable to it.
In Kemble v. Farren, 6 Bing. 141, Tindal, C.J., said—“We see nothing illegal or unreasonable in the parties in their mutual agreement settling the amount of damages, uncertain in their nature, at any sum upon which they may agree. In many cases an agreement fixes that which is almost impossible to be accurately ascertained, and in all cases it saves the expense and difficulty of bringing witnesses to that point.”
Therefore although it may be true, as laid down by Lord Watson, that a presumption is raised in favour of a penalty where a single lump sum is to be paid by way of compensation in respect of many different events, some occasioning serious and some trifling damage, it seems to me that this presumption is rebutted by the very fact that the damage caused by each and every one of those events, however varying in importance, may be of such an uncertain nature that it cannot be accurately ascertained. The damages have been proved to be of that nature in the present case, and the very fact that they are so renders it all the more probable that the sum of £5 was not stipulated for merely in terrorem, but was really and genuinely “a pre-estimate of the appellants’ probable or possible interest in the due performance of this contract.”
Swinfen Eady, L.J., holds that clause No. 5 of the agreement applies to the first part of clause 3, the supplying of these goods to persons on the appellants’ black list, as it was styled. I confess that this seems to me a very very doubtful construction. What is prohibited by the second clause is “the sale or offering for sale of motor tyres, cases, or tubes, at prices less than those in the price list.” What is dealt with in clause 5 is a sale or offering for sale of these particular kinds of goods in breach of the agreement. What is dealt with in the first part of clause 3 is the supplying without consent of any such goods to these black-listed agents at any price whatever; but even if Swinfen Eady, L.J., should be right in this it would not lead me to a conclusion different from that to which I have come.
The appellants, like the respondents, are most probably good business men. Neither of them contemplated, presumably, the black-listing of these agents without adequate trade reasons. Nothing was more natural than that the appellants should seek to prevent the supply of their goods indirectly to persons to whom they would not supply them directly. Considerable injury to the appellants’ trade interests might obviously be done by putting such persons in a position to undercut their prices, and derange their supply organisation, and nothing conceivable could be more difficult than to prove by evidence, or to estimate precisely in money, the exact amount of damages which might be caused by such an injury. The passage in the judgment of Tindal, C.J., above quoted, applies directly to such state of things.
I entirely concur with Kennedy, L. J., in his criticism of the agreement. I agree with him that on the face of it, on this point of liquidated damages, it contains nothing unreasonable, unconscionable, or extravagant; and I further think that the same may be said of the real transaction between the parties if its substance be regarded, reasonably.
For these reasons, I think that the judgment of Kennedy, L.J., was right, that the judgment appealed from was wrong and should be reversed, and the judgment of Phillimore, J., be restored, and the appeal allowed with costs.
Lord Parker—Where the damages which may arise out of a breach of contract are in their nature uncertain, the law permits the parties to agree beforehand the amount to be paid on such breach. Whether the parties have so agreed or whether the sum agreed to be paid on the breach is really a penalty must depend on the circumstances of each particular case. There are, however, certain general considerations which have to be borne in mind in determining the question. If, for example, the sum agreed to be paid is in excess of any actual damage which can possibly, or even probably, arise from the breach, the possibility of the parties having made a bona fide pre-estimate of damage has always been held to be excluded, and it is the same if they have stipulated for the payment of a larger sum in the event of breach of an agreement for the payment of a smaller sum.
The really difficult cases are those in which the Court has to consider what presumptions or inferences arise from the number or nature of the stipulations on breach of which it is agreed that the sum in question should be paid. In the case of a single stipulation, which if broken at all can be broken once only, and in one way only, such as a covenant not to reveal a trade secret to a rival trader, there can be no inference or presumption that the sum payable on breach is not in the nature of agreed damages, and if the parties have referred to it as agreed or liquidated damages, no reason why the Court should not treat it as such. The question is more complicated when the stipulation, though still a single stipulation, is capable of being broken more than once, and more ways than one, such as a stipulation not to solicit the customers of a firm. A solicitation which is unsuccessful can give rise to only nominal damages, and even if it be successful the actual damage may vary greatly according to the value of the custom which is there by directly or indirectly lost to the firm. Still, whatever damage there is must be the same in kind for every possible breach, and the fact that it may vary in amount for each particular breach has never been held to raise any presumption or inference that the sum agreed to be paid is a penalty, at any rate in cases where the parties have referred to it as agreed or liquidated damages.
