Cavendish v Makdessi: implications for penalties in Scottish contracts

Scotland

We recently reported on the Supreme Court’s decision in the Cavendish and ParkingEye appeals. The Court’s decision has significantly changed the law with regard to contractual penalties in English law contracts – but what is the position in Scotland? In this Law-Now we take a brief look at the effect of the decision on Scottish contracts.

The Supreme Court’s decision

For a detailed summary of the Supreme Court’s decision and its impact on the law of penalties, please see our earlier Law-Nows here. Here we will concentrate on the key points that impact on Scots law.

Scots law

  • In theory, parties on both sides of the Border have freedom to contract as they please. In practice, this freedom is hedged with various restrictions – this case was concerned with one particular legal restriction – the rule against penalties.
  • In Scots law, a penalty in a contract has been described historically as having two essential features: - it is payable or comes into effect on the occurrence of a breach of contract - it does not constitute a genuine pre-estimate of the loss likely to be suffered in consequence of the breach of contract and it is designed to operate oppressively or punitively.
  • The law in each of Scotland and England has developed along similar lines with many cross references to cases in the other jurisdiction and is now considered to be the same in all essential elements. The El Makdessi decision is therefore likely to have a material influence in Scotland too.
  • However, moves are once again afoot to formalise the law in relation to contractual penalties in Scotland. A previous attempt in 2010 was put on hold. The Scottish Law Commission now plans to issue a discussion paper on penalty clauses early next year.

Following Makdessi? The Scottish view

Lord Hodge considered the case from a Scots law perspective. He reached the same conclusions as the English judges and confirmed that the rule against contractual penalties is essentially the same in each jurisdiction.

However, he pointed out that the Scottish courts also have power to modify or abate a penalty in certain circumstances which the English courts do not. The Debts Securities (Scotland) Act 1856 gives the Scottish courts authority to modify and restrict penalties imposed for non-payment, over and above performance, contained in bonds or other obligations for sums of money.

It seems that the previous emphasis on whether a clause constituted a ‘genuine pre-estimate of loss’ for breach of contract was too narrow. Instead, Lord Hodge suggested that proportionality is key – does the party seeking to enforce the obligation have a legitimate interest to protect and is the effect of the clause proportionate to the protection of that interest? In the words of the judge, the sum or remedy stipulated [must not be] exorbitant or unconscionable when compared to the innocent party’s interest in the proper performance of the contract.

Other points included:

  • the application of the rule does not depend on any disparity of power of the contracting parties
  • whilst there is some scope for careful drafting to circumvent the rule, the courts will look at the substance rather than the form or description attributed to a payment or other obligation to determine whether it is in fact a punishment for non-performance – therefore drafting which is designed to ‘disguise’ something which is in reality a penalty may not work!

Following the El Makdessi decision, the law against contractual penalties in Scotland appears to be the same as in England in all material respects. However, some divergence between the regimes may be expected to follow any future Scottish legislation which may be introduced after the Scottish Law Commission report next year.

References:

Cavendish Square Holding BV v Talal El Makdessi [2015] UKSC 67