UK Court adds VAR-like guidance to the rule on penalties

The introduction of Video Assistant Referees (or VARs) in this year's Emirates FA Cup has to many prompted more questions than it has answered. Meanwhile we lawyers have looked on with envy, wondering what assistance we might call upon when a client asks - is this clause an unenforceable penalty? Fortunately the High Court has recently come to our assistance in the case of Holyoake and another v Candy and others [2017] EWHC 3397 (Ch).

1. Background 

The defendants included the luxury property developers, the Candy brothers, one of whom is married to a popular Australian soap actress. Mr. Holyoake had borrowed monies from the Candy brothers to purchase a mansion block in London with the intention of converting it into high-end residential use. Sadly the project was unsuccessful and substantial losses were incurred.

Mr Holyoake brought various claims against the Candy brothers, including a range of torts such as duress, actual undue influence, intimidation, extortion under colour of due process (abuse of process),  unlawful interference with economic interests and unlawful means conspiracy. All these claims failed. Mr Holyoake also claimed that a number of provisions in the agreements between the parties were penalties and therefore unenforceable. 

Among the clauses disputed by Mr Holyoake were the following:

a) A provision requiring payment of a redemption amount in the event of prepayment of the loan. The redemption amount included the entire amount of interest which would have accrued by the end of the full term of the facility. On the facts of the case, the borrower having borrowed £12 million, this meant an aggregate repayment sum of £17.74 million.

b) Various clauses requiring Mr Holyoake to pay certain extension fees under a loan extension agreement.

c) A provision in a related escrow deed, according to which in the event that Mr Holyoake failed to repay the original loan and complete the sale of the property to the Candy brothers, a new debt in an equivalent amount (£17.74 million) would arise.

2. High Court guidance

The High Court held that, as a matter of form and substance, none of the clauses referred to above were penalties. Most importantly, they failed to engage the penalty rule because they were not triggered by any breach of contract. Instead they operated as primary obligations. 

In particular, the redemption amount referred to at 1(a) above was not a penalty as it was not triggered by any breach of contract but by the borrower electing to repay the loan early. The obligation to pay the extension fees referred to at 1(b) above was construed as consideration in return for the extension of time in which to repay the loan. As such, it also represented a primary obligation that did not operate by reference to any breach of the extension agreement.

Similarly the provision referred to at 1(c) above was not activated upon any breach but rather if the relevant circumstances arose.

3. Practical takeaways

This is an interesting decision, as it illustrates that it is possible to circumvent the penalty rule by careful drafting. This reinforces the approach of the Supreme Court in a previous case, Talal El Makdessi v Cavendish Square Holding BV [2015] UKSC 67, in which the Court also confirmed that a clause may escape the rule against penalties if it bites in circumstances other than a breach of contract.

Taking these decisions in tandem, we would highlight the following practical takeaways:

• Firstly, the penalty rule still exists but as a result of the cases referred to above the courts have helpfully clarified the circumstances in which it applies.
• Secondly, care should be taken in respect of contractual provisions which deal with the consequences of breach; if they result in a secondary obligation which is out of all proportion to the legitimate interest of the innocent party in enforcing the primary obligation, then they risk engaging the penalty rule.
• Finally, lawyers should draft obligations to make future payments on the basis that payment is required following a triggering event rather than by any breach of contract. For example, a payment which is conditional on performance is likely to avoid the wrath of the penalty rule unlike an entitlement to liquidated damages in the event of breach.