The question becomes still more complicated where it is agreed to pay a single sum on the breach of a number of stipulations of varying importance. It is said that in such a case an inference or presumption is raised against the sum in question being in the nature of agreed damages, even though the parties have referred to it as such. In this respect I think that a distinction should be drawn between cases in which the damage likely to accrue from each stipulation is the same in kind, and cases in which the damage likely to accrue varies in kind with each stipulation. Cases of the former class seem to me to be completely analogous to those of a single stipulation, which can be broken in various ways and with varying damages; but probably it would be difficult for the Court to hold that the parties had pre-estimated the damage if they have referred to the sum payable as a penalty.
In cases, however, of the latter class I am inclined to think that the prima facie presumption or inference is against the parties having pre-estimated the damage, even though the sum payable is referred to as agreed or liquidated damages. The damage likely to accrue from breaches of the various stipulations being in kind different, a separate pre-estimate in the case of each stipulation would be necessary, and it would not be very likely that the same result would be arrived at in respect of each kind of damage. In my opinion, however, any such presumption or inference would be prima facie only and capable of being displaced by other considerations. Supposing it were recited in the agreement that the parties had estimated the probable damage from a breach of one stipulation at from £5 to £15, and the probable damage from a breach of another stipulation at from £2 to £12, and had agreed on a sum of £8 as a reasonable sum to be paid on the breach of either stipulation, I cannot think that the Court would refuse to give effect to the bargain between the parties.
In the present case, even accepting the construction of the contract which makes clause 5 apply not only to a sale or offer contrary to the provisions of clause 2 but also to one contrary to the provisions of clause 3, I think it reasonably clear that the damage likely to accrue from the breach of every stipulation to which clause 5 applies is the same in kind. Such damage will in every case consist in the disturbance or derangement of the system of distribution by means of which the appellants’ goods reach the ultimate consumer. The parties by their contract agree that the sum payable on breach of any such stipulation is to be paid by way of damages and not by way of penalty, and I can see nothing to justify the Court in refusing to give effect to this bargain.
Union Eagle Ltd v Golden Achievement Ltd
[1997] UKPC
Lord Hoffmann
“The boundaries of the equitable jurisdiction to relieve against contractual penalties and forfeitures are in some places imprecise. But their Lordships do not think that it is necessary in this case to draw them more exactly because they agree with Litton V.-P. that the facts lie well beyond the reach of the doctrine. The notion that the court’s jurisdiction to grant relief is “unlimited and unfettered” (per Lord Simon of Glaisdale in Shiloh Spinners Ltd v. Harding [1973] A.C. 691, 726) was rejected as a “beguiling heresy” by the House of Lords in The Scaptrade (Scandinavian Trading Tanker Co. A.B. v. Flota Petrolera Ecuatoriana [1983] 2 A.C. 694, 700). It is worth pausing to notice why it continues to beguile and why it is a heresy. It has the obvious merit of allowing the court to impose what it considers to be a fair solution in the individual case. The principle that equity will restrain the enforcement of legal rights when it would be unconscionable to insist upon them has an attractive breadth. But the reasons why the courts have rejected such generalisations are founded not merely upon authority (see Lord Radcliffe in Campbell Discount Co. Ltd v. Bridge [1962] A.C. 600, 626) but also upon practical considerations of business. These are, in summary, that in many forms of transaction it is of great importance that if something happens for which the contract has made express provision, the parties should know with certainty that the terms of the contract will be enforced. The existence of an undefined discretion to refuse to enforce the contract on the ground that this would be “unconscionable” is sufficient to create uncertainty. Even if it is most unlikely that a discretion to grant relief will be exercised, its mere existence enables litigation to be employed as a negotiating tactic. The realities of commercial life are that this may cause injustice which cannot be fully compensated by the ultimate decision in the case.
