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A significant automatic payment for breach of a contract not necessarily unenforceable

Parties seeking to include a contractual clause imposing a significant, pre-determined, fixed financial penalty if the other side breaches the contract, may find it is enforceable – even if they don’t suffer any financial loss from the breach, provided the clause has a valid social and/or commercial justification.

A motorist overstayed his two-hour free period in a car park. There was a ‘liquidated damages’ clause in his contract with the car park operator stating he was automatically liable to pay a charge of £85 if he stayed beyond two hours.

The aim of liquidated damages clauses is to avoid a protracted and expensive dispute about the amount of compensation payable for the breach. However, liquidated damage clauses are only valid if the fixed sum is not ‘extravagant and unconscionable’. If it is, the courts will not enforce it.

Traditionally, the courts have ruled that the fixed sum must be a genuine pre-estimate of the financial loss the other party will suffer as a result of the breach – ie, a genuine estimate of the amount of damages that would have been awarded had the other party had gone to court. If it is a deterrent to discourage breaches of the contract, it is a ‘penalty’ and unenforceable.

The motorist in this case argued the clause was a penalty because it was not a genuine pre-estimate of the loss to the car park operator caused by his breach. Its only purpose was to act as a deterrent to stop motorists from breaching the two-hour rule, and a sum imposed simply to deter breach could only ever be a penalty.

The car park operator said that the test was simply whether the sum payable was ‘extravagant and unconscionable’. There was no blanket rule that liquidated damages clauses providing for payment of a sum in excess of the other party’s financial losses were unenforceable. Payments set high simply in order to deter breaches would be enforceable if, in the circumstances, they were neither extravagant nor unconscionable.

The Court of Appeal found that the £85 looked like a penalty because it was payable even though there was no specific financial loss to the operator if a motorist overstayed the two hours. However, it decided the charge was commercially justifiable as it was ‘neither improper in its purpose nor manifestly excessive in its amount’, and was therefore enforceable.

It highlighted the following:

• While there was no direct loss to the operator if motorists overstayed the two-hour period, there would be indirect losses. Free car parking for a limited period was an obvious benefit to consumers and businesses which could only be achieved by penalising those who abused it by overstaying. The car park operator therefore had a valid commercial interest in stopping motorists from overstaying.
• It had to be economic to enforce any charge. A sum of less than £85 would not be worth chasing.
• Therefore, while the £85 charge was simply a deterrent which far exceeded the actual financial loss to the car park operator, it was not extravagant and unconscionable.

The Court took into account the social context in which the charge was imposed, deciding there was a commercial justification for deterring motorists from breaching the two-hour rule. It also said that, even though the motorist was a consumer, without access to sophisticated legal advice, there was no significant imbalance between his rights and obligations under the contract, and those of the car park operator. Therefore, consumer protection laws did not protect the motorist.

Recommendations

• Parties who want to include a clause in a contract imposing a significant, pre-determined, fixed financial penalty in the event of a breach, may find the clause is enforceable, even if they haven’t suffered any financial loss, provided the clause has a valid social and/or commercial justification meaning it is neither extravagant nor unconscionable.
Case ref: ParkingEye v Beavis [2015] EWCA Civ 402

19 June 2015

Alex Cook initially trained as a Barrister (non-practicing) before cross-qualifying as a specialist commercial and property litigation solicitor. Prior to becoming joint owner of Helix Law in 2013, he was Head of Litigation and one of the youngest partners in the region in a large firm based in Eastbourne. Comfortable and experienced litigating against large international City firms, he has successfully resolved complex commercial and property disputes for clients ranging from large international businesses and property investors to individual business people. Alex is an accredited commercial mediator  and he is increasingly asked to advise on contracts, risk, dispute avoidance and exit strategies. He also continues to develop and innovate our products, services and funding arrangements with the aim of making specialist litigation services more transparent and accessible.

This article is written to raise awareness of the issues it discusses and it may not be updated after it is first written, even if the law changes. It is not intended to be legal advice and cannot be relied on as such. Helix Law is not responsible or liable for any action taken or not taken as a result of  this article. If you think the matters set out affect you and you wish to apply them to your particular circumstances then we are happy to give you free initial telephone advice. 

Contact Helix Law on 01273 761 990 or email: [email protected]