Penalty clauses in commercial agreements: El Makdessi v Cavendish Square Holdings

By Rebecca Gardner and Zachary Brown

It is common for parties to commercial agreements to agree mechanisms for resolving breaches of their agreement without having to resort to legal proceedings. Typically this is done by incorporating provisions, such as forfeiture or compulsory buy-back clauses, into a contract, which are activated upon one party’s breach of its terms.

In such a situation, it is important for the parties to ensure that such provisions could not be characterised as penalties so as to render them unenforceable. This issue was considered in the case of El Makdessi v Cavendish Square Holdings BV and another *2013+ EWCA Civ 1539, where the Court of Appeal was asked to review an earlier decision by the High Court on the question of whether clauses in a share purchase agreement (SPA), which were activated in response to the seller’s breach of restrictive covenant, constituted unenforceable penalties.

It is a long-established rule of law that a clause that is deemed to be a penalty will be unenforceable. In determining whether a clause is a penalty, the courts often use liquidated damages clauses (which are enforceable) as a point of comparison…

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