The considerations of this nature, which led the House of Lords in The Scaptrade to reject the existence of an equitable jurisdiction to relieve against the withdrawal of a ship for late payment of hire under a charterparty, are described in a passage from the judgment of Robert Goff L.J. in the Court of Appeal [1983] Q.B. 529, 540-541 which was cited with approval by the House: see [1983] 2 A.C. 694, 703-4. Of course the same need for certainty is not present in all transactions and the difficult cases have involved attempts to define the jurisdiction in a way which will enable justice to be done in appropriate cases without destabilising normal commercial relationships…
…It remains for consideration on some future occasion as to whether the way to deal with the problems which have arisen in such cases is by relaxing the principle in Steedman v Drinkle supra, as the Australian courts have done, or by development of the law of restitution and estoppel. The present case seems to their Lordships to be one to which the full force of the general rule applies. The fact is that the purchaser was late. Any suggestion that relief can be obtained on the ground that he was only slightly late is bound to lead to arguments over how late is too late, which can be resolved only
by litigation. For five years the vendor has not known whether he is entitled to resell the flat or not. It has been sterilised by a caution pending a final decision in this case. In his dissenting judgment, Godfrey J.A. said that the case “cries out for the intervention of equity”. Their Lordships think that, on the contrary, it shows the need for a firm restatement of the principle that in cases of rescission of an ordinary contract of sale of land for failure to comply with an essential condition as to time, equity will not intervene.”
Murray v Leisureplay Plc
[2005] EWCA Civ 963
Conclusions on the Penalty Issue
The penalty issue is one of considerable jurisprudential interest. English law is well-known for the respect which it gives to the sanctity of contact. The question which the law of penalties poses is this: to what extent does English contract law allow parties to a contract to specify for their own remedies in damages in the event of breach? The answer is that English law does not in this particular field take the same laissez-faire approach that it takes to (for example) the question whether parties can agree to time limits for the performance of obligations which they subsequently find difficulty in meeting. So far as that is concerned, pacta sunt servanda. So far as pre-determined damages clauses are concerned, English contract law recognises that, if the parties agree that a party in breach of contract shall pay an unjustifiable amount in the event of a breach of contract, their agreement is to that extent unenforceable . The reasons for this exception may be pragmatic rather principled. Diplock LJ made the following observations on this point in the Robophone case:
“I make no attempt, where so many others have failed, to rationalise this common law rule. It seems to be sui generis. The court has no general jurisdiction to re-form terms of a contract because it thinks them unduly onerous on one of the parties—otherwise we should not be so hard put to find tortuous constructions for exemption clauses, which are penalty clauses in reverse; we could simply refuse to enforce them. … But however anomalous it may be, the rule of public policy that the court will not enforce a “penalty clause” so as to permit a party to a contract to recover in an action a sum greater than the measure of damages to which he would be entitled at common law is well established, and in these days when so often one party cannot satisfy his contractual hunger a la carte but only at the table d’hote of a standard printed contract, it has certainly not outlived its usefulness.” (at pages1446 to 1447)
Interestingly, despite the influence of equity, English law has not always taken a consistent approach. As cases cited by the parties show, that the present position was only reached through the influence of Scots law and Commonwealth jurisprudence. Dunlop Pneumatic Tyre v New Garage and Motor Company, Ltd is thus a remarkable example of the ability of English common law to absorb rules from other legal systems, and in addition of the influence of the Privy Council. The latter point is relevant to the question which Baroness Hale recently raised for consideration, namely the question whether this court is bound by previous decisions which have been disapproved as part of the ratio decidendi in a Privy Council case (see her speech in National Westminster Bank plc v Spectrum Plus Ltd [2005] UKHL 41,[163]).
