Does the rule against penalty clauses apply to repayment obligations?

Holyoake and another v Candy and others [2017] EWHC 3397 (Ch)

The background

Mr Holyoake, a property developer, sought to purchase Grosvenor Gardens House through a company, Hotblack Holding Limited (HHL).  To finance the purchase, Mr Holyoake agreed an unsecured personal loan with Christian Candy for £12,000,000.

Mr Holyoake defaulted on the loan and the property was sold without having been redeveloped to repay the loan.  Part of the resulting claim was that the loan contained wrongful penalty clauses:

• the borrower was required to pay a redemption amount in the event of an early repayment (which included interest for the two year period of the loan, for a total of £17,740,000);
• the escrow deed provided that if the borrower did not repay the debt and complete relevant documents, a new debt of £17,740,000 would arise;
• the borrower was required to pay certain extension fees under loan extension agreements.

The decision

The Court concluded that the clauses were not penalties.  The clauses were not triggered by a breach of contract and so the penalty rule was not engaged (applying Cavendish v El Makdessi and Parking Eye v Beavis [2015] UKSC 67). 

The redemption clause was triggered by the borrower exercising the option to repay the loan early, not a breach of contract.  The requirement to pay the interest which would have accrued over the term of the loan was a primary obligation.

Similarly, the escrow deed clause operated on a failure of a condition, rather than a breach of contract and was therefore not caught by the penalty rule.  The way the clause was drafted gave the effect that the borrower had agreed to pay £17,740,000 if he did not complete the relevant documents or refinance the loan. 

The extension fees were also construed as primary obligations, as they were payment for consideration ie an extension of time for repayment of the loan.

Why is this important?

This case demonstrates that it is possible to circumvent the penalty rule with careful drafting, for example, when a clause can be drafted as a primary obligation, which operates on a particular event or condition, as opposed to being triggered by a breach of contract.

The penalty rule only applies to a breach of contract, so if a clause is not triggered by a breach of contract the penalty rule is not engaged. 

Any practical tips?

Consider whether the consequences of a default can be drafted as primary obligations (eg obligations to pay or indemnities) that arise on particular events.  If the financial consequences do follow a breach, include appropriate wording to justify the imposition of those consequences (eg legitimate interests in performance, the benefits to both parties of certainty, etc).