Mr Beavis' case was joined with another case in which a share sale agreement between a Mr Makdessi and Cavendish Square Holdings BV provided that Mr Makdessi could be deprived of some deferred consideration and be required to transfer his remaining shares to Cavendish at a price that excluded goodwill if he breached non-compete restrictions in the share sale agreement. Mr Makdessi's argument that such a clause was penal also failed.
The traditional test of whether a clause should be held to be unenforceable as a penalty was whether the clause that took effect on a breach of contract was a genuine pre-estimate of loss and therefore compensatory or whether it was aimed at deterring the breach of contract and therefore penal. The Supreme Court held that the true test is whether the provision imposes a detriment which is out of all proportion to any legitimate interest of the innocent party in the enforcement of the other party's obligation. This shifts the focus from an analysis of whether the clause is aimed at compensation or deterrence to one of proportionality. The new test is therefore firstly to consider what legitimate business interest is served and protected by the clause and secondly whether the effect of the clause is extravagant, exorbitant or unconscionable.
On a practical level a clause in a settlement agreement that seeks to recover monies in the event of a breach no longer has to be a genuine pre-estimate of loss. Carefully drafted commercially justifiable claw back provisions in settlement agreements will not be penalty clauses. The decision also makes it harder to argue that a substantial golden parachute clause, carefully drafted claw back arrangements in bonus schemes or deferred bonuses linked to compliance with post termination restrictions are unenforceable penalty clauses.
If you would like to discuss this decision and its impact on your business please do not hesitate to contact me or another member of the team.