The Clydebank case, cited by counsel, was a Scottish appeal. It concerned a contract for the construction by a Scottish shipbuilder of four torpedo boats for the Spanish government. The contract provided that: “The penalty for late delivery shall be at the rate of £500 per week for each vessel”. The House of Lords held that this sum was not a penalty. In the words of Lord Halsbury LC, it was “obvious on the face of the contract that the very thing intended to be provided against by this pactional amount of damages is to avoid [the] kind of minute and somewhat difficult and complex system of examination that would be necessary if you were to attempt to prove the damage.” (page 11). Lord Davey applied a principle of interpretation of contracts in Scots law:
“My Lords, I therefore conceive that it may be taken as an established principle in the law of Scotland that, if you find a sum of money made payable for the breach, not of an agreement generally which might result in either a trifling or a serious breach, but a breach of one particular stipulation in an agreement, and when you find that the sum payable is proportioned to the amount if I may so call it, or the rate of the non-performance of the agreement – for instance, if you find that it is so much per acre for ground which has been spoilt by mining operations, or if you find, as in the present case, that it is so much per week during the whole time for which the non-delivery of vessels beyond the contract time is delayed – then you infer that prim? facie the parties intended the amount to be liquidate damages and not penalty. I say “prim? facie” because it is always open to the parties to shew that the amount named in the clause is so exorbitant and extravagant that it could not possibly have been regarded as damages for any possible breach which was in the contemplation of the parties, and that is a reason for holding it to be a penalty and not liquidated damages notwithstanding the considerations to which I have alluded.”
Lord Davey held that evidence as to the loss which the Spanish government had actually suffered was inadmissible, and that it would be contrary to the purpose of the clause to admit such evidence. For different view on this point, see per Lord Woolf in the Philips case at pages 59-60.
The Clydebank case was decided in 1904, and it was followed by two decisions of the Privy Council, namely Public Works Commissioner v Hills [1906] AC 368 and Webster v Bosanquet [1912] AC 394. The former case was an appeal from the Cape of Good Hope. The advice of the Privy Council was given by Lord Dunedin, who later gave the leading judgment in the Dunlop case. He noted that the Clydebank case was decided according to “the rules of a system of law where contract law was based directly on the civil law and no complications in the matter of pleading had ever been introduced by the separation of common law and equity.” (page 375). The Privy Council held that the clause in that case was a penalty. It held that the principle to be deduced from the Clydebank case was that the criterion of whether a sum was a penalty or damages was to be found in whether the sum in question “can or cannot be regarded as a “genuine pre-estimate of the creditor’s probable or possible interest in the due performance of the principal obligation.” (page 376). In Webster v Bosanquet the appeal to the Privy Council came from Ceylon. The Privy Council again applied the Clydebank case.
The three cases just cited play an important role in the speech of Lord Dunedin in the Dunlop case. In that case, a contractual provision in an agreement between a manufacturer and dealer in tyres for the payment of 5s per tyre sold below list price in breach of contract was held on the facts not to be a penalty. The House reversed the (unreported) decision of this court (Vaughan Williams and Swinfen Eady LJJ, Kennedy LJ dissenting). The Court of Appeal held that, since the contract in question provided for damages to be paid on breaches of varying degrees of importance, the relevant provision had to be treated as a penalty. The House took the view that such a clause did not inevitably have to be treated as penalty. The leading speech was that of Lord Dunedin and he, drawing on the three cases mentioned above, enunciated the law on penalties which is now embedded in our common law. The classic statement of the law on penalties by Lord Dunedin in the Dunlop case is set out below.
The judge took the analysis of the case law on penalties in the recent Cine case as a complete statement of the law for his purposes. I will take it as my starting point. The facts of that case are complex and issues arose which are not relevant for the consideration of penalties, and accordingly I will restrict my examination of the case to a statement of the facts and principles set out therein relevant to the question of penalties. The first judgment was that of Mance LJ. The other members of the court, Peter Gibson and Thomas LJJ, agreed with him, but gave concurring judgments.
The Cine case concerned the appeal of a Turkish cable television company and its guarantor from the order of Mr Julian Flaux QC giving summary judgment for damages to be assessed for breach of an agreement dated as of 1 May 2000 in favour of the claimant, a joint venture company (“UIP”). Under this agreement Cine was given a licence to exhibit films of the members of the joint venture. Two critical provisions of the agreement were clauses 16 and 17. Clause 16 required Cine to hold an amount of $4,836,155 (“the AB amount”) in a special account for use by UIP and the members of the joint venture in advertising the films licensed. On termination of the agreement the full AB amount had to be paid to UIP. Clause 17 dealt with termination. If Cine failed to maintain a letter of credit in favour of UIP, for payment of the licence fees, UIP could terminate the agreement and thereupon the whole of the licence fees payable over the balance of the term of the licence became due and payable, together with all damages resulting from such breach the AB amount and the outstanding costs of certain prior proceedings between the parties which had been compromised.
