It was never a penalty!
The law has been clear: a clause in a contract imposing a penalty for breach of contract was unenforceable. What was completely unclear was (1) what amounted to penalty and (2) whether the rule applied beyond the payment of money following a breach of contract. For many years the accepted formulation was that if contract term provided for a payment which was "more than a genuine pre-estimate of loss" it would be an unenforceable penalty; otherwise it was a legitimate "liquidated damages" clause and not a penalty. In more recent years more complex cases have tested the rule, involving more than a straightforward payment for non-performance. the trend seemed to suggest that any clause whose effect was intended to be deterrence rather than compensation was potentially vulnerable to attack as a penalty.
In a judgment today (4 November 2015) these developments of the law on invalid
penalty clauses has been rolled back by the Supreme Court. It gave a combined judgment on two cases that could hardly be more different. Cavendish Square Holding v El Makdessi concerned "bad leaver" type clauses under which Mr El Makdessi, who had sold shares in a company, stood to lose the remaining instalments of the price and to be forced to sell his remaining shares cheap — the last limb alone would cost him $44m — because he had breached non-compete covenants. ParkingEye v Beavis was about an £85 penalty charge for overstaying in a retail car park.
In both cases the Supreme Court said the clauses were not penalties and were valid. The test for a penalty is now
"whether the sum or remedy stipulated as a consequence of a breach of
contract is exorbitant or unconscionable when regard is had to the innocent
party’s interest in the performance of the contract", which will allow far
more aggressive terms than some of the cases suggested. Deterrents are allowed, so long as they are not exorbitant or unconscionable, and there is no longer any necessary relationship with the damages that might be awarded by the courts for the breach. Contract writers are likely to become bolder in specifying remedies for breach.
Most “bad leaver” clauses
are now probably safe, though still subject to possible equitable relief from forfeiture if the party in breach can provide recompense by other means.
The £85 parking overstay charge was also held not to be an unreasonable term under the Unfair Terms in Consumer Contracts
Regulations 1999 (now Part 2 of the Consumer Rights Act 2015).
The Supreme Court did close one loophole: in deciding whether the clause is a remedy for a breach of contract, the courts will look at the substance of the obligations and not just at how they are expressed. Writing the contract so that there is no breach, but just a conditional obligation, will not get round the rule on penalties if the substance is that one is the primary obligation and the payment is a secondary compensation: so if instead of saying "you must supply the goods; if you do not supply the goods you will pay me £1m" you say "you can either supply the goods or pay me £1m", the court can still decide that the supply of the goods is the primary obligation and the payment is a penalty for breach of it.
The case is a victory for traditional freedom of contract and for certainty, at the expense of the introduction of concepts of fairness, proportionality and the protection of the weaker party into contract law.
Courts clash on jurisdiction over employees
It will come as a great surprise to many international employers that their US stock option plans are subject to the exclusive jurisdiction of European courts, as the plans apply to employees in Europe.
Many American companies offer stock option plans or other share incentives on a global basis, with employees having conditional rights to receive stock in the US holding company, or stock issued by a vehicle created for the purpose in the USA. The stock option plan will be established in a state of the USA and subject to its laws, and may or may not be tailored through sub-plans to meet tax requirements in other countries, such as the Enterprise Management Incentive Scheme in the UK.
Rights are granted under a contract direct between the American entity and the employee.
The Brussels Regulation (recast) governs the jurisdiction of all courts in the EU to hear cases, and says that an employer may bring proceedings only in the courts of the Member State in which the employee is domiciled. At first glance, the stock plan is not an "individual contract of employment" and the US entity is not the employer, so the special rules for contracts of employment in would not apply. As an English lawyer I have no difficulty with the concept of a separate contract with a third party dealing with stock options or incentives, and I would not consider it to be a contract of employment, or the incentive provider to be an employer. Indeed, in English law it has been held that a share option is not a term of the contract of employment: Micklefield v SAC Technology Ltd [1990] 1 W.L.R. 1002.
But Samengo-Turner v J & H Marsh & McLennan (Services) Ltd held that words used in EU legislation must be given an autonomous (European) meaning so that each Member State will apply it consistently and not interpret it in accordance with its own national law. The terms of the Brussels Regulation are essentially an employment protection measure, to stop employees being sued anywhere other than than their own home jurisdiction, and the English courts would give effect to that: not only by including any contract relating to employment as an "individual contract of employment" and the benefits provider as an employer, but also by granting an anti-suit injunction preventing the foreign company from taking proceedings in its own country.
