On 4 November 2015 the UK Supreme Court handed down its decision
in the case of Cavendish Square Holdings BV v Makdessi  UKSC
67.1 As had been widely anticipated, the Supreme Court
took the opportunity to fundamentally review, and largely restate,
the common law rules relating to the enforceability of contractual
The court noted that existing case law on the subject was
tortuous, and in many respects had been superseded in England by
subsequent statutory provisions. However, the court declined the
temptation to abrogate the rule entirely. They also declined to try
and create one single rule to supersede the common law rules in
relation to penalties and the equitable doctrine of relief from
forfeiture. Instead their Lordships settled for simply
reformulating the rules on penalty clauses.
Instead of the old test, which was widely interpreted as
requiring the courts to determine whether a clause was a
"genuine pre-estimate of loss", the courts should now
simply ask whether the relevant clause imposes a sanction which is
"out of all proportion" with the legitimate interests of
the protected party.
Further the court noted that a party's legitimate interest
could extend beyond simply the damages that they were entitled to
upon breach. Accordingly, a determination of whether the remedy was
out of all proportion to their interest was not simply a matter of
comparing it to the damages which might be payable.
The Supreme Court also reaffirmed that the law relating to
contractual penalties only applies to clauses which impose a
sanction for breach of the contract itself. They have no
application where the terms of the contract simply provide for
onerous stipulations upon the happening of certain events. In this
regard they applied existing English case law2 in
preference to the more radical approach adopted by the Australian
High Court in 2012 abolishing the requirement for breach of
contract in order to invoke the strictures on penalty
Lords Sumption and Neuberger, giving the leading judgment,
acknowledged that "[t]he penalty rule is an interference with
freedom of contract", and helpfully added that "[i]n a
negotiated contract between properly advised parties of comparable
bargaining power, the strong initial presumption must be that the
parties themselves are the best judges of what is legitimate in a
provision dealing with the consequences of breach."
the judgment is likely to be welcomed by commercial lawyers as
reducing the potential impact of the rule against penalties, and
strengthening the freedom of parties to make their own bargains.
The one regret from the judgment is that the Supreme Court did not
take the opportunity to definitively state the consequence of a
clause being held to be penal – whether it is merely
unenforceable, or void ab initio4 (Mr Makdessi's
lawyers had pleaded both as alternatives, but as the clause was
held not to be penal no ruling on that point was called for).
However, the fact that the Supreme Court used the word
"unenforceable" to the almost total exclusion of the word
"void" may indicate their thinking on that point.
The decision of the Supreme Court is likely to be followed and
applied in other common law countries, like the BVI, Cayman Islands
1 The case was heard as a joint appeal with Parking Eye v
2 Berg v Blackburn Rovers FC  EWHC 1070
3 Andrews v ANZ Banking Group Ltd  HCA
4 The question is not purely esoteric. If a party made a
payment under a clause which was subsequently held to be a penalty,
whether they could recover any sums paid would depend on whether
the clause was void or merely unenforceable.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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