The relevant issue on the Cine appeal was whether the argument that clauses 16 and 17 were unenforceable as penalties had a real prospect of success. If so, the claimant was not entitled to summary judgment and the matter would have to go to trial. Because this was an appeal from the grant of summary judgment, this court did not have to reach a final view on these matters.
There is a useful and succinct statement of the law in the judgment of Mance LJ:
“11. The general scope of the law relating to penalties was identified by Lord Browne-Wilkinson giving the advice of the Privy Council in Workers Trust Bank Ltd. v. Dojap Ltd. [1993] AC 573:
“In general, a contractual provision which requires one party in the event of his breach of the contract to pay or forfeit a sum of money to the other party is unlawful as being a penalty, unless such provision can be justified as being a payment of liquidated damages being a genuine pre-estimate of the loss which the innocent party will incur by reason of the breach. One exception to this general rule is the provision for the payment of a deposit (customarily 10% of the contract price) on the sale of land. …..”
12. The classic distinction drawn by Lord Dunedin in Dunlop Pneumatic Tyre Company v. New Garage and Motor Company Ltd. [1915] AC 79, 86f was between a payment on breach stipulated as in terrorem of the offending party and a genuine covenanted pre-estimate of damage. Lord Dunedin added that the question was one of construction of each contract, to be decided as at the time of its making, not the time of breach. He offered as tests which might prove “helpful, or even conclusive”, these:
“a) It will be held to be penalty if the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach ..….
b) It will be held to be a penalty if the breach consists only in not paying a sum of money, and the sum stipulated is a sum greater than the sum which ought to have been paid ….. This though one of the most ancient instances is truly a corollary to the last test. Whether it had its historical origin in the doctrine of the common law that when A. promised to pay B. a sum of money on a certain day and did not do so, B. could only recover the sum with, in certain cases, interest, but could never recover further damages for non-timeous payment, or whether it was a survival of the time when equity reformed unconscionable bargains merely because they were unconscionable ….. is probably more interesting than material.
(c) There is a presumption (but no more) that it is penalty when “a single lump sum is made payable by way of compensation, on the occurrence of one or more or all of several events, some of which may occasion serious and others but trifling damage”.
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…..”
13. Although the phrase in terrorem has appeared in many cases since Dunlop, there is force in Lord Radcliffe’s comment in Campbell Discount Co. Ltd. v. Bridge [1962] AC 600, 622, that
“I do not find that that description adds anything to the idea conveyed by the word “penalty” itself, and it obscures the fact that penalties may quite easily be undertaken by parties who are not in the least terrorised by the prospect of having to pay them ….”
A more accessible paraphrase of the concept of penalty is that adopted by Colman J in Lordsvale Finance Plc v. Bank of Zambia [1996] QB 752, 762G, when he said that Dunlop Pneumatic Tyre showed that:
“whether a provision is to be treated as a penalty is a matter of construction to be resolved by asking whether at the time the contract was entered into the predominant contractual function of the provision was to deter a party from breaking the contract or to compensate the innocent party for breach. That the contractual function is deterrent rather than compensatory can be deduced by comparing the amount that would be payable on breach with the loss that might be sustained if breach occurred.”
