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Archive for May, 2017

Liquidated damages: how much is too much?

30/05/2017 | Matthew Littlestone
When two parties enter into a commercial contract, they do so with the best intentions.  After all, neither party wants to spend time, energy and money involved in a dispute over the performance of

When two parties enter into a commercial contract, they do so with the best intentions.  After all, neither party wants to spend time, energy and money involved in a dispute over the performance of the contract.

However, back in the real world, parties will continue to enter into agreements and subsequently fail to comply with their contractual obligations.  In most cases, a breach of the contract will require the offending party to pay the innocent party damages for such breach.  But how much will the innocent party be entitled to in damages?

Generally speaking, the guilty party will pay damages as required under common law.  However, in order to avoid the difficulties that can arise in calculating how much this will be, and to provide a level of certainty, parties will often make provision in the contract for the level of damages to be awarded to the innocent party by including a liquidated damages clause.  A liquidated damages clause also has the advantage, for the guilty party, of limiting its liability where the stipulated sum is less than the actual loss.

So if a contract includes a liquidated damages clause, that is the end of the problem right? Well, not quite.

One of the defences to a claim for liquidated damages is that the clause is unenforceable on the basis that it is a penalty.  If a clause is considered by the Court to be a penalty, then it will not be enforced beyond the actual loss incurred by the innocent party.  But under what circumstances is a liquidated damages clause deemed a penalty?

For over a century, the leading case on this particular question was Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79 in which a liquidated damages clause was deemed to be a penalty if it is extravagant or unconscionable, with the predominant aim of deterring a party from breaching the contract, instead of compensating the innocent party by way of a genuine pre-estimate of loss.  In Dunlop, Lord Dunedin referred to the following four tests to help determine whether a clause is extravagant or unconscionable:

  • A clause may be penal if it is extravagant by comparison to the maximum possible loss arising from the breach.
  • A clause may be penal if the breach of contractconsists only of not paying a sum of money, and the amount stipulated as damages is greater than the sum that ought to have been paid (if assessed at common law).
  • A clause may be penal when a single lump sum is made payable by way of compensation, on the occurrence of one or more events, some of which may cause serious and others “trifling” damage.
  • A clause is not a penalty merely because a precise pre-estimation of loss is impossible.

It remains the case that determining whether a liquidated damages clause is a penalty or not will depend on many factors, including the wording of the clause itself and the circumstances at the time of making the contract (rather than the time of the breach).  The tests set out in Dunlop also remain relevant when considering straightforward liquidated damages clauses.

However, the Supreme Court, in Cavendish Square Holding BV v El Makdessi and ParkingEye Ltd v Beavis [2015] UKSC 67 stated that the real question is whether the clause is penal and not whether it is a genuine pre-estimate of loss.  It held that in considering whether a provision in a contract is a penalty:

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.  The innocent party can have no proper interest in simply punishing the defaulter.  His interest is in performance or some appropriate alternative to performance.”

As such, while the fact that the clause is not a genuine pre-estimate of loss may be relevant, it is necessary to consider other factors such as whether the innocent party has a commercial interest in the performance by the other party of its obligations under the contract.  Similarly, even if the clause seeks to protect a legitimate interest of the innocent party, it may still be a penalty if it is extravagant or unconscionable.

So what can be deemed to be a legitimate interest of a party?

At its simplest, it may be the case that a party’s legitimate interest is to receive compensation for breach of a contract.  However, there are more complex scenarios where compensation may not be the only legitimate interest.  Whether a clause is justified will depend upon the facts of the case.

For instance, in Cavendish, the relevant clause in question was in a share purchase agreement which provided that, if the sellers carried out certain activities which competed with the interests of the relevant company, the buyers could withhold any outstanding deferred consideration payments and exercise a call option over the sellers’ remaining shares.  The Supreme Court held that the buyers had a legitimate interest in the observance of the covenants which aimed to protect the goodwill of the business and the loyalty of the sellers was essential to preserve that goodwill.

In ParkingEye, the relevant clause imposed a charge for overstaying the free period of parking in a car park.  The Supreme Court held that although the claimant had not suffered any direct financial loss from the defendant overstaying the period of free parking, it had a commercial interest in the observance of the terms of its contract with the defendant which extended beyond the recovery of any loss (i.e. the management of the efficient use of parking space and the generation of income to run the scheme).

In light of these cases, when drafting a liquidated damages clause, it is worth bearing in mind that not only should you ensure that the figure in the clause can be justified as a genuine pre-estimate of loss but also that it is commercially justified.

This article should not be taken as definitive legal advice on any of the subjects covered. If you do require legal advice, please contact Rosenblatt as above.

Search Orders: Nugee goes Nuclear

04/05/2017 | Tom Spiller
On 3 February 2017, Mr Justice Nugee dismissed an application to set aside a search order that had been granted against non-parties in legal proceedings - the first time this has happened. The searc

On 3 February 2017, Mr Justice Nugee dismissed an application to set aside a search order that had been granted against non-parties in legal proceedings – the first time this has happened.

The search order has been described as one of the Court’s two “nuclear weapons” as its consequences are considered to be draconian and oppressive. (The other atomic device is the freezing order, which restricts a Respondent’s rights to deal with his or her own property.) Once granted, a search order required a Respondent to allow an Applicant’s solicitors to enter his or her premises or home to search for, copy and remove specified documents and information.

