Commercial contracts 'that are as free as a bird

On 4 November 2015, the Supreme ?Court introduced a new and wholly different test for whether a clause is unenforceable as a penalty. The notion that a penalty is unenforceable unless it is a ‘genuine pre-estimate of the likely loss’ has fallen by ?the wayside. 

In Cavendish Square Holding BV v Talal El Makdessi; ParkingEye Limited v Beavis [2015] ?UKSC 67, the court looked at two quite different instances of penalties – a parking fine of £85 and ?a restrictive covenant, breach of which disentitled the seller from shares to part of the purchase price and required him to sell his remaining shares at a discounted price. Neither penalty was dismissed by the court, which instituted a new standard ?for unenforceable penalties: ‘[W]hether 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 the parking fine, the court recognised the car park operator’s legitimate interest in managing the efficient use of the car park and obtaining an income stream to meet its costs and make a profit. The charge was not out of proportion to that interest and so it was not penal. 

In the case of the restrictive covenant, the consequences of breach helped to achieve ?the buyer’s commercial objective in acquiring ?the business. 

The court’s strong message from the latter case ?is that in a negotiated contract between properly advised parties of comparable bargaining power, the strong initial presumption must be that the parties are the best judges of what is legitimate in a provision dealing with the consequences of breach.

What is really interesting about this is that ?the Supreme Court decided not to follow the Australian court’s example and extend the rules ?to all clauses in contracts. Hence the rule does not apply to primary obligations, but only to clauses that are an alternative to common law damages. 

One can therefore avoid the rule altogether with careful drafting – for example, by providing that a payment or contractual duty is conditional on performance and not liquidated damages in the event of breach. One must not underestimate ?the power of that construction. We will see its ?use become very common.

It would be wrong though to suggest that this ?will make it easier to determine whether a clause ?is an unenforceable penalty or not. It is not clear what ‘out of all proportion to any legitimate interest’ means. Future cases will have to shed further ?light. This judgment certainly gives parties more freedom from court interference and more freedom to structure contracts so that the parties’ intentions can be less easily challenged. It will be less easy for lawyers to unwind their clients’ rash agreements ?(in negotiations or in contracts) to be subject to some form of deterrent clause. It may lead to clarifying statements of intent in commercial contracts, of the type one sees usually only in restrictive covenants – that a particular clause is to protect a particular or general but identified interest and is agreed to be proportionate. Whatever the consequences, contracting parties now have more freedom to be bound by provisions that naturally occur to laymen as sensible and effective.

Assignment of receivables

More freedom is shortly to arise in respect of assignment of debts. In 2009, parliament enacted the longest-ever statute in the Corporation Tax ?Act 2009. It is shortly to bring into force one of the shortest regulations in the form of the Business Contract Terms (Restrictions on Assignment of Receivables) Regulations 2015. Brevity is welcome. So are these terms: they allow any creditor to assign receivables by rendering ineffective any term in a business-to-business contract for the supply of goods, services, or intangible assets, which prohibit, or restrict, any assignment of a receivable. Both parties must be acting in the ordinary course of their business, trade, or profession and, somewhat oddly, one must ?carry on business in the UK.

The regulations will not apply to such terms as they appear in financial services contracts, tenancy agreements, or contracts which create an interest in land. Nor will they apply to terms giving rise ?to a duty of confidence. 

The draft regulations had retrospective effect but the government has indicated that it will ensure only contracts concluded after enactment will be affected.

Modern slavery

Section 54 of the Modern Slavery Act 2015 came into force on 29 October 2015. It requires every organisation carrying on a business in the UK ?with a total annual turnover of £36m or more ?to produce a slavery and human trafficking statement for each financial year. That statement must contain the steps that the organisation has taken to prevent modern slavery in its supply chain and own business. The form of the statement is not prescribed but the guidance indicates that it may include a description of its structure, business, and supply chains; policies relating to slavery and trafficking; due diligence processes in relation to slavery and trafficking; key areas where there is a risk of slavery and trafficking taking place (and the steps it has taken to assess and manage that risk); and its effectiveness in ensuring that slavery and trafficking are not taking place in the business or supply chains, with such key performance indicators as it considers appropriate and training that is available to staff.

Businesses with a year end on or after ?31 March 2016 will be the first required to publish ?a statement covering their 2015/16 financial year.

What is most notable is that the new statement must be published on the organisation’s website with a link in a prominent place on its homepage. While failure to follow any injunction to comply ?is punishable by an unlimited fine (as well as the consequences of contempt of court), the real consequence for most businesses will be the spotlight this shines on the implementation ?of their ethics. Are the values that most larger businesses publicly claim backed up by policies that are effective in turning those values into actions? Pressure groups and stakeholders will read the section 54 statement, scrutinise the ?reality of what is claimed, and ask further questions. Many commercial contracts currently contain warranties and termination rights relating to slavery (as well as a range of other abuses) but by no means all. Expect such clauses to become as prevalent as those relating to bribery have since the Bribery Act 2010 came into force. 

Challenging unfair terms

On 27 November, the Department for Business, Innovation, and Skills (BIS) closed its consultation on grossly unfair payment terms and practices.

The Late Payments of Commercial Debts Regulations 2013 give trade bodies the power to challenge any grossly unfair terms and practices, but only in so far as they relate to the interest rate chargeable for late payment. BIS wants to extend those powers so that a representative body is free to challenge any grossly unfair terms or practices, and to do so on behalf of an individual business, ?a group of individual businesses, and members and non-members.

Examples of grossly unfair practices are long payment terms, demands for ‘contributions’ from suppliers (e.g. ‘pay to stay’ requests or ‘balance sheet bonuses’), clauses withholding or delaying payment, limitations on remedies (for example, the inability to use statutory demands and applications for winding up to help collect undisputed debts), and ‘pay when paid’ clauses. Legislation is a long way off, as is the first exercise of these powers, but it will be fascinating to ?see what clauses are challenged and how the courts respond. Suppliers to large industries ?(for example, large food retailers) or to large businesses with few competitors will relish the opportunity to challenge their customers’ buying power, especially if the law allows the challenge to be brought by proxies who need not prove the issue is a general issue.

Overall then, the law is giving more freedoms. On the one hand, the courts are reeling back from interference in contracts. Parliament, on the other hand, is using its powers to empower and protect those who are unable to bargain on a level playing field. These superficially contrary themes can only be to the good.

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