Aftershocks of commercial contract changes

Rarely do the courts produce a seismic shift in the laws relating to commercial contracts - more often the law develops gradually. The following recent cases from 2016 are good examples of small tremors in the wake of tectonic shifts on three issues affecting commercial contracts.

Penalty clauses

The change to our understanding of the enforceability of penalty clauses in Cavendish Square Holding BV v Talal El Makdessi; ParkingEye Limited v Beavis [2015] UKSC 67 was certainly a major tremor.

In Cavendish Square, the Supreme Court instituted a new standard to establish whether penalties are unenforceable. This replaced Lord Dunedin's tests in Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79 (which differentiated between clauses that are a genuine pre-estimate of loss and penalties) with the question: 'Is the impugned provision 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 Edgeworth Capital (Luxembourg) SARL and Aabar Block SARL v Ramblas Investments BV [2016] EWCA Civ 412, a borrower refused to pay an arrangement fee to a lender on the basis that the fee was a penalty. The payment of the fee was deferred well beyond the norm, such that it was payable only on 'the repayment of the loan... or, if earlier, the date on which any such... repayment falls to be made pursuant to the [agreement]'.
The borrower had defaulted and the lender had given notice to accelerate the loan.

The court held that the fee was not a penalty but was simply part of the consideration due to the lender for providing part of the finance.
It had nothing to do with damages for breach of contract and was payable on the happening of a specified event, and did not fall foul of the rules against penalties.

In Brown's Bay Resort Ltd v Pozzoni [2016] UKPC 10, the Privy Council considered whether a penalty clause excluded remedies which a court might otherwise impose. The appellants had granted a two-year lease to the respondent which contained a clause stating that failure to respect every aspect of the lease could result in an 'interruption' upon which the responsible party would pay a penalty fee of US$4,000 and any expenses of either party were to be paid
before the contract was terminated.

The appellant argued that the clause was both a liquidated damages clause and a restriction on the damages which the respondent could recover to US$4,000. The Privy Court held that the clause did not provide a substitute for common law damages. It did not refer to damages, liquidated damage, or the provision of a sum in lieu of damages. It referred to a penalty fee, which was a contractual charge or fee to be paid if the contract was interrupted, and which was itself not unconscionable as it did not fail the Cavendish Square test.

Interpretation of contracts

Our understanding of how contracts are to be interpreted has been subject to many
aftershocks since the big quake of 1997 in Investors Compensation Scheme v West Bromwich Building Society [1997] UKHL 28, particularly in Rainy Sky SA v Kookmin Bank [2011] UKSC 50.

One of the principal issues in the Investors Compensation Scheme case was whether, when determining the meaning of a contract, the
law treats as inadmissible the pre-contract negotiations between the parties. Lord Hoffmann was blistering in his dismantling of the arguments in favour of the courts being forced to rake over the coals of what had been discussed before the contract was entered. But what about the admissibility of deletions from the contract agreed? Are there any circumstances in which what the parties actively considered but did not agree can be considered by the court?

The Court of Appeal in Narandas-Girdhar and another v Bradstock [2016] EWCA Civ 88 held that, in the face of such ambiguity, it was legitimate to have regard to deleted language from a proposed draft of a contract. The appellant was seeking to set aside an individual voluntary arrangement on the grounds that the parties had agreed to remove a condition precedent from a standard document that had been present in the original proposals.

The Court of Appeal confirmed the principle that 'if the fact of deletion shows what it is the parties agreed that they did not agree and there is ambiguity in the words that remain, then the deleted provision may be an aid to construction, albeit one that must be used with care'.

Implied terms

Our continuing understanding of how and when terms may be implied into contracts is a more typical example of the gentle development of the common law.

Further levelling of the ground - or, in the words of Richard Hayes (see SJ 159/47), 'a return to orthodoxy' - on the issue of when terms may be implied occurred in Marks and Spencer plc v BNP Paribas Securities Services Trust Company (Jersey) Ltd and another [2015] UKSC 72.

The court tactfully dismissed Lord Hoffmann's observations in Attorney General of Belize and others v Belize Telecom Ltd [2009] UKPC 10 'as a characteristically inspired discussion rather than authoritative guidance on the law of implied terms'. In doing so, it rejected the idea that the rules on implying terms had been relaxed in AG Belize and reformulated the test. Any proposed implied term must be, the Supreme Court clarified, both capable of clear expression and not contradictory of any express term of the contract, and either necessary to give business efficacy to the contract or so obvious that 'it goes without saying' (the officious bystander test).Hence, in Rosenblatt v Man Oil Group SA, a firm of solicitors had agreed with a client a fixed fee, subject always to a right to 'revisit the fees' on any of the assumptions proving incorrect. When some of the assumptions failed, it could not charge on an hourly basis without notifying the client that it intended to revisit the fees and obtaining the client's agreement to the actual change. There was no implied right for the firm in 'revisiting the fees', the court held, having considered Marks and Spencer plc, automatically to revert to charging an hourly rate. Indeed, the court reiterated the 'either/or' aspect of the test: a term should not be implied in the absence of obviousness unless it was necessary to give a contract business efficacy.

In Hockin and others v Royal Bank of Scotland and National Westminster Bank plc [2016] EWHC 925, the High Court considered whether there were reasonable grounds to apply into a facility agreement a duty of good faith and, in particular, whether the discretion for the bank to assign its rights should be exercised subject to such a duty.

Mrs Justice Asplin considered Lord Neuberger's judgment in Marks and Spencer plc. Her thought process is illuminating. Given that the facility agreement was a standard commercial contract, she considered that the threshold for the implication of a term into such a commercial contract was high: 'Is it necessary to give it business efficacy or, to put the matter another way, is the term so obvious that it goes without saying or does the contract lack commercial or practical coherence without it?' She noted that any such implication is not dependent upon the intention of the actual parties to the contract
and is concerned with what notional reasonable people in the position of the parties at the
time would have agreed.

She noted that any implication must also
be sensitive to the relevant factual matrix. Interestingly, she determined that it was not possible for the court, on the basis of the scanty evidence before it, to strike out that part of the claim which sought such an implied term:
'To do so would be to come to such a conclusion in almost a factual vacuum.' Hence it would appear that a defendant to a claim for an implied term must in seeking a strike out bring sufficient evidence before the court in order to achieve
its aim.

Thus the law constantly settles and levels the ground in the aftermath of seismic changes and will continue to do so.

Mark Lucas is a partner at Barlow Robbins @barlowrobbins www.barlowrobbins.com

Copyright & permissions