Early termination payment not a penalty
BERG v BLACKBURN ROVERS FC [2013]
The High Court has confirmed that the law on penalties only applies where the trigger for payment is a breach of contract and not where an agreed sum was payable as compensation on the exercise of an early termination right in a fixed term contract.
Facts:
- Berg (B) was appointed by Blackburn Rovers FC (BRFC) as its manager on a fixed term contract dated 16th November 2012 for about two and a half years. After a very short period, on 27th December 2012, BRFC exercised an express contractual right to terminate his contract with immediate effect.
- B claimed that under the terms of the contract he was due £2.25 million, being the remaining amount he would have been paid until the expiry of the fixed term. His contract provided, “In the event that the Club shall at any time wish to terminate this Agreement with immediate effect it shall be entitled to do so upon written notice to the Manager and provided that it shall pay to the Manager a compensation payment by way of liquidated damages in a sum equal to the Manager’s gross basic salary for the unexpired balance of the Fixed Period assuming an annual salary of £900,000...”
- BRFC argued the clause was a penalty and therefore unenforceable beyond the sum that represented B's actual loss.
Decision:
- The Court held in favour of B allowing him to claim £2.25 million against BRFC. It said that as termination of B's employment prior to the expiry of the fixed term did not constitute a breach of contract, the law relating to penalty clauses was immaterial and BRFC’s argument failed.
- In fact early termination by BRFC was permitted as of right – whereupon a sum of money became payable by BRFC to B. This was a payment that became due on the occurrence of an event other than a breach of contract. In a fixed term contract a party is either entitled to terminate before expiry of the fixed term or it is not and here there was no question of whether there had been a breach of contract by either party. The judge went on to refer to the approach adopted in a previous case:
"The clause was not a penalty clause because it provided for payment of money upon the happening of a specified event other than a breach of contractual duty... The main purpose of the law relating to penalty clauses is to prevent a plaintiff recovering a sum in respect of a breach of contract committed by a defendant who bears little or no relationship to the loss actually suffered by the plaintiff as a result of the breach by the defendant. It is not and never has been for the courts to relieve a party from the consequences of what may in the event prove to be an onerous or possibly even a commercially imprudent bargain.”
Points to note:
- This case serves as a helpful reminder that the rule against penalties only applies where the trigger for payment is a breach of contract. This is often misunderstood. A penalty clause would only be unenforceable if payment was triggered by a contractual breach and where its primary purpose is deterrence against breach, with the penalty for breach being an ‘extravagant and unconscionable’ sum. The reference to the payment being ‘liquidated damages’ was not use of the phrase in the strict legal sense and the fact that the payment had been described as such was not conclusive.
- As the £2.25 million was payable as a matter of right as a debt claim, issues of mitigation of loss were also irrelevant.
- Contracting parties should therefore consider very carefully whether they are actually exercising a contractual option. If that is indeed what is being exercised, a contracting party will be unable to rely on a seemingly generous compensation provision being held to be unenforceable as a penalty.