14. In Philips Hong Kong Ltd. v. The AG of Hong Kong (1993) 61 BLR 49, the Privy Council in advice delivered by Lord Woolf underlined test (a) suggested by Lord Dunedin, endorsed the view that the “court should not be astute to descry a ‘penalty clause'” and emphasised that it would “normally be insufficient …. 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” (pp.58-59). However, Lord Woolf went on:
“A difficulty can arise where the range of possible loss is broad. Where it should be obvious that, in relation to part of the range, the liquidated damages are totally out of proportion to certain of the losses which may be incurred, the failure to make special provision for those losses may result in the “liquidated damages” not being recoverable. (See the decision of the Court of Appeal on very special facts in Ariston SRL v Charly Records Ltd (1990) The Independent 13 April 1990.) However, the court has to be careful not to set too stringent a standard and bear in mind that what the parties have agreed should normally be upheld. Any other approach will lead to undesirable uncertainty especially in commercial contracts “
15. I have also have found valuable Colman J’s further observation in Lordsvale at pp.763g-764a, which indicate that a dichotomy between a genuine pre-estimate of damages and a penalty does not necessarily cover all the possibilities. There are clauses which may operate on breach, but which fall into neither category, and they may be commercially perfectly justifiable. In the case before him, Colman J was concerned with a provision for prospective increase in the interest rate payable by a borrower, following the borrower’s default. He said that, although the payment of liquidated damages is “the most prevalent purpose” for which an additional payment on breach might be required under a contract
“…. the jurisdiction in relation to penalty clauses is concerned not primarily with the enforcement of inoffensive liquidated damages clauses but rather with protection against the effect of penalty clauses. There would therefore seem to be no reason in principle why a contractual provision the effect of which was to increase the consideration payable under an executory contract upon the happening of a default should be struck down as a penalty if the increase could in the circumstances be explained as commercially justifiable, provided always that its dominant purpose was not to deter the other party from breach.” “
In essence, this court held in the Cine case, that in determining whether provisions were a penalty the court had at the outset of its enquiry to look at the aggregate amount that would be payable on breach under the terms of the agreement, and compare that with what would have been payable if UIP had had to bring its claim under the common law. In other words the alleged genuine pre-estimate of loss in clause 17 had to relate to the overall net balance of losses payable on termination less the credits to which Cine would have been entitled at common law. The court declined to treat the AB amount as separate from the other items payable on breach under clause 17. It noted that under the agreement UIP did not have to give credit for the right to use the films licensed to Cine, which came to an end on the termination of its licence.
In the circumstances, this court concluded that a triable issue was shown with respect to the question whether the provisions of the agreement for the acceleration of licence fees and the payment of the AB amount to UIP in the event of breach were unenforceable as penalties. At [50], Thomas LJ held that it would have to be investigated at trial why what appeared to be benefits to UIP on termination were not brought into account when the agreement was drawn up. He added: “A genuine pre-estimate would ordinarily imply consideration being given to bringing into account the material and significant matters that went into the ascertainment of the actual loss suffered by the innocent party.” As Peter Gibson LJ observed, the question, whether the failure to bring the benefit of the termination of the film rights into account in determining the amount payable on breach rendered clause 17 a penalty, had to be assessed on the basis of the position at the date of the agreement.
It was also argued in the Cine case that there was a triable issue as to whether the other amounts payable on breach were also penalties but for reasons which were specific to the facts of that case and which I need not explore the court held that the only triable issues were as I have set out above.
What, to my judgment, is striking about the statement of the law in the Cine case and its application is the way in which the court sought objectively to rationalise its conclusions as to whether the provisions of the agreement constituted a penalty. The court’s reasoning turns on a comparison between the overall amount payable under the agreement in the event of a breach with the overall amount that would have been payable if a claim for damages for breach of contract had been brought at common law. The court proceeded on the basis that, if such a comparison discloses a discrepancy, which can be shown not to be a genuine pre-estimate of damage or to be unjustified, the agreement provides for a penalty.
The usual way of expressing the conclusion that a contractual provision does not impose a penalty is by stating that the provision for the payment of money in the event of breach was a genuine pre-estimate by the parties to the agreement of the damage the innocent party would suffer in the event of breach. As Lord Dunedin said in the Dunlop case, the “essence” of a liquidated damages clause is “a genuine covenanted pre-estimate of damage” (at page 86). As the Dunlop case and the citation from the Philips case (in the Cine case) show, a contractual provision does not become a penalty simply because the clause in question results in overpayment in particular circumstances. The parties are allowed a generous margin.
The judgments in the Cine case show the continued usefulness of the authoritative guidance given by Lord Dunedin in the Dunlop. There are two particular points I would make about that guidance for the purposes of this appeal. First, paragraph (a) envisages an exceptional payment, though paragraph (a) does not state that this is the only circumstance in which a payment will be held to be a penalty. Second, paragraph (c) of Lord Dunedin’s guidance shows that there are several types of clause which may amount to penalties. Some may provide for the same sum to be paid on different breaches of contract. That is the sort of penalty clause which Lord Dunedin had in mind in (c). There are other kinds of clauses which may constitute penalties, such as those which provide for a single sum or aggregate sum to be paid on a single breach. This was the situation in the Cine case. It is also the case in this case where there is a single event giving rise to the payment of money under clause 17, namely the termination of the agreement without giving one year’s notice.