That this order has been made against a party who is not a defendant to a claim in the English courts makes this decision somewhat remarkable. It is also notable from the perspective of successful claimants hoping to obtain satisfaction from underhanded opponents.

Procedural and Factural Background

The underlying claim was brought by (1) Mr Albert John Martin Abela [“Mr Abela“], (2) Albert JM Abela SRL and (3) Albert JM Abela Catering and Interactive Services Limited [together, the “Claimants“]. Mr Abela was heir to a substantial catering business operating internationally.

In 2002, the Claimants purchased 40% of the shares of an Italian company, Gama Spa [“Gama“], for $14m. Two percent of Gama was owned by the defendant, Mr Ahmad Baadarani, a Lebanese businessman. At the time of the purchase, the Abela group owned the remaining 52% of the balance of Gama shares, while Mr Abela was Gama’s Chairman. The purchase agreement was governed by English law, with disputes arising from it subject to the non-exclusive jurisdiction of the Courts of England and Wales.

The Claimants alleged they were induced to purchase an interest in Gama as a result of fraud by Mr Baadarani and others, who concealed Gama’s true financial position from them.

Mr Abela alleged that, following his father’s death in 1998, he lapsed into depression and that, whilst depressed, and unknown to him, Mr Baadarani conducted the business of Gama so that its assets were substantially diminished. Mr Baadarani had significant interests of his own in Kazakhstan, and used a Kazakh subsidiary to divert Gama’s funds for his own benefit.

In 2009, the Claimants issued what became proceedings in the English courts. Initially, Mr Baadarani defended the claim and disagreed that the English courts had jurisdiction. This question reached the Supreme Court in December 2013. Mr Baadarani lost and was ordered to pay the Claimant’s costs of the appeal, which were substantial.

Mr Baadarani was similarly unsuccessful in defending the underlying claim. On 3 June 2015, after failing to comply with various orders made against him, Chief Master Marsh entered judgement in default against him, for a sum of just over $20m.

Having obtained judgement against Mr Baadarani, the Claimants sought to enforce it. This process proved to be lengthy, not helped by Mr Baadarani’s lack of co-operation and efforts to avoid his liabilities. On 19 June 2014, he was required to attend Court to provide information about his means to aid the enforcement process. During his cross-examination, it became clear that Mr Baadarani had failed to disclose numerous documents. This discovery began a long process of unsuccessful attempts to obtain full disclosure from him.

Eventually, the Claimants obtained a world-wide freezing order against Mr Baadarani and third party disclosure orders against an individual and company that had had dealings with him, being Mr Fakih and Leesdel Limited.

One of the documents disclosed by one of Mr Fakih and Leesdel Limited relating to Mr Baadarani’s possessions included a statement of assets, dated 17 April 2013, which Mr Baadarani had signed. The Claimants understood this had been provided to the National Bank of Kuwait in connection with the re-mortgage of a leasehold property in Hanover Gate Mansions, London.

This document proved to be forged: it has been created in 2015 but was back-dated to 2013, a discovery was made as a result of a separate third party disclosure order the Claimants had obtained from the National Bank of Kuwait.

Following this discovery, the Claimants applied for a search order against both Mr Fakhi and Leesdel Limited. The order was granted. Mr Fakih and Leedsel Limited applied to have it set aside. It was this application that gave rise to the decision of Mr Justice Nugee.

The “Nuclear” Decision

As stated above, search orders are considered to be a remedy of “nuclear” impact. In making such an order against a non-party to proceedings, the Judge was sending a clear signal as to how and when such an order could be used. The importance of the decision is underscored by the fact that this is the first Court decision in this area in at least twenty years.

Mr Fakih and Leesdel Limited’s lawyers argued that the wording of the Civil Procedure Act 1997 (the statute that gives the Court the power to grant search orders) made clear that this power could only be exercised in ongoing “proceedings”. They submitted that, as judgement had been given and the parties were now dealing with enforcement, it was too late to make a search order.

Mr Justice Nugee rejected this argument, and concluded that there was no need for such restrictive interpretation, nor did the authorities (some of which pre-dated the Civil Procedure Act) support that view. The word “proceedings” could include steps taken to enforce a judgement. He found there was no doubt that the Claimants were actively pursuing Mr Baadarani under the judgement, and hoped to obtain information via the search order to identify assets against which to execute that judgement.

In rejecting the application to set aside the search order, Mr Justice Nugee made it clear that he was taking a pragmatic approach.

He also rejected the proposition that a search order could not be granted against a person against whom the Applicant has no cause of action. All that was necessary was for the Respondent to have the relevant evidence in their possession and that there be good reason to grant an order so as to preserve that evidence.

Practical Lessons

In claims involving fraud, a dishonest opponent is often willing to use all manner of underhanded tactics at the pre-action stage, throughout proceedings, and during trial, even to the extent of lying under oath. Such behaviour is unlikely to end at the point at which a judgement is given.

Mr Justice Nugee’s decision strengthens the hand of successful claimants who are still grappling with an opponent after judgement, and shows that the Court will be willing to act in a pragmatic fashion against potential conspirators attempting to help a judgement debtor shield his assets from enforcement. Making search orders against non-parties may be a “nuclear” option, but that does not mean the Court is not willing to use it, if it is persuaded that it is just and fair to do so.

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