Penalty clauses
Holyoake v Candy (High Court) [2018]
This case demonstrates how careful drafting can avoid the operation of the rule against.
Facts:
The Claimants had purchased a London property (the “Property”) with the aim of converting it for residential use. The Claimants raised the purchase price through three loans, one of which was an unsecured personal loan to Mr Holyoake (one of the Claimants) of £12 million from one of the Defendants, CPC Group Limited (“CPC”).
Mr Holyoake defaulted on the loan. The Claimants brought proceedings against the Defendants and alleged that certain provisions in the loan agreements were unenforceable penalties notably:
1. A clause that required the borrower to pay a sum (the “Redemption Amount”) on early repayment of the loan. The Redemption Amount was equivalent to the whole of the interest that would have accrued by the end of the two year period of the loan.
2. Clauses that required the borrower to pay certain fees in return for an extension of the period of repayment (the “Extension Fees”).
Decision:
The judge decided that the clause requiring payment of the Redemption Amount was triggered by the borrower exercising its option to repay the loan early; not on a breach of contract. The judge therefore determined that the requirement to pay the Redemption Amount was, both in substance and form, part of the primary obligations of the borrower and, as a result, not within the scope of the rule against penalties.
Similarly, the judge determined that the requirement to pay the Extension Fees under the extension agreements was in consideration for the lender extending the time in which the borrower could repay the loan. Mr Holyoake agreed to the Extension Fees because he needed the extension. The payment of the Extension Fees was drafted as a primary obligation, payable in any event under the various extension agreements, and not on default. The judge held that “as a matter of form and substance [these provisions] did not operate on a breach and did not engage the penalty rule”.
Points to Note:
- It is possible in many cases to effectively avoid the penalty rule by expressing an obligation to pay as a primary obligation or as an obligation which is conditional on performance. However it is also clear that the court will always be alive to the fact that what matters is substance over form.
- The English courts are, in recent years, taking a much more commercial approach to the interpretation of agreed remedy clauses in commercial contracts and so it is now really quite rare for a provision to be struck down as a penalty.