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Supreme Court Ruling on Penalties: A Genuinely Commercial Approach

The Supreme Court has clarified and restated the scope of the English law rule against penalties. This important decision will have a far-reaching impact on commercial parties' assessment of whether contract provisions dealing with the consequences of breach will be regarded as unenforceable penalties. In Cavendish Square Holdings BV v El Makdessi, the Supreme Court has replaced familiar formulations of the rule against penalties with a more flexible test based on whether the clause in question imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party. The decision also confirms the courts' reluctance to use the rule against penalties to interfere with parties' freedom of contract, especially where they are sophisticated commercial parties.

While the new focus on the innocent party's legitimate interest and the proportionality of the consequences imposed on breach is welcome, it remains to be seen how the courts will apply this in practice.

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