Firm foundations year in review_19-01-16_FB

The Court was of the view that the parties themselves are the best judge of what constitutes a legitimate consequence of a breach, and extending the penalty rule could hinder freedom of contract. If the rule extended to other types of penalty, such as the ability to terminate a contract upon the occurrence of an insolvency event, that could represent an expansion of the Courts’ jurisdiction into new, uncertain territories. On that basis, the Court felt the penalty rule should neither be abolished nor extended. This followed Lord Hoffmann’s judgment in the case of Else (1982) Ltd v Parkland Holdings Ltd - [1994] 1 BCLC 130, where he stated “I would answer that the penalty doctrine, being an inroad upon freedom of contract which is inflexible compared with the equitable rules of relief against forfeiture, ought not to be extended.” If the contractual remedy is enforceable, its inclusion benefits contractually wronged parties in the event of breach. However, if a contractual clause does not relate to any legitimate business interest, and the remedy for any breach of it would be disproportionate considering the innocent party’s interest in the performance of the contract, then the remedy is likely to be unenforceable.

As accepted by the Court in this judgment, the application of the penalty rule can still turn on questions of drafting. As noted above, LDs clauses are generally upheld by the courts, providing they do not constitute a penalty; it is therefore worth remembering when inserting such provisions that the obligation to pay LDs must be expressed as a secondary obligation which only operates once the primary obligation has been breached for the rule to apply, and it should not be out of all proportion to any legitimate interest the injured party had in performance of the primary obligation. Most standard form construction contracts contain straightforward LDs provisions, but care should be taken when amending these provisions or producing bespoke versions. Rachel Chaplin Professional Support Lawyer, London T: +44 (0)20 7876 4235 E: rachel.chaplin@clydeco.com

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