Third, paragraph (d) of Lord Dunedin’s guidance is also relevant in this case. When a person is dismissed without notice, it is difficult to forecast in advance what the damages payable will be. It may depend for instance on whether he is able to obtain comparable employment. Paragraph (d) makes it clear that, even in the situation when the parties cannot at the time of contracting, predict the loss likely to result from a breach of contract, a sum can be a genuine pre-estimate of damage.
In paragraph (a) Lord Dunedin refers to the sum stipulated in the parties’ contract being “extravagant and unconscionable”. The decision of this court in the Cine case shows that those words have to be given a contemporary meaning. The real question is whether the sums for which the parties have provided the paid on breach differ substantially from the sums that would be recoverable at common law and whether there is shown to be no justification for that.
In paragraph 13 of his judgment, quoted above, Mance LJ refers to the observation of Lord Radcliffe in Campbell Discount Co Ltd v Bridge [1962] AC 600, 622 that the description of sums being stipulated as in terrorem adds little to the concept of penalty. That point has particular resonance in this case. The evidence of Mr Murray at trial was not that he wanted to terrorise MFC or that he wanted to deter MFC from dismissing him without one year’s notice. His evidence was that he wanted a remuneration package which, seen overall, was generous because of the loss that his working for MFC would cause to his other business interests. In other words Mr Murray was motivated by his own desire to protect his own interests not a desire to terrorise MFC. Since he had other business interests, he would not necessarily want to deter MFC from terminating his agreement. For the reasons given below, I do not consider that the absence of evidence that Mr. Murray intended to deter MFC from breaching the agreement means that clause 17.1 cannot be a penalty.
I have already referred to the Philips case, which is referred to by Mance LJ in paragraph 14 of his judgment. The words of Lord Woolf which he quotes are a timely reminder of the importance of legal certainty. The court should give weight to the fact that the parties have agreed the particular clause. In the same case Lord Woolf said:
“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. ” (at pages 58 to 59)
The appellant has relied on the opening phrase in this passage. He contends that this is not a case where domination can be shown and that accordingly the respondent cannot, simply by pointing to the absence of any deduction for mitigation from the payment provided for by clause 17 in this case, contend that clause 17 must be a penalty because in some situations a greater loss could be recovered under clause 17 than at common law. In my judgment there are two answers to this point. The first is that Lord Woolf was not laying down any principle that a different rule would apply in the case of domination; he simply recognised that there might be a different rule in that case. Indeed this court in the Jeancharm case held that the Philips case did not represent a departure from the law as laid down by Lord Dunedin in the Dunlop case. Accordingly I do not consider that oppression on a party to make a contract is of itself a criterion in determining whether a contractual sum is a penalty. Second the fact that a greater loss can be recovered under a contractual provision than at common law may lead to the conclusion that the clause in question is a penalty, although that result is not inevitable. It all depends on the circumstances.
In paragraph 15 of his judgment, Mance LJ makes the point that it need not simply be shown that the clause was a genuine pre-estimate of the damage that would occur on breach. There is scope for other justification for the amount payable on breach. The Cine case illustrates this point. Clause 17 of the agreement in that case provided for the payment of costs of prior proceedings. Those proceedings had been compromised on terms which did not require Cine to pay UIP’s costs. However, Mance LJ was not prepared to hold that the clause was necessarily a penalty. It was open to the parties to agree to forego the costs in the prior litigation on terms that the new agreement was entered into and duly performed.
However in the normal situation, the test will be whether or not the parties genuinely pre-estimated the loss that would occur on breach. This is a relatively low level of review: see paragraphs 44 and 45 above. I agree with Mr Bannister that the parties do not have to make an accurate assessment of the damages that would have been awarded at common law. Indeed it may be very difficult for them to do so. That will frequently be the case in an employment contract. In ascertaining whether the parties have made a genuine pre-estimate of the damage, the court will consider the reasons which the parties had for agreeing to the clause in question at the time when the agreement was made.
