Cornerstone - That was a clear penalty referee!

Published: 07/07/2016

Most of us have been there, dashing back to put more coins into a car parking meter, only to find a yellow ticket on the car windscreen. In a case towards the end of last year one individual’s annoyance over an £85 fine lead him all the way to the Supreme Court. Little did he know the wider implications the decision would have on liquidated damages in the construction industry.

The Supreme Court heard two joined cases on the issue of penalty clauses: Cavendish Square Holding v. El Makdessi and ParkingEye Limited v. Beavis [2015] UKSC 67. In ParkingEye, Mr Beavis had parked at the Riverside Retail Park in Chelmsford and overstayed the two hour maximum stay by 56 minutes. He was issued with an £85 fine. It is a long established common law rule that a penalty clause is unenforceable and Mr Beavis argued that the £85 fine was a penalty and not a genuine pre-estimate of loss.

It was the first substantial top court consideration of liquidated damages principles in around a century. Prior to these cases, it was considered that for a liquidated damages clause to be enforceable and not a penalty clause it had to be a “genuine pre-estimate of loss”. Parties to a construction contract often used this position as their starting point for negotiating a liquidated damages clause (such as late completion).

The Supreme Court held that this test was outdated and introduced a new ‘legitimate interest test’:

“The true test is whether the impugned provision is a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation…. In the case of a straightforward damages clause, that interest will rarely extend beyond compensation for the breach…But compensation is not necessarily the only legitimate interest that the innocent party may have in the performance of the defaulter’s primary obligations.”

In ParkingEye it was found that the £85 fine did engage the penalty rule, but it was necessary in protecting the parking company’s legitimate interest in not allowing the car park to be filled with overstayers and maintaining a steady stream of new users to use the car park. So to be enforceable, a liquidated damages clause does not necessarily have to be a genuine pre-estimate of loss, although if it is one, it is likely to be enforceable.

The impact on the construction industry is yet to be fully realised but on the employer side it seems to give greater scope for arguing that their ‘legitimate interests’ in performance of the contract justifies the sums stipulated by way of liquidated damages. In contrast it may make it harder for contractors to argue that the liquidated damages clause constitutes a penalty even where the other party has not suffered a similar level of loss.

It appears that once the liquidated damages have been agreed and the contract signed, no matter how many times you ask the referee for a penalty you’re unlikely to get one.

The content of this article is for general information only. For further information regarding liquidated damages, please contact Ruth Sunaway. Law covered as at July 2016.

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