UK: Unenforceable Penalties

Last Updated: 18 October 2007
Article by Sara Partington

The recent case of Volkswagen Financial Services (UK) Ltd v Ramage (unreported, Cambridge County Court, 9 May 2007) focuses attention on the effectiveness of the payment clauses in circumstances where the hirer defaults or repudiates the contract.

The Facts

George Ramage hired a car from VW for a fixed period of 36 months under a hire agreement, agreeing to pay a set amount per month but also agreeing that, upon any repudiation, he would be liable to pay the total amount of rentals payable during the total hiring period, less the amount of rentals paid or due, less a rebate on the rentals not yet due. The relevant part of cl 8.2 provided that the hirer had to pay: compensation or agreed damages on acceptance of [the hirer.s] repudiation, or a debt on our termination, the total amount of rentals payable during the Hiring Period. less the amount of rentals paid or which have become due..

When Ramage fell into arrears, VW notified him that his non-payment showed an intention not to be bound by the agreement and that he had therefore repudiated it, and that VW accepted his repudiation. VW recovered the car and sued for £13,365, comprising the amounts which it said were outstanding under the agreement: arrears of rentals to date of termination, recovery fee and what Judge Sennitt termed .a sum expressed to be future rentals amounting to £10,428..

Reasoning at First Instance

At trial before District Judge Pearl, it was accepted that, for cl 8.2 to be enforceable, it had to provide for payment of a sum that was a genuine pre-estimate of the loss that VW was likely to suffer as a result of Ramage.s breach and, if it did not so provide, that it was unenforceable as a penalty. Ramage submitted that cl 8.2 was indeed penal and unenforceable.

The judge rejected Ramage.s argument, finding that cl 8.2 was a liquidated damages clause and that this was a case where just such a clause was appropriate, since the calculation of VW.s loss on early recovery was not an easy exercise given that VW would have to take into account variable factors such as a vehicle.s mileage and condition, and even matters such as its make and colour, which might affect value. She further held that the court should be slow to strike out as penalties terms that were freely agreed and observed that she had found Ramage an articulate, intelligent man who had contracted in a free market without oppression to enter into the hire agreement. Ramage appealed.

Overturned on Appeal

Allowing Ramage.s appeal, Judge Sennitt held that cl 8.2 did not provide for a genuine pre-estimate of loss, was in fact a penalty and therefore unenforceable. He found that Ramage was liable for the unpaid rentals and recovery charges element of VW.s claim but not for compensation or damages for his repudiation.

Clause 8.2 was held to be penal because:

  • It provided for payment of the entirety of the future rental payments but took no account of the fact that the car had considerably greater value as the result of being returned at that earlier stage rather than at the end of the three years. It was unfair that cl 8.2 required payment in effect of 100% of the hire payments. subject to the rebate.and did not take the residual value of the car into account, which it should have if it was to be interpreted as VW suggested.
  • In hire contracts, the general principle remained the same whether or not the chattel.s capital cost/value was written off over the period of the hire; however, when it came to considering whether a liquidated damages clause was a genuine pre-estimate of loss, one had to take into account this additional factor if that chattel was intended to be returned at the end of the hire period and would still have had value at that time.
  • The owner had undertaken no prior exercise to calculate what loss it might suffer calculated on common law principles. As such, it could not show that the contract was intended to contain a genuine preestimate and had always approached they clause as having the effect of a penalty.

It is not clear from the judgment quite what approach the claimant (VW) had in fact taken to the clause but the lesson to be learned if that the onus is on an owner who wishes to assert that a clause is not penal to show how it was arrived at.

An owner who wishes to be secure that his liquidated damages clause will entitle him to make recovery of sums to cover the contract value should therefore ensure that the above are taken into account. This may be trickier than it sounds, as it will require the owner to allow for likely variations in the subsequent value of a car in its depreciation dependent on mileage and other factors but, without it, a clause asserted to be designed to cover liquidated damages is vulnerable as a penalty.

Lastly, Judge Sennitt found that the district judge might have attached undue emphasis to Ramage being an articulate, intelligent man who did not have to enter into the contract, and he found that such a person was equally entitled to rely on the fact that a provision in an agreement was a penalty if it did not represent a genuine preestimate of loss.

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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