Lord Dunedin in the Dunlop case makes the point that, although the issue is one of construction, the court is not confined to the terms of the agreement and may look at the “inherent circumstances of each particular contract, judged of as at the time of the making of the contract, not at the time of the breach…” (at page 87). In my judgment, the inherent circumstances to which the court may have regard extend beyond those which may be adduced in evidence for the purposes of determining the true interpretation of the agreement under the well known test in the Investors’ Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896. But the purpose of adducing that evidence is not so that the parties can demonstrate that they agreed to opt out of the remedies regime provided by the common law but rather that the reasons that they had for doing so constitute adequate justification for the discrepancy between the contractual measure of damages and that provided by the common law.
The parties in this case cited a number of further authorities not cited by Mance LJ in the Cine case. I need only deal with Abrahams v Performing Right Society. In this case, the plaintiff was employed for an indefinite period under a contract by which his employer had agreed to give him two years’ notice of termination of his employment or pay him a lump sum of two years’ salary in lieu. The employer failed to give notice and so the plaintiff sued him for the lump sum. The employer argued that the plaintiff had a duty to mitigate his loss but this argument was rejected because the payment of two years salary was a contractual payment, viz one which the employer was bound to make. Termination of the plaintiff’s employment was not a breach of the contract but if the employer elected to terminate the contract, it had either to give notice or to pay a sum equivalent to two years’ gross salary. Hutchinson LJ, with whom Aldous LJ agreed, observed that the contractual sum could not be impugned as a penalty. He did not give any reasons for this conclusion. Accordingly it is not clear whether Hutchinson LJ meant that the clause was a genuine pre-estimate of the employee’s loss or whether he meant that since the sum was not payable on breach but on the exercise of an option to terminate the employment of the plaintiff with a lump sum payment. In my judgment, he meant the latter. In that case it is distinguishable from the present case where the sum payable under clause 17 is payable on breach. There does not appear to have been argument directed to the penalty question in any event.
With the benefit of the citation of authority given above, in my judgment, the following (with the explanation given below) constitutes a practical step by step guide as to the questions which the court should ask in a case like this:-
i) To what breaches of contract does the contractual damages provision apply?
ii) What amount is payable on breach under that clause in the parties’ agreement?
iii) What amount would be payable if a claim for damages for breach of contract was brought under common law?
iv) What were the parties’ reasons for agreeing for the relevant clause?
v) Has the party who seeks to establish that the clause is a penalty shown that the amount payable under the clause was imposed in terrorem, or that it does not constitute a genuine pre-estimate of loss for the purposes of the Dunlop case, and, if he has shown the latter, is there some other reason which justifies the discrepancy between i) and ii) above?
A point that neither the Dunlop case nor the Cine case considers is the position if either there is no evidence at trial as to why the parties agreed a particular clause, or if the evidence is that they did consider it but took a wholly wrong view about what damages would be payable under the general law in the event of breach. In the Dunlop case, trial had taken place and there had been evidence as to why Dunlop needed the clause. In the Cine case, trial had not take place but the court proceeded on the basis that there would or could be evidence about the reasons for the clause in question at the trial to which the case was remitted. What happens if there is no evidence about the reasons for the clause? There would in my judgment be no reason why the court could not draw inferences of fact as to the reasons and as to the genuineness of those reasons. What if it appears from the evidence that is given (or from the inferences that the court makes from the facts) that the decision to include the damages clause was included on the basis of a mistaken belief that the damages at common law would be assessed on a materially more generous basis than in fact would occur? This would be the case if for example the parties failed to have regard to the fact that a party would have to give credit for a benefit that he obtained on breach, such as a tax saving as a result of the receipt of damages for lost income in the form of a lump sum payment of damages. In my judgment, the good faith belief of the parties is not the deciding factor here. The court would look at the result and (bearing in mind that the onus is on the party challenging the clause to establish that it is a penalty) ask whether it is satisfied that the parties could not, if they had had the proper information or considerations in front of them, genuinely have considered that the damages payable under the contractual provision were a realistic pre-estimate of the damages payable on breach at common law. In other words, in the context of Lord Dunedin’s speech, the test of genuineness is objective. A pre-estimate is genuine if it is not unreasonable in all the circumstances of the case.
I now turn to the facts of this case