In the recent case Petter v EMC Europe Ltd the English Court of Appeal became engaged in an unseemly scramble to establish jurisdiction either in England or in Massachusetts, with both courts being asked to grant injunctions preventing a party from continuing proceedings in the other place. Courts of different countries usually try to respect each other and not fight over jurisdiction, but in this case the Court of Appeal decided it had to grant an injunction effectively overturning the decision of the Massachusetts court, in order to protect the employment rights of UK employees.
A fight over the choice of court is not the end of the matter: an English court will still apply foreign law if that is the law chosen in the contract: the Rome I Regulation on the law applicable to contractual obligations allows the parties to choose the applicable law, even for a contract of employment, and an English court can apply foreign law if presented with evidence of what the foreign law is. However, this is subject to the application of mandatory rules of local law. Whilst the courts of England and Massachusetts should theoretically apply the same laws in reaching their decision, a court in England is likely to give far greater weight to English employment rules such as the duty of trust and confidence between employer and employee, principles of English law banning contractual penalties and granting relief from forfeiture of assets, restrictions on deductions from pay and the requirements for non-compete restrictions not to be unreasonable restrains of trade. The legal environment in the UK is far more friendly to the employee than in the USA, so employees may be very keen indeed to have any litigation heard here.
Directors' responsibilities in sharp relief, and a piercing of the veil of limited liability?
There may be nothing new in the idea that a nominee director must exercise independent judgement and act in the interests of his own particular company, rather than the interests of a parent company or the person appointing him, but Central Bank of Ecuador v Conticorp SA provides an eye-watering illustration to make nominee directors sit up and think!
A Mr Taylor, acting as nominee of a banking group, was the sole director of a Bahamas company. He acted only on the instructions of the banking group, and was paid the princely sum of $2,500 a year for acting as director. On instructions, he signed away a portfolio of assets worth $190m in a transaction at an undervalue. He made no enquiries as to the commercial benefit to his company of the transaction, and did not exercise any independent judgement. Because of that, he was fixed with the knowledge of the nature of the transaction of those instructing him. He was found personally liable for the whole $190m, plus interest that took the claim over $1/2billion.
That can easily happen when someone takes the office of director without taking seriously the attached responsibilities. Perhaps more interesting from a legal perspective, and more worrying for corporate groups, is that the court also found that other group companies, and individuals in them, were also liable for the full amount due to their "dishonest assistance" of a breach of fiduciary duty. That potentially gives a claimant a much wider range of defendants to aim at, and could effectively avoid the limited liability of the company. It is not only the deluded nominee director who is at risk, but also those who give him instructions and devise the company's transactions. The other people involved could could not honestly have considered the transactions to be in the company’s interests, in the light of what they knew, so they were liable for dishonest assistance.
Turning a blind eye can be enough to establish liability for dishonest assistance: “Dishonest assistance requires a dishonest state of mind on the part of the person who assists in a breach of trust. Such a state of mind may consist in knowledge that the transaction is one in which he cannot honestly participate (for example, a misappropriation of other people’s money), or it may consist in suspicion combined with a conscious decision not to make inquiries which might result in knowledge..." (Barlow Clowes International Ltd v Eurotrust International Ltd).
No-one should ever act as a "nominee" director, in the sense of blindly acting on the instructions of someone else; but nor should anyone assume that they can safely let such arrangements go ahead when it is plain that there is a breach of duty, or plain enough to require further investigation.
A trap for administrators and a workload for the FCA
Consumer credit businesses used to be licensed by the OFT, in a fairly relaxed licensing regime. It included not only consumer credit lenders, but also businesses with a tangential involvement in credit such as credit brokers, debt collectors and debt advisers. Credit brokers include most businesses who introduce consumers to credit providers, such as motor, furniture and electrical retailers. Many large businesses held consumer credit licences for minor activities outside of their main businesses, such as employee loan schemes or other employee benefits.
The Financial Conduct Authority has now taken over regulation of consumer credit, with all the complexity of the financial services regime. Consumer credit businesses have become "authorised persons" (including those who have the transitional "interim permission"). That has many consequences, some of them possibly unforeseen. One of them is the application of the FSMA insolvency legislation to all consumer credit businesses.
