The latest on ‘penalty’ provisions
Simantob v Shavleyan (Court of Appeal) [2019]
This case raises issues relating to the question of penalties and what, mutual consideration or value is required, if any, in order to make the variation of a contract binding.
Facts:
The parties were traders in antiquities. They got into dispute. By a Settlement Agreement dating from 2010 it was agreed that one would pay the other US$1,500,000 in full and final settlement of all claims. Under the terms of the settlement, in the event of non-payment on the due date, ‘1,000 dollars… for each extra day as a penalty’ was to be payable.
The $1,000 per day clause was invoked when payment was not made. This was, based on the entirety of the outstanding debt, an effective annual rate of interest of 24.33% which, although high, was accepted as not being particularly unusual in the market in which the parties operated.
A part payment of $500,000 was then made. However, the effect of the $1,000 per day clause continued without alteration. It was the debtor’s evidence, accepted by the court, that he had always considered the $1,000 per day clause unfair and unconscionable and had intimated that he would challenge it.
Subsequently, the parties concluded a further business transaction in 2014, which the debtor asserted represented an agreement to modify the Settlement Agreement. Under this new ‘Variation Agreement’, the creditor would accept $800,000 in full and final settlement of the debt.
This was denied by the creditor, who brought proceedings claiming $2,454,000 as the sum outstanding under the original Settlement Agreement. Of this, the vast majority (over 90%) represented interest due based on the $1,000 per day clause, and the creditor further claimed continuing interest at this rate of $1,000 per day. In response, the debtor claimed that the $1,000 clause was void as a penalty.
Decision:
The first issue which came before the courts was whether the $1,000 a day represented a penalty and was therefore unenforceable. This was decided in a preliminary hearing. Somewhat surprisingly in our view, the court found for the creditor and the interest provision was upheld. Unfortunately there doesn’t seem to be any public record of the court’s thinking on this point.
The court then had to consider whether the Variation Agreement itself was binding. There is a longstanding principle of English law that part-payment of a debt by itself cannot satisfy the whole indebtedness unless some additional benefit is conferred on the creditor. The High Court distinguished this case on the grounds that the creditor had indeed received additional benefit, namely the debtor giving up any possibility of claiming that the $1,000 a day provision was a penalty. The Court of Appeal effectively upheld that ruling. It said that where a litigant intimates a defence which he or she [genuinely] believes in and intends to pursue in court if necessary, (even if there is a recognition that it raises a doubtful or undecided legal point), giving up such a potential defence can amount to valuable consideration. This is distinguished from a case where the debtor threatens a defence in which they have no confidence in at all. This has to be judged according to the circumstances prevailing at the time the settlement is reached, not at the later point when the defence is actually found to have no basis in law.
The Variation Agreement was therefore held to be binding on the parties.
Points to Note:
- Even with the more relaxed attitude of the courts as to what amounts to an unenforceable penalty, the provision in this case for sums to be paid at the same rate irrespective of the principal amount outstanding ran a significant risk of being struck down as a penalty. The fact it was not should not in our view be relied upon. It would be much more sensible to have tailored the provision to ensure that it was in some way reflective of the principal amount outstanding.
- It is extremely rare for the issue as to whether there has been sufficient consideration flowing between the parties to come before the courts. The reason for this is that in most contracts or variations there are mutual promises / undertakings which avoid any suggestion that the contract in question is akin to a unilateral promise. However, if there is any doubt about consideration always bear in mind that any necessary consideration can be imported by drafting the documentation as a deed (following the wording prescribed by relevant legislation which varies according to the legal entity concerned).