The Court also emphasised that the rule against penalties is concerned only with the secondary obligation to pay damages as the remedy for breach of an underlying primary obligation, and is not concerned with the primary obligation itself: “There is a fundamental difference between a jurisdiction to review the fairness of a contractual obligation and a jurisdiction to regulate the remedy for its breach…the courts do not review the fairness of men’s bargains…This means that in some cases the application of the penalty rule may depend on how the relevant obligation is framed in the instrument…. Thus, where a contract contains an obligation on one party to perform an act, and also provides that, if he does not perform it, he will pay the other party a specified sum of money, the obligation to pay the specified sum is a secondary obligation which is capable of being a penalty; but if the contract does not impose (expressly or impliedly) an obligation to perform the act, but simply provides that, if one party does not perform, he will pay the other party a specified sum, the obligation to pay the specified sum is a conditional primary obligation and cannot be a penalty.” This doesn’t mean, however, that contracting parties can try to avoid the rule against penalties simply by labelling as a primary obligation what is, in reality, a contractual remedy for breach of a primary obligation. To emphasise this, the Court added: “…the capricious consequences of this state of affairs are mitigated by the fact that…the classification of terms for the purpose of the
penalty rule depends on the substance of the term and not on its form or on the label which the parties have chosen to attach to it.” Application of the test to the two cases In C avendish Square Holding BV v Talal El Makdessi , the Court held that both clauses 5.1 and 5.6 were primary obligations. The Court held that clause 5.1 was a price adjustment clause, not a contractual alternative to damages at law: “Although the occasion for its operation is a breach of contract, it is in no sense a secondary provision…Its effect is that the Sellers earn the consideration for their shares not only by transferring them to Cavendish, but by observing the restrictive covenants.” These covenants were intended to safeguard and protect the goodwill in the business, and the fact that the parties had agreed a price for their observance that bore no relation to the actual loss that would be recoverable on their breach was not a matter on which the courts could intervene: “The goodwill of this business was critical to its value to Cavendish, and the loyalty of Mr Makdessi and Mr Ghossoub was critical to the goodwill. The fact that some breaches of the restrictive covenants would cause very little in the way of recoverable loss to Cavendish is therefore beside the point…It is clear that this business was worth considerably less to Cavendish if that risk [of breach of covenant] existed than if it did not. Howmuch less? There are no juridical standards by which to answer that question satisfactorily. We
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