A possible major trap is that an appointment of an administrator by the directors of a consumer credit authorised business, or of one that should be authorised, needs the prior consent of the FCA (section 362A FSMA 2000). The directors must obtain the consent of the FCA before filing a Notice of Intention to Appoint Administrators, or if there is no qualifying floating charge holder and therefore no need to file such a notice, the consent must be filed at the same time as the Notice of Appointment of Administrators. Failure to obtain the FCA’s consent renders the administrator's appointment invalid; but the case of Peter Lloyd Bootes and others v Ceart Risk Services Ltd holds that this is a curable defect, so the appointment will take effect when the consent is obtained and filed.
If there is a qualifying floating charge holder, and it makes the appointment, no prior consent of the FCA is required. But all documents in relation to the administration issued to creditors must also be sent to the FCA, and similar requirements apply to other forms of insolvency.
This is yet another thing for insolvency practitioners to look out for before appointment, and a potential source of uncertainty in the validity of appointments. A search of the FCA register should probably be routine (and the separate specialist registers, including the consumer credit register), but even that is not complete protection: if the business should have been authorised, for instance because it introduced consumers to credit providers, the FCA's consent is still needed. Whether the FCA will give timely consents in respect of firms it has never heard of, or precautionary applications for consent, remains to be seen.
First impression of the new free access to UK company data
The new Companies House search facility, giving free access to information on UK companies and copies of filed documents, has been launched in beta here.
My first impression is that it's excellent - immediate one-click access to documents, a huge improvement on the previous elaborate process of selecting, paying for and downloading documents through the public Webcheck facility and the subscription services used by business customers.
The only downside I can see is that information is now so easily accessible that I'm sure there will be an increase in abuse. There appears to be no attempt to prevent automated services harvesting information, which is now all free of charge, which could be used to assist in identity fraud, to identify targets for spam, or to put together more sophisticated abuses. the information was all there before, but was only available if you knew you wanted it and were prepared to pay your quid per document.
Not worth the paper it isn't written on?
A recent High Court case is the latest reminder that even where the parties intend to enter into a formal written contract, they can become bound by the contract even before it is signed.
Most kinds of contract do not need any particular formality, such as written terms or a signature (property contracts being a notable exception). Written terms can be accepted orally. Contract terms can be accepted by conduct, even where the written terms make it clear that a formal signature was expected, and even where there are remaining terms that have not been agreed.
In A v B the buyer of a large quantity of cotton did not sign the purchase contracts, but did initiate the price fixing mechanism under the contract terms. The court held that this was unequivocal acceptance of the contract terms, so the buyer was bound by the contract. The seller was awarded over US$7m.
This is not new: if the parties work under the terms of a document, even a draft document, the court is likely to conclude that they intended those terms to be binding. Similar cases include RTS Flexible Systems Ltd v Molkerei Alois Muller Gmbh & Company KG (UK Production) in the Supreme Court in 2010, and it was held long ago that the partnership deed for a solicitors' firm became binding even though it was never formally executed.
Once commercial parties start to work together, the court will be very reluctant to find that there is no contractual relationship. The question then is what the agreed terms are. the most obvious source is the latest draft of the proposed written contract. that seems obvious, if all the terms were in fact agreed; but what if one party was holding out for something they regarded as important, which the other side clearly had not agreed? In RTS v Muller the Supreme Court said "an objective appraisal of their words and conduct may lead to the conclusion that they did not intend agreement of such terms to be a pre-condition to a concluded and legally binding agreement." So it is bad luck, or carelessness, on the part of the person arguing for the extra condition.
The same applies to an agreement that is expressly "subject to contract". If the parties start to work to the terms, the court is likely to say that the "subject to contract" position has been waived.
There would be no contract if all the "essential" terms were not agreed, but what is "essential" is just the legal minimum to create a binding contract. The law does not require all commercially-sensible terms to have been agreed - just price and quantity may be enough.
These cases are over the negotiation of bespoke terms, but they are related to the "battles of the forms" where both sides try to impose their standard terms - usually the buyer is assumed to have accepted the seller's terms by accepting delivery of the goods.
How should you protect yourself? If you must start work on a project before the formal contract is signed, it is best to have an interim agreement (often called a letter of intent) that sets out the terms for the immediate work, and what will happen if the parties fail to reach agreement on the main contract. An agreement to agree is generally unenforceable, so the interim agreement should include terms to unwind the relationship and ensure that no-one loses out unfairly if the terms do not get agreed.
